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Fragile Banks, Durable Bargains:
Why Banking is All About Politics
and Always Has Been
Charles Calomiris
and
Stephen Haber
Presented at World Bank Financial Structures Conference
June 16, 2011
The Puzzle to be Explained
Why is it so hard to create banking systems
that are efficient and stable?
This is especially puzzling because
there is a causal relationship between
finance and growth
1.
2.
3.
4.
Evidence from economic history (Gerschenkron 1962;
Cameron 1967; Sylla 1975, 2006, 2008; North and Weingast
1989; Neal 1990; de Vries and van der Woude 1997; Rousseau
and Wachtel 1998; Rousseau 2003; Rousseau and Sylla, 2003,
2004).
Evidence from cross-country regressions (King and Levine
1993; Levine and Zervos 1998; Beck et. al, 2000).
Evidence from cross-regional studies (Jayaratne and Strahan
1996; Black and Strahan 2002; Guiso, Sapienza, and Zingales
2004;, Cetorelli and Strahan 2006; Dehejia and Lleras-Muney
2007;Correa 2008).
Studies of finance dependent industries (Rajan and Zingales
1998; Wurgler 2000; Cetorelli and Gamberra 2001; Fisman and
Love 2004; Beck, Demirguç-Kunt, Laeven, and Levine 2007).
More puzzling still considering that:
1. Banking crises are not in the interest of
politicians or bankers.
2. Banks are highly regulated and closely
supervised.
Nevertheless, crises are endemic
The Frequency of Banking Crises,
By Number of Countries, 1970-2006
60
Number of Countries
50
40
30
20
10
0
Number of Countries that had
Zero Crises
Number of Countries that had
One Crisis
Number of Countries that had
Two or More Crises
Source: Laeven and Valencia 2008; does not include former communist countries.
Many countries are under-banked
The Relationship Between Financial Depth
(Private Credit/GDP) and GDP Per Capita Categories, 2008
225%
200%
Ratio of Private Credit to GDP
175%
150%
Mean=117%
125%
100%
Mean=56%
75%
Mean= 38%
50%
25%
Mean=20%
0%
Low Income
Lower Middle Income
Upper Middle Income
Source: World Bank Financial Structure Database
High Income
And they tend to be the same countries
Average Ratio of Private Credit/GDP by
Frequency of Banking Crises, 197080%
70%
Private Credit as % of GDP
60%
50%
40%
30%
20%
10%
0%
Crisis Free Countries
One Crisis
Two or More Crises
Source: Laeven and Valencia 2008 and World Bank Financial Structure Database
Even more puzzling:
Crisis prone countries have
slower rates of credit growth
Rates of Growth of Private Credit, by Number of Banking Crises, 1993-2006
Rate of Growth of Private Credit to GDP
60%
50%
40%
30%
20%
10%
0%
Crisis Free Countries
One Crisis
Two or More Crises
Source: Laeven and Valencia 2008; World Bank Financial Structure Database
And causality is not running solely
from crises to under-banking
Mean Ratio of Credit to GDP, 1993 and 2006,
by Number of Banking Crises, 1970 to 2006
90%
2006
80%
Ratio of Private Credit to GDP
70%
60%
1993
50%
2006
40%
1993
1993
30%
2006
20%
10%
0%
Zero Crises
One Crisis
More than One Crisis
Source: Calculated from Laeven and Valencia 2008, and World Bank Financial Structure Database.
A very troubling implication
Many “under-banked” economies
repeatedly supply credit imprudently;
After a crisis is resolved, banks appear to
once again misallocate scarce credit.
How do we resolve these paradoxes?
In order for there to be a banking system, three
property rights problems have to be mitigated:
1.
2.
3.
Bank insiders, minority shareholders, and
depositors must be protected from expropriation
by the government.
Depositors and minority shareholders must be
protected from expropriation by bank insiders.
Bank insiders, depositors and minority
shareholders must be protected from
expropriation by debtors.
Solving these property rights
problems requires institutions
1.
To solve problem of government expropriation, institutions must be
created that limit the authority of government (veto points in legislatures),
or that compensate bankers for the risk of expropriation (limits on
competition to raise rates of return).
2.
To solve problem of expropriation of depositors and minority
shareholders, institutions must be created that punish fraud and
tunneling (prudential regulation)-- or that compensate depositors and
minority shareholders for the risk that they will be expropriated (limited
liability, deposit insurance, and limits on competition).
3.
To solve problem of expropriation by debtors, institutions must be created
that allow bankers to damage debtors’ reputational capital (credit
reporting), repossess physical collateral (property registers, commercial
and bankruptcy law, courts and police)--or compensate bankers for the
possibility that they will be expropriated (limits on competition to raise
rates of return, limited liability).
Virtually all of these institutions
involve the government, which:
•
•
•
•
•
Allocates bank charters
Supervises and regulates the banks.
Enforces bank accounting standards.
Enforces debt contracts.
Runs the deposit insurance system.
This creates a dilemma:
• Any government strong enough to
regulate banks, protect against fraud
and tunneling, and adjudicate contracts
is also strong enough to expropriate the
banks.
Worse, the government is not a
disinterested party
The parties that control the government may have
their own financial interests.
The parties that control the government
simultaneously borrow from the banks and regulate
them.
The parties that control the government
simultaneously enforce debt contracts and may
need the political support of debtors.
The parties that control the government
simultaneously liquidate failed banks and allocated
the losses--but they may need the political support
of depositors.
Even worse, the parties that control the
government have multiple margins for
opportunism. They can:
1.
2.
3.
4.
Expropriate banks outright.
Monetize debt by printing money.
Borrow from the banks and then renege on the loans.
Raise reserve requirements and force the banks to hold
those reserves in government bonds that yield negative
interest rates.
5. Force banks to direct loans to government enterprises.
6. Force banks to direct loans to politically crucial
constituencies.
7. Force banks to forgive or reschedule debts.
8. Insure depositors beyond statutory limits.
9. Show regulatory forebearance towards bank insiders.
10. Rescue or bailout bank insiders, minority shareholders,
depositors, and debtors at the expense of taxpayers.
Worse still, economic actors cannot
easily monitor every margin
Both the intent of reforms and their actual
economic consequences can be difficult to
determine ex ante.
This is especially the case if the government
is simultaneously reforming multiple
institutions, some of which potentially
enhance the value of property rights and
some of which reduce them.
Nor can economic actors rely on
cross monitoring
1. The incentives of bank insiders, minority
shareholders, depositors, debtors, and
taxpayers are not aligned.
2. This means that parties in control of the
government can exploit those differences
in incentives for their own ends.
The Implication:
It’s the politics, stupid
The property rights institutions that underpins banking
systems are the product of political deals.
These deals are about the creation and distribution of
economic rents and the maintenance of political
power.
The deals determine which laws are passed, which judges
are appointed, who bears the risk in the event of loss,
and which groups of people have which licenses to
contract with whom, for what, and on what terms.
All deals are not created equal
Some political coalitions will generate deals that
produce a financial crisis.
Some political coalitions will produce a stable
banking system, but credit will be allocated
narrowly and growth will be constrained.
Some political coalitions will produce a stable
banking system, in which credit will be
allocated efficiently
The basic autocratic deal
A coalition can be formed between the parties in
control of the government and bank insiders
to create rents by limiting entry, compensating
the insiders for the risk of expropriation
through super-normal returns.
Minority shareholders are compensated for the
double-risk of expropriation by super-normal
returns.
The government’s incentives are aligned
through loans and corruption.
Everyone else is a source of rent.
Democracy changes the calculus,
but it is not a panacea
Debtors can vote, making it harder to block entry in
the long run.
The authority and discretion of the parties in control of
the government are more limited, meaning that
insiders and minority shareholders face lower
expropriation risk.
But, mass politics creates a special problem: unless
the owners of capital can exert influence beyond
their numbers, they are going to be subjected to
expropriation by debtors.
Their best move may be to pass the burden of
expropriation on to taxpayers.
In order to study these coalitions and
the deals they generate, we…
look at what actually happened
Our approach is to study the history of politics,
bank regulation, the structure of the banking
industry, and its performance over long time
spans for six cases:
Scotland, England, USA, Canada, Mexico, Brazil
A stable deal under autocracy:
Porfirian Mexico, 1876-1911
1.
2.
3.
4.
The political system: an autocracy that needed to create a
banking system for its own political survival.
The deal:
A. Regulated entry and segmented monopolies.
B. Special privileges for two banks.
C. Credit for the federal and state governments.
D. Rent sharing with politicians.
E. Tunneling and fraud mitigated by interlocking
directorates and high capital ratios.
The coalition: political elites, bank insiders, and minority
shareholders.
The outcome: A stable banking system, a source of public
finance, but credit distributed very narrowly.
Mexico’s Banking System
Grew
The Mexican Banking Industry, 1897-1913
35
Number of Banks
30
25
Assets as % GDP
20
15
10
Deposits as % Assets
5
-
97
18
98
18
99
18
00
19
01
19
02
19
19
03
04
19
05
19
19
06
07
19
19
08
Source: Anurio de Estadística Fiscal, 1912-13.
09
19
10
19
11
19
12
19
19
13
With a concentrated competitive structure
Structure of the Mexican Banking Industry
90%
80%
BLM
Banamex
70%
Market Shares
60%
50%
40%
30%
20%
10%
0%
1896 1899 1900 1901 1902 1903 1904 1905 1906 1907 1908 1909 1910 1911 1912
Bank Shareholders Earned Rents
Ratio of Market to Book Values (weighted average), Mexican Banks
2.50
2.00
1.50
1.00
0.50
0.00
1901
1902
1903
1904
1905
1906
1907
Source: Maurer and Haber 2007.
1908
1909
1910
1911
And mostly lent to themselves
Percent of non-government loans made to
banks’ own boards of directors:
Banamex 1886 to 1901
100%
Mercantil de Veracruz 1898-1906
86%
Coahuila, 1908
72%
Durango, 1908
51%
Mercantil de Monterrey, 1908
31%
Nuevo León, 1908
29%
Source: Maurer and Haber 2007.
Limits on bank entry created barriers
to entry in downstream industries
Four Firm Ratios in Textile Manufacturing
40%
35%
30%
25%
20%
15%
Mexico
10%
Mexico
Expected
Brazil
5%
USA
India
0%
1888
1891
1893
1895
1900
1904
1909
1912
1913
When Porfirian political institutions fell
apart, the banks were expropriated
Ratio of Bank Assets to GDP, Mexico, 1897-1929
35%
30%
25%
20%
15%
10%
5%
Haber, Razo, and Maurer 2003.
29
28
19
27
19
26
19
25
19
24
19
23
19
22
19
21
19
20
19
19
19
18
19
17
19
16
19
15
19
14
19
13
19
12
19
11
19
10
19
09
19
08
19
07
19
06
19
05
19
04
19
03
19
02
19
01
19
00
19
99
19
98
18
18
18
97
0%
The subsequent regime could not generate a coalition-so most credit had to come from state-owned banks
Bank Credit in Mexico, as Percent of GDP, 1940-1978
18%
Developmen
t Banks
16%
14%
12%
10%
Other Private
Banks
8%
6%
4%
Commercial
Banks
2%
Source: Del Angel 2002
78
19
76
19
74
19
72
19
70
19
68
19
66
19
64
19
62
19
60
19
58
19
56
19
54
19
52
19
50
19
48
19
46
19
44
19
42
19
19
40
0%
When deficits grew, the government
expropriated the banks
Deposits, Private Credit, and Reserve Ratios, Mexico, 1948-1982
60%
Reserve
Ratio
50%
40%
Deposits/GDP
30%
20%
Private
Credit/GD
10%
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
1971
1970
1969
1968
1967
1966
1965
1964
1963
1962
1961
1960
1959
1958
1957
1956
1955
1954
1953
1952
1951
1950
1949
1948
0%
When the banks were re-privatized the coalition
that was formed produced a banking crisis
Bank Claims on Private Sector, as Percent of GDP
40%
35%
30%
25%
20%
15%
10%
5%
0%
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
PRI leaders, bank insiders, and depositors jointly
expropriated minority shareholders and taxpayers
Non-Performing Loans, as Percent Total Lending
60%
50%
40%
30%
20%
10%
0%
1991
1992
Declared NPL
1993
Rediscounts
1994
Renewed and Restructured
1995
FOBAPROA
1996
The initial coalition in the U.S. was
between federalists, bank insiders, and
minority shareholders
1.
2.
3.
4.
At the state level, bank insiders received charters and
shared rents with state governments--who in turn
granted few charters.
These banks did not lend to all comers.
The Bank of the United States was: the government’s
bank, the largest commercial bank, and the only bank
allowed to branch across state lines.
In short, the U.S. banking system was made up of
segmented monopolies.
This coalition was not stable given
America’s political institutions
1.
2.
State-chartered bankers pressured their
Congressional delegations to not renew the
charters of the Banks of the United States.
State governments also had counter-incentives:
A. The need to finance public works
B. Political demands to expand access to banking
services
3.
State governments responded to these counterincentives:
A. Political demands could be channeled through
suffrage and party competition
B. Suffrage expanded because of competition between
states
An example: Pennsylvania’s Omnibus
Banking Act
Until 1814, Pennsylvania had only 4 banks, all
located in Philadelphia and owned by
Federalists--who only lent to Federalists.
The 1814 act (passed over the objections of the
state’s governor) ended the oligopoly, dividing
the state into 27 banking districts, and
allocated at least one bank to each district. In
all, it chartered 42 new banks.
But…reform meant creating monopolies in each
district! And they had to share rents with the
state government!
The basic history of US banking
1.
2.
3.
4.
Demands by debtors create smaller and
smaller monopolies through unit banking.
Unit bankers form a coalition with debtors and
parties in control of the government to block a
more competitive structure.
In short, the system of segmented monopolies
not broken down until the 1990s!
But even then, politics intervenes. It is possible
to get a coalition of bank insiders, minority
shareholders, and debtors expropriating
depositors and taxpayers.
Conclusions and Implications:
No banking systems outside of politics
1. There are systematic differences in banking systems
between authoritarian and democratic governments.
2. But parliamentary democracy, in and of itself, does not
necessarily produce efficient credit markets.
3. Banking is a fragile plant.