Regulation and shadow banking: the threats to the system on the threshold of another recession

The economic downturn sounds the alarm about the proximity of the last recession. The slowdown, the lack of synchrony in the growth, the trade war, the strengthening of the dollar and the weakening of the European Union are the keys of the macroeconomic scenario drawn up in the last biannual report by ESADE business school, in which the following question is also raised: Is the financial system sufficiently written off to face another economic crisis?

Miguel Ángel Ordóñez, the former governor of the Bank of Spain, and José María Roldán, president of the Spanish Banking Association, both agree on the acknowledge of a more complex environment, with excessive banking regulation and a new digital setting that blurs operators and operations.

Under the title The financial system after the crisis, what has changed? Has enough been done?, Ordóñez and Roldán exposed yesterday in ESADE the risks that the banking system has yet to overcome to be sustainable and able to face another financial crisis. Both pointed out that the new regulatory framework proposed in order to avoid repeating the banking crisis of 2008 hinders the measures of action and warned that the new economic and political scenario also needs to consider new strategies.

The slowdown, the lack of synchrony in the growth, the trade war, the strengthening of the dollar and the weakening of the European Union are the keys of the macroeconomic scenario

According to Roldán, two unintended consequences that led to the crisis and the rescue of the banking system were, on the one hand, an excessively extensive and very complex new regulatory framework and, on the other hand, having too many authorities for banking regulation and surveillance. The manager underlines the main risks of the system when facing a new crisis: the high capital in shadow banking (operations that move outside the financial system) and the complexity added by the new digital environment, which blurs borders.

Regarding if what has been done so far will stop another financial crisis, Roldán assures that it is very difficult to predict because digitization created a completely different scenario. “We must pay attention to the undesired consequences of an excess of regulation and a different environment that can make what was done to resolve the last financial crisis become not valid for the next one,” he explained.

Ordóñez, on his behalf, noted that the 40 billion euros destined to the bank rescue in Spain constitutes a small donation for a debt of more than 600 billion euros that the Government had to invest to mitigate the effects of the crisis, in addition to ten years of economic advance lost. According to the former governor of the Bank of Spain, one of the measures that contributed the most to save the system was the international cooperation of all countries, something that was not possible in the recession of the thirties and that not even Donald Trump questioned.

The director agreed with Roldán in an excessive regulation, “of more than two million words and three times The Bible,” but necessary so that it does not happen again. However, Ordóñez maintains that the system is still not safe because banks keep investing money from deposits. In this regard, he noted that there are authors who begin to talk about the need to establish a secure banking with public deposits in the Central Bank to avoid that, in case of a crisis, it affects the citizens.

Slowdown in the economy

In the last economic and financial report, which is biannual, published by the business school, it is concluded that the economy maintains its growth, but it shows, on the one hand, a trend to slow down and, on the other hand, a lack of synchrony, that is, that not all regions are joining this expansion.

Thus, while advanced economies such as the United States, Canada, Australia or New Zealand, continue to grow above the average, others, like Japan or the core countries of the Euro zone, such as Germany or France, are slowing down. Besides, China is also growing less than the expected, partly due to the impact of the trade war with the United States.

The accession to power by populist movements and the impact of the Brexit could raise tensions within the European Union

The Department of Economy, Finance and Accounting of ESADE emphasizes that this downturn is associated with four risks. The first one is a possible worsening of the trade war with the application of protectionist measures, which will not only affect international trade but also business expectations and investment.

The second implies an increase in financial tensions in front of a rise in interest rates that would cause capital outflows in emerging economies and a further strengthening of the dollar, which would further weaken these regions. The third of these risks is debt. According to the report, the global economy continues to have very high levels of public and private debt, even more than during the 2008 crisis.

Finally, the fourth risk has to do with politics and, specifically, with the Euro zone, where the growth slows down. This new scenario can weaken the European Union, due to the contagion effect of policies such as that of the Italian Government and the impact that a hard Brexit would have on relations within the European Union in full financial and fiscal integration.