PowerPoint Presentation

Rethinking banking after the crisisProfessor Brian LuceyTrinity College Dublin November 2013Portoroz Business Conference November 2013Banking Crises are costlyIn Debt

In lost output

IMF preliminary estimates are of crisis cost > $12trPortoroz Business Conference November 2013But are relatively infrequent

Were we overdue? (Data from Laven systemic crises databasePortoroz Business Conference November 2013GFC was a worldwide phenomena

Portoroz Business Conference November 2013Main thesis of this talkGFC was a function of overly large and powerful banking sectorNeed to rein this inBut this will be costlyPortoroz Business Conference November 2013Good news : Long-term trend 1Portoroz Business Conference November 2013This is a GOOD THINGCompanies need consumers with sufficient income to purchase goodsConsumers need companies with sufficient profits to innovateBoth need modern, effective, banking systems to intermediate spatially and temporallyThe latter has broken down it needs fixingPortoroz Business Conference November 2013Slow steam aheadPortoroz Business Conference November 2013GDP PC Slovenia tradepartners

Portoroz Business Conference November 2013Euro crisis continuingEurope continues to be bedeviled by a combination of imbalancesPersonal financial indebtednessBanking weaknessGovernmental financial weaknessBalance of Payments issues

Portoroz Business Conference November 2013Personal financial indebtednessSignificant net wealthSignificant hidden strains on household budgetsEuro Household Finance survey useful database but major caveats on household size, role of homeownership, corporate etcBanks mispriced debt issuance to consumers

Portoroz Business Conference November 2013PSC growth was widespreadPortoroz Business Conference November 2013PSC Growth > GDP usuallyPortoroz Business Conference November 2013PS Debt as % GDPSince 2001 most countries have seen significant rises Median debt/GDP is 136%, rise 61%Portoroz Business Conference November 2013Low income = vulnerable43.7% 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 2013s for indicators of debt burden, the 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%. The debt-asset ratio and the debt service-income ratio suggest that low-income households may be 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.15Household Debt by countryPortoroz Business Conference November 2013Government weaknessBailouts were in one way or other the order of the dayA Doom Loop was createdBank Capital escaped relatively unscathed.

Portoroz Business Conference November 2013Balance of Payments issuesWe cannot export our way out of this crisisnot even Germany canPersistent imbalances are a problem. And they are not all on one side of the equationOverly large surplus => unwarranted deflationary biasOverly large deficit => unwarranted expansionary biasPortoroz Business Conference November 2013Trade balances improving

Portoroz Business Conference November 2013German 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 201320Germany needs to spendGerman Final Consumption slowest growing behind Netherlands and Greece..Portoroz Business Conference November 2013Germany needs to spend

Portoroz Business Conference November 2013Banks weaknesses Not delivering on SME FinanceSenior Debt overrelianceIncoherence at European level regarding funding modelPortoroz Business Conference November 2013SME 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 problemPortoroz Business Conference November 201324Discouragement/ 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 SMEsPortoroz Business Conference November 201325Policy IncoherenceBanks need to become more stable => deposit base needs to increaseBail in possibility reduces attractiveness of deposits Senior Debt remains a large part of fundingPortoroz Business Conference November 2013Senior Debt overreliance

Portoroz Business Conference November 2013Problem of Banking sectorGeneral 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 apaceBanking system is brokenPortoroz Business Conference November 2013Solving this ? Two elements on thisShrinking the size of the system and the size of the elements of the systemShifting emphasis from the broken banking model to a more sustainable approachPortoroz Business Conference November 2013Shrinking the systemBanks and the financial sector are As a whole too largeIndividually too big to fail and too big to bailEuropean fumbling has created a bank-sovereign doom loop that is as yet unbrokenBank governance and organization focused to much on shorttermDanger of more and more Minsky Moments

Portoroz Business Conference November 2013Moral Hazard Redux and reduxBanks fail in their ability to price riskCorporate Macroeconomic Systemic Banks get bailed out, some people goBut culture remains the same or worseStulz findingsPortoroz Business Conference November 2013StulzBanks that did poorly before do poorly againShareholder board alignment => taxpayers on hookAs per Eurozone SME DEMAND biggest issue

Portoroz Business Conference November 2013Towards sustainable finance Three things need to happenSupply side arguments alone dont work. Need for demand and supply stimulationBanking 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 2013Utility Banking.What would this look like?Banks small enough to failRemuneration and governance linked to long-term social and economic wellbeingPooled, prefunded deposit insuranceBank 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 diversificationPortoroz Business Conference November 2013

Bordo-Lane NBER 2010 : era of strong regulation = era of less crisesPortoroz Business Conference November 2013Unity Can we have in the future a monetary but not fiscal union?Political misalignment with common goodMyopic politicians and voters

Portoroz Business Conference November 2013