Government, Financial Institutions and the Global Financial Crisis

3 Decembrie 2009

PRICEWATERHOUSECOOPERS in ROMANIA

 

Executive summary

Forced to bail out an industry too strategically important to fail systemically, government is firmly inside the financial services tent where it is set to remain for a considerable time.

The complexity of individual financial institutions' situations, difficult market conditions and an unattractive disposal environment combine to make the possibility of early government exit from their stakes in the private sector highly unlikely. It will take two to three years to sell major holdings, but five to seven years or more before governments are able to fully divest of their stakes and related guarantees.

Given that temporary state ownership will stretch into the medium term, governments should not waste this opportunity for reform. They must clearly define their objectives, focus on taking a positive role and navigate three key public policy challenges:

• Government must seek to be ‘good owners', focusing on wider social and economic objectives as well as narrow financial goals as shareholders;
• They must rebuild the confidence and trust that are essential for the financial system to function efficiently; and
• They must put in place credible plans to address financial deficits.

Being a good owner

As owners governments can take a longer-term approach and adopt the role of an activist investor, thereby focusing not just on the financial return on investment but also on the economic and social returns. They must challenge strategy but avoid politically motivated meddling and be mindful of the market distortions introduced by state ownership. Governments also need to manage carefully the conflicts arising from their distinct roles as owners/ shareholders, acting on behalf of taxpayers, and supervisors/regulators, acting on behalf of consumers and businesses.

There is an important distinction, however, between maximising shareholder value within a context that is supportive to wider economic and social goals and using government ownership of the banks as a substitute for more appropriate policy mechanisms to achieve those social objectives.

The need to tackle the problem of toxic assets is a key lesson from previous crises and historically ‘bad bank' structures have proved the most effective method of dealing with them. The sheer breadth and scale of the current crisis in comparison to previous more localised periods of turmoil have, however, necessitated a wider range of solutions, some involving retaining assets on balance sheet.

Restoring trust

Breaking up the banks is no panacea. Proposed solutions to address market failures by dismantling large and complex financial institutions could generate unnecessary costs and are a distraction from more useful market reforms to diversify risk by encouraging diversity of provision. Similarly, product regulation has limited effectiveness and attraction as a solution and can introduce conflicts of interest with wider public policy objectives.

Restoring the long-term trust and confidence of business and consumers in the financial system will require a combination of regulatory and market driven reforms as well as a return to more conservative approaches to doing business. More could and should be done to strengthen governance through more effective board-level understanding, oversight and accountability. Compensation design needs to be reformed, with remuneration plans focused on the long term. An internationally agreed set of principles on compensation reform is required, which can then be tailored to specific countries.

Whilst many reforms to the regulation of individual institutions are focused at national level, this is necessary but not sufficient. A more international approach to regulation is needed and systemic risks must be addressed over and above the risks in individual institutions. Current reforms are moving in the right direction, but more work is required to develop effective global regulatory mechanisms, which are likely to arise through a collaborative international approach rather than a single regulatory institution.

Dealing with debt

Many governments have a fiscal mountain to climb as they deal with the combined effects of state bailouts, recession and the consequences of the financial crisis extending beyond banking boundaries, for instance to the insurance and automotive sectors. In the short-term, the focus remains on stimulating economies by maintaining increases in public spending as the global economy turns around and heads towards the recovery ward. But, in the medium term, dealing with debt on such an unprecedented scale and avoiding a long term drag on economic recovery requires credible, sustainable plans to address the fiscal gap and avoid a return to intensive care.

There are steps governments can take to do more with less, starting with operational efficiency improvements. Efficiency savings, however, will not be enough to turn around major fiscal deficits. The role of government must be revisited and all options considered, including service decommissioning.

Even now, governments must not forget the need to plan for the future. A return to growth is essential: the priority for government is to spend on projects with a high social and economic return, which will assist private sector wealth creation. At global, national, regional and local levels, governments need to act as the runway for future growth, navigating their economies through current troubled waters, while charting the way ahead to a better and more sustainable future.

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Legal updates

25 Februarie 2010 Legislative Summary - January 2010 19 Februarie 2010 Certification of annual profits tax returns 5 Februarie 2010 State Budget and State Social Security Budget for 2010 Laws 5 Februarie 2010 Changes brought to certain VAT statements 5 Februarie 2010 Draft amendments to the Fiscal Procedure Code 29 Ianuarie 2010 Certification of the annual tax returns by a tax consultant 29 Ianuarie 2010 Fiscal regime for micro-enterprises

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