Learning the Lessons of the Past: SWIFT Institute @ Sibos

New ways to think about familiar problems will be proposed by the SWIFT Institute in Singapore.

The SWIFT Institute will present a series of lectures at Sibos 2015 from leading academics and experts inspired by a Japanese proverb: ‘Better than a thousand days of diligent study is one day with a great teacher’. The lectures – typically lasting 30 minutes, including Q&A – cover topics ranging from clearing and settlement in Asia to RMB internationalisation to risk management in a networked world.

The thread running through the series is that valuable insights can be gained by examining practical economic or financial issues through a rigorous theoretical framework. In his lecture ‘Safeguarding financial integration’, Erik Jones, professor of international political economy at the Johns Hopkins University and senior research fellow at Nuffield College, University of Oxford, considers the euro-zone crisis in terms of the preconditions for stable financial integration. Jones – who has co-written a related SWIFT Institute working paper – draws on previous experiences of financial integration in countries including the US, UK and Canada to argue that European policy makers have focused too much managing exchange rates and macro-economic adjustments, rather than creating the institutional framework needed to support capital mobility and cross-border transactions.

In the euro-zone, this failure of policy caused severe economic difficulties in Greece, Ireland, Spain and Portugal in the aftermath of the global financial crisis, when foreign capital evaporated, leaving those countries needing huge bail-outs. Jones’ analysis proposes six institutional arrangements to mitigate the forces of financial market disintegration, but admits several – such as a central system of sovereign debt management – are “hotly contested”.

While some economists regard the euro-zone as fundamentally flawed, Jones suggests that financial integration has always been a matter of trial and error, with political expediency besting academic theory. Moreover, he believes that Europe has belatedly put in place some crucial underpinnings, for example the dominant role of the European Central Bank in prudential oversight of euro-zone banks and standardised resolution mechanisms. “There is always the risk of political pull-back, resulting in a half-baked banking union,” warns Jones.

New models needed

Like Jones, fellow SWIFT Institute lecturer Alan Laubsch believes we can get better at anticipating and withstanding future crises. Laubsch, director of Financial Network Analytics, will argue that prevailing approaches to risk management are ill-equipped to help us anticipate, quantify and handle the risk. As a co-founder of the RiskMetrics group at JP Morgan, Laubsch contributed to the development of value at risk (VaR), a technique that came to dominate bank risk management. But Laubsch claims over-reliance on established methodologies draws our attention away from the most potent threats in a highly-connected and highly-disruptive post-crisis environment.

“The basis of VaR was that more volatility implied more value at risk, but subsequent events suggest a trade-off between apparent stability in the short-term and structural risk in the longer term,” he says. “In the long run, the more stable you seem, the more vulnerable you are to disruption.”

Laubsch says the global economy faces unprecedented levels of disruption, often from the least expected sources. “Innovation and change does not take place at the centre, it happens at the periphery,” he asserts. As such, large firms that relied on command-and-control management structures should take a ‘sense and respond’ approach, in order to be more nimble in a period of constant change.

Risk management strategies therefore should be broad enough to alert us to the least, as well as the most, likely threats. Stress-testing can falsely boost confidence if scenarios focus too much on known threats. In the shadow of the crisis just past, there is an understandable search for stability, but if – as Laubsch suggests – stability is not possible, it’s pursuit by banks and regulators could lead to new threats. “We need to remember to consider the hidden risks and the unintended consequences. Regulators want banks to be less risky, but this could also make them less innovative and therefore more vulnerable to disruption from challengers,” he says.

This article first appeared in Sibos Issues, Issue No. 2, July 2015 – download the entire issue here.

The full agenda for the SWIFT Institute @ Sibos is available here.

Register for Updates

Enter your email address below for paper and proposal calls, updates and info