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Financial Sector

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

Thorsten Beck's picture

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.

Generating Jobs in Developing Countries: A Big Role for Small Firms

Asli Demirgüç-Kunt's picture

These days, job creation is a top priority for policymakers. What role do small and medium enterprises (SMEs) play in employment generation and economic recovery? Multi-billion dollar aid portfolios across countries are directed at fostering the growth of SMEs. However, there is little systematic research or data informing the various policies in support of SMEs, especially in developing countries. Moreover, the empirical evidence on the firm-size growth relationship has been mixed. Recent work of Haltiwanger, Jarmin, and Miranda (2010) in the U.S., suggests that (1) Startups and surviving young businesses are critical for job creation and contribute disproportionately to net growth and (2) There is no systematic relationship between firm size and growth after controlling for firm age. It is not clear whether these findings apply in developing countries where there are greater barriers to entrepreneurship, and where venture capital markets that finance young firms are not as well developed as in the US.

In a recent paper Meghana Ayyagari, Vojislav Maksimovic and I put together a database that presents consistent and comparable information on the contribution of SMEs and young firms to total employment, job creation, and growth across 99 developing economies. Our sample consists of 47,745 firms surveyed in the period 2006-2010. We then examine the relationship between firm size, age, employment, and productivity growth and how this varies with country income and find the following:

Should It Be our Business to Promote Business Training?

Bilal Zia's picture

Firms in developing countries face many constraints, from lack of access to finance and physical capital to poor infrastructure. Recently, however, there has been a growing focus among researchers on “managerial capital”, or business skills, as an important determinant of entrepreneurship in developing countries. Policymakers have been equally interested in the perceived deficit of managerial capital, and have been pouring resources into financial and business literacy education programs around the world (see my earlier post on The Fad of Financial Literacy?).

Yet we still have a very incomplete understanding of the effectiveness of these programs, and their specific impact on business outcomes. Until recently, there were only two completed randomized impact evaluations of business training programs in developing countries: one in Peru for rural women, which found positive effects on certain business practices but not on profits (Karlan and Valdivia, 2010), and the other in the Dominican Republic, which found that basic rules-of-thumb-based training had a greater effect on business outcomes than formal business training (Drexler, Fischer, and Schoar, 2010).

Does Competition Make Banking More Dangerous?

Thorsten Beck's picture

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:

What's at the Top of the Agenda for the Financial Sector after the Crisis?

Maria Soledad Martinez Peria's picture

The 2011 Overview Course of Financial Sector Issues took place earlier this month at the World Bank's headquarters in Washington, DC. This annual event is sponsored by the Office of the Chief Economist of Finance and Private Sector Development, and it provides an overview of issues of current importance for policy-makers, researchers, and practitioners working in the financial sector. Speakers included a number of well-known thinkers and researchers on financial sector issues such as Simon Johnson, Ross Levine, and Franklin Allen, and attracted some 70 external participants from central banks, ministries of finance, and bank regulatory agencies representing 45 countries.

The theme of the course this year was Financial Sector Practices and Policies after the 2007-2008 Crisis (view the full agenda). Lectures, case studies, and panel discussions covered a broad spectrum of issues surrounding this theme, such as long-run policy lessons from the financial crisis, the role of the government in the financial sector after the crisis, bank risk management models before and after the crisis, bank resolution mechanisms, building crisis management capabilities, the future of bank regulation, macro-prudential regulation and stress testing banking systems, capital markets and pension systems after the crisis, to mention the main ones. Also, the course looked into longer-term issues related to the development of the financial sector, e.g. remittances, financial inclusion, SME finance, and microfinance.

Introducing the Global Financial Development Report

Martin Cihak's picture

How should we measure and assess financial development around the globe? Why has financial development progressed so quickly in some regions and countries while seriously lagging in other parts of the world? At what point does the financial sector become too large or too complex? What mix of banks, other financial institutions, and financial markets is the best from the broader development perspective? How to ensure healthy competition in the provision of financial services? Which policies help in supporting robust financial development, and which ones do not? And which ones help in providing people and firms with better access to finance?

These are just some examples of questions to be addressed by a new annual publication, the Global Financial Development Report (GFDR), a flagship report of the World Bank Group. As highlighted by its title, the report will have global coverage with a focus on finance and an explicit developmental angle. The GFDR will provide an overview and assessment of financial sector development around the world, with a particular attention on medium- and low-income countries. The preliminary target release date for the inaugural issue, GFDR 2013, is September 2012.

Should State Banks Continue to Play a Role in the Middle East and North Africa?

Roberto Rocha's picture

In the past three decades the role of state-owned banks has been sharply reduced in most emerging economies. This reflects a general disappointment with their financial performance and contribution to financial and economic development, especially in countries where they dominated the banking system. But despite their loss of market share, state banks still play a substantial role in many regions, especially in East Asia, the Middle East and North Africa, and South Asia (figure 1).

Figure 1 Share of state banks in total assets by region, various years, 1970–2005
(percent)

 

The arguments put forward to justify the continuing presence of state banks have included market failures (resulting from asymmetric information and poor enforcement of contracts) that restrict access to credit; the provision of essential financial services in remote areas (where supply may be restricted by large fixed costs); and the provision of countercyclical finance to prevent an excessive contraction of credit during a financial crisis. These arguments may well justify policy interventions in many countries, although it does not necessarily follow that state banks are the optimal intervention. Moreover, even where the presence of state banks may be justified, policy makers still face the challenge of ensuring clear mandates and sound governance structures in order to minimize political interference and avoid large financial losses.

New Ideas in Business Growth

Miriam Bruhn's picture

My colleague Bilal Zia and I organized a conference on New Ideas in Business Growth: Financial Literacy, Firm Dynamics and Entrepreneurial Environment that took place at the World Bank last Wednesday. The conference brought together researchers and policy makers in the area of private sector development to share new findings about the types of policy interventions that are effective at promoting business growth. We decided to focus the discussion on three topics that have recently received increased attention from both a research and a policy angle: 1) business and financial literacy training 2) the business environment and 3) corporate governance and firm dynamics. The selection of these three topics also raised a larger question in my mind—should the research community spend so much of its effort on microenterprises, when larger firms may have much higher growth potential? That’s a question I’ll return to at the end of the post.

In recent years, many governments, international institutions, and NGOs around the world have been providing business and financial literacy training for entrepreneurs. However, so far, we know relatively little about the impact of this training on business performance and growth. In an effort to contribute to filling this knowledge gap, Bilal and I conducted a randomized control trial in Bosnia-Herzegovina, where we collaborated with a microfinance institution and an NGO to provide business and financial literacy training to young entrepreneurs.

What Drives the Development of the Insurance Sector?

Erik Feyen's picture

The insurance sector can play a critical role in financial and economic development in various ways. The sector helps pool risk and reduces the impact of large losses on firms and households—with a beneficial impact on output, investment, innovation, and competition. As financial intermediaries with long investment horizons, life insurance companies can contribute to the provision of long-term finance and more effective risk management. Moreover, the insurance sector can also improve the efficiency of other segments of the financial sector, such as banking and bond markets, by enhancing the value of collateral through property insurance and reducing losses at default through credit guarantees and enhancements.

Indeed, a growing literature finds that there is a causal relationship between insurance sector development and economic growth. However, there have been few studies that conduct look at what drives the development of the insurance sector. Of the literature that does exist, most focuses on the growth of the life sector as measured by life insurance premiums.

Ladies First? Understanding Whose Job is Vulnerable in a Crisis

Mary Hallward-Driemeier's picture

In an economic crisis, whose job do employers put on the chopping block first? Many gender equality advocates and policymakers are concerned that “women are at risk of being hired last and dismissed first” during crises. This concern is fuelled by evidence showing that employers often discriminate against women even during less volatile times, that women often bear the brunt of coping with economic shocks, and that, in many countries, gender norms prioritize men’s employment over women’s. Despite a lot of rhetoric, existing studies of the labor market consequences of macroeconomic crises have yielded ambiguous conclusions about the differential impact across genders. Might claims about women’s vulnerability be exaggerated?

Most studies that look at the distributional impact of crises rely on household and labor force data. However, these data cannot distinguish between two mechanisms that could account for gender differences in employment adjustment. First, differences in vulnerability could be the result of sorting by gender into firms and occupations that differ in their vulnerability to crises. In this case, the effect of gender is indirect; women may take jobs that are relatively more or less vulnerable. Second, there could be differential treatment of men and women workers within the same firm. Faced with the need to adjust, do employers treat women differently, either by firing them first or cutting their wages more? It is this second mechanism that underpins concerns about discrimination. To distinguish between these mechanisms, we need to compare the employment prospects and wage trajectories of men and women both across and within firms—which means we need firm-level data.

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