Does financial reform entail real change?

Joseph F.X Zahra's blog on Newsbook

A year after issuing its “Proposals on Finance and the Common Good”, theCentesimus Annus pro PontificeFoundation once again invited the Dublin Group on Finance and the Common Good, a group of bankers, banking supervisors, financial economists and specialists in financial ethics to a consultation meeting, this time hosted by the Governor of the Central Bank of Malta. What I will be publishing here in three parts is a summary report of the conclusions of this Valletta meeting. I have no authored this report, but as a member of the Dublin Group, I feel comfortable with these conclusions.

The crisis context is still more urgent and tragic in 2016 due to the European refugee influx which is not an isolated problem, but forms part of a broader set of social problems we face in a post-secular society. In this context, with long term views postponed by the urgency of immediate needs, Pope Francis has “an emotional connection with people around the world, whether Catholic or not”; he was described as “the most prominent figure addressing issues that have dominated global debates since the financial crisis began” (Worth magazine, 5.10.15). This gives added audience to Catholic Social Teaching and opens new possibilities of change, but the challenge remains: how are these calls to be implemented?

Pope Francis starts from an anthropology where primacy is given to the human person, and where money should not be idolized. These principles have universal value. He says that the market will not, by itself, succeed in bringing about greater justice and inclusiveness: in fact, economists know that choices concerning common goods cannot be solved by regulation or price, but only through a decision process based on ethics. The preferential option for the poor is essential to the Christian view, but not to foster a passive state of dependency on welfare; the Pope says that helping the poor financially “must always be a provisional solution in the face of pressing needs. The broader objective should always be to allow them a dignified life through work” (Laudato Si,128).

No doubt, financial reform does entail real change and banks are in the middle of a resource-consuming implementation process. The financial sector is stronger. But there are also some unintended negative effects.

The two phases of the policy response were, first, stabilization by means of liquidity injections by the Central Banks and, second, strengthened regulation, unified supervision, resolution, data gathering and stress tests. Contrary to popular belief, the carnage wrought on bank valuations shows that public money was used essentially to protect depositors, not shareholders. The system is now better capitalized and more solid. But is stabilization all that needs to be done? And must the policy response address only banks?

While successfully reaching their immediate aim, the stabilization plans however have left a legacy of problems: a possible risk of new asset bubbles, excessive bank holdings of public debt and an unsustainable overall debt mountain. Increased capital requirements are causing credit rationing and high spreads for low-grade borrowers (often SMEs). An increased weight of compliance risks is squeezing out smaller financial agents and bringing about more concentration. On a longer view, the hidden causes of the crisis, which made the system so vulnerable, still need to be addressed: they ask for a rethinking of the functions society requires of a good financial system and how resources should be allocated.

Conventional banks today are just one variety of financial agents. A large sector of unregulated lending is developing in the corporate world. The digital revolution, with the creation of an indefinite number of new means of payments and the increased knowledge of potential customers by financial institutions will pose a number of new regulatory and ethical questions.

The next steps in the reform process will probably lead to extend the supervision perimeter and set additional limits to some purely speculative activity. However, the problem is not so much to introduce more regulation, but better regulation. There might be a degree of hubris in believing that regulation is sufficient to reform the financial system. A good regulatory framework can be a complement, but never a substitute to a solid set of ethical values. There is a need to rethink regulation holistically in view of the aims and to find a balance between previous deregulation and present re-regulation.

The principles set in reform programs adopted by the G20 or the European Union are ambitious and truly intend to put finance at the service of the economy, but the actual process does not yet meet all of these aims and there still is a big accountability gap. There being no “perfect” financial markets, the remaining problems of the past and the new problems posed by digitalization and an integrated approach to inclusive finance will need more than ever the construction of a financial professional ethos underlying a continued, permanent reform effort.

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