Where is the global economy headed in 2010, and is the financial crisis really behind us? Two banking heavyweights, Barclays president Robert E. Diamond and Standard Chartered CEO Peter Sands, give their take to NEWSWEEK's Stefan Theil. Excerpts:
A year and a half on, what are the lessons you've learned from the financial crisis?
Sands: The first is that if things seem too good to be true, then they are too good to be true. Second, the downside of getting bank regulation and risk management wrong is very significant. Third, when things go wrong in the financial system, they can go wrong in a self-reinforcing and violent way. In the summer of 2007 we saw something was going wrong and took all sorts of preventive measures, but we underestimated how badly wrong it would go.
Diamond: Banks have clearly learned from the crisis and changed their behavior. Banks are and will be operating with more and better capital, less leverage, and higher liquidity in a more intrusive regulatory environment.
Where are we now in how the crisis is playing out? What problems are still lurking in the financial system?
Diamond: We've worked through a lot of the excesses in the system. The financial markets are on a sounder footing. In most sectors the worst is behind us, with some concerns remaining in commercial real estate and around those banks that haven't been clear yet about all their write-downs. For the larger financial institutions, we think that probably applies more to Europe than the U.S. and U.K.
Sands: We're clearly in a better place, but there are unresolved areas and problems. The weakness of the recovery creates challenges for companies and consumers, and in turn for banks in terms of credit quality. There is a fair amount of deleveraging still to happen, especially in the West, and that process is always painful when and where it happens. Second, banking systems are still very dependent on central-bank monetary support. The question is whether economies and banking systems can stand on their own two feet when governments run out of money for fiscal stimuli and central banks pull back on monetary support. The final unresolved issue is the huge agenda to be worked on in regulation.
Governments have gotten deeply involved in the financial sector, through state ownership, massive assistance, and political pressures to keep lending. How is that affecting the way banks operate and compete?
Diamond: Two things. One, the way politicians dealt with some of the issues around bonuses and bank levies doesn't distinguish between those who succeeded and have been strong in the crisis and those who failed. Second, having certain banks subsidized and others not creates a conflict in competition. If in a couple of years we continue to compete with banks that are largely owned by the government, that will have unintended consequences. The sooner we get out of this, the better.
Sands: Bringing banking into the political limelight is not a bad thing, because it makes both bankers and nonbankers aware of the crucial role banks play in an economy—they're vital to prosperity and growth, but if things go wrong they also cause huge problems. Both bankers and nonbankers lost sight of how critical that role is. It's important that those of us who are bankers understand that and are accountable for that, and that other parts of society also understand that. We've had an inflection point where banking is going to be intrinsically more in the political domain than before the crisis.
Bonus taxes, bank levies, capital requirements—are regulators focusing on the right things?
Diamond: The proposed bank levy in the U.S. and the British bonus tax have been driven by politicians, not regulators. If you look at what the regulators are doing, they're working on the right issues. We all agree that relative to 2007, banks need more capital, higher quality capital, less leverage, and more liquidity. Are there differences in degree? Absolutely. But the dialogue is getting more constructive. What we want to be careful about is the aggregate impact of all these measures, how far they will drive up the cost of credit and the impact of that on the economy and jobs.
Sands: What I would like to see is prioritization. Trying to change all the rules of the game all at once carries quite a lot of risk with it and makes it more difficult for banks to play their role in the recovery. Capital and liquidity regulation would be on the top of my list.
So far each country is setting its own agenda. Won't that just shift business to financial centers with less regulation?
Sands: If we don't get coordination, activity will move to where the cost of regulation is lowest. The second reason for coordination is fairness of competition. Third—and I'm increasingly convinced this is the most important—if every country in the world does a slightly different variant of regulation, and they each do it on a slightly different timetable, the complexity of managing large financial institutions and the complexity for our clients in dealing with us will be enormous. That means higher operating costs, higher cost of credit, less efficient financial markets. And complexity breeds opacity, making it harder for the people managing the banks or the regulators to understand what is really going on.
Diamond: The regulators must create a level playing field, especially between London and New York.
The Bank for International Settlements is concerned that "financial firms are returning to the aggressive behavior that prevailed during the pre-crisis period"—the idea being that central banks are handing out essentially free money that banks are pumping up into new asset bubbles.
Sands: It's true that central banks are providing very low-cost liquidity, and that appears to be translating into asset inflation in some parts of the world. Some of that is through the banking system, but I'd question whether it's true for most banks. Borrowing cheaply from central banks and investing it is not the business that Standard Chartered is in; indeed the low interest rates cost us money. They're quite right to have their concerns, but I question whether that happens because of "aggressive behavior." Rather, it's a natural consequence of injecting a lot of low-cost liquidity into the market.
Diamond: I strongly disagree with the accusation. In our case at Barclays we more than doubled our capital, significantly reduced leverage, and increased liquidity, and even during the most difficult times of the crisis were profitable in every reporting period. We feel we're running a responsible business, and we're not the only ones.
Are central banks doing the right thing?
Sands: They have a difficult judgment to make on how fast and how far they pull back from providing liquidity support to the financial system and the underlying economy. I worry about them doing it, and I worry about them not doing it. If they do it too fast, they risk pulling the rug out from under the recovery. If they don't do it, they risk stoking up inflation. It's complicated by the fact that most fiscal stimulus will probably have to be wound down relatively rapidly because of public-sector deficit levels in most Western countries. As this process unfolds in 2010 and onwards, we are quite likely to see bubbles and volatility in various asset markets and currencies.
Do you believe in the idea that we're entering a "new normal" of permanently slower growth in a highly regulated world?
Sands: That may not be a bad description of where the U.S. is going with higher savings and lower consumption, but I'm not sure it's true of the world. China's pace of growth is still very high by anyone's standard. I'm always a little skeptical of people articulating a new equilibrium because the nature of the world is that there is always something else going on.
Diamond: I worry very much about the aggregate impact of all the new regulatory measures and capital requirements, how far they will drive up the cost of credit, and the impact on economic growth and job creation. The importance of the big global banks to foreign trade, to the global economy, is real. There is a connection between how we manage through this political and regulatory process and what the global economy is going to look like. A long-term lower-growth track is the risk if we get this wrong.
How has the crisis affected the position of the Western world versus the BRICs?
Sands: Undoubtedly the crisis has accelerated the shift, but we shouldn't exaggerate it. Most of the world's economy is still in the developed countries. The more dramatic shift in economic power is from those who consume and borrow to those who save and produce. China is an archetype, but even a continent like Africa is not that badly placed in the world emerging from the crisis. It is rich in commodities, hasn't been that badly affected by the crisis, and has rapidly increasing ties with the new dynamos, China and India.
Some analysts worry China might be the next bubble economy.
Sands: China faces all sorts of challenges, from rebalancing its economy away from investment and exports to domestic consumption and services, to rural poverty and environmental stresses. But the underlying drivers of economic growth are very robust, and I think the Chinese government has a very good grasp of the issues it needs to tackle.