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The paper provides an overview and an economic analysis of the development of the corporate governance of German banks since the 1950s, highlighting peculiarities – as seen from the meanwhile prevailing standard model perspective – of the German case. These peculiarities refer to the specific German notion and legal-institutional regime of corporate governance in general as well as to the specific three-pillar structure of the German banking system.
The most striking changes in the corporate governance of German banks during the past 50 years occurred in the case of the large shareholder-owned banks. For them, capital markets have become an important element of corporate governance, and their former orientation towards the interests of a broadly defined set of stakeholders has largely been replaced by a one-sided concentration on shareholders’ interests. In contrast, the corporate governance regimes of the smaller local public savings banks and the local cooperative banks have remained virtually unchanged. They acknowledge a broader horizon of stakeholder interests and put an emphasis on monitoring.
The Great Financial Crisis, beginning in 2007, has led to a considerable reassessment in the academic and political debate on bank governance. On an international level, it has revived the older notion that, in view of their high leverage and their innate complexity, banks are “special” and bank corporate governance also – and needs to be seen in this light, not least because research indicates that banks with a strong and one-sided shareholder orientation – and thus with what appears to be the best corporate governance according to the standard model – have suffered most in the crisis. In the German case, the crisis has shown that the smaller local banks have survived the crisis much better than large private and public banks, whose funding strongly depends on wholesale markets. This may point to certain advantages of their governance and ownership regimes. But the differences in the performance during the crisis years may also, or even more so, be a consequence of the business models of large vs small banks than of their different governance regimes.
This study provides a graphic overview on core legislation in the area of economic and financial services. The presentation essentially covers the areas within the responsibility of the Economic and Monetary Affairs Committee (ECON); hence it starts with core ECON areas but also displays neighbouring areas of other Committees' competences which are closely connected to and impacting on ECON's work. It shows legislation in force, proposals and other relevant provisions on banking, securities markets and investment firms, market infrastructure, insurance and occupational pensions, payment services, consumer protection in financial services, the European System of Financial Supervision, European Monetary Union, euro bills and coins and statistics, competition, taxation, commerce and company law, accounting and auditing. Moreover, it notes selected provisions that might become relevant in the upcoming Article 50 TEU negotiations.
The German savings and cooperative banks of the 19th century were precursors of modern microfinance. They provided access to financial services for the majority of the German population, which was formerly excluded from bank funding. Furthermore, they did this at low costs for themselves and affordable prices for their clients. By creating networks of financially viable and stable financial institutions covering the entire country, they contributed significantly to building a sound and “inclusive” financial infrastructure in Germany. A look back at the history of German savings and cooperative banks and combining these experiences with the lessons learned from modern microfinance can guide current policy and be valuable for present and future models of microfinance business.
Effective market discipline incentivizes financial institutions to limit their risk-taking behavior, making it a key element for financial regulation. However, without adequate incentives to monitor and control the risk-taking behavior of financial institutions market discipline erodes. As a consequence, bailing out financial institutions, as happened unprecedentedly during the recent financial crisis, may impose indirect costs to financial stability if bailout expectations of investors change. Analyzing US data covering the period between 2004 and 2014, Hett und Schmidt (2017) find that market participants adjusted their bailout expectations in response to government interventions, undermining market discipline mechanisms. Given these findings, policymakers need to take into account the potential effects on market discipline when deciding about public support to troubled financial institutions in the future. Considering the parallelism of events and public responses during the financial crisis as well as the recent developments of Italian banks, these results not only concern the US, but also have important implications for European financial markets and policy makers.
On 15 August 2017, the Bundesverfassungsgericht (BVerfG) referred the case against the European Central Bank’s policy of Quantitative Easing (QE) to the European Court of Justice (ECJ). The author argues that this event differs in several aspects from the OMT case in 2015 – in content as well as in form. The BVerfG recognizes that it is a legitimate goal of the ECB’s monetary policy to bring inflation up close to 2%, and that the instrument employed for QE is one of monetary policy. However, it doubts whether the sheer volume of QE would not distort the character of the program as one of monetary policy. The ECJ will now have to clarify the extent to which the ECJ’s findings in its OMT judgment are relevant for QE as well as the standard of review applicable to monetary policy. The author raises the questions of whether the principle of democracy under German constitutional law can actually provide the standard by which the ECB is to be measured, and how tight judicial review could be exercised over the ECB without encroaching upon its autonomy in monetary policy matters – and thus upon the very essence of central bank independence.
Crowdfunding is a buzzword that signifies a sub-set in the new forms of finance facilitated by advances in information technology usually categorized as fintech. Concerns for financial stability, investor and consumer protection, or the prevention of money laundering or funding of terrorism hinge incrementally on including the new techniques to initiate financing relationships adequately in the regulatory framework.
This paper analyzes the German regulation of crowdinvesting and finds that it does not fully live up to the regulatory challenges posed by this novel form of digitized matching of supply and demand on capital markets. It should better reflect the key importance of crowdinvesting platforms, which may become critical providers of market infrastructure in the not too distant future. Moreover, platforms can play an important role in investor protection that cannot be performed by traditional disclosure regimes geared towards more seasoned issuers. Against this background, the creation of an exemption from the traditional prospectus regime seems to be a plausible policy choice. However, it needs to be complemented by an adequate regulatory stimulation of platforms’ role as gatekeepers.
Fleckenstein et al. (2014) document that nominal Treasuries trade at higher prices than inflation-swapped indexed bonds, which exactly replicate the nominal cash flows. We study whether this mispricing arises from liquidity premiums in inflation-indexed bonds (TIPS) and inflation swaps. Using US data, we show that the level of liquidity affects TIPS, whereas swap yields include a liquidity risk premium. We also allow for liquidity effects in nominal bonds. These results are based on a model with a systematic liquidity risk factor and asset-specific liquidity characteristics. We show that these liquidity (risk) premiums explain a substantial part of the TIPS underpricing.
Coming early to the party
(2017)
We examine the strategic behavior of High Frequency Traders (HFTs) during the pre-opening phase and the opening auction of the NYSE-Euronext Paris exchange. HFTs actively participate, and profitably extract information from the order flow. They also post "flash crash" orders, to gain time priority. They make profits on their last-second orders; however, so do others, suggesting that there is no speed advantage. HFTs lead price discovery, and neither harm nor improve liquidity. They "come early to the party", and enjoy it (make profits); however, they also help others enjoy the party (improve market quality) and do not have privileges (their speed advantage is not crucial).
The bail-in tool as implemented in the European bank resolution framework suffers from severe shortcomings. To some extent, the regulatory framework can remedy the impediments to the desirable incentive effect of private sector involvement (PSI) that emanate from a lack of predictability of outcomes, if it compels banks to issue a sufficiently sized minimum of high-quality, easy to bail-in (subordinated) liabilities. Yet, even the limited improvements any prescription of bail-in capital can offer for PSI’s operational effectiveness seem compromised in important respects.
The main problem, echoing the general concerns voiced against the European bail-in regime, is that the specifications for minimum requirements for own funds and eligible liabilities (MREL) are also highly detailed and discretionary and thus alleviate the predicament of investors in bail-in debt, at best, only insufficiently. Quite importantly, given the character of typical MREL instruments as non-runnable long-term debt, even if investors are able to gauge the relevant risk of PSI in a bank’s failure correctly at the time of purchase, subsequent adjustment of MREL-prescriptions by competent or resolution authorities potentially change the risk profile of the pertinent instruments. Therefore, original pricing decisions may prove inadequate and so may market discipline that follows from them.
The pending European legislation aims at an implementation of the already complex specifications of the Financial Stability Board (FSB) for Total Loss Absorbing Capacity (TLAC) by very detailed and case specific amendments to both the regulatory capital and the resolution regime with an exorbitant emphasis on proportionality and technical fine-tuning. What gets lost in this approach, however, is the key policy objective of enhanced market discipline through predictable PSI: it is hardly conceivable that the pricing of MREL-instruments reflects an accurate risk-assessment of investors because of the many discretionary choices a multitude of agencies are supposed to make and revisit in the administration of the new regime. To prove this conclusion, this chapter looks in more detail at the regulatory objectives of the BRRD’s prescriptions for MREL and their implementation in the prospectively amended European supervisory and resolution framework.