27/5/19: LSE Business Review: Capital Markets Union: An Assessment

Our article for the LSE Business Review blog on the research paper covering the European Capital Markets Union reforms is available here: https://blogs.lse.ac.uk/businessreview/2019/05/23/the-unfinished-business-of-the-eus-capital-markets-union/.

Link to the full paper here: https://trueeconomics.blogspot.com/2019/04/2419-capital-markets-union-action-plan.html. 

2/4/19: Capital Markets Union: An Action Plan of Unfinished Reforms

Our paper on the progress of the EU Capital Markets Union reforms is now available on SSRN:

Capital Markets Union: An Action Plan of Unfinished Reforms (March 21, 2019). with Tracy Lee Lyon, Alexandra Cohen, Margaret Poda and Matthew Salyer (Middlebury Institute of International Studies at Monterey (MIIS); GUE/NGL Group, European Parliament, Policy Analysis Paper, March 2019. Available at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3357380.

25/2/19: Europe's TBTF Banks are only Bigger-to-Fail...

Since the start of the Global Financial Crisis (GFC) and through subsequent Euro area crises, the EU frameworks for reforming financial services have invariably been anchored to the need for reducing the extent of systemic risks in European banking. While it is patently clear that Euro area's participation in the GFC has been based on the same meme of 'too big to fail' TBTF banks creating a toxic contagion channel from banks balance sheets to the real economy and the sovereigns, what has been less discussed in the context of the subsequent reforms is the degree of competition within European banking sector. So much so, that the Euro area statistical boffins even stopped reporting banking sector concentration indices for the entire Euro area (although they did continue reporting the same for individual member states).

Chart below plots weighted average Herfindahl Index for the EA12 original Euro area states, with each country nominal GDP being used as a weight.

The picture presents a dire state of the Euro area reforms aimed at derisking the bank channel within the Eurozone's capital markets:

• In terms of total assets, concentration of market power within the hands of larger TBFT banks has stayed virtually unchanged across the EA12 between 2009 and 2017. Herfindahl Index for total assets was 0.3249 in 2009 and it is was at 0.3239 in 2017. Statistically-speaking, there has been no meaningful changes in assets concentration in TBTF banks across the EA12 since 2003. 
• In terms of total credit issued within the EA12, Herfindahl Index shows a rather pronounced trend up. In 2010 (the first year for which consistent data is provided), Herfindahl Index for total credit shows 0.0602 reading, which rose to 0.0662 in 2017.

Put simply, TBTF banks are getting ever bigger. With them, the risks of contagion from the banking sector to the real economy and the sovereigns remain unabated, no matter how many 'green papers' on reforms the EU issues, and no matter how many systemic risk agencies Brussels creates.

15/4/16: Banking Union, Competition and Banking Sector Concentration

One of the key changes in recent years across the entire U.S. economy has been growth in market concentration (lower competition) and regulatory burden increases in a number of sector, including banking. A good summary of the matter is provided here: http://www.americanactionforum.org/research/market-concentration-grew-obama-administration/ .

However, an interesting chart based on the U.S. Fed data, shows that even with these changes U.S. banking sector remains relatively more competitive than in other advanced economies:

Source: @HPSInsight

Interestingly, European banks are also becoming more regional, as opposed to global, players as discussed here: http://www.nakedcapitalism.com/2016/03/the-us-is-beginning-to-dominate-global-investment-banking-implications-for-europe.html

Chart next shows market shares of the European Investment Banking markets accruing to banks originating in the following jurisdictions:

Source: @NakedCapitalism

As an argument goes: “Deutsche Bank and Barclays are the only Europeans left in the top seven for the EMEA market. But they are likely to lose their positions because Deutsche Bank is currently undergoing a major reorganisation and Barclays is in the process of executing the Vickers split. In the investment banking field, the only pan-European banks will all soon be American. This has the corollary, for good or bad, that European national and EU-level authorities, such as the European Commission, will have rather less direct control over them. A key part of the European financial system is slipping out of the grasp of the European authorities.”

Which begs two questions:

Does Europe need more regulation-induced consolidation in the sector, aiming to make TBTF European banking giants even bigger and even less diversified globally, as the European Banking Union and European Capital Markets Union, coupled with increasing push toward greater regulatory constraints on Fintech sector are likely to do?

Or does Europe need more disruptive and more agile, as well as risk-diversified, smaller banking systems and more open innovation culture in banking and financial services?


Note: you can see my analysis of the European Capital Markets Union here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2592918

23/4/15: Why is Investment Weak?

Despite all the QE and accommodative monetary policies, despite all the state funding directed toward new lending supports, and despite unorthodox measures aimed at inducing the banks to lend into the economy, the following took place in the advanced economies over the course of the Great Recession:
1) financing conditions globally have first tightened (during the Global Financial Crisis) and then eased, in majority of the advanced economies reaching the levels of stringency comparable to pr-crisis peak;
2) cost of borrowing fell on pre-crisis levels across all advanced economies with exception of a handful of countries; and
3) investment remains weak.

Want to see the problem illustrated?

Banerjee, Ryan and Kearns, Jonathan and Lombardi, Marco J., (Why) is Investment Weak? (March 2015, BIS Quarterly Review March 2015: http://ssrn.com/abstract=2580278) ask: What explains this apparent disconnect?

Per authors, "The evidence suggests that, historically, uncertainty about the future state of the economy and expected profits play a key role in driving investment, and financing conditions less so. As a result,
investment after the Great Recession appears to have been broadly in line with what could have been expected based on past relationships. A stronger recovery of investment would seem to depend on a reduction in economic uncertainty and expectations of stronger future growth."

As I argued in the paper on the European Capital Markets Union (CMU) proposal here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2592918 - you might think that lack of investment is because markets for credit supply are dysfunctional. But you can also think of the demand side: if there is no growth prospect ahead, why invest in new capacity? And taking the second view, the prescription for solving the problem is: growth. Which requires improved prospects for investors, entrepreneurs, SMEs and, above all else - households.

19/4/15: Three Strikes of the New Financial Regulation: Part 4 – CMU's Economics

My fourth instalment on the latest policy innovation in Finance in the EU, covering the shaky economics of the Capital Markets Union is available on LearnSignal blog: http://blog.learnsignal.com/?p=173#more-173.

19/4/15: Higher Firm Leverage = Lower Firm Employment (and Output)

In a recent briefing note on the Capital Markets Union (CMU) (here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2592918), I wrote that the core problem with private investment in the EU is not the lack of integrated or harmonised investment and debt markets, but the overhang of legacy (pre-crisis) debts.

Here is an interesting CEPR paper confirming the link between higher pre-crisis leverage of the firms and their greater propensity to cut back economic activity during the crisis. This one touches upon unemployment, but unemployment here is a proxy for production, which is, of course, a proxy for investment too.

Xavier Giroud, Holger M Mueller paper "Firm Leverage and Unemployment during the Great Recession" (CEPR  DP10539, April 2015, www.cepr.org/active/publications/discussion_papers/dp.php?dpno=10539) argues that "firms’ balance sheets were instrumental in the propagation of shocks during the Great Recession. Using establishment-level data, we show that firms that tightened their debt capacity in the run-up (“high-leverage firms”) exhibit a significantly larger decline in employment in response to household demand shocks than firms that freed up debt capacity (“low-leverage firms”). In fact, all of the job losses associated with falling house prices during the Great Recession are concentrated among establishments of high-leverage firms. At the county level, we find that counties with a larger fraction of establishments belonging to high-leverage firms exhibit a significantly larger decline in employment in response to household demand shocks."

In short, more debt/leverage was accumulated in the run up to the crisis, deeper were the supply cuts during the crisis. Again, nothing that existence of a 'genuine' capital markets union or pumping more credit supply (debt/leverage supply) into the system can correct.

10/4/15: Comments on the EU Comm Paper “Building a Capital Markets Union”

I have recently been asked to present my views on the European Capital Markets Union proposals from the European Commission to the Oireachtas Joint Committee on Finance, Public Expenditure and Reform. Here is the briefing paper to accompany my presentation:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2592918