Charting a path out of the crisis

Editor's Note: Costas Stephanou is a senior financial economist in the Financial and Private Sector Development Vice Presidency of the World Bank Group.

The World Bank Group (WBG) has just released the first batch of a series of policy briefs on the financial crisis, whose aim is to assess government responses to the crisis, shed light on the financial reforms currently under debate, and provide insights for emerging-market policy makers. The first three papers cover a lot of ground in a short amount of space—sizing up the global policy response, forecasting what future financial systems will look like as a result of these policy responses, and determining how financial regulation will evolve. They will be followed by papers, written by different authors inside and outside the WBG, which will take ‘deep dives’ in specific crisis-related financial sector topics.

• Dealing with the Crisis: Taking Stock of the Global Policy Response provides an overview of the immediate financial sector policy responses to the financial crisis—including emergency liquidity support, expansion of financial safety nets, and interventions in financial institutions—that have succeeded in stemming widespread panic. But the effort has generally been ad hoc and insufficient. Issues that remain include the resolution of problem assets, the restructuring of troubled, systemically important financial institutions, and the development of credible exit strategies. Only a handful of countries have attempted to tackle these issues head-on. As past experience has shown, that may well have negative repercussions for the duration and strength of a subsequent recovery.

• The Reform Agenda: Charting the Future of Financial Regulation reviews the crisis-induced shift toward a tighter and more macro-prudential approach to financial regulation. But the reform agenda still needs to address the role of supervisory (rather than regulatory) failures, while the institutional arrangements needed to implement the new framework remain to be worked out. For most emerging economies, the existing reform agenda—developing institutional and legal underpinnings for the financial system and promoting financial access—remains valid. But for those characterized by weak financial oversight structures and more volatile economic cycles, adopting capital “buffers” as part of a macro-prudential regime may be a useful complement.

• Safe but Smaller? The Shape of Financial Systems to Come describes how global trends taken for granted in recent decades—the big expansion in global financial assets compared with underlying economic activity, growing global financial integration, shrinking role of the state in financial systems, and rising share of cross-border ownership of financial institutions—may reverse over the foreseeable future. In addition, the structure of financial systems, particularly in developed countries, will likely become oriented less toward capital markets and more toward traditional (and simpler) banking activities. The impact on economic growth and overall welfare is likely to be negative—perhaps the price we have to pay for living in a brave new (and presumably safer) financial world.