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News : International Last Updated: Sep 24, 2009 - 5:05:58 AM


G-20 Pittsburgh Summit: Europe and US rift on bank capital; IMF says banking crises leave “long-lasting scars”
By Michael Hennigan, Founder and Editor of Finfacts
Sep 23, 2009 - 6:35:40 AM

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G-20 Pittsburgh Summit: Leaders from the Group of 20 leading developed and emerging who meet this week on September 24-25th, Pittsburgh - - the former steel capital of the US- - are expected to agree that banks should hold more capital to protect against future losses but a rift has developed between Europe and US on the issue. Meanwhile, the IMF said on Tuesday that banking crises usually leave “long-lasting scars” and affected countries endure steep drops in output, that do not rebound for at least seven years.

"A principal lesson of the recent crisis is that stronger, higher capital requirements for banking firms are absolutely essential,"the US Treasury Tim Geithner said in early September.

He said the rules used to measure risks embedded in banks' portfolios and the capital required to protect against them must be improved. Risk-based capital requirements should be a function of the relative risk, including systemic risk, of a banking firm's exposures, and risk-based capital rules should better reflect a banking firm's current financial condition.

The procyclicality of the regulatory capital and accounting regimes should be reduced and consideration should be given to introducing countercyclical elements into the regulatory capital regime.

On Tuesday, Sept 22, 2009, US Treasury Secretary Tim Geithner and Energy Secretary Steven Chu, who is also a winner of the Nobel Prize in Physics, hosted a group of clean energy developers and manufacturers at the White House to discuss how the $787 billion stimulus program, officially known as the American Recovery and Reinvestment Act (Recovery Act) is creating jobs and helping expand the development of clean, renewable domestic energy. At the meeting, Secretaries Geithner and Chu announced $550 million in new awards through the Recovery Act's 1603 program, bringing the total to more than $1 billion awarded to date to companies committed to investing in domestic renewable energy production.
Geithner said he wants leaders to agree on new standards by the end of 2010, a target other G-20 officials also have in their sights. Implementation would come by the end of 2012.

As US banks were required to hold more capital than most of their foreign competitors before the crisis, European banks have a longer way to catch up. Europeans also say US banks maybe at an advantage because the US has recapitalisd many of them with taxpayer money.

"All the banks in the world will need to be more capitalised than they were pre-crisis," French Finance Minister Christine Lagarde said last week. But she added: "It would be the ultimate irony if as a result of one particular set of rules we favour one group [of banks] that had to be massively restructured through public funding to the detriment of others."

The Financial Stability Board, a committee of financial regulators created by the G-20, is expected to present proposals on capital to the summit and recommendations on how to limit bonuses in order to discourage excessive risk-taking.

IMF

The global financial crisis is likely to leave long-lasting scars on the world economy, but governments can act to stimulate a quicker revival and counter output losses, according to a new IMF study.

The study finds that banking crises typically have a long-lasting impact on the level of output, although growth eventually recovers. Lower employment, investment, and productivity all contribute to sustained output losses. While there is a strong association between the initial economic conditions and the size of the ultimate output loss, short-run macroeconomic stimulus and sustained structural reform efforts may help reduce ultimate output losses, according to the study released as part of the IMF’s World Economic Outlook (WEO).

The findings, according to authors Ravi Balakrishnan, Petya Koeva Brooks, Daniel Leigh, Irina Tytell, and Abdul Abiad, suggest that the forceful macroeconomic policy response so far may help mitigate the losses. Implementing structural reforms could also help to limit output losses, says the report, “What’s the Damage? Medium-term Output Dynamics after Financial Crises,” published as Chapter 4 of the WEO.

How strong a recovery?

The IMF will publish its full global economic forecast on October 1st in Istanbul. But even as the global economy begins to recover from the most severe financial crisis since the Great Depression and the deepest recession since World War II, financial systems remain impaired and domestic and external imbalances persist in many economies.

In this context, the study uses the aftermath of past financial crises to provide useful insights into the medium-run prospects for economies currently recovering from the present crisis. Specifically, what happens to output over the medium run following financial crises? And what can be said about the role of policies after a crisis?

New evidence

To answer these questions, the study looks at the medium-term output dynamics after 88 banking crises in advanced, emerging market, and developing economies over the past 40 years. The research also seeks to explain the substantial variation in medium-term outcomes, relating it to pre-crisis conditions and post-crisis policies.

For the average country, output per capita declines by about 10 percent of its precrisis trend and fails to rebound seven years after the crisis, although there is a large variation in outcomes across crisis episodes. This result holds for both advanced and emerging economies.

The good news is that, on average, banking crises do not seem to permanently decrease medium-term output growth, although the variation across country experiences is again substantial.

Jobs hit

The depressed path of output after a crisis results from reductions of roughly equal proportions in the employment rate, the capital-to-labor ratio, and productivity.

While productivity may recover somewhat toward its precrisis trend over the medium run, capital and employment suffer enduring losses relative to the previous trend because the crisis depresses investment as the supply of credit becomes more limited. Also, the typically large increase in the actual unemployment rate tends to persist for a long time, as the crisis implies a substantial reallocation of labor across sectors.

Initial conditions have a strong influence on the size of the output loss. What happens to short-run output is a reliable predictor of the medium-term outcome. Also, a high precrisis investment share is a good predictor of large medium-term output losses.

Not inevitable

The IMF says the medium-run output loss is not inevitable. Some countries succeed in avoiding it, ultimately exceeding the pre-crisis trajectory. Although post-crisis output dynamics are hard to predict, the evidence suggests that economies that apply macroeconomic stimulus in the short run after the crisis tend to have smaller output losses over the medium run.

The study also finds some evidence that structural reform efforts are associated with better medium-run outcomes, although there is certainly no “one size fits all” when it comes to establishing the right policy after the crisis.

The authors say the analysis has sobering implications for the medium-term output prospects in economies that have suffered recent banking crises. The forceful macroeconomic policy response so far, in the form of substantial fiscal and monetary stimulus, should help to mitigate the crisis’ impact on output. Nevertheless, remaining concerns about losses underscore the importance of implementing reforms to help raise medium-term output and facilitate the shift of resources across sectors following the crisis.

The G-20 represents about 90 percent of global gross national product, 80 percent of world trade (including trade within the European Union) as well as two-thirds of the world's population, according to the IMF.

Measured by purchasing power, Asia accounts for more than 35 percent of world GDP, compared with the US and the EU at 20 percent each.

The G-20 comprises Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the UK and the US, plus the European Union, represented by the rotating Council presidency and the European Central Bank. The managing director of the International Monetary Fund and the president of the World Bank, plus the chairs of the International Monetary and Financial Committee and Development Committee of the IMF and World Bank, also participate at G-20 meetings.

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