The effects of possible crises and upheavals on the worldwide economic system and particularly on systemic risks cannot all be predicted prematurely. The best we are able to do is prepare for a spread of systemic risks and ensure markets have the precise infrastructure and regulatory frameworks in place to weather the storms.
In the case of the war in Ukraine and other geopolitical conflicts, this implies understanding the results of sanctions, embargoes and possible tariffs and countering the spillover effects on energy, food and other commodity markets. For financial institutions, because of this they’ve sufficient liquidity to face up to unexpected shocks. For stablecoins, cryptoassets and other newer markets, because of this regulatory oversight, authority and mechanisms are in place to guard investors.
War in Ukraine
What impact does the continued war in Ukraine have on systemic risk? “We’re watching this very closely,” Johnson said. “[You] have the Russians, who are trying to drive up gas prices in Europe. They were actually very successful. They’re trying to disrupt and unbalance the global oil market – the results are a little more mixed, but they’re definitely still having a shot. And all of these things, of course, affect inflation, particularly headline inflation. Food prices were impacted, energy prices absolutely.”
Will the conflict threaten the solvency of economic institutions? “That’s the question of the day and every day right now,” Johnson said. “The key is capital. How much equity do we have in the financial system as a buffer against losses? This was the problem worldwide in 2008 and was a major recurring problem in Europe after 2010.”
But there may be excellent news. The reforms introduced within the United States and Europe after the worldwide financial crisis were more practical than many individuals, including Johnson, expected. “This means banks are better prepared for unexpected shocks,” he said. “And unexpected shocks — well, we’ve basically only had two big ones in the last two years.”
“This is a big stress test,” Johnson continued. “COVID was a real stress test. We should agree on that. But COVID has actually gotten better and easier in some ways. For a while, at least in economic terms, there was a fairly unified and well-organized government response. I would suggest that we are now dealing with something much more complicated and probably more difficult.”
Johnson has written extensively about find out how to reply to the Russian invasion of Ukraine, whether in the shape of Sanctions, the oil embargo, tariffs or other measures. He fears that Russia could close grain and agricultural trade within the region. “This is another way they are maliciously putting pressure on the world,” he said. “And I think we need more coordinated, I would suggest G7-led, responses to this economic problem, which has a massive overlap with national security considerations.”
Climate change as a systemic risk
What role, if any, should central banks play in addressing the risks of climate change? According to Johnson, there may be now a consensus in each developed and emerging markets that climate change could have a direct or indirect impact on the economic system through its economic impact. “I think that’s actually already decided,” he said. “I think that’s where central banks want to go.”
The query is how.
“There is an ongoing debate about what exactly central banks should do – what tools they have at their disposal and what scope of action they have appropriately.” Is it a proactive thing that’s directly related to financing energy, or is it more of a circumstance Capital buffer and the way will we calibrate this?” he said. “This is a very active, somewhat technical discussion that is not always clearly expressed in a public context.”
Johnson emphasized that a part of the SRC’s role is to have interaction and be certain that its members understand the problems, that they’re talking to officials and really engaging with them on such technical but critical details.
Johnson believes that each the physical risks of climate change and the risks of the energy transition to achieving net zero are interconnected and systemic.
“I believe there is a saying within the U.S. military like, ‘Plans are worthless, but planning is all the pieces.“I think the same thing applies to systemic risk,” Johnson said. “Because markets will go up, markets will go down. Financial institutions will fail. The questions are: Does this affect the core financing of your economy? Does it have spillover effects on energy prices, for example? Does this affect the macroeconomics in any destabilizing way? These are the issues we have to deal with every day.”
Stablecoins, crypto assets and CBDCs
The SRC has been vocal concerning the need for regulatory motion around “stablecoins,” issuing a letter to the U.S. Treasury Department and members of the Financial Stability Oversight Council (FSOC) in February 2022 calling for motion: “Address the risks to U.S. financial stability posed by unregulated stablecoins.“The SRC advisable that the FSOC designate stablecoins as systemically vital payment, clearing and settlement activities and called on FSOC member authorities to make use of their existing powers to observe and regulate stablecoin markets.
Johnson identified that it just isn’t necessarily systemic in itself that there are markets for assets that go up and down. However, if the general public views stablecoins as such as money in the normal US sense, the SRC believes they’ve the potential to have a systemic impact.
“This is banking without a license, and banking without a license usually ends in tears,” he said. “That’s what we said in the comment letter, and we support action to get ahead of this problem.”
More recently, in light of the collapse of Terra, SRC member and former FDIC chairman Sheila Bair stressed the necessity for immediate motion, even when the regulator just isn’t entirely clear. “It is time for regulators to get creative and use their current powers to act,” She wrote.
“I think a lot of people in these markets or innovators in these markets have resisted regulation and are now perhaps learning some of the consequences of not having an appropriate level of regulation,” Johnson said.
US Treasury Secretary Janet Yellen has pushed for laws to control stablecoin issuersbut getting this laws through Congress will probably be a protracted and difficult process.
“There is clearly tension in official circles,” Johnson said. “But we still believe that sufficient legislative and regulatory powers already exist. And it has to be used.”
A related area that the SRC is eyeing is central bank digital currencies (CBDCs). “There is certainly an organized push or consideration to that effect [CBDC] Problems within the central banking community,” he said. “This is of course partly a response to cryptoassets and partly an attempt to ensure that the US dollar is available through appropriate channels and appropriate mechanisms to people who need it and want to use it.”
The application of CBDCs in wholesale versus retail markets is an area that has attracted interest from central bankers. They are currently conducting experiments with CBDCs to hurry up cross-border payments and move funds between financial institutions and central banks to see if the method is more efficient.
Central banks are gathering data on the potential of CBDCs, and in about 12 months we are going to know so much more, Johnson said. The recent difficulties and issues surrounding stablecoins within the crypto market will influence their decision-making around CBDCs. “Central banks will continue to consider whether the CBDC would actually improve stability,” he said, “or whether it could potentially have a destabilizing effect.”
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Photo credit: ©Getty Images/Posnov
