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Catching-Up: Financially Integrating Europe

Catching-Up: Financially Integrating Europe. Erik Berglof, SITE, Stockholm School of Economics; CEPR; and The Brookings Institution. “Had I been present at the creation I would have given some useful hints for the better ordering of the universe”

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Catching-Up: Financially Integrating Europe

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  1. Catching-Up:Financially Integrating Europe Erik Berglof, SITE, Stockholm School of Economics; CEPR; and The Brookings Institution SITE

  2. “Had I been present at the creation I would have given some useful hints for the better ordering of the universe” Alphonso X, The Wise,1252-84, King of Leon and Castile SITE

  3. Core and Periphery (infrastructure) SITE

  4. Core and Periphery (market size) Core and Periphery GDP per capita per km SITE

  5. The European Challenge:Catching-Up • Financial integration with real integration (financial and real development) • CEE catching up with Western Europe • Europe catching up with the United States • Enforcement of laws and regulation • Periphery: mostly FDI (few multinationals) • Some countries less competitive, less reform SITE

  6. Catching-Up will require more(Aghion, 2005) • From imitation to innovation • Different source of productivity growth • Entrepreneurship, exit, and entry; not existing firms • Different quality of human capital • Tertiary (graduate) education <=> R&D • Different financial system • Promote entry and exit; finance innovation SITE

  7. New engines of change needed • Most trade gains from accession already realized • FDI flows weakening as large privatizations are over, and service gap is closing • Institutional change difficult to sustain as EU membership is achieved… • ...and EU center weakened SITE

  8. Financial integration: Basic premises • Institutional development => financial development and economic growth • Finance not been the driver so far • Financial development <=> integration • Finance critical for future growth • Access to finance, not integration per se SITE

  9. Financial Integration (and Development) • Integration of EU 15 • Uneven (bonds vs. retail banking; private equity vs. syndicated bank lending) • Integration of CEEC • Foreign ownership, but little functional integration; poor access to investment finance • Integration of hinterland • ”Great Divide” (underdevelopment + fragility) SITE

  10. Policy implications • Enforcement of existing laws and regulation key to financial development and integration in CEE • Not only government (EU and national) • Private ordering (soft law), and private and public enforcement complement each other • Success stories suggest change possible, but is their political will? • EU pressure weakened, but ”club-in-club” initiative may trigger EU-wide change SITE

  11. Part I: EU financial integration SITE

  12. Financial integration at EU level:A lot has happened… • Financial Services Action Plan (FSAP) to broaden and deepen capital markets • Lisbon European Council set 2005 as the year when Action Plan fully implemented • Introduction of euro • Creation of single market (for services?) • EU accession (Copenhagen Criteria) SITE

  13. …but integration remains uneven(Berglof et al., 2005) • Across sectors • Bonds vs. retail banking (particularly to SMEs) • Private equity vs. syndicated bank lending • Across countries • Italian banking (protectionism) • Banca Antonveneta and Banca Nazionale de Lavoro • CEEC Banking (access to finance) • Strong control, but little functional integration SITE

  14. Financial integration at EU level: Remaining challenges • Multiplicity of regulatory and supervisory regimes • Slows down functional integration • Regulatory and non-regulatory barriers to entry • Discriminatory vs. non-discriminatory barriers • Slow progress in implementation of regulatory and supervisory framework • Compared to speed of industry transformation • Integration of new member states • Broader, functional integration needed (enforcement) SITE

  15. Implementation and enforcement • EU (EMU) accession effect waning • Implementation of FSAP lagging • Lamfalussy Process not sufficient • Options • Single regulator and supervisor • Lead regulators/supervisors • Enhanced cooperation (avant-garde) SITE

  16. Part II: CEE financial integration SITE

  17. Different starting points… • Soviet heritage • Degree of central planning • Experience of private enterprise • Early reforms • Macroeconomic overhang… SITE

  18. …different policies… • Bad loan restructuring (Hungary vs. Poland) • “Hospital” banks (Poland vs. Czech Republic) • Bank privatization (Poland vs. Czech Republic) • Entry policy (Poland vs. Czech Republic) • Foreign entry (Hungary vs. Czech Republic) • Firm privatization (Poland vs. Czech Republic) • Stock markets (Hungary vs. Czech Republic) SITE

  19. …different trajectories… SITE

  20. … but systemic convergence • Strong domination for bank intermediation • Investment financed through internal funds • Most external funds from FDI • Markets limited role in corporate finance • Legal environment: Laws and regulation on the books, but weak enforcement SITE

  21. Emerging European Capitalism(Berglof and Bolton, 2002; Berglof and Pajuste, 2004) • Private owners dominate, but state still important • Ownership concentration high and increasing • Increasing separation of ownership and control • Corporate groupings and large foreign owners • Firms still owner-managed, but changing • Commercial banks dominant creditors SITE

  22. Control Increasingly Concentrated SITE

  23. Ownership and Control in Central and Eastern Europe SITE

  24. Western Europe and the US SITE

  25. Financial integration • Lagged real integration, uneven and partial • Rapid integration of ownership • But less functional integration • Narrow banking portfolios • Fee-based activities • Working capital, but little investment finance SITE

  26. Foreign bank penetration(Gianetti and Ongena, 2005) • Broken up related (crony) lending • Expanded credit volumes • SME benefitted (much) less than large firms => CEE financial development (integration) about broadening and deepening access to finance; institutional environment SITE

  27. 10.0 9.0 8.0 7.0 Bulgaria Czech Republic Estonia 6.0 Hungary Index Latvia 5.0 Lithuania Poland 4.0 Romania Slovak Republic Slovenia 3.0 2.0 1.0 0.0 1997 1998 1999 2000 2001 2002 2003 Year Rapid implementation of Acquis (company law) SITE

  28. SITE

  29. Corporate governance disclosure (Berglof and Pajuste, 2005) • Regulation – Annual reports - Websites • The data • All companies listed on the main (regulated) exchange in ten countries and covered by Amadeus; financial companies excluded • Sample of 370 companies (from 5 in the Slovak Republic to 153 companies in Poland) • Website (370) + annual reports (128) SITE

  30. Website Disclosure SITE

  31. Uneven Enforcement (Required and actual report disclosure) SITE

  32. Disclosure patterns • Level of disclosure and enforcement varies substantially across firms and countries • Disclosure depends on legal framework, but not on the firms’ financial performance • But financial performance strongly correlated with availability of information (on website) • Larger, less leveraged, higher market-to-book, and more concentrated ownership => more available SITE

  33. What is the CEE problem? • Controlling shareholders have come to stay • Main conflict: controlling vs. minority shareholders • Few alternative mechanisms, but… • Preventing fraud is paramount problem • Enforcement overriding issues • But is there the political will…? SITE

  34. Part III: How to improve enforcement SITE

  35. Enforcement, not laws-on-the-books, vary with development SITE

  36. What enforcement mechanisms?(Berglof and Claessens, 2005) • Private initiatives • Unilateral (e.g., reputation) • Bilateral (e.g., controlling shareholders) • Multilateral (e.g., self-regulating arrangements; soft law) • Private law enforcement • Litigation most important tool • Public law/regulation enforcement • Traditional view of enforcement • Outside anchor (e.g., EU accession) SITE

  37. Choice of enforcement mechanisms • Overall institutional environment matters • Relative importance of a particular mechanism • Relative scope for policy impact • Mix of technologies will be used • Is there the political will? • Outside anchor? SITE

  38. Corporate governance and finance when enforcement weak • Large blockholders main response => Conflicts: controlling vs. minority shareholders => Strong reliance on internal finance => Bank finance dominate => bank supervision => Illiquid financial (and takeover) markets => Other corporate governance mechanisms weak SITE

  39. Limits to what firms (can) do(Doidge, Karloyi, and Stulz, 2004) • Almost all the variation in governance ratings across firms in emerging market economies explained by country characteristics • in developed market economies 50% depends on firms • Access to global markets improves governance • decreases the importance of home-country laws SITE

  40. Change in enforcement possible • Variation across and within countries + change over time => large scope for improvements • Disclosure: Czech Republic vs. Poland • Not all aspects of enforcement equally important or easy to reform • Transparency: Related transactions vs. director income • Transparency vs. control arrangements • Combine public and private enforcement; and private ordering SITE

  41. SITE

  42. Part IV: Club-in-Club to speed up pace of reform(Baltic Financial Zone) SITE

  43. Club-in-club(Berglof et al., 2004) • Mere threat can trigger change • Latent threat to form an EU ”inner core” • Maastricht: EMU • Amsterdam: Reinforced Cooperation • Nice: Enhanced Cooperation + regulation • European Convention put it in the Constitution • Less than unanimity for ratification of Constitution? • Enhanced cooperation • Controlled by the Commission • Minimum 8 countries SITE

  44. Baltic Sea Financial Integration • Pan-Nordic financial industry strongly integrated • A few banks dominate seven markets and have significant presence in two more • OMX now control seven stock exchanges • Face nine regulators, nine supervisors plus numerous national private initiatives • Extensive regulatory/supervisory coordination SITE

  45. Baltic Financial Zone: A test case and trigger • Financial integration proceeded very far • Same issues as whole of EU • Multiplicity of regulatory/supervisory regimes • Old and new member states • Less integrated members (Germany + Poland) • Closely integrated non-member (Norway) • Hinterland (Russia) • “Club-in-club” initiative => EU-wide effects? • a complement, not a substitute, to EU integration SITE

  46. Policy implications • Enforcement of existing laws and regulation are key to financial development and integration • Success stories suggest change possible, but is their political will? • Not only government • Private ordering (soft law), and private and public enforcement complement each other • ”Club-in-club” initiative may trigger EU-wide change SITE

  47. Core and Periphery (infrastructure) SITE

  48. "If the Lord Almighty had consulted me before embarking upon the Creation, I should have recommended something simpler." Alphonso X, The Wise, 1252-84, King of Leon and Castile SITE

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