In the aftermath of the credit crunch and the recession, many banks had to be bailed out by central banks and some, such as Northern Rock and RBS, were wholly or partially nationalised. Tougher regulations to ensure greater liquidity and higher proportions of capital to total liabilities have been put in place and further regulation is being planned in many countries.

So are banks now able to withstand future shocks?

In recent months, new threats to banks have emerged. The first is the prospect of a double-dip recession as many countries tighten fiscal policy in order to claw down debts and as consumer and business confidence falls. The second is the concern about banks’ exposure to sovereign debt: i.e. their holding of government bonds and other securities. If there is a risk that countries might default on their debts, then banks would suffer and confidence in the banking system could plummet, triggering a further banking crisis. With worries that countries such as Greece, Spain, Portugal, Italy and Ireland might have problems in servicing their debt, and with the downgrading of these countries by rating agencies, this second problem has become more acute for banks with large exposure to the debt of these and similar countries.

To help get a measure of the extent of the problem and, hopefully, to reassure markets, the Committee of European Banking Supervisors (CEBS) has been conducting ’stress tests’ on European banks. On 24 July, it published its findings. The following articles look at these tests and the findings and assess whether the tests were rigorous enough.

Articles
Bank balance: EU stress tests explained Financial Times, Patrick Jenkins, Emily Cadman and Steve Bernard (13/7/10)
Seven EU banks fail stress test healthchecks BBC News, Robert Peston (23/7/10)
Interactive: EU stress test results by bank Financial Times, Emily Cadman, Steve Bernard, Johanna Kassel and Patrick Jenkin (23/7/10)
Q&A: What are the European bank stress tests for? BBC News (23/7/10)
Europe’s Stress-Free Stress Test Fails to Make the Grade Der Spiegel (26/7/10)
A test cynically calibrated to fix the result Financial Times, Wolfgang Münchau (25/7/10)
Europe confronts banking gremlins Financial Times (23/7/10)
Leading article: Stressful times continue Independent (26/7/10)
Europe’s banking check-up Aljazeera, Samah El-Shahat (26/7/10)
Finance: Stressed but blessed Financial Times, Patrick Jenkins (25/7/10)
Were stress test rigorous enough? BBC Today Programme, Ben Shore (24/7/10)
Banks’ stress test ‘very wooly’ BBC Today Programme, Peter Hahn and Graham Turner(24/7/10)
Stress test whitewash of European banks World Socialist Web Site, Stefan Steinberg (26/7/10)
Stress tests: Not many dead BBC News blogs: Peston’s Picks, Robert Peston (23/7/10)
Not much stress, not much test Reuters, Laurence Copeland (23/7/10)
Stress-testing Europe’s banks won’t stave off a deflationary vortex Telegraph, Ambrose Evans-Pritchard (18/7/10)
European banking shares rise after stress tests BBC News (26/7/10)
Euro banks pass test, gold falls CommodityOnline, Geena Paul (26/7/10)

Report
2010 EU-wide Stress Testing: portal page to documents CEBS

In the past few days, the euro has been under immense speculative pressure. The trigger for this has been the growing concern about whether Greece would be able to force through austerity measures and cut its huge deficit and debt. Also there has been the concern that much of Greece’s debt is in the form of relatively short-term bonds, many of which are coming up for maturity and thus have to be replaced by new bonds. For example, on 19 May, Greece needs to repay €8.5 billion of maturing bonds. But with Greek bonds having been given a ‘junk’ status by one of the three global rating agencies, Standard and Poor’s, Greece would find it difficult to raise the finance and would have to pay very high interest on bonds it did manage to sell – all of which would compound the problem of the deficit.

Also there have been deep concerns about a possible domino effect. If Greece’s debt is perceived to be unsustainable at 13.5% of GDP (in 2009), then speculators are likely to turn their attention to other countries in the eurozone with large deficits: countries such as Portugal (9.4%), Ireland (14.3%) and Spain (11.2%). With such worries, people were asking whether the euro would survive without massive international support, both from within and outside the eurozone. At the beginning of 2010, the euro was trading at $1.444. By 7 May, it was trading at $1.265, a depreciation of 12.4% (see the Bank of England’s Statistical Interactive Database – interest & exchange rates data

If the euro were in trouble, then shock waves would go around the world. Worries about such contagion have already been seen in plummeting stock markets. Between 16 April and 7 May, the FTSE100 index in London fell from 5834 to 5045 (a fall of 13.5%). In New York, the Dow Jones index fell by 8.6% over the same period and in Tokyo, the Nikkei fell by 7.6%. By 5 May, these declines were gathering pace as worries mounted.

Crisis talks took place over the weekend of the 8/9 May between European finance ministers and, to the surprise of many, a major package of measures was announced. This involves setting aside €750bn to support the eurozone. The package had two major elements: (a) €60bn from EU funds (to which all 27 EU countries contribute) to be used for loans to eurozone countries in trouble; (b) a European Financial Stabilisation Mechanism (a ‘Special Purpose Vehicle (SPV)’), which would be funded partly by eurozone countries which would provide €440bn and partly by the IMF which would provide a further €250bn. The SPV would be used to give loans or loan guarantees to eurozone countries, such as Greece, which were having difficulty in raising finance because of worries by investors. The effect would also be to support the euro through a return of confidence in the single currency.

In addition to these measures, the European Central Bank announced that it would embark on a ‘Securities Markets Programme’ involving the purchase of government bonds issued by eurozone countries in difficulties. According to the ECB, it would be used to:

.. conduct interventions in the euro area public and private debt securities markets to ensure depth and liquidity in those market segments which are dysfunctional. The objective of this programme is to address the malfunctioning of securities markets and restore an appropriate monetary policy transmission mechanism.

Does this amount to quantitative easing, as conducted by the US Federal Reserve Bank and the Bank of England? The intention is that it would not do so, as the ECB would remove liquidity from other areas of the market to balance the increased liquidity provided to countries in difficulties. This would be achived by selling securities of stronger eurozone countries, such as Germany and France.

In order to sterilise the impact of the above interventions, specific operations will be conducted to re-absorb the liquidity injected through the Securities Markets Programme. This will ensure that the monetary policy stance will not be affected.

So will the measures solve the problems? Or are they merely a means of buying time while the much tougher problem is addressed: that of getting deficits down?

Webcasts and podcasts
Rescue plan bolsters the euro BBC News, Gavin Hewitt (10/5/10)
The EU rescue plan explained Financial Times, Chris Giles, Emily Cadman, Helen Warrell and Steve Bernard (10/5/10)
Peston: ‘Crisis is not over’ BBC Today Programme (10/5/10)
Greece ‘will get into even more deep water’ BBC Today Programme (11/5/10)

Articles
EU ministers offer 750bn-euro plan to support currency (including video) BBC News (10/5/10)
EU sets up crisis fund to protect euro from market ‘wolves’ Independent, Vanessa Mock (10/5/10)
Euro strikes back with biggest gamble in its 11-year history Guardian, Ian Traynor (10/5/10)
Debt crisis: £645bn rescue package for euro reassures markets … for now Guardian, Ian Traynor (10/5/10)
The E.U.’s $950 Billion Rescue: Just the Beginning Time, Leo Cendrowicz (10/5/10)
Eurozone bail-out (portal) Financial Times
Bailout does not address Europe’s deep-rooted woes: Experts moneycontrol.com (11/5/10)
An ever-closer Union? BBC News blogs: Stephanomics, Stephanie Flanders (10/5/10)
Eurozone crisis is ‘postponed’ BBC News blogs: Peston’s Picks, Robert Peston (10/5/10)
Multi-billion euro rescue buys time but no solution BBC News, Lucy Hooker (11/5/10)
No going back The Economist (13/5/10)
It is not Greece that worries EURO: It is China that teeters on a collapse Investing Contrarian, Shaily (11/5/10)

Data and official sources
For deficit and debt data see sections 16.3 and 18.1 in:
Ameco Online European Commision, Economic and Financial Affairs DG
For the ECB statement see:
10 May 2010 – ECB decides on measures to address severe tensions in financial markets ECB Press Release

President Obama has proposed a major reform of the US banking system. This follows on from the proposed levy to be imposed on banks’ assets announced a few days ago (see “We want our money back and we’re going to get it”).

There are two elements to the new proposals. The first is to limit the size of banks’ market share. Currently, banks’ deposits are not permitted to exceed 10% of total retail deposits in the USA. This 10% limit would be extended to cover wholesale deposits and other liabilities. The idea is to reduce concentration and increase competition. At present the largest four banks hold over half the total assets of banks in the USA.

The second element involves separating casino banking from retail banking. This would be achieved by barring retail banks from owning or investing in private equity or hedge funds or from engaging in ‘proprietary trading operations’. As the second BBC article below states:

Proprietary trading involves a firm making bets on financial markets with its own money, rather just than carrying out a trade for a client in which only the client’s money is at risk.

This comes close to restoring the Glass-Steagall Act, which was repealed in 1999. The Act, which was passed in 1933 in the wake of the 1929 Wall Street cash and the subsequent Great Depression, separated commercial banking and investment banking. It was designed to prevent customers’ deposits being exposed to the riskier activities of investment banking.

What have been the reactions to President Obama’s announcement? Are these reactions justified? Will the proposals prevent another banking crisis and credit crunch? The following articles explore these questions.

Obama hammers the banks Financial Times, Tom Braithwaite and Francesco Guerrera (22/1/10)
Obama pushes new bank regulation (including video) BBC News (21/1/10)
Q&A: Obama’s bank curbs BBC News, Martin Webber (21/1/10)
Obama announces dramatic crackdown on Wall Street banks (including video) Guardian, Jill Treanor (21/1/10)
Barack Obama bank reforms: Trying to fix a broker society Telegraph, Louise Armitstead and Helia Ebrahimi (23/1/10)
Glass-Steagall lite The Economist (22/1/10)
Obama’s Plan Finally Attacks “Too Big to Fail” The Huffington Post, Neil K. Shenai (21/1/10)
Obama Sizes Handcuffs For Banks Forbes, Liz Moyer (21/1/10)
Obama’s Showdown With Wall Street Forbes, Richard Murphy (22/1/10)
President Obama shows the way Independent (23/1/10)
Wall Street’s $26m lobbyists gear up to fight Obama banks reform The Observer, Andrew Clark (24/1/10)
Obama’s drawn first blood – now it’s the UK’s turn The Observer, Ruth Sunderland (24/1/10)
Gordon Brown to push for ‘Tobin tax’ after Wall Street crackdown Guardian, Larry Elliott and Jill Treanor (22/1/10)
Myners: UK does not need to copy Obama banking reforms Guardian, Andrew Clark, Jill Treanor, Paul Owen (22/1/10)
Debate on London’s banking system The Observer, Will Hutton and Boris Johnson (24/1/10)
What Obama’s bank reforms really mean BBC News blogs, Peston’s Picks, Robert Peston (22/1/10)
Davos 2010: Central bankers seethe behind closed doors BBC News, Tim Weber (29/1/10)

In these news blogs, we’ve considered a Tobin tax on a number of occasions: see A Tobin tax – to be or not to be? and Tobin’s nice little earner. On 10 December 2009, the Treasury published a discussion document, Risk, reward and responsibility: the financial sector and society. This, amongst other things, considers the case for a financial transactions tax – a form of Tobin tax. As Box 4.A on page 35 states:

“James Tobin’s original proposal for a transaction tax was to tax foreign exchange transactions. The purpose of the tax was to tackle excessive exchange rate fluctuation and speculation on currency flows, as Tobin felt that short-term movements in capital flows could severely limit the ability of governments and central banks to follow appropriate domestic policies for their economies.

However, the recent crisis has shown that there is considerable risk inherent in other financial markets. In some of these markets trading volumes have also grown enormously compared to the value of underlying assets. As set out above, instability may result from these markets due to the complex nature of counterparty networks and a lack of transparency, and the transmission of financial shocks through the system.

Recent attention has therefore focused on a broader tax on financial transactions – potentially, this would include trading in a wide range of instruments, currently traded both on and off-exchange.”

The goverment in the UK has recently taken one step in increasing taxes on the financial sector. In its 2009 pre-Budget report, delivered on 9 December (see Cutting the deficit and tackling the recession. Incompatible goals?), a new tax on bank bonuses was imposed. The rate is 50% on bonuses over £25,000. Since then a similar tax has been imposed in France and Germany’s Chancellor, Angela Merkel, said that she found it a ‘charming idea’, although probably not practical under German law. She did support, however, the use of a Tobin tax on financial transactions, similar to the one being considered in the UK. Such a tax, to be effective, would ideally have to be imposed worldwide, but at least by a large number of countries.

So is the case for a Tobin tax gathering momentum? The following video podcast considers the tax’s aims, effectiveness and practicality – as do the articles.

Video podcast
Radical Tobin Tax proposal could go mainstream BBC Newsnight, Paul Mason (10/12/09)

Articles
Now’s the time for a Tobin tax Guardian, George Irvin (11/12/09)
EU leaders urge IMF to consider Tobin tax Financial Times, Tony Barber and George Parker (11/12/09)
We can always get to Utopia – even from here Irish Times, Paul Gillespie (12/12/09)
HM Treasury makes case for Tobin tax City A.M., Julia Kollewe (11/12/09)
The Tobin Tax – a brief history Telegraph (8/11/09)
European Union presses IMF to consider Tobin tax Telegraph (11/12/09)

The problem with banks and the financial sector is that we need them. Who knows what might have happened if the government hadn’t stepped in to bail out the banks. And that’s one of the key arguments for continuing to pay bankers’ bonuses. If they left their jobs and the banks ceased to exist, we’d be looking at a very bleak future.

The truth is: ‘we need them’ and, what’s worse, they know it. As Frank Skinner said in a Times article: ‘during the crisis bankers will be thinking, “Don’t panic. The public have got short memories. Show them the slightest hint of recovery and most of them will forget their moral indignation and we can start where we left off – making the biggest splashes we can and not worrying about the ripples” ‘.

Despite the argument for continuing to pay out bonuses, a large proportion of the public are understandably angry that bankers are still receiving enormous bonuses. Not only are banks and the financial sector largely responsible for the current recession, but it is taxpayers who have bailed them out and who now pay their bonuses. However, things could be about to change.

The FSA is set to get powers, allowing it to ‘tear up’ bankers’ bonus contracts, especially for those taking reckless risks that threaten the stability of the financial sector. The new regulations will be found in the Financial Services Bill, which, if approved by Parliament, will apply to all British banks, as well as the British subsidiaries of overseas banks operating in the UK. Multi-million pound payments will be able to be blocked and fines will be imposed on banks who offer unjustified ‘mega-bucks pay-outs’.

Despite this impending regulation, not everyone thinks it will be successful. Sir George Mathewson, the former Chairman of RBS, has said that interfering with bankers’ contracts is a ‘dangerous route to go down’. Read the following articles that consider this contentious issue.

Bankers bonuses’ ‘will soar to £6bn’ after government bailouts and rising profits Times Online, Katherine Griffiths (21/10/09)
Bonus crackdown plans dangerous BBC News (16/11/09)
Financial regulation ‘has broken down’ BBC Today Programme (16/11/09)
Roger Bootle: Bank reform hasn’t gone far enough (video) BBC News (25/12/09)
FSA to get powers to tear up’ bankers’ bonus contracts Citywire, Nicholas Paler (16/11/09)
It’ll be tough for bankers on a £200k bonus Times Online, Frank Skinner (13/11/09)
Prince Andrew defends bankers’ bonuses even as economy stays mired in recession Mail Online, Kate Loveys (24/10/09)
Curb on bankers’ bonuses to be unveiled in Queens’ speech Mail Online (13/11/09)
Bankers warn laws on pay and bonuses will scare off talent Telegraph Angela Monaghan (13/11/09)
Labour to overturn bonus deals at risk-taking banks Guardian Patrick Wintour (13/11/09)
Banking on the State Guardian (17/11/09)
Queen outlines new banking laws BBC News (18/11/09)
Queen’s Speech: what the Financial Bill really means for bankers’ bonuses Telegraph, Tracy Corrigan (18/11/09)
Brown Puts Deficit Curbs, Bonus Limits on U.K. Agenda Bloomberg, Gonzalo Vina and Thomas Penny (18/11/09)
Queen’s speech 2009: financial services bill Guardian, Jill Treanor (18/11/09)

In a speech to Scottish business organisations, Mervyn King, the Governor of the Bank of England, argued that it might be necessary to split banks up. The aim would be to separate the core retail banking business, of receving deposits and lending to individuals and businesses, from the more risky and exotic wholesale acitivites of banks, such as securitisation, speculation and hedging – so-called ‘casino banking’.

Governments around the world, as represented at the G20 meeting at Pittsburg in September, have favoured tougher regulation of banks. But Mervyn King believes that this is not enough. It may not prevent the reckless behaviour that resulted in the credit crunch and bank bailouts by the government. “Never has so much money been owed by so few to so many. And, one might add, so far with little real reform.” And if regulation were to fail and banks were to get into difficulties, what would happen? There would have to be another bailout. As Mervyn King said, “The belief that appropriate regulation can ensure that speculative activities do not result in failures is a delusion.”

There are two key problems.

The first is Goodhart’s Law. If rules are set for bank behaviour, banks may adhere to the letter of the rules, but find ways around them to continue behaving in risky ways. The rules may cease to be a good measure of prudent behaviour.

The second is moral hazard. If banks know that they will be bailed out if they get into difficulties because they are too big to fail, then this encourages them to take the risks. As Mervyn King said in his speech, “The massive support extended to the banking sector around the world, while necessary to avert economic disaster, has created possibly the biggest moral hazard in history. The ‘too important to fail’ problem is too important to ignore.”

So should the banks be split? Is there any likelihood that they will? Or are Mervyn King’s proposals merely another headache for the government? The following articles looks at the issues. The first link below is to his speech.

Speech by Mervyn King, Governor to Scottish business organisations, Edinburgh (20/10/09)
Mervyn King: bail-outs created ‘biggest moral hazard in history’ (including video of part of speech) Telegraph (20/10/09)
Governor warns bank split needed BBC News (20/10/09)
A sombre warning BBC News, Stephanomics (20/10/09)
Alistair Darling rebuffs Mervyn King’s attack over timidity of banking reforms Guardian (21/10/09)
King and Brown in rift over whether to split the banks Independent (22/10/09)
Tucker set to join calls for stricter controls on banks Scotsman (22/10/09)
Testing times for bank regulators Financial Times (21/10/09)
Mervyn King is right - the economy is changing and we’re blindfolded, without a map Telegraph, Edmund Conway (22/10/09)

The blame for the global economic crisis has been placed on many different people, but one area that has been severely criticised for the extent of the financial crisis is banking and financial regulation (or a lack thereof). One thing that has been repeated is that we must learn from our mistakes and therefore tighten financial regulation on a global scale. The Institute for Public Policy Research (IPPR) says the ‘rapid return to the City’s bonus culture shows that real reform has been “very limited”’. France in particular is arguing for tighter financial regulation, including curbing bankers’ bonuses to avoid a repeat of last year’s meltdown. However, it is meeting resistance from the UK and USA. Indeed, some banks appear to have extended their bonus culture.

As the banking sector slowly begins to recover, there is concern that few changes have been made to ensure that there is no repeat of the recent crisis. Banks have been warned that they should not resume taking risks, as they did before, as future bailouts by the government (and hence the taxpayer) will not keep happening. The European Union has now unveiled plans for new ‘super-regulators’, but only time will tell whether they will be a success.

EU unveils new ‘super-regulators’ BBC News (23/9/09)
EU proposes new Financial-Market supervision system The Wall Street Journal, Adam Cohen and Charles Forelle (24/9/09)
FSA head launches fresh attack on ‘swollen’ system ShareCast (24/9/09)
Bank crisis lessons ‘not learned’ BBC News (15/9/09)
US, UK resisting French drive for regulation AFP (22/9/09)
European System of Financial Supervisors (ESFS): Frequently Asked Questions Mondovisione (23/9/09)
Tighter grip on economy needed BBC News (13/9/09)
Turner warns against regulation overkill Money Marketing (23/9/09)
EU calls for European Banking, Securities Regulators Bloomberg (24/9/09)
EU financial watchdog to rely on moral authority The Associated Press (23/9/09)
Obama issues warning to bankers (including video) BBC News (14/9/09)

The global economy has been in a recession since December 2007, but have we now passed the worst of it? Whilst companies are still going bankrupt, unemployment is still rising, the housing market is still looking pretty gloomy and government debt surely can’t go up anymore, there are indications that we’ve reached the bottom of the recession. There are murmurs that the economy may start to recover towards of the end of the year.

But, of course, economics wouldn’t be economics if there wasn’t considerable disagreement. Many still believe that the worst is yet to come. According to the OECD, the recession is ‘near the bottom’. Yet, output in the UK is still set to decline by 4.3% in 2009, and by 2010 the budget deficit is predicted to have grown to 14%. Unemployment is at its highest since November 1996, but US consumer confidence is said to be rising and the pound is climbing. Read these articles and make up your mind about the state of the UK and global economy!!

Business and Consumer Surveys (After following link, click on chart) European Commission, Economic and Financial Affairs (29/6/09)
Pound climbs against euro as King sees signs recession easing Bloomberg, Lukanyo Mnyanda, Gavin Finch (20/6/09)
Bank says banking crisis easing BBC News (25/6/09)
First signs of optimism returning to some parts of financial services CBI PRess Release (29/6/09)
Darling and King agreed on tentative recovery Guardian, Ashley Seager (17/6/09)
Sharp contration for UK economy BBC News (30/6/09)
Housing market knocked by price falls Moneywise (22/6/09)
OECD says recession ‘near bottom’ BBC News, Steve Schifferes (24/6/09)
US Federal Reserve says recession is ‘easing’ Telegraph, James Quinn (24/6/09)
Public borrowing at record levels BBC News (18/6/09)
Leading index suggests recession easing UPI.com (18/6/09)
US consumer confidence up in June BBC News (26/6/09)
Blow for housing market as prices fall The Independent, David Prosser (22/6/09)
Most UK businesses freeze pay as recession bites, CBI says Telegraph, Peter Taylor (23/6/09)

The G20 countries meet each year. Normally their meetings are full of fine words resulting in little action. But at a summit in London on 2 April 2009, the fear of a deepening global recession focused minds and a package of measures worth over $1 trillion was agreed to stimulate trade and growth. This included $750 billion for the IMF to help economies in severe difficulties, $250 billion for financing world trade and $100 to multilateral development banks (such as the Asian Development Bank) to provide extra aid to the poorest countries.

The extra money for the IMF would include $500 billion of loans from member countries and £250 billion in new money – a form of international quantitative easing. This new money would be in the form of ‘special drawing rights’. These are denominated in dollars and are created by the IMF to be drawn on by countries in difficulties.

There was also agreement to tighten financial regulation and to resist protectionism. A ‘Financial Stability Board’ would be set up and work with the IMF to design a strengthened regulatory system for banks and other financial institutions and for financial markets and instruments.

The following articles look at the agreement and its likely effects.

‘This is the day the world came together to fight back’ Independent (2/4/09)
G20 communiqué: Point by point analysis Telegraph (2/4/09)
G20 summit – leaders’ statement. Full text of the communiqué Guardian (2/4/09)
G20: Economic summit snapshot BBC News Online (2/4/09)
G20 leaders seal $1tn global deal BBC News Online (2/4/09)
G-force The Economist (2/4/09)
World leaders declare war on risk Sydney Morning Herald (3/4/09)

Postscript (Sept 2009)
G20: What progress has been made? BBC News (23/9/09)
G20: Pledge by pledge BBC News (25/9/09)

An ongoing debate in economics for many years has been the extent to which governments should intervene in the economy. The debate has re-emerged in recent months with the global financial crisis as many commentators have arged that had a tighter regulatory system been in place, it could have helped to prevent some of the poorer lending practices of banks internationally. Even the recent G20 meeting (dubbed Bretton Woods II by some analysts) discussed regulatory reform of the international financial system. The two articles below look at this debate about the extent of government intervention from two very different angles. The first is from the perspective of Victorian England and Little Dorritt, while the second (by Peter Mandelson) looks at how globalisation and the financial crisis have informed the debate about state intervention.

So much for ‘late’ capitalism Guardian (24/11/08)
The future active state Guardian (4/12/08)