Download Bank Lending in Insider Financial Systems

Bank Lending and Regulation in Insider Financial Systems: a theoretical
assessment*)
draft version
Dr. Elisabeth Springler
[email protected]
Vienna University of Economics and Business Administration
Department of Economics / Institute of Monetary and Fiscal Policy
Abstract
Serving two purposes simultaneously – ensuring financial stability and providing banking
liquidity - modern banking regulation has to find the balance between credit restriction and
credit extension. This does count especially for insider financial systems or bank based
financial systems, in which bank credit is of high importance for investment decisions of
firms. This paper investigates the effects of the evolution of banking regulation mechanisms
with a focus on the Capital Adequacy Ratio of Basel II on the relationship between banks and
firms. Using an adapted endogenous money model the impacts of changes in banking
regulation for credit lending are analyzed on a theoretical level. Theoretical aspects are
enriched by evidence from the Austrian Banking sector.
Keywords:
Endogenous money, asymmetric information, banking regulation, Insider Financial
Systems, Bank lending, Basel II
*)
Parts of a preliminary version of this paper have been presented at the ICAPE Conference
2003 under the title: “A new Architecture for International Financial Markets is needed: A
chance for heterodox economics?”
1
Banking lending and Regulation in Insider Financial Systems: a
theoretical assessment
Introduction
Numerous studies have been conducted to evaluate the effects of the Basel II for specific
groups of firms, like small and medium sized enterprises. Additionally national Qualitative
Impact Studies show the effects on a macroeconomic level. Despite these fields of intensive
research which rely heavily on econometric data evaluation a concise integration of these
methods of economic policy into monetary theory is still missing. Therefore this paper tries to
fill that theoretical gap and integrates the effects of modern banking regulation into an
endogenous money model. With this ambiguous theoretical starting point the obstacle of
different approaches - structualist, accomodatist or horizontalist and circuit approach towards endogenous money have to be overcome. The questions that are addressed in the
paper are:
1. Do modern forms of Banking Regulation lead to credit constraints within economies
with insider financial systems from a theoretical point of view?
2. Can empirical evidence be found supporting the results on bank lending of an adapted
endogenous money model in a selected country with insider-oriented financial
system?
The paper proceeds with an analysis of the relevant features of endogenous money for
economies with insider financial systems, which can be regarded as a synonym for bank
based financial systems that are characterized by the important role of banks for external
investment financing of firms and strong institutional ties between creditor and debtor. 1 is
This leads to an adapted endogenous money model following Post-Keynesian tradition . In the
following special attention is drawn on problems of asymmetric information and the impact of
banking regulation mechanisms for credit supply and money supply. The behaviour of banks
and their active role in the generation of money supply besides the efforts of a central bank to
1
In contrast to the distinction between market and bank based financial systems, which heavily relay in the flow
of financial funds and incorporate methods to investigate activity, size and efficiency of banks and stock
exc hange in relation to each other (quantitative concepts for investigation have been implemented among others
by Demirgüc-Kunt and Levine, 1999), refers the distinction of insider and outsider financial systems - which
traces back to the works of Hirschman (1970) and in which he develops the effects and possibilities of “voice”
and “exit” on financial markets - on individual behaviour in the two different concepts of financial systems and
the relation between debtor and creditor.
2
control the money bases has to be investigated. First steps for research on empirical evidence
for endogenous money and the role of banks are shown by using Austria as a case study.
I. Stylized Facts on Banking Regulation
After the liberalization of the banking sectors in Western Economies, which started in the 80s
after the works of McKinnon and Shaw (1973) and in economies with socialist tradition ever
since the transformation process started, national and international Banking Regulation has
undergone a heavy restructuring process and led to a ‘new financial order’. This is
characterized as Eatwell and Taylor (2000: 209) put it by ...”the conscious removal of
controls that was a necessary part of the privatisation of foreign risk, and from the process of
internationalisation itself. Liberalization has created a seamless financial world, with
regulators confined inside increasingly irrelevant national boundaries”. Nevertheless the
period of ‘pure’ liberalization was replaced with thoughts of ‘reregulation’ and the
enforcement of ‘self-regulation’ 2 mechanisms. When talking about ‘reregulation’ mechanisms
it has to be mentioned that the purpose of these measures is not to take back former
liberalization procedures but to introduce proper means of prudential banking supervision and
financial markets supervision on an international level to stabilize the financial sector, which
showed increased fragility throughout the 90s. 3 The ‘old’ mechanisms of banking regulation,
like administrated interest rate ceilings and credit rationing for certain industries are still
regarded to cause ‘qualitative’ and ‘quantative’ credit distortions and as McKinnon (1973)
calls it: ‘financial repression’. 4
Although the newly introduced measures of financial regulation, mainly those of the Group of
Thirty, OECD guidelines and EU Regulation mechanisms (Menkhoff and Frenkel 2000,
Strulik 2000) including the proposals of the Committees of the Bank of International
Settlements, were heavily discussed among economics and economic politicians all around
the world (Akyüz, 2000), the proposals of Basel II have been implemented into the law of the
European Union and therefore have to be transformed into national law in the member states.
2
‚Self-regulation’ mechanis ms define all measures which do not integrate a supervisory party into the system
but are put into action because of market forces. As an example for such a mechanism Corporate Governance
Codes can be quoted, which aim to increase trust and transparency in a market system – in this case into the
relationship between investor and firm – and try to reduce the negative effects of asymmetric information.
3
Numerous developed and less developed countries - in means of financial sector development - suffered from
financial crises after liberalising their financial systems. For example Finland faced a banking crisis from 1991 to
1994, Italy from 1990 to 1994, Norway from 1987 to 1993 and Portugal from 1986 to 1989. (Demirgüc-Kunt
and Detragiache, 1998)
4
Although McKinnon (1973) addressed especially emerging financial markets and their fragmented economy in
which external financing of investment projects is rare, when discussing the negative credit distortions arising
out of banking regulation, economists did also believe in the negative effect in higher developed economies.
3
In this paper only pillar I of Basel II - the capital adequacy ratio- will serve as an example for
changes in banking regulation, although it has to be mentioned that also the impacts of the
implementation of pillar II (measures of prudential supervision) and pillar II (market
disclosure) and their influence on national financial systems 5 and monetary policy deserve
investigation. When putting pillar I of the Basel II framework into the centre of the analysis
basically the changes from a general capital adequacy of 8% for all loans given by
commercial banks into a more sophisticated scheme of risk sensitivity into the internal
analysis then providing a loan becomes the main point of discussion. In Basel II concrete
changes in reserve requirements take place according to the risk of the project or the firm
(internal risk or standardised approach). This means that in contrast to the up to now valid
required minimum capital of 8% the bank has to hold capital according to the groups of
debtors, which are classified into 5 categories (0%, 20%, 50%, 100% and 150%). For some
portfolios like loans to other states with rating AAA to AA- no minimum capital is required
(0%) for others loans to states under rating B- up to 150% of 8% have to be kept as minimum
capital requirement. For non-banks the risk assessments consists of 4 categories starting with
a risk weight of 20% of 8% up to 150% of 8%. Therefore banks have to underlie loans from
firms with higher risk (or lo wer rating) with 12% capital, whereas for firms with the lowest
risk weight 1.6% is sufficient (Bank for international Settlements, 2003).
II. Endogenous money model, Asymmetric Information and Banking
Regulation
The view that money is endogenous in the economic process is nowadays, according to Pollin
(1991), widely accepted among economists and central bankers with different theoretical
economic backgrounds. Pollin traces the roots of this acknowledgement back to Alan Holmes,
a former New York Federal Reserves Senior vice president, who stated in 1969 that …”in the
real world banks extend credit, creating deposits in the process, and look for the reserves
later.” (cited by Pollin 1991: 367) Apart from this general consensus that Central Banks are
not in full control over money supply diverge approaches of how endogenous money can be
5
Especially effects Basel II might have on the national financial systems via changes in the institutional
structure of banking regulation have to be taken into account. As Wolfson (1993) points out, the mechanisms of
pillar II in Basel II basically consist of preventive measures to ensure banking stability, whereas a direct
institutional influence has a minor role. Therefore shifts in national financial systems towards a more marketbased system, which do not put the same emphasis on institutional settings as bank-based countries do, cannot be
neglected.
4
integrated into monetary theory significantly even within one school of economic thought 6 .
The model developed in this paper follows Post-Keynesian tradition. The first step of this
paper therefore is to create a useful framework of endogenous money within Post-Keynesian
Economics, which will draw attention to the relationship of banks and firms and enables to
distinguish institutional features to show the effects of the capital adequacy ratio of Basel II
for insider financial systems. Endogenous money means that “banks liabilities finance bank
assets” and “money is credit driven but supply determined” (Rochon, 2001).
Table 1
Theoretical disagreement between Structuralists and Accomodatists
Structuralists
1. Central bank fully accommodates reserve
requirements of commercial banks?
• Liquidity preference theory compatibility?
o Borrowed and non-borrowed funds
perfect substitutes?
o Functioning of Keynesian
multiplier?
• Liquidity management
• Open market operations are useful?
2. Amount of newly created deposits equals the
amount of demanded deposits?
• Independent money supply curve
• Convenience lending
• Money stock vs. money flow problem
No
Horizontalists
or
Accomodatists
Yes
Yes
No
No
Yes
Yes
No
Yes
partly
No
No
Yes
Yes
Yes
No
No
No
Yes
Yes
Disagreement in endogenous money models within Post-Keyesian economics starts with the
second part of Alan Holmes statement when he claims that banks will look for reserves later
and cumulates in two main questions:
•
How and when do banks look for reserves? Different assumptions about the role of
commercial banks in conducting these reserves also lead to distinctive central bank
behaviour.
•
Does the amount of newly created deposits equal the amount of money individuals are
willing to hold?
6
Economic schools of thought that try to incorporate endogenous money models into their theoretical
framework are among others, New Keynesian Approaches, Post-Keynesian Economics, Economists in Marxian
Tradition as well as Neo-Austrian Economists. (Flanders, 1997; Lapavitsas, 2003)
5
Primarily two approaches within Post-Keynesian Theory arise out of these differences, the
accomodadist approach and the structuralist approach. 7 The following table 1 gives answers
to these two questions and highlights the resulting theoretical disagreements.
Out of the question how the central bank reacts to the requested reserves of the commercial
banks a set of theoretical differences between the two approaches arise. Since horizontalists or
accomodatists claim that the central banks always fully accommodate the requests of
commercial banks. This results in a perfectly horizontal credit and money supply curve. Since
this fact leads to the incapability of financial authorities to control money at all liquidity
preference, similarly to the neoclassical assumption of a vertical money supply curve
although completely opposing this approach, does not fit in the scheme. (Chick and Dow,
2002; Brown, 2003-4) Structuralists approach conversely chooses a middle way by stating
that the central bank does not fully accommodate the commercial banks’ request for reserves.
Banks’ institutional setting and liability management has therefore an influence on the
reserves demanded and on the shape of the credit and money supply curve, as Palley (1996)
shows. On the one hand causality results in a stronger position of the central bank in short
term, since the central bank can have an influence of commercial banks via restricting the
growth on non-borrowed funds - which leads to a non-perfect substitution between borrowed
and non-borrowed funds in the Structuralists approach - and on reserves in the following. This
is also the condition under which liquidity preference holds. On the other hand the central
bank’s position is weakened in the long run, since the liability management of banks enables
them to create reserves themselves. Open market operations which serve as useful tools in
monetary policy from a horizontalist point of view have less self-assertion in the structuralist
view due to the importance of the institutional setting. Therefore credit supply shifts outward
and flattens in the long run. Fontana (2003) and Fontana and Venturino (2003) show these
developments in the money supply curve of the two approaches within a time framework. The
institutional setting has therefore a bigger influence in the structuralist approach than in the
horizontalist approach. The answer to how the central bank reacts to reserve requirements of
banks has also an influence on the functioning of the Keynesian multiplier. Moore (1994,
1988) as representative of the horizontalist approach points out, that endogenous money
undercuts the functioning of the Keynesian multiplier. Conversely, as Cottrell (1994) points
out, on might assume that within the endogenous money model the Keynesian multiplier is
7
Often the circuits approach, carried out among others by Rochon (1999) and Parguez (1996) is quoted as third
line of argumentation of endogenous money within Post-Keynesian theory. Since this concept has a close
connection to regulation theory it is left apart in this analysis as to widen the theoretical background.
6
reinstalled in its functioning, since endogenous money would also emphasise a horizontal LM
curve within the IS-LM model and therefore offset the diminishing effect of an rightward shift
of the IS curve intersecting with an upward LM curve that leads to a smaller effect on income
(GDP) than expected. 8
Also out of the second question described in Table 1 different theoretical aspects for the two
endogenous money frameworks arise. The fact that borrowed and non-borrowed funds are
perfect substitutes in the horizontalist approach lead to the conclusion that the amount of
newly created deposits always equals the amount of demanded deposits. Therefore also credit
and money supply curves are not independently. The results and arising problems out of this
statement can be highlighted by the opposing opinions between Moore (1997) and Arestis and
Howells (1996). Whereas Moore (1997) states that “convenience money” via interest rates
leads to a reconciliation between additional demanded deposits and additionally demanded
loans, Arestis and Howells (1996) refer to inconsistencies between stock and flow analysis
that arise out of Moore’s assumptions. According to them – representatives of the structuralist
approach – convenience lending and the statement that relative changes in interest rate can
count for a reconciliation of demand of additional deposits and demand of additional loans
refer to a flow analysis which would define ex post the money supply. Money stock or bank
lending are on the other hand ex ante defined by the discount rate and the mark up. Within the
analytical framework of Basil Moore are therefore ex ante and ex post definition of interest
rates questionable as well as problems with the definition of the axes which incorporate in the
flow analysis - according to Arestis and Howells - interest spreads and therefore liquidity
preferences for additional loans and additional deposits (although liquidity preference theory
is neglected by horizontalists) whereas at the same time money supply has to be defined.
Since neither in theoretical aspects nor from empirical observations 9 one approach seems to
be better than the other, the capability to integrate institutional features turns out to be the
crucial factor for choosing an approach. Institutional features are of importance for the
research question of this paper, since individual behaviour can only be incorporated when
institutional settings are taken into account. Therefore the structuralist approach seems to be
more appropriate, where liability management of banks can have an effect on the outcome of
8
For a precise description of the causal mechanism applying in this case, see the discussion between Moore and
Cottrell in the Journal of Post Keynesian Economics in 1994.
9
Although only few empirical studies have been carried out to find evidence for endogenous money, a clear
superiority of one framework over the other could not be found, neither in underdeveloped nor in developed
economies. See for empirical investigations which all came to the conclusion that endogenous money is relevant.
Gedeon, (1985-86), Howells and Hussein (1998), Shanmugam, Nair and Li (2003)
7
money supply. Furthermore the institutional setting is more prominent in the view of
representatives of the structuralist approach (see Chick and Dow, 1996 and Niggle, 1991).
The second theoretical starting point of this paper is the effect of asymmetric information and
its relevance for Basel II. As shown above one main argument against the former forms of
banking regulation - mainly against interest rate ceilings - have been quantitative distortions
due to credit rationing. To evaluate the effect of Basel II on bank lending the relation between
asymmetric information – adverse selection in this case - and potential credit rationing has to
be clarified. The next step will be to integrate assumptions of asymmetric information into the
Post-Keynesian Structuralist endogenous money model described above. Discussions about a
potential integration arise due to the postulate of fundamental uncertainty, which seem to be
incompatible with probabilistic approach of asymmetric information.
Per se Ritthaler (1994) and especially Hillier (1997) among others have shown, based on the
assumption of Stiglitz and Weiss (1981) that on the loan market equilibrium credit rationing is
possible. Their assumption of an exogenous credit volume and neglecting of time in the
analysis does not conflict with the argumentation here. Graph 1 shows such a possible
outcome. The demand curve is a gradual function for loans. Creditors are split into two
groups according to the risk of their demanded loans. The supply function for loans on the
other hand has its shape due to the bank’s uncertainty of the success of the investment project.
The interest rate level for loans has to be multiplied with the expected return of the bank.
When there are two groups of investment projects - some with higher risk and higher profit
and others with lower risk and lower profit - the supply function for loans is first increasing to
break down when the second group with high risk projects is reached. Once this turning point
is overcome the supply function increases again.
8
Graph 1
Asymmetric information and credit rationing
Source: Hillier, 1997:25
In graph 1 the possible outcome is shown that leads to credit rationing due to asymmetric
information. There exists an intersection between supply and demand for loans at point B’
which would be combined with an interest rate of ia. The interest rate level will not be set at
point B’ in the end but at point B, where the supply function is equal to the horizontal part of
the demand function for loans, because this leads to a higher effective interest rate. 10 The
result is that at point B credit rationing takes place since the demand function exceeds the
supply function and the project types cannot be distinguished.
Within Post-Keynesian economics on the other hand fundamental uncertainty together with
the concept of historical time and the assumption of non-ergodicity form the basic theoretical
paradigms, which lead to problems in integrating asymmetric information. The idea of
fundamental uncertainty traces back to Keynes’s General Theory of Employment, Interest and
Money in which he describes fundamental uncertainty:
“By ‘uncertain’ knowledge, let me explain, I do not mean merely to
distinguish what is known for certain from what is only probable. The
game of roulette is not subject, in this sense, to uncertainty…. The sense in
which I am using the term is that in which the prospect of a European war
is uncertain, or the price of copper and the rate of interest twenty years
hence, or the obsolescence of the new invention… About these matters
there is no scientific basis on which to form any calculable probability
whatever. We simply do not know.”
(Keynes, 1936:213-214 cited by Rousseas, 1986:17)
10
See Hillier (1997:12, 23) for a detailed discussion.
9
Corresponding to this definition, economists (Van Ees and Garretsen, 1993; Crotty, 1996)
state that asymmetric information would replace the concept of fundamental uncertainty by
known and measurable probabilities and would converse therefore the paradigm of nonergodicity. Similarly argues Rousseas (1986:17) against the conversion of uncertainty into
‘risk’ which would, according to him treat uncertainty like certainty. Davidson (1991)
qualifies this strict opposition against probability theory, but claims once more that risk is not
a synonym for uncertainty, when stating:
“For many routine decisions, assuming the uniformity and consistency of
nature over time (that is, assuming ergodicity) may be a useful
simplification for handling the problem at hand. For problems involving
investment and liquidity decisions where large unforeseeable changes
over long periods of calendar time cannot be ruled out, the Post
Keynesian uncertainty model is more applicable. …. The result is a more
general theory, encompassing cases of both ergodic probability and
nonergodic uncertainty.”
(Davidson, 1991:142-143)
Nevertheless has this incompatibility between the concept of fundamental uncertainty and
asymmetric information also been heavily opposed by economists like Dymski (1993, 1996)
and Fazzari and Variato (1994, 1996). 11 Dymski (1996) argues that the two concepts can be
integrated and claims (p.379) that
“the presence of uncertainty and finance constraints, in turn, depend on
the primitive assumptions made about information, time, and market
coordination. It is also shown that whether intermediary structure matter
depends first on whether finance constraints exist, and then on whether
financial intermediaries have any special ability to counteract the effects
of asymmetric information with information gathering or monitoring”.
This would mean that asymmetric information and therefore ergodic probability, as Davidson
puts it, serve as additional information about the institutional setting. Dymski (1996) in the
following defines the integration of asymmetric information as the adding of an ex ante risky
environment on the level of micro-economic behaviour to the macro-economic concept of
fundamental uncertainty. Asymmetric information would therefore be synonym for
exogenous uncertainty, whereas fundamental uncertainty can be defined as endogenous
11
A similar possibility to integrate the concepts of fundamental uncertainty and asymmetric information,
compared to the one discussed in this paper, is used in Springler (2004) to resemble trust increasing regulation
methods and traces back to Dymski (1993) and Bossone (1999).
10
uncertainty. This paper follows this line of argumentation and treats asymmetric information
as a relevant factor determining individual behaviour and the relationship between creditor
and debtor. The integration therefore focuses on defining an appropriate setting for analysis
and will not introduce models of probability to decrease risk but discusses the causal
mechanisms within the assumption of fundamental uncertainty. As a result Graph 2 presents
an endogenous money model in structuralist tradition, which has been adapted to the
assumption of asymmetric information. The main differences between this model and a
common structuralist view are highlighted in the shape lay therefore in the shape of the credit
supply function as well as the money supply and reserves function.
Graph 2
Asymmetric Information in an adapted endogenous money model
Starting from the upper right quadrant graph 2 shows the demand for loans (Dl) and the
supply for loans (Sl) in a structuralist view without taking asymmetric information into
account. The intersection of supply and demand leads the credit volume C0. Since the central
bank does not fully accommodate the reserve demands of commercial banks the credit supply
curve is not horizontal but increases as a result of the banks dependence on the interest rate
set by the central bank, which is shown in the upper left quadrant in graph 2. Nevertheless
commercial banks set their interest rate as a mark up over the central banks interest rate. Since
credit creates deposits shows the lower right quadrant the relation between demands and
deposits. Without asymmetric information this results in a constant slope of the DL line. Also
the demand for reserves, as shown in the lower left quadrant is drawn with a constant slope
11
according to the requirements of the central bank, which are exogenous determined and fixed
in graph 2 and leads to R0 required reserves.
Incorporating asymmetric information changes immediately the slope of credit supply and
credit demand. As discussed in graph 1 the demand for loans now consists of at least two
different groups of potential debtors and of a supply curve, which according to the horizontal
part of the demand curve shows a horizontal part which reflects the drawbacks in potential
revenue. The intersection of Sl* and Dl* leads therefore, as shown by the dotted line in the
upper right quadrant, to a credit volume of C1. The difference between C1 and the
intersection of Dl* with the axes in the volume of credit shows again the potential of credit
rationing. Consequently also the shape of the DL line changes. In graph 2 this change is
indicated in the lower right quadrant by the dotted line of the DL line’. A jump discontinuity
is observable according to the draw back in revenue of the credit supply curve and leads to
higher deposits compared with a situation without asymmetric informatio n. The reserves
demand curve in the lower left quadrant is unaffected by the integration of asymmetric
information since banking regulation and reserve requirements are assumed to be unchanged.
Therefore the overall result consists of a slight decrease in the volume of loans due to the
potential effects of credit rationing compared to a situation without asymmetric information
(see points A and A’ following a potential credit supply curve Sl ’ to the level of deposits in
the lower right quadrant).
What happens when changes on the banking regulation similar to the requirements of Basel II
occur? As mentioned above changes in banking regulation due to Basel II will lead to an
increase in deposit requirements for some debtors and to a relaxation for others. Graph 3
shows according to these effects in 3a the results for an increase in reserve requirements and
in graph 3b the consequences of a decrease in reserve requirements on credit volume and
money supply. An increase or decrease in reserve requirements immediately has an impact on
the demand for reserves of the commercial banks, shown in the lower left quadrant of graph 3
a and b. Changes according to Basel II which result in an increase in the reserve requirements
of both debtor- groups mentioned above (for simplicity graph a as well as graph b discuss the
similar movement of both groups of debtors, although it has to be noted that changes in
reserve requirements might also lead to a reduction for one group and an increase of reserves
for another group) result in an outward turn (3a) or inward turn (3b) of the reserve demand
curve. This at the same time splits the curve up into two individual curves.
12
The required amount of reserves might result in r1 . R3 would arise in case that also part of the
credit demands of the riskier group are supplied. According to the banks dependency on the
reserve accommodation of the central bank the volume of reserves supplied will be set
between r1 and r3 . But this amount of required reserves does not symbolize the final requested
volume, since also the supply for credit is affected by changes in reserve requirements. The
13
partial dependence of commercial banks on the central bank is reflected by this change in the
credit supply curve. Commercial banks are dependent on the central bank and can due to their
liability ma nagement partly create their own reserves. Therefore the credit supply curve does
not necessary reflect the slope of the reserve supply curve by the central bank including a
mark up but might change its slope due to the banks ability to use liability management to
gain reserves. In case of an increase in reserve requirements the supply curve will tend to
become steeper, since even without changes in the central banks reserve supply curve banks
will face different revenues. This concludes in a new intersection point between loan demand
and loan supply, which is below the old level (c0 and c1 in the upper right quadrant in graph
3a). Consequently, also the DL line will adjust according the new draw back in revenue
between the groups of debtors. The slope of the DL line stays the same, since the relation
between the supplied credit and the deposits created stays the same. Nevertheless leads the
lower level of credit volume also to a lower level of created deposits, d1 in graph 3a (similarly
a higher volume of credit and deposits is expected in case of a relaxation of reserve
requirements, shown as d1 in graph 3b), which in turn has an effect on reserves requirements.
The volume of reserves required (r2 for group 1 and r4 for group 2) will therefore be higher
than before the change in reserve requirements but lower than with the former volume of
credit. The contrasting effect is observable when fewer reserves are necessary (see graph 3b).
This shows that credit rationing can be affected by reserve requirements and methods of
banking regulation, although the possibility of banks to create their own reserves might
change the slope of the credit supply curve and therefore diminish the effect. The result is that
an increase in reserves due to Basel II for certain debtors might increase credit rationing,
whereas on the other hand a relaxation of reserves for other groups might only have a
marginal effect on credit extension within an endogenous money model.
III. First attempts for an empirical assessment in Austria
As mentioned above empirical investigations of the significance of endogenous money are
conducted very rarely. But as the effects of changes in reserve requirements and therefore the
impact of banking regulation on the credit volume indicates especially the ability of
commercial banks to create their own reserves is of interest for the developments of credit
rationing and credit extension. Since the specific effects of Basel II cannot be measured yet
the investigation of endogenous money and structure of liability management is even more
interesting.
14
Austria is chosen as case study since it represents an insider financial system for which the
effects described in section III are of high relevance regarding the macroeconomic
development of investment. So far no study has been accomplished to test the existence of
endogenous money in Austria within a Post-Keynesian framework. To investigate the
relevance of such an assumption this paper will follow the proposed methods of Pollin (1991)
for his investigation of the US commercial banking sector. The analysis will accordingly be
carried out in two steps. The structuralist model of Post-Keynesian endogenous money
implies that deposits follow the credit volume and that causality runs from central banks to
commercial banks and vice versa in supplying reserves.
1. Do deposits follow credit?
To empirically answer this question the development of totals loans and reserves, which
consist of vault cash plus the reserves of commercial banks at the Austrian Central Bank, is
observed by using the mean and variance of the loans reserves ratio over the business cycle.
First is has to be clarified that the time series is stationary. The results of this investigation are
shown in table 2, which presents the evolution of the means and variance of the loan reserve
ratio in 4 cycles, which are identified by BNP development. Data is used for the period
between 1987 and 2003. The used lag structure is 4 months, which is similar to the lags Pollin
(1991) uses, although there quarterly data is used, whereas here monthly data was available.
As observable in table 2 did the ratios in both cases follow the same trend.
Table 2
Means and Variances of loans/reserve ratios in the Austrian commercial banking sector
Periods
L/R
mean
Lt-4/R
variance
mean
variance
1987.1 - 1992.12
26,95
6,61
24,85
42,48
1993.1 - 1995.11
28,96
5,94
28,52
5,26
1995.12 - 2000.12
12,75
3,86
12,54
3,64
14,32
6,23
2001.1 - 2003.12
14,42
6,23
Data source: Austrian Central Bank
No specific pattern in the development of the variances is observable, only when using the lag
structure a significant difference in the variance of the first period compared to the outcome
without time lag has to be noticed. This occurs due to a break in the time series in 1996.12. It
can be observed that till 1995.11 the means were much higher than in the periods after. The
15
participation of Austria in the European Union from 1995 and the changes in reserve
requirements thereafter seem to be a reasonable explanation for this development.
2. Is liability management significant for Austrian commercial banks?
In general table 2 shows a downward trend in the loan reserves ratio, which is further
investigated in table 3. By following the identity that Pollin (1991:380) presents
Log (L/R) = log (L/D) + log (D/N) + Log (N/R)
the meaning of liability managements and therefore the plausibility of using a structuralist
approach as well as the proportional development of loans and reserves can be further
investigated. The two new variables D and N focus on the volume of liability management
Austrian commercial banks can conduct. D summarizes short term deposits, which means
savings account of up to 1 year and checkable deposits. N consists of long term deposits savings of over 1 year - federal funds and time deposits, which altogether are supposed to
form managed liabilities of commercial banks. These managed liabilities enable banks to
accomplish liability management. Columns three (D/N) and four (N/R) in table 3 present the
development of the ratio of traditional deposits to managed liabilities and the development of
managed liabilities to reserves. The ratio D/N symbolizes the accomodatist point of view in
which the causality runs from loans to deposits and from deposits to reserves. The ratio N/R
on the other hand stands for the structuralist view of endogenous money.
Table 3
Single periods and full period growth rates of ratios from the Austrian commercial banking sector
L/R
L/D
D/N
N/R
full period
1,34
0,66
1,17
1,73
1987-1992
1,39
0,67
1,26
1,64
1993-1995
1,39
0,67
1,27
1,64
1996-2000
1,26
0,65
1,04
1,86
2001-2003
1,30
0,66
Data source: Austrian Central Bank
1,12
1,78
As observable in table 3 managed liability ratio increased in the second two periods, whereas
the traditional deposits to managed liabilities ratio decreased in the respective periods. This
fact is of even higher importance when taking the decreasing loan reserve ratio into account
(presented in the first column).
16
This development explains the evolution of the loans reserve ratio, gives evidence to
proportionality and shows the increasing importance of liability management for Austrian
commercial banks, which can be taken as a sign of structuralist endogenous money. To test
for the structuralist approach of endogenous money further the proportion of borrowed funds
to non borrowed funds is of importance. As discussed in table 1 when analyzing the
theoretical disagreements between Structuralists and Accomodationists do the later believe
that borrowed and non borrowed funds are perfect substitutes. This opinion is opposed by the
Structuralists. From an economic policy point of view non borrowed funds would summarize
commercial banks refinancing via open market operations, whereas borrowed funds would
consist of overnight liquidity given by the central bank and discount policies. Since Austria is
member of the European Monetary Union no individual monetary policy can be conducted.
This evolves problems with the time series, which is only ava ilable after 1999. Nevertheless
can be observed that borrowed funds, which were administered as the residuum of total
reserves minus the participation of Austrian commercial banks within the European Monetary
Union in placing tenders, are of much higher importance for Austria than for the US, as
observed by Pollin (1991). Due to the high ratio of borrowed funds it seems at first sight as if
the structuralists approach would hold for Austria, although the necessary Granger Causality
Test cannot be conducted with the data available.
Table 4
Borrowed reserves as a share of total reserves in percentages
B/R
1999
66,82
2000
68,65
2001
71,55
2002
85,21
2003
74,72
Mean
73,39
Data Source: Austrian Central Bank
Conclusions
Theoretical assessment shows that imposing methods of banking regulation has an impact on
the credit volume, which seems to be of high importance for the macroeconomic development
of insider financial systems. When introducing asymmetric information into an endogenous
money model, credit rationing is possible. This evidence might decrease in case of proper
banking regulation but it can be shown that changes in reserve requirements might not have
17
the expected impact on the credit volume, since commercial banks can create their own
reserves via liability management.
Empirical evidence for Austria follows these assumptions and shows that liability
management was increasing since 1995, which makes central banks influence smaller.
Although the effects of Basel II cannot be forecasted for the individual groups of debtors in
the presented endogenous money model it is evident that banking regulation has an overall
effect on credit restriction and even in cases of credit extension, credit rationing might still be
the case. Therefore an even more sensible conduction of banking regulation as well as the
implementation of different institutional methods of supervision, which have to be added to
the role of central banks in supervision monetary policy seems to be necessary.
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