Finance: Research, Policy and Anecdotes

More interesting papers I have had time to read.  Angelo d’Andrea and Nicola Limodio gauge the relationship between “High-Speed Internet, Financial Technology and Banking” in Africa. While a lot has been written about financial innovation, including in Africa, this paper focuses on the technological condition that allows financial innovation, in this case the staggered arrival of submarine cables between 2000 and 2013 and thus high-speed internet across African coastal countries. First, having access to high-speed Internet increases the probability of moving towards real-time gross settlement (RTGS) payment systems. Gross instead of net settlement in turn reduces liquidity risk and increases size and liquidity of the interbank market. African banks hold traditionally a large share of liquid assets, the reduction of liquidity hoarding following the adoption of RTGS hence allowed for a statistically and economically significant increase in private sector lending, part of the financial sector deepening that I have documented earlier in several policy publications (Financing Africa-Through the Crisis and Beyond). While we focused more on the micro-elements of financial innovation, this paper documents very nicely how even back-office technology can help deepen financial systems.  And finally, the authors use enterprise survey data to show that higher private sector lending also improved access to credit by firms and the maturity of their loans.

Bjoern Richter and Kaspar Zimmermann show in “The Profit-Credit Cycle” that an increase in banks’ return on equity predicts credit booms and subsequent busts.  Part of an expanding literature on understanding credit cycles and building on a historical macro-financial literature, the authors use data for 17 advanced countries between 1870 and 2015. The increase in credit following higher bank equity comes with lower interest rates, suggesting that it is a supply- rather than demand-driven phenomenon. There are several channels through which bank profitability can influence future credit growth, but the strongest evidence seems to be for a behavioural channel – low loan losses and high profits increase the confidence of banks and results in stronger credit growth. This is confirmed by looking at more recent survey data from the US: there is a high correlation between bank profitability and bank CFO optimism. To close the circle, the authors show that increases in bank profitability predict banking crises a few years ahead. Ultimately, a lot of evidence in line with Minsky’s hypothesis that good times cause future instability.

Isaac Hacamo and Kristoph Kleiner have a fascinating paper on Forced Entrepreneurs. Research on entrepreneurship in developing countries has shown that a large part of micro-entrepreneurs are life-style or subsistence entrepreneurs, forced into self-employment due to the lack of salaried employment. Estimates for Sri Lanka has shown that 30% of informal entrepreneurs are life-style type, while Miriam Bruhn has an estimate of 50% in Mexico. In my work with Mohammad Hoseini we found that 54% in India are subsistence entrepreneurs. This paper considers such entrepreneurs in the US. Analysing the employment histories of 650,000 workers, the authors document that graduating college during a period of high local unemployment increases the likelihood of entry into entrepreneurship given poorer employment perspectives. Surprisingly, these entrepreneurs do not seem of lower quality, neither ex-ante nor ex-post in their entrepreneurial performance. Rather, based on multiple measures of success, including survival, growth, innovation, and venture capital, recession-driven entrepreneurs are equal to or even more successful than voluntary entrepreneurs. Ultimately, it seems that recession pushes more risk-averse graduates into entrepreneurship. So, it seems that it is risk aversion rather than the lack of entrepreneurial skills that holds graduates back from becoming self-employed.  These are very different results from those in the developing world, which is not surprising – in this paper, the focus is on college graduates with typically good employment perspectives, though significantly varying over the business cycle.

Overview