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Portoroz Business Conference November 2013 Rethinking banking after the crisis Professor Brian Lucey Trinity College Dublin November 2013 Portoroz Business Conference November 2013 Banking Crises are costly In Debt In lost output IMF preliminary estimates are of crisis cost > $12tr Portoroz Business Conference November 2013 But are relatively infrequent Were we “overdue”? (Data from Laven “systemic crises database” Portoroz Business Conference November 2013 GFC was a worldwide phenomena Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 Good news : Long-term trend 1 Share of World GDP 100 90 80 70 60 50 40 30 20 10 0 Rest of World North America Sub-Saharan Africa European Union China, People's Republic of India Russian Federation 2018 2016 2014 2012 2010 2008 2006 2004 2002 2000 1998 1996 1994 1992 Brazil Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 Slow steam ahead… % Growth in world GDP Share 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 92-00 00-10 10- Portoroz Business Conference November 2013 GDP PC Slovenia tradepartners Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 PSC growth was widespread 60 Belgium 50 Bulgaria 40 Czech Republic 30 Germany Denmark Estonia 20 Ireland Greece 10 Spain France 0 Croatia -10 Italy Cyprus -20 Latvia Lithuania -30 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Portoroz Business Conference November 2013 PSC Growth > GDP usually Years since 2001 when PSC growth > GDP Growth Sweden Slovakia Romania Poland Netherlands Hungary Lithuania Cyprus Croatia Spain Ireland Germany Czech Republic Belgium 0 2 4 6 8 10 12 Portoroz Business Conference November 2013 PS Debt as % GDP 400 2012 350 %increase 300 250 200 150 100 50 0 -50 Since 2001 most countries have seen significant rises Median debt/GDP is 136%, rise 61% Portoroz Business Conference November 2013 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. Portoroz Business Conference November 2013 Household Debt by country 250 200 150 100 50 0 Debt to Income D service / Income Portoroz Business Conference November 2013 Government weakness • Bailouts were in one way or other the order of the day • A Doom Loop was created • Bank Capital escaped relatively unscathed. 5000 0 -5000 -10000 -15000 -20000 -25000 -30000 -35000 -40000 -45000 BE CZ DE IE ES HR CY LT HU NL PL RO SK SE Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 Trade balances improving Portoroz Business Conference November 2013 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 . Portoroz Business Conference November 2013 Germany needs to spend… Germany lagging in final consumption.. 150.0 140.0 German Final Consumption slowest growing behind Netherlands and Greece.. 130.0 120.0 110.0 100.0 EU28 Germany Ireland Greece Spain France Croatia Italy Netherlands Austria Slovenia Finland United Kingdom United States Japan Portoroz Business Conference November 2013 Germany needs to spend… Portoroz Business Conference November 2013 Banks weaknesses • Not delivering on SME Finance • Senior Debt overreliance • Incoherence at European level regarding funding model Portoroz Business Conference November 2013 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 710), 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 Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 Senior Debt overreliance Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 Stulz • Banks that did poorly before do poorly again • Shareholder board alignment => taxpayers on hook • As per Eurozone SME DEMAND biggest issue Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 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 Portoroz Business Conference November 2013 Bordo-Lane NBER 2010 : era of strong regulation = era of less crises Portoroz Business Conference November 2013 Unity • Can we have in the future a monetary but not fiscal union? • Political misalignment with common good • Myopic politicians and voters