We need to return to a diverse, small-scale banking system in order to reduce the risk of another financial crisis, according to Professor Eckhard Hein from the Berlin School of Economics and Law, Germany, who was involved in the EU-funded FESSUD project examining the causes and consequences of the 2008 - 2009 financial and economic crisis.
It’s almost 10 years since the last financial crisis began to take shape, what lessons do we need to learn to prevent another one?
‘We should go for banking that is targeted to the requirements of the small- and medium-scale businesses and to the requirements of households at a local or regional level. We should avoid big banks, in particular we should avoid too big to fail banks, and if we have them we should nationalise or socialise them. It’s about going for diversity, for small-scale banking, to make banking boring again, as it was in the 50s and 60s.
‘In Germany, roughly two-thirds of our banking sector is not-for-profit, we have the public sector banks, the saving banks, we have the cooperative banks and then we have the private banks. If you look at it closely, in the course of the crisis these small- and medium-sized public and cooperative banks didn’t have any problems.
‘We also have to increase transparency in the financial sector in order to reduce the uncertainty, to reduce moral hazard (taking risks because someone else bears the cost) and even fraud. The financial sector is particularly prone to this so we should standardise financial products, we should apply tests to financial products before they are allowed to enter the market. We are doing that with all other sorts of products, so why not financial products?’
Is another financial crisis likely?
‘My major concern is from a global perspective. The problem we have been facing to come out of the crisis has been the level of global private debt, which now constrains private spending for goods and services.
‘Since 2010, the US and the UK have seen a dramatic deleveraging of the private sector (a reduction of spending on goods and services in order to reduce debt), both in the household and corporate sector. It has been the willingness of governments in countries like the US and UK to run high deficits (spending more than they receive) – and thus increase government debt – which has stabilised the world economy over the last couple of years. This is not an economic problem as such. However, it runs the risk that ill-guided government policies to put a limit on government debt can destabilise the respective economies, and the world economy, by reducing aggregate demand for goods and services.
‘On the other hand, we have countries like Germany and Sweden which are still exporting a greater value of goods and services than they are importing, and are thus relying on the demand (from) countries, (who are) importing more than they are exporting, like the US or the UK. If demand growth in these countries comes to a stop, it will also affect those countries relying on rising exports.
‘We should avoid big banks, in particular we should avoid too big to fail banks, and if we have them we should nationalise or socialise them.’
Prof. Eckhard Hein, Berlin School of Economics and Law, Germany
‘The euro area as a whole is running a current account surplus (more exports than imports) of more than 3 % of its gross domestic product, and is thus relying on demand being generated in the rest of the world. This is not feasible in the long run and (this) is a major, major problem for the world economy.’
What needs to change to ensure a stable economy?
‘We need to develop demand and growth regimes that are not drawing on ever-rising debt or debt-to-income ratios of private households. We have to come back to a growth regime which can rely on income-financed consumption. This should then stimulate private investment and growth, which of course need to be credit-financed.
‘Central banks or financial market authorities need to prevent credit going into areas in which bubbles develop. We are now monitoring that but, as far as I see, there is little to effectively stop that, other than raise interest rates. But raising interest rates means you affect those sectors of the economy which are not moving towards a bubble. Therefore, other instruments would have to be applied, like credit controls or different types of reserve requirements (the money banks must hold against debt).’
Apart from decentralising and regulating the financial sector, what else can we do to prevent another recession?
‘With regard to the non-financial sector, we should re-establish the conditions where stakeholders are interested in the long-term performance of their corporation. Workers should have a bigger say (in) their corporations because they and their representatives are interested in the long-term survival of the firm. Management should also come back to this (view of prioritising the) long-term survival of the firm, and we should remove incentives, like stock options and bonuses, which have led management in the past to go just for short-term profit and shareholder value.’
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