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Thorsten Beck's blog

Bank Competition and Stability: Cross-Country Heterogeneity

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In a recent Economist debate, Franklin Allen and I discussed the relationship between competition and stability. In the debate I argued that it is not so much the degree of competition in the banking market but rather bank regulation and supervision that drives bank fragility. In a recent paper with Olivier de Jonghe and Glenn Schepens, we now combine these two areas and test whether the regulatory and supervisory framework influences the competition-stability relationship. And we indeed find several dimensions of the market, regulatory and institutional framework that influences the degree to which competition harms or helps bank fragility.

But let us first review what theory tells us about the competition-stability link, and then examine how this relationship might vary with certain country features.

Which Households Use Banks? And Does Bank Privatization Make a Difference?

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Access to banking services is viewed as a key determinant of economic well-being for households, especially in low-income countries. Savings and credit products make it easier for households to align income and expenditure patterns across time, to insure themselves against income and expenditure shocks, as well as to undertake investments in human or physical capital. Up to now, however, there is little cross-country evidence which documents how the use of financial services differs across households and, in particular, how cross-country variation in the structure of the financial sector affects the types of households which are banked. In a recent paper with Martin Brown, we use survey data from 28 transition economies and Turkey to:

  1. document the use of formal banking services (bank accounts, bank cards and mortgages) across these 29 countries in 2006 and 2010,
  2. relate this use to an array of household characteristics,
  3. gauge the relationship between changes in bank ownership and the financial infrastructure (deposit insurance and creditor protection) over time within a country and changes in the use of banking services, and
  4. assess how cross-country variation in bank ownership structures, deposit insurance and creditor protection affect the composition of the banked population.
     

Cross-border Banking in Europe: Implications for Financial Stability and Macroeconomic Policies

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Understanding the role of banks in cross-border finance has become an urgent priority. The recent Global Financial Crisis and ongoing European crisis have shown the importance of creating the necessary regulatory and macroeconomic conditions for a Single European Banking Market to function properly in good and in tough times. Together with five other economists (Franklin Allen, Elena Carletti, Philip Lane, Dirk Schoenmaker and Wolf Wagner) I have  published a CEPR policy report that analyzes key aspects of cross-border banking and derives policy recommendations from a European perspective. We argue that for Europe to reap the important diversification and efficiency benefits from cross-border banking, while reducing the risks stemming from large cross-border banks, reforms in micro- and macro-prudential regulation and macroeconomic policies are needed.

The benefits and risks of cross-border banking have been extensively analyzed and discussed by researchers and policy makers alike. The main stability benefits stem from diversification gains; in spite of the Spanish housing crisis, Spain’s  large banks remain relatively solid, given the profitability of their Latin American subsidiaries. Similarly, foreign banks can help reduce funding risks for domestic firms if domestic banks run into problems. However, the costs might outweigh the diversification benefits if outward or inward bank investment is too concentrated. Based on several new metrics, we find that the structure of the large banking centers in the EU tends to be well balanced. However, problems are identified for the Central and Eastern European countries which are highly dependent on a few West European banks, and the Nordic and Baltic region which are relatively interwoven without much diversification. At the system-level, we find that the EU,  in contrast to other regions, is poorly diversified and is overexposed to the United States.

Does Competition Make Banking More Dangerous?

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Post-Debate Update:

The debate is over, opening statements, rebuttals and closing remarks have attracted lots of comments and the votes been cast and counted. The results show that a (probably not very representative) majority do not think that competition is dangerous for stability, though the reasons for this might vary quite a lot. Some might have been swayed by my argument that it is regulation that makes banking more dangerous – if of the wrong kind. This is also consistent with Ross Levine’s view that the recent crisis "represents the unwillingness of the policy apparatus to adapt to a dynamic, innovating financial system." Understanding the links between competition, regulatory policies and stability is certainly a topic that deserves to be to be explored more – stay tuned for an update over the summer.

Original Post:

Bailing Out the Banks: Reconciling Stability and Competition in Europe

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The relationship between market structure, competition and stability in banking has been a policy-relevant but controversial one (see Beck, 2008 for a pre-crisis survey).  The current crisis has put the topic back on the front-burner, and particularly so in Europe, where competition concerns about the effect of national bail-out packages on competition across Europe rank high.  Together with four other European economists, I have tackled this question in a recent CEPR report: Bailing out the Banks: Reconciling Stability and Competition.

The crisis has provoked two common but quite different reactions concerning the role of competition policy in the banking sector.  One reaction has been to jump to the conclusion that financial stability should take priority over all other concerns and that therefore the "business as usual" preoccupations of competition regulators should be put on hold.  Another reaction has been to fear that intervention to restore financial stability will lead to massive distortions of competition in the banking sector, and therefore to conclude that competition rules should be applied even more vigorously than usual, with the receipt of State aid being considered presumptive grounds for suspecting the bank in question of anti-competitive behavior.  We endorse neither of these points of view. 

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