“Numerus Rei Publicae Fundamentum” (“Data is the foundation of a republic” in Latin).
Data, measurement and information are at the heart of the modern concepts of the market economy and good governance. In the financial sector, in particular, sophisticated business models have been developed to accomplish its “social” mission of allocating savings to their best uses. In essence, the task of banking, insurance and financial markets is this: using data measurement and information to channel efficiently financial resources towards the economy and society.
But a formidable threat has arisen in today’s new risk scenarios, of which the ongoing pandemic is a conspicuous illustration. Black swans, once considered inexistent or very rare, are now becoming more and more frequent and disruptive. Think of investors who betted on the entertainment industry or air travel just a few weeks before the lockdowns. Examples are plentiful: stranded assets, unforeseeable litigation risks, uninsurable hazards, decommissioning of nuclear or carbon power stations due to accidents, NPL (nonperforming loans) caused by systemic shocks—not to speak of geopolitical risks or terrorism. A nightmare for responsible risk managers.
So what!? One might say, paraphrasing James Carville: “It’s the finance, stupid!” Managing risks is the DNA of financial intermediation, the bread and butter of risk managers and actuaries, the way that bankers earn their living and make money. High risks, high yields, high returns, high talents. Or, not?
To think in this way would be superficial and misleading. Because, in the post-COVID-19 world of “new normals”, risks have changed nature (F. Knight). They have become “unknown unknowns” (D. Rumsfeld), systemic contagion, unmeasurable hazards—i.e., risks that cannot be identified, measured and, therefore, managed. Managing risks is one thing. Managing “structural uncertainties” is another story. And the world of finance loves risks but loathes and dreads uncertainty.
What do we do then? How do we cope with the “Great Uncertainty”? And what are the consequences of financial intermediation? This is the most important question for the post-pandemic recovery. Can we make the transition to a more resilient “new normal”? Can we monitor pandemic risks, learn the lessons of the mistakes of the past and prepare for a future of more frequent systemic shocks? Investing in addressing this question should take priority in the present context of unprecedented public-policy concern and response to the crisis. We were caught by surprise and unprepared by the coronavirus, our dangerous, unexpected guest. This cannot, and should not, happen again in the future.
On July 24, the Italian Banking, Insurance and Finance Federation (FeBAF) gathered together (virtually) national statisticians, scientists, policy analysts, financial regulators and bankers to discuss pandemic risks: how they can be identified, monitored and managed; what data and indicators are available; how the various players are responding to the challenge. The state of play of COVID-19 information, the gaps and lags, the complexity of the tasks of building reliable indicators of prevalence, incidence, exposure to risk, lethality and transmission. Regrettably, much of the current information and data, which are publicly discussed and used to guide decision-making, are of poor quality, low comparability and dubious objectivity. This not only creates angst and concern in the population, but it also affects the business confidence, consumption, trust of investors and strength of the economic recovery.
The good news is that many initiatives are underway to improve our monitoring capacity. New tools are being developed and made available by technology and research, which is creating a promising environment of new opportunities. Powerful mechanisms for testing, tracking, tracing and isolating infectious outbreaks are being experimented with. The new tools are extremely powerful for leapfrogging over the present constraints. Official statistics, central banks and regulators are opening up to the full utilisation of new sources of data, big data, telemedicine, e-commerce and ad-hoc surveys. In principle, we have the tools for getting a granular picture of risks and challenges to health and safety—and financial stability. Analysts, economists and actuaries are building new models that exploit the wealth of existing information to identify trends and turning points and enable early warnings. And financial players, investment banks, insurance companies, capital markets have engaged in multiple partnerships with policymakers to define the architecture and the infrastructure of a new business world, in which normal activities, and normal lives, will have to co-exist with the pandemic and other tail-risk scenarios, a world of resilience to unanticipated shocks, preparedness and enhanced response capacity.
Such monitoring systems should be developed not only at the local or national level but also at the European and global levels, in line with the global nature of pandemic threats and other risk scenarios. Luckily, we are not starting from scratch. Several commendable efforts in that direction were made in the last two decades, by both public bodies and private players, often under the impulse of the WHO (World Health Organization). For instance, in the early 2000s, an independent operational network of technical and public-health institutions, labs, NGOs (non-governmental organisations) and others (more than 600 public and private partners) was established under the aegis of the WHO, with the objective of observing and responding to threatening epidemics. The Global Outbreak Alert and Response Network (GOARN) is a multilateral and multidisciplinary network aimed at standardizing ”epidemiological, laboratory, clinical management, research, communication, logistics and support, security, evacuation, and communication systems” and intervening to support local efforts to combat outbreaks. But GOARN was hampered by budgetary constraints and growing reticence from governments. The latter, in the end, bypassed and marginalised the WHO as well as other international multilateral organizations, presently struggling with their lost credibility and the lack of support from national governments.
A blueprint for action can be found in an excellent report issued in 2016 by an independent international commission (the Commission on a Global Health Risk Framework for the Future), chaired by Peter Sands and supported by the US National Academy of Medicine. The aim was to develop a “framework for institutions, policy and finance that would be resilient to a wide range of such potential threats, whether known—such as influenzas, coronaviruses and haemorrhagic fevers—or as yet unknown”. The report contains detailed recommendations in three critical areas: national public health capabilities and infrastructures; reinforcing international leadership and coordination for preparedness and response; accelerating R&D (research and development) in the infectious-disease arena.
To conclude, unfortunately, we will never be able to eliminate structural uncertainty and bring back the world of fully measurable risks we were used to living in, a world of candid white swans. We will have to live with the threat of coronavirus and other unknown risks. Welcome to the Age of the Great Uncertainty! But there is a lot we can do, and should do, to limit the scope of unforeseeable threats and build a more resilient economy, society and policymaking. This is a must that should involve and engage policymakers, scientists, businesses and society—in sum, all citizens. But it should see the financial sector at the forefront of the battle. For bankers and the world of finance, learning to cope with the Great Uncertainty is nothing less than a condition of survival. Without reliable and quality data, measurement and information, finance would become akin to gambling, which is a completely different trade. And it would not be able to play its essential social function: allocating efficiently, based on merit (creditworthiness) and trust, precious savings and financial resources.