The Global Financial Crisis of 2007 to 2009 has spurred renewed widespread debates on the “bright” and “dark” sides of financial innovation. The traditional innovation-growth view posits that financial innovations help reduce agency costs, facilitate risk sharing, complete the market, and ultimately improve allocative efficiency and economic growth. The innovation-fragility view, by contrast, has identified financial innovations as the root cause of the recent Global Financial Crisis, by leading to an unprecedented credit expansion fueling a boom-bust cycle in housing prices, by engineering securities perceived to be safe but exposed to neglected risks, and by helping banks and investment banks design structured products to exploit investors’ misunderstandings of financial markets and exploit regulatory arbitrage possibilities. Paul Volcker, former chairman of the Federal Reserve, claims that he can find very little evidence that the financial innovations in recent years have done anything to boost the economy.
Economists often disagree on policy advice. If you ask 10 of them, you may get 10 different answers, or more. But from time to time, economists actually do agree. One such area of agreement relates to the role of incentives in the financial sector. A large and growing literature points to misaligned incentives playing a key role in the run-up to the global financial crisis. In a recent paper, co-authored with Barry Johnston, we propose to address the incentive breakdowns head-on by performing “incentive audits”.
In the run up to the global financial crisis, European banks significantly increased their lending activities both domestically and outside home markets driven by a pro-cyclical spiral of cheap abundant funding, increasing profitability, and economic growth. In the process, European banks became excessively leveraged and reliant on sources of wholesale short-term funding making them more susceptible to shocks which could force them to adjust their operations abruptly and shrink their balance sheets (Le Lesle (2012)).
When the crisis erupted, a process of bank deleveraging was put into motion and European bank lending standards deteriorated significantly during various episodes of financial stress (Feyen, Kibuuka, and Ötker-Robe (2012), Giannetti, and Laeven, (2012)). First lending standards in Europe deteriorated considerably as the US subprime mortgage crisis unfolded in 2007 and reached a peak in 2009 in the wake of the default of Lehman Brothers in September 2008. Credit supply weakened significantly in 2011Q4 again when the European crisis deepened.
Favorable growth prospects and higher asset returns in emerging market economies have been led to a sharp increase in flows of foreign finance in recent years. Massive inflows to the domestic economy may fuel activity in financial markets and — if not properly managed — booms in credit and asset prices may arise (Reinhart and Reinhart, 2009; Mendoza and Terrones, 2008, 2012). In turn, the expansion of credit and overvalued asset prices have been good predictors not only of the current financial crises but also of past ones (Schularick and Taylor, 2012; Gourinchas and Obstfeld, 2012).
Credit to firms can be classified in two categories: revolving credit lines and term loans. Revolving credit lines offer borrowers the option to draw funds up to a limit, repay and redraw them as they see fit. In term loans, borrowers usually make a single draw of funds and commit to pay a fixed amount periodically. Both types of credit have pros and cons. However, it is not clear what determines whether a firm obtains a revolving credit or a term loan. In particular, two interesting questions arise. First, what is the relationship between the type of credit to firms and the economic cycle? Second, are there any differences between those types of loans in terms of pricing? In a recently released paper, I explore these questions for Mexican firms, using credit level information from Mexico’s National Banking and Securities Commission (CNBV) for the period of 2001-2012.
Who uses formal financial services? What policies are associated with greater use of accounts among the poor and rural residents? And why do certain segments of the population remain unbanked? Is it by choice or is it due to barriers such as high costs or large distances to the nearest bank branch? In a new paper we co-authored with Franklin Allen and Sole Martinez Peria, we explore these questions using an exciting new micro-dataset from the Global Financial Inclusion (Global Findex) database. This dataset, based on interviews with over 150,000 adults in 148 countries, lets us identify account ownership, the use of an account to save, and whether an account is used frequently, defined as three of more withdrawals per month. (For a detailed description of the data, see our earlier paper, Demirguc-Kunt and Klapper, 2012). Figure 1 shows summary statistics of our financial inclusion measures.
Bank regulation and supervision has become subject of vigorous debates during the global financial crisis. Many observers pointed out weaknesses in regulation and supervision in the run-up to the crisis (see, for example, Caprio, Demirguc-Kunt and Kane, 2010, Dan 2010, Levine 2010, and Barth, Caprio, and Levine 2012). The crisis prompted policymakers to consider changes in regulation and supervision. But much of the policy discussions focused on a small number of major (and mostly high-income) economies. And despite the high degree of interest in the global regulatory framework, there has been a surprising lack of consistent and up-to-date information on the national regulatory and supervisory approaches pursued in individual countries around the world during the crisis. This lack of information led to important gaps in understanding what works in regulation and supervision and what does not.
Distance to financial services has long been a constraint for financial inclusion in Sub-Saharan Africa, a region characterized by an especially high proportion of rural dwellers. Suggestive evidence for the role played by geographic isolation in financial exclusion in Sub-Saharan Africa is provided by the new Global Findex database, which finds that rates of formal financial inclusion are considerably lower in rural areas (see Figure 1).1
This week, the BBC and the International Rescue Committee blog both featured a project that I am evaluating together with coauthors Maddalena Honorati and Pamela Jakiela. IRC approached us because they were interested in conducting a rigorous impact evaluation of their project.
Here are a few of the things IRC has to say about its project:
"NAIROBI, Kenya —
In many ways, 19-year-old Susan Kayongo is a typical Kenyan teenager. Brought up by her grandmother in Eastleigh, one of Nairobi’s poorest neighborhoods, she did well in primary school but could not afford to continue her education. Her future looked bleak, like so many young women in her country with little education and work...
Susan partnered with nine other teenagers like herself to open the Downtown Salon. Located in a repurposed freight container left behind in the inner city, the parlor is surprisingly inviting, its white walls decorated with bright posters of trendy cuts. The women sell beauty products and hair extensions as well as style hair."
This week’s FPD Chief Economist Talk featured Sendhil Mullainathan, Professor of Economics at Harvard University and co-founder of Ideas42, a non-profit that uses insights from behavioral economics to inform the design of products, innovations and policies. Sendhil is well known as one of the leading thinkers in behavioral economics and much of his research has focused on topics at the intersection of psychology and development economics, ranging from corruption in the allocation of drivers’ licenses to the role of psychology in the take-up of micro-finance and consumer loans — all very important issues that matter for what we do at the Bank and so Sendhil’s talk provided great food for thought!