Rome Club Report 2018, Chapter 3.11: “Financial Sector Reforms”

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3.11 Financial Sector Reforms

Section 1.1.2 addressed the risks of the monetary system. The system is unstable. This creates asset bubbles. Only an insignificant share in the real economy and the system leads to inequality, increases volatility and, as a rule, procyclical, that is, it strengthens booms and recessions. The financial crisis of 2008–2009 has demonstrated how destructive these features can be. Last but not least, financial institutions willingly donate large sums to companies at significant risk when energy, climate and other environmental issues are taken into account, or invest in them (see Figure 3.6) - with greater risk for shareholders, including pension funds, and the deterioration of air pollution and the destruction of vital ecosystems.

The question is what to do with it? How can the global economy and monetary system be restructured in order to ensure adherence to the principles of sustainability? We, the authors of 'Come On', are not experts in the monetary system - they are far from it. However, extensive reading and discussion with various experts led us to the suggestions below. A number of measures need to be considered. The central solution to the problem of the main factor of "growth" and financial instability: debt.



Deregulation during the 1980s and beyond led to a massive increase in the creation of money. Revenues of banks in OECD countries have more than tripled. The accumulation of private and public debt, which is the other side of the coin, is part of the growth model fueled by loans, which is favored by both center-right and center-left policies. This policy is also supported by most monetary authorities and central banks.

To stop the growth of debt, we need to increase the required reserves and capital ratios, as well as tighten control over the creation of private loans. While the mainstream economists — and the public — seem to assume that lending is funded mainly by savings, this is clearly not true. Banks create money in debt creation - largely from the air. There are restrictions in the form of so-called money multipliers, which are associated with different classes of assets for which new money is intended to finance. These money multipliers are politically controlled and can be used more actively to direct the creation of money towards the real economy, rather than into financial bubbles. But these restrictions became less and less stringent and, as a result, the credit expanded far beyond the needs of the real economy.

The immediate task will be to stimulate banks to create money for real investment, and not for excessive speculation by various types of financial assets and consumer loans or real estate loans. It should be recognized that it is technically difficult to suppress the creation of money for purely speculative purposes. Incentives to find ways to overcome any obstacles posed by policy makers are significant.

Without a doubt, we are racing against time. To stabilize the system, it is necessary to curb the excessive creation of money and debt dependence. On the other hand, if lending were stopped too abruptly, a “liquidity drought” would develop immediately, and asset bubbles could burst, and many banks would fail.

Ulf Dalsten, former Secretary of State in the Swedish Government, describes the problems in the following book in the following way:

“The main problem is that financial markets are becoming increasingly global, while the supply of institutions is mainly carried out at the national level. At the global level, there are no institutions that would make decisions and implement laws and regulations in the general interest. There is no global lender of last resort, there is no Central Bank for managing global imbalances, global liquidity, issues of reserve currencies, international rules, resolutions, etc. on a regular basis. There is an IMF that could take on these tasks, and there is an extensive global network, but no international solution. Financial markets are probably the area in which the need for international market law is the most obvious. International institutions, central banks and regulators need new power structures and new instruments. ”

A number of measures certainly deserve serious consideration for reforming the financial sector.

3.11.1 Separate Commercial and Investment Banking

The separation of commercial banks from investment banks ensured financial stability for more than 40 years after 1933. If commercial and retail banking operations are again separated from speculative investment banking operations, taxpayers will no longer be called upon to save banks destroyed by speculative setbacks. Such banks will cease to be tied to the deposits of citizens who require state protection. These proposals were made in both the USA and the EU. But so far, little has been done. The US Congress actually decided on some measures during the Obama administration, but after the election of Donald Trump and with the Republicans controlling both chambers, efforts are being made to reduce the regulation of financial markets rather than tighten them.

Another step might be to reverse the tendency for more and more large commercial banks to turn away from customer groups such as start-ups and family businesses that are less profitable, but nonetheless very important to our society. This can occur by granting limited banking licenses to specialized banks specializing in certain types of customers or regional areas. Lawmakers and regulators should exercise great caution and selectivity in granting a banking license in relation to both commercial purposes and the geographic area. The trend of the last 50 years has been in the opposite direction. Smaller and more commercial banks are more profitable for the shareholders of these banks, but they are often less efficient in meeting the needs of our society.

3.11.2 Solving the problem of debt

Increasing debt in a company is not necessarily a problem in itself. This can be viewed as a healthy sign of increasing the level of trust in society. More money in the system allows more events: new businesses are starting up, new technologies are being developed, infrastructure is being created, and more people who are potentially able to get out of poverty and want are being created. The problem is how this newly created money is used.

No matter how debt is created, it is a requirement for the real wealth of the future. As Australian economist Richard Sanders explains, "in the simplest analysis, the root of the sustainability problem lies in an exponentially growing set of requirements (money) for the final (and indeed decreasing) pool of natural capital . " Along with this discrepancy to environmental realities, excessive credit leads to a financial crisis and leaves behind an unbearable debt overhang, similar to that existing today.

What was very lacking was the sufficient opportunity to absorb losses in banks due to their excessive debts, while the leverage ratio between 3% and 5% is the norm for the largest banks. This means that most banks can still absorb only about 5% of losses on their balance sheets before they go bankrupt. Efforts are being made to tighten leverage. The new capital adequacy rules expected by Basel IV will undoubtedly strengthen the solvency of the banking system. According to McKinsey, the implementation of the proposed rules will increase the average capital ratio for European banks to 13.4%. This would undoubtedly be a step in the right direction.

However, we would prefer to see four times the leverage. This would greatly contribute to the stabilization of the system and the protection of taxpayers. Whether the changes will be sufficient is difficult to say. However, we would like to see a significant increase in the leverage ratio. We again turn to Anat Admati and Martin Hellwig: “Banks usually ask us to hold 20 percent of the capital when we borrow. We should ask them the same thing. ”

3.11.3 Money Generation Control: The Chicago Plan

The money in circulation today, according to most experts, is several times more than is required to support the real economy. This is largely the result of the uncontrolled creation of money by banks. The proposals discussed above, that is, the tightening of leverage, would undoubtedly help to remedy the situation. If banks had to keep total capital within 20% of their liabilities, the nature of their business would have to change. They will no longer be willing to take risks, as was the case in the recent past.

But many people believe that tightening the leverage system and mobilizing greater equality are not enough to reform the system. They compare the current situation in terms of debt and money creation with the situation during the Great Depression of the 1920s and 1930s. A radical approach to solving the problem of too much debt at the time, which later became known as the Chicago Plan, was proposed by the Nobel Prize in Chemistry Frederick Soddy in 1926. He argued that the creation of money should be returned exclusively to the state. The Chicago Plan was developed in the 1930s, mainly by Professor Irving Fisher of Yale University. However, he was unable to gather enough support in the Roosevelt administration, which instead chose to strengthen the rules of the banks.

After the 2008 financial crisis, the Chicago Plan received new attention. Several NGOs studied this plan and approved it. The analytical center Positive Money has developed a detailed proposal for reforming the British banking system based on the Chicago Plan.

Of particular interest is the recent verification of the Chicago Plan conducted by IMF economists Benes and Kumkhov. They used the modern model of the US economy to verify the findings of Fisher and found support for all his assertions. Taking on the role of creating money, the state will cover all deposits in banks and cancel any risk of banking routes. National debt will be reduced by 40%, and the average household will be free from debt. According to Benesh and Kumhoff, "there will be no losers."

3.11.4 Tax Financial Trade

All over the world, it is preferable to introduce a small “Tobin tax” on financial transactions (possibly from $ 1 million). But recent negotiations show that this will not happen in the near future. It is more realistic to allow some strong countries to start with tax, discouraging speculation, and allow pioneering countries to keep revenues for themselves.

3.11.5 Increasing transparency

The entire derivatives market must be carefully studied to see if any of them serves any purpose other than speculation. Pure speculative instruments can be phased out or taxed, and any derivative instruments that are deemed useful should be moved in sight of properly centralized and globally controlled central counterparties. “The shadow banking system” (about 70% of all banks at the time of the 2008 crash) should be limited to regulation as tough as in relation to the banks themselves.

3.11.6 Independent Regulatory Authority

Regulators are usually taken from a class of bank executives who manage multinational banks. Regulators must be truly independent; To help achieve this goal, long “waiting periods” can be introduced. Bankers do not object to regulation as such, but, as a rule, oppose excessive regulation. Regulators should respect the principle of proportionality. This means that the regulation required for large banks may be somewhat softer for small and medium-sized banks.

3.11.7 Taxation of the rich and tax collection

The combination of tax evasion, tax evasion and secrecy of jurisdictions where assets can be hidden (tax shelters) is a system that, as well as facilitating money laundering for criminals and dictators, can also isolate more legitimate wealth from their social financial liabilities. According to estimates for 2012, from 21 trillion to 32 trillion US dollars were hidden in these jurisdictions of secrecy. Their essential features are low or zero tax and secrecy provided through a maze of dummy companies where beneficial ownership cannot be identified.

Efforts to obtain taxes from TNCs and wealthy individuals (very rich) will require international cooperation and serious use. Representatives of tax-evading corporations always state that they comply with all laws. In many cases this is true, therefore the laws must be changed. As a rule, companies must pay taxes in the country where their profits are.

Ensuring full transparency is the first requirement. Oxfam calls for the creation of a public register of ultimate beneficial owners of companies, funds, trusts and accounts, including those in secret jurisdictions. For 20 years, the OECD has taken the path of reform and is beginning to carry out its automatic exchange of information (between governments, including all the banking data of their residents) and its reporting standards across countries. When they are enacted, expected for 2017 and 2018, it is believed that some of the tax evasion practices that are used today will no longer be possible.

Economist Gabriel Zuckman, however, warns that progress has been glacial and ineffective, and that tax accountants and lawyers, being much better endowed than tax departments, may well bypass these rules - the wealth hidden in tax havens has increased by 25% in recent years. 5 years, despite the actions of the OECD. Zuckman proposes to develop a formula in which the total global profit of TNCs is distributed across the countries where it is earned, negating the avoidance scheme.

This whole system contributes significantly to the growth of inequality. Currently, developed countries are losing revenues that should be directed to health care, education, environmental protection, or other national priorities. Their existing budget deficit would be less serious if these taxes were collected. For the global South, the loss is even more radical, since there is insufficient infrastructure and enough capital to finance sustainable development to ensure the well-being of citizens.

Oxfam called for the creation of a global tax authority tasked with assessing the risks associated with secret jurisdictions. Oxfam recommends disclosing the results as an incentive to those who use and facilitate the use of tax havens. Oxfam favors cooperation with the IMF and the OECD in developing a list of tax havens, so that governments can legislate constraints.

3.11.8 Harnessing the Big Four accounting firms

The historical role of accounting firms was to audit and verify corporate accounts. After the era of financing (Section 1.1.2), only five large firms remained: PwC, Deloitte, KPMG, Ernst & Young (EY) and Arthur Andersen, which broke up in 2002. The remaining four giants, protected by non-transparent partner structures, conduct an audit of 98% corporations with a turnover of $ 1 billion or more. They also assist numerous large corporations in developing tax evasion schemes, such as the Luxembourg schemes, became famous in 2014.

Such schemes cost governments and their taxpayers more than $ 1 trillion a year, according to tax lawyer George Rozvani, an insider who worked for EY, PwC and Andersen. He recommends separating the Accounting / Auditing business from the business of a consultant / tax consultant in all four firms, similar to the reform of the separation of commercial and investment banking.

Such recommendations may depend on whether governments can regain power over the fate of the people they represent and on the ability to make key choices regarding direction and goals. They also depend on the OECD and the IMF to implement and enforce the proposed new rules. As mentioned in section. 2.6.1 and 2.10.3 we need a healthy balance of power between private and public interests, that is, between private business and the state or international bodies representing the states of the world.

Considerable political will is needed to counteract the seizure of many governments by vested interests that will resist change. Unfortunately, financiers were able to overcome the actual crisis of 2007–2008, practically without interfering in their industry, despite the fact that taxpayers supported them with huge sums. The opportunity to insist on the return of control to sovereign governments was missed by representatives under the influence of the financial industry (especially in the United States). It is imperative that governments avoid such an outcome in the event of a next crisis.

To be continued...

For the translation, thanks to Jonas Stankevichus. If you are interested, I invite you to join the “flashmob” to translate a 220-page report. Write in a personal or email magisterludi2016@yandex.ru

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