Getting the Dog to Bark: Disclosing Fiscal Risks from the Financial Sector

 

Posted by Tim Irwin[1]

For many years, the IMF has said that governments should publish statements of fiscal risk—or reports that explain what could cause the government’s debt and deficit to be higher than forecast. A question that arises is whether these statements should disclose implicit guarantees, or the risk that the government will have to rescue a failing bank even if it has no legal obligation to do so. Careless talk could exacerbate the problem of moral hazard, or even trigger a bank run. Yet a statement that says nothing about implicit guarantees ignores one of the biggest risks around. In the United Kingdom, to take a striking example, the nationalization of banks during the financial crisis caused gross public debt to rise from 51 to 202 percent of GDP in the space of a year—an effect that few other fiscal risks could produce.[2]

Certainly, governments shouldn’t say they have implicitly guaranteed anything unless they really want to offer a guarantee. Nor are statements of fiscal risk the place to reveal previously unknown information about a particular bank’s problems. But the crisis has cast doubt on the idea that silence is the best approach to limiting moral hazard. And publicly discussing the problem of implicit guarantees could help build support for policies that try to solve the problem—such as requiring banks to reduce their leverage and separate their speculative business from their traditional deposit-taking and lending activities—policies that tend to be opposed by banks because they may reduce their profits.

Before the global financial crisis, it was hard to find any budget documents that talked about the fiscal risks created by banks. Since the crisis, however, a few governments have started to refer to them; a notable example is the Finnish government’s Overview of Central Government Risks and Liabilities 2015. A recent IMF policy paper, From Bank to Sovereign Stress, also argues that governments should regularly disclose the fiscal risks that banks create, while still being careful to avoid moral hazard.

This working paper considers the arguments for and against disclosure and offers a view of how a statement of fiscal risks could prudently discuss the financial sector—how, that is, the dog could be trained to bark.

[1] Tim Irwin is a consultant.

[2]This measure of public debt is larger than those that are usually mentioned, because it is gross not net and because it includes the debts of government-owned companies. It comes from the UK Office of National Statistics, Public Sector Finances June 2013, Table PSF6A; GDP is inferred from table PSF1 in the same document.

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