Global Agenda Council on Financing & Capital 2012-2013
Across developed and emerging economies, the need for economic growth is a universal theme, and capital represents a key necessity. However, distortions in capital allocations, either from the recent economic crisis or before, are still in place in many cases. While small and medium enterprises (SMEs) complain about difficulties in obtaining finance, arguably too much money is allocated towards sovereign debt and other assets perceived as lower risk.
Three main factors contribute to this adverse situation: 1) banks which traditionally provided credit are shoring up their balance sheets to conform to new regulatory requirements, constraining their capacity to lend to enterprises, particularly those with a weaker credit history; 2) the uncertain economic outlook leads to conservative behaviour by firms and investors; and 3) periodic fear of tail risks (such as a eurozone break-up) leads to “liquidity jams” in institutional markets, which need central bank intervention to be unblocked.
The system of financial intermediation is severely impaired and will be difficult to mitigate for several reasons. Additionally, even external guidance will have to be handled delicately to avoid causing distortions in the system. Some issues that should be considered include:
- incentive structures
- the degree that banks fulfil utility functions for the economy
- sources of capital (mainstream or shadow finance) that best match the goals of SMEs, infrastructure and others
- instances where regulatory arbitrage could either be harmful or could help to stabilize the system (by exposing loopholes and bubbles)
- how governance/measurement/reporting standards can improve to make the financial system more long-term oriented and less volatile
- In 1980 there was one regulator for every 11,000 employees in the UK financial sector; in 2011 there was one regulator for every 300 people in finance. In 1935 there was one regulator for every three banks in the USA; in 2012 there are three regulators for every USA bank.
- European banks slashed leveraged lending to private equity by over US$ 50 billion (42%) in 2012.
- The IMF warned that European banks might shrink lending by US$ 700 billion through the end of 2013.
- At the end of the first quarter of 2012, US corporations held a record US$ 1.7 trillion in cash (equivalent to 12% of US GDP). Although a large sum, it is important to note that most of this capital is held overseas and, therefore, not necessarily available to invest within the US.
“One interesting statistic is lending in the Middle East is down 78% from [pre-crisis 2007 levels], and whatever lending is left goes mostly to the large government-related entities and the large corporations. So the small and medium enterprise space is suffering tremendously and SMEs are starved for growth capital. This will have a direct repercussion on their ability to keep on growing and generate more jobs.”
Karim El Solh, Chief Executive Officer and Director, Gulf Capital
“From the creation of the ‘euro-dollar’ in the 1970s, it has been a chess game between capital and governments. It seems to me that if we get to a principle-based regulatory system where everyone can look at conduct and define it, we have a chance. But as soon as we make rules, the practitioners go right around them and create the kind of aberrations we saw in the United States in 2007.”
Steven J. Gilbert, Chairman, Gilbert Global Equity Capital
World Economic Outlook, International Monetary Fund, October 2012
Financial Development Report 2011, World Economic Forum
The Council seeks to address how capital/financing can be allocated in line with economic growth and minimal adverse effects. It will refine its scope across three key dimensions: the supply/demand of financing and capital; trust in the financial system and capital destinations; and allocation mechanisms/frameworks of financing and capital.
A central issue regarding supply and demand is gaps in specific asset classes/capital destinations, the most prominent being SME financing. So far debate on this topic has failed to resolve it, as lending and borrowing have dried up globally and SMEs are suffering. The Council is interested in knowing what the effects might be of the institutionalization of banks on SME financing.
The Council feels that trust in financial systems plays a major role in the non-allocation of capital. The recent crisis demonstrated the complexities of the system and its actors, and the uncertainty caused by a lack of transparency. Clearly understanding the current and future role of banks is key.
Regarding the allocation mechanisms/frameworks of capital and financing, the Council questioned what roles intermediaries now have and how that is changing. The Council considered factors including how the ability to support various financing schemes depends upon a country’s legal framework. For example, outside of the Anglo-Saxon world, it is difficult to employ market-based financing schemes, since courts view and deal with property rights differently.
The overall goal of the Council is to clarify how capital/financing can be allocated in line with society’s needs for economic growth, while minimizing adverse effects. After identifying the key findings, the Council will raise their awareness by encouraging a multistakeholder dialogue. To begin, the Council is designing a session on the role of banks in society in a changing world for inclusion in the programme of the World Economic Forum Annual Meeting 2013 in Davos-Klosters.
Research Analyst: Ethan Huntington, Senior Associate, Global Agenda Councils, firstname.lastname@example.org
Council Manager: Isabella Reuttner, Associate Director, Financial Institutions Industries, email@example.com
Forum Lead: Giancarlo Bruno, Senior Director, Head of Financial Services Industries, firstname.lastname@example.org