With apologies to Shakespeare, one could argue that systemic complexity and inter-connectedness remain as daggers pointed at the heart of the world’s economy. Or, to use another unpleasant analogy from epidemiology, there are still quite a few “super-spreaders” around (such as the largest international banks) able to “infect” the global financial system.
In a recent speech, Andrew Haldane (Chief Economist, The Bank of England) discussed how complexity theory could be used to try to understand the ways in which economic and financial systems interact and inform the design and application of tools to create effective policy and regulatory instruments.
A key point that Mr. Haldane made was that modern economic and financial systems are not, in fact, complex adaptive networks, but more akin to “systems of systems”. This sounds tautological, but what it really means is that both the economy and its financial architecture comprise a nested set of sub-systems, and that within each sub-system there lies its own complex web of interactions. Not only that, but such systems are regarded as “scale free”, being configured to appear as a hub-and-spoke network. This is important because something which affects the “hub”, the element that is widely connected, can create a so-called “systemic cascade”. One could certainly argue, that the demise of Lehman Brothers demonstrated that if the failure of a supposedly medium-sized financial entity could have such an effect, preventing the failure of, say, a CitiGroup was actually essential, because no-one could know the extent of its linkages to the financial system, only that they were extensive and dangerous if severed.
Of course, the debate over whether one can actually ever avoid “Too Big To Fail” continues to rage, with regulators pursuing various approaches intended both to reduce the risk of failure and also to minimize the impact should a failure occur. Paradoxically, however, being designated as a G-SIB or G-SII (Global Systemically Important Bank/Insurer) almost seems to be like a “scarlet letter”, because such a designation carries with it the assumption that failure is not an option because of the damage it could wreak. And yet, we then have the spectacle of the largest banks being required to create “living wills”- essentially a guide for a regulator to dismantle and “save” the essential components- and being threatened with unpleasant consequences if they are unable to comply.
So, in reality, attempts to curtail or corral complexity have simply engendered further complexity and uncertainty; because, while a better-capitalized and more rigorously monitored banking system ought to be less prone to failure and its destructive consequences, no-one really knows if that is true.
Interestingly, there is one part of the financial system that has generally proved robust in the face of wider systemic issues, namely the large, diversified P&C (re)insurers who are Awbury’s partners and provide its capacity. That is not fortuitous, but a deliberate component of our robust business architecture.
– The Awbury Team