1. ASCENT AFTER DECLINE: RE-GROWING ECONOMIC GROWTH Observations on Financial Sector: Constraints and Reform Agenda
Stijn Claessens
Assistant Director, Research Department, IMF
WORKSHOP,  November 19, 2010, World Bank

2. Outline State of financial sectors and reforms
Finance as constraint on growth and risks
Due to crisis & because of ongoing reforms, or lack thereof
Issues in the session
Links to financial sector, possibilities to accelerate financial restructuring?
General observations, and qualifications

3. State of financial sectors, in advanced countries
Financial sector still weak
Weakly/undercapitalized/reduced profitability
Large overhang (households) to be resolved
Sector facing new regulations, risk averse
More/stricter capital adequacy, etc. requirements
Higher general risk aversion
Yet (systemic) risks not necessarily lowered
Migration of risks to outside banking system
Limited fundamental reforms

4. State of financial regulatory agenda
Progress on some, but “easier” elements
Higher/better capital adequacy, some buffers
Limits on leverage
Better coverage of risks
Some progress on derivatives/CCPs/OTC
At the same time, because of interventions
Moral hazard increased
Market structures largely similar (same top SIFIs)
Concentration greater

5. Ongoing agenda, in various stages
Market discipline
Accounting (note MtM waived): underway
Rules on rating agencies, role of CoCos: TBD
Better corporate governance of FIS: TBD
Regulatory governance
So far, some moving around of boxes (FSA/BOE)
Or more new agencies (US 7 new, only 1 out)
Little progress on independence (less perhaps), accountability, integrity, and transparency

6. U.S.: 1 less, 7 (?) more agencies
Gone (?): Office of Thrift Supervision
New: Consumer Financial Protection Bureau, Financial Stability Oversight Council, Office of Financial Research, Federal Insurance Office, Investor Advisory Committee, Office of Housing Counseling, Office of Minority and Women Inclusion

7. Problems still to be addressed
Limited progress in fixing deeper “causes”
Resolution: few countries fixed so far
Liquidity: requirements still TBD
Cross-border: little so far (some in EU)
Procyclicality: hard, but much to be done
Only some limits on activities
Little on incentives/compensation
Dynamic provisioning, through the cycle TBD

8. Long-standing issues (still or even more so) to be addressed
Shadow banking system
Perimeter: remains TBD
Macro-prudential policy
Concepts and operations: TBD
Surveillance (national, regional, global)
Mandates, powers, institutional structures: TBD
e.g., ESRB, FSOC, IMF/FSB
Data, analyses: to be set up/done
e.g., OFR, BIS, G-SIFIs, data on interconnections

9. Surveillance in EU: quite complex

10. Costs have risen for provision, while risks may remain
Financial services industries facing higher (compliance) costs, reflected in prices and quantity
Spreads up/higher, access less (good to a degree)
Drag on growth (MAG: 0.3% GDP loss in medium)
Emerging /developing markets affected in medium term
Costs of cross-border/capital flows up (like for Basel II)
Foreign banks: less eager to expand in local markets
Short-run, because deeper causes of crisis not addressed, advanced countries’ 2nd best policies create externalities
QE2, low interest rate → capital flows ↑
Asset prices bubbles, credit booms (and busts?)

11. Issues in the session
Fiscal
Infrastructure
Labor

12. Fiscal policies relate to financial sector: see outcomes to date
Source: Laeven and Valencia (2008 and 2010).

13. Macro policies provided much more support than in the past

14. Which helps explains why NPL’s rose more gradually this time

15. Public recapitalization implemented sooner, with less triage (assets/institutions)

16. Combination made direct fiscal costs generally less than in earlier crises

17. Still, weak financial sector hinders growth: more direct fiscal?
Can direct fiscal support help growth?
Tradeoff between fiscal stimulus and recapitalization/household debt restructuring: what are the relative multipliers?
Scope for more direct financial sector support? Or not for incentives, political economy, other?
Other fiscal policies
No disagreements with paper. There is also a financial sector link with taxation (VAT, levies)

18. Other issues in the session
Infrastructure
As noted, largely Keynesian, less long-term
While big part of discretionary, small part of overall fiscal deficits (in advanced countries at least)
Infrastructure financing to be more public, but:
Tradeoffs with already large fiscal debt/exposures
Efficiency arguments to go other way, so stuck?
Labor
Agree on the impacts of financial crisis on empl’ment
Not sure on the channels, though

19. Current Unemployment Rate (US)
Higher than in Normal Recessions (Year over Year Change; x-axis in quarters, in percent) 1 2 3 4 5 6 7 8 9 10
-12 -8 -4 12
Previous Recessions
Current Recession

20. But Recessions Associated with Crunches and House Prices Busts are Generally Deeper (percent drop)

21. And Such Recessions Have Much Greater Cumulative Output Losses

22. And Unemployment Picks Up More After Crises (percentage point change four quarters after trough)

23. What is driving current unemployment?
Agree: Housing was leveraged sector, and construction is labor intensive, with low substitutability. And yes, mortgage overhang is holding back mobility.
Yet economic situation is similar across US states, even though housing mess localized in few states
Suggests that supply of financing has been hit, in part due to the housing crisis, which is holding back growth, needed for jobs
So: “Could save jobs by restructuring finance”?