Recently, a debate has begun on direct restrictions on some banking activities – in other words, prohibition. This is recognition of the social costs of systemic risk. Bankers are in uproar. This paper examines the costs of banking pollution and the role of regulation and restrictions in tackling it. In light of the crisis, this is the $ billion question. The last time such a debate was had in earnest followed the Great Depression. Evidence from then, from past crises and from other industries helps define the contours of today’s debate. This debate is still in its infancy. While it would be premature to be reaching policy conclusions, it is not too early to begin sifting the evidence. What does it suggest? Counting the systemic cost One important dimension of the debate concerns the social costs of systemic risk. Determining the scale of these social costs provides a measure of the task ahead. It helps calibrate the intervention necessary to tackle systemic risk, whether through regulation or restrictions. So how big a pollutant is banking? There is a large literature measuring the costs of past financial crises. 1 This is typically done by evaluating either the fiscal or the foregone output costs of crisis. On either measure, the costs of past financial crises appear to be large and long-lived, often in excess of 10% of pre-crisis GDP. What about the present crisis?
The steeper projected drop in investment considers shutdowns at several sites due to the sanitary crisis and the fact that companies have been re-evaluating their planned investment projects, which is consistent with the findings of the Bank’s survey. These showed that a non-negligible fraction of the respondents shelved their investment plans for this year and about half were having second thoughts about their execution. The projection also contemplates a near 2% contraction in consumption during 2020 with its private component being more concentrated in durables. This is in line with the significant depreciation of the peso and the double-digit drop in consumer goods imports in the early months of this year. The recovery of consumption will depend especially on the evolution of employment and income, and how companies manage to live through the most critical period without destroying a significant number of jobs. Chile’s exports will also shrink in 2020, reflecting the reduction in trade flows associated with the world recession. Actually, already in February and March they posted year-on-year drops. Imports will contract too due to weaken domestic demand. Thus, the substantial adjustment in business and household spending will not be compensated by the government’s savings depletion implicit in the announced fiscal package, so this year the current account balance will become marginally positive (Figure 9). 5  The medium-term inflation trajectory will be dominated by the sharp widening of the activity gap projected in the scenario just described.