Issue Overview

The global financial system consists of the establishments and regulators that oversee all private financial institutions operating on a global scale. Today, the governance and structure of this system are rapidly evolving in response to the debt crisis in the eurozone, the lingering effects of the 2008 financial crisis and the associated risks to financial stability and economic growth that continue to weigh down global markets.

The roots of the current crisis are numerous:

• Excessive pre-crisis expansion of private-sector credit, much of it mispriced, which generated unsustainable economic growth and fiscal expectation
• The fiscal implications that broadened the financial crisis into one embracing sovereign debt, which in turn caused additional damage to the balance sheets of banks holding such debt
• Concern over sovereign credit ratings and further damage to the banking system, which forced policy-makers to provide additional official assistance and to radically increase banks’ capital requirements

Within this context, the International Monetary Fund declared in September 2012 that remaking the global financial system remains a work in progress. Given the global nature of the financial and economic turmoil, new approaches and solutions from both governments and the private sector are required.

However, the financial crisis has revealed significant limitations in the current regime of global coordination and financial regulation. The progress made to stabilize financial markets at the national, regional and global levels has often proved misaligned. Approaches aimed at developing national regulatory frameworks have often departed from the international regulatory harmonization and coordination that the G20 and the Financial Stability Board, in particular, are seeking to achieve. While some progress has been made, significant gaps remain in the global regulatory architecture requiring further efforts by all actors.

Did You Know?

• The overall size of the financial system is impressively large: there are 7,100 banks in the US alone. The US has 82,000 bank branches, and China more than 65,000; there are 10,000 hedge funds and 4,100 private equity firms. 
• Some 1.645 trillion euros of European sovereign debt in Belgium, France, Germany, Greece, Italy, Spain and the United Kingdom is held by European banks. 
• In the US, shadow bank liabilities equal traditional bank liabilities at US$ 14 trillion.

Quotes

“A lot of people seem to have preconceived notions about where we want the boundaries of our banking system drawn and then they work backwards from that to try to argue in favour of whatever it is – narrow banking, traditional banking, universal banking, ring fencing. They all seem to have something in mind, without first bringing it back to the principles we are trying to accomplish.”
Darrell Duffie, Dean, Witter Distinguished Professor of Finance, Stanford Graduate School of Business, USA 

“In many countries, large financial institutions are effectively off-balance sheet obligations of sovereigns, but at the same time these institutions hold large amounts of sovereign debt. This interconnection creates a potentially dangerous cycle: if the sovereign gets into trouble, the riskiness of the banks increases. But this also increases the likelihood of a government bailout that would only cause the sovereign to get into even more trouble. Similarly, if the banks get into trouble, the sovereign also may be put at risk, in turn deepening the banks’ troubles. Hence, a negative shock to either the sovereign or the banks can lead to a vicious cycle of sovereign and bank downgrades that can spiral out of control.” 
Dr Randall S. Kroszner, Norman R. Bobins Professor of Economics, University of Chicago Booth School of Business

Further resources

Latin Lessons
Are Banks Affected by Their Holdings of Government Debt?
Shadow Bank
Regulating Shadow Banking
Global Financial Stability Report: Restoring Confidence and Progressing on Reforms

Calendar

International Monetary Fund and World Bank Annual Meetings
9-14 October 2012
Washington DC, USA

G20 finance ministers and Central Bank Governors' meeting
4-5 November 2012
Mexico City, Mexico 

Council Insights

Focusing on the nature of the systemic risks that continue to threaten the stability of the global financial system, the Council on the Global Financial System will convene leaders from government, business and academia to consider efforts by international institutions and regulators to reshape the financial architecture of the global economy. It will seek to build a more stable system that can protect the global economy against similar crises in the future. 

The Council will explore several issues, beginning with the relationship between financial institutions and sovereigns. This issue is particularly topical in Europe, and touches on fiscal and financial aspects as well as the relationship between how financial regulation may affect the financing and the credit worthiness of the sovereign. It also raises various issues, such as the role of large financial institutions, cross-border resolutions, leveraging and the future role of finance in society. To provide a roadmap for what should be recommended, policy reactions to past financial crises will be examined. 

The key areas of work will include:

• Discussions on the issue of “complexity in the financial system” with Members of the Global Agenda Councils on Financing & Capital and on Complex Systems
• Scrutiny of the world of shadow banking, including in the context of the current World Economic Forum project on Alternative Investments 2020
• Provision of inputs to “The Role of Finance in Society” project, as well as exploration of linkages with other Global Agenda Councils, with emphasis on the specific issue of trust in the banking sector 

Contact Information

Research Analyst: Ethan Huntington, Research Analyst, Global Agenda Councils, ethan.huntington @weforum.org 
Council Manager: Andre Belelieu, Senior Community Manager, Financial Services, andre.belelieu@weforum.org
Forum Lead: Giancarlo Bruno, Senior Director, Head of Financial Services Industry, giancarlo.bruno@weforum.org