Bank resolution in Portugal and across the globe
My paper “Sharing the Pain? Credit Supply and Real Effects of Bank Bail-ins”, with Andre Silva and Samuel Da-Rocha-Lopes, has been accepted for publication in the Review of Financial Studies. This paper gauge the credit supply and real effects of the resolution of Banco Espirito Santo in Portugal in August 2014. The bank was split into a bad bank, sent into liquidation with equity holders and junior debtholders effectively bailed in, and a good bridge bank (Novo Banco) that continued operating. We find that firms exposed to the failed and resolved bank see a reduction in lending by Novo Banco, but can make up for it by borrowing more from other banks they already have relationships with. However, SMEs exposed to the failed and resolved bank experience a reduction in credit lines and those SMEs with low liquidity reserves before the shock reduced investment and employment, while increasing their liquid assets. In summary, the resolution was not a panacea as there were some real sector effects, but the negative effects were contained. The pain was shared across bailed-in debtholders and some of the banks’ borrowers, but the taxpayer did not have to shoulder the burden, unlike in the case of bailouts.
I have discussed this paper before on my blog and am happy to report that the main message has not changed. But the reviewers and editor pushed us hard to think more carefully about what drives the result that lending by Novo Banco (the “good-bank” remainder of Banco Espirito Santo) went down. Were it the losses in BES? No, as the bridge bank was recapitalised during the resolution to its original level, well above the minimum. Rather, it was the bail-in as part of a broader restructuring process, replacing management, extensive reorganisation and changes in risk management. This is different from bailouts, where management is not necessarily replaced and there is not necessarily a broader reorganisation.
A second interesting result from the revised paper is that on the substitutability of cash reserves and credit lines. There is a clear differential effect between firms with high and low cash reserves before the shock. Those with high reserves can draw down their cash reserves thus making up for the loss in credit lines, while those with low reserves have to refill them after suffering a reduction in credit lines.
While this paper is a case study of one specific bank, in a new paper with Deyan Radev and Isabel Schnabel, we look at the effect of bank resolution frameworks across banks in 22 countries. Rather than specific bank failures, we focus on the reaction of banks’ systemic risk contribution after system-wide shocks across countries with different bank resolution frameworks. This paper is still very much work in progress so I will leave the discussion for another day.
21. February 2020
Postcard from Barbados
I am on my way back from Barbados – not for an early spring break, but rather an IDB workshop on economic inclusion. It was my first time in this beautiful region in the world (but certainly won’t be the last time). Opening remarks by politicians are typically not the highlights of any workshop, but it was refreshing to listen to the Prime Minister of Barbados delivering competent and data-based remarks on the situation in her country, without the bluster or empty words that we have had to get used to in the US, UK and some European countries.
Not surprising, my presentation was focused on financial sector development and inclusion in the Caribbean – more specifically, on the six countries of the IDB Caribbean country department Bahamas, Barbados, Guyana, Jamaica, Suriname and Trinidad and Tobago. It is quite a mixed group of high- and middle-income countries, two of which have off-shore financial systems and some of which have natural resource-based economies. However, there are several common themes: One is the need of an efficient financial system to provide risk mitigation instruments due to natural disasters. More than in other regions of the world and increasingly so in times of climate change, this function of the financial system is critical and might also explain why in many countries of this region the insurance sectors are relatively well developed.
Another common theme is that of the small size of all six economies and, hence, their financial systems. Their banking systems are concentrated with few banks, thus reducing competition. Stock markets are large compared to the size and income level of the host economies, but exhibit a very low liquidity – a phenomenon that can be directly linked back to the small scale, as it is especially public capital markets that rely on network externalities. The small scale makes a focus on competition and contestability in the financial system even more important, which includes tapping the potential of non-bank players such as fintech.
The dominance of banking within the broader financial systems in the six countries also limits financing options for SMEs. As I have repeatedly argued, the segment of micro-, small and mid-sized enterprises is a very diverse one; and rather than focusing on the size criterion, the age of enterprises and the character of entrepreneurs as lifestyle or transformational entrepreneurs might be more important. This also implies a diversity of different financial products and players and looking beyond banks, which might not be best positioned to finance, e.g., start-up companies. It also implies the need to look beyond the borders of each economy and draw on resources and expertise from the global financial system.
7. February 2020
Brexit, finally!
So here we are. More than 3.5 years after the referendum the UK finally leaves the EU. The cliff-edge of a no-deal Brexit has been avoided, to be replaced with the fear of a no-trade deal cliff-edge at the end of 2020 when the transition period ends.
Before leaving, the public was again exposed to the rather confused approach of the UK to the EU and Brexit. A few days ago, even the Brexit MEPs noticed that Brexit implies loss of influence in Brussels. And last weekend the FT exposed us to the confusion that many British intellectuals have about the EU and the role of the UK in Europe as well the Little England philosophy. And while the EU has clearly set out its negotiation strategy, the UK government keeps sending confusing signals (one day it is complete divergence in regulatory standards, the next day no divergence at any price). If this looks like deja-vu from the withdrawal treaty negotiations, then yes, welcome to the next season of the Brexit soap opera.
As Tony Connelly pointed out, the negotiations will not result in a Canada plus/minus agreement, but rather in a Swiss-type approach, especially given the time pressure, a patchwork of different agreements, with permanent negotiations for the next decade. So, the end of the transition period will be dominated by Swiss cheese – a new framework of EU-UK relationships with lots of holes. In addition to negotiations on the future relationship between the UK and the EU, the practical arrangements for the customs border between Great Britain and Northern Ireland will offer ample space for conflicts in the future. And the more the UK diverges from the EU, the harder the Irish Sea customs border turns.
Boris Johnson has declared that Brexit is done and that the word is not to be used after 11 pm tonight. Some observers predict that trade negotiations are technical so will not attract headlines. But how will he (and government, Tories, Brexit media etc.) refer to the negotiations with the EU, especially once they turn nasty and affect the future of manufacturing companies in the UK? What about the future of the fishery industry? Will they claim that the EU is taking revenge against the “independent UK” after Brexit by not allowing the UK to have its cake and eat it? Will they blame again the civil servants for caving in? And what if the dream of a US and an EU trade agreement before the end of the year is not achieved? It will be hard to disentangle the next phase from the previous one, even in the mind of the most-convinced Brexit voters.
There is more and more evidence on the high price that the UK has already paid for Brexit over the past year, with the weekly bill now even exceeding the fake 350 millions Brexiters claimed the UK pays to the EU every week. There are now clear indications that the manufacturing sector will decline if the Johnson government follows its approach of divergence from the EU (and even under a zero-tariffs, zero quota regime). But will Brexiters ever acknowledge that there were wrong in their predictions? Certainly not; it will always be someone else’s fault. And assuming there will be no cliff-edge at the end of the transition period (either because it gets extended or there will be a bare-bone agreement in place with lots of additional temporary measures unilaterally introduced by the EU), the decline will be a slow one. In addition, the economic predictions of lower growth and GDP loss are under ceteris paribus assumptions (with lots of other things moving, e.g., increasing government deficits to cushion any economic hit), so simple comparisons undertaken in ten years might not give necessarily the same picture as a hypothetical counterfactual of the UK having stayed in the EU.
There are those who hope that the UK will rejoin the EU quickly. I think this is a rather naïve hope. It would require a much broader political and societal consensus than 52-48 to do so and the UK is far away from that. And there is the “minor” issue that leavers and remainers keep forgetting – joining the EU is based on negotiations between the UK and the EU! The best that remainers (after 11 pm aka rejoiners) can hope for and should work towards is a closer alignment of the UK with the EU in the future, the Norway model, which in turn might eventually lead to a rejoining in the second half of this century.
Today is a sad day. Brexit makes the UK poorer and the EU smaller and possibly weaker. Unfortunately, it is not the end of a sad story, but just the beginning of what will be a fraught cross-channel relationship, with lots of potential for future conflicts.
31. January 2020
Financial stability in Paris
My last conference of the year (and even decade) was on Funding Stability and Financial Regulation and organised by ACPR and ANR in Paris. Yet, another financial stability workshop, I thought, but it turned out to include a number of very interesting and policy-relevant papers, some of whom I will mention in the following. I will not discuss my own paper, as I will dedicate a separate blog entry to it next year, when a presentable working paper version will be finally ready.
Helene Rey presented work on Machine Learning and the Financial Crisis. Using a general framework that draws on different crisis prediction models in a type of meta-analysis, it improves on standard crisis prediction models (which typically have a relatively poor out-of-sample prediction power) and is able to predict systemic financial crises 12 quarters ahead in quasi-real time with very high signal to noise ratio. Melina Papoutsi shows the importance of lending relationship for borrowers that fall in distress. Using data from Greece, she shows that firms that experience an exogenous interruption in their loan officer relationship are less likely to renegotiate their loans and, if they manage to renegotiate, they are given relatively tougher loan terms, compared to firms whose loan officer relationships were not interrupted. Relating this to my own work, yet again, more evidence that personal lending relationships are far from dead. My former colleague Max Bruche presented fascinating work on leveraged loan syndication (a better description would be: junk loan syndication), making a strong case that supervisors better pay more attention to retention risk in this market segment. Neeltje van Horen presented a paper that is effectively an impact evaluation of Basel III on the repo market. Specifically, she shows that the adoption of the leverage ratio (which should have a dampening effect on low-margin business such as repo transactions) had transitory effects on the access to the repo markets by smaller clients. Thibault Libert shows that large borrowers can have an impact on aggregate lending, in work that uses credit registry data from France and builds on an expanding literature that looks at the importance of firm-specific shocks for macro-aggregates. Laura Blattner uses Portuguese credit registry data to show that increased capital requirement can have perverse consequences as affected banks respond by not only cutting lending but also by reallocating credit to distressed firms with underreported loan losses. Finally, Eva Schliephake presented some very interesting theory work on how informed and uninformed depositors interact in bank runs, showing that more information can actually result in a higher likelihood of panic runs.
23. Deember 2019
Brexit – a new trilemma
The voters have spoken and the uncertainty is over. Unless something unexpected happens in the next few weeks, the UK will finally leave the EU on 31 January. There must be quite a feeling of relief in Brussels and across the EU that the naughty kid has finally decided to leave. But the show will go on – far from getting Brexit done, in February the new season of the Brexit show will start, this time negotiating the future relationship between the EU and UK. It will then become clear that Boris Johnson has fooled his voters yet again – after lies about 350m extra for the NHS and about no controls in the Irish Sea. There will be a rather long drawn-out negotiation with the EU on the future trade relationship. Of course, this can be done within three months, if the UK accepts everything (EVERYTHING) the EU proposes (including in such sensitive areas as fishing and the UK following EU rules). And even that would have to imply that there are no contrasting interests among the 27 member countries of the EU in these negotiations – unlike in the withdrawal negotiations, where little conflict could be expected among EU member states on money (more is better), EU citizen rights (as water tight guarantees as possible) and avoiding a border across Ireland. All three objectives are achieved with the withdrawal treaty, but the interests among EU member states might very well diverge when it comes to the new relationship with the UK. And let’s not forget that unlike the withdrawal agreement, a comprehensive free trade agreement between the EU and the UK has to be approved by all national parliaments as well as some regional ones.
So, here is the new Brexit trilemma – there are three objectives for the Johnson government– (i) exit from transition phase by end-2020, (ii) get as good a deal as possible for the UK economy and the Conservative Party, and (iii) avoid another no-deal cliff edge at the end of the transition period - and at most two can be achieved. To achieve (i) and (iii), (ii) has to give, i.e., the UK has to accept everything the EU proposes. To achieve (ii) and (iii), (i) has to give, i.e., at a minimum a two-year extension of the transition period has to be accepted by the UK government. Objectives (i) and (ii) are not compatible from the start.
What will happen? What will Boris Johnson do? He threw the DUP over board when it was convenient in order to get a deal with Brussels that ensures no border in Ireland but a border in the Irish Sea. Will the ultra-Brexiteers among the Tories also just roll over when he defaults on all his promises to them? If he gets the big majority the exit polls predict, he might not care. He can then either agree to an extension of the transition period (more likely) or give in to all of the EU’s proposals (less likely). In any case, I would argue that the new deadline is now 2024, i.e., the Conservatives will aim to get all new relationship with EU defined before the next elevations. It does promise many more seasons of the Brexit soap opera then.
These landslide results also indicate that the opposition has failed. It has failed to successfully make the case for a second referendum. It has failed to combine forces to translate a large voting share into actual seats at parliament. It has failed to stop the populist nationalist English wave. We will see a lot of infighting in the Labour Party over the next year or so and a lot of soul-searching among the Liberal Democrats.
My comments so far have been somewhat removed, without personal touch – it does help that I am in Sydney right now, far away from the Brexit mess. But on a personal level, there is a degree of sadness, somewhat similar to the morning of 24 June 2016, a feeling of loss and finality. It is sad to see a country close itself off the world and embark on a long path to long-term decline. It is scary to see its governing party appeal to people’s lowest instincts of xenophobia and attack the media at every feasible point. If this sounds familiar – yes, there are clear parallels now between the transformation of the Republican party in the US and the Tories in the UK – though there is hope of a post-Trump era for the US and the Republican party, whereas it seems harder to revert the populist trends in the UK. As an economist and observer, the next years promise to be as interesting as the last three, as UK resident, it is dispiriting and sad.
13. December 2019
Infrastructure finance in Latin America
Yesterday, I participated in an exciting panel discussion on infrastructure finance at the IFABS conference in Medellin, together with Eduardo Cavallo (IDB) and Alejandro Sanchez (Corficolombiana), thus combining practitioner, policy and academic viewpoints. There are lots of things to be noted on this topic, so here just some highlights – linking also to some projects I have done in this area over the past years. First, on a theoretical and practical level, infrastructure finance (or project finance more broadly) shows several characteristics that increase cost and risk profile – large size (requiring syndicates), long maturities, a lack of collateralizable assets in the early stages of funding and repayment flows only feasible after the construction phase. There are also higher skill and capacity requirements in infrastructure compared to other financing modes. These challenges have been around for many decades and it is an on-going area of learning, both for practitioners and policymakers. This also implies that one segment of the financial sector might not be positioned well to take on this challenge by itself, nor the private or public sector independently. It also implies that there are many policy and regulatory challenges in this space and a close connection with the larger challenge of financial sector development.
Second, as pointed out by Eduardo, most of infrastructure financing in Latin America is undertaken by banks, rather than non-bank financial institutions, which would be much better positioned to do so. Specifically, pension and mutual funds are in a better position (especially the former due to long-term liabilities and the latter due to risk profile) to invest in infrastructure. My own case study for Colombia (undertaken a few years ago for the IDB) shows that pension funds are relatively well developed in Colombia, though mutual funds focus mostly on low-risk, low-return securities (also referred to as “AAA-itis”). So, infrastructure is still supported mainly by banks rather than by non-banks. On the upside, the Financiera de Desarrollo Nacional, set up in 2011 by the government, with support from IFC and CAF, as well as – at a later stage – by the IDB, has evolved into a best practice example of public-private partnership taking on a critical role in structuring financing arrangements using a mix of instruments. It has successfully provided not only direct finance, but also been a catalyst in bringing in domestic and foreign private funding for infrastructure. However, broader challenges in long-term finance continue: how to bring a larger share of the active population into the pension fund system – mainly a problem of informality -, how to address the high concentration in the pension fund industry and how to lower entry barriers. The ultimate challenge, however, is: how to increase the risk appetite of non-bank financial institutions?
Third, has regulatory tightening under Basel III resulted in banks moving even further away from infrastructure financing, given the recent regulatory focus on reducing maturity mis-matches? This FSB evaluation suggests that no, but some caveats are due with such an assessment, including that the impact on infrastructure finance is likely to be slower moving than that on other segments because infrastructure finance involves fewer larger transactions, typically with longer maturities. In this taskforce report with Liliana Rojas Suarez, we point to several potential adverse effects that Basel III can have on infrastructure finance (through liquidity requirements, output floor, exposure limits etc.). Most important, however, seems the lack of infrastructure as asset class. If projects can be developed in a more standardized fashion, and if there is agreement on the different dimensions of risk and how they should be quantified, it may become easier to issue securities backed by infrastructure projects, potentially also resulting in lower risk weights. This could allow banks to finance infrastructure projects in the early stage before selling them off. It also makes investment by non-bank financial institutions in such projects more likely!
Finally, infrastructure finance is part of the larger long-term finance landscape. While the focus of researchers and policymakers has been on financial inclusion over the past decade, it is important to focus again more prominently on the challenges of long-term finance. I have earlier written about an effort to get data on long-term finance for Africa. The strong needs in infrastructure funding as well as long-term funding needs by firms and households calls for a comprehensive approach to strengthen the intermediation and maturity transformation capacity of banks and non-banks alike, taking into account their critical linkages and synergy effects.
6. December 2019
Entrepreneurship and finance – the bright and dark sides
I had the pleasure of discussing two excellent papers at the 1st Finance and productivity conference at the EBRD this week, on the role of finance in fostering or impeding entrepreneurship. Christoph Albert and Andrea Caggese use survey data from the Global Entrepreneurship Monitor for 21 OECD countries over the period 2002 to 2013 and show that GDP and financial sector shocks hurt the establishment of new enterprises, especially of high-growth enterprises, providing convincing evidence that financing constraints are especially binding for transformational, potentially high-growth entrepreneurs. Nandini Gupta and Isaac Hamaco, on the other hand, document a drain brain from manufacturing into the financial sector in the US. Specifically, engineering graduates between 1998 and 2006 are more likely to work in financial sector if they start out in an area with a higher share (and thus higher growth) of financial sector employment or study in a state that deregulates interstate banking. This, in turn, results in relatively fewer start-ups founded by engineering graduates that go into finance, as well as less innovation and less VC funding by such start-ups.
Together, these papers add evidence to two strands of the macro-finance literature that have developed somewhat parallel – on the one hand, the importance of alleviating financing constraints to foster entrepreneurship and thus ultimately improve resource allocation and increase productivity growth; on the other hand, the unhealthy growth of the financial sector, extracting rents from the real economy and drawing talent away from the manufacturing sector. Both papers thus relate to the decline in start-ups (as documented for the US in this Economic Policy paper, which also shows that it is not related to higher federal regulation) and the slow-down in productivity growth. But what to make of the seeming contradiction – financing constraints vs. brain drain? Well, these findings are consistent with an important role of financial intermediation for economic growth (which works through productivity growth and thus entrepreneurship), but also with a growth-impeding effect of an oversized financial system that does not necessarily focus on intermediation anymore. It is thus consistent with tentative results that Hans Degryse, Christiane Kneer and I documented - financial intermediation helps growth in the long-run, while an indicator gauging the size of the financial sector (e.g., employment share) results in higher short-term growth, but higher growth volatility in the long-term. These findings are also consistent with work by Christiane Kneer who documented a brain drain, looking specifically at the US – industries with higher financing needs benefit from a larger financial sector, while industries with a higher share of R&D and skilled workers actually loose. In summary, efficient financial services are important for the real sector, while an oversized financial system is not necessarily and might even be damaging for the real sector.
2. December 2019
Technology and the future of banking
The future of banking in light of technological disruption has been high on the agenda of banking sector analysts, policy makers and researchers. The Libra announcement by Facebook has raised the urgency of the topic of digital currencies in central bank corridors around the world. As most banking/corporate finance researchers, I have somewhat contributed to this literature by (i) looking at the effects of financial innovation in banking more generally (finding both a stability-reducing and growth-enhancing effect) and (ii) analysing the real sector effects of mobile money in Kenya. While both studies are (by their empirical nature) backward-looking, I am also getting involved in more conceptual discussions, both on the inclusion as on the stability side. So, in the next few months, I will publish some thoughts on the future of banking and technological disruption on my blog – all of this purely my own thoughts, but often based on other people’s research.
Financial innovation has been around for centuries and often has had disruptive effects. The introduction of the ATM in the 1970s allowed US banks facing geographical constraints to undermine them and ultimately contributed to the liberalisation of branching restrictions in the US. Financial innovation often comes in the form of new types of intermediaries. As discussed by Laeven, Levine and Michalopoulos (2015), specialized investment banks emerged to facilitate the construction of vast railroad networks in the 19th and 20th centuries across North America and Europe, screening and monitoring borrowers on behalf of disperse and distant investors. In the second half of the 20th century, venture capital funds arose to finance IT start-ups, characterized by limited if any tangible assets that could be used as collateral and thus requiring patient investment capital and close screening and monitoring as well as technical advice. Today’s disrupters are FinTech and BigTech companies, although there is a big difference between the two. FinTech refers to technology-enabled innovation in financial services with associated new business models, applications, processes or products, all of which have a material effect on the provision of financial services. While often undertaken by independent start-ups they do not really compete against banks – to the contrary, banks encourage experimentation in this space and often take over successful companies. BigTech companies, on the other hand, are large existing companies whose primary activity is in the provision of digital (platform) services, rather than financial services; for these companies financial services is thus an add-on service. A critical difference between BigTech companies and other large companies that (want to) branch out into financial services (e,.g, Banco Azteca in Mexico, Walmart in the US) can be summarised with the acronym DNA, an expression coined by the BIS – data, network and artificial intelligence. Banks have always relied on their ability to collect and process hard and soft information about borrowers; BigTech firms have such data readily available from their non-financial business with customers; artificial intelligence allows them to also convert soft information into hard information. Several papers have shown that information collected this way is better in predicting default than information shared between banks in credit registries (e.g., here and here). In addition, given their platform character, BigTechs enjoy network economies, helping to reduce transaction costs and allowing better diversification. This provides the chance for BigTech companies to enter areas so far dominated by banks, including retail banking.
The increasing accumulation of data raises important questions on the use of such data but also the ownership of data. The Open Banking initiative in the EU allows customers to share data across different banking institutions. The question is whether this should be expanded to BigTech companies, especially when they move into financial service provision. It also raises concerns on new risk sources, such as cyber risk, and might require a stronger focus of regulators on consumer protection.
The possibility to use an increasing amount of data also raises question on how they are being used. The financing constraint view has argued that more data allows more efficient provision of financial services and allows reaching households and small enterprises that so far have been excluded due to their lack of collateral and audited accounts. Credit registries are typically seen as critical component of the institutional infrastructure underpinning financial deepening, as they allow clients to build up reputation collateral. On the other hand, there is increasing evidence that such data can also be used for client-specific targeting. More data allow price discrimination and targeted shrouding, where the latter is more consequential in finance, given intertemporal nature of contracts. I recently had the honour of discussing a paper by Antoinette Schoar showing exactly that for credit card offers in the US: Less educated consumers receive more back-loaded terms (low teaser interest rate but high late-payment fees), and more shrouded offers, exploiting behavioural biases.
In summary, the financialisation of the modern economy and society seems to give way to the digitalisation of finance. This offers great opportunities for innovation and increased competition in the financial sector, but also lots of public policy challenges. In a future blog entry, I will focus more on the stability challenges.
28. November 2019
Neo-liberalism vs. Marxism revisited
There have been quite some events – some more peaceful than others – over the past weeks that have put different outspoken economists in conflict. Take Chile where a price rise in public transport was the spark that set off week-long violent protests against the government, with wide spread destruction of public infrastructure (most notably the Santiago metro, which I fondly remember from past visits) as well as police violence. These protests came as a big surprise to many; after all, Chile has been regarded as a Latin American success story having reached high-income status and being a healthy democracy. Obviously, not everything has been as good as it looks from the outside. Some regard this as the ultimate proof that “neo-liberal” reforms have failed, achieving growth only for the 1% and not the 99% (to borrow one of Jeremy Corbyn’s slogans). Top of the list of “failed reforms” are pension and health insurance. What these critics seem to ignore is that income inequality has actually reduced over the past years, even though from a very high level. Throwing the baby out with the bathwater (as Jeremy would also love to do in the UK) does not seem the right answer. But two things seem problematic in Chile (and I am NOT talking as a Chile expert, simply from outside observation and drawing on broad experience in Latin American economies) – a very limited civil society and democratic participation (especially in comparison with other – European – high-income countries), with voter turnout dropping below 50% after voting stopped being mandatory, and the problem of a small market. A small economy easily allows the establishment of monopolies, especially if you have a small political and business elite and if the two are closely interlinked – so, in addition to the market not being able to maintain to many players, there is a political and thus regulatory bias in favour of incumbents. Again, I am not trying to undertake a comprehensive analysis of Chile, but this crisis certainly drives home one point (and here I am in synch with the above mentioned critics): per capita growth is not enough – income and wealth distribution is critical (where economists have moved to analyse the former, there is still limited analysis of the latter). And we also have to move beyond material achievements! In the short-run, I am most concerned about the well-being of my Chilean co-authors and friend; in the long-run, this crisis has given us lots of food for thought (and research).
Take next Bolivia – a coup or a public uprising? While working for the World Bank in the early 2000s, I was struck by the enormous contrast between the rich (and white) neighbourhoods (e.g., Zona Sur in La Paz) and the indigenous neighbourhoods (large parts of La Paz but especially El Alto). The early 2000s was a time of crisis and I still remember an intensive discussion with students and social activists during one of my World Bank missions – the conclusion was that much more was needed to address the underlying socio-economic problems than the technocratic solutions we were offering. I also remember a conversation with the representative of the chamber of commerce who saw us out at the end of the meeting on bank and corporate restructuring, opened the door and said: “Well, we have had a very nice and interesting discussions, but out there – that is the real Bolivia,”, referring to the informal economy so predominant in Bolivia. Evo Morales has brought enormous change to his country, addressing an important historic injustice by giving voice and power to the indigenous population. He managed the natural resource wave somewhat smarter than other “leftists” in the region (especially Argentina). But as so often, entrenchment in power leads to hubris and arrogance. It was pretty clear that there was cheating at the last election, which triggered the protests. Ideally, he would have stayed on as caretaker president with a commitment not to run again (as per the referendum result in 2016), but unfortunately, the tension had raised to a point where this no longer seemed possible. One can only hope that the Bolivian political system is capable of managing the transition to peaceful elections and a new government. As in Chile, the situation in Bolivia does not lend itself to the neo-liberalism vs. socialism contrast, but has many more facets.
And to round this up, there was a row about libertarianism, Marxism and the Doing Business indicators. Simeon Djankov, a former World Bank colleague of mine (and who returned to the World Bank a few months ago) dismissed criticism by economists of the Center for Global Development by referring to them as Marxists. He did make a valid point that Doing Business gauges the business environment and not economic and societal success; I disagree with him when he implies that there is no philosophy or (at a minimum) hypothesis behind the data collection - whenever you collect data, there is always some idea in the background, in the case of Simeon, one only has to consult the multiple publications that use the data. More generally, the labelling of critics with historic ideologies is not conducive at all to a fruitful debate. I have written on Doing Business before and will not warm up old debates, but we have to get back to a point where we can discuss theories, empirical findings, policies, and – most importantly – recent events without referring to silly labels and point scoring.
15. November 2019
Long-term finance in Africa
Financial inclusion has been at the top of the agenda for financial development researchers and policy makers over the past decade. There has been enormous progress in data collection, financial innovation and policy formulation in this area. Another important area of finance, however, has been long-term finance, the provision of long-term savings and credit services for households, enterprises and governments. It is a challenge in advanced and developing countries alike. In Europe, the objective of creating a capital market union is partly driven by the objective of more long-term financing. In developing countries, there is a remarkable long-term finance gap, with underdeveloped capital markets and contractual savings institutions and banks focusing mostly on short-term transactions.
But how much long-term finance is there actually? And what are the bottlenecks to increasing the provision of long-term finance? I have worked on this challenge across two continents - in Latin America for the Inter-American Development Bank, developing a scoreboard and undertaking country diagnostics in Colombia and Paraguay (unfortunately, only the former has been published) and in Africa for a consortium of donors, helping to develop a long-term finance scoreboard.
This long-term finance scoreboard was finally launched today, providing an array of data on long-term finance in Africa. Some of the data were compiled from readily available cross-country databases, other through survey work, undertaken with the invaluable help of the African Development Bank’s Statistics Department. The result is a website which allows users to compare different countries or focus on one specific country. It presents indicators across different dimensions - the depth of long-term financial markets, access to these markets, different sources of funding and policies and institutions supporting long-term finance. Critically, it also provides the results of a benchmarking exercise, which compares countries’ indicators of long-term finance with a synthetic benchmark that takes into account the socio-economic characteristics of each country.
One critical factor for the financial inclusion revolution was the availability of data, which allowed benchmarking countries and progress over time and the success of policy reforms. We hope that this long-term finance scoreboard will be the first step in a similar revolution - it starts with measuring, it continues with policy reform and it (hopefully) ends with progress.
30. October 2019
Brexit – more action, same themes
It is always insightful to look at Brexit from a safe distance, such as Santorini where I spent the last few days relaxing. As the Brexit soap opera races towards its next season finale, many of the same themes that have become so familiar over the past 3.5 years are being revisited. And from the outside, the Westminster debate looks as ridiculous as they have over the past years, with politicians seeing Brexit as the response to a question they have forgotten.
First, the Brexit trilemma is alive and kicking, with the UK wide backstop negotiated by Theresa May replaced with a Northern Ireland front-stop, taking NI effectively out of the UK customs union and internal single market. As repeated ad nauseam by many observers, only two out the following three can be achieved: no border in Ireland, UK leaving the European customs union and Single Market, and no border in the Irish Sea. The last one had to give under Johnson’s deal, resulting in a rude awakening for the DUP who felt themselves let down not only by the Tory government but especially by the Brexiters in the ERG.
Second, the utter incompetence of Tory ministers has been proven again, such as when not being able to respond whether or not there would be customs control between Great Britain and Northern Ireland (yes, there will be and they will not go away with a Free Trade Agreement between the UK and the EU as some suggested). Also, the idea that this FTA can be negotiated within the next 14 months of the transition period is on the same level as the prediction that it will be the easiest trade deal negotiated in human history.
Third, the idea that Brexit will help take back control. Once Article 50 was triggered, all control was with the EU, including the option to avoid no-Deal (better described as Crash) Brexit. The same will repeat itself at the end of 2020 when the extension of the transition period has to be agreed on. And this daunting cliff will also put the UK in a weaker position during the trade negotiations. But, yes, the UK has had enough of experts who have pointed this out for the past 3.5 years!
Fourth, the idea that once Brexit has been “achieved”, it will all be done, the nation can find again together and the government can turn its attention to more pressing issues. The simple fact that post-Brexit the relationship of the UK not only with the EU has to be redefined, but also trade negotiations with many other countries will be informed by the future UK-EU deal tells us otherwise. The anger on the Remainers’ side if and after Brexit happens will not go away. Add to this the anger of Brexiters who will not get to see the blooming landscapes promised in 2016. And the continuous negotiations with the EU will give lot of opportunities to Brexiter politicians to grand-stand, threaten with the Royal Navy, appeal to the German car industry etc.
Can Brexit still be avoided? Johnson has certainly been poorly advised over the past months. He could have gotten his deal through Parliament, if not by Halloween, then by mid-November or so. But he certainly behaves like a spoiled toddler who keeps throwing his toys out of the sandbox if things do not go exactly his way. The opposition is as hopeless, I should add! Yes, they got together to prevent a Crash Brexit. But the obvious consequence - link the new deal with a confirmatory referendum - seems not to be part of their agenda; Remainers obviously want a referendum as a last chance to reverse Brexit before it happens, but sensible Leavers (i.e., politicians who originally were in favour of Remain, but feel obliged to implement the result of the 2016 referendum) should clearly see that only a referendum will be able to settle the issue in a democratic manner, much more than a general election.
As so often before, it is hard to predict what will happen next. It is unlikely that there will be Brexit next Thursday, but apart from that, many things can happen, including a General Election. And even as the EU and its member countries’ governments are losing patience with the Westminster chaos, they are unlikely to pull the plug! Although the arguments stay the same, there is lots of new excitement to be expected in the last two months of 2019.
25. October 2019
Postcard from Beijing
I just came from China where I spent an intensive week giving talks at UIBE and Peking University and meeting lots of outstanding academics (including several Tilburg/EBC alumni). I am truly impressed how the academic scene in economics and finance has developed since my last visit in 2014. Luckily, the weather also played a positive role during the week, with a mostly blue sky. And not being able to access twitter for five days might actually have been positive for psyche.
One important question that came up again and again was to which extent research on the Chinese financial system is of interest and relevance for a non-Chinese audience; my response was always an emphatic yes. First, there are a number of valuable sources of micro-data, including firm- and bank-level data. There have also been several interesting macroeconomic developments and policy changes over the past years that can be exploited (boom-bust cycle in the stock market; branch deregulation; expansion of postal savings bank into lending; changes in corporate governance rules).
Second, the financial system in China is a very diverse one. On the one hand, it seems antiquated, with an important role for large state-owned banks and (until recently) quite some restrictions, including on interest rates. On the other hand, financial development has leap-frogged the West, primarily in payment services but increasingly also in other areas, with an important role for BigTechs; when I asked my host whether the Chinese bills I had brought from my last visit were still valid, he laughed and said that it might be difficult to pay with cash at all. These challenges will provide new research questions to be answered primarily with micro-data.
So, the question is no longer whether China is different but what we can learn from these differences between China and other countries as well as differences within China. China stands to become not only a powerhouse in economic research but also an important source for novel research questions and data!
20. October 2019
Randomistas rule
This year’s Nobel Prize in economics went to Abhijit Banerjee, Esther Duflo and Michael Kremer for their work on understanding development and poverty alleviation. A lot has been written about their research and the significance of this prize for the broader community of development economists but academic economists more generally (young and still active researchers as well increasing diversity), so what does a non-randomista like myself who works with observational rather than experimental data have to add? I enjoyed both the commentary of Martin Sandbu in the FT and my former WB colleague David McKenzie. Among the few things I’d like to add are the following four:
First, a setting under control of researchers as in randomised control trials is now often treated as gold standard. And even though there is an ongoing debate on the advantages and shortcomings of this approach, it certainly has raised the bar for inferring causality, including for non-experimental settings. And while some argue that the identification focus has gone too far, I am convinced that proper policy implications can only be drawn where endogeneity is successfully addressed. By the way a discussion we have had also in journals such as Economic Policy, which never has published any randomised control trial.
Second, while Abhijit, Esther and Michael have applied their methodology across a large number of fields, their approach has become dominant in the field of assessing microfinance interventions and has provided very useful insights. Having myself worked intensively in the field of financial inclusion, financial development and poverty alleviation, I see their findings as very much complimentary to the research I have done. Their findings of a moderate but not transformative effect of microcredit (as quoted in the committee’s document as “On credit, growing evidence indicates that microfinance programs do not have the development effects that many had thought when these programs were introduced on a large scale.”) is critical in assessing the role of finance for poverty alleviation and points to other channels, such as credit for SMEs and job creation, through which financial deepening can contribute to poverty alleviation.
Third, the increasing importance of randomised control trials has not only forced academics out of the ivory tower but also shown the importance of cooperation between researchers, practitioners and policy makers. Researchers’ ultimate objective should be to influence the policy debate and process; addressing questions with direct policy relevance is thus critical. This in turn implies continuous engagement with policy makers, to gain insights into their policy concerns and to feed back into the policy process. Similarly, direct interaction with financial institutions (be they microfinance NGO or banks) is critical for both sides – access to data and research questions for researchers and influencing the structure and behaviour of these institutions. This also applies to non-randomistas. To give one example, exploiting credit registry data (often housed at central banks) can lead to a broader cooperation between central banks and researchers that result in important policy research, but also translation of research into policy actions and improvements in data collection.
Finally, the RCT revolution has led to a rethinking of evaluation in the donor community. I have been myself part of this as member of the FMO advisory panel on evaluation. And again, while little of the evaluation taking place actually relies on field experiments, the focus of development economists on experimental set-up has led to a paradigm shift in evaluation work, away from counting jobs that were supposedly created by an intervention to focusing on additionality and contribution of an intervention to an ultimate outcome.
16. October 2019