Long-term finance in Africa – the website
I have discussed the issue of long-term finance in previous occasions (here and here). After many years of work, yesterday saw the formal launch of the website. While not formally involved anymore, I was invited as panellist to discuss the importance of this initiative during the launch event. While the main focus of the event was to describe the website, with the available data, tools and country reports, we also discussed the importance of long-term finance as part of the overall financial deepening process and, more importantly, as critical for infrastructure, housing and private sector development in Africa. Unlike the development success stories of East Asia, African countries are unlikely to ever be able to exclusively rely on domestic savings for long-term financing and will have to attract foreign funding, both private and public. The bottleneck, however, is more in the intermediation capacity, in channelling funds to where it is needed most – this is both due to lack of adequate institutions, markets and products, but also due to missing ‘infrastructure’ to better manage risks, including effective collateral and credit registries. Another important element (and here we can certainly learn from the East Asian success stories) is an important role for private-public partnership, including public guarantees to lengthen the maturity of funding. While it is always tempting to try to identify the one silver bullet that will unleash a stream of long-term finance, it is a long agenda and in many aspects a very country-specific one. It is therefore important to look at the two components of this initiative as complementary – the scoreboard, based on cross-country data, and the country diagnostics. Quantitative data can only go so far to produce a good picture – it is like a picture from 30,000 feet, which has to be complemented by on-the-grounds assessment, both with country-specific granular data and qualitative assessment.
If you want to change something you have to measure it first. However, it is not sufficient just to collect data and make them available, but these data have to become part of the conversation. So, having data and presenting them in a reader-friendly way is a necessary but not sufficient condition for informing the conversation on long-term finance. Dissemination is key, but also full of pitfalls, as I discussed here – specifically, the scoreboard is not about ranking, but about stock-taking, identifying bottlenecks and policies to address constraints.
14. July 2021
Politics and finance – the second edition
Last week saw the second edition of the London Political Finance Workshop, as last year on-line. There were eight outstanding papers; as I won’t be able to do justice to all of them, a quick overview of some of them.
In Power, Scrutiny, and Congressmen’s Favoritism for Friends’ Firms, Kieu-Trang Nguyen and co-authors question the standard wisdom that “power tends to corrupt and absolute power corrupts absolutely”. Rather, using a Regression Discontinuity Design of close Congress elections in the US, they find evidence a politician’s win reduces his or her former classmates’ firms stock value by 2.8%. This adverse effect is most prominent among younger candidates, when career concerns are arguably the strongest. They explain this result with politicians reducing quid-pro-quo favours towards connected firms to preserve their career prospects when attaining higher-powered positions. Certainly a surprising result, but it clearly underlines the importance of scrutiny in restraining favouritism in politics.
In Does Political Partisanship Cross Borders? Evidence from International Capital Flows, Larissa Schäfer and co-authors gauge whether partisan perception shape the flow of international capital. Using data on syndicated loans and equity market funds, they show that the ideological alignment or distance of individual investors/lenders in the US (based on political contributions by banks and voter registration for fund managers) with foreign governments affects the international capital allocation by large institutional investors. Specifically, considering investment in the same country around the same foreign elections, the authors show that US banks reduce lending after an increase in the ideological gap after the election between their own (Republican or Democratic) political stance and the political stance of the foreign government and charge higher interests (while they do not face higher default); similarly, US mutual funds decrease portfolio allocation, again with no difference in performance. The authors also confirm the results for non-US investors (Canada and UK), even though with less granular data. Quite striking results, as partisan politics used to stop at the water’s edge; but it seems no longer so.
In Political Polarization in Financial News, Ryan Israelsen and co-authors find strong evidence of political polarization in corporate financial news. Comparing coverage in the Wall Street Journal and the New York Times over 30 years on the largest 100 companies, they document that newspapers are more likely to cover and write positively about politically aligned firms (as measured by campaign contributions by employees and corporate political action committees to Democratic and Republican Party candidates). For example, an article in the WSJ about a firm that donated only to Republican Party candidates in the previous election cycle uses 20% more positive words than an article in the NYT, while an article in the WSJ about a firm that donated only to Democratic Party candidates uses 10% fewer positive words compared to the NYT. And this different reporting also has implications for investment and trading. Specifically, there is more trading on days where there is more politics-induced disagreement in the reporting on a specific firm. Finally, matching data on individual investor trades from a retail brokerage data set to newspaper circulation data based on the zip code location of the investors, the authors find that when news about a stock appears in the newspaper an individual investor is more likely to read, the investor trades more and in the same direction as other investors who read the same paper.
In The Political Polarization of U.S. Firms, Elisabeth Kempf and co-authors show that executive teams in U.S. firms are becoming increasingly politically homogenous, based on voter registration records for top executives of S&P 1500 firms between 2008 and 2018. This seems to be driven by politically misaligned executives more likely to leave, especially between 2015 and 17 and the effect is stronger in states where there is no legal prohibition of political discrimination, in firms with lower institutional ownership and for firms with CEOs with longer tenure. The authors also show that differences in executives' political views manifest in differences in beliefs about the company's future stock price performance after political events, such as the surprise win by Donald Trump in 2016, with Democratic executives having a significantly higher likelihood of selling the firm’s share than Republican executives of the same firm after this specific event.
One of the highlights of the workshop was a keynote lecture by Renee Adams – to describe it as provocative would be an understatement. Rather than presenting a paper, Renee decided to discuss her experience with the politics of finance academia – in her specific case, how a paper on the governance structure of Federal Reserve Banks ran into push-back (and rejection recommendations) by referees from the Federal Reserve system (who outed themselves as such). There is certainly a bias in our academic community to ‘not rock the boat’ and a risk of getting too close to authorities such as central banks that provide us with data and consultancies. The good news is that unlike ten years ago, this is now being openly discussed; the bad news is that we have only taken the first (baby) step in addressing this problem.
27. June 2021
Trump, Brexit and Northern Ireland
While I was convinced early on that Brexit would be a never-ending tragic soap opera, I had been more optimistic about US politics after Trump lost in November. I was clearly wrong. But even though the US president has changed while the Tory/Brexit government continues in power, there are lot of parallel political developments in the US and UK and they are not exactly reassuring.
There have been comparisons between Donald Trump and Boris Johnson, but I think these comparisons do not quite get to the point. In the US, there is a personality cult around Trump, while in the UK, there is a cult around the idea of Brexit. There is also an element of obsession, of not being able to let go. In the case of Trump, it is the constant relitigation of the 2020 elections, which Joe Biden clearly and fairly won, ranging from questionable election audits over calls for a military coup to rumours that Trump will be reinstated as president in August. In the UK, it is the obsession with the EU, even now that the UK has left; the Tory/Brexit press (Daily Express, Daily Mail, Sun) cannot go a week without blaming the EU for some (perceived) problem in the UK (most recent: the EU conspired to give the UK representative zero points in the most recent Eurovision contest).
There has also been a rewriting of history on both sides of the Atlantic. In the US, Republicans are now pretending that the insurrection of 6 January was either just a bunch of tourists taking photos in the Capitol or antifa protestors dressing up as Trump supporters (obviously, these two explanations cannot be reconciled). In the UK, the rewriting of history refers to “the UK being frozen out of the Single Market”, the Northern Ireland protocol being imposed on the UK etc. It does not seem to matter that the same columnists praised the Northern Ireland protocol just a bit more than a year ago and that is was the UK that decided to leave the Single Market.
Another parallel is that the focus on Trump and Brexit has served as façade to hide an incredible degree of corruption and nepotism. Trump as private person has benefitted substantially from staying as president at his own properties; rather than draining the swamp in DC as he promised, he filled it with his friends and family members; and he regarded the Attorney General of the US as his private attorney, a role that William Barr was too happy to fill, even though the events of 6 January were even too much for him. Similarly, in the UK, the pandemic has resulted in private citizens (including a former prime minister) using their access to ministers to gain advantages in the form of overpriced contracts (with Michael Gove’s recent case just one of several examples). Maybe this best summarised by Tommaso Valletti in his tweet on Italy 20 years ago vs. UK today.
A final parallel is the role of media in both countries. In the US, it is Fox News who has played the role of facilitator of Trumps lies and alternative facts; in the UK, it is the Tory/Brexit press (Daily Express, Daily Mail, Sun), which continues to spread lies on the EU and the Brexit process on a daily basis. It is sometimes hard to tell who is the dog and who is the tail in this relationship; then, again, in the person of Boris Johnson, mis-leading journalism and politics have merged. It has become clear, however, that the Brexit supporting press in the UK would make any authoritarian leader proud!
What about the role of academics/experts? Most economists have pointed to the negative effects of Brexit. There has been a small number of economists and legal scholars who have been happy to lend their academic reputation to support questionable statements, alternative facts and conspiracy theories. Unfortunately, university media departments are always excited to see their academic staff being cited in newspapers, even if it is on conspiracy theories that can be easily proven wrong, which creates perverse incentives for such academics to get quoted as often as possible, no matter how nonsensical their comments are.
While the above seems more like an academic comparison between the transformation of two political parties and movements on both sides of the Atlantic, there is obviously a dangerous element to it, that of undermining democracy. Recently, in the U,. a group of political scientists and historians recently signed a statement of concern, related to Republican attempts to undermine voting rights under the cover of election integrity. And in the UK it has become similarly clear that an unwritten constitution that relies on norms is not sufficient against a government that is keen to tear up democratic norms and traditions and get rid of checks and balances.
Turning to the latest development in the Brexit soap opera, the conflict between the UK and the EU on the Northern Ireland Protocol (which used to be known as the oven-ready deal in the UK) has serious possible implications for Northern Ireland, the relationship between UK and EU but also the global standing of the UK (as became obvious during the G7 meetings). The British government has managed to destroy any of the remaining trust that the EU and European countries might have had after the bruising Brexit negotiations. It is becoming clearer and clearer that the British government signed up to the Northern Ireland Protocol and thus the border in the Irish Sea knowing well what this implied but without the intention of ever implementing it. Statements such as “we underestimated the costs” are contradicted by former government officials at the centre of the discussions in 2019 (also here). And it is this perfidious behaviour and break-down in trust that ultimately makes further compromises from the EU side so much more difficult – given that the British government has no interest in complying with the spirit (much less with the letter) of this agreement, any compromise by the EU would lead just to further undermining of the Protocol and controls by the British government.
Why does this matter? When the UK decided to leave Single Market and Customs Union, it was obvious that there had to be a border somewhere. Imposing a border in the Irish Sea is easier than imposing a land border between Northern and the Republic of Ireland (and one can argue is much more compliant with the Good Friday Agreement). And while some British 19th century nostalgics would like to see the border between Ireland and the rest of the EU, this shows a degree of foolishness hard to beat even after five years of Brexiters’ stupidity. And while there has been a lot of focus on unionist resistance in Northern Ireland against the Irish Sea Border, it remains to point out that (i) 56% of Northern Irish voters voted against Brexit in 2016, (ii) the unionist parties do not represent the majority of the voters in Northern Ireland and (iii) Northern Ireland’s voters support the Protocol 47% to 42% according to a recent poll.
One can envision many different ways how this will end. If the UK government continues with its aggressive stance, one can expect sanctions from the EU, with a tit-for-tat conflict emerging. And if the UK government insists on unilaterally deviating from the NIP agreement or even suspending it completely, there will be no other choice for the Republic of Ireland (and, yes, there will be pressure from Brussels and other European capitals) to start controls at the land border with Northern Ireland. It is easy to see that this will not calm but rather further raise the temperature. As much as I hope for peace, I also hope that no one will forget who triggered this conflict – Boris Johnson who first refused (during the campaign) to acknowledge that Brexit might constitute problems for peace on the Irish island and then signed up for an international treaty he never intended to comply with.
Ultimately, Brexit is primarily a domestic politics show in the UK. David Cameron called the referendum to settle the EU dispute within his own party, Theresa May started out with a hard Brexit stance in 2016 to polish her credentials vis-à-vis the European Research Group, and Boris Johnson signed up for the Northern Ireland Protocol to win an election. Even the resistance to actually implementing what has been signed seems to be purely driven by political considerations – keep alive the conflict with the EU to divert voters’ attention.
14. June 2021
Bank supervision and the composition of firm investment
Fresh off the press, as CEPR Discussion Paper and with a Vox column, Miguel Ampudia, Alex Popov and I are gauging the impact of introduction of centralised bank supervision in the euro area on corporate investment. Following an asset quality review and stress tests (together referred to as Comprehensive Assessment), a number of significant euro area banks became supervised by the SSM in late 2014, while others remained under the supervision of their national authorities. While previous research has shown that the shift to centralized supervision resulted in stability-enhancing actions by the affected banks our research shows the impact of this change in supervisory architecture on the real economy.
Our results show that firms borrowing from SSM-supervised banks experienced a significant reallocation across different types of investment, relative to firms borrowing from banks that remained under the supervision of national authorities, namely from intangible to tangible assets and cash. These results are robust across a number of sensitivity analyses, including a parallel test analysis and a placebo test where we apply our empirical setting and estimation to European countries whose banks did not fall under the SSM from 2014 onward – there is no significant difference between firms borrowing from SSM-eligible banks and other banks. The decline in intangible investment is particularly pronounced in innovation- intensive sectors. Finally, we find a reduction in lending, both using firm- and bank-level data. These findings are consistent with theories that predict more rigorous supervision by a centralised supervisor resulting in less lending by banks, with a consequent move by firms towards more collateralisable assets.
In summary, this points to a trade-off between growth and stability – yes, the move towards a European safety net has helped increase banking sector stability. On the other hand, the shift away from intangible to tangible assets suggests that centralised bank supervision can slow down the shift from the "old", capital-based, to the "new", knowledge-based, economy .
11. June 2021
Economics of supranational supervision – forthcoming in JFQA
In 2010, in the wake of the Global Financial Crisis that saw the failure and bungled resolution of quite some cross-border banks, my then colleague Wolf Wagner and I started a research programme on cross-border supervisory cooperation. Together with Consuelo Silva-Buston, we have now published the third paper in this line of research. Our first paper showed theoretically that resolution decisions concerning cross-border banks by national supervisors are biased and provided empirical evidence from the Global Financial Crisis. The second paper showed theoretically that the trade-off between cross-border externalities of bank failures, on the one hand, and differences between countries’ preferences, on the other hand, should determine whether countries are better off moving towards supranational supervision or staying with national supervision.
The third paper provides empirical evidence for this theoretical and other models and has just been accepted for publication in the Journal of Financial and Quantitative Analysis. A first major contribution of the paper is that we have put together a cross-country database on cooperation between countries in Europe, the Americas and Africa (no data for Asia, unfortunately) for the period 1995 to 2013, as well as on different forms of cooperation (including Memorandum of Understanding, Colleges of Supervisory, broader cooperation including on resolution and supranational supervisor). We use this database to ask two questions in this paper: first, is cross-border supervisory cooperation associated with higher bank stability; second: what determines the incidence and intensity of cross-border supervisory cooperation? On the first, question, we exploit variation within large cross-border banks in terms of cooperation between the parent bank supervisors and different host country supervisors over time. We find that as the parent bank supervisor cooperates with more host country supervisors, a bank’s stability, as measured both by accounting-based (z-score) and market-based measures (Marginal Expected Shortfall). Interestingly, this holds for ‘smaller’ cross-border banks (which includes, for example, Nordea, so still very large banks) rather than for the largest cross-border banks (the moral hazard risk of too-big-to-fail might simply be too large for these) and works through asset risk rather than capital levels. We also find that effectiveness of cooperation increases both with the stringency of home and host supervision, as well as the quality of information that is available to supervisors.
In the second part of the paper, we explore why we observe such a large variation across countries in terms of supervisory cooperation, which seems to contradict our findings discussed so far. The absence of cooperation can be explained by the presence of (economic) costs to cooperation, arising in the form of heterogeneity between countries, such as different preferences, or differences in economic and institutional structures. Benefits from cooperation, on the other hand, stem from the externalities arising from decisions of national supervisors for other banking systems; e.g., individual countries may choose supervision levels that are insufficient from a global perspective as they will tend to ignore that the failure of their banks has international spillovers. We find that the cooperation pattern observed in the data vary consistently with (net) cooperation gains arising from externalities and heterogeneities. Specifically, the existence and intensity of cooperation between two countries, as well as the propensity of a given country-pair to move to cooperation increases in externalities and decreases in bilateral heterogeneities.
What can we learn from our results? First, cooperation improves banking stability but the impact depends critically on institutional characteristics, such as supervisory powers and access to information. Second, the effectiveness of cooperation declines with bank size. Third, a uniform global push towards more coordination of banking supervision may not necessarily be optimal as the (net) gains from cooperation differ across countries, and actual agreements may already reflect this.
Much more research to be done? So, far, we have taken bank’s cross-border exposures as given, but banks certainly react to supervisory actions, including cross-border cooperation agreements. Stay tuned….
On a final note, as part of my new job at the Florence School of Banking and Finance, we will be organising an on-line Academy on Cross-border Supervisory Cooperation in November/December, combining technical aspects with comparisons of different models of cooperation and policy discussions. Details to come in the next weeks and months on fbf.eui.eu.
10. June 2021
Bank sectoral concentration and risk; forthcoming in JMCB
People outside economics academia are always surprised to hear how long it takes to publish a paper. They often also think it is rather straightforward to write a paper – well, yes, but the tough part is to publish it. This paper is certainly an extreme case. We started working on it almost 10 years ago, and had a first draft in June 2013 (background paper for a World Development Report). At some point I told my co-author Olivier De Jonghe: this paper will be like a red Bordeaux, which will take a long time to mature – I did not imagine it would take that long. At some point, we invited a third co-author – Klaas Mulier – who gave us new impetus. We almost gave up last summer when we were rejected in the third round. But here we are, the paper is now forthcoming in the Journal of Money, Credit and Banking.
The paper tries to make both a contribution to methodology and tests specific hypotheses. First, we construct measures of sectoral concentration along three dimensions: specialization (capturing high exposures), differentiation (capturing deviation from peer banks), and financial sector exposure (capturing direct connectedness), using a method used in the mutual fund literature. Typically, researchers had to rely on credit registries for a specific country to compute such measures. Our measures, on the other hand, we capture more than lending exposure of banks. Specifically, our measures also take into account banks' securities holdings and derivative positions through which banks might hedge excessive sectoral lending exposures (or, alternatively, create such positions when there is no sectoral lending exposure). Furthermore, they also account for sectoral exposures at the liability side of banks' balance sheets (e.g. sectoral concentration in corporate deposits).
The underlying assumption of our methodology is that one can identify a bank's sectoral concentration choices from the covariation between its stock returns and the returns on sectoral indices, and thus relies on market participants' information on bank choices. Going through earnings calls transcripts, for instance, we found indicate that analysts often ask questions in terms of actual exposure to and performance across economic sectors but also in terms of hedging instruments used to hedge against sectoral concentration. We then define bank sectoral specialization as the percentage variation of the bank's stock returns that is incrementally explained by the sector-specific indices over and above the variation explained by the other factors. Next, we define bank sectoral differentiation as the Euclidean distance between a bank's estimated sectoral exposures and the average sectoral exposures of all other banks in the same country and year. Lastly, we define a bank's financial sector exposure as the estimated sensitivity of its stock returns to the returns on the financial sector index.
The advantage of our measures is that they can be computed for a large number of banks and countries without having to draw on proprietary information. On the downside, we capture only listed banks and inferring information on sectoral concentration from banks' stock prices also hinges upon faith in weak form efficiency of the efficient market hypothesis.
We gauge the validity of our market-based measures with hand-collect actual sectoral lending exposures from the notes to the annual statements for a small subsample covering the largest banks in our sample (with the help of several master students under the supervision of Olivier almost ten years ago). We show a significant correlation between our market- and the accounting-based measures of sectoral specialisation.
In the second part of the paper, we relate our three new measures to individual bank risk, proxied by the banks' distance to default, and to systemic bank risk, proxied by the banks' marginal expected shortfall, We find four relationships that exhibit a consistent sign and significance over time and across countries and numerous robustness checks. First and second, bank specialization is negatively related to individual bank risk and to systemic bank risk, in line with theories advocating the benefits of specialization. Third, differentiation from peer banks is positively associated with individual bank risk, consistent with theory that argues that differentiation may imply higher funding costs for banks, which --all else equal-- imply lower margins and higher risk. Fourth, financial sector exposure is positively associated with systemic bank risk in line with theoretical models on financial contagion.
Our findings stress the importance of distinguishing between specialization on the bank-level and differentiation within the banking system and thus the distinction between micro- and macro-prudential regulation. Our approach is sufficiently flexible enabling additional applications. First, it allows identifying which sectors contribute to aggregate specialization, as well as identifying whether this is due to an over- or underexposure. Likewise, our approach allows constructing semi-aggregate sectoral specialization indices (cyclical versus defensive sectors, tradable versus non-tradable sectors). Such sector-specific specialization measures might be more useful for regulatory or early warning purposes than our aggregate measure of specialization as it allows assessing which banks will be hit more when a specific shock hits the economy (e.g., an oil price shock, a pandemic). Second, our methodology can also be used for also be implemented to determine a bank's exposure to certain geographical areas, certain types of companies (SMEs or large corporates), sovereign bond exposures or commodity prices. Finally, there is much more to explored. Why do banks specialize in certain sectors? Why do banks differentiate from or herd with other banks? Do regulatory variables influence the choice of sectoral concentration? Certainly, lots more research to be done.
29. May 2021
Banking and Covid-19: recurring themes
Last week, I participated in three virtual panel discussions on banking and COVID-19, twice as moderator and once as speaker. One of the events was organised by the Florence School of Banking and Finance in cooperation with European Economy, with the latest issue featuring lots of interesting papers, including one by yours truly, a second event by CEPR-SAFE and a third by the Financial Risk and Stability Network. Several themes came up again and again; in the following I will elaborate on some of these (important to stress that even if there are references to specific people, all opinions are my own:
The presentation by Andrea Enria pointed to a discrepancy between optimistic market expectations on banks’ profitability and asset quality and a more sceptical supervisory assessment, where the latter, however, is still to be confirmed with the on-going stress tests. Why such a discrepancy? While the macroeconomic perspectives certainly look bright (the projections by the European Commission point to GDP reaching pre-pandemic levels in 2022), leverage has gone up across the corporate sector; further reallocation needs will result in non-performing loans; as borrower relief measures expire or are phased out, there is potential for concerns. One important feature, however, will be the uneven recovery across countries, also exacerbated by different starting points before the crisis. There has been a lot of talk of a K-shaped recovery; this relates not only to cross-sectoral differences but also differences across countries (partly driven by different sectoral composition). Obviously, this links to fiscal support for the recovery phase, which might be also uneven across countries, exacerbating divergences. While fiscal policy was not the focus of any of the three panel discussions, it always lurks in the background.
Corporate overindebtnedness can result in both zombie lending and non-performing loans (NPLs), effectively two sides of the same coin. Not recognising and resolving NPLs swiftly can result in zombie lending, with negative repercussion for economic recovery and long-term growth. However, banks have to be given the right incentives and tools to do so. Returning to standard loan classification and provisioning rules is a critical part; asset quality reviews and stress testing another. At the same time, deficiencies in corporate insolvency frameworks have to be addressed. However, with a large number of non-performing borrowers, even this might not be enough, which brings us to the potential role of asset management companies taking over large number of NPLs.
Asset management companies (AMCs) can exploit economies of scale in the workout of non-performing assets and help close the gap in pricing, when asset prices are temporarily depressed. AMCs might also be in a better position to restructure the debt of borrower with multiple bank relationships and – by taking on a coordination role – avoid fire sales that result in a further depression of asset prices. At the same time, being able to off-load non-performing assets allows banks to focus on lending to performing and new borrowers. While in theory, similar effects can be achieved through market-based securitisation schemes, asymmetric information between banks and investors (resulting in a lemons problem) and the more urgent need for banks to offload assets than for investors to buy might result in market failures, in addition to absorption limits of private markets. Public-private partnerships, where publicly-supported AMCs are partly funded by private investors, seem a more promising route. The more successful AMCs, including after the Global Financial Crisis in Ireland and Spain, however, have dealt with real estate rather than with SME loans, which are more heterogeneous, complex and costly to work-out.
An uneven recovery and thus incidence of corporate insolvency and thus NPLs will also result in variation in bank fragility across countries. One important topic that was discussed is whether the current bank resolution framework is fit for purpose in the case of systemic fragility. There seems an increasing consensus that it might not be enough and that additional tools and mechanisms might be needed (including the above mentioned AMCs, though they are subject to rather strict, maybe too strict, state aid conditions). Of course, there is a broader question on the extent to which authorities should rely on bail-in and possibly liquidation or on taxpayer support to limit the negative externalities of bank failures. Christian Stiefmüller from Finance Watch was part of one of the panels – the motto of Finance Watch is to “making finance serve society”; there is an obvious trade-off, however: closing too many banks might undermine the economic recovery; bailing banks out, on the other hand, sends strong and possibly wrong political signals about the privileged position of bankers (apart from setting wrong moral hazard signals).
Applying strict bail-in rules in the context of bank resolution relates to the broader question of restructuring the European banking system and reducing the bank-bias in Europe’s financial system. However, it also relates to a possible re-emergence of the bank-sovereign link that featured so prominently during the Eurodebt crisis. Only a completion of the banking union and a move away from national banking systems can prevent such a re-emergence. Fostering cross-border mergers in the context of banking restructuring can be one important dimension. If there is the perceived need for taxpayer support, any such resources should be clearly linked to overarching objective or restructuring and Europeanising Europe’s banking system.
One important barrier when addressing the problems of Europe’s banking systems is the close links between politicians and bankers, on the local, regional and national level. There will certainly be political resistance against the necessary restructuring if not retrenchment of banks. One can only hope that there will be some political leaders courageous enough to hold against these pressures.
25. May 2021
The German obsession with titles and academic rules
For the first time in post-World War II Germany, three parties have put forward candidates to be the next chancellor that have a serious chance of also taking over this position from Angela Merkel this fall. The candidate that has drawn most attention so far is Annalena Baerbock, not only because she could be the first Green chancellor of Germany, but also because of her rather young age. As any candidate for high political office, she has also drawn more scrutiny to her biography – so far, so good and understandable. Where this has become very German is when commentators started to focus on her educational achievements. Unlike other leading German politicians she has not been accused of plagiarising her PhD thesis, rather that she went to study for a Master of Public International Law (LLM) at the London School of Economics without first having obtained an undergraduate degree (non-existing at this time in Germany) or the traditional Diplom. Nobody has doubted that her admission and her degree (with distinction) have been obtained legitimately. And she certainly is not pretending to be a professional lawyer, i.e., having passed the German equivalent to the bar. What critics have been focusing on is her unusual educational path, combining studies in Germany and the UK and the fact that she has not followed the conventional and traditional German academic path (to get a flavour of how upset this makes some people, see the comments on this website - though all in German).
Behind this seems to lurk the German antipathy against any non-German academic degrees. I cannot call myself Dr. in Germany, as my PhD is from outside the European Union. Actually, until some years ago, anyone with a doctoral degree from outside Germany was not allowed to use that title in Germany (with penalty of up to one year in prision)– a law going back to the 1930s. While it might seem like a protection against lower-qualification-degrees from abroad, one can also see it as an entry barrier (though this barrier has reduced significantly). Any short-cuts must be wrong. Anyone who has not gone through the formal procedures and done his or her academic duties must be an impostor.
This contrasts a lot with my own experience outside Germany – at my PhD defence in Virginia, my main supervisor told my second and third supervisors: “Thorsten has a job lined up, he has written three papers; let us give him the degree, so he can go out and prove himself.” And that’s what I did. It is only when I change jobs that I have to take out my PhD certificate to prove that I really have this title. At the World Bank (as in other international financial institutions), doctor titles are not used (unless medical doctor), so it was not until I joined academia in Europe that I encountered the practice of using doctor and professor titles. Unfortunately, too often these titles seem more important than the actual academic or professional achievements. Too often, academic degrees seem an objective in themselves rather than a starting point. Too often, the question is asked by prospective students: how much more can I earn if I get a PhD?, rather than asking: would I be more successful in a certain job or profession if I have a PhD?
Turning back to the political campaign in Germany, the saddest part about this focus is that it takes away from the real discussions that should be had: is Annalena Baerbock qualified to be chancellor, what are her and her party’s policies? This is what this electoral campaign should be about, not about the way she has been obtaining her education.
17. May 2021
Weekend of anniversaries
This past weekend (8 and 9 May) brought two anniversaries that are decisive for Europe’s history of the past 75 years. On 8 May 1945, World War II ended and on 9 May 1950, French foreign minister Robert Schuman set out his idea for a new form of political cooperation in Europe, which would make war between Europe's nations unthinkable. These two days are closely linked with each, both for Germany, the aggressor and ‘loser’ of World War II, and Europe. Both days have very personal meanings for me, as I want to discuss in the following. They have even more meaning for me now that I have joined the Robert Schuman Centre at the European University Institute.
For decades, 8 May was an anniversary of ambivalent feelings in Germany – the end of the Nazi terror regime, on the one hand, total military defeat of Germany, on the other hand. My late parents told me that, growing up in the 1950s, this topic was rather avoided in school - history has been traditionally taught chronologically in German high school, starting with Greek and Roman history and ending with the 20th century; but my late mother told me that somehow history teachers always ran out of time towards the end of grade 10 and ended the history curriculum with World War I. My own school experience was very different – in grades 5 and 6 (even though formal history classes did not start until grade 7), our classroom teacher insisted on discussing with us different Nazi period anniversaries – appointment of Hitler on 30 January 1933, Reichskristallnacht (Night of Broken Glass) on 9 November 1938, start of World War II on 1 September 1939 but also the 20 July resistance plot in 1944 – to sensitise us for recent German history. But there was a continuous ambiguity about 8 May 1945 and heavy discussion among us high school students whether this day was to be a day of celebration or a day of national humiliation. Federal president Richard von Weizsaecker set a clear political signal in 1985 on the 40th anniversary, defining the 8 May as day of liberation, adding that even though younger generation do not bear responsibility for the past, Germans must accept the past – “ there can be no reconciliation without remembrance”. Over the past decades, Germany has developed a more open relationship to its past - it has become clear that 8 May is as much a day of celebration for us as for other countries in Europe, though also a day of somber remembrance and gratitude; looking at my own children (who have never lived in Germany) it seems obvious that they do not bear responsibility for this darkest of all chapters in European history, but collectively Germans have a responsibility to remember, even more important in the time of rising right-wing populism. Studying history in grades 12 and 13, I read eagerly about German history to better understand a regime that my grandparents did not want to talk about and that seemed so completely foreign to my own little world in late 20th century West Germany. However, it was not until the past few years that I finally learned more about my own grandparents, only after my parents had passed away. And it was only a few years ago, that I learned about the psychological struggles for my parents’ generation (but to a certain extent also for my own generation), as described in this Economist article from 2015.
As much as 8 May 1945 closed the darkest chapter of modern European history, 9 May 1950 opened the most successful chapter in modern European history! This anniversary allows us to remember that the European Union was founded as peace project and continues to be one; it is easy to forget over the daily politics of budget negotiations, parliamentary discussions, and disputes between countries what our continent has collectively achieved! And it is important to remember on a regular basis, as memories of the dark chapters fade.
Considering these two anniversaries, together, however, also carries an important but maybe uncomfortable message for Germans! The project of the European Community and later Union allowed first West Germany and later a unified Germany to be at the core of building and maintaining peace in Europe, only a few years after having unleashed terror across the continent; however, this also carries a responsibility with it. Being the largest country and economy in the EU and the anchor country of the euro, Germany has benefitted enormously from European integration; we also owe it – even more than other countries - our full support; we owe this both to history and to future generations.
A third anniversary this weekend was the 100th birthday of Sophie Scholl, part of the resistance group White Rose in Munich, executed (or rather murdered) in 1943 by the Nazi regime. Even though the group failed in its attempt to incite broader resistance against the Nazi regime, their example stands as shining beacon of personal courage in the darkest hours of a country. The more despicable is that some anti-lockdown protestors pretend to be a modern version of Sophie Scholl. Drawing such ludicrous and abusive parallels does as much damage to the process of remembering and learning as simply forgetting history.
10. May 2021
Supervising auditors: need for reforms
Last week, the Lisbon-based CIRSF (Research Center on Regulation and Supervision of the Financial Sector), joint with CMVM (the Portuguese Securities Regulator) and the Florence School of Banking and Finance, organised a very timely and interesting panel discussion on the Supervision of Auditors: Lessons Learned from Landmark Cases, with a number of legal scholars and economists. In the centre of the discussion were recent accounting/auditing scandals, including Wirecard, and how the regulatory supervisory frameworks have to be adjusted. I was asked to provide some concluding remarks, which I used both to summarise the discussion and to provide some additional perspectives.
As economist, my first concern is: why do we care about these scandals? Well, we need functioning capital markets for resource allocation, which is especially important coming out of the pandemic. This requires sufficient information for investors and investors’ trust in the accuracy of such information. Scandals like Wirecard come at the end of a long misallocation process and undermine investors’ trust. It is clear that criminal activity such as in the Wirecard case can never be completely prevented; what a functioning regulatory and supervisory framework can do is to detect such fraud earlier and thus minimise losses.
Auditors are supposed to provide a third-party independent assessment of whether financial statements are free of material misstatements and fraud, so have the function of monitors. But who monitors the monitors? And where does the buck stop? It is clear that German authorities have failed, but what are the necessary reforms? One suggestion has been to move from national to supranational supervision within the European Union - similar as in banking, with the additional motivation that a functioning and effective capital market union can benefit substantially from common regulation and supervision. And as in the case of banking, it is not necessarily about centralisation (which carries not only benefits but also shortcomings) but about diversity of approaches and building a joint European culture.
On a more conceptual level –what is the role of public vs. private enforcement. Andrei Shleifer and co-authors find in a seminal paper “little evidence that public enforcement benefits stock markets, but strong evidence that laws mandating disclosure and facilitating private enforcement through liability rules benefit stock markets.” This would suggest not necessarily a stronger oversight, but stricter liability rules. In terms of liability, there is a clear trade-off, however,– on the one hand, this might provide auditors with more discipline, on the other hand, it might also raise prohibitive entry barriers into the auditing profession.
The world is always more complicated than in our regression models. I believe we need both, more supervisory and more market discipline. Industry self-regulation (as is the case for the first level of auditor oversight in Germany) can work in certain circumstances (closed and concentrated market with high stakes for market participants, as in the case of the German private banking market before 2000), but it is less likely to work in open and competitive markets as we have them now. European markets simply do not work with national regulation and supervision.
Often the argument has been made for more competition in the auditing market, actually an argument that regularly comes up after every scandal. I am not convinced that more competition (in the form of more auditing companies) helps. It might actually drive down standards as long as companies can choose their auditor. More competition can drive down franchise values of incumbent auditing firms and thus lead to auditors being less careful rather than more. What seems urgent is to force firms to change their auditors on a regular basis.
As so often, what stands in the way of meaningful reforms is politics. On the upside, crises are often good moments to trigger change. Unlike in banking, however, the pressure in this case might weaken rapidly, so events such as this one are critical to maintain the pressure.
8. May 2021