This research material discusses the scenario prevailing in the Global economy and provides a glimpse on the effects of the global financial crisis and the significant measures taken under the theme of 'God's Global Governance'
Let us look at the causes for the financial crisis in detail. We have to analyze what the root of the issue was. In retrospect, this crisis was caused by lapses at three different levels -
The main factors contributing to innovation in financial services are technology revolution, legal and regulatory changes, as well as the economic environment. Improved technologies have allowed "financial engineers" to amass data, assess risks, and thereby design new products and services that can better meet the financial demands of individuals and enterprises. This contributed to securitisation of many previously illiquid loans. Fewer restrictions and low protectionism also supported innovation.
As a result of financial innovation, new business models of banks emerged. This altered the underlying economics of banking, as new financial instruments enabled credit risk to be shifted away from the originators of loans. However, securitisation also changed the nature of risks and in particular transformed credit risk into liquidity risk, then into a funding risk, and ultimately into a solvency risk.
The market environment became one of uncertainty rather than valued risk. In these circumstances, two trends emerged: it became difficult to price risk and assets, which meant that trading ceased; and banks began to hoard liquidity rather than make funds available. As a result, a substantial premium opened up between inter-bank interest rates and central bank market intervention rates.
In November 2009, I convened a conglomeration of banking and insurance professionals to discuss the gravity of the financial crisis and the challenges of global turmoil. I highlighted the current global crisis, its impact on the global economy, the financial stability of world economies and the outlook for the global economy. With world-renowned firms collapsing around the world, I was shocked to see this kind of a disaster eclipsing the financial world. The world was going through a seismic shift governance and transparency was gaining importance as never before. I mentioned then that the world order is real and the crisis is really not limited to banks or financial institutions, but rather to the entire corporate world where rules were based on greed. The time to revamp the entire framework, and institute a new method of governance had come. I saw the crisis as an opportunity to create a better world based on sound transparency principles. I also highlighted the order of events that led to the ongoing global financial crisis; the impact of the crisis on the global economy; the impact on currency, commodity, bond, stock and property markets; the effect on the financial stability of diverse economies; the economic outlook for the economy; and the policy changes that were required at a macro-economic level and financial/monetary level. Truly, the global financial crisis is an opportunity for real commodity driven economies like the State of Qatar to showcase their fundamental strengths and come out of the crisis stronger. The crisis also brought to attention the crucial need of having sound global governance principles in place. The new world order learned the hard way that there are no short cuts to success and fame. Sustainability was the new vision for corporations.
AREAS THAT REQUIRED ATTENTION:
REGULATORS AND MARKET DISCIPLINE
By increasing the amount of capital that banks are required to hold during upswings, regulators can create a buffer for banks during downturns. An international framework for provisioning is needed to deflect expected losses. Supervisors should also routinely assess compensation schemes to ensure that they do not create incentives for excessive risk-taking.
More disclosures on off balance exposure would enable regulators to assess systemic risk better.The valuation of complex financial instruments also required greater transparency. The market discipline will be strengthened from these measures. Regulation should focus on activities and not institutions as activities contribute to risks. Regulators should have been equipped to address the innovation models in financial services industry.
Credit rating agencies need to adequately assess risk, institute initiatives to reduce conflicts of interest,and improve investor due diligence. Other steps could include less reliance on ratings to meet prudential rules, and a differentiated scale for structured products.
There is a need for improving accounting by acknowledging the potential for mispricing in both good and bad times.
MACRO ECONOMIC POLICIES
Pre-crisis macroeconomic policies did not focus on systemic risks. As a result, these countries now find themselves limited in their ability to stimulate their way out of the crisis.Tax rules which encouraged debt financing should have been changed.
Policies should be brought in to rebalance savings and investment and regulation to reduce systemic risk. Monetary policy should focus on systemic risks. It is sometimes difficult to identify and then to react to an inflating bubble. However, there is a need for expanding the mandate of monetary policy to explicitly include macro-financial stability and not just price stability.
Global governance is the key.Regulatory requirements should focus on global governance, global transparency and financial stability. There has to be a unified approach to the overall framework. Whether it is Basel or any other supervisory framework, we need to have a new world Older and It will be sustained when we have new governance, as is the intention of the international Monetary Fund (IMF), finance ministers and central bankers. They need to correct Imbalances, convert financial economies into real economies, show how real economies are going to be sustainable and thereby build consumer confidence and global trust.
Whether it is a local bank or a private financial institution,there is global and public interest at stake. Typically a good bank can afford to have a minimum of eight percent Capital Adequacy Ratio. This crisis has shown that it can be a public-private partnership and ensure consumer protection through governance and transparency. This crisis has provided an opportunity for policymakers to stand hand-in-hand with financial institutions.
I believe financial institutions are public property. In addition to shareholder money they accept customer's deposits. They need to establish public-private partnerships. Global imbalances were visible during the time that financial institutions were supported by central banks. We have seen a stock market recovery; and now is the time for discipline. We need to wait for a recovery. It is good to have supervision from regulators, but total governance and financial stability is the key.
The policy warnings at the global level should be more specific. The crisis has opened up the G8, G20 and IMF to more actively work on global issues. Leadership is needed at a global level to respond to systemic global risks. The need for Global Governance has emerged after the current financial crisis.
Rules for cross-border financial sector resolutions are needed. A credible global liquidity framework is also needed. A single regulatory body should have the responsibility for systemic stability over the major institutions, as well as critical payment and settlement systems. The regulator will enforce stringent liquidity, counterparty, and credit risk management requirements. Hedge fund, private equity and venture capital fund advisers would also have to register with the main financial regulator.
Has the world economy recovered? No. However, the developed economies that over spent have resorted to quantitative easing and increasing money supply by printing money and creating liquidity. The result of this can be seen in the stock market. Globally the stock market has recovered. We have seen QE 1, QE 2 and QE 3 introduced by the Federal Reserve since the beginning of the crisis. When easing measures were taken by the US Federal Reserve, the dollar weakened and commodities strengthened. The IMF meeting in October 2012 highlighted concerns over global economic growth mainly due to the Eurozone crisis and the U.S fiscal cliff.
The US fiscal cliff was resolved with a deal that included an extension of income tax cuts for household income up to US$450,000, expanded unemployment insurance through 2013, a rise in tax on capital gains and dividends for wealthier households, a rise in inheritance tax for individuals and couples, and a five-year extension for tax credits that help poorer and middle-class families.
Expectations on Gold
In 2009 we saw gold increasing to US$1100 dollars. Gold functioned like a currency instead of a commodity. Gold's rise in the recent years has been mainly on account of easing measures from major central banks.
While global balance and global governance are important, quantitative easing measures was one of the key stimulants that the US Federal Reserve had to resort to.
The real estate market has not yet recovered.The world at large will only recover if the G20 decisions on regulation can be implemented. Hedge fund companies need to be measured, managed and controlled. Tax evasion should be avoided and measures implemented. People are showing cautious optimism.
This crisis has compelled the western economies 'to cut their coat according to the cloth'. In the future there would be an increased emphasis on savings rather than spending, reduced trade freedom, and unexpected swings In the commodities and financial world.
The Financial Stability Board (FSB), the IMF and the Bank for International Settlements (BIS) are working on macro-prudential policy frameworks, including tools to mitigate the impact of excessive capital flow. A policy framework for systemically important financial institutions is underway. Regulation and oversight of shadow banking is being developed. The FSB and the Organisation for Economic Co-operation and Development (OECD) are working on common principles for consumer protection and risk disclosure practices for structured products. The Global financial architecture is undergoing a change with more powers being given to FSB's resources and outreach.
There aren't enough universal standards on governance; hence global governance is in dire need. Global governance and corporate governance are able to produce benefits for all. This crisis is a social crisis and not just a financial crisis.As a result of financial innovation new business models of banks emerged, which shifted the underlying economics of banking and new financial instruments enabled credit risk to be shifted away from those that gave loans. However, securitisation also changed the nature of risks and, in particular, transformed credit risk into liquidity risk, then into a funding risk, and ultimately into a solvency crisis.
Thoughts on Global Governance
If you look at the key banking activities, one is lending and another is investing. What If we lend to mlcrofinance, lift the poverty lines, lend for sustainable projects, and invest in renewable energies and alternatives? Financial institutions should work on lending and investing towards renewable energy. Banks should create a separate section for "Green Banking", focusing on how to reduce carbon. Today there needs by an order, commitment and responsibility in banking for lending or investments.
What is happening in the global economy is a positive lesson. Financial economies are exotic when compared to real economies. Institutions and Individuals that are living beyond their means or leveraging beyond capacity are passing on debts to younger generations. The same applies to countries and corporations.The change in the global market is real and is good for the world order. Institutions must practice good governance.
One doesn't have to look far to realize that the world is filled with Infectious greed. Where is it heading? This is a problem where there is no quick solution. On account of globallzation, regulation, technology and consumerism, the new world order is creating new markets and new opportunities. I look at this crisis as an opportunity for real economies to prosper, and financial economies to correct their values to become real and more ethical. People should focus on generosity and happiness. This crisis will lake longer than ever for economies to be normal. People in economies such as the GCC and India know how to live for tomorrow. Developing economies such as India have to spend to stimulate their economy in a global crisis, whereas financial economies should save so they should conserve for global growth.
In Oct 2007, I was asked by CNBC what would happen to oil prices. Knowing the capacity constraints, refinery backups and downwards dollar deflation, I predicted US$100/barrel for oil futures. My judgment turned out to be correct by December 2007. The weakening dollar resulted in hedging the risk on oil futures, which in turn led to the hike in the oil price. By July 2008, oil was costing US$147/barrel. A combination of factors including the dollar depreciation, demands from emerging markets, an OPEC supply management and geo-political tension in the Middle East have always been the driving force for the price of oil.
There has to be an ethical balance in global growth. The capital markets, currency markets, commodity markets and bond markets reflect huge swings because of phenomenal speculation. For example, the price of oil was phenomenally higher in July 2008. The dollar was weakening and hedging the risk by buying oil. Demand for oil futures was increasing but this was not the real demand. In 2009, after the easing measures were announced, I expected WTI oil price to go upto US$70/barrel.
Today the world is beginning to accept new governance. I personally call it God's Global Governance. I would say that financial economies will take 2-3 years to recover, depending on the political convergence and integrated measurement. Politics preceded economics before globalization, and now economics precedes over politics. This new world order is good for real economies, as they will recover in less than a year. Financial economies may take a longer time. Rich countries are getting poorer, which will allow the poor man to have better material comforts. A rich man sliding down is torture. This crisis is punishing those who had exotic means, whether it was a country, an individual, a corporation or a block of countries. Such countries are getting into correction mode.
Now aware of God's Global Governance, we should also review how the current global governance has implemented various regulatory reforms.