Ripple effect – The profound impact of the global financial crisis

The world economy – Recovery and financial risks

The global financial crisis that broke out in 2007–2008 impacted on the major world economies in various ways. Economic growth remained sluggish for 10 years but is finally improving, with the US economy now performing strongly, the eurozone picking up and China entering a ‘new normal’ in which supply-side structural reform has been smoothly introduced. However, uncertainties still exist, and the current world economy exhibits a mixture of recovery and remaining financial risk.

The driving force of the world economy in the post-crisis era

The Group of 20’s role in the recovery has been of utmost importance. Countries have enforced a series of regulatory reforms, such as strengthening financial supervision, building global regulations and bilateral financial safety nets. Co-chairman of the International Finance Forum (IFF), president of the 56th United Nations General Assembly and former prime minister of the Republic of Korea, Han Seung-soo, highlights that Asia and China have been an engine of the global economy during this uncertain period. The International Monetary Fund (IMF) predicted that Asia would make up 63% of  global growth in 2017, with China contributing around half of that. 

China’s role in global economic growth in the post-crisis era has also been recognised by Chinese scholars. Shen Jianguang, chief economist of Mizuho Securities Asia, has discussed the corner-overtaking industries and the rapid rise of China’s exports over the past 10 years to the top of the global marketplace – particularly in low- and medium-to-high-end exports to the US. China also ranks top in exports of high-speed trains, industrial robots and new energy vehicles. China’s independent exploration of economic development has achieved great success; Shen believes that China’s strengthening has altered the world economy as well as trade patterns, which provides a solid foundation for global economic governance reform.

Potential risks still exist in the current world economy

When it comes to the current global economy and finance, there is consensus among government officials, scholars and entrepreneurs in various countries that the world economy is still prone to potential risks. Zhu Xian, vice-president of the New Development Bank, founded by the Brics (Brazil, Russia, India, China and South Africa) co-operation mechanism, argues that, although the world economy is gradually recovering, overall the economic environment is still sluggish. Edmond Alphandéry, IFF vice-chairman, chairman of the Euro 50 Group and former finance minister of France, believes that, even though we are witnessing an economic up-trend, we still need to be aware of the possibility of similar risks, since the current world economic climate is unbalanced and we are not completely out of danger. Alphandéry also believes, despite encouraging signs – such as low interest rates, low oil prices, abundant liquidity, rising financial asset prices and a universal sense of improved wealth – an unsustainable current monetary policy could lead to future problems. It is inevitable that the world financial market will undergo adjustment, for many countries have accumulated large debts, either public or private, and the geopolitical environment also remains unstable. 

The possibility of future crisis looms large. Shen indicates that the GDP of the major economies has increased, as shown by the rise of asset prices and the prosperity of capital markets. However, populism and anti-globalisation are intertwined with this situation. Shen explains that central banks’ quantitative easing (QE) policy has resulted in skyrocketing asset prices and the mismatching of the real economy and labour force, which have led to a widening gap between rich and poor – and thus populism.

Whether a developed or developing country, neither can ignore certain risks. Alphandéry believes that major economies in
Europe and the US all face potential dangers. For example, the monetary policy implemented by the US Federal Reserve Board may have performed well in the past, but an increasing number of commentators believe that current monetary policy is unsustainable, since a swelling market bubble could pop at any time. In the eurozone, QE has forced the European Central Bank to purchase government bonds, obscuring the fragmentation of financial markets in eurozone member countries. Marsha Vande Berg, former chief executive officer of the Pacific Pension Institute, notes that changes in the regulatory environment in the US have brought new challenges to the global financial system, and will influence driving forces in the ensuing five to seven years. She also notes the uncertainties in global politics: the US is cutting taxes for enterprises, increasing the quality of enterprise assets, as well as enhancing business confidence and global trade. 

Activity among investors is increasing, and financial stability seems to be solidifying. However, many policy uncertainties still exist; for example, the advent of both populism and nationalism, and the shift from multilateralism to unilateralism. The global political environment has become interesting since the financial crisis; Vande Berg analysed the impact of the previous US presidential election, noting a series of new regulations in monetary policy and banks that may trigger challenges to the world market. 

In the case of China, experts and scholars have, from different perspectives, emphasised the importance of preventing financial risks. Shen insists that preventing financial risks was an urgent task and the Chinese government’s deleveraging was also crucial. He emphasised China should be concerned about the rapid increase of money multipliers. Broadly, money has skyrocketed in the past 10 years, yet this brings financial risks. At the same time, China faces challenges in real estate bubbles, credit and debt. Wan Zhe, chief economist at the International Cooperation Center of National Development and Reform Commission, declared that a major complication of the Chinese economy was its apparent trend of virtualisation. Wan said that, from the 18th to the 19th National Congress of the Communist Party of China (CPC), society has agreed the notion that finance must provide support for the real economy. The report of the 19th CPC National Congress proposed eight major reforms and a deepening of financial reform, establishing China’s prime mission as one of avoiding systemic financial risk, to prevent a ‘black swan’ or a ‘grey rhino’.

Lessons from the financial crisis – Strengthening regulation and adherence to national reality

Experts have attempted to summarise the empirical principles concerning economic crisis. Wan Zhe notes that, in retrospect, the Federal Reserve has always shifted from QE or increasing the money supply to reduce the effects of austerity before economic crises and, after the outbreak of such crises, a large amount of international capital flows out of crisis-hit countries. In addition, experts have analysed the profound impacts of this financial crisis. Zhu Xian concludes that the financial crisis of 10 years ago brought about not only cyclical but structural impacts. Economic, political and social reform was rarely effective and, with no economic structural reforms in place, negative effects might appear in middle- or long-term growth. Zhu also believes that unequal redistribution around the world could result in globalisation going into reverse.

Policymakers have all drawn lessons from the financial crisis in 2008, and improved regulatory frameworks to various degrees. Zhou Yanli, IFF vice-chairman and former vice-chairman of the China Insurance Regulatory Commission, insists that preventing and resolving financial risks are important elements of ensuring steady and healthy economic development and suggests three distinct routes. First, strengthening the regulation of the financial market and maintaining its stability is the most realistic, concrete and essential requirement. Financial risk is elusive and complex; a lack of control over it will seriously affect the stability of the financial market. 

Second, financial supervision should play the important role of promoting economic development. Finance should support the real economy so that financial structure can be optimised and financial reform reinforced. 

Third, attention must be paid to financial risks during the operation process, such as blindly pursuing speed or failing to enforce the regulatory system.

Loopholes in the regulatory system should be closed, regulatory improvement sped up, messes in the financial markets cleaned up and the financial industry developed steadily and healthily.

These are not the only lessons learned from the financial crisis – developing countries have also formulated a series of responses to similar crises. Shaukat Aziz, IFF co-chairman and former finance minister and prime minister of Pakistan, has told how the country adhered to the national reality and thus chose the most suitable route for economic development. In 1999, Pakistan’s economy was on the brink of collapse. Aziz, entrusted with the country’s future at that critical moment, found the strings attached to IMF aid difficult for Pakistan to bear, and not compliant with the national reality. Pakistan rejected the IMF’s overtures and carried out its own reforms in industry and employment. Aziz stressed that, most importantly, a country should not seek economic dependency on another country or international organisation, but develop its own unique way to evade disorder and improve its economic structure through adopting a new ethos. Aziz also identified that, in comparison with developed countries, developing countries enjoy greater flexibility. Deregulation, privatisation and liberalisation are the watchwords of Pakistani reform. Important measures also include establishing competition strategies for privatisation, open markets, capital flow and foreign currency. 

Fintech innovation – A double-edged sword

Fintech innovation, led by blockchain technology, has gained huge momentum, but such technology-based financial innovation remains a mystery to most. At the 2017 IFF Annual Conference, fintech experts and scholars conducted in-depth and enlightening discussions on this subject.

Technological revolution can bring about change in the financial system, and decentralisation may be the first feature of that change. Professor Cao Heping, vice-president of the Institute of Digital China at Peking University, believes that networking technologies have already upgraded the new economy and reinvented the regulatory relationship between central banks, commercial banks and banking financial institutions, and the new economy. In this sense, networking technology is the ultimate weapon, capable of weakening the position of the central bank and the traditional clearing system. Professor Cao asserts that successful blockchain technology can lead to the rebuilding of top-level accounts in the central bank, as well as new technological methods for settlement and payment systems, and possibly the future phenomenon of ‘de-central banking’.

Experts and financial scholars have welcomed the positive potential of fintech innovation. Ye Yanfei, inspector of the China Banking Regulatory Commission, says that fintech can aid risk identification, management, mitigation and solution. He cites examples in the Chinese banking industry to explain the role of big data and the internet in connecting society, consumption scenarios and personal credit, and the more accurate, economical and accessible targeting of users. Technologies such as the internet, big data and artificial intelligence (AI) can enable better data analysis and personal credit rating, for example, in risk management and mitigation. When carrying out supply-chain financing, blockchain technology requires all parties involved to be registered, and classified accounts. This requirement has greatly constrained the authenticity of trade and validity of contracts, which can be of huge assistance to risk management and mitigation. 

IT experts also praise the blossoming of fintech innovation. Yan Weining, managing director of Asian Pacific Net-Space Port Limited, introduced the internet protocol version 9 (IPv9) application – an alternative naming system – and is confident it will be applied in the global financial system. IPv9, with larger storage capacity and safety insurance, has advantages over IPv6 and IPv4 as it supports the spatial anchor of assets and ensures address encryption in digital currency transactions. Wei Qing, chief technology officer of Microsoft China, believes digitalisation can greatly increase efficiency – the most important feature. Efficiency improvement is equivalent to cost reduction, and can be increased as the world effectively becomes digitalised – software can define a universal measure to regulate the financial industry and increase efficiency. 

Some experts incisively identify the new challenges emerging in fintech innovation. Shahmeem Ahsan, chairman of eGeneration Group, emphasises the threat of cyber attacks against financial, national defence and security systems, and the inevitable challenges to the security of information. Ben Shenglin, director of the International Monetary Institute of Renmin University of China and a member of the IFF Academy, sees three fintech challenges, and interdisciplinary and intellectual problems confronted by China in terms of financial regulation. The first challenge is that financial regulation may lag behind the development of the market. Second, some regulatory measures in Chinese fintech are inferior to advanced international practices. Third, the supervision of Chinese financial giants, and the measures to give full rein to these companies to serve both national and consumer interests, will prove difficult.

Technology, finance and fintech must be people-centred. Wei Qing recommends avoiding technological obsession about innovation; otherwise, though technology is more advanced, it cannot serve the people properly. Technologies such as AI and big data are merely mathematics or engineering tools. Wei asserts that it only takes a handful of people to create and develop these technologies for the convenience of all of society. Therefore, whoever can take advantage of these tools can seize the opportunity of this industrial revolution.

Fintech is gaining momentum, and China already ranks among the top countries in global fintech market size and depth of innovation. Li Dongrong, president of the National Internet Finance Association of China and former deputy governor of the People’s Bank of China, says that China needs to broaden its horizons and draw lessons from other countries in the experience of developing fintech. Equally, it should be practical and take a Chinese stance, fully considering China’s market reality, institutions and regulations. Only in this way can it devise a fintech system with Chinese characteristics in line with the requirements of the information era, and make unique contributions to global fintech. Li also emphasises the importance of fintech’s ability to carry out steady and active innovation by promoting efficiency at the level of the real economy and protecting consumer rights. Excessive innovation not based on reality and going beyond risk management’s capabilities should be avoided, as should innovations that do not comply with laws and are separated from the requirements of the real economy. In addition, Li uses examples of personal experience in finance regulation to put forward the following four suggestions: pay attention to value guidance and innovation, lay emphasis on technological and institutional innovation, balance financial innovation and risk management, and co-ordinate administrative regulation and self-discipline of the industry.

Global financial governance in the post-crisis era – The role of developing countries 

Consensus has been reached over joint efforts in global economic development and financial stability. Marsha Vande Berg believes that, in an effort to stabilise, the future global economy will become increasingly integrated. Countries should tackle issues from an overall perspective and promote policy and regulatory reforms to form a more stable economic system. Edmond Alphandéry posits that, in addition to the internal reforms carried out by various countries, co-operation between regions and countries is of equal importance. Only co-operation can ameliorate global imbalances and future financial risks.

Developing countries should demand louder voices to achieve equal consultation. Ashfaque Hasan Khan, former finance minister of Pakistan and principal dean of the school of social sciences and humanities at the National University of Sciences and Technology, emphasises countries’ increased disadvantage in formulating regulations of global financial governance that do not match with their contributions. Developing countries’ participation is conducive to strengthening the rationality of the global financial governance structure. Khan believes that dissatisfaction with globalisation lies in the decision-making process, since developed countries have played a dominant role that has resulted in unnecessary, heavy and unfair losses in emerging economies since the 2007–2008 financial crisis. Khan’s opinion was applauded by Chinese experts; Zhu Xian, vice-president of the New Development Bank, also asserts that developing countries should have a louder voice and a broader platform within the global economic governance system. He explains that current major policymakers are Organisation for Economic Co-operation and Development countries headed by the US – self-interested when formulating rules, and often having double standards in implementation, so that the requirements of developing countries cannot be accurately heard. However, developing countries have not yet established a clear and practical plan to adjust the current economic governance system, with the exception of the Belt and Road Initiative (BRI). The BRI is not only an interconnected proposal to build infrastructure in countries along its route, but also an opportunity for enabling the greater assimilation of developing countries into the global economy.

More and more concerns are arising around China’s role within global financial governance. Former Republic of Korea prime minister Han Seung-soo believes that, despite fragility and risk, Asia and China – particularly with China’s resources in supporting economic development and buffering economic crises – are integral to the global economy. On the political front, China is also determined to implement a more balanced and more sustainable reform. In this sense, it proposes the following: first, inclusive growth, rather than focusing on short-term goals, should be prioritised. Second, solving the problems of the financial sector, such as risk, credit and co-ordinated supervision. Third, emphasising the quality of assets, especially foreign investment. Han says that the stability of the Chinese market is essential to many countries across the rest of the world. 

Khan believes China’s leading role in the global economy is in line with the sustainability of globalisation, and that China is taking proactive measures not just in the global financial system, but also in establishing new mechanisms and financing organisations. For example, on the one hand, globalisation of the renminbi has reduced the pressure of the US dollar on developing countries and, on the other, China’s Asian Infrastructure Investment Bank supplements the shortages of the World Bank’s and the Asian Development Bank’s infrastructure investment. 

Domestic representatives also express their views concerning China’s role in global financial governance: Wang Jingwu, president of the People’s Bank of China, Guangzhou branch, and Administrator of the Guangdong Branch Office, the State Administration of Foreign Exchange, states that China has made remarkable recent achievements in promoting reform and innovation of the global governance system. China is now an important driving force of international monetary system reform, a proponent of IMF structure reform and a leader in promoting global finance for sustainable development. With its entry into domestic construction in the the ‘new era’ of Chinese politics and power, China’s participation in global governance has stepped onto a new stage. China has taken further steps in providing Chinese wisdom and methods in global financial governance. It should actively participate in the reform of world financial institutions and monetary systems, speeding up the globalisation of the renimnbi. China and other developing countries also need a louder voice for formulating international financial rules, and to take advantage of financial tools to promote inclusive and green development, as well as inclusive finance.

Participating in global financial governance must emphasise the management of systemic risk. Shen Shuguang, vice-president of the National Institute of Governance of Sun Yat-sen University, underlines the dangers of systemic risk in the global financial governance system and puts forward several suggestions, including that the global financial governance system pay more attention to systemic risks – rather than technological and operational risks – and that a large amount of systemic risks can be found in the structure and direction of financial systems. In this regard, Shen has three suggestions:

1. Finance should be redirected to focus on livelihood, go green, develop technology and be inclusive.

2. China, as well as emerging markets, should have a louder voice within the global financial governance system to fully realise  and understand the new situation. The financial governance system is open and has multiple participants, and is a win-win situation with many beneficiaries. However, since the skyrocketing of economic growth and the financial volume of China, as well as other emerging markets, the current systems are no longer appropriate. One solution is to allow China and emerging markets more of an input.

3. The value of the insurance industry can also encourage further steps in its development. The insurance industry has played an important role in supporting and stabilising the financial system. We can draw lessons from the experience of the insurance industry and build on it to make a greater contribution to the future of the financial industry.

This article is part of The IFF China Report 2018, which draws mainly on content provided by China-headquartered think tank, the International Finance Forum, and is published in association with Central Banking.