COVID-19 is just the latest challenge to emerge for financial regulators
Banks in markets including the European Union and the US have also been encouraged to tap into the capital buffers they were mandated to establish following the global financial crisis more than a decade ago, and instead now use these funds to help prop up local economies. These regulatory efforts follow others that have had a significant impact on the sector. The EU’s General Data Protection Regulation, for example, which went into effect in 2018, has required banks (and other companies) to be transparent with clients about what personal data they are collecting and why, and to delete that data when a client moves to another bank.
Financial regulators and policy-makers oversee systems routinely shaken by technology innovation, emerging risks (like epidemics and pandemics), disruptive new entrants, shifting global competition and investment flows, and increasingly urgent objectives such as addressing the climate crisis. Many regulators may be tempted to erect barriers amid the COVID-19 pandemic, intended to protect domestic markets from global turbulence. However, a report published by the Institute of International Finance cautioned against such measures, arguing that this would risk creating fragmented approaches that undermine overall stability.
Network of Central Banks and Supervisors for Greening the Financial System, a group that seeks to integrate climate-related risks into supervision and stability monitoring, had garnered more than 40 members by the late 2019, according to a report published by the International Monetary Fund. So-called crypto-assets, or digital currencies like Bitcoin that are protected by cryptography, have also raised regulatory issues. While speculation continues about the viability of these currencies for everyday transactions, they have spurred regulators to take a closer look at related trading and financing. The Financial Stability Board said in 2018 that “vigilant monitoring” of crypto-assets is needed, in light of the speed at which the market has developed.
Financial regulators also have a role to play when it comes to helping address concerns about the worsening impacts of climate change. The Bank of England, for example, has sought to embed climate change considerations in financial decisions made under its purview; the Bank has said this is being done in order to manage related risks and to promote safety and soundness, and to facilitate an orderly market transition to a low-carbon economy.
The impact of climate change is pushing financial firms to get more proactive about related risk. According to a study published in the journal Nature Climate Change in 2018, as much as $4 trillion in global wealth could be lost as a result of stranded assets - hitting energy exporting countries like the US, Russia, and Canada particularly hard. Insurance companies face significant related issues; a report published by Lloyd’s of London in 2017 noted that the increased rates of physical environmental damage incurred around the world could spur higher rates of stranding, directly impacting international insurance markets.
In 2018, the Bank of England published a sobering report on the preparedness of that country’s financial institutions for the impacts of climate change. Only about one in ten banks there were taking a long-term, comprehensive approach to the financial risks tied to climate change by engaging at the board level, publicly supporting more detailed climate-related financial disclosures, and considering how to apply climate-related risk analysis to financial portfolios, according to the report. Former Bank of England Governor Mark Carney warned in 2015 that companies linked to fossil fuels may well end up with reserves that are “literally unburnable” in a low-carbon future, and expose the financial institutions backing them to losses. However, a number of tools are in development to help financial firms better account for climate-related risk.
Banks, asset managers, and insurers all have a role to play in financing the transition to a net-zero carbon emissions future. Working together with the industries they help to fund and protect, these institutions must step up efforts to help reduce energy consumption, tap into more sustainable energy sources, adopt new facilitating technologies, and to generally better appreciate climate change risk.
The challenge described by Carney related to “stranded assets” - or those like coal and oil reserves that may go unused as the global economy shifts to more environmentally-friendly energy use - has broad implications. For example, according to a study published in the journal Nature in 2015, more than 80% of all coal reserves should remain unused between 2010 and 2050, in order for there to be a realistic chance of limiting global warming to no more than 2°C above pre-industrial levels (a target set by the Paris Agreement on climate change).
Financing the Transition to a Net Zero Future
Financial Stability, Risks and Resilience
Central banks, banks, and investors have all faced new challenges as a result of COVID-19
The US Federal Reserve cut interest rates essentially to zero in March 2020, while central banks in other countries including the United Kingdom, Canada, Australia, and Malaysia also implemented rate cuts around the same time. In some ways, central banks - and financial systems generally - were better-prepared for the impact of the pandemic than they had been for the preceding crisis; many regulators had begun applying “stress tests,” for example, which require large banks to regularly report on their stability, in addition to requirements for protective capital.
Attempts to cushion and counter the impact of a global pandemic have underlined the risks inherent in the global financial system. However, they have also highlighted the resiliency added since the last global financial crisis more than a decade ago. Central banks, banks, asset managers, insurers, and investors all have unique challenges when it comes to helping shape the post-COVID-19 world. Central banks, for example, have been looked to as providers stimulus and stability; many have responded to pandemic-related slowdowns by cutting interest rates, in hopes of loosening the flow of money and encouraging spending.
Banks have also been expected to adapt during the pandemic. Many have been asked to eliminate or delay dividend payments to investors, to help the banks retain cash reserves that could then be used both as internal buffers and to make loans to businesses potentially in dire need should the economic situation worsen. In the United Kingdom, for example, executives at banks including HSBC and RBS agreed to give up 2020 bonuses, which in many cases were donated to charity. For bank investors, in addition to new uncertainty about dividends, the faith of many has been tested by market swings corresponding to shifting prospects for an economic recovery.
In Switzerland, for example, the large banks UBS and Credit Suisse each said in April 2020 they were asking investors to accept delays in dividend payments, which was welcomed by the country’s financial regulator. In addition, regulators have expressed a desire for banks to restrict or eliminate bonuses for top executives - a key element of their annual compensation - at a time when job security has become uncertain for much of the global population.
Meeting the Needs of Changing Populations
The pandemic is having an impact on banking services, as is the ongoing shift of wealth to emerging markets.
Demand for digital banking is likely to grow, for example; Deloitte published the results of a survey in Switzerland showing nearly one in five retail banking customers used at least one online service for the first time during the crisis.
The ageing populations in many advanced economies, and growing amounts of wealth in many emerging markets, have forced financial services companies to revisit their offerings. At the same time, rising inequality, new threats to job security, and other social forces have created new demands on these companies.
There are abundant examples of other fast-growing emerging markets (India in particular has made increasingly meaningful contributions likely to continue in the coming years, according to Credit Suisse), which is rapidly expanding the ranks of the global middle class - and there are related implications for global monetary policy and banking services. Dozens of foreign banks have begun operating in China, in hopes of tapping into the biggest consumer and retail banking market in the world. However, they maintain relatively few branches there, and are subjected to significant financial regulations and capital controls that limit their ability to fund their operations from abroad.
As the health of global economy suffers amid the COVID-19 pandemic, pressure on the financial services industry to provide more accessible, equitable services may accelerate; in June 2020, the International Monetary Fund estimated that the slowdown resulting from the pandemic means the global economy will decline by 4.9% in 2020, and that the recovery will be slower than originally anticipated. Meanwhile unemployment levels in many parts of the world are likely to remain elevated indefinitely. While this may affect demand for banking services, the pandemic may also change the ways these services are accessed.
The world’s emerging market and developing economies accounted for 39% of global GDP by 2018, up from about 31% in 2007, according to a report published by the World Bank. China has been on pace to overtake the US as the world’s biggest economy by 2030, according to an analysis published by HSBC, and China overtook the US in 2019 as the country with the most people in the top 10% of global wealth distribution, according to a report published by Credit Suisse.
Financial Innovation and new Business Models
Many established banks have begun making efforts to tap into novel facets of fintech - by partnering with accelerator programs that foster startups, for example, in order gain exposure to talent and develop pilot programs based on artificial intelligence, the Internet of Things, and robotics. Fintech and insurtech products are maturing, and creating new opportunities
Global investment in fintech during 2019 in the form of M&A, private equity, and venture capital deals totaled $135.7 billion, according to a report published by KPMG. While the total number of deals during the year declined compared with 2018, venture capital deal sizes grew as more mature fintech firms took in larger funding rounds, according to the report. A number of these maturing fintech companies in China were expected to go public over the following year in locations including Hong Kong, China, the report noted, and China’s growing population is likely to lead to growing interest in “insurtech” products - which was also anticipated to be a growing focus of investment in India.
Large, incumbent institutions and newer entrants have each invested massively in developing new technologies to deliver financial services. These tools are now shaping how services are being provided around the world - and potentially enabling greater inclusion and efficiency, while creating new risks and questions about proper governance. Financial technology, or “fintech,” has been designed to digitalize and democratize everything from payments to lending.
Quantum computing, which involves manipulating quantum bits that can store more information than standard computer bits, has drawn particular interest from banks (and other companies) due to its potential to crunch information hundreds of thousands of times faster than traditional computing. For example, banks including JP Morgan Chase, Barclays, and Mizuho have joined IBM’s Q Network, a quantum computing system unveiled in 2017 that can potentially be used to accelerate trading and risk analysis. Distributed ledger technologies, like blockchain, have also drawn significant interest. Blockchain, which can provide a record of transactions where every change is explicitly recorded, is being actively explored by banks. In 2018, HSBC announced that together with ING Bank it had successfully executed a live trade financial transaction using blockchain tied to the shipment of soybeans from Argentina to Malaysia.
FINANCIAL AND MONETARY SYSTEMS
In a global view, financial systems include the International Monetary Fund, central banks, government treasuries and monetary authorities, the World Bank, and major private international banks.
How can the global financial system reinforce its contribution to sustained economic growth and social development during a period of significant industry transformation?
Our Platform describes a more efficient, resilient, inclusive and equitable financial system that protects customers, enables saving and investment for sustainable growth, while supporting the creation of jobs, enterprises and the broader multi-stakeholder community.
The management of financial and monetary systems is intimately connected to global risk - in the form of potential market meltdowns or pandemics. In the wake of the global financial crisis more than a decade ago, populist movements cast doubt on monetary institutions like the euro, and critics questioned efforts made by central banks to inject liquidity into markets via asset purchasing programs. Now, these institutions and efforts are being relied upon to help keep international financial waters calm despite the devastating impacts of COVID-19.