Banking union – a never ending journey
In this second blog post, I would like to pick up on my earlier discussion on the capital market union, but focus more on the banking union aspect of the Single Market in finance. As written earlier, the concept of both ‘unions’ is closely connected, as is more generally banking and capital market development in advanced countries. Capital markets cannot function without efficient banks who are an important player on capital markets. A thriving capital market, on the other hand, can also help banks by allowing them to raise funds more easily, securitise assets and sell-off non-performing assets, as well as enable an easier resolution and exit process for failing banks. Ultimately, a strong European banking system, where large banks are no longer tied to specific sovereigns, and a single capital market can not only provide the necessary efficiency and scale for financial service provision in Europe but also reduce dependency on large US investment banks.
Unlike the capital market union, which is still more a concept than reality, the banking union has a strong supervisory leg, a limited resolution leg and no deposit insurance leg. As written before, even though progress has been made with the establishment of the Single Resolution Board and the Single Resolution Fund, limited progress has been made towards a banking system where banks are not bailed out (or saved through preventive recapitalisation) and where any failure management is not primarily national. The recent CMDI reform package is entering trilogue negotiations (between European Parliament, Commission and Council), but the counter-proposal by the Council to what the Commission has proposed might make things worse rather than better.
Even if we had a perfect banking union with all three pillars, would that ‘guarantee’ a Single Market in banking? Far from it, I would argue. National politics still looms large and cross-border mergers are still hard to undertake. We will only have arrived at a Single Market in banking, when we no longer refer to French, German or Italian banks (or champions) but European banks. The French president Macron recently mentioned that he would not put any resistance if a major French bank would be taken over by another large bank from a different European country; it remains to be seen whether this would really be the case. The current wave of nationalist parties taking political power or getting close to it will certainly not help in such a push for a truly European banking system.
So, the main barrier for both completing the banking union and for a truly European banking market is national politics. Unless national governments are willing to take a backseat when it comes to their banking systems, limited progress seems feasible.
24, June 2024
Time to talk about the capital market union
Last month, we had our annual conference with the theme of “From Birth to Maturity: 10 years Banking Union” as well as a half-day workshop on the Capital Market Union. While the banking union project seems to be stuck with its half structure of well-functioning bank supervision, de facto limited supranational bank resolution and no deposit insurance, the capital market union project has been all but dormant since it was first announced 10 years ago.
In this first post (out of two) I will discuss the capital market union project, before going in a second one into the banking union project.
As written earlier, Europe urgently needs to diversify away from a bank-based or bank-biased financial system towards a stronger role for non-banks and capital markets, to support the green, digital and demographic transition as well as foster innovation and growth. Even the necessary funding for strengthening European defence can benefit from efficient financial markets. This was at the core of the capital market union project launched in 2014/15. Not much has happened, however. Why and how can we overcome this lack of progress?
One important element is the lack of cross-border investment into investment funds, especially by retail investors. Different taxation rules, including withholding tax regimes, are a strong disincentive to do so. The fact that the majority of management companies of investment funds are owned by banks introduces another home bias and undermines competition. However, these two hurdles also point to specific policy actions that can be taken.
Another important element is the lack of enforcement by market authorities. Only if investors can trust in governance and enforcement of rules, will they be willing to invest and with possibly lower returns. Some observers also pointed out that the current structure of ESMA is not conducive in this respect, as its board is dominated by NCAs and its enforcement powers are too weak.
A third important barrier (and link between banking and capital market unions) is the lack of a true euro-wide safe asset. Issuance of a common safe bond to fund EU environmental and defense investment projects can be helpful in this context by also providing a backbone for the CMU. At the same time, it can help fill the gap of a missing safe assets for European banks.
One important question (both in terms of policy but also politics) is which segments of the very broad non-bank financial sector should the focus be on. There is the argument that this should be the public capital markets – by developing them, one creates additional options for venture capitalists and equity funds. Having a large and thriving capital market can also be an important political symbol (thought this is very the national politics come in, a point I will come back to below).
As pointed out by one observer, the European capital market (union) used to be in London, now that the UK has left the EU, we are still looking for a substitute. But national interests as well as national banking interests go against a single capital market. And as we do not have a crisis (which gave rise to the banking union), no one feels the pain of not having a CMU. The cost is rather in foregone (green) investment and sustainable growth. And even as Europe faces existential threats to its socio-economic model, the need to foster the scale and efficiency of non-bank financial intermediation is not seen as urgent!
How to overcome vested interests and reinforce the urgent need for a European capital market? On the one hand, the challenge will be to identify possible winners from a true Capital Market Union. On the other hand, political leadership is necessary – but this has to go beyond publishing joint editorials in leading European newspapers! One option would be to link the CMU to the transition processes mentioned above, ‘learning’ from the US experience where the financing of railway construction with bonds helped boost capital market development. There is certainly also a stronger role for ESMA needed, both in supervising an increasing number of specific market segments and in pushing for integration of European capital markets more generally.
One important stumbling point seems to the location of a common capital market. After Brexit, major cities in the EU tried to attract as much financial sector business as possible. It will be all but impossible to agree on one location, so a hub model, where different market segments are based in different cities but are closely connected and supervised by one supervisor might be a politically feasible solution.
As these comments show, creating a truly Single Market in finance in Europe is a long-term challenge – academia, including the Florence School of Banking and Finance, has an important role to play in advocating for out-of-the-box solutions and overcoming political resistance.
24. June 2024
Elections, elections, elections
The elections for European Parliament earlier this month was less than a shock than confirmation of a trend towards the hard right; the only advantage that ‘mainstream’ parties have is that they are more coherent and the fact that nationalist parties – by their nature – have a harder time cooperating across borders, even within Europe.
The big shock came after the polls had closed, when president Macron announced snap elections for the French parliament, later this month and early July, opening the door for a first hard-right Prime Minister. A huge bet, hoping that either the French voters will step back in the last moment before voting in a hard-right majority, or if they do so, that they will sour promptly of such a Prime Minister, in time for the next presidential elections in 2027.
In either case, Macron looks very much like a lame duck at this stage. With Bundeskanzler Scholz struggling and the Spanish prime minister Sanchez under pressure as well, it is the hard-right Italian Prime Minister Meloni who is the last one standing tall; a curious reversal from only a few years ago. Not much to celebrate about in the European Union and one wonders what can be achieved in the next five years in Brussels under such circumstances or whether the EU will ultimately go back into crisis mode.
Looking across the Channel and with less than two weeks to go before the UK elections, the result seems all but given, with the parties other than Labour playing for second place, with wild if unthinkable (at least a few years ago) scenarios of Lib Dems becoming the official opposition or the Tories being all but wiped out (maybe some of them would even have to fall back on the foodbanks, whose rise they have overseen over the past 14 years; note: not a serious concern, given the number of grifters on the Tory bench!).
But even if it seems all but obvious that 5 July will see a new Prime Minister, that’s when the real ‘excitement’ starts. How long until voters get disillusioned once they note that the Labour government has limited space to ease the burden of Brexit, is too constrained by limited fiscal headroom unless it breaks its campaign promise of not increasing taxes for the general public, and will thus not be able to improve public services quickly?
Where will the Tories head? The most likely outcome seems a takeover by the populist ultra-Brexiters who will move the Conservative party to the extreme right and/or even merge with Farage’s Reform Party? Will the next elections (2029) be the choice between Labour and Reform (even if by then it is call Conversative)?
Unlike in 1997, when Labour last won with a landslide after 17 years of Conservative government, there will be no honeymoon and no perspective of “things can only get better”. Then, again after the second round of the French parliamentary elections, we on the Continent might look with envy towards London political landscape, even if it only might be a temporary relief for the UK.
22 June 2024
Is the Tory nightmare finally over?
Those who know my political stance know that I am no fan of socialist wet dreams a la Jeremy Corbyn or the idea that you can solve problems of the 21st century with policies that miserably failed in the 1970s (such as nationalisation, price controls or permanent subsidies for dying industries). But as the vast majority of British voters I am looking forward to a Labour government in 10 Downing Street. The conversative governments over the past 14 years have left the country in a worse state than when they took over 2010 (right after the economic shock caused by the Global Financial Crisis). This article by the FT makes this point very clearly.
Three specific issues stand out in this failure: one, austerity – yes, there was a need for consolidation after extensive deficit spending during the Great Recession – but the Tories have not only used this austerity drive to tear away from the social fabric of the UK, but have damaged economic growth, both in the short- and medium-/long-term. The idea of crowding in of private investment and expenditures through aggressive deficit reduction turned out to be a pipe dream, with the negative multiplier effect of lower government expenditures on GDP much higher than expected. Ultimately, these policies have also lowered long-term aggregate supply through reduced funding in infrastructure, schooling and other critical services for businesses and households alike (this is where British economic policy meets German economy policy, I am afraid, a similarly negative story).
Two, (and partly as consequence of austerity) Brexit has inflicted substantial economic damage on the UK, a fact that few if any serious observer denies. And it has not been the way that Brexit was implemented that caused the damage, but the concept itself. The idea that it could have been a success if only implemented properly is an illusion. It has also worsened politics in the UK, by pushing out a number of competent politicians from the Conservative party during the Johnson purge of 2019 and thus promoting many of the current incompetent clowns in government. Given the failure of Brexit, it has also led to this continuous revolutionary spirit, where yesterday’s extremist views are considered mainstream today and woke tomorrow (from ‘we will leave the EU, not the Single Market’ to ‘only hard Brexit fulfils the referendum’s mandate’ to ‘we have to leave the European Court of Human Rights’, a non-EU institution). Given the failure of Brexit, new extremist policies have to be put forward to keep the revolutionaries excited!
Three, the embezzlement of public funds has been outrageous; yes, the emergency of spring 2020 gave rise to corrupt behaviour and attempts at making a quick buck in many countries, but the way that Conservative donors filled their pockets in spring 2020 with pandemic funding (without delivering what they were supposed to deliver) was beyond the pale.
Unlike 1997, the Conservatives will leave Labour with a country in decline and a number of bad choices. Lots of new trilemmas are popping up. Take this one: the current government wants to reduce immigration, strengthen university education as export sector (at least that’s what they claimed in 2019) and have fiscal space for tax cuts. Well, by reducing immigration through limiting graduate visas, you hurt both the university sector and limit fiscal space (as high-skilled immigrants are net contributors to the public purse) – you cannot even achieve two out of the three goals (you could achieve both second and third goals at expense of first). The Labour government will be faced with similar choices: increase the number of foreign graduate students to help university finances (with the consequent political backlash by the right-wing press), increase university tuition for British (almost a non-starter) or increase government expenditures on university education (reducing fiscal space elsewhere, including for NHS or violating fiscal rules they promised to stick to).
There is clearly no optimism in the air as there was in 1997. Yes, ‘things can only get better’. But the sober approach by Keir Starmer might not just reflect his personality but also the dauting choices ahead.
24 May 2024
Israel, Gaza and European universities
The protest wave against Israel’s war with Hamas has reached European campuses, though in a much more civilized way than in the US. It has also affected the EUI, with yesterday’s traditional student protest during the State of the Union focusing on the Palestinian cause. Last week, the Academic Council (of which I am a member for this Academic Year) agreed on the following statement:
The Academic Council of the European University Institute (EUI) (i) condemns the ongoing violence against civilians in the conflict in the Middle East and calls for an immediate ceasefire and the release of hostages; (ii)
is committed to ensuring the EUI remains a safe space for all, in particular its students and researchers, to freely express diverse opinions and engage in peaceful protest; (iii) reaffirms that open dialogue is vital for the EUI as a research university.
This rather short and ‘neutral’ statement was not to the liking of student protesters in Florence (these include the University of Florence and the Scuola Normale Superiore, in addition to EUI PhD researchers) who are calling for a widespread boycott of any Israeli institution as well as the EU Horizon programme (where Israel participates). Extremist positions targeted at undermining academic exchange with universities in democratic countries seem the wrong way forward; giving up on substantial European research funding because one does not like the actions of the current government in an associated country seems rather odd for a European institution like the EUI.
Outside the Ivory Tower, things got even more complicated this week, with the call for indictment by the chief prosecutor of the International Criminal Court most likely leading to a circling-the-wagons moment in Israel, exactly the opposite what one is hoping for. It seems clear that the brute force and destructive approach by the Israeli government will bring limited short-term benefits and create even bigger problems in the medium-term for Israel itself (not to mention the suffering of the Palestinian population from Israeli attacks and Hamas terror). One can only despair!
22 May 2024
Digital finance and innovation
Are regulations and financial innovation friends or foes? This was one of many topics we discussed in a closed door meeting recently in Brussels in the context of our Supervisory Digital Finance Academy. The European approach to financial innovation has often been described as regulation-driven, i.e., setting the regulatory framework early on, in which new (and incumbent) financial service providers can offer new financial products. This is a very different approach to a more market-driven approach, where innovation is being allowed within the existing framework and only later this framework is being updated. The most successful example of such an approach has been mobile money in Kenya where the laissez-faire approach by the Central Bank allowed Safaricom to launch M-Pesa in 2007, with enormous success and transformational impact on access to finance in Kenya, before adjusting the regulatory framework later.
One might see the European approach as a legalistic and formalistic one, which undermines innovation. One can even see the recent legislation on Artificial Intelligence as pre-empting attempts to draw benefits from this technological advance.
There are two strong arguments in favour of the regulation-driven approach to financial innovation (obviously there might be more): First, unlike in developing economies where almost any advance in financial deepening and financial inclusion can be considered progress, such advances are seen very different in more advanced countries (remember financial ‘innovations’ such as Icesave deposits and Lehman Brothers certificates in 2008). Second (and very specific to Europe), Single Market considerations loom large. Avoiding the fragmentation of the Single Market by creating a level playing field across countries, avoiding forum shopping and regulatory arbitrage and thus enabling fair competition is key. As one participant said: you can either have strong institution or strong regulations, and in the absence of strong EU-level institutions, the EU has to go for strong regulations.
This poses a clear trade-off and the EU is bound to err on the side of regulations even at the expense of financial innovation. Allowing innovators to access a large potential clientele across the Single Market is certainly a benefit that might partly offset the cost of regulation. Nevertheless, one might criticise this approach as ‘killing’ innovation, but it is a classical ‘European compromise’. Only the long-run will show the benefits and costs of this approach.
27. April 2024
Financial Access Survey - what a long way we have come
Almost 20 years ago, Asli Demirguc-Kunt, Sole Martinez and I started a data collection effort on financial inclusion (back then still referred to as Access to Finance) and published a database in 2006, with the companion paper published in 2007. We presented data on bank accounts per capita and branches and ATM per capita and per square km, being the first to document the vast variation in the banking sector outreach across countries as well as showing that banking sector outreach is correlated with firms’ financing constraints. While our survey was purely supply-side based, limited to the banking system and providing only proxy indicators of outreach, it served as an important first data collection. A few years later, in 2009, the IMF took over the data collection exercise and the Financial Access Survey was born. In subsequent years, this survey has been extended to other variables, in total over 100, and to 189 countries. Over time, new dimensions have been added, including mobile money and, importantly the gender split of access to and use of financial services.
Over the past decade, the Global Findex database has somewhat stolen the limelight from the Financial Access Survey – based on household surveys, it provides a more granular picture of what population share has access to what kind of financial services. It allows to also focus on specific population segments: women, rural and less educated groups. It provides insights into the reasons of why individuals do not access financial services, differentiating between supply and demand-side constraints. The one downside of the Global Findex is that it is only undertaken every three or four years and data collection incurs rather high costs. The Financial Access Survey, on the other hand, is on an annual basis and much more cost-effective to put together.
Earlier this week, I was invited to participate in the second meeting of the Advisory Group of the Financial Access Survey to discuss how to improve data quality and availability, including through capacity development, to leverage synergy and complementarity between different databases, and to utilize modern data collection tools. Combining different databases (in addition to the Financial Access Survey and the Global Findex Survey, there are policy-focused databases such as put together by the Alliance for Financial Inclusion) is in my view critical to get a proper picture of financial inclusion across countries and within a country over time. Country-specific surveys (such as FinAccess in Kenya) can provide additional insights.
Data collection on financial inclusion has come a long way since the International Year of Microcredit in 2005, when the lack of data on financial inclusion became apparent. One cannot improve what one cannot measure, was the conclusion back then. At the same time, the financial inclusion community has avoided the pitfalls of ranking countries, a pitfall which turned out to be the downfall of the Doing Business database. Now that we can measure financial inclusion, we have taken a big step towards designing policies that can help expanding inclusion in a sustainable and effective way. I am sure the next 20 years will bring many additional insights on financial inclusion and the policies that work and that don’t work.
26. April 2024
Ukraine – two years on
If the murder of Navalny has made one thing clear it is that Putin has no interest whatsoever in backing down from his murderous campaign against his enemies within and without Russia. As the second anniversary of his invasion of Ukraine nears, it still seems that too many in the West have still not realised that Ukraine is not just defending itself but the whole of Europe against an expansionist and murderous regime. The America-First or Putin-wing of the Republican party seems not to have learned anything from history, in the best case assuming that a broader conflict in Europe will not affect US economy and security, in the worst case, sympathising with the ‘strongman approach’ to international relationships. Left and right extremists in Western Europe, in the best case, are naïve believing that Putin will simply stop at the Western border of Ukraine and that once he gets the parts of Ukraine he wants plus the rest of the country as buffer zone, everything will go back to the status before the war; in the worst case, they are simply paid by Putin.
Western Europe is in a war, even if bombs 'only' fall on Ukrainian cities and 'only' kill Ukrainian civilians. Pretending otherwise is a dangerous illusion. For us, it is an ‘easy’ war to fight: send military equipment and money. Yes, there is an economic cost, but as much as we benefited from a peace dividend over the past 30 years, we will now have to pay a war tax. Not paying it and not supporting Ukraine will be even costlier in the long-term. I simply cannot understand the hesitation by many European governments to be more forceful in their support for Ukraine’s fight, which is also our fight. Slava Ukraini!
23. February 2024
A note on Israel and Gaza
Last year I came out very strongly in favour of Israel defending itself against the Hamas terror group, even if this included a full-fledged invasion of the Gaza strip. The events over the past 4 months or so, have seen exactly this. While at the beginning, there might have been some attempt at minimising civilian casualties, it has become clear that this is no longer the case. Even if it is hard to disentangle civilians and Hamas militants, the Israeli approach seems brutal and inhumane, with the suffering of the Palestine civil population horrific and unbearable. To add insult to injury, excesses by Jewish settlers in the West Bank seem to have only one aim: humiliate and deprive Palestinians.
From the viewpoint of some in Israel, their brutal approach in Gaza might seem justified in the short-term; in the long-term, however, it is self-defeating, as the Palestinians will still be there after Hamas is hopefully gone (unless you follow the same maniac and murderous idea of Hamas of ethnic cleansing as some extremists in Israel do with respect to Palestinians). The vicious cycle of violence (in this round started by the terrorist attacks by Hamas on 7 October) will simply continue. This is short-sighted and wrong!
The current brutal and short-sighed approach seems driven by the interest of Prime Minister Netanyahu to stay in government as long as possible without thinking about long-term consequences. He has made himself a hostage of extremist settler parties for purposes of political survival, putting his own interests above that of the country.
As mentioned before, Israel is the only functioning democracy in the region; one can only hope that there will be sufficient pressure to change the current approach, not only to reduce the suffering of the Palestinian civilians but also to the benefit of future Israeli generations. So far, the conflict between Hamas and Israel has not escalated into a regional conflict, with many Arab governments holding back in spite of pressure from their population. The risk is that as the destruction of Gaza continues, this will not hold much longer.
19 February 2024
Capital market union – a reset?
I recently participated in a panel discussion on the capital market union, organised by the Portuguese regulatory authority CMVM and CIRSF, conducted under the Chatham House Rule. Here are some take-aways (building on my own remarks and others’ comments) – certainly a topic that I will write more about in the coming months, also because I am co-organising another such event in Florence on 14 May in the context of the EMU Lab. The background for these discussions is that ten years ago there was a big push for such a capital market union; while some progress has been made in terms of legislative efforts, there seem to be limited progress in actual outcomes.
First, drawing parallels between the banking and the capital market union is wrong and counterproductive. The banking union (or at least what has been put in place) was the result of a crisis and has focused on banking stability. There are clear elements (SSM, SRM and EDIS), with broad consensus on what has to be done, though not as much political willingness to also undertake the final steps. The capital market union, on the other hand, is a much broader project, focusing on a variety of markets and institutions, focusing on the sustainable development of different segments of the financial system, both through legislation and regulation, but also creating new authorities.
Second, Europe urgently needs to diversify away from a bank-based or bank-biased financial system towards a stronger role for non-banks and capital markets. This includes both public equity and bond markets, but also non-bank intermediaries such as venture capitalists and equity funds. There is sufficient evidence that a bank-based (or bank-biased) financial system is not only bad for growth, but also for stability (given the more procyclical nature of bank lending).
Third, rebalancing of the financial system towards non-bank segments of the financial system is also needed for innovation and green transition. In a recently published paper, my co-authors and I show that liquidity creation by banks is growth-enhancing through the channel of tangible but not intangible investment, with the aggregate growth effect of banks’ liquidity creation turning insignificant in economies with a larger share of sectors relying on intangible rather than tangible assets. Ralph De Haas and Alex Popov show that market-based rather than bank-based financial systems are better positioned to fund the transition to net zero. Why? Banks generally do not fund innovation and intangible assets as they rely on tangible assets for collateral and companies’ track record (with innovative start-ups might not have); they are also reluctant to fund green transition as this might hurt their legacy borrowers.
The arguments so far make a general argument for fostering non-bank segments on the country-level, but why on the European level? Scale economies matter in finance and even more so in capital markets, where network externalities are also important (as discussed and empirically shown in this paper). Larger countries have larger and more liquid capital markets (as shown here where we compare nascent stock exchanges – the most extreme comparison are the stock exchanges of China and Swaziland, established in the same year). There is also the issue of path dependence, as a vibrant financial centre also relies on lots of ancillary services (legal, accounting, auditing etc.), a reason why London continues to be one of the global financial centres. So, moving towards a European Capital Market Union to benefit from such scale and network externalities is critical. Does this mean that financial service providers have to be concentrated in one location? Not necessarily, but it calls for close interconnections, merger of back offices etc.
What is needed to move towards such a Capital Market Union? One thing certainly won’t work is to ‘lure’ people into buying stocks with marketing campaigns and tax incentives alone. And if it works, it might backfire once people incur losses (remember the mis-selling of preferred shares in the runup to the 2008 crisis). There is a debate on the importance of missing financial literacy as impediment to more households diversifying away from bank deposits; certainly an important factor though in the long-term not necessarily the decisive factor. Enforcement of fiduciary duties of sellers and of transparency standards is important. There is still not enough investor protection. There might also be a need for ‘industrial policy’ trying to aim for larger funds (again with the argument of scale economies and thus lower fees), although there might be competition concerns.
The most important question for me is who can drive this process. I think there is the clear need for a champion on the technocratic side – ESMA would certainly be in a good position. Upgrading ESMA’s position as supervisor across more segments of the financial system within the EU can also help in this context.
One important impediment are national political interests. The open competition to lure business from London’s financial centre after Brexit shows that there are limited interests in creating a truly European hub for financial services. Maybe rather than waiting for a compromise among 27 member states, with capital markets not at the top of the agenda, a ‘coalition of the willing’ is needed.
14. February 2024
Studying across Europe – the backlash from the locals
I spent five years at Tilburg University in the Netherlands, teaching in English and building up a banking research centre. Having moved subsequently to the UK, I have learned to appreciate the Dutch university system even more. One important strength of Dutch universities is that a large share of courses are taught in English, which makes it an attractive destination for non-Dutch students across Europe who have to pay the same (reasonable) tuition fees as Dutch students. University education has thus become an important export industry for the Dutch, with the overall economy and society benefitting. Dutch students benefit from daily interaction with non-Dutch students and society benefits as some of the non-Dutch students might stay on and become part of the Dutch work force. Dutch universities have also managed to attract many foreign academics, not just because of a favourable tax treatment but also because of the international environment. Again, it is students who stand to benefit getting a broader and more global view in their education.
All of this is now at risk.
The Netherlands seemingly has benefitted from Brexit as European students have shifted their focus away from the UK. Given the environment I described above, Dutch universities stand to enormously benefit from this trend; but this influx has also contributed to an increasing stress on the housing market, resulting in higher rents. This has led the previous (and still acting) government to require universities to shift towards more teaching in Dutch, with the explicit objective to discourage foreign students. One can think of few more short-sighted policies! Rather than focusing on building more student housing, damage has to be done to the Dutch university system! There might be a strong argument to limit the number of students, but doing so by reducing quality and global outlook?
It is important to note that it is not only diversity in the student body that will go down with this approach, but also diversity on the academic site. How many non-Dutch speakers will stay and start teaching in Dutch? How can you attract international talent if they find out that they have to teach in Dutch within a few years. While there might not be an immediate exodus, it will certainly hurt the university system and society at large. The Danish example (where a similar policy was introduced in 2021) shows that the damage can be actually done quite quickly.
Finally, it obviously also undermines the idea of Europe; yes, the student exchange programme Erasmus is not at risk yet, but a focus on domestic students is a clear step against the spirit of Europe!
10 February 2024
Are economists a tribal clique? Sad, but true
ECB President Mme. Lagarde (herself a lawyer) recently called economists a tribal clique (see here, from minute 21 onward). One might wonder whether it is wise to criticise the people that work for you, but I will leave this to others to judge. Unfortunately, her statement seems quite correct and also confirmed by research, as reported, for example, here. Compared to other social scientists, economists are less likely to quote papers from other social sciences and are more hierarchically structured. They clearly see themselves as more competent than other social scientists and see less value in interdisciplinarity. Calling this out is important! There is an older and more humorous description of life among economists here.
Having enjoyed an interdisciplinary environment over the past 2.5 years, I have learned to appreciate the opportunities interdisciplinary dialogue offers, especially after having spent eight years in an environment where interdisciplinarity was defined as a corporate finance and an asset pricing researcher having lunch together (I am not criticising my former employer for that as it was a the result of geographic distance from the rest of the university).
How can interdisciplinarity help economists? Mme. Lagarde mentioned examples herself in her Davos remarks, related to climate change and supply-side shocks, but let me add some from my own experience. Take the example of banking union- last year, some of us economists joined forces with forces with legal scholars to explore options of completing the banking union within the legal constraints given by existing European treaties. When discussing options for banking union and capital market union completion, we economists (pretend to) know exactly what is to be done; learning from political scientists and historians how such reforms are actually put in place might not just make us more humble but also more effective.
In summary, Mme. Lagarde’s criticism might sound harsh, but rather than criticising the messenger it might be good for us economists to consider the substance of it and consider it carefully.
30. January 2024
Euro at 25
On 1 January 1999 the euro was formally launched (as accounting currency), thus 25 years ago. Time for some reflections, including on two politicians who feature prominently in the history of the euro and passed away late last year, though one of them seemed to be more an accidental (and rather controversial) giant in the politics of the euro. Jacques Delors, president of the European Commission between 1985 and 95, implemented the Single Market and the Schengen Agreement and set the foundation for the monetary union. The European Union in its current shape owes a lot to policies and institutions created and implemented during his 10 years at the helm of the commission. Free movement of goods, services, capital and people is today seen as the natural state of affairs, but was not just a generation ago. However, in creating the euro, there was also a, what today we would call minimalist approach, focusing exclusively on monetary union and ignoring all other policy areas, a decision that came back to haunt the euro area – more on this below.
Wolfgang Schäuble had a prominent role as German finance minister in the Eurozone. Following the Global Financial Crisis, which brought several European governments to the brink of overindebtedness and losing access to funding markets, the shortcomings of the euro governance structure became clear. While critics had not necessarily imagined this specific scenario, it was the lack of fiscal policy coherence across countries and a geographic mismatch between cross-border banks and national regulation and national interlinkage between governments and banks that made the currency union unsustainable without reforms. The solution proposed by Schäuble and others: austerity! And not only austerity in overindebted countries, but including in core countries such as Germany and the Netherlands, which had no fiscal problems to speak of. This ultimately prolonged the economic slump throughout the euro area and put even more pressure on overindebted countries and the overall euro area.
Yes, progress was made in terms of a Single Supervisory Mechanism but we are far away from a functioning banking union and the bank-government deadly embrace is still very much there. And the new fiscal policy agreement, while more flexible than previous one, will still result in significant retrenchment in government spending. Overall, the role of Delors was that of driving integration, while the role of Schäuble was crisis-solution, but at a (too) slow pace and to a certain extent with wrong instruments as well as preventing deeper integration to address structural shortcomings. Ultimately, this reflects the difference between a pan-European approach, supposedly taken by the Commission, and the national approach, often ignoring externalities of domestic policy decisions (such as austerity) on the rest of the currency union. However, one could also argue that Jacques Delors had an easier time as being not directly accountable to voters (though all important decisions of course were taken by national governments), while Wolfgang Schäuble was always accountable to national voters.
These issues are also related to the launch of the EMU Lab here at the EUI last week, with the first session being titled “The Euro is not what we expected it to be – discuss!”. There are much better summaries by Martin Sandbu on the FT (here) and of Adam Tooze on his blog (here), but here are some of my take-aways: First, it is important to remember the objectives for many countries in agreeing to a joint currency – to overcome the fragility of a fixed-exchange rate regime, such as became obvious in 1992, but not necessarily as first step into an ever deeper union. It can also be seen in the context of the just established Single Market; while the Commission has been in charge of avoiding government subsidies that give uncompetitive advantages to firms, a common currency would exclude competitive devaluations. Barry Eichengreen reminded us that the US did not get to a true fiscal union until the 16th constitutional amendment allowed Congress to impose an income tax in 1913. And as still the case in Europe, labour markets were not really geographically integrated in the US until later in the 20th century. So, taking the long, historic view, maybe we can see the first 25 of the euro project as relatively successful, after all.
One important discussion was on the role of Single Market vs. euro area: the recent move towards joint expenditures for post-Covid recovery and discussions on similar expenditures for Ukraine are on the Single Market level; similarly, the discussions on the capital market union are not limited to the euro area (unlike the banking union). Martin Sandbu made the very valid point that maybe the best way forward should be to focus on resilience and growth on the Single Market rather than the euro area level.
14. January 2024
Banking in Africa: Opportunities and challenges in volatile times
In preparation for the 4th edition of the Oxford Handbook of Banking, Bob Cull, David Mare, Patrizio Valenzuela and I have updated our chapter on African banking, this time sub-titling it: Opportunities and challenges in volatile times. In summary, our paper ”shows a picture of achievements, including stronger resilience, and challenges, including stubbornly high costs, with progress along some fronts but other challenges persisting even as new ones arise, including the turning of the global financial cycle in 2022/23 and increasing geopolitical tensions.”
When discussing banking and finance in Africa, one first has to remember the adverse conditions in which financial service providers operate: First, the small size of many economies does not allow financial service providers to reap the benefits of scale economies. Second, large parts of the economy and a large share of all economic agents operate in the informal sector and do not have the necessary formal documentation that traditionally has facilitated financial transactions, such as enterprise registration, land titles, or even formal addresses. Third, volatility increases costs and undermines risk management.Finally, governance problems continue to plague many private and government institutions
While shallow, concentrated, and costly, Africa’s banking systems have also proven stable and resilient over the past years. There is a focus on the shorter end of the yield curve, also reflected in the marked absence of liquid capital markets and low development of contractual savings institutions such as pension funds and life insurance companies in most countries. There has been deepening of financial systems, but developing countries in Africa are still behind developing countries in other regions of the world.
On the upside, the adverse characteristics described above have also provided a prominent role for technology and innovation. Mobile money providers using agent networks can overcome the size problems by minimising the cost of a physical infrastructure and reducing the necessity for formal documentation requirements. Mobile money also allows more arms-length transactions, reducing governance challenges. And the mobile money revolution has significantly contributed to a substantial increase in financial inclusion in several African countries, even though there is still some way to go. There has also been a rapid increase in lending platforms, although it is still at a very low level, compared to other segments of the financial system.
Turning to the performance during Covid, we make three observations: first, the banking sectors in African countries were less affected by international economic turbulence as they are not well-integrated with the rest of the world, as was also seen in the Global Financial Crisis. Second, COVID-19 had mild negative effects on African banking sectors, at least in part because it was a less severe health crisis in Africa. Third, the lack of policy space (fiscal, monetary, and financial) limited the number of interventions of governments in reaction to COVID-19.
So, while Covid-19 did not have as severe effects on African finance in spite of a less powerful policy response as in advanced countries, the shifting global financial cycle and geopolitical tensions have the potential to test the resilience of African finance. The rise in interest rates since late 2021 across major advanced economies has increased debt burdens across the globe. The increase in foreign debt over the past decade, partly underpinned by rising commnodity prices and not all of it made transparent at time of origination, and the economic losses due to the pandemic have brought many developing including African countries close to unsustainable debt levels and some are already beyond that threshold.And with the Russian invasion of Ukraine and the same Russia trying to expand its footprint in Africa, there is an increasing focus on aligning the system of global financial transactions with new geopolitical objectives. This might also affect the geographic footprint of global banks, in a way similar to the repercussions of sanctions against Apartheid South Africa in the 1980s.
A final and continuous challenge is that of long-term finance, as already mentioned above. While there is no scarcity in the need or in the necessary savings pools, there is a lack of intermediary capacity for long-term finance. A bit like the Capital Market Union in the EU, creating the necessary enabling environment, markets and institutions is a long-term process. First progress has been made with measuring the existence of long-term finance instruments across Africa (as also discussed previously on my blog), but much more is to be done.
11. January 2024