Can we trust our financial institutions?

Aug 5, 2019 by

What are financial institutions? What is speculation and what are its consequences? What is wrong with banks? What are the World Bank and the International Monetary Fund and how do they work? Can we make financial business more sustainable? 

These and other questions that were addressed in the lectures held by Peter Wahl and Kurt Bayer on the 29th of July, 2019 are clarified (and criticized!) in the following lines. 

Exchanges have been the basis for human development as far as one can go back in time. With the appearance of money, society initiated a transition towards a complex system of interconnected transactions. Not without opposition, local markets have been brought together by globalization, giving citizens access to large amounts of goods and allowing for the longest period without major conflicts in human history.

But what are financial institutions? Basically, Financial Institutions (FIs) are market agents whose role is to collect the savings of citizens and lend those savings to the economy. From this point onwards it only gets more complicated, as FIs can interact among themselves and participate in other market activities such as investing, hedging and speculating.

And here comes the first issue, how should we address speculation? As we know, speculation is an activity whereby a product – which can be physical or intangible – is bought with the expectation to realize profits from its future sale. For some economists, as Peter Wahl, speculation is a reprehensible activity, without value added for the economy and the sole goal of obtaining short-term profits out of guessing patterns in the trading of goods. As I see it, as much as the government can implement measures to restrain speculative operations, agents should be allowed to do with their money as they please, always bearing in mind that extensive, uncontrolled speculation might lead to a crisis.

Now it is inevitable to wonder what is wrong with banks, and, more precisely, how did it come to this post-crisis situation? Peter Wahl, as well as mainstream economists, considers that the 2008 financial crisis was largely due to: the asymmetric power of banks with respect to other agents of the market, overindebtedness, the interconnectedness of institutions (high contagion effect), the high exposure of banks and shadow banking (speculation included). Shadow banking particularly raises the point, seconded by Peter Wahl and myself, that Special Investment Vehicles (SIVs) outside the scope of banking regulation and supervision were allowed to operate – needless to say, with a clear cost advantage as they have less costs of compliance – in the market alongside other agents. These SIVs, generally owned by banks, gathered much of the risk and costs that were later transferred to the state, that is civil society, after the major bail-out. From my point of view, regulators were remarkably biased (recall capture theory!), did not take the necessary measures on first place to avoid systemic crash and later took measures that benefited bank stakeholders rather than society as a whole – remark how one could have opted for a bail-in in lieu of a bail-out or follow the Danish proposal of separating “good” from “bad” banks based on the quality of the assets.

Some other FIs that have remained under the scrutiny of the general public are the World Bank (WB) and the International Monetary Fund (IMF), but why? Basically, because the requirements that they have imposed on the countries receiving financial aid from them have proven, as Kurt Bayer and other economists argue, ineffective. Requiring the privatization of most public infrastructure and the drop of all barriers to trade and capital flows, the IMF has pushed developing (as well as developed) economies to a liberalized -competitive- environment that some could not withstand. Echoing Bayer’s words, we would need a more careful assessment of what options fit best for these countries, putting special attention to the local environment. As Kurt Bayer said, if these institutions do not serve their interests, said countries will shift to other bodies that do so!

Bearing in mind the aim of AEMS it comes to: can we make finance more sustainable? Kurt Bayer proposed the amelioration of the WB and the IMF so they served the interest of countries in need. Peter Wahl and several other lecturers have stressed the need to incentivize lending for financial activities to the real economy, thus reducing lending to SIVs. As I see it, the first step that should be taken would be to strengthen the Basel capital requirements and separate investment from commercial banks. Further, in line with Wahl’s ideas, different interest rates should be set by the Central Bank when lending to banks depending on the purpose of such investment (remark how much policy could influence major investments in an economy!).

Briefly concluding, these lectures have opened the Pandora box of finance. While many issues have remained untackled, proposals to change existing behavioural patterns and to promote fair, sustainable and equitable access to credit are feasible, urgent and should be implemented.

Writty by: Albert Vall Garcia

Based on the lectures “Understanding Money, Banking and Financial Markets” by Peter Wahl and “International Money Institutions” by Kurt Bayer during AEMS 2019.