In a speech for the Bank of International Settlements (BIS), Knot sheds light on what the FSB (Financial Stability Board) does and will do to ensure financial stability. Not surprising that he does this, because Klaas is not only president of the central bank, but also the chairman of the FSB. The beauty of these speeches is that they are made for the intimates and experts and not so much for the masses. This allows the audience to take a look behind the scenes and thus form an idea of what is in store in 2023.
Rightly, Knot begins with the observation that predicting a crisis is virtually impossible and that this is therefore not the goal of the FSB; instead, the FSB focuses on analyzing weaknesses in the financial system and how to fix or prevent them. They do this jointly with central bankers, policymakers, and national and international regulators (SEC, AFM, BaFin, etc.).
It is interesting that he starts his story with a scene with Johann Wolfgang von Goethe, the von Humboldt brothers, and Friedrich von Schiller. This German quartet was convinced that using ratio was the right thing to do: “The four of them were the intellectual fab four of late 18th century Germany. They strongly believed in the powers of reason – as opposed to royal decrees or religious dogmas. They strongly believed that individuals were to be enlightened – through science, art, and literature. They strongly believed in “sapere aude” – in daring to know”. So the interesting thing is that he quotes famous Germans and underlines the use of ratio. Was this a wake-up call to the Germans to go back to German (monetary & fiscal) reading? Or is it a warning to the Latin countries to engage in sound (monetary & fiscal) policy? Who knows may say.
Knot continues by sketching the current context, which is not so pretty. There is a lot of debt and inflation is high. This means that if there is a shock, governments have little room to ease the pain (sovereign debts are already too high) and central banks can also do little because the central bank balance sheet is already very large and the high inflation offers no room to to lower interest rates.
Knot does not explicitly provide a real solution for the above observations. Knot does say that many of these problems have been glossed over by governments’ corona aid programs. Now that these are all being phased out, the implicit expectation is that things will come out of the closet.
In addition, he touches on three topics that the FSB will devote extra attention to in 2023: 1) the share of non-banks in financial transactions, 2) digitization in the financial sector, and 3) climate change.
Due to increasingly strict regulation (oh the irony!), more and more financial activities have moved from banks to non-banks (shadow banks). Where in 2008 42% of all financial values were brokered via shadow banking, that will have grown to 49%, or $239 trillion, by the end of 2021. In other words, imagine that 0.5% will cause problems, so that means just under 1200 billion… Traditionally, regulators have less overview and therefore a grip on this part of the financial sector. It is therefore not surprising to assume that if there is a shock, it will most likely come from this quarter. Knot therefore argues for more overview and regulation of this part of the market.
The second point is very broad, digitization, but Knot took the opportunity at this point to fire at crypto. He notes that despite the advanced technology, crypto has the same common risks as plain vanilla banking: liquidity mismatches, hidden debts, and counterparty risk. For that reason, Knot advocates for rapid and strict introduction of regulation for crypto. In his eyes, “same activity, same risk, same regulation”. So the ideas about crypto regulation presented in October, which you here will be rolled out in 2023.
And then climate change. Notice that again Global Warming now has been traded by Climate Change, which in any case covers the load a bit better (even better is to distinguish between what is caused by humans and what is not). The vulnerabilities as Knot sees them is the effect of the changing climate, of energy price increases and of the transition to net-zero on financial stability.
In my booklet, points 2 and 3 are linked, because the transition policy itself is a major source of rising energy prices; the (too fast) green transition is itself a cause of vulnerabilities in the financial sector (and the economy as a whole). Something Knot ignores. So if he wants to mitigate these vulnerabilities, he will have to plead with policymakers for a slower green transition. However, I do not believe that this is now seen as politically expedient by Knot and his associates…
Knot argues that the emphasis should now be on data, because without good information about climate risks, no good policy can be made. In doing so, he also implicitly makes the link with ESG regulation (SFDR, NFRD, CSRD) and EU Taxonomy that will require 49,000 companies to report this kind of non-financial information (think Co2 emissions, water consumption, anti-corruption practices, salary scales, diversity and so on) to the world before the end of 2029.
Basically, crypto and shadow banking get to face a crack down. In addition, more and more companies and financial institutions must identify all climate risks. This data will later help regulators to force the aforementioned companies and financial institutions to make the “right” choices by introducing far-reaching regulation.
Oh yes, and by implication Knot notes that the ECB, and many governments, will be impotent to absorb the next blow because debt levels are too high. So when that blow comes, it will be a big one…
