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Summer notes

As much as I love Florence, the summers are hard to bear for Northern Europeans like me. So, I decided to escape for a few weeks up to Norway and Scotland, trying to catch a breath, catch up on research and some summer reading.

After two years in Italy, I am still intrigued by this country and its many contradictions. Take public services – they seem to work, as long as you don’t look behind the scenes – take the example of trash retrieval, so much better than London but don’t try to put in a request via Internet, am still waiting for the response for one I put in late-2022.

Take the food culture – as one of my non-Italian colleagues told me early on, Italy is one of the countries with the most stringent rules on food culture (no cappuccino after 11 am; no pizza in the evening; no cheese on pasta with fish etc.). On the other hand, it seems that many of these rules were developed only relative recently as this FT article argues.

What do I miss of London, home for 8 years – the cosmopolitan nature and the diversity! What do I not miss: the bad weather and the sometimes hectic speed of life!

Some issues I am following: the amazing paper by Florian Ederer and co-authors on the Economic Job Market Rumors community, showing that many posters are based in the top universities in the US. One can only hope that bringing in more transparency into this ugly and toxic underbelly of our profession is the first step towards reducing its negative influence.

Also worthy to read is this comment by Michael Makowsky, explaining why this finding is not surprising after all, and offering a solution, such as addressing core problems in the academic economics profession.

On a different note, seven years after he won the Brexit referendum, the unelected grifter Nigel Farage is still able to pull the strings in the UK, forcing even a bank CEO to resign. Why? Because he no longer qualifies for an account at elite bank Coutts and was therefore referred to NatWest, but a document came out assembled by Coutts staff relating to the disgusting politics of Farage. This is not about forcing someone out of the banking sector; it is simply the next step in the culture wars – why talk about all the major problems the UK faces (to which Farage has contributed) and the continuous Russian influence in the UK, when you can start a new Brexit fight somewhere. And the media – as always – either fuel the fire (Daily Mail etc.) or play ball (like BBC) – what a sad country!

28. July 2023

Fortress Europe or strategic autonomy?

The chief economist of DG Competition of the European Commission typically does not dominate any newspaper headlines. Until last week that is, when the candidate for the position – Fiona Scott Morton - withdrew her application after her choice was heavily criticised by politicians across the EU. Target of the criticism was primarily her nationality: a US citizen. There was a second argument against her: that she had consulted for several large tech companies (which are, not surprisingly, in the US).

Let’s start with the second argument: Scott Morton has been active as academic, policy maker (US Department of Justice) and consultant. This is not uncommon for academics of high calibre (the current chief economist Pierre Régibeau has a similar bio). In the area of monetary economics, it is rare to find well-published and recognised academics who have not had some link with a central bank. Financial academic economists often work both for policy institutions and private financial institutions (I have done so as well, as can be seen from my own CV, even though not as much as others). There is a lot to be said about the ‘revolving door’, conflict of interest or (to put it differently) academics getting their hands dirty by stepping out of the ivory tower, but it is important to stress that the chief economist position is an advisory position, not a decision position.

Now to the first argument, that of nationality. In the time of ‘strategic autonomy’ and increasing divergence between US and European interests, having a US citizen in this position is seen as not appropriate. Strategic autonomy or fortress Europe that pulls up the drawbridge?

As expat for all of my professional life, I have a personal relationship with this issue. In the Netherlands, I was not part of the circle of economists closely involved in policy advice for the government, but in several occasions had advisory roles; my nationality was never questioned. On the other hand, one of the low-points during my eight years in the UK came after the Brexit vote, when the UK government wanted to restrict academic consultancies on Brexit for the government to UK citizens.

In a world where talent is globally mobile, it would be a shame for any country to not tap the talent where it can find it. For us globally mobile economists it is a reminder of our limitations and that nationality often still trumps talent. So, yes, I share the frustration of many of my fellow (expat) academics across Europe that this is a very negative signal.

24. July 2023

…and the winner is…

As every year, the Advisory Scientific Committee of the ESRB is awarding the Ieke van den Burg Prize to recognise outstanding research conducted by young scholars on a topic related to the ESRB’s mission. This year’s prize is awarded to the paper Systemic climate risk by Tristan Jourde and Quentin Moreau. Unlike other papers that have explored the impact of climate risk on stability of individual financial institutions, this paper gauges whether such an impact can result in contagion, i.e., systemic financial stability risks (in line with the macro-prudential mandate of the ESRB).

The authors find that it is transition risk more than physical risk that affects the Value-at-Risk of European financial institutions, particularly life insurance companies and real estate investment trusts. Importantly, these transition risks can also exacerbate tail risks within the financial system. Physical risk again does not seem to have any impact on systemic risk. The authors also provide a number of interesting cross-sectional regressions, showing that larger, more profitable institutions and those more sensitive to market movements have higher exposure to transition risk, while smaller institutions are more exposed to physical risk. Interestingly, exposure to tail climate risk also seems to influence financial institutions’ disclosure strategy and their propensity to engage in initiative aiming at reducing their environmental footprint.

The paper is not easy to read as lots of technical details are being presented, but it makes an important contribution to the increasingly important literature and policy challenge of the impact of climate risk on financial stability, making the strong case that here as in other areas there is a macro-prudential dimension.

5. July 2023

Corporate leverage in Europe – a new ESRB report

Fresh of the print, a new report of the Advisory Scientific Committee of the ESRB, joint with Tuomas Peltonen, Enrico Perotti, Antonio Sanchez Serrano and Javier Suarez. Unlike the traditional finance-growth-stability and credit cycle literatures, this report does not focus on credit-GDP developments, but rather on corporate leverage. Specifically, we present a long-term view of the evolution of financing of non-financial corporations (NFCs) in Europe in recent decades and compare this with the contemporaneous evolution of NFCs in other advanced economies. Maybe surprisingly, we find that corporate leverage in the EU (measured as ratio between debt and total assets

both at market prices and at book values) has continuously declined since the Global Financial Crisis. This is observed across most EU countries, firm sizes, and sectors. Over the same period of time, there has been a growing role of non-bank financial intermediaries in the provision of credit to non-financial corporations, albeit starting from a very low level.

In a second part, we discuss different supply- and demand-side factors that can explain the decline in leverage. Both bank fragility and post-2008 regulatory reforms are important supply-side explanatory factors although it might be difficult to explain a long-term decline in leverage with these factors. Candidate demand-side explanations for the decline in corporate leverage include a general decline in investment prospects in a period of secular stagnation, and the technological shift in investment composition towards intangible assets, which need less upfront funding and are less suitable as collateral for debt financing.

In a third part we discuss potential general equilibrium outcomes and financial stability implications. The decline in credit for NFCs could lead to a reallocation of credit to other sectors or financial assets, which might generate financial instability if increased credit supply to those sectors (or the concentration of investment in specific assets) were to produce greater systemic risk, as a result of unsustainable valuations or exposure to more highly correlated negative shocks, for instance, especially in adverse aggregate scenarios. In Europe, a major reallocation of credit to governments and, to a lesser extent, to household mortgages can be observed. Finally, the growing role of non-bank financial intermediaries stresses the urgency of developing a comprehensive macroprudential framework that avoids leakages across segments of the financial system and guarantees that similar risks are addressed consistently across the whole system.

One important additional point we stress is that the general decline in corporate leverage does not necessarily imply fewer stability concerns. First, if NFCs reduce their leverage in response to higher uncertainty, lower profitability prospects or costlier access to bank funding, this does not mean that NFCs are less vulnerable than in an economy in which, under less adverse economic and financial conditions, they were adopting less conservative financing choices. Second, the analysis of average leverage ratios may conceal the existence of NFCs that are exposed to debt overhang problems and at high risk of financial distress.

29. June 2023

The Brexit vote – 7 years on

Seven years ago, I woke up in London to the news that a majority had voted in favour of the UK leaving the European Union in the Brexit referendum. In addition to being surprised (more on this below), I felt an enormous loss. The idea that the UK would no longer be part of the European Union (which comprises most of Western and Central Europe) with all the implications for EU citizens living and working in the UK was a terrible one. I also felt that this clearly was a major historic mistake.

I was surprised as I simply did not understand how a country could either leave EU, Single Market and Customs Union and voluntarily take an economic hit, or leave EU and stay in Single Market and Customs Union and thus avoid the economic hit but become a rule-taker. Ultimately, the UK decided for the former and the hit predicted by 99% of economists has materialised. The UK ended up outside any of the major institutional structures in Europe: the EU, Schengen, Single Market and a customs union. None of the supposed benefits has materialized: the NHS (supposedly benefitting from additional money) is worse off than before (among other b/c European doctors and nurses leaving); immigration has gone up rather than down (but European immigrants now being outnumbered by non-Europeans); the UK fishing industry has not gained at all and the UK manufacturing industry is in decline. The sunny uplands described by Daniel Hannan read like a fairy-tale.

The question that people keep asking – what if the UK government had handled Brexit in a smarter way? The rather polemic answer to this is that smart people would not have undertaken Brexit in the first place, but might have found a way around the referendum result. A more serious answer is that the same arguments put forward during the referendum campaign (‘they need us more than we need them’; ‘there are no downsides; ‘we can have our cake and eat it’) prevented the Brexiters from designing a sensible negotiation strategy as they denied the existence of any trade-offs. Ultimately, however, the Barnier staircase made clear the trade-offs and gave the UK different choices. The attempt by Theresa May of a half-house position of the UK half-in, half-out of the customs union and the Single Market for goods, to thus minimise economic damage, was never a credible plan. So even a better prepared and smarter UK government would most likely have ended up with a similar if not the same Brexit deal.

A lot has been written about how Brexiters have damaged the institutions of the UK (very prominently by my favourite Brexit observer and writer Chris Grey); however, it is also the process of Brexit itself that has undermined the political culture in the UK. Yes, the people were given the choice to vote in or out, but they were never given the chance to opine about the nature of Brexit. The decisions about the future relationship between the UK and the EU were negotiated within the Conservative Party and ultimately taken by a few advisors around Boris Johnson (most prominently David Frost). A broad national discussion about the nature of Brexit was never allowed (‘Brexit means Brexit’, ‘the people knew what they voted for’ and ‘any discussion serves to undermine and reverse Brexit’). And even today, both Conservatives and Labour refuse to engage in any serious debate on the relationship between the EU and UK. Given that Brexit was clearly mis-sold, this ultimately undermines trust in the democratic process and in the institutions of the UK.

So, no wonder that the majority of UK voters is now unhappy about the Brexit that they have been served with. Unfortunately, they cannot send it back to the kitchen. The EU has no appetite of a major renegotiation in the near future; there are other much more important priorities and the trust that Johnson has destroyed over the past years will take a long time to be rebuilt. And any idea of rejoining seems also far away in spite of what some European politicians claim: why would the EU even start negotiating with a country where one of the two major parties (and a certain part of the other) is against EU membership.

23. June 2023

Financial inclusion and cross-border finance

Last week, I was invited by the WTO Committee on Trade in Financial Services to give the introductory presentation to a one-day workshop onTrade, Inclusion and Accessibility. I discussed both recent evidence on financial inclusion and the role of cross-border financial institutions. There is a large literature on financial inclusion and there is a large literature on foreign bank entry in developing economies and even the interaction between the two has been expanding rapidly over the past years. While far from being an exhaustive literature survey, in the following some remarks:

There are lots of theoretical arguments in favour of a positive and lots of arguments in favour of a negative relationship between foreign bank entry and financial inclusion. On the one hand, foreign banks can bring capital, technical skills, and product innovation; their entry can increase competition and lead to improvements in the efficiency of the banking sector, including by pushing domestic banks down-market; they can also increase resilience to domestic shocks because of greater diversification and access to capital and liquidity and thus help maintain a stable access to external funding by smaller enterprises. On the other hand, foreign banks can “import” shocks from their home countries and/or spread shocks from other countries in which they operate and thus undermine financial inclusion in host countries; fierce competition with foreign banks can threaten the survival of the local banks and if foreign banks do not have the appropriate lending and outreach techniques for developing countries, this will reduce financial inclusion as foreign banks might concentrate on a top and selected segments of the market.

The evidence is very mixed once one starts looking beyond cross-country comparisons, but there are several generalisable lessons: one, foreign bank entry is more likely to have a positive impact on financial inclusion in middle- than in low-income countries (where lots of other institutional constraints, such as the absence of credit and collateral registries, hold back financial inclusion); two, foreign bank entry is more likely to have a positive impact on financial inclusion if they have a significant market share rather than being niche banks (which might reflect the nature of foreign banks catering to niches). Three, not all cross-border banks are alike.

Specific country studies provide detailed insights. There is an expansive literature on the effect of foreign bank entry on Central and Eastern Europe. On the one hand, there is quite some evidence (among others, by my former colleagueSteven Ongena and Mariassunta Giannetti) that foreign bank entry helped cutting entrenched relationships between banks and incumbent, often (formerly) state-owned firms and helped mitigate local shocks, thus contributing to macroeconomic stabilization and the transition process. Inwork with Martin Brown, on the other hand, we find that when it comes to household finance, foreign banks focused primarily on higher-income and formally employed individuals with higher personal assets, thus cherry-picking financially more transparent clients.

In astudy on Mexico, Sole Martinez and Ifind that following the 1994 Tequila crisis and the sale of most large Mexican banks to international banks, their outreach went down, as measured by branch presence and the number of accounts, especially so in more rural and in poorer areas. While on might interpret this as foreign bank entry undermining financial inclusion, one wonders whether the boom period before the 1994 crash had resulted in an overextension of the Mexican banking system.

Foreign banks often use different lending techniques than domestic banks. Specifically, foreign banks often use transaction-based lending techniques, relying on hard information and hard assets as collateral. In a seminal study,Atif Mianshowed that foreign banks in Pakistan are less likely to lend to smaller, more opaque firms in smaller towns. In a study on Bolivia and a sample of firms that borrowed from both domestic and foreign banks in the same month (thus controlling for different banks catering to different borrowers),Vasso Ioannidou, Larissa Schaefer and Ifind that foreign bank loans are more likely to be collateralised and of shorter maturity. While we cannot gauge the real economic repercussions of this, shorter-maturity loans might hold back long-term investment and the insistence on collateral reduce the use of external funding for innovation. Foreign banks are also more likely to use hard information and collateral as basis for loan pricing, unlike domestic banks that rely more on soft information.

The prevalence of different lending techniques can have repercussions for firms’ access to external funding during crisis situations. In a study on Central and Eastern Europe,Hans Degryse, Ralph De Haas, Neltje van Horen and Ifind that relationship-based lenders were more likely to ease firms’ financing constraints during the Great Recession than transaction-based lenders. It is important to note, however, that many of the foreign banks in that region (unlike in Bolivia in in our earlier work) are relationship lenders, given their geographic proximity and their SME/rural focus in their home countries. However, distance can play an important during crises, as shown byPatrick Bolton and co-authorswith Italian data, where longer distances between borrowers and lenders resulted in more lending retrenchment during the Global Financial Crisis. So, this evidence can be interpreted of being in line with the argument above that foreign banks might withdraw from smaller and more opaque clienteles during crisis situations.

One important development over the past two decades has been the rise of regional, South-South banks. Most prominently, in Africa, South Africa banks expanded North, Moroccan banks expanded South and Nigerian banks expanded East. While the ultimate jury is still out, anecdotal andtentative econometric evidencepoint to a potentially positive impact. For Pakistan, Atif Mian shows that foreign banks that are geographically and culturally closer to Pakistan, are more likely to behave like domestic lenders than cross-border lenders from Europe and North America.

Beyond foreign banks, there are other important foreign players in the financial inclusion space in many developing countries (as also detailed in thepresentation by Juan Marchetti). Micro-finance institutions are often funded and even managed by foreign donors; while in some cases they have grown into full-fledged banks catering to the low-end of the market (e.g., ProCredit), other MFIs cater to a small population segment; my reading of the micro-finance literature is that the focus on credit by the microfinance movement has had a moderate but not transformative impact on financial inclusion and poverty alleviation. Remittance service providers belonging to large international companies, such as Western Union and MoneyGram also play an important role in financial inclusion – however, the pay-in, pay-out model prevents savings channeled through remittances contribute to financial deepening in receiving countries; further,remittance prices, even though they have come down, continue to be too high.

Another important, more recent, player are telcos that in many countries have either led or have cooperated in the mobile money revolution, which has increased financial inclusion substantially in many developing countries. Many of these players are large multinational companies with subsidiaries across the globe. And while they have the potential to significantly contribute to the roll-out of mobile money and thus financial inclusion, their often monopolistic position raises regulatory challenges (some of which are discussed inthis report).

Another more recent class of players are fintech and bigtech companies that have expanded across borders. As in the case of MFIs, there are donor-supported platforms and providers as there are profit-oriented. Large platform companies (e.g., Mercado Libre in Latin America) are often multinational enterprises, benefiting from network externalities and thus expansion across borders. As documented in an expanding number of papers, the access to new sources of data allows fintech and bigtech companies as good if not better credit worthiness assessment as banks. Similarly to telcos, some of these players have the potential to significantly change the financial system, but also raise regulatory challenges related to stability and consumer protection.

The debate on cross-border finance has thus the potential to change its focus over the next few years. Over the past two decades we have learnt a lot about the causes and consequences of foreign bank entry; the emergence of new players raise new questions and new research topics.

20 June 2023

Trump/Johnson – chickens coming home to roost

The end of last week saw the past of two leading autocratic populists in the US and UK finally catch up with them. In the US, Donald Trump was charged for not only taking secret documents from the White House, but also showing them to people without security clearances and lying about it. In the UK, Boris Johnson pre-empted a damning report by the House of Commons’ Privileges Committee about him having lied to Parliament and resigned. In both cases, Trump and Johnson lashed out against their accusers, showing clearly that they think the law does not apply to them and that institutions and norms are only for suckers. I guess depending where you stand you can see this as the dark state fighting back or as the rule of law reclaiming its predominance over personal ambitions.

In both cases, these men have done enormous damage to their respective countries, Trump undermining institutions, fueling a culture war and questioning the role and integrity of democratic elections; Johnson with Brexit and – again – undermining institutions and democratic norms. In both cases, they were driven by personal ambition and not by any political conviction.

One critical difference is the reaction of their respective parties: a large part of the Republican party in the US doesn’t seem to mind being led by a criminal, while the Conservatives in the UK seem to be relieved to see the last of Johnson. While in the Republican party the main test is loyalty to the Dear Leader, in the Conservative party the test is loyalty to Brexit and denying any negative effects (even though this is slowly being punctured).

Both have made clear that their personal ambitions are above party and country; in the case of Trump pushing Republican Senate candidates that are not electable in purple states, in the case of Johnson undermining the current Conservative Prime Minister with him and two of his acolytes triggering by-elections by resigning from Parliament.

With the passing of Silvio Berlusconi today (often seen as the first post-WW2 populist leader in Western Europe) and the events of last week in the US and the UK, one might be tempted to hope for an end to the populist era. If only; it seems rather unlikely – what these three have sowed, will be harvested for a long time to come.

12. June 2023

Central Bank Digital Currencies

Central Bank Digital Currencies (CBDC) have been in the discussion for the last couple of years, having received further impetus by the plans of Facebook/Meta to launch Libra (later renamed Diem, before being shelved upon regulatory pressure). While it very much seemed that the push for CBDC was initially a reaction against stablecoins such as Libra/Diem, lots of more positive arguments have been made over the past year (for an earlier Oxford Union style debate, organised by FBF, seehere). Arecent FT article has revisited the debate.

One important argument is that CBDC are simply the new digital cash, bringing public money into the 21stcentury. The question, however, is whether it is not rather a substitute for private money, i.e., bank deposits, and might thus undermine banks’ franchise value. Another argument is that with the rise of stablecoins and/or BigTech provided payment system, personal data become more and more commercially valuable and there are important risks to privacy. Having the central bank as neutral party provide a digital currency can address these privacy risks. Opponents would argue that access to information by a government authority (and unlike with stablecoins not having the option to opt out), raises even more privacy concerns. In any case, while the use of cash starts out from being completely anonymous, in the case of digital currencies one has to undertake deliberate steps to ensure a sufficient degree of privacy. More generally, central bank digital retails currencies can be seen as an attempt to maintain monetary sovereignty and prevent digital dollarisation or the creation of private digital currency areas that undermine such sovereignty. In the euro area another argument has been made: unlike euros in bank accounts, which at the height of the eurodebt crisis were not really equal given unequal backstops across countries, a digital euro would not face such a problem.

Both advanced and emerging markets have looked carefully at the option of introducing CBDC although so far it is only a handful emerging markets that have actually introduced them (for an excellent tracking tool, seehere). The most striking result so far is the very limited uptake across these countries. While careful studies are still missing, there are different reasons for this limited uptake: In some countries (e.g., China where the digital Yuan is still in a pilot phase) there is strong competition from efficient BigTech payment systems. In other countries, the infrastructure for the central bank digital currencies is still limited.

Is the digital euro a solution looking for a problem (as the FT titled its article)? The argument that a digital euro might help overcome denomination and fragmentation risks seems to focus on a second-best solution in the absence of creating the necessary financial safety and fiscal framework conditions for a sustainable currency union. And it also stands in contrast with a limit to digital euro holding.

My EUI colleague and former SSM Board member Ignazio Angeloni titled a recentbriefing for the European Parliamentas follows: “digital euro: when in doubt, abstain (but be prepared)”. As many others, I would argue that there are better alternatives to the digital euro, such as improving retail payment systems (why does it take me a day to send a payment from Italy to other euro countries?). The recent introduction ofPixin Brazil, a retail payment eco-system that enables immediate transactions across any transaction account in Brazil, has revolutionised a traditionally inefficient payment system, without introducing a new form of money.

29. May 2023

On a personal note - ESRB

Over the past 4.5 years I have been a member of the Advisory Scientific Committee (ASC) of the ESRB. Starting this month, I will be a co-chair for the next four years, together with Loriana Pelizzon and Steve Cecchetti. The actual chair(wo)manship is rotating, with each of us taking the lead for 16 months. In addition to co-chairing the ASC, this also involves participating and voting in ESRB General Board meetings. Unlike other European institutions, the ‘academic’ branch of the ESRB has three votes in the General Board (thus as much as three countries).

What is the ESRB? It was established at the end of 2010 as part of a wider reform aiming to improve financial supervision in the EU and brings together EU central banks and supervisors, the European Commission, and the European Supervisory Authorities (ESAs). It aims to identify and mitigate risks to the stability of the EU financial system that could damage the real economy. It may issue warnings and recommendations on how to mitigate those risks, thus relying on soft law rather than hard enforcement (the recommendation on dividend restrictions during Covid-19 is a classic example).

The Advisory Scientific Committee (ASC) is made up of 15 academically oriented independent experts from across the globe. In addition to providing input to the General Board (together with the Advisory Technical Committee), it produces its own reports and insights, including some quite prominent and influential ones, such as on overbanking in Europe, and transition to a low-carbon economy and systemic risks, but also contributes prominently to ESRB reports such as on safe assets in the euro area and macroprudential implications of a low-interest rate environment.

While some might see the ESRB as a macroprudential authority without teeth, it is also Europe at its best. In the absence of clear macroprudential regulatory and supervisory responsibilities on the supranational level, it forces authorities across the EU to share their views and come to joint conclusions on financial stability risks. The involvement of academics is rather unique but also reflects the increasing importance of a close dialogue between policy world and academia.

23. May 2023

Research conference at the SSM

Early May saw the first SSM research conference, where I had the honour to serve as chair of the programme committee. Lots of great submissions and an excellent conference programme. While there is a rich research culture in the ECB and national central banks in Europe, such a research culture is now starting to be built up in the SSM. It is important to note that there was an active participation of senior management and board members of the SSM so clearly the programme also reflected SSM priorities in the area of bank supervision and financial stability.

I will not be able to do justice to all the excellent papers that were presented, so here a quick rundown of some that caught my attention.

Several papers have gauged the impact of the extraordinary macroprudential measure of asking banks to refrain from paying dividends during the pandemic. One further contribution is by Ernest Dautovic and co-authors. Using data on planned but non-distributed dividends (thus exploiting cross-bank variation) and credit registry data they can disentangle loan demand and supply effects by focusing on firms borrowing from several banks. Their result suggests that the dividend restrictions helped support financially constrained firms, especially small and mid-sized enterprises and firms operating inCovid-19 vulnerable sectors. At the same time and reassuringly, there seems no evidence of a significant increase in lending to riskier borrowers and zombie firms.

Cyberattacks have emerged as a major new source of vulnerability for banks and other financial institutions. Antonis Kotidis and Stacey Schref="javascript:void(0)"t analyse a major multiday cyberattack that disrupted the operations of a major third-party technology service provider (TSP) in the US, on which some banks relied for core banking services, including payment services. When the TSP took its systems offline, this disrupted users’ ability to send payments (the first-round effect), which in turn disrupted payments received by non-users of the TSP, leaving them with fewer reserves available for sending their own payments. The drop in non-users’ reserves was sufficiently material for them to seek other sources of funds (the second-round effect). In addition, non-users sent payments after normal business hours to avoid sending materially fewer payments themselves, which could have disrupted yet other non-users’ ability to send payments (the third-round effect). So, certainly some domino and spillover effects. However, the authors also document that the negative effects were mitigated through actions under business continuation plans by the TSP, banks and the Federal Reserve (including switching to manual ways of sending payments, prioritizing larger payments, and extending business hours of the Fedwire system). The authors point to three important policy lessons: First, business continuity planning matters; second, liquidity buffers matter; third, support by the central bank matters.

In a theory paper, Gyöngyi Lóránth and co-authors model supervisory interventions in cross-border banks under different institutional architectures where a bank may provide voluntary support to an impaired subsidiary in a different country using resources from a healthy subsidiary. With supervisory authority on the national level, there is the risk of ring-fencing, thus authorities restricting the parent bank from supporting an impaired subsidiary in another country. This risk increases the more correlated the returns of subsidiary and parent bank are as national authorities will be worried about the costs for the national deposit insurer. Such ringfencing would be eliminated under supranational supervision (i.e., SSM). However, there are also incentive effects, with weaker cross-border banks possibly taking more risks (or exerting less effort) under supranational rather than national supervision. An important contribution to the debate on cross-border supervisory cooperation (and directly related to my own research with Wolf Wagner).

Following the Global Financial Crisis, there was pressure to move from backward-looking to forward-looking provisions to make them less cyclical (‘provisioning too little, too late’). Expected Credit Loss (ECL) approaches such as the International Financial Reporting Standard 9 (IFRS 9) were introduced (although partly suspended in March 2020 given the high uncertainty). IFRS 9 requires provisions to be based on estimated future credit losses, expected to be varied over time as credit risk evolves and usually obtained from dedicated provisioning models operated by banks themselves. Using loan-level data from the ECB’s credit registry, Anacredit, Markus Behn and co-authors gauge how the implementation of IFRS 9 has affected euro area banks’ provisioning behaviour. They find that, overall, provisioning is generally higher under IFRS 9, but the bulk of provisioning is still done at time of default. They also find evidence that IFRS 9 has increased variation in provisioning practices across banks, with banks with higher capital headroom more likely to provision to the same borrower than banks with less capital head room. Thus, accounting discretion and capital management motives seem to affect not only the overall level of provisioning, but also the distribution of provisions across a borrower’s banks.

Finally, Barry Eichengreen and Orkun Saka have a fascinating paper (that I will discuss myself later this week in a conference in Tilburg) on how cultural stereotypes influence cross-border banks’ investment decisions in sovereign bonds. They use hand collected bi-annual data on banks’ investments in European sovereign debt and show that when residents of the country or countries where a bank operates have a high level of trust in residents of another country, the bank is more likely to hold claims on that other country. Specifically, they create bank-specific measure of trust in a specific country, by calculating a weighted average of bilateral trust between two countries, where weights are the share of host-country branches in the network of the bank. They show that this bank-level measure of trust predicts banks’ entry/exit decisions vis-a-vis sovereign debt of a country and that the effect is less strong for more diversified banks, while – not surprising – it is stronger for countries that have gone through a sovereign debt crisis.

23. May 2023

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