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The worldwide banking industry has been significantly impacted by the global financial crisis, the post-crisis market climate, and changes to regulatory frameworks. The CGFS Working Group analysed developments in bank business models, performance, and market structure over the previous decade, as well as their implications for the stability and effectiveness of banking markets.
Structural Change
After the financial crisis, the research identifies numerous significant structural changes in the banking system. First, there does not appear to be any evidence of a systemic retreat from core credit supply, even though many significant banks in advanced economies have withdrawn from trading and cross-border activity. Second, the return on equity of banks has dropped globally, and individual banks have had continuously low profitability and bad investor sentiment, indicating the need for more cost reductions and structural reforms. Thirdly, by the anticipated direction of the regulatory changes, banks have greatly strengthened their balance sheet and financing resilience and reduced their participation in several complicated operations. In addition, the study offers a complete dataset at the country level that includes measures of market structure, balance sheet composition, capitalization, and performance. The data, spanning 21 nations from 2000 to 2016, is supplied in the report’s appendix tables and as a data file for the convenience of use. The report identifies several causes for these changes, including exceptionally accommodative monetary policy, which provided abundant central bank liquidity to the market and reduced the need for banks to trade reserves through the repo market, and changes in regulation, which have increased the regulatory capital requirements for intermediation. When seen from the limited viewpoint of repo markets, the balance between these developments’ costs and benefits is unclear and varies among jurisdictions. It will take more time for the effects of market adjustments to develop. The operation of the repo market has been enhanced by measures taken by some central banks to alleviate the shortage of specific repo collateral, as well as measures taken in some jurisdictions to facilitate monetary policy.
Growing Government Debt
Before 2008, the Great Recession prompted a decline in tax revenues and an increase in social-welfare expenditures, which exacerbated the growth of public debt in several industrialised nations. Some nations, like China and the United States, adopted fiscal stimulus packages, while others recapitalized their banks and essential businesses. Consistent with historical precedent, a debt crisis that originated in the private sector subsequently spread to governments (Exhibit 1). Global government debt more than quadrupled between 2008 and mid-2017, hitting $60 trillion.
Government debt surpasses GDP in Japan, Greece, Italy, Portugal, Belgium, France, Spain, and the United Kingdom, among Organisation for Economic Cooperation and Development nations. Periodically, rumours of imminent national defaults and anti-EU political forces have stressed the eurozone. In the distant future, high amounts of government debt set the setting for contentious debates about spending priorities.
In emerging economies, rising sovereign debt reflects the sheer magnitude of the investments required for industrialization and urbanisation; yet, some nations are also financing huge public bureaucracies and inefficient state-owned firms. Nevertheless, the average public debt in developing nations is 46 percent of GDP, compared to 105 per cent in developed economies. However, there are areas of worry. Argentina, Ghana, Indonesia, Pakistan, Ukraine, and Turkey, among others, have recently come under strain as the combination of big loans denominated in foreign currencies and falling local currencies becomes more difficult to sustain. According to the International Monetary Fund, over 40 per cent of low-income nations in sub-Saharan Africa are in a debt crisis or face a significant danger of falling into it. Sri Lanka recently transferred the management of the port of Hambantota to China Harbour Engineering, a huge state-owned company, after falling behind on the loan used to construct the port.
Banking Crisis
Banks are vulnerable to several hazards. Credit risk (loans and other assets going bad and stopping to perform), liquidity risk (withdrawals exceeding available cash), and interest rate risk are examples (rising interest rates reduce the value of bonds held by the bank, and force the bank to pay relatively more on its deposits than it receives on its loans).
A decline in the value of banks’ assets is frequently the cause of banking issues. A decline in asset values may occur, for instance, as a result of a decline in real estate prices or an increase in nonfinancial sector bankruptcies. Or, if a government ceases paying its commitments, this might precipitate a precipitous decrease in the value of bonds held by banks. When the value of a bank’s assets declines significantly, the bank’s obligations might exceed its assets, resulting in negative capital or insolvency. Or, the bank may have some capital, but less than the regulatory minimum (this is frequently referred to as “technical insolvency”).
A bank’s issues might be triggered or exacerbated if it has too many liabilities coming due and not enough cash (or other easily convertible assets) to meet those liabilities. This can occur, for instance, if many depositors attempt to withdraw their funds at the same time (depositors run on the bank). It can also occur if the bank does not have enough cash on hand and its debtors want their funds. The bank may go insolvent. It is essential to recognise that illiquidity and insolvency are distinct concepts. For example, a bank might be solvent yet illiquid (that is, it can have enough capital but not enough liquidity on its hands). However, insolvency and illiquidity frequently occur together. When there is a significant fall in the value of a bank’s assets, depositors and other borrowers sometimes become concerned and demand their funds, therefore compounding the bank’s problems.
Conclusion
A (systemic) banking crisis happens when numerous banks in a nation simultaneously face severe solvency or liquidity issues, either because they are all affected by the same external shock or because the failure of one or more banks spreads to the rest of the system. Specifically, a systemic banking crisis is a circumstance in which a country’s corporate and financial sectors encounter a high number of defaults and financial institutions and businesses have tremendous difficulty meeting their contractual obligations on time. As a result, nonperforming loans rise dramatically, and all or almost all of the total capital of the banking system is depleted. This circumstance may be followed by lower asset prices (such as equities and real estate prices), rapid increases in real interest rates, and a deceleration or reversal of capital flows. In some instances, the crisis is precipitated by a run on the banks by depositors, but in the vast majority of instances, it is the recognition that systemically significant financial institutions are in difficulty.
