**Johan Van Overtveldt MEP**, Chair of the European Parliament's Budgets Committee and former Finance Minister of Belgium, explores the rise of debt levels globally. **José Manuel Campa**, Chairperson of the European Banking Authority (EBA), shares his views on priorities and challenges for the years to come.
Contents
Speaker View: Johan Van Overtveldt MEP, Chair of the European Parliament's Budgets Committee and former Finance Minister of Belgium >>
An interview with José Manuel Campa, Chairperson of the European Banking Authority >>
Johan Van Overtveldt MEP is the Chair of the European Parliament's Budgets Committee. He served as Minister of Finance of Belgium from 2014 until 2018. The views and opinions expressed in this piece are those of the author and do not necessarily reflect the views or positions of Bloomberg. This article is titled Death By Debt and was written in September 2022.
Central bank policies have contributed significantly to the phenomenal rise in debt levels throughout the world. This untenable debt explosion is however about much more than simply central bank policies.
Structural reforms. There is no other concept in recent decades that has received comparable amounts of lip service. ‘We need structural reforms...’, so it went in speech after speech, to cure the many ills that have befallen us since the beginning of the 21st century. Such reforms would tackle only the most general of principles, such as liberalizing the labor market, preparing the pension system for the new reality of an aging population, streamlining the energy market, increasing the safety of the financial system or improving the efficiency of government services. Beneath these highbrow musings, the detail was largely absent.
What only rarely hit the structural reform priority list was the need to deal with the escalating debt levels in the world. Fueled by the Great Financial Crisis, the Covid pandemic and by a more general neglect of orthodox budget principles, globally debt has increased to levels never seen before. As a result, the financial and economic system has become much more vulnerable to negative shocks. The frequency, as well as the duration, of episodes of turmoil has substantially increased due to the enormous quantities of debt sloshing around. The relentless increase of these debt mountains also weighs heavily on economic growth prospects, job creation possibilities and investment and innovation efforts.
"Debt has increased to levels never seen before."
In its latest Global Debt Monitor (May 2022) the Institute of International Finance estimated that during the first quarter of this year global debt increased by $3 300 billion, to an eye-popping new record level of $305 000 billion, equivalent to 348% of world GDP.
The debt increase during Q1 2022 was mainly attributable to China (+ $2 500 billion) and the United States (+ $1 800 billion). It is primarily government and corporate lending that has pushed upwards the overall outstanding debt levels in recent years. Overall outstanding corporate debt now stands close to $100 000 billion.
With rising interest rates, the cost of servicing debt will evidently rise too. This may create substantial problems, particularly for emerging markets where a lot of the debt is held in dollars. Debtors in emerging markets face a double blow: higher interest rates, as the Fed intensifies its fight against inflation and a rising dollar exchange rate.
"348% of world GDP"
The Great Financial Crisis showed in a dramatic way the fragility of an over-indebted economic and financial system. After the GFC, numerous oaths were sworn that everything needed to be done to bring down debt. The simple truth is however that we just kept accumulating debt as if the GFC never happened. Yet the larger the debt content of the overall balance sheet, the more quickly the solvency of the whole system is jeopardized and in a more structural way.
The other side of the coin is that a more capital-intensive system is more resilient and much more able to deal efficiently with shocks. By “capital” I mean financing coming out of the own resources (“acquired income”) of investors and citizens. A debt-intensive system in contrast is a system characterized by what is often labeled as a high degree of leverage (multiples of debt in relation to capital).
Of course, leverage is not per se bad. On the contrary, a healthy degree of leverage enlarges growth opportunities and contributes to welfare and well-being. It is all a question of degree. The unanswerable question is where exactly leverage shifts from being a positive contributor to the economic and social environment to becoming a drag on that environment. In the midst of these fine margins there is however hardly any discussion at all of the fact that the world as a whole has shifted in recent years into such a leverage position that the negative consequences have come to dominate.
For example, in the very recent discussion on the fragility of large energy companies in an environment of rising and highly volatile gas prices it is often forgotten that more capital and less debt would automatically make the whole system more resilient.
Central banks have contributed to the attractiveness of debt accumulation through their policies that kept interest rates ultra-low for many years. Such policies have constantly flooded the markets with additional liquidity.
Nevertheless there’s much more to the awkward debt story of today than just central bank policies. Tax regimes in many countries offer important incentives to use debt instead of capital for financing needs. The same goes for many regulatory regimes. The link between debt and the collateral offered to cover the debt is often weak. Recognizing the deteriorating quality of collateral often takes a lot of time, if recognized at all.
If policymakers are serious about structural reforms – and they’d better be because they are essential to escape the inflation-cum-recession environment and to make the system much less shock-prone – monetary, fiscal and regulatory policies are needed that disincentivize the use of debt.
The alternative will be an utterly messy process involving high inflation, debt restructuring and possibly outright debt defaults. Each of these alternatives to intervention to move to more manageable debt levels will put a heavy burden on the economic, social and political fabric of democratic societies.
Continue to the next article, An interview with José Manuel Campa >>
Q: After more than ten years since its establishment, how has the EBA grown into its role as the EU's banking regulator, and what are the priorities for the coming years?
A: We were established in 2011 in response to the great financial crisis of 2007-2009 that had brought the global economy and investors to its knees and affected the levels of trust that citizens had in the system and its institutions. Since our establishment, we have developed a harmonized and consistent set of rules on prudential and resolution aspects and provided additional guidance on how they should be implemented.
One of the key principles governing our regulatory effort is proportionality, to ensure that rules are not “one-size-fits-all” but that every single measure in the EU’s rulebook is fit for purpose, effective, proportionate, operational, and as simple as possible.
Within our broader priority of maintaining a comprehensive and efficient single rulebook, our focus for 2023 will be the timely and faithful implementation of the outstanding elements of Basel III reforms in the EU, which will further strengthen the EU regulatory framework. Enhancing transparency to ensure better monitoring of risk build-up and increased market discipline is another important priority for the EBA. In this context, we will be running an enhanced EU-wide stress test in 2023, building on the lessons learned from previous bi-annual exercises since 2011.
Another important priority that is increasingly on our radar is digital finance and ICT risks. In these areas, our activity is driven by the numerous mandates in the Regulation on Markets in Crypto Assets (MiCA) and the Digital Operational Resilience Act (DORA).
The EBA's work on conduct, consumer protection, anti-money laundering, and countering the financing of terrorism (AML/CFT) will strive to enhance the capacity to fight money laundering and the financing of terrorism in the EU. We'll prepare to hand over powers relating to AML/CFT compliance and supervision to the new AML/CFT Authority (AMLA).
Finally, another important priority is to properly integrate ESG into the regulation where we are working on many fronts, including enhancing disclosure, advancing the risk management standards for banks, and updating core elements of the prudential framework and stress testing methodologies.
Q: Policymakers and regulators worldwide are increasingly focused on the opportunities and risks posed by new technologies, how does the EBA plan to approach these issues?
A: The EBA closely monitors technological innovation in the EU financial sector to ensure that risks are mitigated and barriers to adoption are removed. Where the EBA identifies issues, it guides supervisory authorities to promote a consistent supervisory approach and/ or advise the European Commission on the need for new or amended legislation at the EU level.
This approach, "monitor, identify, address", ensure the benefits of the technologies can be fully realized without jeopardizing the crucial objectives of consumer protection, prudential resilience, and the stability of the financial sector.
Q: What can we expect to see from the EBA specifically as the regulatory focus intensifies on the growing digitalization of the financial sector and risks in new markets such as crypto?
A: With enhanced digitization across the banking and payments sector, the EBA emphasizes the need for effective ICT risk mitigation. In the context of the implementation, this includes using the new Digital Operational Resilience Act, which consults with the EBA (and the other ESAs) on new tasks concerning critical third-party providers (CTPPs).
With the recent development in the crypto-asset sector, the EBA is encouraging industry and supervisory authorities to invest in skills-building to ensure compliance with the Markets in Crypto-assets Regulation (MiCA). Global convergence in these areas is vitally important and the EBA is proactively engaging in all relevant international work streams, including those of the BCBS and FSB.
Continue to the next chapter, Bloomberg Policy Series showcase >>
