MISHRA ON GLOBAL FINANCIAL CRISIS

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Systemic Risk and Macroprudential Regulations by Dr.Rabi Mishra ; Published by Sage; Pages 455 ; Price Rs 1445/-                                                                                      **********************************

Let me begin my review with a charming  true story. Queen Elizabeth  on being  invited for a function by the London School of Economics  asked the impressive gathering  of professors, economists, politicians  and bankers why the experts  had failed to foresee the  “Global Financial Crisis?”. That question continued to  haunt  the world of economists and bankers. In the years preceding the catastrophe only two persons uttered a note of warning. Post event a number of books have been written to unravel the mystery of  the Global Financial Crisis (hereafter GFC). One of the significant volumes is the book under review and it is an outstanding contribution to that venture.

The author Dr.Rabi Mishra is presently an Executive Director in the Reserve Bank of India. He acquired his Ph.D from the University of Mumbai. He distinguished himself as Principal of the Reserve Bank Staff College which imparts training to Senior Executives of RBI. He spent a year in the Department of Economics of the Harvard University and conducted a serious study of the problem of financial risk management and consequent challenges to public policy.

The book has an illuminating (fifteen pages) Foreword by Dr.Benjamin Friedman, the Maier Professor of Political Economy, Harvard University.

Ten years ago the world faced a collapse of major financial firms, decline in asset values and consequent destruction of paper wealth, interruption of credit flow and loss of confidence in both firms and credit market instruments.

Several countries overhauled their regulation and supervision of  financial institutions, The “Buzz” words now are “Macroprudential Policy” and this is the agenda and aim of both developed and developing economies.

Economists have turned the searchlight on the design of the     “ International Financial Architecture”. The increasing globalisation of international activity in general and of financial markets and institutions especially is surely a source of strain on the ‘Nation-State system’. The challenge is to devise elements of a broader system that resolves the tension between preserving the advantages of decentralized private sector financial systems and minimizing the associated risks which can develop within the ‘Nation-State’ itself.

The task currently  faced by economists and policy makers is to rethink the economics underlying the behaviour that can lead to a crisis. In addition, they have to design new policies and procedures.

Mishra’s book is an attempt to combine different ideas and thought believed to be the cause of the GFC, the consequences and the responses. He clinically analyses the regulatory reforms that have been adopted as a response to the GFC and how to improve the toolbox to ensure a safe financial system that offers genuine and undiluted  support.

The GFC was a result of ‘Vulnerabilities’ that were building up since the start of the millennium. Mishra discusses threadbare these ‘Vulnerabilities’. The GFC brought to light the ethical deficit and trust deficit that pervaded the system. The problems were compounded by the lack of crisis management tools and the public perception and objection to helping  troubled firms.

Mishra provides an admirable summary of the developments that installed entities like Fannie Mae and Freddie Mac and the Housing Price Bubble---which was transformed  into a Financial Bubble and the disastrous consequences when the bubbles burst.

Public policy failure was most visible in the weakness in the  regulation and supervision. Basel I  and Basel II  suffered from procyclicality embedded in the rules. The inadequacies in anticipating systemic risks and dealing with them were a major shortcoming of the pre-crisis regulatory and supervisory regime. Systemic risks were not under the radar of the regulators. Basel I  and Basel II  did not have any macroprudential elements in the regulations. All these led to increased focus on macroprudential tools to deal with systemic risk.

The GFC revealed serious shortcoming in the governance and risk management practices in regulated institutions. Mishra emphasizes that achieving financial stability is an elusive objective and demands policy coordination at both the national and international level.

The author concludes that a robust financial system is essential for economic well-being of people. The GFC  exposed many cracks in the financial system and its adverse results. Post crisis reforms can succeed only if we strengthen prudential oversight and finally behaviour and governance in the private sector.

According to Mishra the world economies should strive for a more balanced system and rule-based monetary policies taking into account the likely spillover effects it will create the world over. An immediate objective can be creating a more stable world with less financial turbulence, as central banks traverse down the exceptional monetary measures they had taken to stimulate the economy.

The book is divided into three parts. Part I deals with the post-crisis financial regulatory reforms. It analyses issues such as strengthening of the capital, liquidity, ring fencing of  banks and the resolution plans post-financial crisis. Also discussed are the other structural reforms that became inevitable after the crisis.

Part II is dedicated to managing systemic risk through macroprudential policy. Mishra thoroughly discusses various sources of systemic risk and provides a framework to manage such risk by macroprudential regulation and its coordination with monetary policy authority. One chapter is devoted to the significance of early warning methods to predict crisis and offers positive steps to avert the crisis. Details are provided of stress-testing programmes to be implemented at macro-level by financial sector supervisors and central banks. This offers help to recognize the weakest link and be armed with the necessary cushion at unexpected stressful events. Also provided are tools for macroprudential regulations for adoption and use by policymakers.

The third Part of the book is concerned with managing financial crisis and  furnishes a policy tool-kit for adequate response to  any likely financial crisis.

The fourth and final Part is “ Coordination in international policymaking” and has three chapters. They deal with measures that will help develop better coordination among global financial institutions. Dynamics of such an exercise are analysed cogently. The final two chapters present a list of possible challenges to global coordination and enumerate several approaches to improve the methods of coordination.

An Epilogue offers a catalogue  of potential risks in the financial sector threatening central banks the world over.

 All of us know that Nobel Laureate Joseph Stiglitz gave Dr.Y.V.Reddy a Certificate--  "If America had a central bank chief like Y.V.Reddy, the U S economy would not have been in such a mess." 

Now let us view the certificate  that the learned RBI ex-Governor has given to  Mishra and his book—

“The impact and implications of Global Financial Crisis on the theory and practice of financial sector are brought out very clearly. It has the imprint of deep insight, long experience and clarity in articulation.”

The volume is of immense value to central bankers, economists and policy makers. The book is a valuable addition to the  exiguous literature on G F C.

P.P.Ramachandran.

1/9/2019.