Is the global financial system any safer than before?

There is more work to be done, but the global financial system is safe, simpler and fairer today than it was a decade ago.

The 2007-08 financial crisis: what was the impact?

The 2007 financial crisis was one of the worst on record. And it was global in nature. Financial markets seized up, world trade plummeted and the global economy went into recession. The cost of supporting banking sectors around the world reached $15 trillion. The impact on people’s lives was severe. Many lost their jobs or saw their wages fall.

What’s been done to fix the global financial system?

A decade on since the start of the crisis, what’s changed?

After the crisis hit, the G20 – made up of the leaders and central bank governors from 20 major economies – set up the Financial Stability Board, which is tasked with monitoring the global financial system and making recommendations to make it serve society better.

Since then, various reforms have taken place. The video below summarises these changes: from the amount of ‘capital’ banks need to have, to new rules on bankers’ pay. While there is more work to be done, the video argues that the global financial system is today safer, simpler and fairer than it was a decade ago.

Bank of England's KnowledgeBank guide, is the financial system safer, simpler and fairer than before.

  • If the financial system can't withstand economic shocks, the results are catastrophic.

     

    10 years ago, when the global financial crisis hit, it spread panic for a banking system built on weak foundations. Global production plummeted. Round the world, the number of people who lost their jobs soared. People took to the streets as governments around the world had to use public funds, your money to save banks from failure, in order to prevent a global depression. A decade on has anything changed? In short yes, and here is how; G20 countries, through the Financial Stability Board have rebuilt the financial system so that it serves society, not the other way round. By fixing the fault lines that caused the crisis, the financial system is now safer, simpler and fairer.

     

    How is the financial system safer?

    A safe banking system needs to have enough capital. That's the money that bank owners put on the line to absorb unexpected losses, so that they can withstand economic shocks, large banks now need to have 10 times more capital than before. In addition, a decade after the crisis, G20 reforms have brought shadow banking, bank-like activity that was away from the gaze of regulators, into the light. Relative to where we were in 2007, the toxic parts of shadow banking have shrunk by 40 percent and been made safer.  And through various reforms, other shadow banking activity has been transformed into resilient market-based finance that is more transparent, robust and useful to the real economy than before.

     

    How is the system simpler?

    In 2007 the complexity of the financial system meant that when the crisis hit, distress spread rapidly. The G20 reforms are driving change. Take the 500 trillion dollar global markets for derivatives contracts, which companies use to manage their risks. Before the crisis derivatives formed a complex and fragile web between banks. If one big bank were to go down panic followed because no one knew which other banks might be next. A decade on, we've untangled this web to create a simple hub-and-spoke model where these trades now go through single central counterparties. Now if a big bank fails the rest carry on operating as before.

     

    What about a fairer financial system?

    A decade ago, it was heads I win, tails you lose, for the big banks. They enjoyed high profits during good times, but during tough times they relied on government bailouts because they were too big to fail. This had to change and it is. We're nearing the point where large banks can fail without bringing down the rest. Today it is no longer the taxpayers, but the banks investors who would foot the bill for the failure, and you can see this in the biggest banks credit ratings which show the fall in the subsidies. A decade on market discipline is back

     

    What about bankers pay?

    Before the crisis, bankers were paid generous cash bonuses regardless of the long-term risks involved. This encouraged short-term thinking, contributing to the Global financial crisis. But now there are new international standards, which mean that bonuses awarded today are paid out in instalments over a number of years. And bonuses can be clawed back, if it emerges that senior people haven't behaved responsibly. While there remains more to be done, a decade on, individual responsibility is returning.

     

    To summarise, G20 countries have led a reform effort to fix the fault lines that caused the last crisis. The financial system is now safer, simpler, and fairer. But just as a footballer needs to focus on where the ball is going, not where it is now, we are scanning the horizon for new and emerging risks and addressing them before they get out of hand. That way the financial system can concentrate on serving households and businesses. So you can concentrate on what really matters to you.

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