Policy, Risk & Future of the International Banking System

By Don Alexander, MBA
Associate, RSD Solutions Inc.
Mr. Alexander also lectures at NYU and SunySB

The international banking industry faces a challenging future, having to consolidate at a time of heightened global financial volatility, anemic growth in advanced countries, and shifting global growth balances. After a long period of sustained expansion and accommodating regulatory treatment, the structure of   international banking is changing as global banks’ business strategies shift toward fast-growing emerging-market economies. 

The center of gravity for international lending is shifting, with the role of European banks shrinking and American, Japanese, and emerging-market banks filling in the space.  These issues were raised in a recent World Bank Economic Premise called What Does the Future Hold for the International Banking System  by Mansoor Dailami and Jonathon Adams-Kane (October 2012).

As the international banking community goes through a long-period of soul-searching and introspection in an effort to understand the causes and consequences of the 2008 global financial crisis, in which international banks were at the epicenter, looking ahead to anticipate the configuration of the international banking system would help to formulate regulatory reforms to strengthen the banking sector itself, but also to inform the current debate on international macroeconomic policy. The forward-looking analysis contains a policy warning regarding the current mix of fiscal and monetary policy stances in the context of ongoing deleveraging by banks. By now there is a fair degree of consensus that progress in fiscal consolidation in advanced economies is likely to be slow, painful, and charged with political tensions as austerity kicks in.

Against this backdrop, the current debate on adding economic stimulus to support the global economic recovery should consider the possible contractionary impacts of bank deleveraging, even with global interest rates remaining at historically low levels.  The timing of the deleveraging cycle currently underway is poor in terms of its impact on near-term global economic conditions.  Deleveraging among banks is reinforcing the contractionary economic environment already at work in the form of tight government budgets.

At the same time, there is a limit to how much monetary policy can be relied upon to simultaneously provide macroeconomic stimulus and address the specific needs of sovereign and banking finance, especially given the ways central banks have intervened to stabilize financial markets . The important implication that emerges from the current policies and public debt profiles is that the banking sector may bear a significant part of the burden of elevated sovereign debt distress. For euro area banks affected by sovereign debt distress, the most visible sign is deteriorating funding market conditions, significant credit rating downgrades, and a decline in market capitalization. Indeed, given the significant international presence of European banks and their role in global interbank markets, the potential for spillover of the negative feedback loop among public finances, the financial sector, and the real economy currently underway in the euro area should be of concern to the broader international policy community and risk managers.

www.siteresources.worldbank.org/EXTPREMNET/Resources/EP94.pdf