More recent blog entries

Looking back, looking forward


This year has been a busy one, the first one without any Covid restrictions and plenty of travel, ranging from India to Brazil, from South Africa to Svalbard (ok, this last one was private travel 😊). My main job, that of Director of the Florence School of Banking and Finance, has become even more demanding, as the school has grown from a start-up into a mid-sized firm. With the additional task as co-editor of the Journal of Banking and Finance and the new responsibility as one of three co-chairs of the Advisory Scientific Committee of the European Systemic Risk Board, time for research has dramatically reduced, although I am confident that the holiday period might offer some time to catch up and make my co-authors a bit less angry with me.


Politics in Europe has taken another step towards the worse, with the right-wing populist Wilders winning in the Netherlands and extreme right-wing parties making progress across countries. At a time, when geopolitical tensions are rising and the threat of a second Trump presidency is increasing, Europe needs stronger cooperation rather than a return to nation states as demanded by the extreme right. In light of Putin’s aggression (and it is naïve to think he would stop at Ukraine’s Western border) an economically strong and politically more united European Union is needed; while the political change in Poland is welcome, Hungary’s Orban seems to have gone fully over to Putin’s camp.


The Israeli-Palestine conflict has led to incredible human loss and suffering. While it is important to remember that it were the terrorist attacks on 7 October that triggered the current war, there are clear questions to be asked about the proportionality of the Israeli response.  Importantly, one suspects that certain military decisions are driven purely by domestic political considerations of the current right-wing Israeli government.  As hopeless as the current situation looks, one can only hope that things will look better in 2024 rather than turn for the worse. It is clear, however, that the initiative either way lies primarily with Israel, the only democracy in the region.


So, 2024 will be another critical year for the defence of democracy, both within countries but also from enemies outside.

27. December 2023

Financial stability implications of climate change


Last week, I was asked to moderate a discussion on the financial stability implication of climate risk at the IV Central Banks Conference on Environmental Risks in Mexico City, organised (among others) by CEMLA, with panellists from central banks and academia and with central bankers and regulators from the Latin American region in the audience. Interestingly, the discussion turned quickly to the political economy of central banks working in the area of climate change and other environmental risks.


Here are some take-aways:


  1. The relative importance of physical and transition risks varies significantly across region: while in Europe the emphasis has been on transition risk (i.e., how do policy responses to climate change affect households and firms and thus financial institutions’ balance sheets) physical risks looms much larger in Latin America.
  2. There was quite some debate on the mandate of central banks/supervisory authorities. It is clear that any actions by either cannot work independently but only in the context of a broader policy package of taxes and subsidies.  In Europe, where transition to net zero is an EU policy, the ECB is in ‘safe waters’ as its mandate demands general support for EU policies. In other countries and regions, a more strict focus on financial stability and awareness campaigns might be needed.
  3. What should central banks/supervisory authorities do in a political environment that does not see climate change mitigation and environmental risks as priority (the previous administration in Brazil comes to mind)? How to square government ownership of fossil fuel companies (as in Mexico) with the need to phase out fossil fuels and thus possibly establish additional capital buffers (related to the transition risk of having to phase out at a future point, thus having financial stability implications)? There are no clear and definitely no easy answers to these questions! However, there was consensus that central banks still have an important role to play in terms of raising awareness for climate risks.
  4. Climate stress tests are important for financial stability purposes, but are the current macroprudential tools sufficient? The systemic risk factor can certainly be also used for environmental risks, but more is needed. In the EU, the use of the systemic risk buffer has been extended to climate change-related risks. But a broader discussion is needed on how to properly incorporate climate risks in the macro-prudential policy toolbox.


As with many stability and regulatory challenges, the political economy looms large also in the case of prudential responses to climate change and other environmental risks.

22 December 2023

Financial Sector Priorities for the next Commission


My colleague Maria Ana Barata and I moderated a debate last week in Brussels on the financial sector priorities for the next European Commission. We started from the goal of a financial system that (i) can support Europe’s transition to net zero, (ii) makes its economies and societies more competitive and innovative, (iii) helps address other challenges (e.g., demographic change), and (iv) makes Europe’s financial system more robust to geopolitical risks and strategically autonomous.  Such a role for the financial sector implies (i) a diverse financial system, with stronger role for NBFI and capital markets, (ii) one that is stable, efficient, integrated and with a level playing across the Single Market, (iii) embracing digitalisation, but cognisant of risks, (iv) a public-private ‘partnership’ for an active role of financial system in transition to net zero, and (v) a high level of integrity and consumer protection. But what would this imply in terms of policy actions?


  1. Completing the banking union: while the CMDI reforms are a small, but important step, even they are unlikely to pass before the elections for European Parliament. But beyond this, a European deposit insurance scheme and a stronger central European role in macroeconomic policy are important steps towards a banking union that deserves its name.  But as I have argued before, even such regulatory reforms would only be a necessary but not sufficient condition for a Single Market in Banking in Europe
  2. Restarting the Capital Market Union project, including creating an EU securitisation market and an EU strategy to incentivise retail investors to invest in securities markets. But the stability aspect is also important, with cross-border supervisory convergence and a possibly stronger role for ESMA and EIOPA. In addition to help leverage private savings to finance Europe’s transition to net zero, the Capital Market Union has taken on an additional dimension to help foster Europe’s strategic autonomy.
  3. Non-bank financial intermediaries have taken on an increasingly important role in financing enterprises in Europe, though from a much lower level than in the US. On the one hand, fintech companies can provide the necessary innovation and competition in the financial system; more critically is the role of bigtech companies. One specific concern are the CCPs and the equivalence of London-based CCPs – on the one hand, European policy makers are eager to see the clearing of European securities go through a CCP in the euro area, on the other hand, market participants point to the inefficiency of forcing just a solution. This discussion will certainly continue in the next few years.
  4. Finally, Anti-Money Laundering: recent scandals have led to a push for a new European authority as apex institution for national authorities, whose location is still to be determined. However, there are broader questions on consumer protection and financial literacy where scale economies on the European level can be exploited.  Another very broad but important agenda.


A challenging agenda and if only a fraction of this will be accomplished, it would be a success. Not to mention other challenges that might arise on short notice in the next few years. But as academics, we are allowed to dream big! I would also like to note that Maria and I are planning to write up a longer note on these priorities in the next few months.

15. December 2023

SSM – a ‘mid-term’ evaluation


Last week, I was invited to participate as panellist in the ECB Forum on Banking Supervision. As the lone academic, I was asked to comment on what research has to say about the effects of the SSM.


Most papers considering the effect of the establishment of the SSM on the banking sector find a positive stability effect. The identification of this effect comes primarily from distinguishing between significant institutions (the ones that underwent the Comprehensive Assessment and are now directly supervised by the SSM in Frankfurt (through Joint Supervisory Teams) and Less Significant Institutions that continued under direct supervision by national supervisors). Fiordelisi et al. (2017) show that banks that expected to come under the supervision of the SSM reduced their lending activities and increased their capital ratios in comparison with banks below the asset threshold for supervision by the SSM. This is in line with the findings of Eber and Minoiu (2016) who show that SSM-supervised banks reduced their asset size and reliance on wholesale debt over the period 2012-15, compared with banks that did not fall under the supervision of the SSM. It is also consistent with Altavilla et al. (2020) who show – using credit registry data - that supranational supervision reduces credit supply to firms with very high ex-ante and ex-post credit risk, while stimulating credit supply to firrms without loan delinquencies.


In one of my own papers (joint with Miguel Ampudia and Alex Popov), we find a somewhat more nuanced picture. Specifically, we find that relative to firms borrowing from less significant institutions, firms borrowing from SSM-supervised banks reduce intangible assets and increase cash holdings. The reallocation of investment away from intangible assets is stronger in innovation-intensive sectors. While this suggests that centralising bank supervision within the euro area might have slowed down the shift towards a knowledge-based economy, it also stresses the need for stronger non-bank financial institutions.  This would be in line with the observation that Europe’s financial system is too bank-heavy and not sufficiently reliant on capital markets.


So, overall a good grade for the SSM. Does this mean we can rely exclusively on the SSM (as the first pillar of the banking union) in the next crisis? At the risk of sounding like a broken disk, my answer to this question is NO. During the Eurodebt crisis, the euro area relied primarily on the ECB. The ECB (now including supervisory responsibilities) would again play a leading role in any financial distress. However, a financial safety net without a robust resolution and – more generally – crisis management framework is not sufficient. Not to speak of the lack of a European deposit insurance and the continued sovereign-bank linkage.  While not of immediate concern, such a link can become a concern again during distress times. At this stage we would be back at a situation where a euro in one country is not the same as in another (as was the situation in Greece and Cyprus during the eurodebt crisis). So, as much as there is to celebrate with the first decade of the SSM, the banking union continues to be work in progress.

8. December 2023

Germany’s debt brake – a bad idea comes back to bite


Germany’s constitutional court has declared the government’s fiscal tricks to get around the debt brake unconstitutional, putting in doubt not only investment into the transition to net zero, but also the energy support and ultimately, the political flexibility of Germany’s government to address the numerous crises Germany, Europe and the world face. It has pushed the ‘traffic-light’ coalition – never easy partners to start with – into a crisis and I would not be surprised if the government falls (though there seem to be sufficient adults in the room to find a solution).


Ultimately, the current crisis is the result of a bad fiscal policy decision taken back in 2009, which – through a constitutional amendment - limited the structural budget deficit to 0.35% of the GDP beginning in 2016. It is important to note that the debt brake is not absolute, allows fluctuation with the business cycle and allows the country to exceed the borrowing limits during a national emergency or a recession. For example, it was suspended in 2020 during the pandemic.


Fiscal rules like the debt brake can be seen as the fiscal policy equivalent to independent central banks in monetary policy, i.e., taking the punchbowl away from politicians tempted to increase spending before elections. There are strong political economy arguments for such fiscal policy rules in countries with a history of stop-and-go fiscal policies (UK comes to mind); however, it also ties the government’s hands during a time of great volatility and multiple shocks, such as we are experiencing right now. It can undermine critical investment, not just in infrastructure (anyone who recently has taken a German ‘high-speed’-train can attest to that) but also in generational projects, such as transition to net zero. Ultimately, such rules delegate responsibilities from politicians to courts. Alternatively, it results in governments looking for fiscal trickery, such as through creating special funds (Sondervermögen), supposed to get around the debt brake (now declared unconstitutional by the Constitutional Court). In this specific case, the government had tried to use 60bn euros left-over from the extraordinary additional pandemic borrowing limit for the climate and transformation fund.


There is another important point, often forgotten in national debates on fiscal policy. National fiscal policy within a currency union has important spillover effects on other countries within the currency union through aggregate demand effects and even more so in the case of the largest and euro anchor country Germany. As much as high-deficit, high-debt countries pose a risk to the sustainability of the euro area, rigid fiscal policy rules as the German debt brake pose not only a macroeconomic risk to the euro area, but more broadly to the strategic priorities of the EU (which given the limited budget of the EU still rely on national fiscal policies and implementation). After its austerity policies (including and especially at home) had dampened aggregate demand for the euro area during the eurodebt crisis, Germany risks again to hold back the continent during these volatile times. Let’s hope German politicians come to their mind.

23. November 2023


Postcard from Rio


I just came back from the first Elsevier Finance Journal Conference and among others we had a Q&A with journal editors. Some interesting questions and topics came up. In the following, I react to some of them.  Let me clearly state that this reflects strictly my own view and not necessarily those of my JBF co-editors.


Fit for journal: I desk-reject quite a lot of papers that clearly do not fit into the JBF, for different reasons. One, they are not really about finance, but more in the area of accounting, monetary economics or other fields in economics or management. How can authors find out about the fit beforehand? The easiest way is to look at the references; if most of them are from journals of a different field, then a finance journal is most likely not a good fit. Two, case studies or geographically too limited studies; examples: introduction of a new information management system in a specific bank or a customer survey in a small geographic area. Three, studies that replicate previous studies but for a different country or period; while interesting, the incremental contribution seems limited and a more specialised journal seems a better fit.


Reject and Resubmit: I still remember the first time I received a Reject and Resubmit decision (over ten years ago) and my confusion, so I can certainly feel for others who do not quite know how to interpret such a decision letter. One can look at it from two sides: on the one hand, it is the weakest form of a revise and resubmit; it is clear that the revision will require lots of work and the ultimate outcome is uncertain. On the other hand, it can be seen as a positive signal: in spite of a formal rejection and while the paper has not convinced reviewers or editors, there is enough of a good idea that might turn this paper into a publishable article.


Is there a bias against non-results? It is clear that readers are more excited about papers reporting significant findings than non-significant ones. However, not all is lost. There are occasions where such a paper can make an important contribution and can be attractive for reviewers, editors and ultimately reader. If there is an interesting theoretical or policy debate on whether or not there is a significant relationship between two variables (e.g., firm size distribution and growth) or an ongoing debate (e.g., market- vs. bank-based financial system), papers with non-significant results can be interesting.


Impact beyond publication: we all know that most published papers are read in detail primarily by referees and editor. If you’re lucky, your paper serves as basis for follow-up papers by others and/or your paper ends up on the reading list of a PhD class. Even so, though one can count the number of careful readers on a few hands. How do you get impact beyond scientific publication?  One way is to contribute to portals like VoxEU and others. Getting your paper’s message across on social media can be another mechanism. Ultimately, using your research expertise and record to get involved in policy work can result in impact, even though often not directly measurable.


Replicability: there have been several cases recently, where papers were retracted as their results turned out not to be replicable or because of mistakes in their code.  While such problems can be discovered when the paper uses publicly available data or the authors make data and/or code available, in most cases, we have to take the results reported in the paper at face value. At Economic Policy (where I was co-editor between 2014 and 19), we used to have all papers replicated or at least the code checked by a third party (obviously, at a cost). In finance, we are still far from that, but it is certainly a concern. A related topic is that of replication studies; to which extent should we publish papers or notes that question the findings of previously published papers (either in the same or other journals). I don’t have a clear answer to that, but can share that we currently have two papers under review at the JBF that can be considered replication studies.


ChatGPT: a discussion came up on the use and abuse of artificial intelligence in writing papers. There is certainly a case to be made for using ChatGPT to support research and writing papers (e.g., literature review, polishing papers), as long as it is being acknowledged. Where it becomes trickier is when ChatGPT becomes a full-fledged co-author, trying to replace human with artificial intelligence. One can only hope that as artificial intelligence develops, methods to detect its use are being developed to the same extent.

23. November 2023

UK politics, autumn 2023

It has been some time that I have written about UK politics. Even though I no longer live in London, I still closely follow it. These last weeks have shown the worst and the best of the UK political system – I know this might sound surprising but let me explain.


On the bad side, the UK has entered a year-long election campaign, where policy and government funding decisions are driven by electoral considerations rather than long-term objectives to the benefit of the country. The hysterical way of addressing the migrant boat crisis (big and meaningless announcements rather than working through the backlog of asylum applications) and the backtracking on climate transition commitments are just two examples. This is politics by headlines, where policies are defined in search of some electoral group that might reduce the coming defeat of Conservatives, such as the discussion on the inheritance tax.


At the same time, the elephant in the room – Brexit – is not being discussed by almost anyone in the political arena; the one topic not-to-be-named. There seems to be a quiet consensus emerging that the negative effects of Brexit should be minimized, most prominently by avoiding active divergence (in the case of the Tories) and possibly even passive divergence (maybe under a Labour government). No more talk about the illusory benefits of Brexit, but at the same time no one wants to reopen the debate.


On the ugly side, the Conservatives are trying to fight the next election on the basis of culture wars, fighting against the ‘woke establishment’, whatever woke is supposed to mean. The Gaza conflict might give them another opening to divide British society. The next 12 months will get even uglier, before a likely autumn elections in 2024 (while theoretically Rishi Sunak can wait until January 2025 with elections, a winter elections with the current state of the NHS seems unlikely).  At the same time, the electorate is through the public Covid inquiry currently being exposed to the incompetence and arrogance of the Johnson government during the pandemic, destroying what little faith many of us still might have had in UK government quality. Add allegations of a serial rapist among Tory MPs and one can see why they are being considered the toxic party.


On the good side, the fact that the UK is undertaking the Covid inquiry and makes internal government considerations public is in itself a sign of democratic maturity! I wonder what inquiries in other European countries would bring to light if similar inquiries were undertaken. And one wonders, whether there will be eventually a similar inquiry into the Brexit process!

5. November 2023

The war in Gaza and its global repercussions

I have hesitated a long time before writing this blog. Not only has the conflict in Gaza escalated, but there are global repercussions, with the discussions in countries far away from the Middle East turning toxic if not violent.  There has been a wave of Islamophobia and antisemitism, appealing to the worst instincts in humans. For populists painting the world in black and white this is a dream come true; for the rest a nightmare that adds another negative mark to the 2020s.


While it is not surprising that a war between Israel and Palestinians raises emotions, one of the worst dimensions of the debate here in Europe is the black and white – splitting everyone into two camps – Israel vs. Palestine (or Arab world) – forgetting that one can strongly believe in Israel’s right of existence and self-defense and the right of Palestinians to their own state. One can strongly support Israel’s campaign against Hamas in the Gaza strip, while condemning violence by Israeli settlers against Palestinians on the West Bank. One can strongly hope for as complete a defeat as possible for Hamas, while mourning the Palestinian men, women and children being killed or seeing their suffering reaching unbearable levels. But there seems limited space for these voices of reasoning right now. 


One of the most surprising dimensions is how Hamas is being defined as a liberation movement by many on the Western left. A movement that has held 2 million Palestinians hostage and through their terrorist attacks on 7 October wants to turn them into martyrs rather than liberate them. A LGBT-hostile movement, against women’s’ right and undemocratic.   It reminds me of the 1980s when German social democrats were supporting Ortega’s Sandinista dictatorship in Nicaragua as liberation movement and anti-imperialist.


So, here is my view (in line with the below): first, if Hamas stops its terrorist attacks on Israel, there is a chance for peace; if Israel stops fighting Hamas, it might well be the end of Israel. Second, as said before, Israel is a democracy; Gaza is not! This does not mean that everything that the Israeli government (and IDF) is right and defensible (far from it), but it is different from a terror organization holding over two million Palestinians hostage in the Gaza strip. Third, whatever Israel will achieve in the current war, it will not bring peace, only a two (or maybe three-state solution) will do. Islamic terrorism is like a hydra – cut off one head and another will grow. The objective has to be to allow Palestinians not only their own state(s) but a democratic and prosperous one, the only way to defeat terrorism!


One of the major winner of this conflict is obviously Putin – there is less focus on his brutal invasion of Ukraine and it pushes many Arab supporters away from the US. It also raises populist voices and tensions in the US and Europe, which has always been favourable to Putin (see Brexit).  Finally, turning to the economic repercussions here in Europe, it is clear that this shock will add to the doom, with rising oil prices, geopolitical tensions and increased uncertainty! The Time of Great Volatility continues.

31. October

Israel, Hamas, and democracy  


As a German, well versed in my country’s history, it is hard to watch the pictures of and read about the terrorist attacks by Hamas in the South of Israel. Having planned to visit Israel for the first time in a week’s time adds to the pain of watching a society being subjected to a genocide-style massacre, last seen in German concentration camps 80 years ago. There are no ifs and no buts, Israel is under attack and has all the rights to defend itself and ‘neutralise’ its enemies; if this implies killing scores of the terrorists and wiping Hamas of the face of the earth, the better.  Unlike Fatah and the West Bank government, Hamas is as much a serious ‘diplomatic’ counterpart as ISIS was – a terrorist group planning to wipe out Israel and the Jewish population.  There can be no ‘on the one hand, on the other hand’ in this case.


As always in the Middle East, however, things are complicated. Two million Palestinians are held hostage by Hamas in the Gaza strip. Where Israeli citizens have the right (and have used it) to demonstrate against their government, Palestinians in the Gaza strip do not have these rights. Muslim solidarity ends at the border with Egypt, whose government does not want to see Palestinian refugees enter in large number its country.


Israel’s policy over the recent past vis-à-vis the Palestinians has NOT been appropriate, increasing tensions, giving preference to settlers in the West Bank over Palestine inhabitants. Some talk about an apartheid system. Add to the mix a long-ruling Israeli Prime Minister accused of corruption (or worse) who seems to have been more preoccupied with saving his skin than preparing his country for defense. All of this, however, is for Israelis to discuss and to vote on – let’s remember: Israel is the only true democracy in the region!


Where do we go from here – it is easy to call for the invasion of the Gaza strip and ‘elimination’ of Hamas. It will take a lot of cool heads in Israel to think through the long-term consequences of a bloody ground war in the Gaza strip. Some in Israel were naïve to think that containing the Palestine problem (in the physical sense, i.e., within the Gaza strip) was sufficient.  This will be a long and bloody war and no one will win!  But Israel will survive!

13. October 2023

Interesting papers – September 2023    


A quick run-down of some papers I recently accepted for publication at the JBF (interesting is purely subjective, there are many more papers I accept, which are also excellent!)


Robert Adams, Kenneth Brevoort and John Driscoll shed doubt on the stylized fact that distance between lenders and borrowers has been increasing over the past years. They show for the U.S. that while average distance has increased substantially over the past two decades, banks themselves have not materially increased their lending distances. Instead, the increase in average distance has been caused by a small number of financial institutions that specialise in originating very small loans nationwide quadrupling their share of lending. Outside of these very small loans, small businesses remain primarily dependent on local banks. Even though the paper might be considered it is important contribution to the debate on distance in lending, different lending techniques and the role of technology.


Junguo Cheng, Lei Wang and Jing He show the importance of promotion incentives for supervisory actions. They use the merger of the China Banking Regulatory Commission (CBRC) and the China Insurance Regulatory Commission (CIRC) in 2018, which halved the number of regional director positions. They find that the merger-triggered increased promotion incentives are associated with higher frequency, greater amount, and greater severity of penalties in regional banking supervision, which in turn reduced bank risk. After the merger of the two commissions, the regional banking supervision is significantly weakened with the disappearance of these promotion incentives.


Piotr Danisewicz and Ilaf Elard explore whether easier access to credit increases or reduces personal bankruptcy risk, exploiting

a decision by the U.S. Second Circuit Court of Appeals in May 2015 that resulted in doubts about the enforceability of above-usury interest marketplace loans issued to residents of Connecticut and New York and thus resulted in an exogenous reduction in the supply of marketplace credit. A priori, it is not clear whether better access to credit gives households more flexibility and thus lower bankruptcy risk or results in overindebtedness, increasing such risk. The authors document a persistent rise in bankruptcies in the affected states following sharp decreases in marketplace lending, particularly among low-income households and in areas where marketplace loans for financing medical bills are severely rationed. 

29. September 2023

Macro-pru – looking back and looking forward


On Friday, I was asked to give the SUERF Annual Lecture on” “Defining the research frontier for macroprudential policies – where to go from here?”, quite an honour given previous speakers in this series. Ultimately, I decided that it might be good to both look back and forward. My presentation was part of a conference on 20 years of Macrprudential Policy in Europe – looking back and looking ahead and I tried to link my own presentation to the different discussions on the first day. One of my main messages was on the definition of macroprudential regulation and supervision – beyond the focus on specific policies and their success, the boundaries between micro- and macropru and the institutional design, macropru can be understood as an analytical focus on systemic stability factors and the persistent search for possible new sources of financial fragility, even if outside the current regulatory perimeter. A macroprudential approach requires out-of-the-box thinking, even at the risk of mission creep.


The assessment of macropru relies on different methodologies and the conference highlighted several of them. On the one hand, there are quantitative models that help identify optimal macro-prudential policies (as discussed by Javier Suarez and Enrique Mendoza). On the other hand, regression analysis to assess the effectiveness of specific macro-prudential tools and policies.  As pointed out by Ricardo Correa, this literature faces the trade-off between external and internal validity. On the one hand, large cross-country panels allow for the assessment of macroprudential policies across countries and over time, but face multiple challenges: one, making different policies and instruments comparable across countries, two, endogeneity concerns. On the other hand, country-level studies focus on one specific policy or instruments and use micro-data for borrowers and banks to look at differential effects, thus allowing a better identification; however, they face the challenge that it might be hard to extrapolate the results to other countries and settings. One way around this is to run similar studies across countries, such as done by the International Banking Research Network and similar initiatives. An additional challenge that the assessment of macropru faces is that policies are not necessarily implemented immediately, so that the question arises whether one should focus on the announcment or the actual implementation date.


In addition to these methodologies I would like to make a strong case also for pure theory. One specific example that I recently found is an interesting paper by Tamas Vadasz. Tamas models theregulatory decision to ban dividends in the context of bank management decisions to (i)smooth dividends and (ii) shiftrisks during crisis situations. Expectations of a dividend bancan lead to higher dividend payouts before crisis situations and limited holdingof excesscapital, pointing to the time inconsistency of such a policy. The implication (and policyrecommendation) is that dividend bansare only to be used in very bad states out of the world(and here the pandemic certainly qualified) rather than forming part of the generalmacroprudential tool-kit.


What is the research agenda in macropru? First, a lot of research has focused on the ‘time-series’ dimension of macropru, i.e., making the financial system more resilient to credit cycles; however, two other dimensions are also important: first, the cross-sectional, i.e., identifying systemically important financial institutions and minimsising their risk of failure – the question is whether we have truly identified such institutions or whether there are others out there. Specifically (and related to the digitalisation trend in the financial sector), cloud and other bank office service providers  might be systemically important even if not financial institutions. Another dimension is the structural: have incentives and structures in financial markets (and central clearing houses) changed sufficiently to make them more resilient?


Second, there are important interactions with monetary policy, but these are certainly different when macropru and monetary policies aim in the same direction (as before the pandemic) than in different directions. In the current situation, economies (and policy makers) face additional complications with supply-chain disruptions and geopolitical tensions, which further limits the extent to which we can extrapolate lessons from previous cycles to the current one.


Third, one forward-looking lesson (that I have learned being part of the interdisciplinary Robert Schuman Centre at the EUI) is the importance of interdisciplinarity, of looking beyond our own discipline.  Political scientists can make an important contribution to the debate on institutional design (including whether decisions should be assigned to one institution or be committee decisions). Research on the inaction bias and the influence of media, politicians and other part of the government are critical questions.  Legal scholars will be important in telling us economists how to translate optimal policy into laws and regulations. Finally, historians will remind us that while you never step in the same river twice and history does not repeat itself, it certainly rhymes.


Fourth, and coming back to a theme touched upon above, where do we look for sources of systemic risk? Even in Europe, non-bank financial intermdiation has gained in importance, creating new potential sources of fragility. There is also the question whether climate risk is just another (macro)prudential risk?  Paul Hiebert talked about this in the closing panel and partly agreed with me, but also pointed out that the current framework might not be sufficient to handle it. An additional question is whether imposing additional capital charges on banks for climate risk might undermine banks’ role in financing the transitioon to net zero. And as mentioned above, digitalisation creates new potential sources of systemic risk, including fin- and bigtech, but also backoffice providers.


A final important question refers to the trade-off between financial development and stability. Tightening macropru has distributional implications, across firms facing different financing constraints and households with different incomes. To which extent do these distributional effects have to be taken into account?


I ended my presentation on three final remarks and open questions: First, there is a long-standing debate on the role of carefully calibrated policy tools to influence risk-taking incentives and crude but powerful (if binding) tools, and this debate extends to macropru – shall we rely on leverage buffers and strict loan-to-value ratios, or risk-weighted capital buffers and on limitations for high-risk mortgages?  The former tools are crude and might not address incentives and risks directly (and might allow for aggressive risks within the limits), the latter might be open to arbitrage and manipulation and rely on underlying models (and their assumptions).   Second, how can regulators/supervisors get ahead of market participants and regulatory arbitrage? Reminding the audience of the cartoon I often like to show about two bankers concluding: “this regulatory reform will definitely change the way we will get around it”, there is an ongoing debate on how regulators can get ahead of financial market players reacting to regulatory reforms by shifting risk.  How can we make the financial system arbitrage-robust?  Finally, should technocrats (such as macroprudential authorities) rule? Decades ago, monetary policy responsibility was given to independent central banks to address time inconsistency constrained by elected politicians.  Now prudential regulation and supervision is housed in independent and technocratic institutions. In Europe, these responsibilities have been further shifted from the national to the supranational level. For economists, this makes perfect sense; however, we have seen a political (populist) backlash against this restriction of powers of elected governments. Focusing on accountability might not be enough; explaining over and over again can go some way towards addressing this challenge.

24. September 2023

Windfall taxes on banks


A windfall is defined as “an unexpected, unearned, or sudden gain or advantage”. So, windfall taxes seem to make sense, especially in times of crisis.  Last year, windfall taxes have been proposed for energy companies, benefitting from the higher energy prices as result of the exit from the pandemic and the Russian invasion of Ukraine. This summer, the Italian government proposed such a windfall tax for banks, arguing that they benefit from higher interest rates, while borrowers (especially households) suffer from higher loan interest payments. The market reaction was rather negative (not surprisingly), but the broader question is whether such a windfall tax is actually justified.


First, in the case of banks, it is not clear whether these are really windfall profits.  Yes, banks have benefitted from rising interest rates, however, that seems more a cyclical element rather than an exogenous shock. During the period of zero/negative interest rates, banks’ profit margins suffered from shrinking margins, while benefitting from lower NPLs and thus write-offs; similarly, now banks might be benefitting now from widening interest margins, but suffer from higher NPLs. Second, there might be a negative reaction by banks in terms of shrinking loan volumes – bank lending is notoriously cyclical and such a ‘windfall’ tax might exacerbate the cyclicality.  Not to mention that banks might shift lending and profit opportunities outside Italy into other countries. Similar points are also made in the opinion of the ECB on the Italian bank tax: it “may make attracting new equity capital and wholesale funding more costly for banks, as domestic and foreign investors may have less appetite to invest in Italian credit institutions that have a more uncertain outlook.” Ultimately, this will further push fragmentation in the EU banking system and gets us further away from a Single Market in Banking.


This leaves the question of what to do to help struggling borrowers – there are certainly much better, more targeted instruments for that, including help with debt restructuring. If there are really concerns on banks’ profits, restricting profit distribution might be an option– not like in the pandemic as macroprudential policy, but rather on the bank-level, in the context of SREP.  In summary, windfall taxes on banks do not seem a good idea.  If broader issues of inequality are to be addressed, then this should be done with a broader discussion rather than through ad-hoc, ill-conceived tax plans.

23. September 2023

Reconstructing Ukraine’s financial system


I was privileged to participate in an on-line workshop on Ukraine’s future financial architecture, in preparation for a forthcoming CEPR publication.  The workshop with academics and Ukrainian policy makers was under the Chatham House rule, and in the following I will summarise some of my key take aways, a very small part of the overall discussion.  One important first observation is that while looking forward to the reconstruction phase might be seem somewhat early given the ongoing war and no clear perspective of a quick end, but I think it is important to start planning early – further, actions can be (and are) taken even before the end of the war; so this discussion is really timely.


In the banking system, Ukraine faces the benefits of well capitalised banks but also the problem of a high NPL ratio, whose recent rise is obviously related to the war. The largest banks are currently in state ownership and the assumption seems to be that privatisation is the obvious way forward.  I would urge caution - worse than ineffective state-owned banking is privatisation into the wrong hands. Management contracts might be a transitional solution. Choosing carefully and strategically the buyers of these banks is key! And it is not clear whether privatisation should be the first priority; separation of ownership and management from the political sphere and from the regulatory and supervisory sides of government is the most important task.  A second big challenge is the balance sheet composition of these banks, with lots of government bonds and non-performing assets. While the latter might call for an asset management company that helps off-lift non-performing assets form banks’ balance sheet and thus allows them to focus on fresh lending, the former is trickier - on the one hand, government bonds provide a continuous and certain income stream; on the other hand, future restructuring of such bonds might provide a hit to banks’ solvency and might require another round of restructuring for them.


One impression came across very strongly throughout this workshop: the National Bank of Ukraine benefits from an amazing level of competence and skills. It also benefits from experience with bank fragility and bank failure management over the past decade (and unlike some EU countries it seems rather serious about addressing bank fragility). Nevertheless, once Ukraine achieves candidacy status, there will be an even stronger push to reform the regulatory framework according to EU ‘standards’. As discussed in previous work, it is not clear that simply transplanting the rules designed for advanced and developed banking sectors is the best way forward, but this seems a rather irrelevant point at this stage.


There was also a discussion on stock markets. In our nascent stock exchange project, we found that Ukraine classifies among less successful stock exchanges and looking more detailed, this is confirmed. While the number of listings at the start was not too low and market capitalisation was high at some point, there has been the continuously low liquidity. In our paper, we show that initial conditions (liquidity and number of listed companies) are a necessary condition for future success.  So, the shallow stock exchange we observe today is clearly a consequence of the past, related to both factors on supply and demand side for listings and equity investment.  In this context it is important to stress that a lot of work has shown that financial systems typically grow in a certain sequence, with stock markets coming rather towards the end and with contractual savings institutions (pension funds, insurance companies, mutual fund) being an important component in the mix that enables the flourishing of public capital markets. While it is important to stress the need for equity and risk capital, including and especially in conflict-ridden economies such as Ukraine, other forms such as private capital funds, might be more appropriate and promising.


A final point I would like to touch upon: development banks – an institution that cannot miss in any discussion on financial architecture. While I have always been critical about the role of development banks in retail financial service provision, there seems to be an important potential role for a second-tier institution, both as provider of guarantees, subsidiser of fixed costs of financial service providers, and provider of platforms to bring together demand and supply for specific financial services such as factoring and to channel international donor resources to commercial banks. Linking the role of development banks back to the discussions on the lack of deep and liquid capital markets, such a development bank might also have a role in providing initial funding for venture capital funds.


Finally, it is important to stress the importance but also limitations of the financial sector in Ukraine’s reconstructions. There will be an important role of government funds, especially by allied countries and international financial institutions. Especially when it comes to infrastructure and housing reconstruction, direct government/donor funding will be the best choice. It is thus important not to overstretch the role of the financial sector. Most importantly, it is important not to see the financial sector simply as a channelling device for government funds in the form of loans (as done in other post-conflict settings).  Making clear what are grants/support payments and what are loans is critical for a sound and effective financial system.

19. September 2023

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