The quest for financial stability, economic growth, and returns on investment in the post-crisis global economy Jonny Greenhill is Policy Director at the Business and Industry Advisory Committee to the OECD (BIAC). Gianluca Riccio CFA is Vice-Chair of the BIAC Finance Task Force, and Head of Strategy & Framework in Commercial Banking Risk, Lloyds Banking Group “Unusually weak” were the words chosen in June this year by OECD Chief Economist Catherine Mann to describe the recovery from the 2008 global financial and economic crisis. Broadly speaking, the world has been experiencing a strikingly slow, tepid, and uncertain return to growth and job creation. Business investment – a key driver of growth, jobs, productivity, and wellbeing – has not rebounded nearly as quickly or as forcefully as any of the other major recoveries witnessed over the past four decades, including the post-1973 oil crisis recovery. The recent volatility in financial markets generated by China’s economic slowdown has also revealed the continued fragilities in the global recovery. Since the outbreak of the 2008 crisis, countries have harnessed fiscal, monetary, and structural policy levers to steer their economies onto a more sustainable footing. At a global scale, these actions appear to be generating results: latest forecasts by the OECD, IMF, and World Bank all expect growth to gain some momentum in 2016. But, they say, the return to sustainable growth will be slow. There is an urgent need to strengthen the pace of what is currently a lacklustre recovery. To do so, many discussions rightly focus on reducing policy uncertainty, cutting red tape, and introducing product and labour market reforms. But there is another key aspect in this debate that needs to be urgently understood and addressed: how to revive the financing of our economies. It may be obvious, but let’s recall that all actors in markets – ranging from homeowners and pensioners to businesses and governments – use financial services to access credit and/or allocate money. Quite simply, financing is an integral part of growth and wellbeing. But in recent years the financial system has undergone profound change, mainly as a result of new regulatory initiatives. Could constrained financing be one of the main reasons behind the world’s meagre recovery? Financial reforms and their combined consequences The financial system was at the epicentre of the 2008 crisis. Unsurprisingly and rightly so, the reaction of G20 leaders was to strengthen financial stability. The main result was the internationally-agreed Basel III reforms in the areas of capital, liquidity, and leverage. According to Mark Carney, Chair of the Financial Stability Board (FSB), the impact of the internationally-agreed reforms is that the financial system is now safer, simpler and fairer. Stefan Ingves, Chairman of the Basel Committee on Banking Supervision, similarly notes that “the main components of Basel III are essentially done”. Many countries and regions then took additional measures intended to bolster stability. In the EU alone, the European Commission has proposed more than 40 major legislative and non-legislative measures since 2008 (this does not include measures taken by individual European member states). The worry is that the myriad post-2008 financial regulations around the world may cumulatively, and unintentionally, undermine the global economic recovery. While the focus on regulations for financial stability was needed, they are all-too-often uncoordinated. There also appears to have been an underestimation of their potential unintended consequences. Both the sheer volume and inconsistencies of such regulations may be hampering the ability and confidence of firms and individuals to invest, hence curtailing economic growth. This discussion is not new. Since the 2008 crisis, the financial industry has been very vocal about the unintended consequences of financial regulations. But what is new is that other actors have also started to sound the alarm. For example, Jonathan Hill, European Commissioner for Financial Stability, Financial Services and Capital Markets Union, recently highlighted the pressing need to “understand the combined impact of our rules and the consequences, sometimes unintended, of interactions between different pieces of legislation, as well as the cross-border inconsistencies in rules or in their implementation”. In addition, Randall Kroszner, former governor of the US Federal Reserve, has added that “we always need to consider unintended consequences and cost-benefit trade-offs, even for extremely well-motivated rules”. The issue is essentially one of coordination. Where financial regulations and economic policies are poorly coordinated, our economies and societies run the risk of regulatory arbitrage, competitive distortions, fragmented policies, unintended side-effects, and potentially destabilising bubbles. A more coordinated approach for financial regulation Imagine that the global economy sits atop a three-legged stool. The legs represent three pillars of the financial system: [1] financial stability; [2] economic growth; and [3] return on investment. The global economy can only sit sustainably atop the stool if the three legs are balanced in relation to the ground they stand on. Figures 1 and 2 present the three legged stool in the form of a triangle. Figure 1 shows an equal balance between all three pillars, represented by the equilateral triangle. Figure 2 presents a situation where financial stability is over-emphasised to the neglect of economic growth and returns on investment, thereby skewing the triangle and generating unintended consequences. Where attention is only devoted to strengthening the pillars of economic growth and return on investment, to the neglect of financial stability, the global economy may at some point slip off the stool into a financial and economic crisis (as was the case in the run-up to the 2008 crisis). Conversely, where attention is only devoted to strengthening financial stability without equal attention to economic growth or return on investment, the result may be a safer financial system but the global economy may slide into economic stagnation. Where there is focus only on strengthening financial stability and economic growth, but insufficient attention to return on investment, the global economy may eventually topple as ultimately investments are not paying sufficient returns to support growth. Finally, if attention is only devoted to returns on investment, financial sector returns may not feed into broad-based economic growth, may lead to inequalities, and may generate instabilities. The purpose of this analogy is simply to show that governments’ policies for growth, regulators’ approaches for financial stability, and the finance sector’s need to generate returns on investment, are all inherently interlinked. To properly address any one aspect in this ‘triangle’, a coordinated and comprehensive approach involving all actors is needed. Today’s lifeless recovery may therefore reflect an imbalance in the triangle. Efforts to enhance economic growth may be unintentionally offset by measures to strengthen financial stability, and as a result the stool or triangle is unbalanced. The challenge is not to reverse the greater financial stability achieved in recent years, but rather to ensure that stability can proceed hand-in-hand with economic growth and return on investment. Case and point: SME financing Accounting for 60 to 70 percent of employment and over 50 percent of value-added in OECD countries, SMEs are vital for growth, investment, productivity, and jobs. They are therefore central to the recovery of the global economy. But to deliver much-needed growth, SMEs need to be able to access the financing they require to support their business growth and risk management activities – not only domestically, but also across international markets. Worryingly, SME financing has still not recovered to pre-crisis levels in several countries. In Spain, for example, new lending to SMEs fell by almost 65 percent between 2007 and 2013. Research indicates that this widespread decline can be largely attributed to banks deleveraging to meet new banking regulations and reduce their risk exposure. SMEs are hard hit because they rely mainly on bank financing in most markets around the world. An SME expects the financing it receives to be safe and predictable – that’s what financial regulations and supervision are intended to deliver. But an SME also expects that it can access financing without unduly burdensome costs or obstacles. Meanwhile, a bank lender expects the SME client to provide sound information about its creditworthiness in order to meet financial stability requirements. And both parties expect that their relationship should generate appropriate returns on investment relative to the amount of risk involved. One example where regulation is having an unintended impact on SME financing is in the area of Know Your Client (KYC) conduct regulations. While these rules are of paramount importance, their insufficient coordination has led to costs for opening simple accounts in different markets to levels that are significant (and in cases unsustainable) for smaller SME players. A vicious cycle therefore exists, whereby an SME cannot tap into global markets because it is unable to secure the necessary financing to do so, leading to negative impacts on its competitiveness and productivity. The Business and Industry Advisory Committee to the OECD (BIAC) and the B20 Turkey are leading discussions on how to revive SME financing across global markets. A recent BIAC-B20 Turkey publication identifies three recommendations to G20 Leaders to expand their focus from gatekeepers of stability to also being enablers of growth and investment: Firstly, focus on coordination, consultation, and impact assessment. Policymakers should recognise the broader economic impacts and cumulative effects of policy and regulatory approaches – both domestically and across borders – within the nexus of financial stability, economic growth, and return on investment (think of the triangle mentioned earlier). Impact assessment and consistent implementation play an essential role in mitigating against unintended consequences of regulations, and thus an international principles-based implementation process for financial regulation should be introduced. Secondly, raise SME access to finance and skills through an integrated approach that ensures seamless financing to SMEs along global value chains. This may include, among others, greater use of credit insurance, partnerships among financial service providers, high-quality securitization, guarantees, and equity crowdfunding. It may also consist of measures for investing in skills – both financial and digital. Thirdly, maximise the sharing of information through digital platforms to enhance the flows of financing, skills, and investment throughout global value chains. A central global online platform for data and information exchange could be introduced, while existing platforms could be reviewed to strengthen coordination. Future directions Financing has an invaluable role to play in supporting and enhancing the global economic recovery, yet there is too little known about the ways in which the unintended consequences of financial regulations may be affecting the recovery. The retreat of SME financing in many countries may be one such consequence. Most crucially, comprehensive and coordinated approaches are needed to mitigate against such unintended consequences of regulations, built on close dialogue between regulators, governments, and the private sector. Having championed international cooperation in the midst of the 2008-09 crisis, the G20 should rekindle that spirit to coordinate approaches for stability, growth, and investment. Government leaders should seize the opportunity to put this dialogue into motion at the G20 Leaders Summit in November this year in Antalya, and to carry it forwards during the Chinese G20 Presidency next 
year.
Having championed international cooperation in the midst of the 2008-09 crisis, the G20 should rekindle that spirit to coordinate approaches for stability, growth, and investment

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Figure 1: Visualizing three factors necessary for sustainable economic growth, financial stability and returns on investment Figure 2: The current state of play

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