Financial markets are forcing banks to restrict lending, and thus making the recession more acute than it would otherwise be, according to the president of the European Central Bank.
Jean-Claude Trichet said that "the market is demanding more capital requirements than we consider appropriate", with the effect of pushing banks towards hoarding capital and trimming balance sheets, at a time when political pressure on them to pass on interest rate cuts and expand credit has never been more intense.
"The market has a tendency to be pro-cyclical, enormously pro-cyclical," M. Trichet added.
He raised further concerns about a number of forces that have produced "pro-cyclicality" in the economy – amplifying the scale of booms and busts alike. "We have to correct systematically all the pro-cyclicality embedded in the system, on capital ratios, accounting and government policy," he said.
The current vogue among central bankers is for so-called "macroprudential tools", meaning that the credit cycle would be managed by altering the banks' capital ratios to reduce lending in upswings and increasing it in downturns. For now, however, the gyrations in bank share prices, potentially leading to self-fulfilling collapses, are concentrating official minds.
However, in answer to a question from the deputy governor of the Bank of England, Sir John Gieve, M. Trichet did not seem over-enthusiastic about the concept of the "utility bank"; he preferred the creation of "air bags" to buffer the banks in bad times, though he was careful not to rule out any options for banking reform.
Plans for central clearing houses for credit derivatives, which would reduce counterparty risks for banks and hedge funds involved in such financial instruments, also met with M. Trichet's approval. "This is an area where all authorities are looking closely," M. Trichet said. "The initiative on a central counterparty or exchange seems to us very wise," he added. "This is one of the areas where we could see an explosion." A number of exchanges in the EU and US are currently looking at setting up central clearing houses.
Calls for change also came from within the financial world. "The current financial framework, though well-intentioned, has proved inadequate and must be fundamentally revised," said HSBC's chairman, Stephen Green. He said that fair-value accounting and capital adequacy rules had worsened the financial crisis and called for a new set of principles and rules to boost financial market transparency.
However, banks and other firms needed to work with governments and regulators to learn the lesson from the financial crisis, and needed to boost trade by improving transparency and simplicity in the financial system.
Mr Green added that HSBC would stay in the private sector. "We do see value for our proposition, both for investors and customers, in being a clearly independent, international bank, unquestionably," he said.
Henry Kravis, a founding partner of Kohlberg Kravis Roberts, called for a "closer alignment" of the interests of all stakeholders in financial institutions, and criticised the award of bonuses on an annual basis with "no ratchet back" if returns subsequently falter.Reuse content