Financial Crises and the Development of Regulations

Credit’s role in OECD member democracies is at the core of the functioning of their economies. This does not mean that the credit system itself functions well at all times. The evolution of the credit inventory and its rate of growth, as well as instruments developed by the financial industry, can be the cause of major economic crises.

The crisis of 2008 showed how banks and financial markets, through their excessive use of leverage and their ability to ‘exclude’ competitors from the information and transparency necessary for the proper functioning of the system (particularly through the development of complex financial instruments known as derivatives), became one of the main reasons for the economic collapse.

One of the measures of a political system’s strength can be the manner in which it reacts to crises and produces effective corrective actions. Credit’s inventory size in OECD countries reached a level that was excessive compared to the underlying gdp. In this instance, credit became a risk to democratic processes and jeopardised the political sphere in which it operated.

An oversized credit inventory, operated by banks that are ‘too big to fail’, can be a risk for advanced OECD member democracies. Capital requirements were imposed on these banks, aiming to provide a more transparent ‘price’ for leverage rather than changing the mechanism at the core of the financial system.

mena countries, in contrast, face the opposite risks, associated with credit being too small a component in the way economic activity is financed. The trends we have described with regards to the evolution of the financial sector in mena point to a healthy and promising level of growth. These trends vary from country to country and are most evident in gcc member states. While such positive trends are solid, credit still plays too small a part in the financing of these economies to become a main agent of change towards greater reliance on democratic processes.

Regardless, the influence of credit is growing and the financial crisis of 2008 could end up having a positive impact. In 2009, several defaults in mena were triggered as spillovers of the collapse of global capital markets. In particular, the default of Dubai’s flagship corporations significantly impacted the emirate’s access to credit and capital markets. The credibility of Dubai’s implicit guarantees—on which previous loans and bonds, both international and domestic, were based—has been permanently damaged. This can have positive consequences if we consider that compliance with the more transparent and commonly used tools of guarantees and accounting will need to occur. This in turn improves the conditions for credit to grow, as it strengthens the quality of contracts struck between lenders and borrowers, potentially attracting new participants to the credit market.

The defaults of Kuwait’s Investment Dar and Global Investment House, the liquidity difficulties of Gulf Bank in 2009, and—in Saudi Arabia and Bahrain—the Al-Gosaibi’s financial crisis (triggered by the default of the International Banking Corporation and Awal Bank, controlled by Maan Al Sanea) did not endanger the overall solvency of the system given the relatively limited size of credit in the economies of those countries. However, the restructuring of these failed institutions’ debt involved more than 80 banks internationally and domestically. This will tend to force the emergence of improved standards of accounting and increased transparency. The quality of guarantees that borrowers in the Kingdom of Saudi Arabia and in Kuwait will need to provide in order to access credit or issue Sukuks will need to improve. The acceleration of Sukuk issuance throughout the region and beyond reflects the improved quality of ‘trust contracts’ struck, and the increase in the number of participants accessing and providing credit.

At the end of 2014, the Egyptian government issued investment certificates soliciting the savings of national investors to fund infrastructure projects and the expansion of the Suez Canal. The transaction was a success: three weeks after the certificates were issued they sold out; the government netted usd 8.5 billion. The certificates represent an important commitment as they promise a return (12 per cent) and capital protection, providing credit guarantees based on the cash flow of the commercial activity of the Suez Canal as a security for capital and interest payments.

While an autocrat is again in power in Egypt, credit in this example introduces an element of commitment from the issuer or borrower towards the investors, similar to that of an electoral process, given the accountability that the certificates impose. It is difficult for the issuer to default on these commitments without damaging its credibility or facing consequences that would weaken its hold on power. The universe of investors that has subscribed to the certificates is obviously far from representative of the whole of Egyptian society, and only a few Egyptians that had the means to subscribe to the certificates are ‘voters’ in this exercise. Nevertheless, the process still imposes a significant degree of accountability.

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