Have we really learned from Lehman?
Liu Mingkang says the effectiveness of regulatory reformin addressing the weaknesses exposed by the global financial crisis will depend not only on new rules, but on whether they can be implemented successfully
When the US investment bank Lehman Brothers collapsed five years ago, emerging-market economies did not hold many of the toxic financial assets - mainly US subprime mortgages - that fuelled the subsequent global financial crisis.
But they were deeply affected by the drop in world trade, which recorded a peak-to-trough decline of at least 15 per cent.
Soon after the crisis erupted, the G20 countries embraced massive stimulus packages, unconventional monetary policies in the advanced economies, and major institutional efforts, such as the Dodd-Frank financial reform legislation in the US and the Basel III initiative to strengthen banking standards. China's 4 trillion yuan (HK$4.5 trillion at the time) stimulus package restored confidence in global commodity markets. Led by strong Chinese market growth, emerging markets stabilised.
Since 2009, quantitative easing by the US Federal Reserve has resulted in record-low interest rates around the world. But, while the resulting surge in capital flows to emerging markets stimulated economic growth, it also inflated asset bubbles.
Now, with the Fed publicly considering an end to its massive, open-ended purchases of long-term securities and foreign capital fleeing home from emerging markets, many fear that Asia's economies could come crashing down, as they did in the late 1990s. Leverage in some emerging markets' household and corporate sectors has reached record levels. China's annual economic growth has slowed to around 7.5 per cent, while Indonesia and India - and, outside Asia, Brazil and South Africa - are experiencing sharp downward pressure on their exchange rates.
Moreover, there has been no major reform of the global financial architecture. China's renminbi is internationalising, but its share of global payments remains relatively small.
While regulatory reform is progressing, its effectiveness in addressing the weaknesses exposed by the global financial crisis will depend not only on the new rules that emerge, but also on the consistency and quality of their implementation.
There has been commendable progress on the Basel III capital requirements for banks, with 25 of 27 Basel Committee members having issued final rules. Likewise, the impact of regulatory changes resulting from major legislation and policy directives in the US, Europe and Britain on banking, insurance, financial-transaction taxes, anti money laundering and cyberspace is likely to be substantial.
Although rules on shadow banking have yet to be formulated, another problem exposed by the crisis has abated: America's external annual deficit has shrunk to a more manageable 2 to 3 per cent of GDP, accompanied by drops in the surpluses run by Japan and China. Global trade rebalancing has arrived.
The key questions now are whether global growth is self-sustaining without QE, whether emerging markets' output will continue to rise strongly, albeit at a slower pace, and whether global financial-reform efforts will be sufficient to prevent another crisis in emerging markets.
Given the high degree of trade and financial globalisation that now characterises the world economy, there is no doubt that the slowdown in advanced economies will undermine emerging-country growth. Indeed, the threat to withdraw QE is already having an enormous impact on emerging economies' asset markets. As real interest rates and risk premiums begin to rise, the level of global trade and investment will decline.
In the coming years, emerging markets will most likely struggle with implementation of global financial regulatory standards. They will also confront a rapidly changing external environment and a growing need to manage capital flows more effectively.
Indeed, perhaps the most important lesson learned in the aftermath of the collapse of Lehman Brothers is that we can no longer afford to examine problems in terms of individual institutions and from regulatory "silos". The global economy's high degree of interconnectivity, interdependence and complex feedback mechanisms imply that one weak hub can bring down the entire system.
In other words, the world needs a systemic approach to deal with systemic risks and system failures. Unfortunately, there may be little hope of strengthening global financial governance as long as implementation and enforcement of rules remain at the national level.
Like other emerging markets, China is committed to financial stability and playing its role in reforming the global financial system. China was one of the first to sign up to the Basel III standards, and further renminbi internationalisation will be implemented in a prudent manner.
Domestic financial reforms will focus on the strengthening of policy co-ordination and moving towards market-determined interest rates and exchange-rate flexibility.
All this will contribute to sustainable growth and a more stable global financial system. Other major emerging economies' policymakers would be wise to act with the same purpose in mind.