Size matters
March 24, 2011
The global financial system is still much more vulnerable to financial shocks than expected, according to experts at the International Monetary Fund (IMF). A new discussion paper states that large financial institutions with vaguely defined borders continue to present a real threat to economic stability.
While it's true that the IMF document outlining these concerns is "just" a discussion paper, it comes recommended by two powerful figures: the fund's chief economist Olivier Blanchard and the head of its monetary and capital markets department, Jose Vinals.
The paper delivers a clear message: Governments around the world are yet to develop a valid model for restructuring troubled financial giants while sparing taxpayers. The consequences of failed risky investments are still not borne by those who made them in the first place.
Few changes
The IMF experts see an urgent need to reduce the complexity of financial institutions, limit the scope of lenders' activities, and improve their capital structures. In most countries, the architecture of the financial system has only changed slightly since the recession, they say.
Adding to that problem is the fact that large financial institutions considered "too big to fail" are now even more densely concentrated than before. Mechthild Schrooten, a professor at the German Institute of Economic Research (DIW), says that's because struggling banks were often bought by large competitors.
"What's interesting is that the number of banks vital to the system has actually increased," Schrooten told Deutsche Welle. "The importance of banks with systemic relevance has increased. After all, we're seeing a wave of mergers in the banking sector... When big banks merge, the result is an even bigger bank that holds even more significance for the system."
Comprehensive government bailout packages for struggling banks have increased pressure on the system. Those banks that were bailed out now represent major public investments, so national leaders are keen to keep them afloat at any cost.
"If the idea was to prevent another crisis by reducing the number of banks vital to the system, then at least in Germany it hasn't succeeded," Schrooten said.
"Right now we still don't know exactly what's hidden in the banks' balance sheets. We can only assume that because banks have been able to offload significant liabilities into so-called 'bad banks,' their balances are better off now than they were two years ago."
New stress test
Whether banks really are in better shape may only become clear at the end of June. That's when the latest results of the European Banking Authority's "stress tests" are due for publication.
The newly-established authority is examining 88 banks including 13 German lenders. The tests simulate a hypothetical recession lasting through the end of 2012. The banks must survive it without losing too much core capital.
Experts say the last round of stress tests was much too lax. Out of the 91 banks probed one year ago, only seven failed. Shortly after the results were released, four struggling lender nearly bankrupted Ireland. All of them had passed the stress test.
Experts say the first stress test was much too easy on banks. Only seven of the 91 banks tested last year failed. Shortly afterwards, however, four troubled lenders nearly bankrupted Ireland. And all four had passed the stress test.
Author: Rolf Wenkel / gps
Editor: Sam Edmonds