Syndicate content

Financial Sector

Alice in Euroland: What next for Europe’s rapidly shrinking banks?

Inci Otker-Robe's picture

Less than six years ago, policymakers were concerned about a credit boom in central and eastern Europe (see, e.g., Enoch and Otker-Robe, 2007). Now, as the Eurozone debt crisis has taken center stage and bank deleveraging has picked up speed, they worry about a massive credit crunch across Europe, with potentially damaging spillover effects around the world.

How did we get here? How big is the problem? And what is the way forward?

The 2008-09 Crisis: From credit crescendo…

A combination of complex global and domestic factors including structural global imbalances, incentives supported by economic policies and implicit government or supra-national guarantees, and industry practices allowed massive amounts of easy credit to flow from domestic and international sources to doubtful parts of the private sector such as risky mortgages and real estate projects, triggering unsustainable credit booms and asset bubbles across the world. (Much has been written on the topic. See, for example, Brunnermeier 2009, or Obstfeld and Rogoff 2009).

Triggering Disruptive Innovation in Retail Banking in the Digital Age

Ignacio Mas's picture

See what a profound transformation the internet is producing in information-based sectors. Newspapers are under threat from online news sources and blogs. These same web destinations are becoming less relevant as people simply lift and filter the information they want using RSS feeds. The music CD is being unbundled as customers buy individual tracks online. These songs get remixed and re-distributed across an ever-growing number of online content repositories. Books are increasingly digitized, and customers can now sample content and search for information across entire libraries.

The internet is a destroyer of digital products but a great creator of new kinds of customer experiences. Power has shifted to users: it’s no longer about the packages of content suppliers want to sell but about the content mash-ups users want to consume. Providers’ best response is to try to extract more customer information with each interaction, and use that to deliver even more relevance and convenience to their customers. Think Google and Apple and Amazon: the new corporate battlefield lies in the control of the user interface and the customer intelligence system that supports it.

Yet there is one information-based sector that seems deaf to the great sucking sound of the internet: banking. What is banking but managing information of who has what financial claims on whom? For banking, the internet truly is still just another channel. Sure, it has added transactional convenience, but has it changed how banks talk to us?

What Do We Know about the Impact of Tax Reforms on Private Sector Development?

Miriam Bruhn's picture

I recently conducted a literature review on the impact of tax reforms on private sector development as part of the Investment Climate Impact Project.1 My goal was to take stock of what is currently known about the impact of reforms that the World Bank is supporting in this area and to identify the gaps in knowledge that we ought to fill by conducting more impact evaluations. While tax reforms can have a broad range of effects in the economy, the focus here was on private sector outcomes only, as measured by investment, tax evasion by formal firms, formal firm creation, and firms’ economic performance.

It turns out that most papers in this area study the impact of changing tax rates. Both cross-country and micro-level  studies suggest that lowering tax rates can increase investment, reduce tax evasion, promote formal firm creation and ultimately lead to an increase in firms’ sales and GDP growth overall. However, lowering tax rates also has important implications for government revenue and it is thus often difficult to balance the trade-offs between various goals of public policy.

Should Development Organizations be Hunting Gazelles?

David McKenzie's picture

Last week I presented some early findings from ongoing work at the IADB, at Innovations for Poverty Action’s SME initiative inaugural conference. There was a lot of interesting discussion about early results from efforts to improve management and skills in small and medium firms, discussion of the most appropriate ways of financing these firms and the extent to which a personal vs automated approach to determining creditworthiness can be used, and an interesting panel on policies towards the missing middle. However, the one theme that has got me thinking the most is something that seems to come up a lot in discussions of microenterprise development and SME programs recently, namely should development institutions and policymakers be directing fewer resources at microfirms and more at high-growth-potential enterprises or gazelles?

Gazelles are defined by the OECD to be all enterprises up to 5 years old with average annualised growth greater than 20% per annum, over a three year period, and which have 10 or more workers. Recent work in the US, and looking at firms around the world have emphasized the role of a subset of dynamic, fast-growing young firms in net job creation, leading to policymakers and practioners focused on job creation to think we should be devoting more effort to identifying and supporting these gazelles, and decrying the lack of venture capital markets in developing countries. For example, see this scoping note by Tom Gibson and Hugh Stevenson at the IFC.

Informal Networks and Shadow Banking: Policy Implications

Robert Townsend's picture

Panel data can be used to measure directly or infer indirectly the presence and role of informal financial networks. In the Townsend Thai data (a collection of over 12 years of annual panel data for 900 households in 64 Thai) villages, networks are shown to play a beneficial role in smoothing consumption and investment against income and cash flow fluctuations. Villagers who lack formal financial access but are indirectly connected through networks receive the benefits of the formal financial system. Surveys of financial access  that ignore these networks can understate the reach of financial access while hiding the needs of the truly vulnerable (e.g., poor households without any kin in their village). Complementarities between the formal financial system and informal networks show up in bridge loans for repayment and the transactions demand for cash, revealing highly active informal money markets.

The same logic and data make labor supply and hours data conform with those of a sophisticated risk syndicate and make the rate of returns on investment/occupations conform with the theory of modern finance—in particular a capital asset pricing model applied to technologies/occupations with common market/village risk. We found that families engaged in occupations like rice farming require a higher expected return because this activity does well only when the village as a whole is doing well, and conversely occupations which are not covariate with market risk are recognized as particularly valuable. However, heterogeneous risk preferences creates a policy warning: outside insurance targeting village/market risk can actually make some in a village worse off, those had been providing insurance to others.

Has the Global Banking System Become More Fragile Over Time?

Asli Demirgüç-Kunt's picture

The last decade has seen a tremendous transformation in the global financial sector. Globalization, innovations in communications technology and de-regulation have led to significant growth of financial institutions around the world. These trends had positive economic benefits in the form of increased productivity, increased capital flows, lower borrowing costs, and better price discovery and risk diversification. But the same trends have also lead to greater linkages across financial institutions around the world as well as an increase in exposure of these institutions to common sources of risk. The recent financial crisis has demonstrated that financial institutions around the world are highly inter-connected and that vulnerabilities in one market can easily spread to other markets outside of national boundaries.

In a recent paper my co-author Deniz Anginer and I examine whether the global trends described above have led to an increase in co-dependence in default risk of commercial banks around the world. The growing expansion of financial institutions beyond national boundaries over the past decade has resulted in these institutions competing in increasingly similar markets, exposing them to common sources of market and credit risk. During the same period, rapid development of new financial instruments has created new channels of inter-dependency across these institutions. Both increased interconnections and common exposure to risk makes the banking sector more vulnerable to economic, liquidity and information shocks.

Credit Reporting: An Essential Building Block of Financial Access at the Base of the Pyramid

Margaret Miller's picture

Credit information and credit reporting systems are critical to a modern financial sector’s infrastructure. Since past behavior is one of the most powerful indicators of future behavior, credit reports which detail payment histories provide lenders with a valuable tool to classify the risk posed by different borrowers. Credit reporting systems reduce the impact of asymmetric information on credit markets, both by helping lenders to more effectively screen borrowers and avoid adverse selection and by providing an incentive for borrowers to repay their loans—thus reducing moral hazard.

These systems are very well developed in North America and parts of Western Europe but are relatively new in most of the world. As data from the World Bank’s Doing Business database shows (see Figure 1 below), only a small fraction of adults are covered even where credit bureaus do operate. Even in Latin America, which has the best coverage of any emerging market region, only about one third of adults are covered. In many other regions, significantly fewer than 10% of adults have a credit report, and those who are in the system are likely to be high-income consumers with bank loans, not customers of microfinance lenders or retail credit providers.

Conflict Between an International Financial Agreement and the Borrower’s Domestic Law: Which One Prevails?

Ryan Hahn's picture

AAF blog readers who are in Washington, DC this week may be interested in attending an event this Wednesday on Conflict Between an International Financial Agreement and the Borrower’s Domestic Law: Which One Prevails?. The event is part of the World Bank Group's annual Law, Justice and Development week. More details on the event are here, and full details on the LJD week are here.

The Future of Banking

Thorsten Beck's picture

For better or worse, banking is back in the headlines. From the desperate efforts of crisis-struck Eurozone governments to the Occupy Wall Street movement currently spreading across the globe, the future of banking is hotly debated. A new compilation of short essays by leading financial economists from the U.S. and Europe analyzes the short-term challenges in addressing the Euro-crisis as well as the medium- to long-term regulatory issues. The essays cover a wide variety of topics, ranging from Eurobonds to ring-fencing and taxation, but there are several themes that come through across the chapters. First, many reforms have been initiated or are under preparation, but they are often only the first step towards a safer financial system. Second, there is a need to change banks’ incentive structure in order to reduce aggressive risk-taking. Third, there is an urgent – also political – need to move away from privatizing gains and nationalizing losses, thus from bailing out to bailing in bank equity and junior debt holders.

I will not be able to touch on all the topics discussed in the book, so let me discuss some of the main messages in more detail. Ring fencing – the separation of banks’ commercial and trading activities, known as the Volcker Rule but also recommended by the Vickers Commission in the UK – continues to be heavily discussed among economists. While Arnoud Boot thinks that “heavy-handed intervention in the structure of the banking industry … is an inevitable part of the restructuring of the industry”, Viral Acharya insists that it is not a panacea as long as incentive problems are not addressed. Banks might still undertake risky activities within the ring or might even have incentives to take more aggressive risk. Capital regulations have to be an important part of the equation.

Pages