Foreigners vs. Natives: Lending Techniques and Pricing
After a long review process, my paper with Vasso Ioannidou and Larissa Schaefer has been finally accepted by Management Science. While the initial findings with which we started five years ago still stand, lots of additional tests have strengthened the robustness of the findings and - courtesy of review process – we managed to put the results much better into the literature. Our paper – using loan-level credit registry data from Bolivia –explores differences in foreign anddomestic banks’ credit contract terms and pricing models Previous work has shown that the clienteles of foreign and domestic banks are different (as, e.g., by Atif Mian for Pakistan). We rather look at differences in loan conditionality across banks when they lend to the same clients in the same month. We find that foreign banks are more likely to demand the pledging of collateral and give shorter maturity loans. There is also some evidence that foreign banks provide loans at a lower interest rate, though this result is somewhat less robust. A second finding is that foreign banks rely more on hard information than domestic banks. Together this suggests that foreign banks can overcome distance–related information constraints by focusing on hard assets and hard information as well as the disciplining tool of shorter maturity.However, we also show that there are limitations, with foreign banksfacing higher default rates and lower returns on lending if not using collateral and short maturityas disciplining tools.
Our work relates to an extensive literature documentingthe importance of geographic andcultural distance between borrowers and lenders, which shows that loan contract terms and lending techniques are a critical function of the geographical distance between borrowers and lendershe findings of our paper are consistent with other work that shows that foreign bank entry has a more positive impact in countries withmore efficient credit information sharing systems and creditor rights protection. However, our results also show the risks for funding of smaller businesses that comes from foreign bank entry. If domestic lenders cannot cover the remaining segments of the market, the foreign banks’ stronger reliance on collateral and short maturity loans may reduce the options for firm investment. It may also have important repercussions from a capital allocation perspective as it may imply a shift towards firms with short-term financing needs and with pledgeable assets both on the intensive and extensive margin, limiting the potentially beneficial role foreign banks can play in developing countries. In a nutshell: no free lunch to be had here!
17. October 2016
Economic Policy Panel in Florence
I am off the 64th Economic Policy panel in Florence with an exciting set of papers. Among them, this proposal for increasing the supply of liquid assets for the Eurozone’s banking system. What have policy makers and academics learned from the crisis and post-crisis experience for monetary policy conduct and what will be the future roles of central banks? Very prominent will be the topic of migration, with several papers scheduled for a special issue on the topic in 2017. What is the impact of migration on wage levels in the host country and the overall economy? How would a more efficient European asylum system look like? I expect lively discussions and great papers to be published next year!
13. October 2016
From Great Britain to Narrow Minds
And now for something that has affected me personally quite a lot this past week. How much difference a summer can make! As many non-British academics, I was attracted to the UK by the openness of its society, the dynamics of its economy and international character of London. I have not been disappointed so far. Unlike in other countries, there has been no shyness at the Bank of England, the UK Government or Parliament to collect as many views as possible, no matter the nationality of the interlocutors. This seems to have changed dramatically over the past few days.
First, there was the new Prime Minister branding us expats as international elite without roots. Yes, I have left my home country 21 years ago and have lived in the U.S., Netherlands and the UK. My wife has lived outside her own country for the past 19 years. And my children (adopted from Latin America and Asia) never lived in Germany, the country of their passport. So, in this sense we consider ourselves citizens of the world, and proudly so! But: we have paid all taxes that were due wherever we lived. We have tried to integrate into and contribute to our host communities as much as possible. It is quite depressing to be suddenly treated as unwelcome outcast!
Then the call by the Home Secretary for British businesses to hire more British and announce how many non-British staff are being employed. My head of faculty is Italian and my dean American and the international character (with the accompanying wealth of experiences) of Cass’ faculty makes it such an appealing place to work for us academics and for students to study!
And finally the announcement that the UK government will not interact anymore with non-British academics on issues related to Brexit (which will become a dominating issue over the next years). One of the promising factors in the dialogue between policy makers on all levels and academics over the past eight years of crisis management in Europe was the fact that no one ever asked for the nationality of the academic giving his or her opinion and advice. Behind this new approach of the British government seems a new attitude against the "enemy inside” that has to be outed and isolated so (s)he cannot do any damage.
What sad days! As I wrote previously, the Brexit vote can be seen as one step towards bringing to an end a long wave of globalisation. The events of this past week can be interpreted as rapid march towards nationalism and protectionism!
9. October 2016
Alternative finance – new opportunities or new risks?
I recently was asked to serve as moderator-discussant on a panel at the first Annual Conference of the Cambridge Centre for Alternative Finance. What I took away from the presentations is that alternative finance, such as crowdfunding and peer-to-peer lending, has been growing rapidly over the past years, though from a small level. And this is only part of a wider trend towards non-bank financial services, which also includes innovative payment services, such as mobile money. Having worked in this area extensively from an African viewpoint, it was interesting to compare notes with other regions of the world.
Turning more specifically to alternative intermediation models such as crowdfunding and peer-to-peer lending, It is interesting to note that there has been an increase in the volume across three very countries and different regions – in the U.S., in Europe and in China, where each region has experienced quite a different financial sector development over the years since 2008. China has seen an asset price and lending boom while at the same time the banking sector has been subject to restrictions, which might explain why some of this additional lending has come through these alternative intermediation models. Many countries in Continental Europe have been suffering from bank lending retrenchment, while SME lending has never been strong in the UK, opening a market niche for alternative financing forms. And the U.S. has always been open to non-bank and market-based finance, given its historic antipathy against big banks.
Based on the different country experiences, one can paint both a bright as a dark picture of these alternative intermediation forms. On the one hand, these innovative platforms provide welcome competition for banks and might expand access to external funding where it is most needed. On the other hand, one wonders how sustainable these platforms are across a full financial cycle. Also, when it comes to lending platforms linked to banks, is this a form of regulatory arbitrage exploiting lower capital requirements outside the regulatory perimeter? This trade-off relates to a broader trade-off on financial innovation, as documented in this recently accepted paperon financial innovation (forthcoming in Journal of Banking and Finance). On the one hand, financial innovation helps countries exploit growth opportunities by completing markets, allowing diversify and hedge risk better and ultimately improving resource allocation and growth. On the other hand, financial innovations can help feed credit booms and help banks take more aggressive risks resulting in tail risks as materialised during the Global Financial Crisis.
These different views on the alternative intermediation models also see a very different role for regulators. On the one hand, a laissez-faire, hands-off approach, which limits prudential regulation to deposit-taking institutions. On the other hand, a more cautious approach that considers potential fragility risks developing in unregulated segments of the financial system.
Where does this leave the regulator? As argued in this task force report at the Center for Global Development (which I was proudly part of), financial innovations call for a risk-based and functional approach to regulation,ensuring that functionally similar services are treated equally as long as they pose similar risks to the consumers of the service or to the financial system as a whole.For example, payment services must receive identical treatment, whether the provider is a bank or another kind of institution and whether it operates online or from a brick-and-mortar office. It also implies that the regulationdependson the type of services offered by providers, with only deposit-taking institutions that are part of the financial safety net receiving the same kind of prudential regulation as banks.
On a final note, this conference on alternative finance showed again the win-win-win proposition that cooperation between academics,practitionersand policy makers constitutes. Drawing on data from practitioners and questions from them and policy makers, academics can help formulate policy and help the innovation process.
30. September 2016
European banking – too late to grow out of the crisis?
I attended a fascinating discussion on European banking organised by the Brevan Howard Centre on Monday, including Ashoka Mody (Princeton, formerly IMF), Ignazio Angeloni (SSM) and Wolfgang Munchau. While set up as a discussion offering differing views on the state and future of European banking, after the different presentations I came away with a rather grim assessment. First, weak banks continue to put a brake on the recovery (especially in Italy) rather than helping it. And as much as recent reforms, including the banking union and other regulatory reforms are going in the right direction, they might simply come too late and much stronger policy action might be needed at this stage. Ashoka Mody pointed out that the sovereign-bank deadly embrace has turned into a debt-deflation cycle, with the delayed bank restructuring and recapitalization as contributing factor. As much as the monetary tightening in the U.S, came too late in 2005 to help dampen the housing bubble, actions to address this debt-deflation cycle taken now in the Eurozone might be simply too late, especially if limited to monetary policy. Much more dramatic debt reduction, including on sovereign debt across several periphery countries might be needed to get out of this vicious cycle, as also demanded by other economists (see for example Charles Wyplosz here).
Second and beyond the current crisis there are severe structural problems, Europe is still overbanked and overbranched, with cost-inefficient business models. Market-book values that are well below one show limited growth and profit perspectives for banks. Yes, low or zero, if not negative interest rates do contribute to the banks’ profit depression, but as important are structural cost inefficiencies. As pointed out by Langfield and Pagano in their Economic Policy paper Europe has been overbanked for quite some time and it seems this still has not been addressed properly. A substantial downsizing of the banking system across the Eurozone might be the only way to not only escape the debt-deflation cycle but also get out of banks’ low profitability cycle. Consolidation, especially among mid-sized banks and hopefully across countries to create a Eurozone banking system could also serve as contribution to get rid of sovereign-bank doom loop.
Third, a superficial observer might get the impression that in spite of recent turmoil, there is no immediate threat to banking stability in the Eurozone, as even the Brexit vote has not resulted in any major shock propagation mechanism. I wonder, however, whether the banking system and financial markets are being propped up by the morphium of QE and easy access to liquidity, with the main risk not coming from economic but rather political shocks. And as Wolfgang Munchau pointed out, the calendar for the next 12 months is full of potential political shocks waiting to happen. And given the still close connections between banks and government this can be cause for fresh fragility, as in the case of Greece in 2015.
29. September 2016
Bailing in vs. bailing out
I am on my way back from Brussels where I spoke about Bailing-in vs. Bailing-out at the SAFE Summer Academy, a policy workshop organised every September by Jan Pieter Krahnen. The answer to bailing in or bailing out is not clear cut. Trade-off is certainly one of economists’ most popular words (just ask Harry Truman who was desperate for a one-handed economist) and bank resolution is one of the areas where this trade-off is most prominent. On the one hand, bailing banks out sends the wrong signal to banks that aggressive if not reckless risk-taking will always pay off (heads - I win, tail - you lose). It is inherently unfair as those who took risk decisions are able to share the downside with the broader public, i.e., the taxpayer. And it has negative repercussions for resource allocation in the economy and thus, ultimately, for long-term growth. On the other hand, contagion risks, the loss of access to external funding by borrowers and the protection of small depositors and savers are arguments in favour of bail-outs, especially in crisis times. And the empirical evidence has provided evidence for both – for the moral hazard risks of too generous deposit insurance and the negative effects of bank failures for the real economy. And there is also a strong time inconsistency in this - ex–ante it is optimal to insist on market discipline and bail-in, ex-post it might be better to provide a bail-out.
Europe has gone from a system that by construction was biased towards bail-out to a system that features many elements of bail-in. By construction, as there were no proper bank resolution regimes in place in 2008, so that the options were to either send failing banks through corporate insolvency regimes (which would take years and exacerbates any negative effects of bank failure for the rest of the financial system and the real economy) or to bail them out. In most cases, European governments went for bail out, partly motivated by the experience of the Lehman Brothers shock. High debt/GDP ratios and political resistance has resulted in a shift towards more market discipline, formalised in the EU’s Bank Recovery and Resolution Directive, which prohibits state aid before bailing in junior debtholders or Tier 2 capital holders, and applied in several cases even before this Directive, including in the case of SNS Reaal in the Netherlands and the resolution of Cypriot banks. The recent bail-ins of retail investors in Italy (who most likely have been mis-sold their junior debt products) have led to second thoughts. There is also the question whether the new system has become too rigid in terms of focusing on bail-in rather than bail-out, not taking into account economic circumstances. Most problematic, in my opinion, is that the new regime has been put in place without addressing the legacy problems across Europe.
The experience so far provides for a rich policy agenda going forward. What exactly are the instruments to be bailed in? There is still a high degree of heterogeneity across Europe, which calls for harmonisation if we want to achieve a single market in banking. And who should hold these instrument? Retail investors (maybe only if properly informed)? Institutional investors, such as public pension funds (would that have the same effect as bail-out by tax payers)? Most importantly, can bail-in really work in a systemic banking crisis, when the main objective might be to limit contagion effects? When it comes to more efficiently resolving banks, how can we improve the resolvability of banks? Do structural reforms such as ring-fencing help? Are resolution and recovery plans (aka living wills) the way forward? Critically, does one size fit all? While small and mid-sized banks might be resolved through good bank-bad bank and purchase and assumption techniques, this might not work for larger banks, where bridge bank solutions might be more feasible. And this list does not even touch on the issue of cross-border banking, which I will leave for another day.
In summary, market discipline is important and bail-in is an important part of that. Will the new regime be the end of any taxpayer-funded bail out? No, and it might be for the better
14. September 2016
Interest rate caps in Kenya
The Kenyan president has signed legislation imposing lending rate caps and deposit rate floors on banks. This decision comes on the background of continued discomfort about high interest rate spreads in Kenya (as in many African countries). Having worked myself for many years on this issue (while being in the World Bank and afterwards) and having discussed this problem extensively with policy makers in Kenya (including the finance committee of the Kenyan parliament), this is a disappointing development. Experience across the globe has shown that interest rate caps do not just not work, but they might actually do damage to the inclusion agenda that many policymakers including in Kenya are interested in. The development is also disappointing, given all the positive policy developments over recent years in Kenya, including the establishment of a credit registry, regulations of microfinance institutions and cooperatives (SACCOs) and most importantly, the mobile money revolution in the form of M-Pesa. And these positive policy reforms have also been reflected in positive developments in indicators of financial deepening and inclusion, with the number of depositors and borrowers rising and even interest rate spreads showing a decline over recent years (for the latter, see Figure 9 in this CBK publication).
Yes, interest rate spreads are absurdly high in many African countries, including in Kenya. Whereas in many developed countries spreads between average lending and deposit rates vary around two percent, they are often up to ten percent in developing countries. It is important to understand, however, the factors behind such high spreads. One simple explanation is size. This applies both on the system-level and the client-level. Given that part of a bank’s cost basis is fixed, smaller operations incur higher average costs per dollar. This applies on the account (and loan) level, bank-level and even financial system level. Empirically, there is a strong negative correlation between the size of a financial system (in dollar terms) and interest rate spreads. A second important factor is risk, which is still higher in many developing economies than in developed economies, relating both to macroeconomic and to borrower-level risk. There is an important interaction between size and risk, as banks in smaller financial systems have a harder time diversifying borrower-level risks. Third, institutional deficiencies related to enforcing claims in courts and creditor rights in general are important factors. Some of these factors can be influenced by policymakers, such as improving institutions and providing for a stable macroeconomic environment. Competition and transparency (e.g., publications of interest rates and fees) can be important factors that reduce spreads. But these are long-term factors, with little short-term improvements to be achieved. Finally, there is the issue of inclusion and interest spreads. As banks expand towards riskier clients (as data indicate they have done in Kenya), marginal interest rates should increase, which increases also average spreads. While this might be off-set with overall efficiency improvements reducing interest spreads, one would need borrower-level data to actually assess the relative strength of both factors.
I would like to stress that I am not against interest rate caps under any circumstances. The UK has introduced such caps in the wake of extremely high interest rates charged by payday lenders in the UK. However, here the concerns are different – specifically, a certain segment of the population gets stuck in a vicious debt cycle due to predatory lending practices. In this specific case, the challenge is, however, whether such borrowers are pushed towards informal loan sharks – so any such caps would have to be accompanied by intense consumer literacy programmes. The more general question on interest rate caps is how binding such caps are for “regular” borrowers, such as small enterprises, and middle–class mortgage borrowers. And on the first look, the Kenyan interest rate caps (and floors) seem quite binding, with lending rates capped at 4 percentage points above the central bank’s benchmark rate, while the floor for deposit rates is at 70% of the same rate. While with the current benchmark interest rate of 10.5% this results in a spread of 7.15 percentage points, which seems still quite high, this cap might very well become binding for marginal borrowers. It might also become more binding for longer-term loans, effectively also undermining attempts of lengthen maturities in the banking system.
What will be the effect of such caps and flows? One easy response by bankers is: fees – where interest rates do no longer reflect costs and risks, banks will find other ways to reflect costs and risks. Another possible response will be rationing of customers, effectively excluding marginal borrowers and depositors, where the former will not receive any loans and the latter will be priced out of the market with high fees and documentation barriers. Neither of these reactions is favourable to the inclusion agenda nor fosters transparency and efficiency in the financial system.
Note: a recent paper by my co-author and former colleague Samuel Maimbo discusses how wide-spread interest rate regulations still are across the globe and weighs the different arguments in favour and against. I have written several papers on interest rates spreads in Kenya (with Michael Fuchs and with Bob Cull and others) as well this paper on neighbouring Uganda (with Heiko Hesse).
Overall, a sad day for financial sector development in Kenya and the region!
26. August 2016
Cross-border regulatory cooperation Down Under
I spent a large part of my summer break (or maybe I should rather call it winter break?) in Australia and New Zealand. In addition to enjoying the beautiful landscape and great food (and even some skiing), I had interesting conversations in both countries on financial sector issues. One striking issue that came up again and again was the closely interconnected banking systems in both countries. More specifically, the large four Australian banks have subsidiaries in New Zealand, which in turn make up more than 80% of the Kiwi banking system. This has very obvious repercussions for regulatory dialogue and cooperation between the two countries. The situation is similar but also different to that of other home-host country pairs across the globe in the sense that the Australian banks are not only of material interest to the New Zealand host supervisor, but that the Kiwi operations are of material importance for the Australian parent banks. This puts the relationship between Australian and New Zealand supervisors on a somewhat more level playing field than often observed across the globe between home and host country supervisors. Maybe as a result of this or of the close historic links between both countries, the regulatory cooperation is also based on a rather unique legal basis. Rather than relying on legally non-binding Memorandums of Understanding as common across the globe, there are specific legal foundations for regulatory cooperation: specifically the Banking Act in both countries includes language to the effect that the local supervisor is to take into account financial stability interests of the other country.
This close cooperation between both countries is very consistent with the theoretical work by Wolf Wagner and myself, recently published in the International Journal of Central Banking (Supranational Supervision: How Much and for Whom?). Specifically, our model predicts that high externalities from cross-border bank failures and limited heterogeneity across two countries makes it more likely that the two countries agree on regulatory cooperation. As described above, these externalities from the large four Australian banks are relatively symmetric across both countries. And both countries have lots of history, culture and institutional frameworks in common, not to mention the language. And the relatively symmetric nature of the externalities makes the political economy of cross-border regulatory cooperation somewhat less tricky than in many other country pairs and sub-regions, where only one of countries or some members of the sub-region would benefit from closer cooperation. When looking beyond cross-country comparisons and the big picture, however, the details look a bit more tricky. The home-host country split between Australia and New Zealand provides for a divergence of interests. While the Reserve Bank of New Zealand is primarily interested in safeguarding financial stability in their own country and limit any negative contagion effect from the parent bank on the subsidiaries, the Australian authorities cares mostly about the stability of the consolidated bank. There are also differences in the financial safety net structure across the two countries, most prominently, while Australia introduced a deposit insurance scheme after the Global Financial Crisis, New Zealand continues without such a scheme.
There seems no obvious solution to overcome this conflict of interest, but the close cooperation in the form of the Trans-Tasman Council on Banking Supervision and the focus on resolution in the cooperation between both countries in the form of a Memorandum of Cooperation on Trans-Tasman Bank Distress Management certainly help. Ultimately, having a clear understanding of the interests and incentives of the other side and the different tools and possibilities of the other side can go a long way.
23. August 2016
Some interesting papers I have been reading
Everybody talks about fintech, but there are few academic papers on the topic. Thomas Philippon just came out with an interesting paper (The FinTech Opportunity), that discusses the emergence of new challengers in finance and their possible effects on stability and access. He first documents that the costs of financial service provision have been surprisingly stable, which can explain the entry of new non-bank challengers. Prudential regulation, however, is focused on incumbents and the political economy makes it unlikely that existing regulatory framework will allow maximising the benefits of this additional competition. Thomas ends with some regulatory principles that aim at not only ensuring stability but also bringing about structural change in the finance industry.
The revolving door between regulators and bankers has made it back into the headlines recently, with a Deutsche Bank whistleblower turning down his share of the SEC award and pointing the finger at a broken system that allows officials to rotate between regulatory agencies and private financial institutions. But is this revolving door always bad? A recently accepted paper at the Review of Finance Revolving Doors for Financial Regulators (Sophie Shive and Margaret Foster) gauges the motivations and effects of financial firms’ hiring of former US financial regulatory employees. The authors show that in the quarter after the hire of a former regulator, market and balance sheet measures of firm risk decrease significantly and measures of risk management activity increase, especially for hires from prudential regulators, who directly monitor financial firm risk. The authors also find that that firms hire ex-employees of their regulators when they perceive a need to reduce risk, consistent with a schooling hypothesis. On the other hand, there seems little direct evidence of quid pro quo behavior, such as decreased regulatory activity or lower fines in the two years before and after the hire of an ex-regulator.
Do improvements in communication technology make geographic distance less relevant? Barry Eichengreen, Arnaud Mehl and Romain Lagarguette argue no, at least for the case of foreign exchange markets (Cables, Sharks and Servers). They identify exogenous technological changes by the connection of countries to submarine fiberoptic cables used for electronic trading, but which were not laid for purposes related to the foreign exchange market. Making trading more efficient has two off-setting effects on on- vs. off-shore trading, reducing fixed costs of trading on-shore while reducing the importance of distance. The latter effects dominates, boosting the trading share in financial centres, such as London. Ultimately, the world does not become flatter, but more like described in Flash Boys by Michael Lewis, where everyone competes to be as close to the trading centre as possible. Maybe some relief for the City of London after Brexit.
21. August 2016
More on Brexit
More on the causes and effects of Brexit in this recent VoxEU publication, including a chapter by yours truly on the implications for the UK, European Union and the broader discussion on globalisaton.
1. August 2016
Keep walking: are borrowers to walk for their beliefs?
I have been recently working on several Islamic Finance papers. While a small part of the overall global financial system, Islamic finance is an interesting phenomenon. It aims to comply with several provisions of the Sharia of (i) no interest and (ii) funding only transactions that are directly related to real economy transactions. This is being done partly by offering equity-like savings and loan products, partly by rearranging cash-flow claims of the bank vis-a-vis borrowers, replacing interest rates with (partly contingent) fees. One of the challenges for researchers in this area is the access to the necessary data – using our standard database for bank-level data (Bankscope) provides only limited insights into the functioning of Islamic finance (as done in my first paper on this topic, with Asli Demirguc-Kunt and Ouarda Merrouche). Cross-country papers using aggregate data are subject to the usual endogeneity biases. Micro-data is the way to go.
One of the countries, which has seen a recent expansion of Islamic finance (also known as participation finance) is Turkey. In a recent paper with Steven Ongena and Ilkay, Sendeniz-Yuncu we explore the importance of distance between borrower and branches of different bank types for establishing relationship between banks and borrowers. Extant evidence across developed and developing countries has shown that geographic proximity is important for relationships between (especially small) firms and their banks. In the case of Turkey, the average distance between the firm and the closest branch of the bank it has a relationship with, is 1.7 km, though with substantial variation. We find that the probability for a firm to connect to a bank substantially decreases in distance, but that if the bank in the vicinity is an Islamic bank, distance plays a more muted role, especially in cities in the Mediterranean and Aegean regions, as well as in cities with a high conservative party vote and higher trust in religious institutions. This suggests that Islamic financial products are sufficiently attractive for certain borrowers that they are willing to take into account longer distances to access these banking products.
1. August 2016
Long-term finance - the new financial development frontier
Financial inclusion has been at the forefront of both financial sector policymakers' and researchers’ agenda for the past decade or so. Lots of progress has been made, from almost no consistent cross-country data to the Global Findex, a global household survey undertaken every three years. An area that has not received as much emphasis, especially in terms of data collection, is long-term finance. Shallow financial systems across the developing world are not only characterised by limited financial inclusion, but also by a focus on short-term transactions, i.e., limited long-term savings instruments, limited long-term lending, including mortgage finance, and little if any capital market funding and contractual savings institutions. And this on the background that the high economic volatility in these countries and their infrastructure needs makes the dearth of long-term finance especially binding for economic development.
The most recent Global Financial Development Reportof the World Bank provides an excellent overview of the literature in this area. It also shows the limited data sources that are available to gauge the availability of long-term finance across countries and over time. As donors become more interested in this area, there are more attempts to address this dearth of analysis and data. But what data sources are available and what indicators should we focus on? And what are appropriate ways to compare such indicators across countries and over time?
The inter-American Development Bank (IDB) recently asked me to develop ascore board for long-term finance for Latin American countries. In addition to a literature survey and providing an in-depth look at the provision of long-term finance across Latin America, I suggestseveral indicators of both depth and inclusiveness of long-term financial markets, i.e., considering both supply and demand side, but also several policy indicators that the literature has shown to be associated with effective provision of long-term finance, including monetary stability, effective contractual institutions and limited price distortions. However, when assessing the depth and inclusiveness of long-term finance over time across and within countries, it is also important to benchmark it according to structural characteristics of economy, including size and income level. We cannot expect the same level of long-term finance in larger countries (with the necessary scale for capital markets) as in smaller countries and richer economies (with the necessary supply of long-term savings and demand for such by enterprises) as in poorer countries; demographic structures might also play a role. Thus comparing the actual provision of long-term finance to such a benchmark (based on cross-country panel regressions,such as suggested in previous work) allows better identify the necessary policy and institutional gaps.
CurrentlyIam working on a similar assignment on Sub-Saharan Africa for FSD Africa, together with some long-standing collaborators. Stay tuned for updates towards the end of the year.
24. July 2016
Three days after the Brexit vote – some early thoughts
The vote to leave the European Union by a majority of British voters is a historic watershed moment. It is almost impossible to spell out all the implications that this will have for the UK, the European Union, global cooperation and the global, but especially UK, economy. We economists have been ridiculed during the campaign for providing a rather negative outlook for a UK outside the EU and while predictions on the growth impact of Brexit to one digit after the comma are certainly hard to believe (rather than stressing that these are predictions of a mean impact across a range of possible growth outcomes), the UK is slowly waking up to the reality that the “experts” might not have been so wrong after all. And it is easy to predict that the high degree of uncertainly, in financial markets, in exchange rates and therefore inflation rate, all driven by the uncertain future relationship between the UK and the EU and its political and economic repercussions, will result in a recession. And while some of this uncertainty has a self-fulfilling effect on consumer demand, there are important supply-side channels, such as that financial institutions might be less willing to support the real economy, given the high degree of uncertainty. It seems all but certain now that the UK will slip into recession: length and recovery will certainly depend on how quickly certainty can be established on the future of the UK relationship with the EU.
Beyond the immediate effect of the Brexit vote on the economy, what are the longer-term repercussions? Specifically, what are the repercussions for the financial center London of a possible exit of the UK not just from the EU but also from the Common Market (thus not choosing the Norwegian or Swiss model)? Well, one institution will certainly have to relocate: the European Banking Authority, responsible for ensuring effective and consistent bank regulation and supervision across the European Union (and thus beyond the Eurozone). As banks in the UK would lose their passporting rights across the EU (which allows a bank authorized, regulated and supervised by one of the bank regulators in the European Economic Area to be active across the EEA), London would become less attractive as location for European and non-European banks. And there will certainly be a lot of political pressure to relocate much of the euro-related trading away from London to Frankfurt and Paris.
Will the Brexit lead to substantial regulatory deviation of the UK from the rest of Europe? This is somewhat doubtful. First, the major regulatory reforms after the Global Financial Crisis have been initiated on the global rather than European level, including the Basel III accord. Second, UK banks that want to continue to be active across Europe will still have to comply with EU law. The EU will also pressure the UK to not adopt too light-touch regulation that might result in negative externalities for European host countries of London-headquartered banks. However, the Brexit will certainly make cross-border regulatory cooperation more difficult, with one major player - the Bank of England – being outside the EU institutional framework.
Beyond the financial system, Leave campaigners have suggested to get rid of red tape and unnecessary regulation "forced upon" the UK by the Brussels bureaucracy. As pointed out before, some of this red-tape is very much home-made, while being EU member has not prevented the UK from offering one of the most market-friendly business environments in Europe. Importantly, the devil is in the fine print – many of these regulations are part of national legislation; a decade-long challenge for UK government officials and MPs. Not to speak of the constitutional repercussions for the devolution of Scotland and Wales, which relied on some of the policy responsibilities being shifted from London to Brussels and which will now have to be renegotiated (and not to forget the possible need to reintroduce border controls in Northern Ireland). More generally, one can expect a long soul-searching policy debate in the UK about the future role of the state, a topic on which many of the Leave campaigners and their voters certainly do not see eye-to-eye. Just observe the recent discussion on possible state aid to keep the Tata-owned steel plants in Wales open; state aid is rather restricted under EU law and would certainly also not be consistent with the libertarian approach of some of the Leave campaigners; however, there will be much more political pressure in an “independent” UK to provide such state aid.
As the UK woke up on Friday morning, there was an intense discussion of a split country among many dimensions: geography, income level and education. One important split was along age groups, with the overwhelming majority of below-25 years having voted for Remain. Looking at my own (EU passport holding) teenage boys, I can understand the recriminations that British teenagers and young adults will make their parents and grandparents for taking away their opportunities of moving freely around the European continent in the future.
On a final note, one wonders whether this first major reversal of European integration after 60 years is part of a broader trend that points to the end of a long globalization cycle. Populist movements calling for more nationalist and closed societies have gained strength across both sides of the North Atlantic. For Europe the question is whether the dam has broken or whether this crisis will be the one not wasted, in terms of fundamental reform!
27. June 2016
Making the Eurozone more resilient
Just in time after the Brexit vote and before the ECB's Sintra meetings next week a group of leading European economists has published a call for reforms on VoxEU. While there is wide recognition that enormous progress has been made in making the Eurozone stronger, a lot is still missing to make the Eurozone truly resilient against shocks. And as we saw on Friday, such shocks can come at any point in time. But what reforms are neceesary? What is urgent? What can wait (for political consensus)?
This column (of which yours truly is one of many authors) is intentionally kept on a general level. While economists across Europe and across different subdisciplines often disagree on specific policy suggestions and proposals, most of us agree on the broad themes: make the financial system more resilient and mitigate the repercussions of bank failures; reduce the risk of sovereign default and reduce the impact of such default if it happens; and undertake the necessary structural reforms to make the Eurozone grow again. Most importantly, we call for more clarity in institutional responsibilities across the policy architecture of the Eurozone and reduce the burden on the ECB.
This call for reforms follows on an earlier consensus narrative on the causes of the Eurozone crisis, which included many of the same authors. Agreeing on the causes allows us to follow up with policy recommendations.
26. June 2016
May you live in interesting times
The people have spoken and snubbed the elite. The UK has voted for Brexit! Economists will be in high demand now to predict what comes next, but we should remember that economists (aka “experts”) are pretty bad in predicting the future, except in the most general terms. The economic and political future of the UK and Europe will depend on the negotiation process between the UK and the European Union and the reaction of the Scottish government and people. Though I would dare one prediction: 23 June 2016 will enter the history books as a watershed moment in both UK and European history. My gut feeling tells me that it will enter history books with a negative connotation, though I sincerely hope I am wrong! A second, easy prediction is that the uncertainty will negatively affect financial markets throughout the world for days if not weeks to come and will most likely trigger a recession in the UK, with consequent monetary and fiscal policy reactions.
Many will now discredit betting markets as bad predictors; but careful, they might well have been right in predicting this outcome, we might simply have stared at the wrong number: while the volume was in favour of Remain, the majority of recent bets were in favour of leave, even if for smaller amounts! Something to be kept in mind for the future.
The Brexit vote also emphasises the need for further strengthening of the Eurozone! More on this later today!
24. June 2016
A new blog
After several attempts at starting new blogs in cooperation with others, I have now decided to try by myself. In this blog I will write about exciting new research (both my own and that of others), policy developments that I find relevant and other things related to finance, be it in the developed be it in the developing world. I wil try to throw the net wide in terms of topics, from financial development and inclusion to international finance and stability, from European and British topics to developing country challenges. Comments welcome by email.
20. June 2016