The global financial crisis, the EMU sovereign debt crisis and international financial regulation: lessons from a systematic literature review

https://doi.org/10.1016/j.irle.2020.105945Get rights and content

Abstract

To ensure the safety and soundness of the global financial system as well as individual financial institutions and to reduce systemic risk, numerous policy measures and regulatory reforms have been brought forward as a reaction to the Global Financial Crisis and the European Sovereign Debt Crisis. Simultaneously, numerous academic works have critically reviewed these developments. Therefore, based on a dataset of 455 papers, this article intends to structure the multitude of publications and provide a comprehensive overview of post-crisis regulatory research publications. Studies can be roughly divided into three overarching clusters: publications identifying causes of the crisis, articles focusing on policy and reform reactions, and literature investigating whether these reforms fit their purpose. A holistic and systematic review allows us to extract relevant recommendations and areas of action to prevent such a crisis in the future.

Introduction

Financial regulation has become increasingly important, since the reputation of economics as a profession has undoubtedly come under critical scrutiny with the mostly unforeseen outbreak of the last two major crises in the US and Europe (Toarna and Cojanu, 2015). Moreover, the bursting of the internet bubble, the global financial crisis (GFC), and the European sovereign debt crisis (SDC) have jointly generated costs in the world economy of approximately USD 30 trillions (see Taskinsoy, 2019). There are also indications that the causes of many crises are often similar. Overbeek (2012), for example, cites overaccumulation as the main driver of financial markets since the 1980s. As a result, it seems reasonable to address the reasons for the last two major financial crises in the world's two largest economies in a literature survey. To avoid such enormous financial repercussions in the future, scholars have delivered a large variety of critical examinations of the financial and sovereign debt crises and the decisive role of regulatory circumstances in order to eliminate such deficiencies. Thus, the question arises as to what extent the regulatory institutions and framework conditions were insufficient or could even have encouraged crises. Second, the question must be answered as to which measures or automatism influenced regulators’ decisions on how to counteract the crisis. Finally, it is important to consider the extent to which new or ongoing regulatory adjustments or innovations influence the occurrence and course of future crises. Thus, to organize our discussion, we structured the paper into three sections (see Fig. 1) based on the identified crisis-related regulatory literature. This investigation was divided into three areas:

  • Firstly, several authors deal with the causes and triggers of crises and stress situations.

  • Secondly, many studies focus on immediate policy reactions intended to mitigate crisis effects as well as reforms intending to stabilize the financial system.

  • Finally, some researchers deal with the question of future development and, in this context, with the stress resilience of institutions and states as well as the danger of new crises.

However, the question arises why financial markets need to be regulated, when the literature actually assumes the existence of an at least moderately efficient market hypothesis (EMH).1 It can be addressed in manifold ways: externalities such as bubbles and crashes, inefficient market structures, principal-agent problems, market entry/exit barriers, a lack of market integrity, or by considering financial market stability as a public good (see De Grauwe, 2011, Chaudary and Salvador-Adebayo, 2014). Since the incentives that the regulatory framework creates for decision-makers in the financial sector also play an important role, we present future potential research directions from both practical and academic perspectives. We argue in this paper that especially the concept of regulatory arbitrage may reveal that regulatory rules are often no panacea, but may even work to exacerbate crises (see Acharya and Richardson, 2009, Dagher and Fu, 2017). This view must not be taken as an opportunity to completely question the significance of regulatory and legal frameworks. Rather, a critical examination of their strengths and weaknesses is necessary in order to identify possible future Achilles’ heels in the financial system in general and the Economic and Monetary Union of the European Union (EMU), and to deal with them accordingly. In doing so, we draw on the above-mentioned subdivision into the causes and effects of and reactions to the crises. Additionally, we reviewed recommendations to prevent similar crises in the future. In addition to the banking sector and the financial services industry, the insurance sector must also be included in this debate because it has been become an increasingly important actor in maintaining financial market stability (see Trichet, 2005, French et al., 2015).

Our literature survey is based on a structured and standardized search and identification process proposed by a collection of scientific publications (see Biener and Eling, 2012, Biener et al., 2015, Eling and Schnell, 2016, Eling and Lehmann, 2018). We review the English-language scholarly literature by using basic operations of Boolean algebra “TI[(financial regulation) OR (banking regulation) OR (insurance law) OR (insurance regulation) OR (regulatory authorities) OR (supervision)] AND TI[(crisis) OR (subprime) OR (sovereign debt)]”2 in the journal databases EBSCOhost (Academic Search Ultimate, Business Source Elite, Business Source Ultimate and EconLit), ProQuest (20 databases in the social and economic sciences),3 and the Social Science Research Network (SSRN). We then review academic articles, working papers, industry studies, and reports from January 2007 to May 2020 to cover the periods of the GFC and SDC. Moreover, we review citations in the identified papers to include further publications of interest. Additionally, we searched for supportive material via Google Scholar and regular Google searches. Based on this search and identification process a database of 455 papers is generated which main results are discussed.

The objective of this paper is to motivate further research interest in in-depth analyses of financial regulatory issues by bringing together the results of previous studies dealing with the cause-and-effect relationships of crises in a survey and, in particular, link our findings in the context of the regulatory frameworks.4 The remainder of this paper is structured as follows. In Section 2, we review the literature on the causes of the financial and sovereign debt crises, focusing especially on the role of regulatory frameworks. In Section 3, we summarize relevant academic findings on policy reactions enacted over the course of the crises with a special focus on the interdependencies between the individual crisis sectors (i.e., sovereign debt crisis and financial crisis). Section 4 summarizes the findings from Sections 2 and 3 and formulates recommendations for regulatory action. Section 5 concludes the paper and provides recommendations for future research by focusing on the outlook and the question of the financial sector's resilience regarding future crisis events.

Section snippets

The emergence and causes of the Global Financial Crisis and the European Sovereign Debt Crisis

Undoubtedly, the economic and financial crises, starting with the burst of the housing bubble in the subprime segment of US mortgage markets in 2007, were driven by the interaction of many interdependent causes such as macroeconomic developments and (monetary) policy decisions, false expectations about innovations in financial markets, human misjudgments, and regulatory issues (see, for instance, Overbeek, 2012, Rose and Spiegel, 2012). In addition, the tremendous impact of these crises

Reactions to the crises

Failure to effectively regulate the financial system provoked the GFC and the SDC, which in turn have triggered different kinds of reactions to this unique period of stress (Andritzky et al., 2019, Trabelsi, 2012). Today, more than a decade later, immediate reactions to the crisis as well as regulatory changes established in the aftermath of the crisis are widely discussed in academics, politics, and popular media. Some claim that crisis induced regulatory measures did not go far enough (see

Recommendation to prevent future crisis

In order to reduce the risk of similar crisis scenarios, it is necessary to consider what changes in existing regulations are needed. Otherwise, confidence in the stability of financial markets is threatened. When considering the present economic situation, this appears to be of utmost importance: high indebtedness and rising government budget deficits due to increased public spending as a response to the COVID-19 pandemic (see Hale et al., 2020, Fornaro and Wolf, 2020), the technical recession

Conclusion

A lot has happened with respect to regulatory novelties triggered by the GFC and SDC, but not all aspects addressed in this survey have been put into practice yet. Of course, the risk of a financial crisis can probably never be completely excluded by regulatory authorities, and thus some authors, such as Grosse (2017), for instance, argue that the occurrence of financial shocks has to be accepted. However, to improve the safety and robustness of the global financial system and to reduce

References (466)

  • A. Alter et al.

    Credit spread interdependencies of European states and banks during the financial crisis

    J. Bank. Finance

    (2012)
  • D. Anderson et al.

    Fiscal consolidation in the euro area: how much pain can structural reforms ease?

    J. Policy Model.

    (2014)
  • O. Arce et al.

    Credit-risk valuation in the sovereign CDS and bonds markets: evidence from the euro area crisis

    J. Int. Money Finance

    (2013)
  • E. Avgouleas et al.

    Bank resolution plans as a catalyst for global financial reform

    J. Financ. Stab.

    (2013)
  • M.D. Bauer et al.

    International channels of the feds unconventional monetary policy

    J. Int. Money Finance

    (2014)
  • J. Beirne et al.

    The pricing of Sovereign risk and contagion during the European sovereign debt crisis

    J. Int. Money Finance

    (2013)
  • P. Benczur et al.

    Evaluating the effectiveness of the new Eu bank regulatory framework: a farewell to bail-out?

    J. Financ. Stab.

    (2017)
  • E. Bengtsson

    Shadow banking and financial stability: European money market funds in the global financial crisis

    J. Int. Money Finance

    (2013)
  • U.M. Bergman et al.

    Economic stabilization in the post-crisis world: are fiscal rules the answer?

    J. Int. Money Finance

    (2015)
  • U.M. Bergman et al.

    Promoting sustainable public finances in the European union: the role of fiscal rules and government efficiency

    Eur. J. Polit. Econ.

    (2016)
  • O. Bernal et al.

    The importance of conflicts of interest in attributing sovereign credit ratings

    Int. Rev. Law Econ.

    (2016)
  • O. Bernal et al.

    Assessing the contribution of banks, insurance and other financial services to systemic risk

    J. Bank. Finance

    (2014)
  • K. Bernoth et al.

    Sovereign bond yield spreads: a time-varying coefficient approach

    J. Int. Money Finance

    (2012)
  • M. Bijlsma et al.

    Insurance companies’ trading behaviour during the european sovereign debt crisis: flight home or flight to quality?

    J. Financ. Stabil.

    (2016)
  • A. Blundell-Wignall et al.

    Origins of the financial crisis and requirements for reform

    J. Asian Econ.

    (2009)
  • P. Boumparis et al.

    Economic policy uncertainty and sovereign credit rating decisions: panel quantile evidence for the eurozone

    J. Int. Money Finance

    (2017)
  • F. Buck et al.

    The regulator's trade-off: bank supervision vs. minimum capital

    J. Bank. Finance

    (2013)
  • R. Cabral

    A perspective on the symptoms and causes of the financial crisis

    J. Bank. Finance

    (2013)
  • E.M. Abolo

    Banking Regulation and Global Financial Crisis: Issues

    (2008)
  • Accenture

    Most European Insurers Say Compliance With Solvency II Will Cost More Than Originally Expected

    (2010)
  • V.V. Acharya et al.

    Causes of the financial crisis

    Crit. Rev.

    (2009)
  • K. Adam et al.

    Optimal monetary policy under commitment with a zero bound on nominal interest rates

    J. Money Credit Bank.

    (2006)
  • J. Adolff et al.

    Bail-In Im Lichte Des EU-Bankenpakets: Das Zusammenspiel Von MREL, TLAC und TLOF

    Zeitschrift für Bankrecht und Bankwirtschaft

    (2019)
  • T. Adrian et al.

    Liquidity, leverage, and regulation 10 years after the global financial crisis

    Annu. Rev. Financ. Econ.

    (2018)
  • D. Aikman et al.

    Would macroprudential regulation have prevented the last crisis?

    J. Econ. Perspect.

    (2019)
  • J. Aizenman

    Financial Crisis and the Paradox of Under-And Over-Regulation

    (2009)
  • A. Alesina et al.

    Is it the “how” or the “when” that matters in fiscal adjustments?

    IMF Econ. Rev.

    (2018)
  • J. Amann et al.

    Revisiting reinhart and rogoff after the crisis: a time series perspective

    Camb. J. Econ.

    (2020)
  • P.D. Amri et al.

    The political economy of financial sector supervision and banking crises: a cross-country analysis

    Eur. Law J.

    (2012)
  • Y. Anagnostopoulos et al.

    Insider perspectives on European banking challenges in the post-crisis regulation environment

    J. Bank. Regul.

    (2019)
  • P. Andrade et al.

    Can the provision of long-term liquidity help to avoid a credit crunch? Evidence from the eurosystem's LTRO

    J. Eur. Econ. Assoc.

    (2019)
  • J. Andritzky et al.

    A mechanism to regulate sovereign debt restructuring in the euro area

    Int. Finance

    (2019)
  • D. Anginer et al.

    Bank Regulation and Supervision Ten Years After the Global Financial Crisis

    (2019)
  • D. Anginer et al.

    Bank Capital and Risk in Europe and Central Asia Ten Years After the Crisis

    (2020)
  • R. Arezki et al.

    Sovereign Rating News and Financial Markets Spillovers: Evidence from the European Debt Crisis. CESifo Working Paper: Monetary Policy and International Finance

    (2011)
  • L. Arias et al.

    On the Suitability of the Calibration of Private Equity Risk in the Solvency II Standard Formula

    (2010)
  • S. Ashby

    Risk management and the global banking crisis: lessons for insurance solvency regulation

    Geneva Papers Risk Insur. – Issues Pract.

    (2011)
  • B.N. Ashraf et al.

    Capital regulation, deposit insurance and bank risk: international evidence from normal and crisis periods

    Res. Int. Bus. Finance

    (2020)
  • S. Athavale et al.

    Global financial crisis and the regulation of credit rating business

    Vinimaya

    (2015)
  • M.G. Attinasi et al.

    What Explains the Surge in Euro Area Sovereign Spreads During the Financial Crisis of 2007–09?

    (2009)
  • Cited by (24)

    • Financial stability: A scientometric analysis and research agenda

      2024, Research in International Business and Finance
    • Taxing banks leverage and syndicated lending: A cross-country comparison

      2023, International Review of Law and Economics
      Citation Excerpt :

      Bank capital is one of the most significant regulatory tools as it allows not only to reduce moral hazard behavior of banks (Hellmann et al., 2000) but also to absorb production and monetary shocks (Gambacorta and Mistrulli, 2004) such as decreases in loans’ values (Jiménez et al., 2017). The financial crisis of 2008 reopened the debate on additional increases in bank capital to improve banks’ capacity to face financial shocks (Meier et al., 2021). Basel III provided a new regulatory framework with the implementation of time-varying capital requirements to increase provisions in boom phases to mitigate credit crunches in bust phases, and smoothing credit supply cycles (Aiyar et al., 2014; Jiménez et al., 2017).

    • Blessing or curse? Government funding of deposit insurance and corporate lending

      2022, Journal of Financial Stability
      Citation Excerpt :

      A considerable economics and law literature focuses on the benefits and drawbacks of deposit insurance. Although deposit insurance schemes are adopted primarily to enhance public confidence in the banking system, prevent inefficient bank runs, protect small depositors (Diamond and Dybvig, 1983; Demirgüç-Kunt and Huizinga, 2004), and consequently improve financial stability (Bagus and Howden, 2016; Ji et al., 2018; Martin et al., 2018; Meier et al., 2020), the literature also highlights adverse effects (Demirgüç-Kunt and Kane, 2002; Calomiris and Jaremski, 2016; Meier et al., 2020). Specifically, the existence of deposit insurance is linked to lower growth of the financial system (Bergbrant et al., 2016), a decrease in real economic activity (Dehejia and Lleras-Muney, 2007), and an increase in the likelihood of banking crises.2

    • Do social and economic factors affect the technical efficiency in entrepreneurship activities? Evidence from European countries using a two-stage DEA model

      2022, Socio-Economic Planning Sciences
      Citation Excerpt :

      The 2008/09 crisis shook markets and its impact on debt markets was unprecedented, starting with US subprime mortgages and culminating in a European sovereign default. This post 2008 period was a unique and frightening experience [75]. The responses of countries to the crisis were similarly unprecedented.

    View all citing articles on Scopus
    View full text