Lessons learnt from global financial crisis

Rachna Singh

More than a decade has lapsed since the Global Financial Crisis (GFC) of 2007-2008 and yet the world has not completely recovered from the far-reaching rampage caused by it. On the flip side, the crisis has taught the economists, policymakers and bankers of the world a lesson or two in financial risk management. Not surprisingly, books and treatises, analysing the causes and ruminating on the after-effects of the crisis, abound. And yet, ‘Systemic Risk and Macroprudential Regulations: Global Financial Crisis and Thereafter’ by Rabi N. Mishra makes you sit up and take notice. For one, the book is authored by the first chief general manager of the Financial Stability Unit of the RBI set up in the aftermath of the great financial crisis. Also, the writer was instrumental in collating data and models to assist regulators in ascertaining the risks to the Indian financial system and so offers a practitioner’s insights into the global event. More importantly, the author propounds a holistic macroprudential approach that would offer a better tool kit for risk management in the contemporary interconnected global milieu, instead of the silo based micro-prudential approach preferred in the pre-crisis ecosystem.

As a prelude to his argument in favour of a macroprudential policy, the author elaborates upon the factors that led to the debilitating financial crisis which spread like a contagion all over the world. Mishra believes that the major vulnerabilities in the pre-crisis financial eco-system were the dependence on short-term and unstable wholesale funding through unregulated shadow banks and the proclivity for acquiring assets linked to real estate. This reliance on short-term funding to purchase financially engineered assets without sound risk management system produced the perfect recipe for financial disaster. What exacerbated the problem was the leverage that existed in the system. The shadow banks, unfettered by regulations, readily offered credit to the NINJA (persons with no income, no jobs, no assets). Faced with increasing competition from the shadow banks, the regulated banks engaged in regulatory arbitrage and instruments that qualified as capital but were unable to stand the test of loss absorption. The lack of crisis management tools for consumers, like deposit insurance, compounded the problem. The US was the first country to buckle under what is now known as the sub-prime crisis. The author sums up the factors of the housing price bubble in the US which triggered the GFC — government’s push towards affordable housing, weak underwriting standards, resultant increase in house prices and construction, excessive reliance on credit ratings and the innovations in the financial market such as securitisation.

Interestingly, the book engages the attention of the reader with its logical evaluation of the moral hazards associated with the collapse of institutions believed to be TBTF (too big to fail), like Lehman brothers, which was at the heart of the crisis. As such a collapse would have widespread impact, the government is bound to bail out such institutions, thus creating a moral hazard — if creditors believe they will be rescued, there is no incentive to curtail risky endeavours. Mishra also very rightly points out that the discourse on the crisis has been limited to pointing out the gaps in the regulatory mechanism, which has resulted in more stringent regulations. However, supervisory and governance lapses have been overlooked completely. The author also strongly believes that regulatory brief should not be limited to managing price stability but should aim for overall financial stability which would necessitate policy coordination at the national and international levels. The book, in fact, offers an in-depth examination of the sources of systemic risk and provides a framework to manage such risk through macroprudential regulation and co-ordination with monetary policy authority. The dynamics of such co-ordination are also discussed at length. 

The epilogue of the book looks ahead to the potential risks emanating from a changed global financial scenario, where big data and concept of block chain technology have been integrated with banking services, making the system open to cyber attacks. The author mulls over the impact of cryptocurrencies, demise of physical currency, rise of Fin Techs, relevance of money aggregators, etc. Mishra concludes his book with some sound advice to the Central Banks. The need of the hour is for the central banks to emerge from behind ‘gilded doors’, collaborate on research and testing with peer banks and private players to ensure it is not left ‘behind the curve’ and hence redundant. Such an approach would not only facilitate the creation of a safer global financial system but also help launch economies into a new phase of development.

An eminently readable book for practitioners as well as students of economy.