Over the course of the last seven years, following the collapse of Lehman Brothers in 2008, we have succeeded in stabilising the financial system. The most important reforms made include the introduction of higher capital requirements for banks under Basel III, the new rules for bank resolution, including bail-in instruments, and, on the EU level, the Single Supervisory Mechanism and the Single Resolution Mechanism. These reforms reduce the risk that taxpayers will have to pay the bill if banks get into trouble. In addition, they reduce the interdependencies between governments and national financial sectors.
The overall stability of the regulated system has improved, but serious risks persist that may lead to excessive market volatility. First, although the composition of debt has changed in the last few years, debt levels continue to rise. Indebtedness has shifted from industrialised nations to emerging economies and from the public sector to households, businesses and financial institutions. The problem remains that highly indebted countries are more susceptible to financial and economic crises. Rising levels of borrowing have been accompanied by an increase in the number of financial market crises and declining growth rates. Thus, during the last 35 years, there has not been a single year in which the global economy has posted growth of over five percent.
A second risk facing financial markets is the shift of global credit intermediation from the banking sector to many different forms of market-based financing, some of which can be viewed as problematic types of shadow banking. While an increase in non-bank financing may indeed benefit the real economy, regulation of the shadow banking sector is essential to prevent regulatory arbitrage.
Third, the current period of low interest rates puts financial market stability at risk. If this situation continues for much longer, the demand for high-risk investments will continue to rise. The pursuit of higher returns may result in the mispricing of risk, which could in turn lead to bubbles and inflated asset prices.
The German government is watching these trends very closely; within the eurozone and G20, it will continue to be an advocate for public and private-sector deleveraging, regulation of the shadow banking sector and normalisation of interest rates.