Information asymmetries in Brazil
After many years, Patrick Behr, Raquel de Freitas Oliveira and I have finalized a working paper draft gauging the impact of credit information sharing on access to and cost of small business finance in Brazil as well as labour market implications. We exploit an exogenous change in the reporting threshold of Brazil’s public credit registry in 2014 to gauge the impact of negative and positive borrower information becoming visible on intensive and extensive financing margins, loan conditionality, loan default and firm employment. Given the richness of the data, we can differentiate between borrowers of different risk profiles and lenders of different ownership.
We show an increase in borrowing for newly included risky firms and lower interest rates for safer firms. The additional lending comes primarily from new private bank-firm relationships, suggesting that privately-owned banks use this newly available information to reach out to these borrowers with transaction-based lending techniques. However, this comes at the cost of higher loan default for these loans compared to control firms, while across all other borrower and lender types there is a reduction in loan default following inclusion in the credit registry.
Newly visible borrowers see a reduction in interest rates from incumbent lenders, pointing to competition effects. While collateralization decreases, incumbent lenders shorten loan maturities, pointing to important changes in loan contract design: given higher competition, incumbent lenders use higher roll-over of loans as disciplining tool. Finally, the policy change translates into higher employment, especially for riskier firms. Our results are consistent with disciplining and competition hypotheses of information sharing and highlight important heterogeneities across firms’ risk profiles and lender types.
12. May 2023
More on EU-UK financial sector cooperation
As discussed earlier, my co-author Christy Petit and I recently wrote and published a study on financial sector trends in post-Brexit UK and future EU-UK regulatory cooperation. We presented the study this week in the Committee on Economic and Monetary Affairs of the European Parliament as well as at a dinner organized by the Association of German Banks and the Representation of the German state of Hesse to the EU. Summarising an 80-page report in 15 minutes is always difficult, with the additional challenge that between publication and presentation, the agreement on the Windsor Framework did not only ease the tension over the Northern Ireland protocol but also unlocked several other options for EU-UK cooperation that had been on hold. While the most prominent (in the news) is the negotiation about UK participation in Horizon, in the financial sector cooperation it would be the signing of a Memorandum of Understanding and the establishment of a Regulatory Forum to discuss issues of common interest, as laid out in a declaration attached to the Trade and Cooperation Agreement from 2020.
Will such an MoU and Regulatory Forum be a major change in financial sector cooperation between the EU and UK? I would strongly disagree with such a hope and promise. There is a reason why the financial sector was excluded in the first place from the TCA (any reference to trade in services explicitly exclude the financial sector). Also, the provisions on financial sector cooperation in the recent trade deals signed by the UK with third countries are extremely thin, focusing on regulatory dialogue and non-discriminatory market access.
While allowing entry of foreign financial institutions and market participants into a country’s banking system, countries insist for a reason on national regulatory and supervisory power and are loath to share it. And while it is true that the last decades have seen an increase in global and cross-border cooperation (especially after 2008), the sovereignty principle rules strongly in the financial sector policy framework. There are a few cases where countries formally share regulatory and supervisory power, such as in the case of the banking union in Europe. One important reason for keeping regulation and supervision on the national level, in addition to high economic costs (including for non-stakeholders) of fragility and crisis, is the fiscal responsibility that countries often take on for financial sector losses (as nicely documented in this paper by Luc Laeven and Fabian Valencia).
It is therefore not surprising that the EU is reluctant to move beyond sector-specific equivalence agreements with the UK (or Switzerland, for this matter), currently with the UK in only one area, CCPs. And even here, this equivalence decision is temporary (extended until mid-2025), with a clear political will in the EU to attract more euro clearing away from London into the Single Market and preferably into the euro area. There is a clear stability concern, as laid out in this ESMA report, which reports on different crisis scenarios for the UK CCPs and the limited role and powers that EU regulatory authorities would have in case of their failure and resolution, even though there is failure of these CCPs would have enormous implications for EU financial markets.
In sum, I would not expect any immediate changes in the relationship between regulators on both sides of the English channel or in terms of market access for UK based financial institutions and market players. Supervisory cooperation has been ongoing, independent of the political stand-off. Regulatory dialogue is important, including to avoid dramatic regulatory divergence and planning for worst-case scenarios. Expecting more than that seems unrealistic.
29. April 2023
Interesting papers – April 2023
Long overdue, here are some papers recently accepted and forthcoming in JBF that I found interesting!
Klodiana Istrefi and co-authorsstudy the informational content of speeches of Fed officials, focusing on financial stability, from 1997 to 2018. The authors construct indicators that measure the intensity and tone of this topic for both Governors and FRB presidents. When added to a standard forward-looking Taylor rule, a higher share of each speech dedicated to financial stability topics and the use of more negative words in this area is associated with monetary policy being more accommodating than implied by the state of the economy. The results are mainly driven by the sample prior to the global financial crisis and the information in speeches of FRB presidents (rather than the Federal Reserve Chair or governors). This paper is part of an emerging literature focusing on text analysis to get better insights into central banking and the role of financial stability concerns in monetary policy decisions.
Under the title“The more the merrier?”a team of ECB and Bank of England economists assess the value of multiple requirements in bank regulation using a novel empirical rule-based methodology. Exploiting two datasets with banks’ balance sheet data the year before the onset of crises, they apply simple threshold-based rules to assess how different capital and liquidity ratios individually and in combination might have identified banks that failed in the global financial and European sovereign debt crises. Their results support the case for a small portfolio of different regulatory metrics: a portfolio of a leverage ratio, a risk-weighted capital ratio and a liquidity ratio such as the NSFR correctly identifies a high proportion of failing banks with fewer false alarms than any of these metrics individually. The relative usefulness of individual metrics also varies across different crises and regulatory regimes, highlighting how a portfolio approach may be more robust. Finally, they show that market-based capitalisation measures and loan-to-deposit ratios can provide complementary value in monitoring banks. Overall, this suggests that we indeed need a toolbox of regulatory metrics, not just one.
How do banks react in their capital structure decisions to competitive pressure?Allen Berger, Ozde Oztekin and Raluca Romanuse the deregulation episode in the US to explore this question and find an increase in target capital for banks subject to higher competitive pressures. One can think of two different reasons for that: the competitive defense mechanism captures the effects of geographic deregulation in increasing external competitive pressures on banks, whereas the competitive offense mechanism concerns the effects of geographic deregulation in enlarging banks’ capacity to compete in other markets. The authors find evidence consistent with effects of deregulation on bank capital through both mechanisms.
Several authors of the Bank of Spain use credit and corporate registry data to develop ataxonomy of zombie lending. Sustaining unviable firms through evergreening of loans has negative implications for resource allocation, productivity growth and aggregate growth. The authors propose to define a distressed firm as one that is at least five years old and has both an interest coverage ratio –EBITDA over interest expense- lower than one and negative equity during at least three consecutive years. A firm is classified as zombie in year t if it is financially distressed and has received new credit from any bank in that year. Using these definitions, they identify a peak in distressed (zombie) firms in 2013 with 5.7% (2.1%) of all firms older than five years. Worryingly, the share of credit to zombie firms reached 16.4% during the same year. In regression analysis, the authors find that zombie firms exhibit less deteriorated ex-ante financial conditions than non-zombie distressed firms, are larger, have more liquid and more tangible assets (which can be pledged as collateral). Finally, they confirm that zombie firms are less likely to exit the market than non-zombie distressed firms. An important contribution to an important topic given continuous fears of corporate fragility post-Covid and due to the energy crisis.
24., April 2023
SME financing gaps in Europe
My former EUI colleague Natalie Kessler and I have just published a working paper, written for an EIB evaluation project, documenting SME financing gaps across sectors and countries, using different methodologies, one reliant on firm balance sheets and one on firm-level surveys. The most striking finding for me is the limited correlation that we find between different gauges of financing gap, but then again, maybe not surprising given their very different nature.
First, we use Orbis balance sheet data to compute proxies for how much SMEs in a certain industry/sector typically borrow under ‘ideal’, i.e., friction-free conditions. We assume that the demand is similar across different countries and sectors with financial market frictions as in the benchmark country (where debt/sales is highest), given similar technologies and investment cycles. If actual financing is below the benchmark, i.e., if actual supply is lower than the potential demand (as found in benchmark country), this would suggest a financing gap. The advantage of this first method is that it is observable for a large number of enterprises with financial statements and that is objective as not self-reported by firms. On the downside, it relies on specific benchmarks for a ‘natural’ level of external funding and it does not take into account explicitly demand-side and other firm-specific factors.
The other measure relies on firm-survey data collected via the ECB’s SAFE survey and explores the difference between the self-reported desired and actual bank financing that firms receive. The advantage of this measure is that it takes demand directly into account and allows to isolate demand from supply-side constraints and thus firm-idiosyncratic circumstances. On the downside, it focuses on self-assessed and not bankable demand, is subjective, as based on survey and available for a much smaller sample than the first methodology.
Using data over 2013 to 2020, we show significant variation in financing gaps across countries and sectors. The account-based measures point to Czech Republic, Latvia, Hungary, Sweden, Poland and Bulgaria as the countries where firms have largest financing gaps, while the survey-based measures point to Greece and Slovenia as countries with firms’ largest financing gaps. Variation over time, on the other hand, is not as strong or intuitive. As already mentioned, the account- and survey-based measures are only weakly correlated with each other, reflecting their different nature, and both are only weakly correlated with a survey-based measure of self-reported firm financing constraints.
What can we learn from our analysis? First, there is not ONE correct financing gap measure. Each measure we presented captures a different dimension; the ORBIS measure a technological distance from a given benchmark and the SAFE measure distance from self-reported demand. Second, financing gap is not necessarily the same as financing constraint. Self-reported financing constraints refer to access to and conditionality of funding, while financing gap is purely focused on loan amounts. Third and consequently, properly capturing financing gaps across countries and sectors requires the simultaneous use of different methodologies and metrics.
4. April 2023
The demise of Credit Suisse – a case study for the ages
The speed with which Credit Suisse was forced into its shot-gun marriage with UBS over a weekend is certainly an incredibly interesting case study for economists, lawyers and political scientists to study for many years to come.
The first interesting dimension to note is that this was not a resolution or liquidation, but rather a government-supported merger and acquisition. Calling it a market-based solution, however, seems a bit stretched given the heavy involvement of Ministry of Finance, Swiss National Bank and financial regulator Finma.
The second striking dimension is the wipe-out of AT1 bonds, while shareholders retained some value for their shares during the merger. There is a principle of a pecking order, which puts these claimholders ahead of equity, which was overturned with this. On the other hand and as this wipeout was done with Credit Suisse as going rather than gone concerns, the legal rules seems to have been followed.
Why did the Swiss authorities choose this and not another solution? Why not wipe out shareholder claims and create a bridge bank? Why not looking for a new investor? There are many good answers to this (too high a burden on government’s finances; not enough time for such an alternative deal). But there are certainly also political reasons: who are the shareholders and who are the AT1 holders and where are they located? Banking nationalism might have prevented authorities to sell a Swiss institution. And allowing bankruptcy would have been too hurtful for Swiss pride (“ Credit Suisse is a part of Switzerland’s modern national identity story”).
Two additional links that might be of interest:
An interview I did with a Malaysian radio station discussing the recent banking turmoil
A seminar that we are organising tomorrow (31 March) at 2 pm
28. March 2023
Are we headed for systemic financial distress?
The failure of several mid-sized US banks over the last few weeks has raised the spectre of a new financial crisis, even though many observers have pointed (correctly, in my view) to critical differences to 2008, including stronger capital and liquidity buffers and better supervisory preparedness. But parallels to previous episodes of monetary tightening are clearly there (including the S&L crisis).
How did we get here? As far as I can see, the problem in the failed banks has arisen from a maturity mis-match than cannot be addressed by the banks in the short-term. Banks heavily exposed to fixed-rate securities on the asset side of their balance sheet (such as government bonds) have incurred losses, due to rising interest rates (and thus lower bond prices). While these losses can be considered book losses as long as the bonds are not being sold and do not have to be marked-to-market, liquidity pressures of these banks led to sales pressures and thus realization of losses. The problem is that informed large depositors and creditors can see these losses and react accordingly by withdrawing their funds even before realization of losses.
Sectoral specialization seems to be one driving force behind the failure of these banks at this specific point in time. Banks typically do not fund start-ups, especially those reliant on intangible assets, such as tech firms. That seems to be at the core of the reliance of many West Coast tech start-ups on specific lenders and their rush (or run) to withdraw funds when SVB got into trouble. Exacerbating is the fact that the crypto and fintech sector has come under pressure as well. When SVB in turn had to sell government bonds for liquidity purposes it incurred losses mentioned above, thus leading ultimately to solvency pressure and the intervention by the FDIC.
Ultimately, the US authorities decided to make all depositors whole (I am reluctant to call this a bail-out, to make the clear difference to a case where all debtholders, including non-deposit creditors or even shareholders are made whole), using the systemic risk exception. According to the FDIC, the gap will not be filled with taxpayer resources, but with future additional levies on the whole banking industry. It is important to note that this is an approach that can work in idiosyncratic bank failures but not systemic banking crises. One wonders whether it is purely stability concerns or also political reasons and lobbying pressure of a well-connected tech sector that led to this blanket insurance.
Ultimately, this bank failure shows the three externalities of bank failure: the fridge problem (milk outside the fridge going bad), as borrowers of the tech sector lose access not only to their deposits but also external funding, which cannot easily be replaced; the hostage problem, as depositors run and put further pressure not only on the bank in question but similarly positioned banks; and the domino problem, as problems spread out through the banking sector, as seen in rapidly dropping bank share prices, in this context mostly through informational contagion.
The reaction by US authorities also shows that ex-ante commitment (e.g., with respect to limits for deposit insurance) and ex-post policy implementation show the usual gap. US authorities have invoked a systemic risk exception for making all depositors whole, including uninsured deposits. One could argue that this is constructive ambiguity, with the objective of fostering market discipline. One wonders whether such constructive ambiguity really works and if ex-ante insuring all deposits (at least the ones in transaction accounts) would be more honest. An alternative would be private insurance offered to large depositors – but not a realistic business proposal as long as there is a chance of the FDIC stepping in with blanket insurance. I am not sure of the answer to this challenge but this this is a valid question to be discussed.
The current turmoil also raises additional challenges for central banks as they try to tighten monetary policy to stave off inflation and the risk of financial dominance: similarly as the Bank of England in September who had to pause its quantitative tightening programme. Similarly, the Federal Reserve’s new lending facility for banks against securities at face value goes against the idea of monetary tightening.
So far, there seems to be political consensus on the crisis management approach in Washington DC. I would not be surprised, however, if soon the bailout of primarily California-based banks will be used by Republicans (I can see the theme already: Florida and Texas taxpayers/bankers bailing out liberal/woke banks and tech firms on the West Coast). After I wrote this sentence, I found this article in the Washington Post; voila!
15. March 2023
Is Brexit Done?
At the end of the movie “The Truman Show” the protagonist takes a bow and exits the stage, putting an end to a 20-year plus reality show. Similarly, observers might be asking themselves: Does the agreement named Windsor Framework mark the end of the Brexit soap opera? Fear not: this is not the end, even though it is a somewhat surprising twist.
As Chris Grey recently pointed out, there is currently a struggle on-going in the Tory party, between those who want to settle into some kind of reasonable relationship between the UK, making the best out of a bad situation, and those that want to continue living their endless Brexit dream.
It is clear that Rishi Sunak belongs to the first group. He seems to have pulled off a trick that his predecessors never managed: striking a deal with the EU without lying about it, without rancour on either side and uniting most of his party. It is clear that he managed to create a new atmosphere of trust between the EU and UK. It is also welcome that Labour is supporting the Prime Minister in his endeavour, which clearly establishes them as the adults in the room. It again shows the importance of interpersonal skills and trust-building in getting to policy successes, confirming what we have seen during the Greek euro-standoff in 2015.
On the EU side, one can argue that concessions in form of a more flexible and risk-based approach show that the EU can be very adaptable and does indeed care about peace in Northern Ireland (more than many in England and Northern Ireland itself). The EU side also sends a strong signal that a rule-based system rules and adherence to it comes with awards!
So, is Brexit done? In spite of this agreement I very much doubt. It is not clear that future governments, especially on the Tory side, will feel bound by this agreement – after all, Boris Johnson never considered him and his government bound by the withdrawal agreement he signed, praised and won an election with. One swallow does not make a summer! There is much more trust-building to be done before we ban the expression Perfidious Albion back into the history books.
There is still the complication that the unionist parties in Northern Ireland might refuse to accept the agreement, raising the political temperature further. Also, there are a lot of possibilities for future clashes in this framework, including the Stormont brake being more of an ornament than an instrument. Part of the problem is inherent to Northern Ireland and is special status, part is the Brextrimist fringe of the Tory party using this special status for their own ideological wet dreams.
Finally, there is the ongoing domestic argument about the revocation of EU law by the end of the year and (related) the ongoing debate on the post-Brexit economic model. And the Brexit culture wars will certainly be revived in due time for the next General Elections.
In sum, I don’t believe the Brexit soap opera is over but the rest of the 2023 season might be a bit more boring than expected – and that is good news!
3 March 2023
Greenwashing – a panel discussion
I had the honour of moderating a panel discussion on greenwashing at the CEPS Ideas Lab in Brussels. An important and timely discussion, given also recent legislative developments on the European level. The discussion was under the Chatham House Rule, so I will only summarise the main points.
What is the problem? There is increasing pressure on banks and other financial institutions and market participants to take into account the carbon footprint of their asset holdings. This pressure comes from the general public, investors, activist groups and regulators. As predicted by Goodhart’s Law, once a metric (how green is a bank’s balance sheet) becomes a policy target, it ceases to be a good measure, because it becomes subject to manipulation, such as greenwashing or greenwishing.
And while one might think that transparency and court cases might be sufficient to minimize this risk, the financial sector itself has asked the European Commission to step in with their taxonomy. Given the variation in ESG ratings, an increasing numbers of greenwashing scandals and overall lack of globally agreed standards, maybe not surprising. However, beyond setting rules and defining shades of green, one critical challenge is the lack of data! What financial institutions also need is a change in culture (rather than renaming the CSR the ESG department, ingraining green thinking throughout the institution) and capacity building.
Focusing on the banking sector carries the risk of regulatory arbitrage – there is evidence for this on the cross-border level (here and here). There is also (anecdotal) evidence for this across segments of the financial system - the banks involved in lending to the Dakota Access Pipeline ultimately sold off their exposures to hedge funds that are not subject to the same disclosure standards. A question of regulatory perimeter, as seen in other circumstances.
One important question is whether we are too ambitious in our expectations of the financial sector to transition from supporting brown to supporting more green industries and firms. There is clear evidence that banks might drag their feet given their asset exposure to existing traditional ‘brown’ firms and thus delay the necessary transition. But even ignoring this incentive constraint, one might not be able to expect banks to change their portfolio composition over night; but maybe we have to be overambitious to get at least half-way there.
A final important issue I would like to flag is that the financing of the transition requires looking beyond the banking system. Given the amount of funding needed but also the need to fund new projects and enterprises (not necessarily the forte of the banking system), there is thus a clear link to the capital market union and the strengthening of the non-bank segment of Europe’s financial sector.
3. March 2023
Ukraine – one year on
A year ago, we woke up to the news that Russia had invaded Ukraine. The initial shock has given way to a new normal – a war in the centre of Europe for the first time since World War II and an aggressive Russia that will not stop at anything. A fragile consensus has emerged on both sides of the North Atlantic that Ukraine has to be supported at any price, as even a limited victory for Russia will only invite more aggression, not only against Ukraine but against other countries.
There are still those that on the left and right extremes of European politics who continue to be clearly outside this consensus, though for different reasons; the left in its naivety, calling for negotiations (what part of Ukraine and its population are they willing to give up to the Russian butchers? What would be an acceptable outcome of such negotiations, I wonder), the right because it is Russophile, prefers cheap energy over freedom and is part of an anti-democratic front, which includes Trump, some of the Brexiters and Hungary’s Orban.
The Great Power hypothesis (as pushed by Mearsheimer) has been completely discredited. As much as I have referred to Russia as aggressor so far, it is not the country Russia that has decided to brutally invade Ukraine, but its autocratic dictator Putin, with support of its elite. This is not a struggle between Great Powers but between democracy and autocracy. Which again means that negotiations and settlements as done in the 19th century between European powers are not an option.
The economic fallout for Western and Central Europe has been less severe than feared. Adjustments in Europe’s energy markets have been quicker than expected. Doomsayers that predicted a collapse of German manufacturing if cut off from Russian energy have been proven wrong. There is thus the tendency to go back to normality (and I am guilty as charged). However, as important as gains on the battlefield in Ukraine are, this struggle against autocracy is a long-run with many enemies within the EU, ranging (as mentioned above), from the current Hungarian government to many populist parties across Europe, mostly (though not exclusively) on the political right.
24. January 2023
Development Banks in Time of Great Volatility
The pendulum between markets and governments has gone back and forth over the past decades. When I became a professional eonomist, it was the tail end of the Washington Consensus era, with a focus on market-based solutions and governments focusing on providing the institutional and macroeconomic framework. One controversial part of this Consensus was the role of state-owned banks and, more specifically, development finance institutions (DFI). Often set up with the help of the World Bank in the 1960s and 70s, they developed mostly a rather dismal track record (one of my colleague commented on the 80% plus NPL ratio of one African agricultural DFI rather cynically, “why would they not make the extra effort to get to 100%?"). Political interference was ripe (one African finance minister in the same country commented to me once that the cotton farmers in his district really depended on the agricultural DFI for funding; on the way out a local colleague told that there were no cotton farmers in his district ☹).
But pure reliance on market forces has not really helped address many of the failings we observe in developing countries, partly because there are market failures and the challenge is to develop markets rather than to purely rely on them. This has also opened a new role for DFIs, not so much in retail lending but in second-tier activities – on-lending. Almost 20 years ago, my former World Bank colleagues Augusto de la Torre and Sergio Schmukler framed the concept of the visible hand of the government, with tools that include partial credit guarantees, platforms to match small supplier with financiers and large buyers, and start-up subsidies for new market segments. Public-private partnerships in infrastructure financing has become the state-of-the art approach, even though the devil is in the detail.
DFIs might also have a counter-cyclical role. Bank lending is procyclical and typically retrenches most when you need it most, i.e., during recessions and crises. The obvious trade-off is macroeconomic stabilization through DFI (or more broadly state-owned bank) lending and risk of resource misallocation.
Late last year, we organised an on-line workshop with Oliver Wyman to discuss some of these issues, with representatives from different multinational, regional and national development banks. The event was under Chatham House rule, but here are some highlights: While the economic outlook is somewhat better now in February than back in December, the current macroeconomic environment poses major challenges for SME, while governments have limited fiscal space and monetary tightening will make funding conditions even harder and commercial banks more reluctant to lend. That is where DFIs can come in! However, it is hard to reach out directly to SMEs, and might be better to do so through targeted credit lines through commercial banks (if funding constraints are binding) or credit guarantees (if risk premiums are a binding constraint). Beyond access to funding there is also the challenge of formality in many developing countries. The IDB Lab has deployed a combination of grants and advisory services to support innovative ventures that help address the informal sector, such as digital payment solutions.
Going forward, climate change and transition to net zero will be a challenge, especially for SMEs. This will also be relevant for the focus of DFIs. For example, the Brazilian development bank BNDES is to shift the organization’s focus from purely financial value creation to one of positive socio-environmental impact.
Finally, let me mention that together with some colleagues at the FBF, we are currently working on a project with the IDB advising the new government of Colombia on how to strengthen DFIs in Colombia, drawing on examples of other countries, in the areas of financial inclusion, innovation and sustainable finance. More to come…
21. February 2023
Quo vadis financial centre UK post Brexit?
My former EUI colleague Christy Petit and I have written a report for the European Parliament, published last week on recent trends in UK financial sector regulation and implication for financial sector cooperation between EU and UK. A short summary.
Brexit has posed unique challenges for financial sector policymakers in the EU as the most important financial centre in Europe is now outside its regulatory framework. The Trade and Cooperation Agreement agreed in December 2020 between the UK and the EU includes a very thin financial sector chapter, with eight out of 783 articles directly covering this sector. A Memorandum of Understanding to establish EU-UK structured regulatory cooperation on financial services has not been signed and any regulatory cooperation has been paused due to the conflict about the Northern Ireland Protocol, part of the UK Withdrawal Agreement.
Divergence of UK regulation from EU regulation is almost a given outcome following Brexit. The UK’s rationale to actively diverge from the EU pertains to broader political choices and regulatory objectives: flexibility, common law principles-based, competitiveness, growth, and innovation. In addition to such active divergence, there can also be passive divergence, with the UK not keeping up with EU legislative changes or not following new EU regulation in the financial services sector. While there has not been that much divergence yet, one can expect a fair amount over the coming years.
We discuss different scenarios of low, medium and high divergence in the report. Which scenario will materialise is almost impossible to predict, but will to a large extent depend on the resolution of the current stand-off between the EU and the UK over the Northern Ireland Protocol. Before the resolution of this conflict, it is difficult to see any progress happening in terms of regulatory cooperation in the financial sector. A lot will also depend on future governments in the UK and whether they want to bet the economic future of the country on an aggressive strategy to grow the financial sector, including in new segments, such as crypto.
Since 1 January 2021, the UK is a third country and access to the European Single Market can only be given through equivalence decisions by the European Commission, based on the principle of proportionality and a risk-based assessment, but also with some degree of unilateralism and discretion, including political factors. One specific challenge for European authorities is the treatment of CCPs in London. On the one hand, there is the intention to build more clearing capacity within the EU, in particular with the legislative proposals from the European Commission to further develop the EU Capital Markets Union in December 2022. On the other hand, there are financial stability concerns on having a large part of transactions be cleared outside the EU. Supervisory cooperation is therefore critical, but equivalence decisions are not exclusively driven by technical criteria but also by (legal/political) risks stemming from a scenario where such an equivalence would be withdrawn.
Writing this report was not without challenges, the main one being that things change rapidly in London, with new political initiatives popping up frequently, but not always followed through. One can also clearly see a tension between the current government wanting to grow the financial centre UK, similarly as before the Global Financial Crisis, as engine for the overall UK economy, while regulatory and supervisory authorities are much more cautious and more focused on stability. This tension will continue to play out and partly drive the degree of active divergence we will observe between regulation in the UK and the EU.
14. February 2023
Gemany’s lack of leadership
The current hesitance of the German government of whether or not to deliver tanks to Ukraine (or at least allow other countries to deliver German tanks) is shameful! Whether it is based on a deeper political calculus vis-à-vis Russia or for domestic political reasons does not matter – the German government has failed in its European leadership role. It also shows an amazing ignorance about history. Yes, after World War II, there should be no war ever again started from German soil; but this war has been forced upon us and the rest of democratic Europe by Putin’s brutal aggression against Ukraine.
There are different excuses, but the most telling is what recently a German journalist said: “After World War II, never again can German tanks be used against Russia”. Never mind that Russia has been brutally attacking Ukraine, another country invaded by Germany in World War II. Another argument is pure fear – Putin will come after us if we send tanks, possibly even with nuclear weapons. A rather naïve approach – does anyone think he would stop at Ukraine if he gets his way. Almost 80 years after the end of World War II one might think that Germany has finally found its role in Europe – unifying and leading where needed. In many occasions over the past decades it has done so, but it has now all but given up any leadership role during the most immediate challenge for peace and democracy in Europe and that is not just sad and shameful, it is also dangerous.
There is a lot of discussion that a long-term approach has to look beyond the war and to future engagement with Russia – after all, an approach like the defeat and occupation of Germany in 1945 is all but impossible with Russia. And one has to avoid the Allied mistakes after World War I, pushing Germany economically and politically against the wall, facilitating the rise of Hitler. But any future engagement with Russia can only start after a complete defeat of Russia in Ukraine; anything else would simply encourage Putin (or any successor) to repeat such an invasion again in a few decades.
For the past year or so I thought that it was simply a lack of communication skills by the new chancellor; however, it seems more than that. A final argument against delivering tanks to Ukraine now is that the German public is not quite in favour yet. BUT: leadership is not waiting until opinion polls tell us that the right thing to do is finally popular; it is to do the right thing and tell people why one does it.
23. January 2023
Brexit – a new season is opening
As I have written many times, the Brexit soap opera is a gift that keeps on giving. While Brexit was supposedly done on 31 January 2020, it has become clear that the political class cannot ignore what is obvious even to the less informed public – Brexit has been a failure with lots of downsides and no upsides. Yes, some Brexiters keep insisting that the sunlit uplands are just around the corner (though we – or some of us - might get to this corner only in 50 years). In the meantime, the UK has suffered a permanent GDP shock, which also explains the strike wave gripping the UK – a distributional fight over a shrinking pie. The NHS is all but on its knees, with access to basic health services no longer resembling that in a European country.
The degree of corruption in the Tory government is nothing but astonishing for a country that has always prided itself on strong institutions. The former chancellor of the exchequer has seemingly tried to evade taxes (and was caught), Johnson got help from a rich donor in obtaining a loan who subsequently became BBC Chairman. The amount of money that has gone down the drain towards connected Tories in spring 2020 in the name of fighting Covid is astonishing.
To distract from the swamp of Tory corruption, more culture fights have to be started (against ‘woke’, against peaceful protests etc.) and legislative spring cleaning organised – in the form of reviewing a couple of thousand laws ‘imposed’ by the EU on the UK during almost 50 years of membership within a few months. But it is not the sovereign parliament that is supposed to do it, but ministers and civil servants – so much about taking back control! That dumping a large number of laws and rules increases uncertainty for business, depresses investment and make trade with Europe even more difficult does not matter, does it?
Given the disaster that Brexit has turned out (and as predicted by many including this economist), there are discussions of what might have gone wrong. Why is it that the UK had not held all the cards after the referendum? An obvious response is that the EU is simply bigger. However, it is also clear that the UK government made critical mistakes during the negotiation process. Theresa May lost all her cards after showing them – by insisting on “control over laws, money and borders” she all but excluded proper membership of the Single Market and Customs Union, which in turn allowed Michel Barnier and his negotiators to impress on EU member states the risk any concession to the UK in terms of access to Single Market would have in terms of undermining it. However, this basic and consequential mistake had its roots in the fact that everything that UK governments have done over the past seven years vis-à-vis the EU has been dictated by domestic political needs and not by diplomatic considerations. This obviously includes the fantastic deal of late 2019 that helped Boris Johnson win the elections before being denounced by himself and his chief negotiator David Frost.
So, as predicted many times before, Brexit is the soap operate that will keep giving, even if the UK’s political class would rather not.
23. January 2023
Competition in Italy
Having lived in several countries, it is always fascinating to see differences – the good, the bad and the ugly that every country in the world has. The transport sector in Italy provides two interesting examples of the power of competition, a positive and a negative one. Let’s start with the positive – long-distance fast trains. There are two companies sharing the same rail infrastructure and competing with each other. This seems to have really reduced train fares (with two weeks in advance, for 20 euros to Rome, a 90 minute ride). And while not all trains are punctual, the record is certainly better than currently in Germany, including with respect to informing passengers.
The negative example is the taxi monopoly and the absence of Uber or any other competitor for the traditional taxi industry. The results are extremely high taxi rates (compared to other European countries where I have lived) and limited reliability (as I often have to take very early flights I have to rely on taxis) – as I found out the hard way, reserving a taxi for 5 am does not guarantee that there will actually be a taxi – at least you get a text message at 4:58 letting you know there won’t be a taxi ☹. And the power of taxi drivers goes beyond their own segment. Both Bologna and Pisa airports are connected to the respective train stations with shuttle trains, which take 5 to 10 minutes, with a price of one euro per minute of the short (and often crowded) ride! These high prices are supposedly to match the price of a taxi drive between airport and train station.
I am not sufficiently versed in Italian political economy but one can clearly see that competition works if implemented properly.
17. January 2023