Sex and Credit – not forthcoming in JBF
After a long and rather exhausting review process, the Sex and Credit paper has been finally accepted for publication at the Journal of Banking and Finance. The paper and its findings fit relatively well with the recent prominence given to behavioural economics and finance (best illustrated by the Noble Prize for Richard Thaler). Using a large loan-level dataset from an microfinance bank in Albania we gauge whether the assignment of a first-time borrower to a loan officer of the same or the opposite gender has repercussion for loan conditionality and, ultimately, for the likelihood of the borrower to return for a second loan. We find that borrowers that are assigned to a loan officer of the opposite gender (where the assignment is a random process) are less likely to return for a second loan than first-time borrowers that are assigned to a same-gender loan officer, with one possible reason being that they have to pay higher interest rates and receive shorter-maturity and smaller loans. Is this statistical discrimination, i.e. do opposite-gender loan officer impose more stringent loan conditionality because of higher risks in lending relationship between borrowers and loan officers of different genders? We find that no, as there is no significant difference in the performance of such loans. So it is taste-based discrimination? Yes and no! We find that the gender effect comes exclusively from loan officers with limited experience with opposite-gender loan officers (for all loan-officers it is the first job after college). Once loan officers gain sufficient experience with opposite gender borrowers, they overcome this initial bias. But it is not only the experience, but also the incentive structure. The bias comes from loan officers with limited opposite-gender experience in districts where the bank faces limited competition from other financial institutions and where branches are small, i.e. where internal competition is limited and discretion for loan officers larger. Our results are consistent with the existence of an initial gender bias and learning effects that lead to the disappearance of the bias, but also stress the importance of competition in limiting the effects of such bias. Finally, does the bias come from male or female loan officers? While our identification strategy does not allow us to answer this question conclusively, additional estimations suggest that the bias comes from both genders towards the respective other gender.
What do we learn from these results for the functioning of the credit market? First, identity should affect firms’ human-resource practices as loan officers’ opposite-gender experience has repercussions for the size of the effects. Second, from a policy perspective, our findings point to the possibility that financial market competition can be a powerful tool in dampening such discriminatory effects.
For the Vox column on the paper:http://voxeu.org/article/sex-and-credit-there-gender-bias-lending
For a video interview: http://www.youtube.com/v/9uAW4w2DFJg?rel=0&fs=1&hl=en_GB&showinfo=0&autoplay=1
5. November 2017
Economic Policy Panel in Brussels
Tomorrow and Friday is the 66th Economic Policy meeting in Brussels. For personal circumstances I will miss it, but there is a great set of papers! One important highlight will be papers for a special issue on economics and peace – a number of empirical and theoretical papers using economic analysis to contribute to the minimization of violent conflict around the world and summarized in this Economic Policy Digest. There will also be papers on corporate leverage in emerging markets, on the financing of higher education, the financing of fundamental research and when exchange rate appreciation can help economies expand.
18. October 2017
Mobile Money and Financial Development
I participated in an interesting workshop on mobile money last week that brought together academics, policy makers and practitioners and was organized by the International Growth Centre at LSE. It has been 10 years now that M-Pesa took off in Kenya and it is hard to keep up with all the developments in Kenya and other countries. The number of mobile money accounts (be they stand-alone or linked to bank accounts) has exploded over the past years, though their use is not as high as the pure account number suggests. They are still mostly used for transaction purposes, in spite of product offerings in the savings and credit space. Importantly, the use of mobile money is part of a wider trend of using mobile technology for government and other transfers, reducing transaction costs and “leakages” related to corruption and theft. And while mobile money has not been the silver bullet in terms of expanding financial inclusion to the last household in the developing world, it has helped expand the frontier of bankable population substantially. I do not think that the promise of mobile technology has been quite exhausted yet. But it has also become clear that there are other constraints holding back the full use of mobile money technology, including on the demand side (including behavioural constraints, as so prominently featured by the latest Nobel Prize winner Richard Thaler).
My own contribution was giving a quick overview of a task force report from 2016, co-led by Stijn Claessens and Liliana Rojas-Suarez and in which I participated. As mobile money expands, the question on how to regulate its providers and users rapidly arises. Where mobile money provision is restricted to banks this question is easily answered by expanding bank regulation to this new payment and account form. It is where mobile money is offered by non-bank providers that this question becomes relevant. Among other factors, the regulatory approach in Kenya has contributed to the success of M-Pesa by using a wait-and-see approach, which has been adapted into a regulatory sandbox approach in other countries (allowing new players into the market on limited scale without stifling regulation, but monitoring them carefully).
The task force report on Financial Regulations for Improving Financial Inclusion starts with three broad principles: similar regulations for similar functions (no matter what the name of the provider), regulation based on risk (to avoid reverting gains in financial inclusion made thanks to mobile money) and a balance between ex-ante and ex-post regulations (regulatory restrictions and penalties). These principles are then translated into 26 recommendations across three areas – competition policies, levelling the playing field, and know-your-customer (KYC) regulations. The goal is to allow and encourage entry of new, qualified providers of financial services, without deterring useful cooperation where needed to achieve the necessary scale. This gets to a broader challenge in mobile money (but also other segments of the financial systems) – strong network externalities easily result in a winner takes all situation, where innovation only comes about if the winner is assured the biggest share of pie; on the other hand, such a market-dominating position can easily stifle future entry and innovation. In the area of inter-operability (between mobile networks, in agent networks etc.) this trade-off become quite prominent, but it is clear that one single approach does not fit all circumstances. It is also important that non-bank mobile money providers are regulated according to the risk they pose for the financial system, which depends on the type of services they offer, which range from simple transaction services, over value store service to intermediation services. Only the last would require full prudential regulation. Finally, KYC regulations should internalize the trade-off between inclusion and integrity objectives – many countries have now adopted risk-based KYC regulations, which exempts basic accounts with a limited number of transaction s and a small volume from standard KYC rules.
17. October 2017
Whither Europe?
I had the privilege of moderating a panel discussion at the DebtCon (Interdisciplinary Sovereign Debt Research and Management Conference) in Geneva this week under the theme of “Whither Europe?” As impressive as the individual panelists were, the combination was even more interesting, as were the exchanges among panelists and with the audience. We touched upon a broad array of topics under one overarching theme: what are the long-term perspectives for the Eurozone and the European Union?
Frank Gill from Standard and Poor’s thinks the Eurozone crisis is over and pointed to reduced balance of payments imbalances as clearest indication. However, he also pointed to continuous imbalances in financial accounts, which raises the perspective of future fragility, especially in the absence of effective private risk sharing mechanisms in the form of a pan-Eurozone banking market.
Chiara Zilioli (ECB) reported on the progress that has been made in converting the ESM into a full-fledged EMF, which should make future sovereign crises easier to handle (by an explicit mandate to restructure an unsustainable sovereign debt burden, provision of liquidity to financially distressed Eurozone governments, but also with policy conditionality) and would be a more institutionalized replacement for the Troika. On the other hand, Maria Cannata from the Italian Treasury thinks it is rather risky to discuss debt restructuring in the first place, so as to not invite speculative attacks. She insisted that Italian sovereign debt is categorically sustainable, in spite of doubts expressed by academics (e.g., by co-organizer Ugo Panizza and Barry Eichengreen). Is the problem really solved if we do not talk about it, I wonder? And do such sustainability predictions rely on permanently low interest rates?
Michel Aglietta (CEPII) took a long-term perspective and focused on the need for joint, infrastructure investment and countercyclical fiscal policy in the Eurozone or even the European Union, similar to the Juncker plan, and on the suggestions of creating a small Eurozone budget with a finance minister. My doubt is to what extent such long-term investing and infrastructure projects have to be undertaken exclusively with public money and under government management or whether this should be a task for and provide the impetus to construct a capital market union to lever private resources. Several panelists pointed to the need for a fiscal union (however small it starts) in spite of arguments by Martin Sandbu to the contrary. I am in the middle of this and agree with Martin that in the presence of a well working private risk sharing mechanism (which would imply not just completing the banking union but getting effectively to a single Eurozone banking market and frictionless capital markets) a fiscal union might not be as necessary. The problem is that it’ll take some time until we get to this single Eurozone banking market and the start into a fiscal union cannot only be a useful macroeconomic tool but might also help reignite popular support for the European idea, if done correctly.
Last but not least, Yannis Manuelides pointed to the accountability-decision-taking conundrum (my wording) in the Eurozone and European Union. Political accountability is currently primarily at the national level but more and more of the decision-taking has to happen on the Eurozone level, without there being an equivalent institutional structure of voice and accountability. This important point relates back to the discussion on the rise of populism across Europe and the increasing disenchantment of people with the European Union and the European idea. Some contributors to our book Quo Vadis Europe? have pointed to a concrete example in that it is the European Union that imposes austerity while at the same time seemingly not offering any social safety net (which has stayed on the national level). In my view, this points to a deeper problem: the European project including the Eurozone has been constructed through inter-governmental agreements (even though ratified by national parliaments or even national referendums) – does Europe need a Constituante?
In conclusion – yes, the crisis is over, but after the last crisis is always before the next crisis. Europe has started the process of building better crisis management institutions and tools. Are we there yet? Not quite yet… Whither Europe? No, as long as we avoid the pitfalls of nationalist and populist politics and economics.
8. October 2017
A political watershed in Germany
The German elections from last Sunday have been described as a watershed moment for post-WW II Germany – the first time a rightwing populist party (AfD) enters parliament, and right away as third-largest party. For those Germans – like me – who still view and judge German politics under the historic legacy and burden of the Third Reich this is indeed shocking and worrisome. On the other hand, many observers have described the elections as the moment when Germany became a normal country, normal like most other European countries with a right-wing populist party. The question is whether this is simply a new status quo or the entry door to something far worse, as in 1930 (when the NSDAP had its electoral breakthrough moment). The new constellation has also complicated the formation of a new government coalition enormously. Having lived more than five years in The Hague, I had a deja-vu moment on Sunday evening – Germany finally turns Dutch - a multi-party parliament where you need more than two parties to form a government. And that is where there is a positive aspect. For the first time on federal level, a government might include two smaller parties (Liberals and Greens) from two opposing camps and who normally would not govern together. That finally moves German politics away from the rigid political camp approach where smaller parties are bound to a larger partner (Liberals to Christian Democrats and Green Party to Social Democrats). While already overcome on the state-level, such a “transactional” rather than ideologically coherent federal government can be seen as progress.
The results of the German elections stand in the tradition of a populist wave on both sides of the Atlantic. After Macron’s election as French president one might have thought mistakenly that the wave has been beaten back – and with 13%, the AfD is still a rather small group – but the struggle continues for the liberal democratic centre. The underlying conditions of a population segment that feels left behind – in economic, social and cultural terms – are still there and have to be addressed. It is interesting that the social democrats have campaigned on the theme of social justice and redistribution, but have not managed to appeal to this population segment. Rather than blaming immigration (which is rather low in areas with high AfD support), it might be a cultural disconnect between leftist intellectuals and population segments in rural, poorer areas that simply do not feel well represented by the urban global elite. It is a problem beyond economics and thus a challenge for all social scientists. Having just read Hillbilly Elegy, I am increasingly convinced that this was not just another protest vote, but the result of a long-term cultural process of alienation.
It is in these days that politicians have to lead rather than follow the Zeitgeist. Angela Merkel stands in the tradition of Konrad Adenauer and Helmut Kohl as transformative political leaders of post-WW II Germany – the former because of the Franco-German reconciliation with Charles de Gaulle, the latter because of the German unification. By opening the border to the refugees in 2015, Angela Merkel looked beyond any political calculus and followed beliefs and instincts. She has changed the face and socio-demographic structure of Germany forever. It is now her turn to use her fourth and final term in office to work against the populist Zeitgeist to strengthen Eurozone integration, save globalization from its excesses but also slow destruction by Donald Trump and his followers, and uphold a tolerant and liberal society in Europe. She has a willing partner on the other side of the Rhine – it is up to her to use this historic opportunity
29. September 2017
Postcard from Kuala Lumpur
Last week I started my appointment as the 6th Tun Ismail Ali Chair, at the University of Malaya in Kuala Lumpur, a chair sponsored by the Malaysian Central Bank. The first chair holder was the late Ronald McKinnon and I feel certainly honored to follow him, though these are certainly big shoes to fill. Until summer 2018 I will spend a total of around two months at the University of Malaya and the Central Bank, interacting with researchers, analysts and policy makers and giving lectures and seminars.
Malaysia is a fascinating and interesting country, in many aspects. While often in the shadow of Singapore (part of the original Malaysian federation), its financial system is also a very developed one. Its Private Credit ratio stands at well over 100% and well above the value predicted by GDP per capita and other socio-economic factors. Similarly, its capital market and contractual savings institutions are well developed. It has also aimed at becoming a global Islamic finance centre, with research institutes to support it. In terms of regulatory policies, it is certainly interesting, having been the outlier after the East Asian crisis in imposing capital controls. Politically, it is similarly fascinating, a constitutional monarchy with rotating kings (drawn from the nine sultans the country has) and with a careful balance between the three ethnic groups. I am very much looking forward to my next visit in November.
1. September 2017
The uproar about EJMR
We economists keep getting into headlines for the wrong reasons – if it is not for having missed a crisis or for seemingly squabbling over the effects of Brexit, then it is for a sexist culture. Following the publication of Alice Wu’s paper, reported in the NYT, there has been an intensive discussion on the under-representativeness of women in the economics profession, but also more broadly about the culture in our profession.
I have never contributed to EJMR but do check in once in a while, mostly to see whether my name or that of my current or previous employers pops up. So far, I have been lucky and not been subject to any of the hateful threads started by what can only be bored and/or frustrated PhD students. However, one of my PhD students has been subject to unfounded accusations of plagiarism and another PhD student in Tilburg has been subject to sexist remarks.
My main problem with this web-site is that while good and important information is being shared (sometimes in the form of gossip), there are still too many threads, which either target people for all the wrong reasons or just rehash the same silly arguments over and over again (such as the repetitive threads about the quality and standards of the Review of Finance).
I do not believe that EJMR should be shut down, but it certainly needs a lot more rigorous monitoring – obviously, I understand that this would be a thankless job, unpaid with not even intellectual gratification. There are, however, examples of discussion boards that do allow for useful information exchange and friendly banter – my favorite example (not surprising given my life-style) is www.flyertalk.com (where I do contribute once in a while).
As pointed out by James Campbell and others the discussions on EJMR are the symptom for a deeper problem in our profession, with a hierarchical structure of journals and schools and underrepresentation not only of women but different ethnic minorities (especially in the US), but also a certain degree of aggressiveness among academic economists. I share his view that more can be done to “bring together” the profession and bring down barriers of arrogance and clubiness. However, there are also small steps that we can do. As previously reported, I was part of a great workshop in Bonn recently, “teaching” post-docs and assistant professors from German universities on how to publish in finance journals. I was subsequently asked to give a seminar on the same topic at the Bank of England, where there are lots of very bright economists, often with PhDs from top universities but with limited experience in the publication game, for no fault of their own (as they are too busy saving the UK economy from the Brexit damage). I think a lot can be done on a more informal level!
I do not think it makes any sense whatsoever to “ban” EJMR, rather the profession should learn from it. Alice Wu’s paper is a great start and holds an impressive mirror up to our profession. Rather than getting upset, we should see this as opportunity!
1. September 2017
Forthcoming in Review of Finance
A couple of very interesting papers have recently completed successfully the review process at the Review of Finance.
Bo Becker and Victoria Ivashina assess crowding out of corporate lending by banks’ sovereign debt holdings during the Eurozone crisis in ”Financial Repression in the European Sovereign Debt Crisis.” After the Global Financial Crisis of 2008 there was a rapid increase in government debt, driven by the Great Recession (and partly countercyclical fiscal policy) and bank bail-outs. A large share of the additional debt ended up on banks’ balance sheets, a phenomenon often referred to as financial repression, if this happens below market prices and outside the regular market process. While this implied a reduction in bank lending to the corporate sector, the authors are able to isolate the supply-side of this effect (lower demand for corporate lending might have come from the Great Recession and the Great Trade Slump) by focusing on within-firm choices between bond issues and bank loans. As domestic government debt issues increased, more firms switched from bank loans to bond issues. The authors also assess different channels through which this financial repression has worked, including government ownership and government representation on banks’ boards.
The paper is part of an expanding literature that studies the accumulation of domestic sovereign debt during the European sovereign debt crisis. While some claim local information advantages, such as Orkun Saka, others focus on moral suasion, such as in this interesting paper by Steven Ongena, Alex Popov and Neltje Van Horen using bank-level data on government-debt holdings. The paper is also related to another paper forthcoming in the Review of Finance, by Carlo Altavilla, Marco Pagano and Saverio Simonelli who use monthly bank-level data to show that public, bailed-out and poorly capitalized banks responded to domestic sovereign stress by purchasing domestic public debt more than other banks, consistent with both the “moral suasion” but also the “carry trade” hypothesis, first put forward by Viral Acharya and Sascha Steffen.
Melissa Jaud, Madina Kukenova and Martin Strieborny add to the finance and international trade literature in “Finance, Comparative Advantage, and Resource Allocation”, a literature close to my heart as my job market paper contributed to this literature in its early days. Specifically, using disaggregated product-level data from 71 countries exporting to the USA, the authors show that exporters exit the US market sooner if their products are not supported by the exporting country’s comparative advantage, as revealed through the distance between revealed factor intensity of the export good and the exporting country’s factor endowments. This pattern is stronger when the exporting country has a well-developed banking system. These results confirm the disciplining role that competition in the product market can play, in interaction with market discipline exercised by lenders.
Kathryn Dewenter, Xi Han and Jennifer Koski assess the effect of euro conversion on competition across stock exchanges within the Eurozone in “Who Wins When Exchanges Compete? Evidence from Competition after Euro Conversion”. They find that in the year following euro conversion bid-ask spreads across European exchanges fall an average of almost 9% while turnover (defined as trading volume scaled by shares outstanding) rises over 30%, so clear aggregate gains, to be explained by trading with only one currency! However, there are winners and loser across the different exchanges; specifically, Milan, Frankfurt, Paris and London are the winners with significant increases in turnover, while Brussels and Madrid are the biggest losers with significant declines. They explain these differential effects with different composition of the listed firm population. Interestingly, the euro conversion and consequent increase in competition did not result in a winner takes all outcome, in spite of the network externalities for capital markets.
24. August 2017
Some random summer thoughts
I am off to a well-deserved summer break, with a full and exciting fall schedule coming up.
Where do we stand in terms of the populist revolt against liberal democracy? The US and the UK have been seen as the two countries most “affected” with the Trump election and the Brexit vote, an interesting observation in itself that is worthwhile some analysis. The last six months have certainly been depressing for both countries – in the UK a government that supposedly wanted to keep its cards close to the chest has turned out to have no such cards and making up policy on the go; in the U.S. a narcissistic and incompetent president who is attacking the institutions that have underpinned US democracy for more than 200 years and a Republican party that (with few exceptions) puts party above country. On the other hand, a resounding victory in France against the extremist right-wing Front National and an increase in positive attitudes towards the EU in many countries. Certainly an important opportunity for Europe and liberal democracy.
I was recently asked by a Greek blog site about my opinion on the Greek and Eurozone crisis, in case you are reading Greek. Or use google translate as I did.
I was also asked to write a quick blog entry about government’s role in banking: It is a very quick and somewhat superficial summary, but somewhat summarizes my thinking on this critical issue in finance.
On a personal note: I am spending the first two weeks of my summer break in Colombia, visiting my in-laws. City maps in Colombia have a certain system to it, with carreras and calles. All good, and even the navigation system bought into it; unfortunately, I forgot to tell it that I meant to be in the South part of Medellin rather than the North part, with the result that instead of ending up in our hotel we ended up in the middle of a comuna (aka favela). Oh well, at least we got to know Medellin extensively and saw for ourselves how this city has transformed itself over the past 25 years, since Pablo Escobar was killed. A metropolitan city with lots of things to offer. One of the (many) highlights: El cielo, a restaurant that goes beyond food and drink to offer “experiences” – if anyone ever happens to be in Medellin, a must-go (the same chef has also restaurants in Bogota and Miami).
Coming up in September, a new e-book on German ordo-liberalism (jointly edited with Hans-Helmut Kotz) and later this year a Handbook on Finance and Development, edited by Ross Levine and me. I will also start a one-year appointment as the Tun Ismail Ali Chair at the University of Malaya (jointly supported by UM and Bank Negara Malaysia, the Malaysian Central Bank, whose governor Dr. Tun Ismail Ali was for 18 years in the 1960s and 70s) and will spend a total of 10 weeks or so in Kuala Lumpur over the next 12 months, which will certainly be an exciting and insightful experience.
30. July 2017
Banking union at three
The events of the last weeks – first the take-over of Banco Popular by Santander in Spain and then the bad-bank-good-bank solution for two smaller banks in Italy can be seen as first test for the young banking union in the Eurozone. In a new Vox column I assess these first tests. The title summarizes my opinion: a toddler with tantrums. More specifically:
4. July 2017
The UK conundrum of monetary and macro-prudential policies
For teachers of Business Economics to MBA students, like me, the current macro-economic situation in the UK gives plenty of material for class room discussions. The rising inflation we are observing are driven by higher import costs rather than by demand, with lower growth and higher inflation as result. The public discussions among MPC members on what to do about this shows the conundrum they are facing: raise interest rates to counter inflation and you might slow down the sluggish economy further – lower interest rates to increase growth and you might get even more inflation. No surprise that observers now focus on the profiles of individual MPC members, as recently the FT.
On top of this comes the discussion of whether sluggish growth is ultimately part of the adjustment process to a permanently lower GDP per capita level in the UK after Brexit. Paraphrasing the Bank of England governor Mark Carney, monetary policy can help smooth the process towards the new equilibrium but it cannot make up for the damage that is being and will be done with Brexit. An important reminder for politicians as they negotiate Brexit with the European Union.
Then is there is the issue of private indebtedness, which has been increasing, especially due to car loans and (somewhat less) credit card debt. Is this part of the adjustment process towards lower income levels or driven by the prospect of a bright future? Declining consumer confidence suggests it is the former. Higher interest rates would simply squeeze consumers further, so the application of macro-prudential tools (counter-cyclical capital buffers, to be more precise) seems adequate. They do not seem binding in most cases and have to be implemented over a 12-month window anyway. But the FPC has already provided some forward guidance to the effect that these buffers might be increased further, thus sending a clear signal to banks to dampen credit growth. This application of monetary and macro-prudential tools shows the clear advantage of coordinated monetary and macro-prudential tools, by having overlap in membership of FPC and MPC.
What about fiscal policy? The recent elections have sent a clear signal that the electorate had just about enough of austerity and there is increasing pressure to loosen the public purse. The FT has calculated that the 1 billion pounds promised to Northern Ireland to buy Theresa May 2 more years in 10 Downing Street would translate into 60 billion if applied across the UK or 0.2% of GDP; not a big number prima facie, but significant as the fiscal deficit is still at 2% (eight years after the end of the last recession) and debt above 80% of GDP. Though relaxing austerity might have the benefit of reducing pressure on consumer and thus their tendency to incur more debt, it might put more pressure on interest rates. Certainly challenging times for everyone!
30. June 2017
Helmut Kohl, 1930-2017
As most of my generation, I have a very ambiguous relationship to Helmut Kohl; on the one hand, he was not considered to be on the same intellectual level as his predecessor Helmut Schmidt, he was seen as opportunist who relied on relationships rather than principles. On the other hand, he is rightly considered as the father of the German unification – where others hesitated, he saw the unique window of opportunity (which might have closed only a year later with the disintegration of the Soviet Union) to push ahead and achieve what few had considered feasible a few years earlier: a unified, stable and democratic Germany. Politically the right move, it came with some doubtful economic policy decisions – one of the major decisions was a conversion rate of East and West German marks of one-to-one, which turned East German companies completely uncompetitive and is one of the reason why Eastern Germany was not converted into “blooming landscapes” as he promised in 1990. It was one of several economic policy mistakes (nicely documented by HW Sinn in his book “Kaltstart”), which came back to haunt the unified Germany in the early years of the 21st century The second important decision taken in 1990 was that of the introduction of the euro – concession to the French president Mitterand for given his approval for the German unification. While praised as success story for the first 10 years, the governance structure of the Eurozone has been a major cause of the prolonged Eurozone crisis for the following ten years.
How ever one might evaluate Helmut Kohl’s policies and politics, he will enter the history book as the last chancellor of Western Germany and the first chancellor of the unified Germany (for the first time a unified and stable democratic Germany); he helped close a chapter of German and European history and push open a new one. For better or worse, he helped shape the political and economic ground on which today’s European policy makers have to play. A European giant!
16. June 2017
Capital buffer, loan growth and fragility
Two interesting papers from a recent conference in Frankfurt, showing the importance of too rapid expansion for both bank-level and systemic fragility and shedding doubt on whether the focus on higher capital standards should really be a first-order regulatory priority.
Moritz Schularick from Bonn likes to go for big questions – so in a recent paper with Oscar Jorda, Bjoern Richter and Alan Taylor, he asks whether bank capitalization can predict systemic fragility? Using data for almost 150 years, the answer is: NO. Banks’ solvency has no value as a crisis predictor; liquidity indicators, such as the loan-to-deposit ratio and the share of non-deposit funding, have some predictive power, but the most robust and clearest crisis predictor is loan growth. One consolation prize for the higher-capital-buffer-lobby: recoveries from financial crisis recessions are much quicker with higher bank capital (consistent with the recent experiences in U.S., Japan and Eurozone, I would add).
And to complement these macro findings with some micro-evidence, Rudiger Fahlenbrach, in joint work with Robert Prilmeier and Rene Stulz, uses bank-level from the U.S. over 40 years and shows that stocks of banks with high loan growth significantly underperform banks with low loan growth over the following three years, mostly due to higher loan losses stemming from riskier lending associated with rapid loan portfolio expansion. It is interesting that neither markets nor analysts pick up this phenomenon in time.
So, yes, capital buffers are important, but so is macro-prudential trying to affect the credit cycle!
14. June 2017
More turmoil in British politics
The British voter has spoken and has left everybody confused. The promise of “strong and stable leadership” did not seem sufficient to sway voters towards a Tory landslide as predicted just a few weeks ago. It seems that British voters do want to have details and where they got them (e.g., dementia tax) they did not like them. They also do not seem to like kitchen cabinets (e.g., government by unelected Fiona and Nick), but rather more inclusive and transparent governments (which also implies showing up for TV debates). Instead of getting a strong mandate for Brexit negotiations, Theresa May enters these talks now very much weakened and with a certain degree of uncertainty whether she will still be in Downing Street in March 2019, when the process is scheduled to end. I agree with Martin Sandbu, that this can either end in the UK crashing out of the EU in March 2019 or (if cool heads prevail) in a much softer Brexit than Theresa May promised.
How to interpret the rise of Labour under Jeremy Corbyn, fueled, as early indications suggest, by young voters finally turning out (where were you last year in the referendum???). Are these the Remain voters finally standing up? Unlikely, as they should have voted Lib-Dem! Or is it rather that they see that Labour better understands the message that the 52% sent last year, expressing their social and economic frustrations with a vote against the EU? Jeremy Corbyn promised a free lunch, with the tab being handed down to future generations – but it seems Labour better understands the underlying fears and hopes of many people outside the Westminster/Brussels bubble: for many voters, it is primarily not about the European Court of Justice, Single Market or Customs Union, but about education, NHS, income and the future.
9. June 2017
Banking Union passes first test
The banking union has passed its first test – the take-over of Banco Popular by Santander, combined with a bail-in of equity and junior bond holders at Banco Popular was done swiftly and efficiently, without rocking the markets or depositors. Certainly, a success for the new resolution framework in the Eurozone, including in terms of cooperation between SSM and SRM. And judging from the impact of the bail-in at Banco Espirito Santo on the real economy, we can expect some but limited negative fall-out for Banco Popular’s borrowers.
As academics, we are not supposed to simply praise, but point to challenges. So, let me point to two! First, no funding was required (to a large extent, it seems, courtesy of supervisors in Frankfurt and Madrid being alert and reacting in time), which made the operation simpler. The resolution of Italian banks might not be as easy! Second, it was a bank failure in a large country where another bank stood ready to take over the failing bank. We might not always be as lucky; more importantly, if we want a truly European banking system, we should cheer for cross-border resolutions of such bank failures!
9. June 2017
Basel Standards in Low-Income Countries
I spent the last two days at a workshop on the adoption of Basel standards in banking systems of low-income countries. Economists typically discuss regulatory standards under the perspective of maintaining stability and reducing the risk of fragility. Many of the international standards (such as the Basel capital standards) were developed by and for developed financial systems, without taking into account the needs of developing countries. Nonetheless, many developing countries have decided to adopt international standards even where they do not seem fit for purpose. In an ESRC-DFID funded research project with Ngaire Woods and Emily Jones from the Blavatnik School of Governance in Oxford, we are trying to understand what factors drive these decisions, in terms of policy objectives, influence of domestic and foreign banks, internal political power struggles and influence of international financial institutions. Ten country case studies form the core of the project, ranging from Vietnam over several African countries to Bolivia, from non-adopters and closed financial systems, such as Ethiopia, to adopters with open and competitive financial systems, such as Kenya. It seems that in many (though not all) cases, adopting international standards was used as signaling device to international investors, but there is quite a network effect as well, across regulators and with the influence of international financial institutions.
As economist, it is always fascinating to participate in workshops and conversations dominated by political scientists who have different concepts, theory and perspectives on the same important issues that we economists grapple with. Quite interesting their view of the financial system, either in the context of the developmental state (known to us economists as financial repression) or in the context of financialisation (off-shore centre or financial hub). Trying to impress on my colleagues that the financial sector can also serve the rest of the economy (at least in theory)….
8. June 2017
Fixing the Eurozone and beyond
The election of Emmanuel Macron as French president in a run-off with a nationalist-populist candidate underlines the need for the Eurozone to reform. It also provides an opportunity – he clearly has a popular mandate for change, not being tied to one of the traditional French parties. But what should and what can be done at the end of a lost decade for the Eurozone to avoid a second one? Big governance changes require treaty changes, which are politically almost infeasible in the current environment. But there is lot of small steps that can and that should be taken. Some of these are discussed in a new VoxEU eBook, edited by Francesco Giavazzi and Agnes Benassy-Quere, to which I contributed.
The different contributors touch on the need to complete banking union and first steps towards a common fiscal policy. In my contribution, I pick up on a recent Vox column and the idea to establish a Eurozone-wide asset management company (bad bank) to finally address the remaining legacy problems and allow for a sustainable economic recovery of the Eurozone. As other contributors, I also argue for first steps towards common fiscal policy, with the goal of addressing youth unemployment, one of the main social, economic, and political challenges in many Eurozone countries. Most importantly, any policy package to address the deficiencies in the Eurozone has to address the political identity crisis, the disillusion of large parts of the population with the European project, a topic that Geoffrey Underhill and I have addressed in an earlier eBook.
31. May 2017
Bank bail-in: the effects on credit supply and real economy
A lot has been written about the negative effects of bank failures on the real economy and about the adverse effects of bank bail-outs on banks’ incentives to take aggressive risks. But what about bank bail-in, i.e., a resolution of a failing bank that involves maintaining the “good” part of the bank, while shareholders and junior bondholders have to bear the losses? The resolution of the Portuguese Banco Espirito Santo in 2014 offers a good example to study, as it was unexpected, not related to loan losses and as its resolution did not affect negatively the rest of the financial system. Andre Silva, Samuel Da-Rocha-Lopes and I just finalized the first version of a working paper gauging the effect of this bank resolution, also summarized in this Vox column.
Using credit and corporate registry data, we find that (i) the supply of credit from banks more exposed to the bail-in (i.e., BES itself and banks that had to come up with additional funding to the resolution fund) declined significantly after the shock when compared to less-exposed banks, (ii) firms exposed to the shock expanded borrowing from other, less-exposed banks, both on the intensive margin (existing banking relationships) and on the extensive margin (establishing new relationships), (iii) despite not suffering a credit supply shock, SMEs exposed to the bail-in experienced a relative reduction in investment and employment, (iv) SMEs exposed to the bail-in had higher cash holdings after the shock, pointing to precautionary cash hoarding as explanation for the discrepancy in credit supply and real sector effects, and (v) large firms seemed to have achieved a similar effect by increasing outstanding trade credit from their suppliers, thus not having to cut investment and employment.
In summary, credit supply effects were contained by the bank bail-in and good-bank-bad-bank split, but there were real sector effects. While immediate panic and contagion effects were thus avoided, resolution of a failing bank, however well done, may not completely eliminate negative effects on the real economy.
28. May 2017
How to publish in finance journals
One of the most useful classes during my PhD course was on growth economics. Not so much because of the content (which was fascinating!), but rather because our professor (who later became my PhD supervisor and co-author) had one important objective for this course – teach us how to write a paper! He even provided us with an outline for how to write up the Introduction of a paper – something I still use and happily pass on to my own PhD students (with full acknowledgements!).
Last weekend I spent Friday and Saturday at a workshop in Bonn (organized by Ruediger Fahlenbrach and Henrik Hakenes) taking this approach one step further; an intensive and interactive meeting of junior researchers (post-doc and assistant professor level) and more senior researchers (always relative, obviously!), where the latter shared with the former their experience with the publication process. This included not only discussions on how to have appropriate expectations (50% desk reject at top journals, and a Revise and Resubmit almost as rare as a black swan) and to deal with frustrations, but also very practical consideration, such as how to package best your message. The four most important messages (motivation, research question, methodology and contribution) have to be clearly presented in the Introduction, be mentioned on the first page of the paper and summarized in the abstract (where you often face a space constraint). A challenge, but a feasible one! And a skill that can be acquired with practice. Finally, the elevator pitch: how to bring across the main ideas of your research in two minutes (or less if the other person gets off on the third floor!). Bottom line: original, innovative and frontier research is necessary but not sufficient for success in the academic world! The good news: packaging can be learned!
25. May 2017