Happy holidays
Last post for 2016. Let's end the year on a lighter note:
From the the Devil's Financial Dictionary
ECONOMIST, n. A professor who studies the interaction of people, goods and money in a chaotic world. To do so, the economist applies mathematical tools that are the equivalent of using a ruler and a stopwatch to measure the movement of matter in a particle accelerator, where the velocity of subatomic particles can approach the speed of light. The painstaking measurements taken by the economist enable him to make powerful predictions about the future behavior of the ruler and the stopwatch.
And for academics who are thinking of working with tech start-ups:
16. December 2016
Postcard from Cape Town
The University of Cape Town, Economic Research Southern Africa, Imperial College and the Review of Finance organized a conference on Financial Intermediation in Emerging Markets in Cape Town, following a similar conference last September in Rio. While the papers were selected competitively by an excellent program committee, all BRICS countries were covered. Felix Noth and Matias Ossandon Busch track post-Lehman funding shocks of Brazilian banks across their branch network and show a negative effect on local labor markets. Ralph de Haas and Cagatay Bircan exploit variation within Russia to show that the lack of access to finance inhibits firm innovation. Our academic keynote speaker Manju Puri summarized her research on bank runs in India. And Nathan Dong, Ming Gu and Hua He gauge the effect on firm value of private placements of equity securities in China and find quite different effects than in more developed financial markets. South Africa, finally, was not only covered by several papers on the Day Ahead agenda, but also by our second keynote speaker, the governor of the South African Reserve Bank Lesetja Kganyago who discussed the challenges of regulators in South Africa and the region, ranging from the post-GFC regulatory reforms, over changes in global banking (e.g., decision of Barclays to divest from ABSA, one of the large four in South Africa), to fintech (efficiency-enhancing innovation or fragility risk?). Plus many other papers that focus not just on hot academic but also policy-relevant topics, including long-term finance and spill-over effects of monetary policy and liquidity shocks in the U.S./Europe on the rest of the world.
After Brazil and South Africa we are planning a third conference in one of the other BRICS economies in 2017 or 18.... stay tuned!
9. December 2016
The Palgrave Handbook of European Banking
European banking is still in turmoil, with the Italian banking crisis looming large as a first test for the relatively new banking union. But beyond these short-term risks, there are longer-term trends: the European banking landscape has profoundly changed over the last decade, partly driven by the regulatory response to the 2007-2008 global financial crisis and subsequent sovereign debt crisis in the Eurozone.
With this as background, my colleague Barbara Casu and I edited the Palgrave Handbook of European Banking, just published, which aims to offer a broad overview of key issues in European banking, taking stock of its performance after the recent crises and looking forward to challenges ahead. The topics vary from ownership structure, bank competition, innovation to regulation and banking union. We also included five country-specific chapters on the banking systems in Germany, Italy, Spain, UK, France and Central and Eastern Europe. The list of authors speaks for itself; all of them have an impressive track record in the literature on banking in general and European banking topics more specifically. While the hardcover price might seem high, an electronic version will be available soon for a much more reasonable price.
9. December 2016
Interesting papers and events
November and December have been busy months:
The Centre for Banking Research at Cass hosted a panel on bank resolution, based on the publication of the latest issue of European Economy on this topic. An interesting mix of regulators (Bank of England and Single Resolution Board) and academics (both economists and lawyers). Two big questions remain: after all the reform of resolution frameworks on the national and Eurozone level, is the glass half full or half empty? And where do we stand on bail-in vs. bail-out? As regulators are (and should be!) proud of what has been achieved, we academics have the task to point to gaps and deficiencies. And as much as politicians want us to believe that there will never be any bail-out with taxpayer money again (at least until the next election), we academics are more cautious, both on positive terms (rather not good to say never) and normative terms (bail-in might not always under all circumstances be optimal).
I attended an interesting evidence session of the LSE Growth Commission on the effect of Brexit on the financial sector in the UK, with a few academics and lots of industry representatives. Here is what I took away: while the majority of financial service provision in the UK is directed at the domestic economy, the loss of access to the EU market would result in quite a lot of losses in terms of jobs and value added, though the exact numbers are disputed. And while Brexit might open some new opportunities, this loss of being a financial service provider for the EU makes London also less attractive as global financial centre. And as there is no obviuous candidate to compete for the crown of Europe’s financial centre, it might be a loss for the whole continent. One issue that came prominently through was the fear of losing access to a broad talent pool, both under the aspect of migration restrictions but also simply due to loss of attraction of London as city to work and live. On this note: next Tuesday will see a great panel discussion at Cass on the topic of Brexit.
Orkun Saka, a Cass PhD student on the job market this year has a very interesting (and maybe controversial) paper on Eurozone banks’ home bias. Unlike other recent papers, he explains this home bias with an information story – the “closer” a bank to a country, the more it invests in its sovereign bonds as well as corporate bonds. This also holds for foreign banks that are located closer to the crisis countries.
A great new policy report on finance in Central and Eastern Europe by the World Bank has just been launched (full disclosure: I was involved as outside advisor). In-depth analysis based on lots of data crunching with important policy messages. The trade-off between stability and inclusion is one of the main themes. Highly recommended reading if you want to catch up on finance in this part of the world.
Finally, Martin Sandbu has a great discussion of what constitutes populism on FT Free Lunch: anti-globalism, nationalism and nativism, economic policy based on state activism, and anti-rule-based policy making. One can clearly see from this categorization that this goes beyond the old left-right classification. The behavior (read: tweeting) of the president-elect of the U.S. certainly fits this characterization perfectly. And looking back into history (and that is now purely my reading) one notes parallels to the corporatists/fascist policy approach as practiced in Italy, Spain, Portugal and some Latin American countries…
6. December 2016
Future challenges for financial regulation
A discussion that has dominated the regulatory reform debate is that on the appropriate regulatory framework. Any post-crisis regulatory reform solves the problems of the previous crisis, but the known unknowns and, worse, the unknown unknowns, are awaiting. At a time when not only bankers are growing desperate on a regulatory framework that no longer fills binders but whole rooms, the question on basic principles of regulation becomes again urgent. As the U.S. might move towards either dismantling the Dodd-Frank Act or at least modifying it and as the UK considers its options for the City after the Brexit, this debate will revive soon. There are certainly no easy answers to that (so if you are looking for them, please stop reading now), but there are clearly some general principles as Elena Carletti, Itay Goldstein and I have outlined in a literature survey cum think piece we recently published, as well as in an accompanying Vox column. Here are our main conclusions:
First, revisit the necessity for complexity. As the financial system gets more and more complex and sophisticated, there is a tendency to make regulation also more complex to address some of the newly emerging issues. However, this may backfire. First, increasing the complexity of the financial regulation may provide the industry players with stronger incentives to make their institutions more complex. Second, complex financial regulation opens the door for manipulation of rules on the side of financial institutions and investors, as shown by empirical evidence. Hence, it is important to complement ever increasing complex regulation with some simple rules. For example, going back to a simple leverage ratio in the new Basel accord in addition to risk-weighted capital requirements is a step in the right direction. Similarly, while it might make sense to apply price-based regulation to banks that want to be active across different business lines (as in the form of ring-fencing), outright prohibitions might be needed in other cases (as is the case for the Volcker Rule).
Second, there is the need for a stronger focus on macro-prudential policies, in addition to the traditional micro-prudential policies. New policy measures such as bank stress tests and capital requirements that depend on the aggregate state of the economy are steps in the right direction in trying to take the systemic risk aspect into account. But, clearly a lot of work is still needed in better measuring systemic risk and assessing the effectiveness of macro-prudential policy measures. Clearly an area of huge research opportunities.
Third, resolution matters! The experience of the recent crises shows that it is critical to have frameworks in place to resolve financial intermediaries in a way that minimises disruptions for the rest of the financial system and the real economy, while allocating losses according to creditor ranking. An incentive-compatible resolution framework has therefore not only important effects ex-post, i.e. in the case of failure, but also important ex-ante incentive effects for risk-decision takers. This also implies that a lot of attention and preparation is needed ahead of time before the actual failure of big and complex institutions. Imposing living wills and requiring bail-in strategies in case of failures are indeed important steps that will make institutions think more about the event of the failure and internalise better the risks that they are imposing on the system. However, this has to be matched with the acknowledgement that there will be never a “no more bail-outs” and there will always be institutions that are too important to close completely.
Fourth, we need a dynamic and forward looking approach to regulation that stands ready to adjust the regulatory perimeter. The problem with regulatory reforms in the past was that it always addressed the regulatory gaps exposed in the most recent crises. But, as regulators tightened restrictions on institutions that have had problems before, activity and risk taking shifted to other institutions and markets, often outside the regulatory perimeter. It is thus important to think about the system as a whole and understand new innovations as they happen. It is important to remember that regulating one type of institution will lead to the emergence of others, and so design regulation in a forward looking way. This would imply that the regulatory perimeter has to be adjusted over time and that the focus of prudential regulation (both micro- and macro-prudential) might have to shift over time as new sources of systemic risks arise.
On a final note, as I discussed these topics in a recent panel discussion at the World Bank in Washington DC, another important issue came up: personal liability of bankers! There is historic evidence that this has reduced failure and losses in past times (though in less complex banking systems) - maybe an idea to revisit? It would provide the obvious symmetry to bonuses for bankers – let them pay for their mistakes!
22. November 2016
Financial inclusion: measuring progress and progress in measuring
I am on my way back from Washington DC where I presented a paper at the IMF’s Fourth Statistics Forum on Financial Inclusion: Measuring progress and progress on measuring. My first reaction to the invitation was a flash-back – to a conference at the World Bank in October 2004 on Data on Access of Poor and Low Income People to Financial Services: What we know and what we need to know. That conference was part of the Year of Microcredit and a first high-level discussion on what data on financial inclusion were available and what would have to be done. The conclusion of that conference was that we had little if any data and we needed a lot of data.
Over the past 12 years, we have come a long way. Shortly after the above mentioned conference, Asli Demirguc-Kunt, Sole Martinez and I started out with several data collection efforts. The better known of the two – branch and account penetration indicators – was later mainstreamed by the IMF in the form of the Financial Access Survey. While these indicators are relatively easy to collect by national supervisors and can be updated frequently, they are clearly crude proxy indicators. In the case of branch and ATM penetration, there is too strong a focus on (i) traditional delivery channels, ignoring innovative channels, including agency or correspondent banking and digital finance, and (ii) on regulated entities. In the case of deposit and loan account per capita measures, these indicators do not take into account that individuals might have several accounts across different banks. A second, somewhat less known data collection exercise focuses on barriers to access, using a bank-level survey that targeted the largest 5 banks across a sample of 80 countries and present indicators for three types of banking services - deposit, loan and payments - across three dimensions – physical access, affordability and eligibility. Barriers such as availability of locations to open accounts and make loan applications, minimum account and loan balances, account fees, fees associated with payments, number of documents required to open a bank account, and processing times for loans vary significantly both across banks and countries. However, data collection efforts on access barriers based on bank-level surveys face several severe constraints. First, unless channeled through regulatory entities, there is the risk of low response rates. Second, the comparability of such data might be limited given different account types and fee structures across banks and countries. Nevertheless, such bank-level surveys have remained popular, as shown by the EBRD's Banking Environment and Performance Survey, although face-to-face interviews might be to only way to get good response rates.
Given the nature of financial inclusion focusing on individuals having access to and use financial services, more accurate measures of financial inclusion have to focus on users of financial services, in the form of surveys. Early surveys focused on financial access by individuals are the Finscope and Finaccess surveys across several African countries. The World Bank, with support from the Bill and Melinda Gates Foundation, has undertaken over the past years a broad cross-country exercise – the Global Findex Survey - by including financial questions in an existing Gallup global poll to generate baseline data on financial inclusion levels across 150 countries, using samples of 1,000 persons per country. The survey is to be undertaken every three years to measure and track specific data on people’s use and access to formal and informal financial services; the first wave was conducted in 2011, the second wave in 2014, with a third wave planned for 2017. Experience with data from the first wave and the ongoing discussion on financial inclusion has led to adjustments and expansion in the questions for the second wave.
So looking back at the conference in 2004, we have made lots of progress. However, we have also learned important lessons. One important lesson is that of Goodhart’s law: “When a measure becomes a target, it ceases to be a good measure”. Translated into the financial inclusion agenda: when policy makers focus too much on achieving specific inclusion goals, there is a risk that they care less about the quality of the financial services and the sustainability of their provision. In this context it is also important to understand that a positive impact of financial inclusion on individual and aggregate welfare does not come through the pure ownership of accounts but their active use. Finally, and again related to the previous point, it is important to look beyond absolute levels of the indicators on financial inclusion and benchmark them appropriately to properly assess progress in inclusion and gauge the effect of policy reforms.
18. November 2016
Nascent stock exchanges
Lots of research has explored the development and efficiency of equity markets in emerging and developing economies. Few studies, however, have focused on the nascent markets – the recently established stock exchanges across the developing world. At a time, when a third of countries across the globe does not have a stock exchange yet, but many countries still consider establishing ones, there are obvious questions for policy makers: what are the success factors for a successful market, what institutions and policies are needed. In a recent working paper with José Albuquerque de Sousa, Peter van Bergeijk, and Mathijs van Dijk we explore these questions.
Specifically, we use an array of different methodologies to gauge the factors associated with the variation in success and failures of newly established stock markets across a sample of 59 developing countries that have opened a stock exchange since 1975. Herewith our main findings. Paper is here and Vox column with nice graphs here.
17. November 2016
After the Brexit shock the Trump shock – what’s next?
After Brexit another shock for globalisation and integration as we know it. While we should never write history before it actually happens, there are a lot of indications that this might be the start of many upheavals in the political and economic global architecture and the trend does not seem toward more openness and integration (to put it mildly). A U.S. that is withdrawing from the world, a Europe that is mired in a governance and economic if not even identity crisis and an Asia, which is changing alliances away from the U.S. towards China. Previously open societies are closing, the draw bridges are being pulled up, rational discourse is being replaced with shouting and insults. Nationalism, populism and strongmen reign!
After the fall of the Berlin wall, many in my generation had the feeling that things can get only better. The end of the cold war, rapid spread of democracy across Europe and other parts of the world (e.g., in Latin America) and more open societies resulting in more opportunities. We, the Interrail generation, lived the European integration each summer, even though we still had to carry and show our ID cards or passports across Europe in the 1980s and 90s. Further integration and the definite end of any conflict in Europe seemed inevitable, even in spite of brutal setbacks such as the Balkan conflict. This feeling has been supported by ample evidence that globalisation (trade but to a certain extent also financial integration) has helped the global economy grow and has pulled millions out of poverty in the developing world. The overwhelming majority of humanity is better off today than it was 30 years ago! Have Western democracies become tired of the success of their model?
While the 2008 crisis sent a clear warning signal, the G20 cooperation and the swift and coordinated reaction by policy makers across the world prevented the worst and turned a potential second great depression into a great recession. Eight years later, reality has caught up with us. Future history books might see 2016 as a turning point, with a long period of increasing integration, growth and wealth coming to an end. These are interesting times, indeed! However, soon enough we might wish back the boring times.
9. November 2016
A trend back to books in economics
There used to be a time when academic economists wrote books. Considering the finance and development literature, the original wave of works consisted exclusively of books – Shaw (1967), Goldsmith (1969), McKinnon (1973), Fry (1988). On the other hand, when I was in the PhD programme in the late 1990s, my PhD supervisor told me in very clear terms that the only way to make a career in academia was to write papers publishable in top journals. And a paper should focus on one idea; put differently, if you have two good ideas, write two good papers. And that seemed to have been the consensus in our profession for many years. Recently, however, (and all of this is based purely on anecdotal not statistical evidence), there seems to be a resurgence of books in our profession. Books allow a broader view on a topic rather than focusing on one (sometimes narrow) idea in a theoretical model or empirical specification. It also allows reaching a broader audience with potentially a bigger impact on the public discourse. It often also provides a broader overview of the literature in a specific area. Among my favourite examples are Ragu Rajan and Luigi Zingales’ book on “Saving Capitalism from the Capitalists” (a point that should be made over and over again in the public policy discourse) and Ragu’s book on “Fault Lines” on the ongoing fragility in the global financial system. Charlie and Steve Haber provide an excellent historical perspective on why financial sector policies can never be understood without analysing the political framework, which shapes them in "Fragile by Design". And Carmen Reinhart and Kenneth Rogoff's "This Time is Different" was not only published with perfect timing in 2009, but – one can only hope – will not be forgotten so quickly.
What does this imply for young ambitious economists? The above mentioned advice by my own supervisor certainly still holds – one can only get the big picture, after one has collected all the small pieces (almost like in a puzzle) - so the focus on high quality papers is still the most important first step in the career of young economists. But maybe there is a different longer-term objective these days, a stronger focus on the big picture, at least in the long-run.
8. November 2016
Finance and Development: The Unfinished Agenda
Almost 25 years after the empirical finance and growth literature started with simple cross-country regressions (King and Levine, 1993), this field of research seems far from saturated. Aggregate cross-country regressions have given space to carefully identified studies using observational or experimental micro-level data. Asli Demirguc-Kunt, Ross Levine and I put together a one day conference at the World Bank in Washington DC last week to highlight some of the recent work in this area but also point to open reseach and policy questions. Almost a decade after the Global Financial Crisis and seven years into the Eurozone crisis, the role of the financial sector is challenged in many advanced countries, while many developing countries struggle with the right policy mix to deepen and broaden their financial systems. Across the globe, however, and this came out again and again in the different sessions is the (often unhealthy) influence of politics in both development and efficiency of the financial system.
A fascinating set of papers shed light on many of the recurrent research but also pressing policy questions. The SME session included a paper by Allen Berger, Christa Bouwman and Dasol Kim on the continuing importance of small banks for alleviating small businesses’ financing constraints across the U.S., especially during economic downturns and financial crises. A paper by Charles Calomiris, Mauricio Larrain, Jose Liberti and Jason Sturgess points to the importance of movable collateral registries for resource allocation. Specifically, using a unique cross-country micro-level loan data they show that loan-to-value ratios of loans collateralised with movable assets are lower in countries with weak collateral laws, relative to immovable assets, and that lending is biased toward the use of immovable assets.
A session on entrepreneurship included a paper by Meghana Ayyagari, Asli Demirguc-Kunt and Vojislav Maksimovic on firm growth over the first decade of a firm’s life in India, showing that it is all in the beginnings: the size and characteristics of a firm at entry are persistent over the first eight years of a firm's life; access to external finance is associated with greater overall entry, and also smaller sized entry, but cannot explain different subsequent growth rates across firms of different initial sizes. Ross Levine presented a fascinating paper (joint with Yona Rubinstein) on entrepreneurs in the U.S., showing that transformational entrepreneurs (those requiring comparatively strong nonroutine cognitive abilities) are not only smart, but have often run into troubles in their teenage years (parents of teenagers like myself took careful note of this finding!)
The inclusion saw a nice overview piece by Leora Klapper on the most recent Global Findex results and a fascinating paper by Alex Popov and Sonia Zaharia on the importance of financial liberalisation for closing the gender gap in the labor market in the U.S. Finally, Jonathan Morduch offered early results on a randomised control trial involving a mobile money provider (bKash) in Bangladesh.
The conference started and ended with policy panels on open questions in the development, stability and global agenda on financial sector policies. One important lesson (as stressed by Randall Morck) is that a critical review of financial history is always useful to understand today’s challenges. And as important as we often see finance, it is certainly not the only and sometimes not even binding constraint;rather, it has to be seen in the context of the bigger picture of macro-, socio-economic conditions and the institutional framework in a country.
The conference has certainly also pointed to future research gaps and policy challenges, including in better understanding entrepreneurship, demand-side constraints to financial inclusion and policy sequencing in financial sector reform. A truly unfinished agenda; or rather: a continuing never-ending journey.
On a final note, this conference was partly motivated by a Handbook on Finance and Development that Ross Levine and I are putting together and that will be published next year. Stay tuned.
8. November 2016