This article is part of a series of analyses on the challenges facing banking this decade, written by Dr. Andrei Radulescu, Director of Macroeconomic Analysis at Banca Transilvania, and published on #BlogulBT.

Over recent decades, the international monetary and financial system has faced numerous challenges, in a context shaped by structural factors and unprecedented shocks — both endogenous and exogenous.

Globalisation has continued and intensified, especially after China’s accession to the World Trade Organization and thanks to technological progress as the IT Revolution and the Digital Revolution have been absorbed. The world economy has grown strongly in recent decades, driven mainly by emerging and developing countries — including China’s rise, which accelerated after joining the World Trade Organization. In this context, China’s role in the global economy has increased significantly, as reflected by the country’s share in global GDP rising from 2% in the early 1990s to 17% today.

As for endogenous and exogenous shocks, these include the onset of the Great Recession in 2007 — the most severe global economic and financial crisis since the end of World War II — and the pandemic we are living through, which brought a health crisis without precedent in the past century, worldwide.

Not least, after the financial and economic crisis — which started in the US in 2007 and had medium-term implications — we saw the emergence of cryptocurrencies, the growth of shadow banking (shadow banking) and the rise of fintechs, with consequences for both the banking sector and monetary policy.

Despite these major changes over a relatively short period — two decades — the depreciating trend in the real exchange rate of the US dollar, and the significant increase in the US public-debt-to-GDP ratio to record levels, the architecture of the international monetary and financial system has remained unchanged, still dominated by the US dollar.

Unprecedented unconventional monetary programmes & the growth of central bank assets

We have observed a paradigm shift in monetary policy after the Great Recession and especially after the onset of the coronavirus pandemic. What this means:

• In practice, the central banks of the world’s major economies launched unprecedented unconventional monetary policy programmes to help stabilise risk sentiment, counter financial fragmentation and keep funding costs at low levels — all essential to support recovery after unprecedented shocks (a financial crisis, the most severe since World War II, and a global health crisis without precedent in the past century).
• Central bank assets in the US and the Eurozone have increased significantly since 2007, and especially since the pandemic began. Between late February 2020 and end-September 2021, the US central bank’s total assets rose by over 100%, to around 8.5 trillion dollars, while the Eurozone central bank’s total assets increased by more than 75%, to 8.3 trillion euros.
  
  

Evolution of central bank assets in the US and the Eurozone

Sources: US Federal Reserve (Fed) and European Central Bank (ECB)

Effects of the international monetary programmes

• These unprecedented unconventional monetary policy programmes implemented by central banks in the world’s main economies were felt to a lesser extent in the real economy. It is true that they helped stabilise investment risk sentiment, which is fundamental for recovery — also reflected in the declining trend in money velocity (towards historic lows).
• On the other hand, these programmes had a stronger impact on financial markets and housing markets, in the US and the Eurozone as well as globally, as evidenced by the sharp rise in equity indices and real estate prices. For example, home prices in the 20 leading US metropolitan areas rose by 20% year-on-year in July, a record pace, higher than before the Great Recession.
• Also, after the 2007 financial crisis began, we saw both a strong tightening of regulation in financial and banking systems to avoid another medium-term breakdown, and aggressive government intervention in the economy, in both advanced and emerging/developing countries. This pushed the public-debt-to-GDP ratio to record levels today.

I would mention the bank asset purchase programme implemented by the Obama administration after the financial crisis broke out, and especially the large-scale programmes rolled out by governments around the world after the pandemic.

Fiscal impulse after the coronavirus pandemic

Source: International Monetary Fund (IMF)

At the same time, the two shocks (the financial crisis and the health crisis) pushed up the household saving rate.   

Household saving rate (US vs. Eurozone)

Source: Bloomberg

As for companies, their profits increased significantly in recent decades to record levels. This trend was influenced by global economic growth and a supportive financial market environment.

US corporate profits (trillions of dollars)

Source: Bloomberg

Causes and effects

The developments mentioned in this article have driven structural changes in the banking sector (globally and in Europe, including Romania) in recent years, through:

• the build-up of unprecedented excess liquidity, which represents an opportunity cost for the banking sector;
• tighter regulation;
• exiting complex (high-risk) activities and a focus on prudent lending;
• strengthening capital bases; and
• a strong focus on the digitization of financial services.

The next articles on this decade’s challenges for banking will cover:

• Excess liquidity building up in the banking sector
• Banking system asset structure – developments in the Eurozone
• Structural trends in Romania’s banking sector after the Great Financial Crisis
• Outlook for the banking sector