Introduction
There is now a burgeoning literature on the emerging new international financial architecture, both pre- and post-crisis.Footnote 1 These works provide a variety of perspectives on the financial sector reforms. Some take a traditional state-centric view of the process, arguing that such international agreements reflect the relative economic capabilities of the states involved, the most powerful establishing exclusive ‘clubs’ thus ensuring regulatory outcomes that they favour.Footnote 2 Moreover, given the growing importance of Europe, Japan, and China, the effectiveness of the reform process will be highly dependent on these countries reaching accord amongst themselves and the United States. From this perspective, the question of the longer term stability of the international economic system arises as issues surrounding credit supply, interest rates, exchange rates, and trade imbalances continue.Footnote 3 Others look to the domestic arena in an attempt to answer why states are at times proponents of international regulation, yet at other times seek other alternatives. David Singer, for example, examines the tendency of regulators to attempt to resolve issues through domestic legislation, arguing that their ‘penchant for international standard-setting emerges only when they are unable to fulfill their domestic mandates with unilateral regulation’.Footnote 4 Layna Mosely, on the other hand, adopts a top-down approach and examines how ‘domestic political institutions, as well as interests, often will lead to the failure of governments to implement global codes and standards’ in middle to low income countries'.Footnote 5
Many raise the issue of diminishing government autonomy with the state increasingly finding itself at a ‘crossroads position in a complex network of actors, institutions, and processes – nodes of power and authority – from the local to the global’ having to ‘share and coordinate more and more of its regulatory power with those other nodes’.Footnote 6 Specifically in finance, the last few decades have witnessed both a sharp increase in the numbers of self-regulatory bodies and an increase in the frequency of regulatory capture. This has given rise to several studies on the fusion of public/private authority and the input and output legitimacy of actual decisions concluded at the national and international level, that is, ‘policy capture on the input side, and how this might skew substantive outcomes on the output side’.Footnote 7
The article adds to these works by focusing on risk-based regulation and rationalities of risk in post-crisis finance.Footnote 8 In so doing, it treats risk analysis as a core constitutive element of the financial system. From this perspective, risk is viewed as ‘a way – or rather, a set of different ways – of ordering reality, of rendering it into a calculable form’.Footnote 9 Yet, as the recent financial crisis has demonstrated, the multitude of micro-calculations of risk associated with the vast array of financial activities that occurs today produce a macro-risk at the level of the system itself. The task of governance is therefore to balance the ostensible benefits of finance (wealth production via efficient intermediation) with the security and smooth operation of the economy itself. This article analyses the reformed risk dispositif that operates at the heart of financial governance. In so doing, the article critically assesses Beck's world risk society approach and, by deploying a Foucauldian governmentality perspective, demonstrates both regulatory inertia and the epistemological limits of the risk based regulatory architecture currently under (re)construction.
The article draws upon the broader International Relations literature that identifies these two competing perspectives of risk.Footnote 10 The world risk society approach introduces a dichotomy between reflective and reflexive modernisation. The former is associated with the first phase of modernity and involves ‘improving our knowledge of cause-effect relations and control of the world’.Footnote 11 The latter is associated with self-confrontation and an acceptance of ‘our own inability to know’.Footnote 12 The former attempts to reduce potential threats through improved scientific technical knowledge, while the latter involves an appreciation of the uncontrollable threats that lead to catastrophic events prompting full recognition of the unknowability of the future effects of our current activities.Footnote 13 Politically, it is argued, that such catastrophes prompt a shift to a ‘cosmopolitan form of statehood’ – an alliance of the state and civic movements – that will tame global capital.Footnote 14
In contrast, a Foucauldian approach emphasises the ways in which a variety of risk rationalities and technologies are used to manage such challenges. There is thus a fundamental difference between this perspective and that of Beck's because it views risk as a way of ‘organizing reality, disciplining the future, taming chance and rationalizing individual conduct’.Footnote 15 Rather than leading to the questioning of so-called expert knowledge and the auguring in of a process of self-confrontation through which the foundations of modernity are questioned, such challenges are met by new technologies and rationalities of risk.Footnote 16 For this approach, reflexivity refers to the ‘governmentalization of government’ or ‘reflexive government’.Footnote 17 Instead of witnessing a shift towards a cosmopolitan risk society, crises and catastrophes are said to produce reflexive moments through which the governance of our natural and social environments is modified to meet the challenges that confront us.
Although the recent innovations in financial governance show some evidence of the emergence of a financial public sphere, it bears little resemblance to that suggested by Beck. The state has, indeed, reasserted itself and there has been significant reform of the international financial regulatory regimes, but the influence of civil society remains relatively weak.Footnote 18 Certainly, the crisis has not induced a ‘reversal of neoliberal policy – not the economisation of politics, but the politicisation of the economy’, as Beck himself suggested it might.Footnote 19
The article argues, therefore, that the reforms bear a much closer resemblance to that posited by the Foucauldian approach. This reflexive moment has prompted reform of the financial system to reduce the likelihood of such an event occurring again. As a result, the risk dispositif has been reinforced both by more rigorous risk standards and by enhanced surveillance throughout the system. Yet, the outcomes of this reform process reflect its highly political nature with a number of ‘non-decisions’ and compromises as a result of influence from private financial actors.Footnote 20 In addition, the reforms have, if anything, increased our reliance on risk calculation. Partly because of the limited nature of these reforms, a new rationality of risk – that of pre-emption – has been introduced in an attempt to manage the possibility of a unique one-off catastrophe occurring again. However, the emphasis on surveillance and pre-emption may in fact increase the possibility of another financial crisis. Although the Foucauldian perspective provides a more convincing analysis of the current reforms, Beck's warning that ‘risk-reducing practices and technologies have risk-increasing properties embedded within them’, should not be ignored.Footnote 21
Risk, trust, and abstract systems
In his works, Beck distinguishes between a first phase of modernity in which ‘calculating risks is part of the master narrative’ and a later modernity in which we ‘enter a world of uncontrollable risk’.Footnote 22 Classic modernity involves the application of scientific-technical knowledge to industrial society, not only endeavouring to calculate the risks associated with such actions but also employing an infinite iterative knowledge loop – continually learning from problems that arise and applying that new knowledge to further improve control over the environment and society. Potential threats associated with industrial society are recognised and dealt with through a ‘regime of control over risk that enable[d] the estimation, management, control and compensation for risk exposure’.Footnote 23 This regime of control centres on probabilistic risk calculus and insurance to cover potential future events should they turn into reality.
However, late modernity is said to be increasingly beset by dangers of a much greater magnitude and scope arising from the unforeseen consequences of applying our scientific-technical knowledge to the natural and social worlds. Beck argues that this represents a movement towards risk society in which ‘the social, political, ecological and individual risks created by the momentum of innovation increasingly elude the control and protective institutions of industrial society’.Footnote 24 Risk society is thus marked by the predominance of reflexive modernisation, one in which the unforeseen consequences of our technical knowledge hold sway such that ‘the further the modernization of modern societies proceeds, the more the foundations of industrial society are dissolved, consumed, changed and threatened’.Footnote 25 As such, risk society ‘operates and balances beyond the insurance limit’.Footnote 26
For Beck, the continued use of inappropriate social practices is symptomatic of the on-going but incomplete process of modernisation itself.Footnote 27 Although we are increasingly confronted by hazards of our own making, the parallel shift in reflective self-criticism remains, as yet, unforthcoming.Footnote 28 As long as we continue to perceive global risks ‘within the conceptual horizon of industrial society … as negative side-effects of seemingly accountable and calculable actions, their system-breaking consequences will go unrecognized’.Footnote 29 Nevertheless, Beck suggests that the enormity of these hazards will inevitably generate sufficient awareness within global society to prompt such critical self-reflection on our existing practices: ‘Within the horizon of the opposition between old routine and new awareness of consequences and dangers, society becomes self-critical.’Footnote 30
Reflexivity is said, therefore, to involve self-confrontation ‘with the effects of risk society that cannot be dealt with and assimilated in the system of industrial society’ and an acceptance of ‘our own inability to know’ the unintended consequences of our own actions.Footnote 31 Risk society represents a condition in which the ‘recognition of the unpredictability of the threats provoked by techno-industrial development necessitates self-reflection on the foundations of social cohesion and the examination of prevailing conventions and foundations of “rationality”’.Footnote 32 Reflexive modernisation thus goes beyond simply ‘improving our knowledge of cause-effect relations and control of the world’ and actually involves ‘a process of reflection by which the foundations of modernity are questioned and revised’.Footnote 33 This shift, it is argued, prompts a major political movement towards what Beck calls a ‘Cosmopolitan form of statehood’ in which an alliance of the state and civic movements is forged to confront the issues that arise from such threats.Footnote 34
Uncertainty, precaution, pre-emption
As others have pointed out, there are several problems associated with Beck's version of a world risk society.Footnote 35 This article focuses on two of these. First, it ‘fails to recognize the socially produced and culturally constructed nature of risk’.Footnote 36 Second, the idea that reflexive modernisation would involve the questioning of expert knowledge and the opportunity for alternative voices to come to the fore is questionable. Beck further argues that ‘[g]lobal risks empower states and civic movements because they uncover new sources of legitimation and options for action for these groups of actors; on the other hand, they disempower globalized capital because the consequences of investment decisions give rise to global risks.’Footnote 37 For sure, after the financial crisis, there has been a groundswell of support for groups such as the Occupy movement and popular opinion has certainly turned against the financial sector. Yet, as will be argued below, the reform process and the lack of political will to radically transform the situation has demonstrated the continuing influence of the financial sphere in the corridors of power within the state.
In contrast, a Foucauldian approach emphasises the way in which a variety of risk rationalities and technologies are used to manage such challenges. As such, risk, it is argued, can be ‘understood as a dispositif, consisting of ‘discourses, institutions, architectural forms, regulatory decisions, laws, administrative measures, scientific statements, philosophical, moral and philanthropic propositions’.Footnote 38 For this approach, reflexivity refers to the ‘governmentalization of government’ or ‘reflexive government’ whereby ‘the mechanisms of government themselves are subject to problematization, scrutiny and reformation’.Footnote 39 Rather than uncertainty prompting a radical reconfiguration of politics, new modes of governance arise that attempt to ‘compensate and mitigate the uncertainty surrounding “incalculable” threats’.Footnote 40
Risk is most often associated with a ‘form of calculation … that establishes the regularity of events and a calculus of probabilities in order to evaluate the chances of an event actually occurring’.Footnote 41 For such calculations to be applied to a ‘given situation requires some form of regularity in its underlying structure’.Footnote 42 However, major catastrophes emerge from a concatenation of events that, when taken in their entirety, are unique. Uncertainty has as its referent object infrequently occurring and often unique events that can ‘only be “likened” to other cases’.Footnote 43 As such, one can only ‘formulate, between a cause and its effect, a relationship of possibility, eventuality, plausibility or probability without being able to provide the proof of its validity’.Footnote 44 There is thus an ‘absence of certainties, having taken into account the scientific and technical knowledge of the time’.Footnote 45 But this does not mean that uncertainty should be elided with incalculability and disassociated from risk – ‘the distinction between calculable and incalculable threats … ignores the multiple ways in which technologies of risk are deployed to identify, calculate, imagine, assess, prevent, compensate and mitigate the uncertainty surrounding “incalculable” threats’.Footnote 46
There are many examples of attempting to improve our understanding of uncertain environments – ‘the development of trend analysis techniques to social, political and economic phenomena, the use of path dependency analysis to map the trajectory of institutional forms, norms and practices of discrete segments of populations, or the use of Delphi techniques in the generation of political and commercial forecasts, have all emerged as key tools for managing situations of uncertainty’.Footnote 47 For this approach, the focus is therefore on the forms of governmentality that emerge in ‘taming the infinities of risk and integrating it within a dispositif of governance’.Footnote 48
This article argues that the recent financial crisis has led to both the reinforcement of existing risk rationalities and given rise to a new risk rationality of pre-emption founded on the principle of precaution.Footnote 49 Such a principle, ‘implies that, from now on, along with what one can learn from science, in a context that is always relative, it will also be necessary to take into account what one might only imagine, doubt, presume, or fear’.Footnote 50 Such precaution will entail the imagining and drawing up of worst case scenarios when making policy decisions. But more than this, the precautionary principle often requires pre-emptive or ‘weatherman’ policies identifying potential dangers and attempting to reduce the probability of them turning into actual threats by acting in advance of the event.Footnote 51 The following section examines, first, the reinforcement of ‘traditional’ risk rationalities and, second, the new rationality of pre-emption.
Reflexive governance and systemic financial stability
Systemic risk reduction
In the aftermath of the crisis, attention has shifted towards the way in which complex systems operate and the sources of instability within them. Systems with high degrees of connectivity tend to be highly vulnerable to network spillover effects, that is, where the failure of one financial institution has negative knock-on effects throughout the system.Footnote 52 The emphasis has thus been on increasing the ‘absorptive capacity of each of the nodes in the financial network in response to external shocks’ in order to reduce systemic risk.Footnote 53 As a result, the capital adequacy requirements for banks have been significantly increased. Acceptable risk levels have been recalculated and the new Basel III Accord has increased levels of capital adequacy so that the amount of common equity banks hold has to be increased from 2 per cent to 4.5 per cent and a total of Tier One capital amounting to 8.5 per cent of risk weighted assets.Footnote 54 The new requirements also attempt to reduce pro-cyclicality by introducing the added requirement of a conservation buffer of 2.5 per cent common equity which is to be maintained during economic upturns, but can be drawn upon during periods of stress without impacting upon banks’ commitments with regard to maintenance of their minimum capital requirements. Significantly, Basle III also sets bank leverage ratios at 3 per cent of Tier 1 capital to total exposure – including operations in the shadow banking area.
Not only have the nodal points been strengthened through increasing their absorptive capacity but also functional differentiation has been reintroduced. There is now a greater appreciation that homogeneity with regard to financial strategy may ‘minimize risk for each individual bank, but maximize the probability of the entire system collapsing’.Footnote 55 As a result, there have been some attempts to increase modular differentiation within the system by both the US and Europe reinstating the distinction between commercial (UK retail) and investment banking thus creating an essential firewall between the two sectors reducing the possibility of contagion. As part of the Dodd-Frank Act, the Volcker Rule was originally supposed to prohibit commercial banks from proprietary trading altogether, thus producing a firebreak between themselves and the vagaries of the financial markets. However, it will now limit investment in hedge and private-equity funds to 3 per cent of their Tier 1 capital.Footnote 56 It looks likely, following the findings of the European Commission's sponsored Liikanen Report, that Europe will adopt a similar system to the UK's and ring fence the commercial banks’ retail side from their trading activities effectively establishing two separate capital bases for each.Footnote 57
In addition, the reforms attempt to reduce the probability of system failure by identifying those financial institutions that have the potential for being ‘superspreaders’ of instability in times of stress.Footnote 58 In the US, banks regarded to be too big to fail will be limited in size through the Dodd-Frank restriction on mergers which states that, for any merger, total liabilities must not ‘exceed 10 per cent of aggregate consolidated liabilities of all financial companies in the United States’.Footnote 59 Moreover, the Act places significant restrictions on emergency bailouts, with lending prohibited for any ‘individual, partnership, or corporation’, and limited to ‘participant(s) in any program or facility with broad-based eligibility’.Footnote 60 The objective is thus to move away from individual bail-outs and the moral hazards said to accompany such help, towards the general objective of providing liquidity to the financial system.
The Financial Stability Board (FSB) is also playing a central role in addressing the ‘too big to fail’ question of systemically important financial institutions.Footnote 61 Its central tasks are to identify those financial institutions said to be systemically important (29 have been identified), to introduce preventionary measures and ensuring that effective resolution regimes have been put in place in the case of bankruptcy (‘living wills’). To this end, the FSB has set higher capital adequacy ratios for these institutions to ensure that during difficult times they have a greater loss absorption capacity. It has also established an international standard for resolution in the case of a critical failure of any one of these financial institutions. This essentially entails making sure all national resolution arrangements are such as ‘to enable authorities to resolve failing financial firms in an orderly manner and without exposing the taxpayer to the risk of loss’.Footnote 62 These increases in loss absorption capacity and effective winding down arrangements are essentially aimed at lowering the overall vulnerability of the international system.Footnote 63 Financial collapse is made less likely, but should it happen it is hoped that the orderly resolution of financial affairs will limit the possibility of contagion from these so-called super-spreaders. Once again, these reforms are being reinforced in regional structures with the European Systemic Risk Board and the European Supervisory Authorities, for example, currently working towards a common framework concerning these ‘resolution regimes’ with the FSB establishing a process of peer review to ensure consistency across states.Footnote 64
There is also a move afoot to include the so-called shadow banking sector in the new risk regime that is being established. Such a change is highly significant because of the growth in this sector's importance as a purchaser of asset backed securities (ABS) and in providing liquidity in the form of short term lending. The shadow banking system absorbed an increasing number of securities as banks moved away from the ‘originate and hold’ model that previously pertained towards an ‘originate and distribute model’.Footnote 65 Given the supposed low risk of these asset backed securities, mutual funds, sovereign wealth funds, pension funds, insurance companies, etc. were more than willing to take them on to their books.
At the same time, the shadow banking sector has provided an important source of short term lending via repurchase agreements (repos) through which these funds post collateral, such as asset backed securities, for either cash or more liquid assets. Although the main purpose of these funds is to invest for the medium term, they also require cash in order to manage the day to day flow of funds and therefore require some form of maturity transformation.Footnote 66 In order to meet this requirement, short-term loans are obtained through repurchase (repo) agreements in which various securities are used by the asset managers as collateral. On the other side of the transaction, such a process constitutes an important source of leverage for financial entities, such as, hedge funds. If, for example, a hedge fund initiates such a repurchase agreement, it will be charged a fee (‘haircut’) but it can then use the securities to take long or short positions on the market.
One of the central players in maturity transformation is the so-called money market mutual funds (MMMFs). These funds arose in response to interest rate ceilings on demand deposits in the US in the 1970s. In 1982, in the US, banks were allowed to set up short-term accounts with no interest rate ceiling. However, such accounts were not insured and therefore these registered investment companies assure investors by maintaining their shares at a net asset value of $1.Footnote 67 These funds’ activities are limited to short-term highly liquid assets (maximum 13 months).Footnote 68 By 2006, these funds managed ‘24 percent of US business short-term assets’ and ‘held liabilities of asset-backed commercial paper conduits, structured investment vehicles, and financial firms that were troubled, e.g. Lehman Brothers’.Footnote 69
In terms of system stability, it is acknowledged that these entities are important nodal points and potential sources of instability. During the crisis, the interdependence of the formal and informal parts of the financial system was clearly illustrated. The so-called ‘great freeze’ where liquidity dried up was a direct result of an exit by investors from money market funds because of their loss of trust in various ABSs and the possibility that such funds would be unable to maintain the net asset value of their shares at $1.Footnote 70 The possibility of ‘breaking the buck’ thus resulted in a ‘flight to quality’ to safer harbours.Footnote 71 At the same time, the repo market (in which MMMFs played a significant role) collapsed out of fear that if banks started to fail, fund managers would be left with collateral that they would be forced to sell at fire-sale prices.
The FSB, in cooperation with other supervisory bodies, is currently examining the various threats to stability from this sector. It has been instrumental in ensuring that national and regional initiatives to shift much of the trade in OTC derivatives onto trading exchanges and routed through central clearing houses have been conducted in an internationally consistent manner.Footnote 72 Hedge funds are now required to disclose information ‘necessary for the assessment of the systemic risks that they pose’ to their relevant regulatory body.Footnote 73 This includes their levels of leverage. The FSB is now responsible for ensuring the proper monitoring of hedge funds where a fund is ‘located in a different jurisdiction to the manager’.Footnote 74 As Eric Helleiner and Stefano Pagliari point out, given that self-regulation held sway in these areas, this marks a sea-change in attitude with states asserting ‘their regulatory authority in an internationally coordinated manner over these two sectors’.Footnote 75
The Basle Committee on Banking Supervision (BCBS) is examining the consolidation for accounting purposes of non-bank entities with their sponsoring bank. One type of financial innovation was the development of special purpose vehicles (SPVs), which were often set up in offshore jurisdictions by these financial institutions.Footnote 76 Prior to the crisis, the establishment of SPVs by banks had enabled them to shift more and more of their asset backed securities off balance-sheet to these SPVs, which were not subject to the same capital restrictions (although the banks lent money to the SPVs in order for them to purchase their securities, capital adequacy restrictions did not apply to short term lending under the Basel Accord).Footnote 77 The BCBS is currently ensuring that such activities are now brought on to the books.Footnote 78 Moreover, it is considering whether other entities such as money market funds that are sponsored by the bank should also be included in such calculations.Footnote 79
With regard to MMMFs, securities and repos, research and negotiations are still on going on how to reduce the systemic threats that these three areas pose. For MMMFs, it would appear likely that a two tier approach is to be adopted. Those entities that wish to continue to offer customers constant net asset value shares should become special purpose banks. In so doing, they would be required to maintain capital buffers just as banks do and would benefit from government insurance plus access to central bank lender of last resort facilities.Footnote 80 Alternatively, such funds could adopt variable net asset values for their shares where assets are marked to market. Customers would have to accept such price fluctuations in their investments – although the activities of these funds would be limited to the more conservative type of investment.Footnote 81 Both of these measures are aimed at preventing a repeat of the runs on these funds witnessed during the crisis: government insurance and lender of last resort for the former should assure investors during times of instability; variable NAV in the latter avoids rapid divestment arising from concerns that those who remain will be exposed to the greatest risk as the probability of funds ‘breaking the buck’ becomes more likely.
In relation to securities, current proposals include greater transparency and standardisation, facilitating risk assessment and thus reducing dependency on credit rating agencies. Minimum risk retention has been proposed as one way of ensuring the quality of securities – by forcing banks to keep some ‘skin in the game’ it will therefore be in their own self-interest to ensure they have robust quality assurance procedures in place.Footnote 82 For example, the Dodd-Frank Act stipulates that those involved in mortgage backed securitisation must ‘retain at least 5% of the credit risk, unless the underlying loans meet standards that reduce riskiness’.Footnote 83 However, some have suggested that this does not go far enough and propose converting SPVs into narrow funding banks with ‘charters, capital requirements, periodic examinations and discount window access’.Footnote 84
Systemic threats also arise from the repo market due to the procyclicality of leverage and the quality of liabilities used as collateral. During periods of strong economic growth, increases in liquidity and values in various asset classes tend to generate a decrease in ‘hair cuts’ producing higher leverage for borrowers.Footnote 85 During downturns the opposite holds true and in periods of crises the system fails to function with banks/SPVs/funds unable to find anyone prepared to accept their collateral for fear of being left with assets that they would be either unable to sell or be forced to sell at fire-sale prices.Footnote 86 Although the FSB task force will only report back at the end of 2012, possible policy outcomes include: restricting banks'/SPVs' collateral to government securities and liabilities of SPVs. Non-bank entities, such as hedge funds, may use other forms of collateral, but would require a license and be subject to minimum haircuts thus preventing high levels of leverage and reducing the procyclical nature of these transactions.Footnote 87
Surveillance and the rise of pre-emptive governance
At the global level, the surveillance powers of the International Monetary Fund (IMF) and World Bank have been increased with the financial health assessment of 25 key economies being made compulsory (to be conducted every 5 years) as well as continuing the plethora of voluntary assessments of other countries.Footnote 88 These ‘health checks’ involve both the Financial Sector Assessment Program (FSAP) and Reports on the Observance of Standards and Codes (ROSCs).Footnote 89 The latter reports use a set of international auditing standards in 12 economic areas ranging from banking to insurance, which serve as benchmarks by which the quality of economic governance within countries is measured.Footnote 90 The FSAPs constitute a new layer of macro-prudential surveillance with the explicit objective of assessing the ‘soundness and vulnerability of financial systems, encompassing a range of economic, regulatory, and institutional issues pertaining to financial stability’.Footnote 91 In essence, FSAPs seek to provide a ‘“comprehensive health check-up” of a country's financial sector’ using an array of financial soundness indicators established by the IFIs.Footnote 92
Indeed, this role has been further strengthened through the production of a Risk Assessment Matrix (RAM) based on the FSAPs thus enhancing the visibility of a country's financial sector.Footnote 93 The use of such a matrix is designed to ‘combine the identified major sources of risks (for example, over-indebted households, undercapitalised banks), possible triggers (for example, a severe macroeconomic downturn, a failure of a systemically important institution), and transmission mechanisms, with the assessment of regulatory, supervisory, and crisis management frameworks and the results of stress tests to arrive at qualitative assessments of: (i) the probability of risk triggers being activated (low, medium, high); and (ii) the potential impact on financial stability and on the broader economy were those events to materialize’.Footnote 94
The FSB, whose membership has been expanded to include all of the G20, is charged with ensuring that national regulations and surveillance competencies meet the required international standard. The FSB plays a key role in surveillance of the global economy and pre-emption as it is tasked with identifying and monitoring potential threats, conducting ‘early warning’ stress tests to spot any potential problems. Such surveillance has the objective of ‘detecting problems proactively and intervene early to reduce the impact of potential stresses on individual firms and therefore on the financial system as a whole’.Footnote 95
It is hoped that this monitoring of systemic risk will counteract the tendency, all too apparent before the crisis, of compartmentalising risks into their associated categories and treating them as self-contained entities ‘without recognising the ways in which these different kinds of risk can be self-reinforcing’.Footnote 96 To this end, the IMF and FSB cooperate on conducting early warning exercises (EWEs) with the FSB taking the lead in analysing vulnerabilities in the financial sector and the IMF concentrating on macroeconomic analysis.Footnote 97 The level of surveillance is unprecedented with operations covering: the external sector; fiscal developments; the corporate sector; asset prices, market valuations and bubble spotting; and financial market risk attitudes.
With regard to external imbalances, current account balances, exchange rate misalignments, foreign currency debt levels, and debt maturity mismatches are monitored. In terms of fiscal risks, the EWE concentrates on public debt, persistent fiscal imbalances, sovereign default risk, and the probability of fiscal crises. The EWE also examines the balance sheets of the corporate sector in order to gauge the leverage, liquidity, and profitability as a whole. Moreover, it now closely monitors real estate and stock prices for the possible emergence of asset bubbles. In determining financial market risk attitudes, the EWE assesses both the prices of assets but also takes on board the judgement of its staff regarding general market sentiment.Footnote 98
The EWE also incorporates spillover and contagion analysis, systemically important financial institutions and macroeconomic scenario mapping of potential shocks to the economic system. With regard to contagion the EWEs cover three areas. In the first of these areas, the EWE examines the dependence ‘among major financial institutions, corporations or sovereigns’ with regard to various financial instruments (credit, equity, exchange rates, and interest rates) by estimating the possible effects of distress of one entity on the others.Footnote 99 In addition, it examines cross border lending and the systemic effects arising from the effects of financial problems in debtor countries, the resulting losses and deleveraging by international banks and the ramifications for inter-bank lending, that is, amplification of deleveraging.Footnote 100
As mentioned previously, the EWE also covers systemically important financial institutions (SIFIs) given their complexity and the likelihood that a collapse would ramify out across the system and have severe repercussions for the global economy. First, each of these institution's balance sheets is examined in relation to current market data to determine the strength of their position with regard to liquidity and maturity transformation as well as leverage and credit risk transfer.Footnote 101 Second, it examines the possible spillover effects of a crisis on other SIFIs and states – which includes a qualitative analysis of the various linkages between these institutions. Lastly, there is a country level examination of the aggregate vulnerability arising from those large banks residing within any given country.Footnote 102
The EWE also produces simulations of a variety of macroeconomic risk scenarios at the global level. Chief amongst these is the global financial stability map covering a wide range of possible threats. These include, macroeconomic risk, credit risk, market and liquidity risk, emerging market risk, risk appetite, and the prevailing monetary and financial conditions in general, It also uses a Global Projection Model examining countries' business cycles capturing growth, inflation, interest rates, exchange rates, unemployment, and bank lending. There is also a multiregional Global Integrated Monetary and Fiscal Model that not only examines the impact of crises but also the effect of various possible monetary and fiscal responses.Footnote 103
Degrees of reflexivity: the reforms in perspective
The reform of the risk dispositif has thus resulted in a strengthening of previous risk rationalities through the reassessment of what is deemed acceptable risk for each part of the financial system In the US and UK, the risk of contagion is being dealt with by re-establishing a division between retail and investment banking. Overall vulnerability at the micro level has been reduced by lowering the risk pertaining to financial activities by increasing capital adequacy ratios and lowering leverage levels. One of the major innovations has been the introduction of greater flexibility with regard to capital adequacy by setting a counter-cyclical buffer, which central banks can raise in times of stress and/or boom periods. With regard to the shadow banking sector discussions are still under way. It looks like much of the ‘informal’ banking sector will be brought out of the shadows into the formal sector and treated in a somewhat similar manner as banks (capital buffers, government insurance system, etc.). If this does not transpire, then major sources of possible future instability will go unchecked.
But the post-crisis landscape has also witnessed the emergence of a new risk rationality based on pre-emption. It is noteworthy, that this shift is explicitly acknowledged by those involved, who see the task as assessing the ‘potential for a crisis to manifest itself’ by examining the underlying tendencies that ‘predispose a system to a crisis’.Footnote 104 It is argued, that it is ‘better to be prepared for risks that do not materialize than to count on luck to see one through’.Footnote 105 Moreover, it is fully understood that such attempts may reduce uncertainty, but not eliminate it as there is ‘no limit to the range of conceivable risks … There is clearly a possibility that global developments could yet again take an unexpected turn’.Footnote 106
Although the reaction to the financial crisis does closely resemble the reflexive government thesis, the actual reforms have also entailed several important ‘non-decisions’ because of the political context that regulators find themselves in.Footnote 107 Certainly, the reforms have indicated a degree of recalibration in the relationship between public and private authorities as national accountability has been reinforced by domestic politicisation of these issues. There has also been a broadening representation in key inter-governmental bodies in comparison to the pre-crisis environment dominated by the G7.Footnote 108 As a result, some see the emergence of an embryonic financial public sphere: ‘increased publicness of debates about the norms and rules of financial governance which a public sphere facilitates has helped to leverage the structure of governance from a highly secretive and closed architecture to a more open and inclusive one’.Footnote 109 Yet, on the one hand, the influence of private financial actors on the regulatory process remains as does the influence/autonomy of states and, on the other hand, the influence of NGOs remains relatively insignificant.Footnote 110
But, it is not only the political environment that acts to restrict the nature of the reforms. As Barry Eichengreen points out, the sheer complexity of the financial system means that it ‘evolves gradually at the margins, not discontinuously in response to the radical visions of some financial Frank Lloyd Wright’.Footnote 111 In addition, the process itself tends to be path dependent ‘building on existing practices’.Footnote 112 Although the changes to the various risk mechanisms has been highly significant and, with regard to managing uncertainty, quite innovatory – the central objective ‘is to upgrade official oversight rather than redesign private institutions. It is on this basis that we can argue that the basic principles of the capitalist market economy are not being challenged by the financial crisis, even if the scope and scale of the regulation of these principles may be shifting’.Footnote 113
Whilst these reforms may temper some of the excesses that the financial sector is prone to, there are several reasons to doubt whether they will prevent similar financial catastrophes in the future. Policies, such as, the creation of a ‘super-sovereign reserve currency’, a permanent ban on short-selling and the more esoteric forms of securities, or, even more radically, the reimposition of capital account controls (as suggested by Beck) have not materialised.Footnote 114 Even the international standards for capital adequacy are still historically low. In the 1960s, it was not uncommon for banks to hold 25 per cent of their assets in cash and readily convertible bonds.Footnote 115
With regard to leverage, even with a minimum international standard set at 3 per cent, this equates to a ratio of over 1:30. As Andrew Haldane has recently pointed out, for ‘the world's largest banks, the leverage ratio needed to guard against failure in this crisis would have been above 7%’.Footnote 116 An issue somewhat related to this is the degree of proprietary trading allowed by the Dodd-Frank Act. Although the permitted level seems relatively low, once leverage levels are factored in, the amount of speculation the banks can engage in will actually be quite significant.
Although the monitoring of systemic threats, nationally, regionally, and internationally is to be welcomed, these various committees have not sufficiently addressed the negative role they may themselves play during a period of financial instability. Several problems are associated with the reliance on pre-emption. First, and most obvious, is the problem that any announcement/action concerning a particular financial institution or system wide threat could itself act as a catalyst for a new financial crisis. When to actually intervene will be far harder to calculate than policymakers have thus far acknowledged. Second, the degree of complexity both in analysis and in rule-making may not necessarily lead to a positive outcome – such concentration may lead to analysts missing the one big thing that counts. A recent analysis by Haldane at the Bank of England suggests that this is a real possibility, that ‘the more complex the environment, the greater the perils of complex control’.Footnote 117
The emphasis on surveillance and pre-emption may therefore, in fact, increase the possibility of another financial crisis thus supporting Beck's argument that new threats pertain to the risk-reducing practices and technologies created in response to crises.Footnote 118 This has become apparent with the passing of the Dodd-Frank Act. Previously under section 13(3) of the Federal Reserve Act loans to non-banks were permitted in a financial emergency (for example, AIG). As mentioned earlier, such lending to individual non-bank entities is now prohibited and is confined solely to ‘participant(s) in any program or facility with broad-based eligibility’.Footnote 119 As such ‘the bill eliminates … a policy safety valve that has been available for more than 75 years in the event of unforeseen circumstances’.Footnote 120 Furthermore, in response to the reluctance of private banks to buy sovereign bonds, the European Central Bank has recently (December 2011) made available funds (almost half a trillion euros) to European banks at ultra-low interest rates for three years. In addition, the European Banking Authority has stated that it will not mark down the value of government bonds that banks possess for the next stress test. It is hoped that this will increase liquidity in the system and create an appetite for government bonds in the financial sector. However, it could well lead to further exposure to highly risky assets and produce further financial turmoil in the future. The danger of another financial crisis has not therefore been fully averted.Footnote 121
Finally, crises have an unerring tendency to arise in the very categories that are thought to be under control and manageable. There is thus a danger that the new regulation will tend to be ‘backward-looking to the dirty deeds done … this means the reforms fall prey to the generals’ curse of fighting the last war, that is, training their soldiers with scenarios from the last war instead of possible future scenarios of the next’.Footnote 122 In relation, to the new surveillance regime, the announcement of the results of the July 2011 European wide stress test on banks led to further instability in the markets, particularly in those countries, such as Spain, where several banks were identified as vulnerable.Footnote 123 The robustness of these stress tests are highly questionable – possibly reflecting concerns that if too many banks are deemed to be short of the mark, this itself would trigger another crisis.Footnote 124 But more than this, the stress test was a classic example of fighting the last war and therefore failing to see where new threats would arise from. The stress test failed to fully include European banks' exposure to sovereign debt, which in the end led to a mini financial crisis.Footnote 125 Such weaknesses were sharply illustrated by the inability of the Franco-Belgian bank Dexia to raise new funding over concerns of its exposure to Greek debt. Despite having passed a clean bill of health in the July stress tests, it had to rely on Franco-Belgian government guarantees in order to stem speculation concerning its future.Footnote 126 More than this, mounting exposure to debt, partly as a result of funding the European Financial Stability Fund, has raised questions about sovereign creditworthiness even for the likes of France.Footnote 127
Conclusion
This article began with two perspectives on risk and responses to major crises. On the one hand, Beck views crises as presenting us with moments of self-confrontation in which the foundations of modernity are questioned and a shift towards a cosmopolitan world order begins. Instead, the reaction has borne a far greater resemblance to the Foucauldian alternative. Reflexive governance has led to efforts to establish a stricter regulatory framework in which these financial entities operate and to endow both the state and international institutions with far greater surveillance capabilities than have hitherto existed. Moreover, the central objective of these increased capabilities is to try to ensure that any similar potential crisis can be nipped in the bud before it leads to another system-wide collapse. As such, we are currently witnessing not only the strengthening of the various risk mechanisms associated with financial governance, but also the extension of the rationality of risk into the realm of pre-emption to deal with the uncertainty that crises confront us with.
The reforms that have followed have radically increased the surveillance role both at the macro and micro levels. However, the emphasis on pre-emption does not simply reflect attempts to deal with the uncertainty of such events, but also reflects the lack of political will to engage in radical reforms of the financial system. In the contemporary phase of capitalism, states are caught between the Scylla of ensuring economic growth partly driven by financialisation and the Charybdis of systemic vulnerability associated with such activities.Footnote 128 This, in large part, explains why fundamental structural reforms that fully address the current imbalances and levels of instability within the global economy have not been introduced.Footnote 129
In the shadow of Lehman Brothers' collapse, Beck warned against attempting to establish the impossible – ‘the perfected surveillance of the administrated world’.Footnote 130 At the time, he argued that the realisation after the financial crisis that the threats confronting us can be ‘averted by political action’ could lead to ‘the fundamental principles of modernity, including the free market principle and the nation-state order itself’ becoming ‘subject to the change, the existence of alternatives, and contingency’.Footnote 131 We should thus focus our attention on the extent to which, ‘the threat and shock of world risk society open[s] up the horizon to a historic alternative of political action’.Footnote 132 Yet, as this article has demonstrated, the reforms have not altered the fundamental practices of the financial sector and there seems little chance that radical alternatives will be adopted.Footnote 133 It is thus unlikely that major change is on the horizon. Instead, the rise of the pre-emptive state in the financial sphere heralds just the type of reforms that Beck warns against – an attempt at remedying a systemic weakness through technical surveillance and control. Although Beck's analysis of the type of political action that arises from crises would appear to be over optimistic, his warning that ‘risk-reducing practices and technologies have risk-increasing properties embedded within them’ should not, therefore, go unheeded.Footnote 134
