Banks play a key role and are inextricably linked to the outlook of the economy, mainly through supporting growth by providing financing to businesses and individuals.

However, as demonstrated during the 2008 financial crisis, banks can become a destabilising factor if they are allowed to engage in malpractices, which include: lax lending standards that do not focus on the borrowers’ actual ability to repay, and excessive expansion into novel high-risk products and new geographic areas, in which they do not possess a competitive advantage over local banks.

Examining the events that led to the global financial crisis in 2008, as well as the events in Cyprus which culminated in the major banking crisis in 2013, three main factors can be identified that lead to the adoption of the above highly problematic practices.

First, a one-sided orientation to short-term profit and the non-observance of appropriate rules regarding risk management, two phenomena that are particularly observed in periods of economic euphoria and expansion of the banks’ deposit base.

Second, the failure to adopt and implement effective governance standards, mainly in terms of ensuring genuine independence of directors, external and internal auditors, but also in relation to interventions by organised groups or other powerful agents, such as political parties, trade unions and influential businessmen.

Third, the absence of strict and efficient supervision by the competent authorities, which aims to proactively address challenges, primarily with respect to the size and quality of the banks’ asset portfolio.

These factors led to excessive lending and unsustainable development in specific sectors, such as real estate and the stock market, while, at the same time, depriving the banks of the necessary resources to lend, which could contribute to more conducive conditions for economic recovery during challenging periods of recession.

The lessons from the 2008 crisis have led to substantial reforms, aiming at greater transparency and accountability towards the shareholders and the wider public, the adoption of modern standards on matters of governance and control of senior management, as well as limiting the assumption of excessive risks, through strict regulations and supervision.

Despite the fact that these reforms are, oftentimes, accompanied by complaints about excessive control and bureaucratic burden, they have contributed to the strengthening of the banks’ resilience. As a case in point, according to a recent Wells Fargo report, American banks currently possess high capital levels, low risk ratios and liquidity that is approaching a fifteen-year high.

Notwithstanding, the risk of repeating malpractices is not remote. In the US, President-elect Donald Trump has recently made statements about the need to limit banking supervision and to lower interest rates, indicating his intention to interfere with the independent operation of the supervisory authority. Recently, a number of credit institutions in the US filed a lawsuit against the Federal Reserve, challenging its key supervisory powers, including the conduct of bank stress exercises.

This would have been unthinkable only a few years ago. The balance is therefore fragile and, if the agents involved do not act responsibly, there is a looming risk of repeated crises.

Andreas Charalambous and Omiros Pissarides are economists and the opinions they express are personal