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Universally challenged – G20 focus on global economic solution

Illustration: David Lyttleton

Eighty years ago a banking crisis on Wall Street triggered a
sequence of events that led to the Great Depression and years of subsequent
misery.

Eight decades later, it seems all but certain the shock that hit world
markets a year ago will now not lead to a similar degree of financial and
economic Armageddon.

For once, world leaders can take some credit. Given the nature of
politicians, it was no surprise that the heads of state that gathered first at
the G20 Summit in Pittsburgh in late September and the finance ministers,
central bankers, academics and businesspeople that convened in Istanbul in
October for the International Monetary Fund meetings, made sure their voters
knew that. As Gordon Brown said in a communiqué from the G20 meeting he chaired:
“Our countries agreed to do everything necessary to ensure recovery, to repair
our financial systems and to maintain the global flow of capital.”

“It worked,” they added.

But the nine days of talks clocked up between both sets of meetings have also
made it clear that any hope of a return to business as usual is a remote
fantasy. However, there were six broad elements to the recipe world leaders
cooked up at the meetings for recovery that finance directors should take note
of.

Emerging powers
The first, and perhaps most long-term one, is the proof these meetings provided
of the shifting balance of power between the West and the fast-growing emerging
economies. The G20, counting among its most currently pertinent members Hu
Jintao’s China and Lula da Silva’s Brazil (jubilant in having won the 2016
Olympic Games, a victory in which Lula tellingly said that the country is no
longer “second class” but had instead “entered the first-class level”) and 11
other developing nations, declared that it was now the “premier forum” for
international economic cooperation, effectively supplanting the G7.

This was evident from another communiqué issued by G7 finance ministers,
which said meekly that it would “adhere to the commitments agreed by the G20 in
Washington, London and Pittsburgh”. But the irony of the location of the IMF and
G7 meetings in Istanbul ­ on the Bosphorus, where Europe and Asia meet ­ was not
lost on those attending.

“The world is moving to a different place,” said Mike Rees, CEO for wholesale
banking at Standard Chartered. The transition of power won’t be immediate,
though: the G7 insisted on talking about the Chinese exchange rate even though
China was not in the room, while the G20 was silent on currencies. That is a
disconnect that needs resolution as the decline in the dollar must be managed,
especially amid speculation that the greenback will lose its role as the global
reserve currency.

In a very outspoken remark, Robert Zoellick, president of the World Bank,
said the US would be “mistaken” to assume the greenback would remain the
dominant global currency ­ but with neither the euro, yen nor Chinese yuan
looking ready to take over such a pivotal role, a more fragmented currency
system seems to be in the offing, according to Ben Cohen, economics professor at
California University. “Without some form of leadership to assure a minimal
degree of compatibility among national policies, global monetary relations will
be at constant risk of instability or worse,” he said.

A second, somewhat depressing point that came out of these meetings is that
countries vehemently abhor protectionism, but continue to practice it. Both
meetings were full of pledges by leaders to resist enacting anti-trade measures:
Yet even as they met, research from independent monitoring unit Global Trade
Alert found that between the November 2008 G20 summit and the Pittsburgh
meeting, 240 measures had been enacted that were either blatantly discriminatory
or likely to harm foreign trade.

That said, there is agreement that the end of recession is in sight and that
the financial system is no longer in immediate danger of collapse. As Youssef
Boutros-Ghali, the Egyptian finance minister who chairs the IMF’s governing
committee, said: “All of the components of a recovery are there. We do not want
to get carried away, [but] things are looking up. Growth rates are beginning to
return to positive territory, systemic risks are coming down, financial sectors
are beginning to recover.” The IMF even raised its latest bi-annual growth
forecasts for the first time in 18 months and now predicts the world economy
will grow 3.1% in 2010: that’s up from expectations of 2.5% just three months
ago and its highest since 2007.

The next element of the road to recovery, though, is understanding that there
will be no orderly return to normal service and that recovery will not be
enjoyed equally across the world. “The recession is not over and it is not
automatic that we will recover,” Gordon Brown told the Pittsburgh meeting. “The
path to recovery is very fragile.” Indeed, the size of the economy at the end of
2010 will still be below what it was at the end of 2008.

Summer fling
It was also clear from the meetings that the recovery over the summer ­ at least
in the West ­ was driven by two factors: the extraordinary package of public
spending, cuts in interest rates and the restocking of warehouses by
manufacturers and retailers which had run down their inventories as demand
vanished. But as Justin Lin, chief economist at the World Bank pointed out, both
by their very nature are temporary. “They will disappear but the large excess
capacity will still be there,” he said.

Governments have decided to co-ordinate their so-called exit strategies,
agreeing at the meetings to keep their stimulus packages in place until the
recovery is entrenched enough for unemployment to start falling back. “We will
continue our stimulus efforts until our people are back to work,” was Barack
Obama’s Pittsburgh promise. All very well, but that, of course, has a
consequence for future recovery in the long-term. It means that for some time to
come, interest rates will stay at their historic low levels, bank guarantees
will stay in place and governments will continue to offer targeted support to
key industries. But at some point, governments ­ including ours – will have to
show the financial markets that they have a plan to bring down the deficits.

Many analysts fear the bond markets will start to push up long-term interest
rates unless deficits fall, seriously undermining recovery. However, that does
not mean all countries will move at the same moment. Instead, they will follow
the same principles for an orderly exit and communicate their intentions to
other nations: an important distinction, being clearly impractical to hope for
all countries to move simultaneously.
Yet it is vital governments do not try to steal a competitive advantage by
moving first, which might trigger a fresh round of protectionism.

Banking on regulation
One of the spiciest elements of decisions made at the Pittsburgh and Istanbul
meetings is that politicians are now serious about reining in the big banks. The
G20 set a strict timetable to design a new regulatory framework in five key
areas; banks must increase their capital bases, adhere to leverage ratio curbs,
set longer-term incentive strategies behind banking remuneration and
contingency plans for the advent of cross-border failures. Critically, there was
a resounding vote to push through global accounting standards by June 2011. If
politicians and regulators hit these targets, the world of banking will not be
the same again and some changes are already underway in Europe.

Five British banks, Barclays, HSBC, Lloyds, RBS and Standard Chartered, will
implement the Financial Services Authority’s new code that itself enacts the G20
agreement; French banks have done the same.

Josef Ackermann, chairman of the the Institute of International Finance and
of Deutsche Bank, said banks had raised more than $650bn of new capital since
late 2007, while the quality of capital has been improved and leverage has
reduced. Sounds good. But as many speakers said over the course of those two
weeks, the devil is in the details.

Bankers, as you might expect, say the new regulations will be excessively
tough and hurt the economy and they maintain that countries will fail to agree
on a single rulebook as they have done to date. “I believe there is a very real
risk that regulatory reforms come into force that could undermine global
recovery and job creation,” Ackermann said.

In Istanbul, Standard Chartered’s Rees urged financial regulators not to rush
into setting new rules on capital requirements while the economic recovery was
still in jeopardy. “A recession is the wrong time to impose big capital
requirements. If you are going to lift them they should do it in the good
times,” he said. The G20 set a target of 2012 for implementing rules on capital
requirements and leverage and Rees thinks they would have to start working on
their implementation now. “The markets will be looking at the banks today,” he
said. “2012 means we have to do it today because the refinancing cannot take
forever. The reality is that we have got to get it right today.”

This could make the next three years even more uncertain for small businesses
that have seen banks withdraw lending facilities and raise their charges.

Early warning
The Istanbul meetings marked the first serious attempt to design an early
warning system to flag up vulnerabilities in the system sufficiently in advance
to enable authorities to take action. The results of the early warning exercise
(EWE) carried out jointly with the Financial Services Board were presented to
finance ministers, central bankers, senior IMF and World Bank officials ­ but
not made public. And that highlights the challenge to set up a system that will
draw attention to potential crises before they become reality.

There are still unanswered questions. Even if regulators succeed in setting
up a new, more puritan system of rules for banks, it is still vital that they
address the ‘Queen issue’. It was Her Majesty who encapsulated what businesses
up and down country wanted to ask: Why did nobody see it coming?

Jean-Pierre Landau, deputy governor of the Banque de France, said that even
if the EWE works, politicians face a “social, not technical” choice over what to
do next. “If you prick [a bubble] too soon you might disturb the economy,” he
said. “If you prick it too late you might get what we have now.” Meanwhile,
Stephen Cecchetti, chief economic adviser to the Bank for International
Settlements ­ one of the few bodies to have gotten anywhere close to
‘forecasting’ the crisis ­ said that he believes warnings were “unlikely to be
heeded” anyway. “You are going to stop people from getting rich; you are going
to stop people from buying homes and from engaging in activities that are
rewarded by the market,” he warned. “The systemic risk manager, in my view,
faces the same challenge faced by a risk manager in a financial institution ­
which is to say, stop people from making money. This is a very serious challenge
to any early warning system.”

The same danger applies to divergence over accounting standards. Politicians
are aware of this problem. Mark Sobel, acting Assistant Secretary for
International Affairs at the US Treasury, commented that different national
standards open the possibility “for regulatory arbitrage, gaps in oversight, and
a race to the bottom. As the crisis highlights, these pitfalls must be avoided,”
he said.

Despite the ongoing threats of regulatory arbitrage, currency volatility,
weak economic recovery and trade protectionism, the G20 and IMF managed to do no
harm. Given the man-made disasters that engulfed the world in the decade
following the 1929 Wall Street crash, that is an achievement in itself.

Lessons for the banks – and for business
Six targets are in place to reset the banking industry for sustainable recovery.
But some of the new rules are worth any business mulling over.
By end-2012: Banks must hold more and better quality capital in
reserve during the good times to act as a cushion in the bad times
In 2011: A leverage ratio to limit the amount that banks can
lend relative to their capital base
By March 2010: Rules on bonuses to end all-cash payouts; defer
payment for up to three years; and allow banks to claw back money if the deals
that led to the payout turn sour
By end-2010: Regulate the vast but opaque over-the-counter
derivatives market
By end-2010: Tighter rules in place for systemically important
firms and global agreements on cross-border failures
By June 2011: A single set of high quality, global accounting
standards

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