The current volatility in markets stems from the policies brought in in the immediate aftermath of the financial crisis. These have now served their purpose, says Brian Caplen, and it is the time for the banking world to move on, unencumbered by red tape, QE and low interest rates, much as it could before 2009.

The current market turmoil is the direct result of policies undertaken to recover from the 2009 financial crisis. At the top of the list is quantitative easing (QE), and in China's case the
decision to pump up the economy through large-scale bank lending. Then there is bank regulation, some of which was necessary, but the scale of which threatens to undermine banking profitability to the point of danger.

Extraordinary measures to avert a recession turning into a depression after the financial crash were clearly needed. But extraordinary measures are only effective if they quickly restore confidence and are then withdrawn. QE and the accompanying low interest rates (increasingly negative interest rates) have dragged on for years. They have completed distorted economies, pushed up asset prices, especially property, and encouraged high levels of unsustainable borrowing.

The failure to get back to normal – and in the European Central Bank's case, the protracted delay in starting – means that economies are now hooked on the QE/low rate drug. Now we need another confidence booster to allow for the withdrawal of the last confidence booster. Turning on the printing presses – or so-called helicopter money – has been suggested by none other than former UK Financial Services Authority chairman Adair Turner. 

I think this would have the opposite impact – it would undermine confidence because of the poor past record of using monetary measures to finance fiscal deficits. It would also represent a radical move away from the principle of sound money. 

In China's case, the measures taken to avert the impact of the US subprime crisis have created a new kind of subprime crisis, including off-balance-sheet assets designed to produce higher yields and excessive property lending. 

Finally, the banks have done what they needed to do and raised much more capital, reduced leverage, withdrawn from high-risk activities and even done a fair bit to change their culture. But at the end of the day, banks are not safe if they are privately owned and not making money. Huge fines for past transgressions, arbitrary taxes and now negative interest rates have undermined the basic banking model. On top of this, given that investors will take the first hits when banks get into trouble, it is hardly surprising that bank shares and bonds are volatile. 

Hard decisions have to be made. Regulation cannot be so stringent that it stops banks functioning and QE and negative interest rates cannot last so long that they become a permanent part of the landscape. 

Maybe it’s time to do the unthinkable and reset policies to where they were before the crash – positive interest rates, no QE and banks that make money. Markets will fall dramatically but then when the world doesn’t end – and things start to recover – we will be in a generally better place. 

Brian Caplen is the editor of The Banker.

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