15 April 2010

Finance and fisheries

The Economics of Ecosystems and Biodiversity (TEEB) workshop organised by the Indian Institute of Technology (IIT), Mumbai, the Conservation Action Trust (CAT), the Bombay Natural History Society (BNHS) and the Green India States Trust (GIST) was inaugurated by an unlikely candidate for this task, RBI Deputy Governor, Usha Thorat. I wonder why someone from the RBI, a 'layperson who needed to learn the jargon', as she put it,  was chosen for this seminar - all I could find was that the TEEB Study Leader, Pavan Sukhdev, has extensive connections with the finance world and the RBI.
Whatever the reason, it was good to see this speech on biodiversity on the RBI website. Her speech makes for an interesting read and took me onto Haldane's paper, linked below.
Excerpt from her speech:
In a speech at the Financial Student Association, Amsterdam, on 28 April 2009, Andrew G Haldane, Executive Director, Financial Stability, Bank of England, drew an interesting parallel between the recent global crisis and ecosystems. He cited the collapse of fisheries that came to a head during the 1970s. and 1980s, leading to the imposition of fishing quotas for various species. In setting quotas, no account was taken of interaction between species and the surrounding eco-system. Relating this to the global crisis, he observed that the existing regulatory rules for financial institutions echoed the fisheries management of the 1970s. Risk quotas are calibrated and applied node by node, species by species approach, which takes no account of individual nodes’ system-wide importance – for example, arising from their connectivity to other nodes in the network or their scale of operations. Apart from interconnectedness, Mr Haldane also uses the natural relationship between diversity and stability to show how lack of diversity was a reason for collapse of the financial system. Studies of coastal eco-systems, he said, reveal some dramatic patterns. For around 800 years, between the years 1000-1800 AD, fish stocks and species numbers were seemingly stable and robust. Since then, almost 40% of fish species across the world’s major coastal eco-systems have “collapsed” - defined here as a fall in population of greater than 90%. That is systemic by any metric. There appear to be many environmental reasons for this collapse, some natural, others man-made. The financial system, Mr. Haldane observed, has mirrored the fortunes of the fisheries, for many of the same reasons. Since the start of crisis many banks have seen their market capitalization fall by a significant amount- the fisheries equivalent of collapse. But what took marine eco-systems two hundred years to achieve has been delivered by financial engineers in two!! In explaining the collapse in fish and finance, lack of diversity seems to be a common denominator

The speech by Haldane cited by her is fascinating:
It considers the financial system as a complex adaptive system. It applies some of the lessons from other network disciplines – such as ecology, epidemiology, biology and engineering – to the financial sphere. Peering through the network lens, it provides a rather different account of the structural vulnerabilities that built-up in the financial system over the past decade and suggests ways of improving its robustness in the period ahead.

The financial system evolved in a way that by 2007 showed more complexity and less diversity. As Haldane says:
But in just about every non-financial discipline - from ecologists to engineers, from geneticists to geologists - this evolution would have set alarm bells ringing. Based on their experience, complexity plus homogeneity did not spell stability; it spelt fragility. In understanding why, it is useful to explore some of the wider lessons from
those disciplines, taking in turn the effects of complexity and diversity on stability.

The tentative policy prescriptions he puts forth:
The experience of other network disciplines suggests a rather different approach to managing the financial network than has been the case in the past, if future systemic dislocations are to be averted. Three areas in particular are discussed: 
• Data and Communications: to allow a better understanding of network dynamics following a shock and thereby inform public communications. For example, learning from epidemiological experience in dealing with SARs, or from macroeconomic experience after the Great Depression, putting in place a system to map the global financial network and communicate to the public about its dynamics;
• Regulation: to ensure appropriate control of the damaging network consequences of the failure of large, interconnected institutions. For example learning from experience in epidemiology by seeking actively to vaccinate the “super-spreaders” to avert financial contagion; and 
• Restructuring: to ensure the financial network is structured so as to reduce the chances of future systemic collapse. For example, learning from experience with engineering networks through more widespread implementation of central counterparties and intra-system netting arrangements, which reduce the financial network’s dimensionality and complexity.

No comments:

Post a Comment