Off to Helsinki
I am off to my last Economic Policy panel meeting at the Bank of Finland in Helsinki, before continuing to a week-long trip to China. It’ll be a bit nostalgic for me after 6 years as managing editor, having met so many great people and worked with so many outstanding economists (and just having met Tullio Jappelli whom I replaced, it was really interesting to take stock of what has changed over the past 6 years). But it’ll be again a great programme, with papers on 20 years Euro and the trade war, among others. There will be also papers on the factors explaining pension reforms, how much bank executives anticipated the Global Financial Crisis by cashing out, and on the divergence in firm productivity and wages. I will try to tweet as much as possible. This panel will also be the last of my fellow managing editor Beata Javorcik who just became Chief Economist of the EBRD, so that there will be quite some editorial turnover, with Moritz Schularick and Ghazala Azmat taking our spots (and Andrea Ichino and Tommaso Monacelli staying on). Expect more great panel and papers in the coming years with this refreshed editorial team.
9. October 2019
Frontier research in macro-pru
The Ieke van den Burg Prize (for outstanding research conducted by young scholars on a topic related to the ESRB’s mission) was today awarded in Frankfurt and I am very happy to report that I have a link to one of the two prize-winning papers.* My former PhD student Andre Silva (now at the Federal Reserve Board in Washington DC) won the prize for his job market paper Strategic Liquidity Mismatch and Financial Sector Stability, forthcoming in the Review of Financial Studies. Andre shows the importance of the systemic dimension of liquidity. Specifically, he finds that banks strategically incorporate their competitors’ liquidity mismatch policies when determining their own liquidity position. While it is typically difficult to identify such peer effects due to the reflection problem and unobserved effects, he uses network structures and cross-border ownership linkages to construct a valid IV to account for potential correlated effects. He also shows that such peer effects in liquidity positions are driven by asset- rather than liability-side effects and asymmetric, with individual banks mimicking their respective peers only when competitors are increasing funding liquidity risk. And these effects also have important stability implications, with correlated riskier liquidity positions resulting in lower idiosyncratic and systemic bank stability. Together, these results emphasize the importance of regulating liquidity risk from a macroprudential perspective; while Basel III has introduced micro-prudential liquidity requirements, Andre’s paper shows the importance of moving to a more systemic approach.
The other paper awarded the price is by Guillaume Vuillemey and is forthcoming in the Journal of Finance. The Value of Central Clearing assesses the effect of the first Central Clearing Counterparty House (CCP) in 1882 in Le Havre for coffee futures. This new contractual institution allowed coffee traders to insulate themselves against counterparty risk. The effect on coffee trade were significant, with more coffee imports channelled through Le Havre, even if subsequently sold to other European countries. There was also a smoothing effect on coffee consumption! Guillaume shows that the CCP helped complete the market, both reducing asymmetric information between traders and offering insurance against counterparty default (as this is taken by the CCP). The success of this first CCP was soon replicated in other European exchanges. This quite insightful historic study shows that financial innovations such as a clearing house can have positive effects on the real economy. After the Global Financial Crisis there was another global push to bring more derivatives onto CCPs, though this was mostly for transparency and stability reasons. However, one important lesson from this and one of Guillaume’s other papers is that high equity, high margin requirements, and good governance are critical for the success of a CCP – in a paper with Vincent Bignon, published in the Review of Finance (with me as responsible editor) he analyses the failure of a CCP for sugar futures in Paris in 1974, related to poor risk management and weak governance structures.
Together, these papers show the importance of specific regulations and institutions for systemic stability. They also show the diversity of tools being used in modern finance research – on the one hand, bank-level data with a carefully constructed instruments; on the other hand, a historical study offering important insights for the present!
*Important clarification – these prize winners are chosen by ASC members; I did not participate in the final voting round given my link to Andre’s paper!
27. September 2019
Brexit and legal traditions
I am trying to avoid writing about Brexit, but somehow cannot help myself. But I promise a rather unique approach today – that of an economist with interest in comparative legal studies. In the early part of my research career I co-authored several papers in the law and finance literature (together with Asli Demirguc-Kunt and Ross Levine), a literature that shows a critical difference in (i) how legal systems have developed over the centuries across different legal “families” and (ii) how this legal system development has influenced the development of the financial system. A headline finding is that Common Law countries (US, UK and former British colonies) have more developed financial systems than Civil Law countries (pretty much everyone else) controlling for other factors. The critical historical difference between Common and Civil Law lies in the role of the judiciary and the flexibility and adaptability of the legal system. One critical difference in the historic development of the UK and France (two mother countries of their respective legal tradition) was the role of the judiciary in the British and French revolutions in the 17th and 18th centuries, respectively. In short, the judiciary was on the winning side in the conflict between Parliament and King in the UK and on the losing side in the conflict between ancien regime and revolutionaries in France. Siding with parliament over the king (under the motive Lex Rex) helped establish the independence and ultimately supremacy of the judiciary in the UK (unlike in France and other French Civil Code countries where the judiciary has a much weaker role among the different branches of government). Another critical difference is the role of jurisprudence (past decisions) and willingness and ability of Common Law judges to adapt legal decisions to circumstances, including looking beyond form to intention.
Given this historic background, the UK Supreme Court decision that the prorogation of Parliament was unlawful should not be surprising. The justification of the decision looks beyond form (proroguing parliament to prepare a Queen’s speech) to intention (avoiding accountability of government) and consequence (opening the door to arbitrary prorogation whenever government pleases). It also confirms the strong role that the judiciary has in the political system of Common Law countries. Finally, it establishes once more Lex Rex – as the Stuart Kings lost in the 17th century, so do Tories claiming to represent the “will of the people” in the 21st century. Those analysts who claim a constitutional coup better read up on British constitutional history.
25. September 2019
Finance and poverty reduction in India
After many years, Meghana, Mohammad and I finally managed to find a home for our paper Finance, Law and Poverty: Evidence from India, now forthcoming in the Journal of Corporate Finance. The paper relates to a longer-standing debate on the role of financial development and – even more important for the policy debate – the relative importance of expanding access to financial services versus increasing the efficiency of the financial system. These are two important though not necessarily correlated dimensions of financial sector deepening. We use state-level variation in India over the period 1983 to 2005 in rural and urban poverty rates, branch penetration and Credit to SDP to explore these questions. While we do not have perfect gauges for the outreach and the deepening of the financial system, we use branch penetration as a proxy for outreach effort of the banking system (before the arrival of digital and mobile finance) and Credit to SDP as proxy for financial deepening. Our findings suggest that over the period 1983 to 2005 it is Credit to SDP rather than branch penetration that is associated with lower rural but not urban poverty. Branch penetration, on the other hand, does not enter significantly, though it enters significantly and negatively in a regression of rural poverty, when extending the sample period to 1965 to 2003, consistent with the seminal paper by Burgess and Pande. As interesting as establishing this result (in line with the findings in the paper by Asli, Ross and me) is to explore the channels. We cannot find any evidence that financial sector deepening reduced poverty by increasing schooling, but find some evidence for more entrepreneurship in the rural areas. Where we find the most robust evidence is in interstate migration into urban areas and the tertiary sector going hand in hand with financial sector deepening in the target states. This is in line with most of the additional credit going into the tertiary rather than the primary and secondary sectors. In summary, the story of financial sector deepening contribution to the long-term reduction in rural poverty in India is one of indirect effects going through labour markets rather than through increasing financial sector outreach. This, again, is consistent with some of my earlier work, with Ross and Alex, on the U.S., but also with evidence on Thailand, by Xavi Gine and Robert Townsend.
24. September 2019
On German euro-populism
One reaction to the Brexit win in June 2016 was that this was the result of two decades of anti-EU propaganda in the British yellow press, with everything bad in the UK (including the weather) blamed on the EU. This was exacerbated by six years of Tories blaming immigrants for declining public services (in reality the results of austerity). As the saying goes… the rest is history.
My co-author Isabel Schnabel has pointed to a dangerous parallel in the German debate on the euro, with the media constantly criticising the ECB. There are justified concerns on whether reducing interest rates further has been the right move by the ECB (I will NOT comment on this!), but declaring the ECB as enemy of German savers seems quite far-fetched. We had references to Mario Draghi as Count Draghila and repeated references that the ECB is acting against German savers! There is the idea that having an Italian head of the Single Supervisory Mechanism will open the door to Germans bailing out Italian banks (Never mind that Andrea Enria is rather unpopular with Italian bankers as he had been rather robust with them during his tenure at the European Banking Authority). As I have argued before (and I hope in due course someone will put numbers on this), Germany has benefitted from the Euro being the anchor country of the currency union; there is a clear interest rate advantage for German sovereign bonds – the fact that the German government is not using the advantage is a different story (see below).
There has always been Euro scepticism among German economists; initially healthy, more recently rather shrill if not hysterical. The debate on Target 2 balances (which many observers wrongly interpret as claims of Germany on other Euro area countries, coming with credit risk) is just one example (as clearly shown here and here: they are NOT). The idea that all the Euro area crisis countries have to do to get out of the crisis is to follow Germany and get as quickly as possible to a balanced government budget ignores the fallacy of composition (a concept any well-trained economist should be aware of). Last year, Hans-Helmut Kotz and I edited a VoxEU book on ordo-liberalism, noting that there is a lot of merit in the microeconomic insistence on market forces in Ordoliberalism, but less so in the rather outdated macroeconomic thinking. This is a legitimate debate that contrasts an economic philosophy that reflects the isolation of German economics for several decades after 1945 with the development of modern economics over the past decades in the Anglo-American world. This discussion has turned even shriller recently, with one of the leading German economists using dog-whistle populism to go against any easing of fiscal policy during a possible recession. Using anti-Semitic references to shut down a debate on the federal government’s debt brake is rather unfortunate, but helps to fuel further Euro-scepticism in Germany.
There is no risk of Dexit any time soon – German policy makers are certainly aware of the enormous economic and political benefits of the Euro for Germany. The question is whether Germany is willing to share the benefits of being the anchor country of the Euro area. And given that negative or zero interest rates are here to stay for quite some time, the question is whether a prolonged attack by media, politicians and economists against the ECB will result in unwelcome political developments in Germany down the road – again, no immediate concerns, but Brexit also took several decades to develop from a fringe idea to a populist movement.
So to pick up on something I said before I am less worried about the rise of the AfD on the basis of xenophobia in spite of its recent electoral successes in Eastern Germany, I am more worried about the long-term damage the media campaign against the ECB and other Euro area institutions has for Germans’ relationship with Europe and the Euro.
22. September 2019
Is cross-border supervisory cooperation effective?
As part of a revision of my recent paper with Consuelo Silva-Buston and Wolf Wagner, we have explored whether stronger cooperation between supervisors is associated with higher stability. This is summarized in this Vox column. Herewith the one-paragraph version: Banks where the parent supervisor has cooperation agreements with a larger number of host supervisors (weighted by share of each subsidiary’s assets in total foreign assets of the parent bank), have higher z-scores and a lower marginal expected shortfall (so both a book and a market-based stability measure). However, these findings are driven by the “smaller” cross-border banks – the larger one might be simply too big or too complex. This relationship is as strong during normal and during crisis times. Obviously, this relationship could be a spurious one – confirming our results with political affinity between countries as instrument for cooperation and the fact that we exploit within-bank variation rather than cross-bank or cross-country variation makes this less likely, however.
5. September 2019
Postcard from Dhaka
I am on my way back from Dhaka, where I attended a workshop on Institutional Diagnostics in Bangladesh, commenting on a paper on the “Political Economy of Private Bank Governance in Bangladesh”. Bangladesh’s financial system is very much in line with its status as a lower-middle income country, dominated by banks, with a large share of government-owned banks. Non-performing loans are high and one can argue that it not quite fulfilling its role in pushing the economic development and transformation (including export diversification) of Bangladesh further. But what holds financial sector development back. If one considers the policies that international experience has shown to be conducive for financial sector development – macro-stability, contractual framework – one sees there is volatility and there are many gaps in the institutional framework. But what are the political constraints to addressing these gaps.
It was my third visit to Dhaka; the first time was in 2006, while at the World Bank, when I was asked to write a background paper for the Country Economic Memorandum on the challenges facing the financial sector. Some readers might not be surprised, but the challenges to which I pointed in 2006 are still around. In addition to the ones mentioned above, the regulatory framework has been anything but conducive for the development of a thriving banking system – heavy-handed regulation, on the one hand, though often not enforced; bank licenses awarded as political favours and regulatory forbearance resulting in fragile private banks never going out of business. What has changed over the past 13 years is that the independence of the central bank and thus supervision has been further undermined, increasing political and regulatory capture. The political background to this is a shift from a competitive political system (where the main two parties alternated in power) to a political system dominated by one party.
What are the solutions? The literature tells us what to do, but these reforms might encounter strong political constraints! Privatization of state-owned banks – politically difficult and not necessarily a solution as regulatory forbearance vis-à-vis private banks and the political “sale” of bank licenses show. Strengthening the independence of the central bank; this has worked in many countries but given the record of political appointees at Bangladesh Bank, it might be difficult to turn de jure into de facto independence.
There are no panaceas but the need to think outside the box. Two suggestion I have made are: first, a stronger role for foreign banks. Foreign banks are more immune to political pressure and can help break the link between politicians, bankers and borrowers. The experience of Central and Eastern Europe has shown the transformational role foreign banks can have. Yes, there are worries that foreign banks might ignore the low-end of the market (as shown by Atif Mian in his paper on Pakistan), but this might be somewhat less of a concern in Bangladesh given a thriving microfinance industry that is eager to move up-market. It is important to note, however, that the benefits of foreign bank entry for host economies can only be reaped when the institutional infrastructure surpasses a minimum quality threshold. Second, strengthening private monitors. Accounting and auditing companies seem to be struggling; given regulatory forbearance, market discipline is very limited. However, it seems that the print media still have an important role to play, but more players would be better. Establishing an independent FCA-style institution might be useful. Strengthening banks’ disclosure requirements (and making CEOs liable for complying with them) might help as well.
Ultimately, it is difficult to address financial sector and institutional reforms outside the political space. Increasing the share of people with a stake in such reforms and creating coalitions that benefit from such reforms can help.
3. September 2019
1. September 1939
Today 80 year ago, German troops attacked Poland, starting World War II, the most horrific slaughter and genocide in European history (I will not be drawn into comparisons with Stalin – “we dealt” with this comparison in the late 1980s during the German “Historikerstreit”). Growing up as German in Germany, I was confronted early on with this horrific legacy. We had furious debates in high school whether Germany lost the war or was liberated from the Nazis by the Allies. I have never had any doubt that it was the latter and that we should be grateful for having lost the war (watching “The Man in the High Castle” these days, it is hard for me understand why anyone in my generation can think otherwise). In later years, I started confronting my personal history, finding out that both my grandfathers had been members of the Nazi party, even though not involved in any of the atrocities of the holocaust or war. There have been vigorous discussions whether Germany is “allowed" to move on from its history, whether it can change the conversation, given the historic distance. And from abroad I could clearly see that German society has taken on a new attitude towards the flag and national anthem. Healthy or risky? In spite of the rise of the AfD, I am generally optimistic. One cannot be careful enough about early dangerous trends, but given how German society has dealt with the recent migration wave, there is not just reason for optimism but even pride! There is a striking difference to what we can see in the US and the UK and what we can see in Germany; an unfortunate reversal of roles.
And one important reason for this optimism is the European Union. No, the European Community and later Union was NEVER a purely economic project. The reason why the European Coal and Steel Community was founded in 1951 was to avoid a future war by regulating and integrating heavy industries across the six founding countries (especially France and Germany). The following trend towards further integration, of which the Single Market is the biggest achievement (more than the euro, I would argue), has created one social, political and economic space, which cherishes national and regional differences and fosters exchange along all possible dimensions. Most importantly, the free movement of people, for travel, study and work, has changed life in Europe. I am part of the Interrail Generation and more than happy to see that it is still around (and would support the proposal to give every young European a free Interrail pass). As Kevin Hjortshøj O'Rourke recently pointed out, part of the success of the EU and the Single Market is that a life without borders is seen as normal (I have personally seen the opposite, traveling from Costa Rica to Guatemala by bus in 1992, crossing through Nicaragua, Honduras and El Salvador, with one hour wait at each border and Nicaraguan citizens being accompanied on the bus by Honduran soldiers on the two hour trip through Honduras before arriving in El Salvador)! There are many good things about European integration, but if there is something I definitely hope we can pass on to the next generations, then it is this absence of borders!
So, on this historic day, we shall not just remember the crimes of the past (and we Germans DO have an obligation to teach future generations across the globe about these events), but I think we can also express gratitude for what came afterwards.
1. September 2019
Brexit – the crisis is here
One of the most insightful bloggers on Brexit, Chris Grey, titled his last blog entry “The August serious season before the September crisis”. His timing was off by only one week, as the crisis started this week, before the end of August, with Boris Johnson’s decision to prorogue parliament for five weeks. The reaction was furious, to put it mildly, though observers should not have been surprised by this move. It is clear now that this unelected government, made up to a large extent of opportunists (who previously came out strongly against proroguing parliament), is dead-set on delivering Brexit by any means possible, most likely by a Crash-Brexit on Halloween day. It seems that they are even willing to undermine the long democratic tradition in this country.
Will taking the initiative away from parliament to prevent a Crash Brexit make it more likely that the EU gives in to the demands of Boris Johnson to drop the backstop? I simply cannot see this! Even if they did, there is no guarantee that there won’t be enough ERG members that would vote still against a new deal. And if the EU gave up on the backstop, it would basically agree to putting up a border in Ireland, once the UK leaves the Single Market and the Customs Union. But wouldn’t they have to do it anyway after a Crash Brexit? Yes, but in this case the EU would not be complicit in violating the Good Friday Agreement and in stoking a new wave of conflict in Northern Ireland. And a Crash Brexit would force the UK back to the negotiating table at some point and the three preconditions for a free trade agreement are obvious – money, citizen rights and backstop. One future possible compromise, which could be included in the political declaration now, but in case of a Crash Brexit will certainly come up later, is a referendum in Northern Ireland on whether the backstop and thus avoiding a border on the Irish island would be acceptable (as also suggested in this letter to the editor in the FT). Polls suggest that there is currently a clear majority for the backstop in Northern Ireland. Given that NI has voted clearly in 2016 to stay in the EU and given that the majority of elected representatives in NI are in favour of the backstop, this would be the most democratic solution.
But back to Westminster: There are some options left for the majority in parliament that wants to prevent this Crash Brexit though the legislative path seems more and more difficult. A vote of no confidence can also succeed if there is a clear majority for a new prime minister, but Jeremy Corbyn certainly does not have it – and in this case Boris Johnson could just hold on and run the clock down. One of the remaining options that Tory rebels have is to cross the aisle and sit with one of the opposition parties (be it Lib Dems or be it Change UK) or as independent, making it clear that the Tories plus DUP have no longer a majority. But this is only necessary not sufficient, as the opposition parties would have to agree on a PM candidate who is not Jeremy Corbyn. But there seems a small hope and the more radical the government gets in its actions, the more it might push the opposition within the Tory party towards radical solutions.
It is sad to consider how far the Brexit debate has pushed the UK towards a constitutional crisis. And while everyone seems to have marked Halloween day as the decisive end day, it is clear that it will be just the starting point of the next season of the Brexit tragedy.
29. August 2019
New papers in Review of Finance
Before taking a week off for summer holidays, quick note on two recently accepted papers at the Review of Finance. While my tenure at the RF ended more than 18 months ago, I am still handling papers originally submitted and invited for resubmission during this period. And it is always a pleasure to see papers finally make it to the acceptance stage, significantly improved and with important conclusions. And as the coincidence has it, both papers concern banks’ risk-taking behaviour in the securitization market.
In Arbitraging the Basel Securitization Framework: Evidence from German ABS Investment, Mattias Efing shows how German banks use regulatory arbitrage for additional risk-taking. Specifically, he uses data on ABS investments on the balance sheets of German financial institutions between 2007 to 2012 and shows that banks go for higher-yielding (but therefore also higher risk) securities within the same credit rating (and thus capital risk weight) class. This effect is especially strong for more capital-constrained banks (not quite betting the bank behaviour, but along the same lines).
In Revenge of the Steamroller: ABCP as a Window on Risk Choices, Carlos Arteta, Mark Carey, Ricardo Correa and Jason Kotter explore banks’ incentives to upload on tail risk through bank-sponsored asset-backed-commercial papers. These securities offer relatively low but safe returns during normal times, but large negative returns during distress times due to maturity mis-match and reliance on wholesale funding. The authors find an interesting interaction between governance and government-provided financial safety net (also known as bail-out expectations). On the one hand, banks with managers that had better aligned incentives with shareholder returns were on average less likely to become sponsors. However, for such banks, which also operated with very high implicit government guarantees, this relationship reverses and such banks are more likely to sponsor such vehicles. Another important reminder that assessing the governance of banks is incomplete without considering the role of government (guarantees).
31. July 2019
Boris, oh, Boris!
We seem only a few days away from Boris Johnson becoming Prime Minister, with the firm pledge to take the UK out of the EU by 31 October, “do or die”. Not that anything has changed in the situation or will change before the end of October. Though the tone of the debate has fallen back into war talk – references to a war cabinet, appeals to the Dunkirk spirit, and one of the Brexit MEPs wanting to use the navy to chase out non-British fishing boats from British waters, appealing to the Falklands War spirit. At the same time, the revolution keeps eating its children with Liam Fox, one of the original Brexiteers shedding doubt on a “WTO-Gatt 24” strategy and promptly being disowned by the “true Brexiteers”.
As it currently stands, there seem to be only three options left: try to pass Theresa May’s deal with a few twists and tweaks in the Political Declaration on the future relationship; revoke Article 50 and remain; or crash out. The first option would require quite some political manoeuvring by Boris Johnson; the second seems quite impossible, which leaves the last option. However, there is an increasing opposition to this option even among Conservative MPs and it might come to a constitutional stand-off between a Prime Minister who insists on the default option in the absence of other legislative action and a Parliament insisting that a no-deal Brexit cannot take place. Something that future constitutional scholars will have a field day in discussing and interpreting; in the current time, however, something that will take the British economy and people as hostage. But then again, we seem to be a stage where large part of the Conservative party and a certain part of the country are so obsessed with Brexit that nothing but nothing can stop them, not even the break-up of the United Kingdom, another economic crisis or even the destruction of the Conservative party.
What is the likelihood of each of these options? I get asked repeatedly but will not participate in the betting game. Many far more qualified people come to different conclusions. One thing we can do is to outline the different scenarios that might play out in the different cases. If – against all odds – a slightly revised withdrawal agreement makes it through Parliament, a very long transition period would follow until the relationship between the UK and EU is sorted out; we can expect quite some more political upheaval in the UK during this time. A no-deal or Crash-Brexit would not be that much different but come with significantly higher economic costs. We can expect lots of recriminations against the EU and within the UK, possibly a general election with a very uncertain outcome and a very long period, during which the UK has to sort out its position vis-à-vis the EU and the rest of the world (but from a significantly weakened position). We might also see Irish unification and Scottish independence (ok, that is very speculative, I admit). Common denominator to both options: there is no such thing as a clean Brexit; it is rather the starting point for a decade-long self-finding-cum-difficult-international-negotiations process for the UK.
But what about the UK-US trade agreement and Donald Trump riding in with the cavalry to save the British economy? Right, I will not even consider these ridiculous ideas, as they are so far out there in dream land, that it is not worth wasting anyone’s time. Suffice to say that Donald Trump does NOT care about the UK, but just about weakening the EU; that Congress (where the house is under Democratic control) has to approve such a deal; and that by the time such a trade deal could be ready (think 2024) the whole political landscape might look very different on both sides of the Atlantic.
So, as we are getting ready for the next season of the Brexit soap opera: there will be lots of common themes from previous seasons (as in most soap operas), but with different actors. The autumn promises to be quite action- and emotion-filled; now if only this were a TV show only and not politicians playing with people’s lives.
13. July 2019
Basel III and SME Finance
The Financial Stability Report has just published a draft report for public consultation on the effects of Basel III on SME Finance. My former colleague and co-author Hans Degryse and I have served as academic advisors on this project. This report is part of a larger evaluation programme that also include an evaluation of the effect of Basel III on infrastructure finance (already published) and an evaluation on Too-Big-To-Fail (just starting).
Here is the summary of the findings of the consultative report: “…the analysis thus far does not identify material and persistent negative effects on SME financing in general, although there is some differentiation across jurisdictions. There is some evidence that the more stringent risk-based capital (RBC) requirements under Basel III slowed the pace and in some jurisdictions tightened the conditions of SME lending at the most ‘affected’ banks (i.e. those least capitalised ex ante) relative to other banks. These effects are not homogeneous across jurisdictions and they are generally found to be temporary.” These results are not that surprising for many observers. They come on the background that regulatory subsidies such as the SME supporting factor in the EU have not really helped SME lending as well as previous findings that higher capital requirements negatively affect private second lending at most in the transition period if at all. One important caveat to keep in mind is the heterogeneity across the different FSB jurisdictions, some of which recovered relatively quickly from the Global Financial Crisis, while others took much longer or went back into recession, while introducing regulatory reforms. There are also significant differences in banking sector structures across banks, in terms of ownership and market structures.
While the main text might not give it away, an enormous amount of data and estimation work went into this exercise, undertaken by different teams across jurisdictions and setting an important precedent for future evaluations of regulatory reforms. Different exercises using cross-country data on the bank- or firm-level were accompanied by country-specific exercises using regulatory data for banks and credit registry data. The latter allows for the most rigorous disentanglement of supply and demand-side effects by linking banks to firms and assess changes in lending (conditionality) over time. While this evaluation might not satisfy the much higher causality standards adopted in the development field, it clearly shows the way forward in terms of evaluations of regulatory reforms. And important next step would be to extend the assessment of such reforms to non-FSB member jurisdiction, especially emerging markets and developing economies, as we call for in this recent task force report on Making Basel III work for the EMDEs.
30. June 2019
The architecture of supervision
The decade since the Global Financial Crisis has seen changes in the architecture of supervision across Europe. On the one hand, the tendency to separate the responsibility for monetary and financial stability into two different authorities has been reversed in many countries. One prominent example is the UK where the Financial Supervisory Authority was dissolved and responsibility for bank supervision returned to the Bank of England. On the other hand, there has been a move towards more cross-border cooperation between supervisors, which in the case of the Eurozone culminated in the creation of a Single Supervisory Mechanism and the ECB and a Single Resolution Mechanism.
I have co-authored a discussion paper with several academic and ECB colleagues on an early evaluation of these trends, just published. Unlike a regular paper, this discussion paper takes a broader look at the literature, complemented with some new theoretical and empirical analysis. Herewith a quick summary:
There are theoretical and empirical arguments for combining or separating the responsibility for monetary and financial stability. The recent crises and past decade, however, have shown that monetary and financial stability cannot be separated and that possible tensions between these objectives do not get more easily resolved if assigned to two different authorities. Assessing different hypotheses on supervisory architecture is difficult in a cross-country settings, given endogeneity concerns. However, we offer some tentative evidence that having an integrated supervisory architecture is not associated with higher inflation or lower growth and there is some tentative evidence that it might help reduce the probability of a credit boom turning nasty.
A lot has been written on the advantages of centralised supervision in the Eurozone, including avoiding supervisory arbitrage, economies of scale in supervision and matching the geographic footprint of banks with the supervisory perimeter. There are also shortcomings, however, including an increase in distance between supervisors and supervised institutions. It is certainly too early to come to a clear conclusion on these trade-offs, though it is important to stress that the SSM model is not one of complete but rather partial centralisation, focusing centralised supervision on systemically important institutions and even here combining national and supranational expertise. The next years will certainly see more research in terms of banks’ reaction to these changes in supervisory architecture and its implications for stability.
27. May 2019
Theresa May – a false sense of duty!
As Theresa May announced her resignation, the airwaves and Twitter were full of praise for her sense of duty! As German very conscient of Germany’s dark chapter in the 20th century I am always sceptical of people claiming to do their duty! Though her duty she did – bully and harass legal residents (remember Windrush generation) and foreign university students as Home Secretary – all to draw attention away from the social consequences of Tory austerity. It is telling and noteworthy that before her resignation, newspaper headlines in the UK were dominated by the disenfranchisement of EU citizen in the European Parliamentary Elections. She claimed to have done her duty by trying to implement Brexit – maybe so, but was it her duty to go into the negotiations without any plan and without properly understanding how the EU works and what the constraints of Brexit are? Was it her duty to draw red lines that cannot be respected at the same time (also known as Brexit trilemma)? Was it her duty to pander to the wet dreams of Brexiteers rather than searching for a national consensus? I will spare the reader an answer to these questions! Most telling in recent political obituaries is the statement that she did not realise the consequences of agreeing to the Northern Irish backstop in December 2017! Really?!?!
Exit the Dancing Queen – enter the clown? As Tories (and in a rare political consensus) most of UK’s and Europe’s political class breathe a sigh of relief that she will be gone soon, it is important to stress that nothing but nothing has changed in the Brexit constellation! Will 27 elected heads of EU governments and a recently democratically elected European Parliament get rid of the Northern Ireland backstop and endanger peace in Ireland just because another unelected British prime minister asks them to do so? No need for an answer here! Risk a “clean Brexit” and negotiate from outside with the EU? Sure, the EU will negotiate, with a few preconditions, though, one of which starts with “back” and ends with “stop”. Will it be easier to negotiate for the UK government under the pressure of economic chaos after a Crash-Brexit? I guess some hard questions that the next unelected Prime Minister of the UK should ask him/herself before taking decisions.
In her resignation speech she cited Nicholas Winton who had saved the lives of hundreds of children from Hitler’s death camps. Less than three years after she paraphrased Adolf Hitler in her Citizen of Nowhere speech, this is not just cynical, it is simply disgraceful! In short: Good Riddance.
24. May 2019
Second young writers workshop
I am just coming back from the 2nd young writers workshop in Bonn; 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.
I have discussed some issues in a blog entry two years ago, but have some additional points, partly coming out of discussions with other participants at the workshop. Over the past six years, I have been editor at three different journals, each one with their different approaches and procedures. In the following, I will discuss some important points on the procedures (mainly referring to the JBF) but also more generally on the editorial process.
First, where and when should you submit? Perfect is the enemy of the good; so, there is a point in not waiting too long for submission. Also, some topics are rather hot and there might be other people working on it (as happened to me in my job market paper, though I was lucky and published first). On the other hand, do not submit a paper before you have presented it at conferences, seminars etc. Get as much feedback as possible, before submitting. As pointed out ad nauseam by editors across the profession – editors and referees are not here to help you improve and polish your paper, there are here to judge it and possibly push you the extra step needed. Choosing a journal is always tricky – one school of thought is to always start at the top, as lower-ranked journals are not worth your time (especially with a tenure clock ticking); my approach has been that sometimes I have very interesting projects and papers that might still be worthwhile publishing even if not in a top journal.
Second, what is the process? For the following, I speak mainly for myself, though I assume that my co-editors at the JBF follow similar approaches. There are three options for papers that come into my editorial inbox at the JBF: first, desk rejects (mainly because of limited contribution or being too specialised for the JBF; in some cases where the paper is in my own area and there are clear methodological deficiencies, I also desk-reject); second, papers I handle myself and send out to reviewers; third, papers I assign to an associate editor. Associate editors again have two options; recommend desk-reject or send out to reviewers. Even though managing editors have the final word, it would be rare for me not to follow the advice of the associate editor. In cases of split reviewer decisions, however, I take another close look at the paper and the reports.
Third, when reading for the first time as editor at a paper, what am I looking for? As for most people in our profession, my time is scarce and I expect to get an overview of the paper after having read the introduction, with a first impression at the end of the first page. As I wrote in my earlier blog entry, the four most important messages (motivation, research question, methodology and contribution) have to be clearly presented in the introduction, (ideally) mentioned on the first page, and summarised in the abstract. How important are title and letter to the editor – the former can whet the appetite (but do not ask a question in the title that you then do not answer), the latter is rather unimportant, unless you have something important to tell the editor (conflict with other papers/authors/possible reviewers).
Fourth, how important is a proper identification and has our profession gone too far in focusing on identification rather than stressing research questions and policy implications? It is a question we often discuss also among the managing editors at Economic Policy (who come from different fields of economics). Proper policy advice should be based on proper identification, but there is also the issue of internal vs. external validity (best example is experimental field evidence vs. broad cross-country evidence). One important aspect in this debate is the novelty of the question (where even documenting correlation might be interesting); in more established if not saturated literature it is much less attractive to have yet another paper with half-baked identification. However, confirming a well-established result by a just slightly refined identification strategy might not be as exciting either. But as always, the devil is in the details, so there is no clear answer here.
Fifth, appeals! The first reaction after any rejection is “how stupid are these referees and how could the editor have followed their advice.” Take a deep breath! If you feel like writing a nasty email, write it, save it, read it the next morning, and delete it! Is it worth appealing a decision? I have appealed myself four times over the past 10 years or so, and was successful twice. Do not argue with an editor or referee over lack of contribution or (even worse) poor writing. There are very limited circumstances where such an appeal makes sense, including obvious and critical mistakes of the referees – but these have to be critical for the decision of the editor to reject the paper. Finance journals have tightened the process for appeals quite a lot recently, including that the paper will go to a different editor and a new reviewer, so the hurdle is quite high. In almost all cases, it is best to move on; after carefully considering the comments of the reviewers, as they might be very valid and they might also be your reviewer at the next journal.
Finally, a word of encouragement. There are many reasons why our profession has trended towards co-authored papers, one might be that it is easier to share the frustration of rejections.
11. May 2019