Rethinking banking after the crisis

1. Rethinking banking after the crisis Professor Brian Lucey Trinity College Dublin November 2013

2. Banking Crises are costly In Debt In lost output IMF preliminary estimates are of crisis cost > $12tr

3. But are relatively infrequent Were we “overdue”? (Data from Laven “systemic crises database”

4. GFC was a worldwide phenomena

5. Main thesis of this talk • GFC was a function of overly large and powerful banking sector • Need to “rein this in” • But this will be costly

6. Good news : Long-term trend 1

7. This is a GOOD THING • Companies need consumers with sufficient income to purchase goods • Consumers need companies with sufficient profits to innovate • Both need modern, effective, banking systems to intermediate spatially and temporally • The latter has broken down… it needs fixing

8. Slow steam ahead…

9. GDP PC Slovenia tradepartners

10. Euro crisis continuing • Europe continues to be bedeviled by a combination of imbalances • Personal financial indebtedness • Banking weakness • Governmental financial weakness • Balance of Payments issues

11. Personal financial indebtedness • Significant net wealth • Significant hidden strains on household budgets • Euro Household Finance survey useful database but major caveats on household size, role of homeownership, corporate etc • Banks mispriced debt issuance to consumers

12. PSC growth was widespread

13. PSC Growth > GDP usually

14. PS Debt as % GDP Since 2001 most countries have seen significant rises Median debt/GDP is 136%, rise 61%

15. Low income = vulnerable • 43.7% of households in the euro area have (some type of) debt; 23.1% have mortgage debt, while 29.3% have non-mortgage debt. • median value of mortgage debt (€68,400) substantially exceeds the median value of non-mortgage debt (€5,000). • median debt-asset ratio among households having debt is 21.8%, the median debt-income ratio is 62.0%, the median debt service-income ratio is 13.9% and the median loan-value ratio of the household main residence is 37.3%. • low-income households particularly financially vulnerable to economic shocks. For these households, an adverse shock to labour income or to interest payments is more likely to lead to an unsustainable debt burden and economic distress.

16. Household Debt by country

17. Government weakness • Bailouts were in one way or other the order of the day • A Doom Loop was created • Bank Capital escaped relatively unscathed.

18. Balance of Payments issues • We cannot export our way out of this crisis…not even Germany can • Persistent imbalances are a problem. And they are not all on one side of the equation • Overly large surplus => unwarranted deflationary bias • Overly large deficit => unwarranted expansionary bias

19. Trade balances improving

20. German demand weakness “The most interesting panel is the third one, which shows that German exports to countries outside the EU have increased rapidly, but German imports from these countries have fallen recently. This suggests that weak German demand should have played a role” Brughel 13 November .

21. Germany needs to spend… German Final Consumption slowest growing behind Netherlands and Greece..

22. Germany needs to spend…

23. Banks weaknesses • Not delivering on SME Finance • Senior Debt overreliance • Incoherence at European level regarding funding model

24. SME a core-periphery problem V large percentage of firms in Greece (61%), Spain Italy (both 50%) and, to a lesser extent, Portugal (40%) reported that this is a very pressing problem (scale 7-10), while the corresponding percentage in Germany and Belgium is around 30% and in Finland it drops to 24%. At the same time, 55% of firms in Finland, 45% in Belgium, and 43% in Germany and Austria considered access to finance a not pressing problem

25. Discouragement/ profitability a problem in line with weak profits the share of SMEs having sufficient internal funds and therefore not applying for a loan was considerably lower in Greece (28%) and Portugal (33%). Especially in Greece (14%) and Ireland (16%), the fear that their application would be rejected was considerable, reflecting the difficult situation in the banking sector and, in particular in Greece, the weak profit developments for SMEs

26. Policy Incoherence • Banks need to become more stable => deposit base needs to increase • Bail in possibility reduces attractiveness of deposits • Senior Debt remains a large part of funding

27. Senior Debt overreliance

28. Problem of Banking sector • General issue : financial sector is a sector of the economy not the whole. • Danger that it has become “tail that wags the dog” • Financialisation of quasi or full public goods gathers apace • Banking system is broken

29. Solving this ? • Two elements on this • Shrinking the size of the system and the size of the elements of the system • Shifting emphasis from the broken banking model to a more sustainable approach

30. Shrinking the system • Banks and the financial sector are • As a whole too large • Individually too big to fail and too big to bail • European fumbling has created a bank-sovereign ‘doom loop’ that is as yet unbroken • Bank governance and organization focused to much on shortterm • Danger of more and more Minsky Moments

31. Moral Hazard Redux… and redux • Banks fail in their ability to price risk • Corporate • Macroeconomic • Systemic • Banks get bailed out, some people go • But culture remains the same or worse • Stulz findings

32. Stulz • Banks that did poorly before do poorly again • Shareholder board alignment => taxpayers on hook • As per Eurozone SME DEMAND biggest issue

33. Towards sustainable finance • Three things need to happen • Supply side arguments alone don’t work. Need for demand and supply ‘stimulation’ • Banking needs to be treated as an utility. • EU needs to decide to U or not. U implies costs on all sides

34. Utility Banking. • What would this look like? • Banks small enough to fail • Remuneration and governance linked to long-term social and economic wellbeing • Pooled, prefunded deposit insurance • Bank resolution including bail in, coco bonds • Chicago plan of 100% deposit backing for credit? • This would not be costless…. • Higher cost of capital (as high as fragmented union?) • Lower credit creation (deleveraging is happening anyhow) • Loss of internal bank diversification

35. Bordo-Lane NBER 2010 : era of strong regulation = era of less crises

36. Unity • Can we have in the future a monetary but not fiscal union? • Political misalignment with common good • Myopic politicians and voters