Declare victory – and fight on

Erik Berglöf 05 October 2009



As the world’s financial leaders assemble in Istanbul for the annual meetings of the IMF and the World Bank, they do so in an atmosphere very different from that of the last annual meetings a year ago in Washington. Lehmann Brothers had just gone under and world trade was in the midst of the most rapid collapse in half a century. Most European economies were in tailspins, some of them about to lose as much as 20% of their output in two quarters. With enormous private debt levels requiring refinancing, primarily in Eastern Europe, the prospects were extraordinarily dire.

Bullet dodged

Understandably, there is now a sense of relief. What happened? Or perhaps more appropriately, what did not happen? The forewarned cataclysmic collapse of banking systems did not happen. Particularly “twin crises” affecting both currencies and banks – as has so often been the case in emerging markets – did not happen. (See Fisher 2009). The political backlash has also so far been much more muted than expected. At the European level cross-border banking is still alive, if not all that well, and economic integration has survived much less wounded than first feared.

Dangers ahead

Europe has now moved away from the precipice, but the cliffs are still there. The greatest risk is that we prematurely exit the impressive policy response to date. The state of the European banking system remains highly uncertain, particularly in some countries (IMF 2009). It is critical that the results of bank “stress tests” are made public with sufficient granularity – and that any capitalisation needs are secured before publication. This will inspire confidence.

It is way too early to declare “all clear”. Lending markets are still frozen. In some respects, the situation has even deteriorated over the summer. Non-performing loans are not growing at the pace feared, but in many countries banks are just extending maturities. These losses will have to be acknowledged sooner or later – in many cases sooner. In the real economy, investments have essentially come to a halt, and unemployment will continue to climb for a long time with the risk of new waves of forced migration.

Fiscal challenges

Perhaps the most serious threat is the rapid deterioration in state budgets. Much is being said about the fiscal situation of the Western European economies, but in Eastern Europe, where most countries entered the crisis with strong public balance sheets, the collapse in revenues has been dramatic.

All this will require the close attention of policymakers everywhere. None of what happened over the last year was obvious when the crisis hit Europe, or even six months ago when the leaders of the G20 met in London. The IMF was just coming out of a severe retrenchment and its resources at the time were not sufficient to deal with the magnitude of the European – not to mention the global – problem. Many of the other international financial institutions also had strained finances, some from long neglect and others from the effects of the crisis. They must now be replenished to ensure that they could respond to a “second dip”.

Europe’s failings

The lack of preparedness was even more conspicuous at the EU level. Europe lacked – and despite some progress still lacks – a meaningful framework for regulating and supervising cross-border financial institutions and for dealing with cross-country spillovers from the crisis responses of national governments. The make-shift use of competition policy to deal with bank restructuring leaves much to be desired. Here, as elsewhere, the European Commission is still grappling with the realisation that the European financial system extends far beyond the Euro area and EU borders.

Vienna Initiative

Nevertheless, the crisis in Europe has resulted in unprecedented collaboration among all of these institutions. They came together under the so-called Vienna Initiative to ensure that the unavoidable reduction in leverage in the financial system would happen in an orderly way. A rapid succession of meetings, starting in Vienna in November last year, brought together the key public and private players. This initiative must now address the remaining issues of debt restructuring and building stronger domestic capital markets that can support the recovery in Emerging Europe.

No time for champagne

Even if the international financial institutions have reasons to congratulate themselves in Istanbul, they must not rest on their laurels. They must use this new-found collaboration and the new informal crisis arrangements – and any new capital granted to them – to manage the unavoidable reduction in leverage in the region.

They must also help push through the much needed improvements in regulation and supervision agreed upon in London and now reinforced in Pittsburgh. Ensuring a more balanced growth based on a healthier development of local financial systems is a worthy challenge for the international financial institutions.


Fisher, Stanley (2009). “Preparing for future crises,” speech at Jackson Hole Seminar "Financial Stability and Macroeconomic Stability", Jackson Hole, Wyoming, 21 August 2009.

IMF (2009). “Global Financial Stability Report: Navigating the Financial Challenges Ahead,” October 2009.



Topics:  Global crisis International finance

Tags:  global financial crisis, Vienna initiative

Director, Institute of Global Affairs at the London School of Economics and CEPR Research Fellow


CEPR Policy Research