2020s - what a decade and it is only 2022
2022 started with lots of hope: we thought (and rightly so) that we were going through the last Covid winter here in Europe, the economy was recovering more swiftly than expected and inflation was increasing but not really considered a major problem yet.
The 24thof February changed everything with Putin’s aggression against Ukraine, the first time war hit Europe in its core since 1945. Everyone in Europe ended up with some embarrassment. The Germans as they had bet on cheap Russian gas and had looked for too long the other way as Putin had become more and more aggressive; the French as Macron tried to negotiate with Putin when it should have become clear that it no longer served any purpose; the UK as it had become home to lots of Russian money and political influence over the past decade or two.
The biggest surprise (at least outside Ukraine) was the fierce resistance by Ukrainians and their ability to push back. Europe and the US came around to support Ukraine relatively quickly, something that certainly would not have happened under president Trump. However, the political will to support Ukraine is primarily in the democratic centre, both in Europe and the US.The left keeps asking for a negotiated solution (as in: what share of Ukrainian population is Putin allowed to massacre). Among economists, Jeffrey Sachs decided to go all-in for the Russian side – sad to see how intelligent people get so captured.The right wants to do a deal with Putin – Ukraine in return for cheap energy. The invasion of Ukraine by Putin and the heroic resistance by Ukrainians is thus part of the broader conflict between democracy and populism/autocracy I have written about earlier.
Inflation has become a major issue across the globe, though inflation expectations still seem to indicate that the anchor has not been lost.Central banks face a major conundrum – tighten too much and too fast and risk a recession; tighten too cautiously and risk de-anchoring of inflation expectations.While there are many indications point to lower inflation rates in 2023, there might be additional unexpected shocks.
The cryptotulipmaniaseems to finally deflate (on a personal level most obvious in that my non-economist son stopped asking me to invest in bitcoin😊). You can fool some people all the time and all people some of the time but not all people all the time. Yes, there are good solutions for the use for distributed ledger technology, but cryptocurrencies do not seem to be one of them.
The 1920s were certainly a decade that started with a lot of hope, after World War I and the Spanish influenza. It ended with the Great Depression, though in between there were some good years. I will certainly not try my hand at predictions (where economists continuously fail), but the 2020s certainly do not seem like a happy decade so far. It rather seems to turn into the decade of the Great Volatility.
31. December 2022
Evolving key risks in the banking sector
Brunella Bruno, Elena Carletti and I recently wrote a paper for the European Parliament's Committee on Economic and Monetary Affairs on evolving key risks in the banking sector and related priorities for the SSM. In this short note, we point to a few new sources of risks, challenges posed to supervisory actions, but also make the important case that traditional risk management tools might face limitations in the current situation.
First, there are significant geopolitical and related risks, including (i) credit risk and effects on corporate and consumer lending business, (ii) market risks and effects on trading, (iii) fiscal policy support result resulting in sovereign debt increases and a renewed doom loop between bank and sovereign fragility, (iv) climate risk including the risk of backtracking on commitments with stranded asset risks materialising even more strongly later, (v) risk of cyber-attacks against financial institutions and critical infrastructure, (vi) geopolitical tensions beyond Ukraine and consequent negative effects on international trade and economic recovery. Beyond these geopolitical risks, there are (i) the risk of financial market disruptions related to increasing interest rates and imbalances in asset holding, (ii) spill-over effects from fragility in the crypto-market, and (iii) risks arising from financial sanctions against Russia.
The challenge for banks will be to be prepared for such extreme scenarios. New approaches to risk management are needed, combining quantitative and qualitative assessment. Scenario analysis seems to be a more effective way to address tail risks that are multifaceted in nature. The challenge for banks (and thus, for supervisors) will be to be prepared for such tail-risk scenarios, for example in the form of back-up solutions in the case of cyberattacks Banks’ strategic plans need be to set towards long-term objectives, but also have to be flexible enough to allow for the possibilities of tail risks. In terms of supervisory actions, these considerations call for a very-bank specific monitoring approach.
8. December 2022
Interesting papers – November 2022
I have meant to write for a long time about papers I have been reading (and some recently published or accepted in the JBF), so here we go:
The effect of bank failures on small business loans and income inequality, by Salvador Contreras, Amit Ghosh and Iftekhar Hasan, relates to and combines three literatures: bank failures and its negative effects on real economy, SME finance and income inequality, a challenge that economists increasingly care about. Using variation in the timing and location of branches of failed banks across the U.S. the authors analyse the effect of these failures on income inequality. Employing a difference-in-differences specification they find that bank failures increased the Gini coefficient by 0.3 units (or 0.7%). This rise in inequality is due to a decrease in the incomes of the poor that outpaces declines of the rest of the population. Further, individuals with lower levels of education exhibit a relatively greater decline in real wages and weekly hours worked. One important channel seems to be a general decline in small business loans following bank failures. This in turn reduces net new small business formation and their job creation capacity, a sector that hires a substantial share of low-income earners.
Bob Cull and co-authors study how one specific type of social capital, private social networks, affects access to credit and its implications for consumption, using a sample of Chinese households. They find a strong and likely causal link between private social networks (as measured by the number of siblings of both spouses), households’ use of informal credit, and household consumption. Facing a health shocks, households with private social networks can rely on informal credit via private social networks to maintain household consumption. This is especially relevant for households that do not have access to formal finance, and these effects are more pronounced in poorer regions and in rural areas. An interesting study that points to the importance of informal finance in the absence of formal finance and the role of social networks as underpinning informal finance.
A lot of Covid paper and the impact on and the role of the banking sector have been written over the past three years. Andrea Bellucci and co-authors add an interesting angle, focusing on reallocation effects of the pandemic on venture capital (VC) investments. Specifically, they construct a sample of VC deals that took place in 126 countries around the world from January 2018 till the end of July 2020. They find that with the onset of the pandemic, VCs invest up to 44% more capital in pandemic-related fields (including biology, chemistry and pharmaceuticals, health, healthcare supply chain, and medical science), while the number of deals increases by up to 5.8%. One could argue that these findings speak to the efficiency of the venture capital market, given that this market exists primarily of informed investors with longer time-horizons.
30. November 2022
The financial resource curse
One of my oldest working papers has finally found a home in the Journal of International Money and Finance. In Follow the money: Does the financial sector intermediate natural resource windfalls?, with Steven Poelhekke, we explore why financial sectors in resource-rich economies are underdeveloped.
A priori, theory provides contrasting hypotheses: On the one hand, the resource absorption hypothesis argues that natural resource wealth, through financial deepening, provides a broader funding basis for financial institutions and markets and increases demand for financial services. On the other hand, the financial resource curse hypothesis argues that natural resource abundance undermines financial sector development if resource-related wealth is shifted out of the domestic financial system, either into foreign investment conduits and offshore sovereign wealth funds or into non-financial wealth, such as real estate. Finally, the modified financial resource curse hypothesis posits that the capacity of financial systems to absorb and intermediate natural resource windfall gains depends on the ability of banks to easily set interest rates and compete with each other, the ability of new entrants – both domestic and foreign – to enter the market and sufficient liquidity in capital market to support the banking system in allocating resources to their best uses and to more sectors of the economy.
Using a panel dataset of over 100 countries over the period 1970 to 2017, we test the short-run relationship between exogenous (as driven by world prices) natural resource price shocks and financial development indicators to control for reverse causation and omitted variable bias. We find that compared to countries with a similar increase in GDP, countries that experience resource windfalls and thus higher GDP see relatively slower growth in both financial sector deposits and private sector lending. This smaller role for the financial sector is accompanied by a stronger role of governments in channeling financial capital into the economy and a relative increase in foreign asset holdings of banks. Importantly, our findings are driven by countries that repress their financial systems.
Overall, our findings are consistent with the modified financial resource curse hypothesis. And while our results relate short-term changes in resource windfalls and financial development indicators, this lack of financial deepening adds over the years to less developed financial systems in resource-rich economies compared to non-resource countries at similar income levels. Our findings also speak to the literature on natural resource curse and shows the importance of the financial sector as mechanism through which natural resource rents can impede the development of a country.
14. November
Completing the banking union
I have written extensively about the banking union (e.g., here and here) and about the need to complete it. Originally framing its incompleteness as glass half-full vs. glass half-empty, it has become clear that the political appetite for completing the banking union is not there. Nevertheless, in a recent Policy Insight and as part of a larger group of economists and legal scholars, I argue that the banking union has not really achieved its objectives and make a strong case for further reform, offering a menu of three different approaches.
One can identify three objectives of the post-2008 regulatory reform, including the banking union: (i) sever the vicious link between bank and sovereign fragility, (ii) restore private liability in banking and thus avoid future bailouts, and (iii) reinforce the basis for a European single market in banking services. If one considers the last few years, these objectives have not really been achieved.
Institutionally, some progress has been made: the Single Supervisory Mechanism (SSM) has been established, shifting the supervision of the largest banks in the euro area (80% of assets) to a large extent to the supranational level. But while a Single Resolution Mechanism has been established, resolution authorities are still fragmented: resolution decisions taken by the Single Resolution Board may need the consent of other authorities, including the European Commission’s DG Competition and the Council of the EU. At the implementation stage, input from national resolution authorities is needed. There has been no progress on a supranational deposit insurance.
The result: the supranational resolution framework has been barely applied, with most cases being resolved at the national level and with taxpayer support. The sovereign-bank link has not been addressed at all and more generally, national political interests still seem to dominate regulatory and supervisory decisions.
In our Policy Insight, we provide three ways forward, which we name the ‘incremental deal’, the ‘real deal’ and the ‘cosmic deal’. The ‘incremental deal’ is the politically least sensitive package of reforms, including extension of resolution tools to mid-sized and smaller banks, tighten state aid rules and provide more powers to the SRB. None of the proposals requires treaty change, although most would require changes in secondary law.
The ‘real deal’ goes a step further and aims at a more comprehensive reform, including addressing the sovereign-bank link by introducing sovereign concentration charges. Further, bank resolution and crisis management powers should be consolidated under the SRB and a common fiscal backstop created. Finally, a European deposit insurance is needed that complements existing national or industry-based schemes. New secondary legislation would obviously be needed to implement these proposals. In our analysis, a treaty change is not required, but may be desirable, given the uncertainty about the Meroni doctrine, which restricts the exercise of discretionary powers by a European agency (e.g., SRB) not originally established in the founding treaties. Whether such a reform is politically feasible or might have to wait until the next financial crisis is a different question.
Completing the banking union is a necessary but not sufficient condition to create a truly single market in banking, in which national banking champions are replaced by European large banks, while smaller, regionally, if not locally focused, financial institutions are maintained. For such a single market to emerge, further conditions would have to be met in what we refer to as ‘cosmic deal’, including: (i) a single system of bank taxation, (ii) a single system for corporate and personal insolvency and (iii) a single framework for housing finance and mortgages. Such harmonisation would enable easy cross-border provision of financial services within the euro area. While radical, these reforms may not require treaty change. The EU can harmonise tax laws under TFEU Article 114 insofar as this serves “the establishment and functioning of the internal market”, though treaty change may be prudent, to avoid overstretching Article 114.
In addition to the policy insight, this VoxEU column summarises our analysis and views.
6. November 2022
Another one bites the dust!
I am certainly not the only observer who has described the UK as having become an international laughing stock. I have been wondering what the superlative of ‘international laughing stock’ is. When the remaining time in office of a Prime Minister is measured with the time that a lettuce can keep fresh and when the whole political class becomes the butt of a joke in US comedy central, you know the country is no longer taken seriously by anyone. And so it happened these past two weeks with the UK.
At a conference dinner in mid-September I made the strong claim that Liz Truss would certainly be an even worse Prime Minister than Boris Johnson. This was before the mini-budget and the reason for my claim was the fact that she owed her ‘election’ to the extreme Brexit wing of the Tories and that she was the instigator of legalisation to break the Northern Ireland Protocol, thus possibly triggering a trade conflict with the EU. Well, she did not have sufficient time in office to blow up relations with the EU and was simply too busy tanking the British economy with the 2020s version of Laffer’s curve and pseudo-supply-side reforms.
It is certainly ironic that on the one hand, one prominent part of these ‘supply-side reforms’ was the removal of bankers’ bonus as share of overall compensation, while on the other hand, it were these same bankers standing to benefit from the removal (as well as from the removal of the 45% income tax band) that triggered the run on the pound and UK government bonds following the mini-budget. Well, if you focus on an international financial centre as core component of your growth strategy you better watch out what these financial markets think about your macroeconomic policies!
Many observers in the UK link the disastrous but short-lived prime ministership of Liz Truss to the adoption of policies promoted by right-wing think tanks in the UK (often with dubious funding sources). What people in the UK (though most people outside) do not want to discuss is that this is ultimately the Brexit chickens coming home to roost. Brexit has reduced the potential GDP in the UK substantially (which explains the higher inflation in the UK than other advanced countries and the higher labour scarcity). The UK is now in a situation, where everyone talks about growth and productivity, but few dare to talk about the elephant in the room – the decision to cut the British economy off the Single Market. At a minimum, honesty would be called for, but few in the media seem capable of even that.
As of Monday, there is a new Prime Minister. For the first time in many years, I would argue that Rishi Sunak might not be worse than his predecessor, though this is really a low barrier. And among all the political turmoil, it is important to note that he is the first Indian-British Prime Minister, which reflects the openness of British society; I can think of few other European countries where this would be possible! This is also one of the few elements that still give me hope for the UK.
Having said this, the new Prime Minister faces the same two major constraints as his predecessors – the reality of Brexit and the myth of Brexit. First, on the Brexit myth, which implies that he has to keep feeding the trolls of the extremist Brexit wing of his party – as became obvious by reappointing the despicable Suella Braverman as Home Secretary who dreams of refugee flights to Rwanda on Christmas Day and resigned just a few days before because of security breaches. This also means that he has limited political capital to come to an agreement with the EU on the Northern Ireland Protocol. Second, on the reality of Brexit: fiscal space will be even scarcer than before and he has already all but announced another austerity drive – how this squares with improving health and other public services remains a puzzle! The downward spiral of politics and economics in Brexit UK continues.
28. October 2022
Me too has arrived in economics academia
This is a topic I don’t enjoy writing about at all, actually I rather hate it. But ignoring it is not an option!
Outsiders (or economists not on social media) might have missed the storm last week, triggered (as far as I can see) by a female behavioural economist in Germany raising serious accusations of sexual abuse against a more senior male economist. Not knowing any of the three people involved, I will certainly refrain from commenting on this case. However, it became quickly clear that this had hit a raw nerve, with more female academic economists coming out with ‘j’accuse’ against specific male economists. It quickly developed into a storm and has triggered an important debate.
First of all, I am disgusted by the idea that senior academic economists abuse their position for sexual favours. Having been approached by young economists of both genders for advice and offering of research assistance to get a head-start in the profession, my stomach turns thinking that other economists might abuse such situations. And no degree of academic excellence should serve as shield for such people. This is not only about creating an inclusive community, it is about basic decency!
I have mixed feelings on the social media campaign accusing specific individuals of misbehaviour: bad or even criminal behaviour should be addressed through either administrative or legal channels! BUT: I understand the frustration of many victims who have seen perpetrators walk away free. There are clearly senior members of our profession who have abused their position and have gotten away for far too long. Calling them out publicly as last resort, everything else having failed, can be justified. And this is also on the background that there is clearly a limitation of what any system to judge and penalise sexual harassment can achieve: too often, there are “he says, she says” situations, reference to different cultures, misunderstandings etc. Yes, there are clear-cut cases, but there are also many cases that non-observing outsiders might perceive as borderline (even though they are not!). As pointed out here, the problem of publicly accusing people is that it might make male economists more reluctant to work with female economists. And unfortunately, there is the risk that innocent bystanders are pulled into this, simply by being co-authors or friends of perpetrators (which also happened this weekend). So, having missed the chance to address the problems in due time has resulted in a very bad situation!
If we cannot completely rely on administrative procedures against sexual harassment, where does this leave us? As pointed out by some economists (of both genders), we have to start on a much more basic level, long before it ever comes to such mis-behaviour. Most of these challenges are for us male economists, though some also for our female colleagues (I am arguing purely in terms of heterosexual people for simplicity, but this also extends to gay and lesbian economists): First, call out bad behaviour when you see it (I have done so in a ‘borderline case’ though have never been in a really serious situation). Second, no locker room talk among academic economists (if you really urge to have such conversations, get a separate group of friends). Third, young economists should be explicitly encouraged to speak out, both privately if they perceive certain words or behaviour as crossing a line, and publicly if it clearly has gone too far. I sincerely hope that I will be told clearly if my behaviour has crossed a line even though I have no intention of doing so. These are some initial thoughts; there is certainly much more to say and to do and I hope that the social media storm of the past weeks will lead to a serious conversation and continuous improvements.
Finally, I saw one tweet this weekend which encouraged victims of sexual harassment to ask editors to not send a submitted paper to this specific person as reviewer. Being an editor, I fully concur with this! If you feel that there is a person that should be ineligible as a reviewer for your paper for such (or other) reasons, say so!
In a nutshell, there will always be bad apples – calling them to order early on or forcefully going against them is important. As important is the overall work environment. We will not change the world overnight, but we can (and have to) take small steps. Let’s hope we can channel the justified anger into a better work environment, for everyone's benefit!
24. October 2022
A Nobel Prize for banking and finance
The 2022 Riskbank Prize in Economic Sciences (the economics ‘Nobel’ prize is actually not among the original Nobel prizes, something that other social scientists like to remind economists of, every October) has been awarded to three economists researching financial intermediation and financial crises: Ben Bernanke, Doug Diamond and Philip Dybvig. Their main contribution: showing the importance of the financial sector in deepening the Great Depression (Bernanke) and laying the theoretical foundation for the role of banks in the economy and explaining their fragility (Diamond and Dybvig). And while the models of the 1980s might seem simplistic from today’s viewpoint and we have gained much richer insights into credit cycles, systemic risk and the working of financial markets, it is the work the three laureates that started this literature.
The Diamond/Dybvig model has been the start of an expansive literature on bank runs, both informed (fundamental) and uninformed (irrational) ones. While some might criticise it because the underlying idea that the depositors’ savings are intermediated into loans (rather than loans originated via the private money creation privilege banks hold) this does not take anything away from the insights of this model: one, banking is fragile; two, banks can help increase long-term investment and growth, and three, growth and fragility go hand-in-hand. And it is the latter that has often been ignored – by being fragile, banks can support growth. One cannot get one without the other. The Diamond and Dybvig (1983) and Diamond (1984) papers were also part of an extensive theoretical literature providing a micro-foundation for the interaction of financial intermediaries and markets and real economy, a literature that ultimately motivated and informed the empirical finance and growth literature, kicked off by King Levine (1983) and to which I have made a small contribution as well. As important, the Diamond and Dybvig model also informed much subsequent work and discussion on the role of the financial safety net (including deposit insurance) and bank regulation, as well as the interaction between financial safety net and market discipline (e.g., Diamond and Rajan, 2001)
The Diamond/Dybvig model has become a workhorse model for financial economists. In a recent paper just accepted for publication, we also use an extension of this model to provide a theoretical foundation of why banks’ liquidity creation is associated with higher growth in tangible but not intangible assets. This ultimately shows the importance but also limitations of banks and points to the importance of other segments of the financial system.
Ben Bernanke’s work has shown the negative impact of bank failures on the real economy and how bank failures exacerbated the Great Depression (and similarly the fall-out of the Great Recession). He makes a clear case that the financial sector is not simply a channel between monetary and real side of the economy (and bank failures a result of the depression) but that agency problems between banks and borrowers as well as banks and depositors have a real impact on the real economy. Ultimately, this motivated an expansive literature on banking crises and its real economy repercussions, but also the importance of bank-borrower relationships. Our paper on the failure of the Portuguese Banco Espirito Santo (2021) relates to Ben’s work. One interesting dimension of this Nobel Prize is that one of the recipients, Ben Bernanke, is not only an eminent academic but was also a policy maker. This has led to some rather embarrassing headlines (as in the New York Times), but also underlines that this type of research is critical for policy making. Ultimately, Ben Bernanke happened to be Federal Reserve Chair right when the Global Financial Crisis brought about a somewhat similar situation as the Great Depression he had studied, something that did influence his (and other central bankers’) policy reaction.
There are the usual criticisms against this Nobel Prize – one is that it is outdated as it rewards work done 40 years ago. What is outdated for some is overdue for others! It is certainly not as close to current research work as the prize for Banerjee, Duflo and Kramer in 2019, but all three are still very active in research and policy debate. Another criticism is that depositor runs do not cause financial crises (or worse that Diamond/Dybvig’s theory is responsible for the Global Financial Crisis). Yes, runs might not cause crises, but they can certainly trigger them (as also seen during the Global Financial Crisis when wholesale markets froze or recently during the Dash for Cash episode in March 2020). Yesterday’s depositor runs are today’s market freezes. And finally, there is the criticism that banks do much more than intermediation – very true, but it does not turn the laureates’ insight obsolete. And those who think that bank funding might not matter for bank lending, might want to consult this recent paper by my (former) colleagues Elena Carletti and Vasso Ioannidou and others.
11. October 2022
Liquidity creation and growth – now forthcoming in JEG
There was a time when I did not think I would write another finance and growth paper (maybe except for literature surveys), but write I did and now it is even being published 😊. In joint work with Robin Doettling, Thomas Lambert and Mathijs van Dijk, now accepted and forthcoming in the Journal of Economic Growth (where many years ago I published my co-authored paper on Finance, Inequality and the Poor), we show that liquidity creation by banks (intermediation of liquid liabilities into illiquid assets) ispositively associated with economic growth at country and industry levels. However, liquidity creation booststangible, but not intangible investment and does not contribute to growth in countries with a high shareof industries reliant on intangible assets. This points to an important non-linearity in the finance-growth relationship but also to the optimal financial structure (mix of banks, non-bank financial intermediaries and capital markets) changing with the economic structure of a country. And taking these results to the current financial structure in Europe, it points again to the need to strengthen non-bank financial intermediaries and the capital market union as financing modes for intangible assets, which are becoming more and more important. And as a reviewer pointed out during the review process, it also makes the case for bank bailouts somewhat less obvious if real economy funding relies less on banks.
3. October 2022
Borrower-based macro-pru
Last week, I participated in a workshop at the Banca d’Italia on “An EU Legal Framework for Macroprudential Supervision through Borrower-Based Measures” and was invited to give the introductory presentation. The reason for the workshop was the ongoing review of the macro-prudential toolkit in the EU by the European Commission. In this context, there have been calls to explicitly include borrower-based measures into EU legislation. This is also on the background that the counter-cyclical capital buffer might not be sufficient as macro-prudential tool and that ongoing shocks might further exacerbate real estate cycles across member states. And as different as residential mortgage systems are across countries, there seems to be an increasing degree of synchronisation between residential real estate cycles.
Borrower-based measures include loan-to-value, loan-income, and debt service-income ratios as well as maturity and amortisation requirements. Interestingly, not every EU member state has a legal framework for borrower-based measures and in others it is not complete. Also, the governance structure might give rise to an inaction bias, something I will discuss further below. Another challenge seems to be the lack of good mortgage loan data in some countries as they are not included in the credit registry; this in turn makes it harder to properly calibrate such policy measures.
It is important to keep in mind that borrower-based measures (as other macro-prudential tools) might clash with other policy areas. Monetary policy might be very loose with the intention to increase aggregate demand, however, this might fuel an unsustainable credit and real estate boom – a situation in some euro area countries over the last years. Fiscal policy measures might also affect housing and thus credit demand – just think of the lowering in stamp duties in the UK last week. More generally, borrower-based measures focused on financial stability might clash with distributional objectives of the government.
This leads me to the big elephant in the room (and something that central banks and macro-prudential authorities understandably do not want to talk about directly): politics. Raising capital requirement to counter a credit boom can be easily justified in terms of financial resilience. In the case of tightening borrower-based measures, the impact is more directly observable. Households with less resources for a down payment, mostly families with lower income (and often younger households) can no longer take out a mortgage. This in turn can lead to political pressure, as documented nicely by my former PhD student Etienne Lepers in one of his thesis chapters. When the Central Bank of Ireland wanted to tighten loan-value ratios in the years before the pandemic, there was strong resistance from media, ministry of finance and politicians. Is a more independent macro-prudential authority (e.g., central bank) less likely to give in to such political pressure and raise borrower-based measures during a credit boom? The maybe surprising finding is that no. This points to limitations in the political independence of central banks and a much more complicated relationship between central banks and governments, confirmed by the Bank of England’s reaction this week (including through statements) to the new government’s fiscal policy chaos.
This takes me to the governance question, on which Anat Keller from King’s College had some very interesting insights. One important question is who the mandate has to impose borrower-based measures; it might be better to have committees taking these decisions to avoid group-think but also to have broad-based consensus, which might protect decision makers against political pressure. There should be a publication requirement for the underlying cost-benefit analysis to thus guarantee a certain degree of transparency. A final recommendation to have a consultation period before taking final decisions seems to be less useful for me, as it would lengthen the period between announcement and implementation even further and might result in regulatory arbitrage.
Another important question is that about leakage. Leakage effects of macro-prudential measures have been well documented, as for example by Aiyar, Calomiris and Wieladeck. One might think that such leakage effects are less strong in the case of borrower-based measures, given that (residential) real estate markets are mostly national; however, leakages can still exist, be they through institutions outside the regulatory perimeter (as documented by this fascinating paper by Fabio Braggion and co-authors on China), foreign branches or direct cross-border lending. And while all of this seems of less immediate concern, there is an interesting interaction with the ambition to create a truly European banking market. In such cases, leakage effects might become important and reciprocity arrangements as already exist in the case of counter-cyclical capital buffers become important.
In sum, it is easy to agree on the usefulness of borrower-based measures, but the devil is in the detail. Three challenges loom large: tensions with other policy areas, leakage effects and political pressure.
30. September 2022