ECJ EUROPEAN Cleaning Journal

Almost 80 years since its inception, the global financial system is showing its age and signs of falling into terminal decline. So how can this keystone institution be rejuvenated at a time when its stability has never been more crucial, asks Hartley Milner.

THE FINANCIAL SYSTEM has historically exhibited remarkable powers of recovery from the impacts of traumatic world events. Today, though, its resilience is being challenged by unprecedented waves of volatility and found woefully wanting.

Economists see an era emerging where the likes of the Covid pandemic, the Ukraine and Middle East conflicts, cyberattacks and climate change will conspire to create a ‘permacrisis’ of escalating threat levels. Without urgent reform, financial regimes will be in no fit state to withstand the socio-economic and geopolitical fallout.

A prime mover for change is Udaibir Das, visiting professor at India’s National Council of Applied Economic Research and senior adviser to the Bank of England. Below, Das explains in stark terms why the monetary system must act decisively to preserve its vital economic role: “2024 will be a make-or-break year for the financial sector. It will rise to the challenge of a changing world or fall into irrelevance and chronic stress. The fate of finance and the global economy hangs in the balance.

“The world faces a perfect storm of threats: inflation, policy shifts, war and socio-economic shocks. The financial sector is vital in navigating these dangers by allocating resources wisely, managing risk effectively and creating wealth for future generations.

“But the old ways will not work anymore. The financial sector cannot afford to remain reactive or dependent. It must decide what transformations are essential to stay relevant to the needs of the hour. It must rethink its role and purpose in a market economy. Retroactively picking up the pieces after every period of stress or economic crisis and expecting central banks to save the day is no longer tenable.

Plagued by flaws

“Today’s financial sector is complex and plagued by structural flaws and unfinished reforms. The interactions between the financial sector and the broader economy are more direct and robust. To this end, financial sectors in both advanced and developing countries need support to stay resilient. All the while, the International Monetary Fund warns of higher interest rates and spillovers from other sectors that could amplify the sources of financial stability and bring out the risks endogenous to the financial sector.

“The balance sheets of governments, corporations and households are weak. Assets are overvalued or underutilised, while liabilities outstrip income. The global credit cycle is unstable, as borrowers struggle to repay and financing dries up. These imbalances threaten financial stability, credit and funding patterns and economic growth.

“In developing markets, stability of the financial system has been elusive and inconsistent. As a result, balance sheets reflect the long-lasting consequences of distorted capital allocation and inefficiency. The availability and allocation of finance and credit essential for long-term economic growth, climate resilience and sustainable development goals are also inadequate.

The financial sector’s choices during 2024 will decide the future of finance and the global economy. How prepared will the system be and what will it choose?

“The financial sector will navigate the complex interplay of transitions likely to unfold during 2024 and the lingering macro-financial risks from the Covid-19 pandemic. Market movements could be higher, and risk aversion even tighter. 2024 might be a year when financial agents prefer to watch rather than assume risk. Most financial resources may remain within the system or move across select asset classes, such as real estate, instead of being aggressively used on the needed scale for productive purposes. The transitions during 2024 will have their own respective drivers, dynamics and relationship with financial stability.

“The final phase of post-pandemic financial normalisation still needs to be completed. It requires unwinding the remaining policy support, addressing the debt burden and developing more straightforward approaches to credit cycles and asset pricing.

“Technological turbulence is another transition. It will involve accelerated developments in artificial intelligence, cloud computing, blockchain and biometrics, which will continue transforming the financial system, blurring the industry boundaries and changing the regulation and governance requirements.

“Financial sectors are more interconnected across borders than ever before. However, this may change in a more fragmented and regionalised global finance and trade environment. The finalisation of the pending UK-EU agreement on financial services after Brexit will have regional and broader impacts on how much access, alignment, competition and cooperation there are between different markets and their central banks and regulators.

Ability and will to act

“The environment of these transitions limits the financial system’s ability and will to act in 2024. Political factors and industry interests restrict space for pre-emptive and macroprudential policies and the coordination among authorities and stakeholders. The international standard-setting and evaluation work has stalled, as the global financial governance and architecture are polarised and incomplete and the existing rules and standards could be enforced unevenly and inconsistently.

“Central banks and regulators face growing challenges from their legislatures demanding more accountability. Public mistrust in finance is evident and the view that regulators can be influenced by the industries they regulate at the public’s expense is widely held across advanced and developing countries.

“Despite these limitations, the financial sector can be part of the solution. Climate change and sustainability will demand new production and consumption patterns. The financial industry will finance and facilitate this transition, manage climate-related risks and align with the 2030 Agenda for Sustainable Development.

“Technological innovation and disruption will create new values and advantages, bring new players and change financial behaviour and norms. The financial sector will face technological risks of data privacy, cybersecurity and ethics. It must adapt to improve the financial system’s efficiency, inclusiveness and security. Inclusion and diversity will require meeting all stakeholders’ various needs and preferences while ensuring the quality and affordability of financial services and access for the underserved and underrepresented segments.

“Other external forces besides climate change will shape these transitions. Social and political change across countries will affect the financial system. These shifts include changes in power, alliances and institutions related to money and finance. Migration and urban shifts will move people across and within countries and change the urban and rural dynamics.

“These will change the financial preferences of the population and alter the demand for and supply of financial services. The financial system must then respond and distribute the costs, benefits, rights and responsibilities among different groups and regions without harming social stability and cohesion.

“These transitions and external forces show the macroeconomic role of the financial sector and the close macro-financial interactions. The industry will play a more significant role in capital, liquidity and risk management related to climate change, technological innovation and reducing frictions, costs and barriers to financial transactions and services.

Create new values

“Competition and co-operation among the financial actors and institutions – old and new, incumbents and disruptors, public and private – will affect the financial sector’s market structure and outcomes. The demand for new forms of financial intermediation will create new values and advantages and new issues and dilemmas, such as data privacy, cybersecurity and ethics.

Alignment and integration with global goals and international standards will require coordination and cooperation among the authorities and stakeholders at the regional and international levels.
“These must meet the needs of the changing national and local situations and circumstances. Implementing frameworks such as the IMF’s integrated policy framework and the Bank for International Settlements’ comprehensive and coordinated policy response will address the structural challenges and opportunities of the financial system.

Profound implications

“2024 stands to be a pivotal year for the global financial system in advanced and developing economies. The transitions and external forces will have profound and lasting implications for the financial sector, the economy and society. 2024 will be decisive for the financial industry and its stakeholders to prove their worth and align with the common good.”

United Nations secretary-general António Guterres acknowledges the international financial architecture is “outdated, dysfunctional and unfair” and must become more “inclusive, just, representative, effective, resilient and responsive”. The UN has made reform a priority topic at its Summit of the Future in September, setting out six themes:

• Economic governance, giving developing countries a greater say in the decision-making of international financial institutions and aligning the system with the UN’s 2030 Agenda for Sustainable Development

• Lasting solutions on debt relief and lowering the cost of sovereign borrowing, including via a debt workout mechanism and ultimately a sovereign debt authority

• International public finance, massively scaling up development and climate financing, including through multilateral development banks

• Global financial safety net, ensuring all countries have access to the full capital account toolbox, revamping the role of SDRs (special drawing rights), ending surcharges and setting up a multilateral currency swap facility

• Addressing short-termism in capital markets and sustainable finance

• An inclusive and equitable global tax architecture that combats tax avoidance.

“Conflicts, poverty, inequality, geopolitical fragmentation and climate catastrophe are the result of choices the world makes … or fails to make,” says Guterres.