Emily Vogl, Frank Vogl
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Multiple Layers of Financial Regulatory Reforms Hold Back Economic Growth and Will Continue to Do So for Some Time
Washington D.C., September 6, 2011 — The cumulative impact of regulatory reforms now underway in the financial services industry is adding to the headwinds that the global economy faces at a time when economic growth – notably in the United States, Japan and in Western Europe – is already disappointingly weak, according to a major study by the Institute of International Finance (IIF), the leading global association of financial services firms.
Dr. Josef Ackermann, Chairman of the IIF Board of Directors, Chairman of the Management Board and the Group Executive Committee, Deutsche Bank AG, said, “This study needs to be seen in the context of the IIF’s strong support of key financial reform measures, such as the new Basel III capital requirements and their implementation timetable. In addition, the Institute has encouraged improvements in important industry practices, such as risk management, compensation and governance.”
Dr. Ackermann stressed that, “Against this background and in light of the IIF’s projections, it is critically important that the macro-economic impact of additional regulatory measures under discussion, as well as the impact of approaches to implement measures already taken, be a major consideration for governments and regulatory authorities.”
Mr. Peter Sands, Chairman of the IIF Special Committee on Effective Regulation, Group Chief Executive, Standard Chartered PLC, stated, “Better financial regulation is necessary and much of the current and proposed regulatory agenda is sensible. Indeed, a huge amount has changed already: increased capital levels, overhauled risk management and governance, and significantly reinforced liquidity management. However, the sheer scale and pace of reform brings its own risks. The economic costs of the transition to a new financial regulatory regime are uncertain, but significant, and as the IIF study shows, there is an acute danger that the pursuit of financial stability imposes too great a cost on economic growth and job creation at a fragile time for the world economy.”
The IIF, which represents over 440 leading financial institutions across the world, today published “The Cumulative Impact on the Global Economy of Changes in the Financial Regulatory Framework.” The study includes a series of scenarios and a considerable number of variables in determining the impact of the sum of financial regulatory measures. It estimated that all the measures combined will significantly boost the capital needs of banks relative to a base scenario – an additional capital requirement for banks in the leading industrial economies of $1.3 trillion by 2015, according to its central scenario, and this could push bank lending rates up by over 3 ½ percentage points on average for the next five years. The result could be 3.2 percent lower output by 2015 in these economies than would otherwise be the case. This would lead to about 7.5 million fewer jobs being created. The negative economic effects would likely fade in 2016 and beyond but, the maximum drag of reform on the global economy would be at a time when it is apparently least well placed to handle it.
The IIF estimates that long-term net debt funding requirements for all banks are likely to be substantial, at $816 billion through 2015 and $1.5 trillion through 2020, of which about $670 billion is accounted for by banks in the Euro Area.
IIF Managing Director Charles Dallara said, “The necessity of financial sector reform is unquestionable. However, it is essential to find the right balance in this process, especially at a time of pronounced economic weakness. We have to recognize that the economic costs of transitioning to a new financial regulatory regime have been significant and further substantial costs are likely. Certainly, deleveraging was essential following the bubble period leading up to this crisis, but a key question that looms now is whether further deleveraging—resulting from a myriad of factors—is productive at this time.”
He added, “It is plausible that the short-term effects of banking reform measures are thwarting much of the monetary policy easing. Aggregate bank credit to the private sector in the US, Euro Area and UK fell by 0.5% in the year to June 2011 and we believe this serves as an indication of what may be ahead if the multiple layers of bank reform are pursued. For example, lending to small and medium-sized enterprises in the UK contracted by 4.4 percent from May 2010 – May 2011, while lending to US households contracted by 7 percent from June 2010- June 2011.”
Mr. Dallara said, “The economic impact that we are projecting will be concentrated on the major mature economies. However, it is likely that emerging countries will also experience negative economic effects of both international and local regulatory reforms. Given the substantial level of exports, for example, from emerging economies to mature economies any economic contraction experienced in the former group of countries will impact the latter group. Growth in emerging markets could well be curbed by any potential reduction in financial flows from mature economies induced by more stringent regulation.”
IIF Chief Economist and Deputy Managing Director Philip Suttle, who directed the new study, noted that, over the last year since the IIF’s Interim Report, “We have made efforts to improve our methodology, and have benefitted from helpful comments and suggestions from analysts in both the private and official sectors. We have been able to take into account a much more comprehensive range of regulatory decisions and plans, both at the multilateral level based on Basel III and actions by the Financial Stability Board, including proposed surcharges on very large bank groups, as well as by national authorities.”
He said, “We have run three scenarios for a wider range of jurisdictions than before and we are now also using the NiGEM model of the UK’s National Institute of Economic and Social Research to map from the implied increase in bank lending rates, and reduced credit supply, to the private sector to broader GDP effects. This model has the major advantage of picking up far more behavioral interaction than our previous approach. It also allows is to indentify global interactions.”
Mr. Suttle explained that, “In addition to our core reform scenario, we also run two variants. The first is a benign funding scenario, where we assume very elastic funding markets for banks – somewhat reminiscent of global conditions before mid-2007. The second is an accelerated adjustment scenario, where we assume that changes which are programmed to occur by 2018-19 happen far more quickly. The most likely driver of such rapid adjustment would be market pressures encouraged, in some cases, by policy statements. The dispersion of the results in these scenarios is a reminder that there is no “right” and “wrong” answer to the question of what the near-to-intermediate costs of banking regulatory reform will be. The central tendency of our estimates, however, is that the impact will be a material one.”
Computing these three variants across five countries provided a total of 15 scenarios. Focusing on a single variable from each of these scenarios, it was possible to plot a histogram, showing the distribution of that variable across the different scenarios. In the case of the level of real GDP, for example, the distribution in the IIF’s work shows an average GDP decline of 2.6% by 2015 (Chart 1). This approach of averaging the results of studies using different methodologies across an array of economies was one adopted by the Macroeconomic Working Group of the FSB/BCBS, and the histogram approach thus provides another way of comparing (and contrasting) the results of IIF work with that of the official sector (for example, Chart II).
The research found that the impact of regulatory reforms will vary significantly in different leading advanced economies, depending in part on the extent to which these economies depend on bank finance and the scale of capital raising to be undertaken in these countries. For example, by 2015 the level of real GDP could be 2.7% less than what would otherwise be the case for the United States, while the changes are estimated at Euro-Area -3%, Japan -4%, UK -5.5% and in Switzerland -3.7%.
Percentage points; overall average is GDP-weighted; all scenarios expressed as differences from the base scenario
Click to enlarge
Emily Vogl, Frank Vogl