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The paper analyses the relationship between deposit insurance, debt-holder monitoring, bank charter values, and risk taking for European banks. Utilising cross-sectional and time series variation in the existence of deposit insurance schemes in the EU, we find that the establishment of explicit deposit insurance significantly reduces the risk taking of banks. This finding stands in contrast to most of the previous empirical literature. It supports the hypothesis that in the absence of deposit insurance, European banking systems have been characterised by strong implicit insurance operating through the expectation of public intervention at times of distress. Hence the introduction of an explicit system may imply a de facto reduction in the scope of the safety net. This finding provides a new perspective on the effects of deposit insurance on risk taking. Unless the absence of any safety net is credible, the introduction of deposit insurance serves to explicitly limit the safety net and, hence, moral hazard. We also test further hypotheses regarding the interaction between deposit insurance and monitoring, charter values and "too-big-to-fail." We find that banks with lower charter values and more subordinated debt reduce risk taking more after the introduction of explicit deposit insurance, in support of the notion that charter values and subordinated debt may mitigate moral hazard. Finally, large banks (as measured in relation to the banking system as a whole) do not change their risk taking in response to the introduction of deposit insurance, which suggests that the introduction of explicit deposit insurance does not mitigate "too-big-to-fail" problems.
This paper uses the co-incidence of extreme shocks to banks’ risk to examine within country and across country contagion among large EU banks. Banks’ risk is measured by the first difference of weekly distances to default and abnormal returns. Using Monte Carlo simulations, the paper examines whether the observed frequency of large shocks experienced by two or more banks simultaneously is consistent with the assumption of a multivariate normal or a student t distribution. Further, the paper proposes a simple metric, which is used to identify contagion from one bank to another and identify “systemically important” banks in the EU.
Depending on the point of time and location, insurance companies are subject to different forms of solvency regulation. In modern regulation regimes, such as the future standard Solvency II in the EU, insurance pricing is liberalized and risk-based capital requirements will be introduced. In many economies in Asia and Latin America, on the other hand, supervisors require the prior approval of policy conditions and insurance premiums, but do not conduct risk-based capital regulation. This paper compares the outcome of insurance rate regulation and risk-based capital requirements by deriving stock insurers’ best responses. It turns out that binding price floors affect insurers’ optimal capital structures and induce them to choose higher safety levels. Risk-based capital requirements are a more efficient instrument of solvency regulation and allow for lower insurance premiums, but may come at the cost of investment efforts into adequate risk monitoring systems. The paper derives threshold values for regulator’s investments into risk-based capital regulation and provides starting points for designing a welfare-enhancing insurance regulation scheme.
We show that market discipline, defined as the extent to which firm specific risk characteristics are reflected in market prices, eroded during the recent financial crisis in 2008. We design a novel test of changes in market discipline based on the relation between firm specific risk characteristics and debt-to-equity hedge ratios. We find that market discipline already weakened after the rescue of Bear Stearns before disappearing almost entirely after the failure of Lehman Brothers. The effect is stronger for investment banks and large financial institutions, while there is no comparable effect for non-financial firms.
We introduce a new measure of systemic risk, the change in the conditional joint probability of default, which assesses the effects of the interdependence in the financial system on the general default risk of sovereign debtors. We apply our measure to examine the fragility of the European financial system during the ongoing sovereign debt crisis. Our analysis documents an increase in systemic risk contributions in the euro area during the post-Lehman global recession and especially after the beginning of the euro area sovereign debt crisis. We also find a considerable potential for cascade effects from small to large euro area sovereigns. When we investigate the effect of sovereign default on the European Union banking system, we find that bigger banks, banks with riskier activities, with poor asset quality, and funding and liquidity constraints tend to be more vulnerable to a sovereign default. Surprisingly, an increase in leverage does not seem to influence systemic vulnerability.
We present a thought-provoking study of two monetary models: the cash-in-advance and the Lagos and Wright (2005) models. We report that the different approach to modeling money — reduced-form vs. explicit role — neither induces theoretical nor quantitative differences in results. Given conformity of preferences, technologies and shocks, both models reduce to one difference equation. The equations do not coincide only if price distortions are differentially imposed across models. To illustrate, when cash prices are equally distorted in both models equally large welfare costs of inflation are obtained in each model. Our insight is that if results differ, then this is due to differential assumptions about the pricing mechanism that governs cash transactions, not the explicit microfoundation of money.
This paper summarizes the key proposals of the report by the Liikanen Commission. It starts with an explanation of a crisis narrative underlying the Report and its proposals. The proposals aim for a revitalization of market discipline in financial markets. The two main structural proposals of the Liikanen Report are: first, for large banks, the separation of the trading business from other parts of the banking business (the "Separation Proposal"), and the mandatory issuing of subordinated bank debt thought to be liable (the strict "Bail-in Proposal"). The credibility of this commitment to private liability is achieved by strict holding restrictions. The anticipated consequences of the introduction of these structural regulations for the financial industry and markets are addressed in a concluding part.
This note proposes a new set-up for the fund backing the Single Resolution Mechanism (SRM). The proposed fund is a Multi-Tier Resolution Fund (MTRF), restricting the joint and several supranational liability to a limited range of losses, bounded by national liability at the upper and the lower end. The layers are, in ascending order: a national fund (first losses), a European fund (second losses), the national budget (third losses), the ESM (fourth losses, as a backup for sovereigns). The system works like a reinsurance scheme, providing clear limits to European-level joint liability, and therefore confining moral hazard. At the same time, it allows for some degree of risk sharing, which is important for financial stability if shocks to the financial system are exogenous (e.g., of a supranational macroeconomic nature). The text has four parts. Section A describes the operation of the Multi-Tier Resolution Fund, assuming the fund capital to be fully paid-in (“Steady State“). Section B deals with the build-up phase of the fund capital (“Build up“). Section C discusses how the proposal deals with the apparent incentive conflicts. The final Section D summarizes open questions which need further thought (“Open Questions“).
Ausgehend von einer Erläuterung der Kriseninterpretation (crisis narrative), wie sie in dem Bericht der Liikanen-Kommission zugrunde liegt, werden die nach Ansicht des Verfassers zentralen Vorschläge des Kommissionsberichts ausgewählt, vorgestellt und in den größeren Rahmen einer erneuerten Ordnungspolitik für die Finanzmärkte Europas eingeordnet. Die mit den Vorschlägen eng zusammenhängenden Reformelemente der Bankenunion werden in diesem Text bewusst ausgeklammert. Die beiden zentralen Strukturvorschläge des Liikanen-Berichts betreffen die Abspaltung der Handelsgeschäfte von dem Universalbankengeschäft für große, internationale Banken (der Trennbankenvorschlag), sowie die verpflichtende Emission nachrangigen, glaubwürdig haftenden Fremdkapitals (der strenge Bail-in Vorschlag). Glaubwürdigkeit der Haftungszusage wird durch strenge Halterestriktionen erreicht. Vorhersehbare Folgerungen einer Einführung dieser Strukturregeln für die Finanzindustrie und -märkte werden in einem abschließenden Teil angesprochen.
In the aftermath of the financial crisis, the ECB has experienced an unprecedented deterioration in the level of trust. This raises the question as to what factors determine trust in central banking. We use a unique cross-country dataset which includes a rich set of socio-economic characteristics and supplement it with variables meant to reflect a country’s macroeconomic condition. We find that besides individual socio-economic characteristics, macroeconomic conditions play a crucial role in the trust-building process. Our results suggest that agents are boundedly rational in the trust-building process and that current ECB market operations may even be beneficial for trust in the ECB in the long-run.
The financial crisis which started in 2007 has caused a tremendous challenge for monetary policy. The simple concept of inflation targeting has lost its position as state of the art. There is a debate on whether the mandate of a central bank should not be widened. And, indeed, monetary policy has been very accommodative in the last couple of years and central banks have modified their communication strategies by introducing forward guidance as a new policy tool. This paper addresses the consequences of these developments for the credibility, the reputation and the independence of central banks. It also comments on the recent debate among economists concerning the question whether the ECB's OMT program is compatible with its mandate.
Monetary theorists have advanced an intriguing notion: we exchange money to make up for a lack of enforcement, when it is difficult to monitor and sanction opportunistic behaviors. We demonstrate that, in fact, monetary equilibrium cannot generally be sustained when monitoring and punishment limitations preclude enforcement — external or not. Simply put, monetary systems cannot operate independently of institutions — formal or informal — designed to monitor behaviors and sanction undesirable ones. This fundamental result is derived by integrating monetary theory with the theory of repeated games, studying monetary equilibrium as the outcome of a matching game with private monitoring.
We examine whether the robustifying nature of Taylor rule cross-checking under model uncertainty carries over to the case of parameter uncertainty. Adjusting monetary policy based on this kind of cross-checking can improve the outcome for the monetary authority. This, however, crucially depends on the relative welfare weight that is attached to the output gap and also the degree of monetary policy commitment. We find that Taylor rule cross-checking is on average able to improve losses when the monetary authority only moderately cares about output stabilization and when policy is set in a discretionary way.
This paper tests whether an increase in insured deposits causes banks to become more risky. We use variation introduced by the U.S. Emergency Economic Stabilization Act in October 2008, which increased the deposit insurance coverage from $100,000 to $250,000 per depositor and bank. For some banks, the amount of insured deposits increased significantly; for others, it was a minor change. Our analysis shows that the more affected banks increase their investments in risky commercial real estate loans and become more risky relative to unaffected banks following the change. This effect is most distinct for affected banks that are low capitalized.
The IMFS Interdisciplinary Study 2/2013 contains speeches of Michael Burda (Humboldt University ), Benoît Coeuré (European Central Bank), Stefan Gerlach (Bank of Ireland and former IMFS Professor), Patrick Honohan (Bank of Ireland), Sabine Lautenschläger (Deutsche Bundesbank), Athanasios Orphanides (MIT) and Helmut Siekmann as well as Volker Wieland.
Um den Teufelskreis sich wechselseitig verstärkender Banken- und Staatsschuldenkrisen zu durchbrechen, haben sich die europäischen Institutionen grundsätzlich dazu bekannt, eine Bankenunion zu schaffen. Der Dreh- und Angelpunkt der verfolgten Strategie liegt dabei darin, durch die Schaffung zentraler, d.h. supranationaler Auffangmechanismen die Ausfallrisiken von Banken und Staaten nachhaltig zu entkoppeln. Dabei ist zu beachten, dass gerade auch die einzelnen Elemente des institutionellen Reformpakets in ihrer Binnenstruktur so beschaffen sein müssen, dass vorhersehbare Ineffizienzen nicht dazu führen, dass Vorteile der Supranationalisierung aufgehoben oder gar in ihr Gegenteil verkehrt werden. Der vorliegende Beitrag diskutiert den Verordnungsentwurf der EU Kommission für einen Single Resolution Mechanism (SRM) vor dem Hintergrund dieser Forderung.
This policy letter provides an overview of the strengths, weaknesses, risks and opportunities of the upcoming comprehensive risk assessment, a euro area-wide evaluation of bank balance sheets and business models. If carried out properly, the 2014 comprehensive assessment will lead the euro area into a new era of banking supervision. Policy makers in euro area countries are now under severe pressure to define a credible backstop framework for banks. This framework, as the author argues, needs to be a broad, quasi-European system of mutually reinforcing backstops.
Außerhalb Griechenlands herrscht die Ansicht vor, dass eine höhere Wettbewerbsfähigkeit gleichbedeutend ist mit Preissenkungen für Güter und Dienstleistungen. Angesichts der begrenzten Bereitschaft in Griechenland, Reformen umzusetzen, fordern die Gläubiger drastische Lohnkürzungen, um die Produktivität zu erhöhen und die öffentlichen Ausgaben zu senken. Doch mit einer Kürzungsrunde nach der anderen lässt sich Wettbewerbsfähigkeit nicht erreichen. Umfangreiche flächendeckende Lohnkürzungen reduzieren vielmehr die erwartete Produktivität, da sie die besten Arbeitnehmer vertreiben, dem Rest Anreize zur Produktivität nehmen und neue gute Leute fernhalten.
In der vierten Veranstaltung der „Gesprächsreihe zu Strukturreformen im europäischen Bankensek-tor“ diskutierte Dr. Elke König, Präsidentin der Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), die Wiederherstellung privater Haftung und die zukünftige Rolle der Aufsicht, insbesondere im Hinblick auf die Vorschläge der Liikanen-Kommission.
König warnte, dass man systemische Risiken, die vor allem während der Finanzkrise zu Problemen geführt hätten, noch nicht im Griff habe. Sowohl die Bankenaufsicht als auch die Wissenschaft suche immer noch nach einer geeigneten Lösung dieses Problems. Systemische Risiken führen dazu, dass komplexe und stark vernetzte Institute von Staaten gestützt werden, wenn diese ins Straucheln gera-ten. In der Finanzkrise hatte dies zur Folge, dass Banken letztlich vom Steuerzahler gerettet wurden. Diesen Quasi-Insolvenzschutz systemrelevanter Institute müsse man aufheben, um Fehlanreize im Markt zu korrigieren, so König. Verantwortung und Haftung für unternehmerisches Handeln müssten wieder in einer Hand liegen, und zwar in der der Institute, seiner Eigner und Gläubiger.
König ist deshalb der Meinung, dass ein einheitlicher Abwicklungsmechanismus für Banken notwen-dig sei, der auch grenzüberschreitend wirke. Als einen wichtigen Bestandteil dieses Mechanismus nannte sie die Umsetzung eines breiten Bail-ins. Durch Bail-in werden Eigentümer und Gläubiger von Bankinstituten an einer Restrukturierung beteiligt. Eine Umwandlung von Fremdkapital in Eigenkapi-tal kann darüber hinaus dazu dienen, ein Brückeninstitut mit Kapital auszustatten.
Zur konkreten Ausgestaltung von Bail-in-Instrumenten gibt es unterschiedliche Ansätze: Die Liikanen-Kommission plädierte in ihrem Vorschlag für eine Schaffung konkreter Bail-in-Anleihen, vergleichbar mit den Contingent Convertible Bonds (CoCo-Bonds), die in der Schweiz bereits eingeführt wurden. Die BaFin setze dagegen, ähnlich wie die Europäische Kommission, auf einen möglichst breiten An-satz und habe sich gegen die Emission einer neuen Gattung vertraglicher Bail-in-Instrumente ausge-sprochen, sagte König. Die Höhe der bail-in-fähigen Instrumente sowie die Reihenfolge der Haftung müssten aber trotzdem für jedes Institut klar definiert sein.
König betonte, dass es wichtig sei, nun die institutsspezifischen Sanierungs- und Abwicklungspläne zu entwickeln. Die BaFin habe mit der Erstellung der Abwicklungspläne auch schon begonnen. Bail-in sei dabei nur ein Baustein in dem wesentlich umfangreicheren Instrumentenkasten der Sanierungs- und Abwicklungspläne.
In der anschließenden Diskussion sagte König, dass es eine Abwicklungsbehörde für Institute, die in Zukunft einer europäischen Aufsicht unterliegen, derzeit nur auf nationaler Ebene geben könne. An-dernfalls sei eine Änderung der europäischen Verträge notwendig, da die Mittel, die für eine Abwick-lung aufgewendet werden müssten, aus nationalen Haushalten kämen. Bei einer Abwicklungsbehör-de auf europäischer Ebene würden die Haushaltsbelastung und die Entscheidung über die Verwen-dung der Mittel auseinanderfallen.
Insurance guarantee schemes aim to protect policyholders from the costs of insurer insolvencies. However, guarantee schemes can also reduce insurers’ incentives to conduct appropriate risk management. We investigate stock insurers’ risk-shifting behavior for insurance guarantee schemes under the two different financing alternatives: a flat-rate premium assessment versus a risk-based premium assessment. We identify which guarantee scheme maximizes policyholders’ welfare, measured by their expected utility. We find that the risk-based insurance guarantee scheme can only mitigate the insurer’s risk-shifting behavior if a substantial premium loading is present. Furthermore, the risk-based guarantee scheme is superior for improving policyholders’ welfare compared to the flat-rate scheme when the mitigating effect occurs.
We outline a procedure for consistent estimation of marginal and joint default risk in the euro area financial system. We interpret the latter risk as the intrinsic financial system fragility and derive several systemic fragility indicators for euro area banks and sovereigns, based on CDS prices. Our analysis documents that although the fragility of the euro area banking system had started to deteriorate before Lehman Brothers' file for bankruptcy, investors did not expect the crisis to affect euro area sovereigns' solvency until September 2008. Since then, and especially after November 2009, joint sovereign default risk has outpaced the rise of systemic risk within the banking system.
Does austerity pay off?
(2014)
Policy makers often implement austerity measures when the sustainability of public finances is in doubt and, hence, sovereign yield spreads are high. Is austerity successful in bringing about a reduction in yield spreads? We employ a new panel data set which contains sovereign yield spreads for 31 emerging and advanced economies and estimate the effects of cuts of government consumption on yield spreads and economic activity. The conditions under which austerity takes place are crucial. During times of fiscal stress, spreads rise in response to the spending cuts, at least in the short-run. In contrast, austerity pays off, if conditions are more benign.
Robustness, validity, and significance of the ECB's asset quality review and stress test exercise
(2014)
As we are moving toward a eurozone banking union, the European Central Bank (ECB) is going to take over the regulatory oversight of 128 banks in November 2014. To that end, the ECB conducted a comprehensive assessment of these banks, which included an asset quality review (AQR) and a stress test. The fundamental question is how accurately will the financial condition of these banks have been assessed by the ECB when it commences its regulatory oversight? And, can the comprehensive assessment lead to a full repair of banks’ balance sheets so that the ECB takes over financially sound banks and is the necessary regulation in place to facilitate this? Overall, the evidence presented in this paper based on the design of the comprehensive assessment as well as own stress test exercises suggest that the ECB’s assessment might not comprehensively deal with the problems in the financial sector and risks may remain that will pose substantial threats to financial stability in the eurozone.
Die Anpassung der EU-Richtlinie über Märkte für Finanzinstrumente (MiFID II) und die Einführung einer begleitenden Verordnung (MiFIR) im Jahr 2014 werden erhebliche Auswirkungen auf die Finanzmärkte in Europa haben und zu einer grundlegenden Neuordnung der Finanzmarktstrukturen führen. Ausgehend von einer Diskussion der Zielerreichung der ursprünglichen Richtlinie (MiFID I) aus dem Jahr 2004 werden im vorliegenden Artikel die Zielsetzungen und Maßnahmen der Neuregelung beleuchtet. Wesentliche Elemente im Hinblick auf Marktstrukturen und den Wertpapierhandel sind die Einführung einer neuen Handelsplatzkategorie, des organisierten Handelssystems („Organised Trading Facility“; OTF), sowie die Ausweitung der bislang für Aktien geltenden Transparenzvorschriften auf weitere Finanzinstrumente. Zudem werden eine Handelsverpflichtung für Aktien und Derivate sowie eine Clearingpflicht für Derivate, die auf geregelten Märkten gehandelt werden, neu eingeführt. Schließlich werden der algorithmische Handel und der Hochfrequenzhandel auf europäischer Ebene reguliert, wobei die Regelungen weitgehend dem 2013 eingeführten deutschen Hochfrequenzhandelsgesetz angelehnt sind. Im Ausblick wird zunächst der weitere Prozess der Regulierung skizziert (insbesondere die sog. Level II-Maßnahmen). Abschließend werden mögliche Auswirkungen von MiFID II und MiFIR auf die Marktstruktur und den Wertpapierhandel aufgezeigt.
n a contribution prepared for the Athens Symposium on “Banking Union, Monetary Policy and Economic Growth”, Otmar Issing describes forward guidance by central banks as the culmination of the idea of guiding expectations by pure communication. In practice, he argues, forward guidance has proved a misguided idea. What is presented as state of the art monetary policy is an example of pretence of knowledge. Forward guidance tries to give the impression of a kind of rule-based monetary policy. De facto, however, it is an overambitious discretionary approach which, to be successful, would need much more (or rather better) information than is currently available. In Issing's view, communication must be clear and honest about the limits of monetary policy in a world of uncertainty.
In the wake of the Global Financial Crisis that started in 2007, policymakers were forced to respond quickly and forcefully to a recession caused not by short-term factors, but rather by an over-accumulation of debt by sovereigns, banks, and households: a so-called “balance sheet recession.” Though the nature of the crisis was understood relatively early on, policy prescriptions for how to deal with its consequences have continued to diverge. This paper gives a short overview of the prescriptions, the remaining challenges and key lessons for monetary policy.
This paper studies the life cycle consumption-investment-insurance problem of a family. The wage earner faces the risk of a health shock that significantly increases his probability of dying. The family can buy term life insurance with realistic features. In particular, the available contracts are long term so that decisions are sticky and can only be revised at significant costs. Furthermore, a revision is only possible as long as the insured person is healthy. A second important and realistic feature of our model is that the labor income of
the wage earner is unspanned. We document that the combination of unspanned labor income and the stickiness of insurance decisions reduces the insurance demand significantly. This is because an income shock induces the need to reduce the insurance coverage, since premia become less affordable. Since such a reduction is costly and families anticipate these potential costs, they buy less protection at all ages. In particular, young families stay away from life insurance markets altogether.
In this paper, we propose a novel approach on how to estimate systemic risk and identify its key determinants. For all US financial companies with publicly traded equity options, we extract their option-implied value-at-risks (VaRs) and measure the spillover effects between individual company VaRs and the option-implied VaR of an US financial index. First, we study the spillover effect of increasing company risks on the financial sector. Second, we analyze which companies are most affected if the tail risk of the financial sector increases. We find that key accounting and market valuation metrics such as size, leverage, balance sheet composition, market-to-book ratio and earnings have a significant influence on the systemic risk profile of a financial institution. In contrast to earlier studies, the employed panel vector autoregression (PVAR) estimator allows for a causal interpretation of the results.
This paper makes a conceptual contribution to the effect of monetary policy on financial stability. We develop a microfounded network model with endogenous network formation to analyze the impact of central banks' monetary policy interventions on systemic risk. Banks choose their portfolio, including their borrowing and lending decisions on the interbank market, to maximize profit subject to regulatory constraints in an asset-liability framework. Systemic risk arises in the form of multiple bank defaults driven by common shock exposure on asset markets, direct contagion via the interbank market, and firesale spirals. The central bank injects or withdraws liquidity on the interbank markets to achieve its desired interest rate target. A tension arises between the beneficial effects of stabilized interest rates and increased loan volume and the detrimental effects of higher risk taking incentives. We find that central bank supply of liquidity quite generally increases systemic risk.
This paper makes a conceptual contribution to the effect of monetary policy on financial stability. We develop a microfounded network model with endogenous network formation to analyze the impact of central banks' monetary policy interventions on systemic risk. Banks choose their portfolio, including their borrowing and lending decisions on the interbank market, to maximize profit subject to regulatory constraints in an asset-liability framework. Systemic risk arises in the form of multiple bank defaults driven by common shock exposure on asset markets, direct contagion via the interbank market, and firesale spirals. The central bank injects or withdraws liquidity on the interbank markets to achieve its desired interest rate target. A tension arises between the beneficial effects of stabilized interest rates and increased loan volume and the detrimental effects of higher risk taking incentives. We find that central bank supply of liquidity quite generally increases systemic risk.
We explore the sources of household balance sheet adjustment following the collapse of the housing market in 2006. First, we use microdata from the Federal Reserve Board’s Senior Loan Officer Opinion Survey to document that banks cumulatively tightened consumer lending standards more in counties that experienced a house price boom in the mid-2000s than in non-boom counties. We then use the idea that renters, unlike homeowners, did not experience an adverse wealth shock when the housing market collapsed to examine the relative importance of two explanations for the observed deleveraging and the sluggish pickup in consumption after 2008. First, households may have optimally adjusted to lower wealth by reducing their demand for debt and implicitly, their demand for consumption. Alternatively, banks may have been more reluctant to lend in areas with pronounced real estate declines. Our evidence is consistent with the second explanation. Renters with low risk scores, compared to homeowners in the same markets, reduced their levels of nonmortgage debt and credit card debt more in counties where house prices fell more. The contrast suggests that the observed reductions in aggregate borrowing were more driven by cutbacks in the provision of credit than by a demand-based response to lower housing wealth.
After the Global Financial Crisis a controversial rush to fiscal austerity followed in many countries. Yet research on the effects of austerity on macroeconomic aggregates was and still is unsettled, mired by the difficulty of identifying multipliers from observational data. This paper reconciles seemingly disparate estimates of multipliers within a unified and state-contingent framework. We achieve identification of causal effects with new propensity-score based methods for time series data. Using this novel approach, we show that austerity is always a drag on growth, and especially so in depressed economies: a one percent of GDP fiscal consolidation translates into 4 percent lower real GDP after five years when implemented in the slump rather than the boom. We illustrate our findings with a counterfactual evaluation of the impact of the U.K. government’s shift to austerity policies in 2010 on subsequent growth.
In this paper, we investigate how the introduction of complex, model-based capital regulation affected credit risk of financial institutions. Model-based regulation was meant to enhance the stability of the financial sector by making capital charges more sensitive to risk. Exploiting the staggered introduction of the model-based approach in Germany and the richness of our loan-level data set, we show that (1) internal risk estimates employed for regulatory purposes systematically underpredict actual default rates by 0.5 to 1 percentage points; (2) both default rates and loss rates are higher for loans that were originated under the model-based approach, while corresponding risk-weights are significantly lower; and (3) interest rates are higher for loans originated under the model-based approach, suggesting that banks were aware of the higher risk associated with these loans and priced them accordingly. Further, we document that large banks benefited from the reform as they experienced a reduction in capital charges and consequently expanded their lending at the expense of smaller banks that did not introduce the model-based approach. Counter to the stated objectives, the introduction of complex regulation adversely affected the credit risk of financial institutions. Overall, our results highlight the pitfalls of complex regulation and suggest that simpler rules may increase the efficacy of financial regulation.
This paper contrasts the recent European initiatives on regulating corporate groups with alternative approaches to the phenomenon. In doing so it pays particular regard to the German codified law on corporate groups as the polar opposite to the piecemeal approach favored by E.U. legislation.
It finds that the European Commission’s proposal to submit (significant) related party transactions to enhanced transparency, outside fairness review, and ex ante shareholder approval is both flawed in its design and based on contestable assumptions on informed voting of institutional investors. In particular, the contemplated exemption for transactions with wholly owned subsidiaries allows controlling shareholders to circumvent the rule extensively. Moreover, vesting voting rights with (institutional) investors will not lead to the informed assessment that is hoped for, because these investors will rationally abstain from active monitoring and rely on proxy advisory firms instead whose competency to analyze non-routine significant related party transactions is questionable.
The paper further delineates that the proposed recognition of an overriding interest of the group requires strong counterbalances to adequately protect minority shareholders and creditors. Hence, if the Commission choses to go down this route it might end up with a comprehensive regulation that is akin to the unpopular Ninth Company Law Directive in spirit, though not in content. The latter prediction is corroborated by the pertinent parts of the proposal for a European Model Company Act.
In this paper, we study the effect of proportional transaction costs on consumption-portfolio decisions and asset prices in a dynamic general equilibrium economy with a financial market that has a single-period bond and two risky stocks, one of which incurs the transaction cost. Our model has multiple investors with stochastic labor income, heterogeneous beliefs, and heterogeneous Epstein-Zin-Weil utility functions. The transaction cost gives rise to endogenous variations in liquidity. We show how equilibrium in this incomplete-markets economy can be characterized and solved for in a recursive fashion. We have three main findings. One, costs for trading a stock lead to a substantial reduction in the trading volume of that stock, but have only a small effect on the trading volume of the other stock and the bond. Two, even in the presence of stochastic labor income and heterogeneous beliefs, transaction costs have only a small effect on the consumption decisions of investors, and hence, on equity risk premia and the liquidity premium. Three, the effects of transaction costs on quantities such as the liquidity premium are overestimated in partial equilibrium relative to general equilibrium.
Der vorliegende Artikel analysiert systematisch die Erreichung der MiFID-Ziele anhand der wissenschaftlichen Literatur. Ziel der MiFID ist es, die Rahmenbedingungen für einen effizienten und kostengünstigen Wertpapierhandel zu schaffen. Erreicht werden soll dies durch die Verschärfung des Wettbewerbs, die Integration der Märkte, die Offenlegung von Handelsintentionen und -geschäften sowie die Stärkung der rechtlichen Position der Investoren. Im Ergebnis zeigt sich, dass die Förderung des Wettbewerbes als erfolgreich bewertet wird, aber die regulatorischen Möglichkeiten der Marktintegration nicht ausgeschöpft werden. Ferner wird die Forderung nach einheitlichen Transparenzbestimmungen für alle Ordermechanismen nur teilweise umgesetzt. Der Anleger erfährt letztlich gegenüber Finanzintermediären durch die MiFID keinen höheren Schutz.
This essay reviews a cornerstone of the European Banking Union project, the resolution of systemically important banks. The focus is on the inherent conflict between a possible intervention by resolution authorities, conditional on a crisis situation, and effective prevention prior to a crisis. Moreover, the paper discusses the rules for bail-in debt and conversion rules for different layers of debt. Finally, some organizational requirements to achieve effective resolution results will be analyzed.
On November 8, 2013, several members of the British House of Lords’ Subcommittee A conducted a hearing at the ECB in Frankfurt, Germany, on “Genuine Economic and Monetary Union and its Implications for the UK”. Professors Otmar Issing and Jan Pieter Krahnen were called as expert witnesses.
The testimony began with a general discussion on the elements considered necessary for a functioning internal market. Do economic union and monetary union require a fiscal union or even a political union, beyond the elements of the banking union currently being prepared? In this context, also the critique of the German current account surplus and the international expectations that Germany stimulate internal demand to support growth in crisis countries, were discussed.
With regard to the monetary union, the members of the subcommittee asked for an assessment of how European nations and the banking industry would have fared in the banking crisis that followed the Lehman collapse, had there not been a common currency. Given the important role that the ECB has played in the course of the crisis management, the members further asked for an evaluation of the OMT-program of the ECB and also if the monetary union is in need of common debt instruments, in order to provide the ECB with the possibility of buying EU liabilities, comparable to the Fed buying US Treasury bonds. Finally, the dual role of the ECB for monetary policy and banking supervision was an issue touched on by several questions.
Austerity
(2014)
We shed light on the function, properties and optimal size of austerity using the standard sovereign model augmented to include incomplete information about credit risk. Austerity is defined as the shortfall of consumption from the level desired by a country and supported by its repayment capacity. We find that austerity serves as a tool for securing a more favorable loan package; that it is associated with over-investment even when investment does not create collateral; and that low risk borrowers may favor more to less severe austerity. These findings imply that the amount of fresh funds obtained by a sovereign is not a reliable measure of austerity suffered; and that austerity may actually be associated with higher growth. Our analysis accommodates costly signalling for gaining credibility and also assigns a novel role to spending multipliers in the determination of optimal austerity.
This paper provides a systematic analysis of individual attitudes towards ambiguity, based on laboratory experiments. The design of the analysis allows to capture individual behavior across various levels of ambiguity, ranging from low to high. Attitudes towards risk and attitudes towards ambiguity are disentangled, providing pure measures of ambiguity aversion. Ambiguity aversion is captured in several ways, i.e. as a discount factor net of a risk premium, and as an estimated parameter in a generalized utility function. We find that ambiguity aversion varies across individuals, and with the level of ambiguity, being most prominent for intermediate levels. Around one third of subjects show no aversion, one third show maximum aversion, and one third show intermediate levels of ambiguity aversion, while there is almost no ambiguity seeking. While most theoretical work on ambiguity builds on maxmin expected utility, our results provide evidence that MEU does not adequately capture individual attitudes towards ambiguity for the majority of individuals. Instead, our results support models that allow for intermediate levels of ambiguity aversion. Moreover, we find risk aversion to be statistically unrelated to ambiguity aversion on average. Taken together, the results support the view that ambiguity is an important and distinct argument in decision making under uncertainty.
Europe's debt crisis casts doubt on the effectiveness of fiscal austerity in highly-integrated economies. Closed-economy models overestimate its effectiveness, because they underestimate tax-base elasticities and ignore cross-country tax externalities. In contrast, we study tax responses to debt shocks in a two-country model with endogenous utilization that captures those externalities and matches the capital-tax-base elasticity. Quantitative results show that unilateral capital tax hikes cannot restore fiscal solvency in Europe, and have large negative (positive) effects at "home" ("abroad"). Restoring solvency via either Nash competition or Cooperation reduces (increases) capital (labor) taxes significantly, and leaves countries with larger debt shocks preferring autarky.
In this paper we investigate the implications of providing loan officers with a compensation structure that rewards loan volume and penalizes poor performance versus a fixed wage unrelated to performance. We study detailed transaction information for more than 45,000 loans issued by 240 loan officers of a large commercial bank in Europe. We examine the three main activities that loan officers perform: monitoring, originating, and screening. We find that when the performance of their portfolio deteriorates, loan officers increase their effort to monitor existing borrowers, reduce loan origination, and approve a higher fraction of loan applications. These loans, however, are of above-average quality. Consistent with the theoretical literature on multitasking in incomplete contracts, we show that loan officers neglect activities that are not directly rewarded under the contract, but are in the interest of the bank. In addition, while the response by loan officers constitutes a rational response to a time allocation problem, their reaction to incentives appears myopic in other dimensions.
Die Stellungnahme befasst sich mit einem wichtigen Aspekt der Offenlegung der Bezüge von Entscheidungsträgern im Bankensektor. Komplementär zu der Diskussion um die Veröffentlichung der Vergütung von Vorstandsmitgliedern börsennotierter Unternehmen ist auch auf Landeseben versucht worden, die Transparenz der Vergütung von Führungskräften kommunaler oder landeseigener Unternehmen zu erhöhen. Namentlich sind die Träger der Sparkassen durch den neuen § 19 Abs. 6 des Sparkassengesetzes von Nordrhein-Westfalen verpflichtet worden, darauf „hinzuwirken“, dass die „gewährten Bezüge jedes einzelnen Mitglieds des Vorstands, des Verwaltungsrates und ähnlicher Gremien unter Namensnennung“ veröffentlich werden. Diese Vorschrift ist jedoch weitgehend wirkungslos geblieben; nicht zuletzt weil das OLG Köln in einer einstweiligen Verfügung die Vorschrift mangels Gesetzgebungskompetenz des Landes als nichtig behandelt hat. In dieser Situation ist am 8. August 2013 der Vorschlag eines Gesetzes „zur Offenlegung der Bezüge von Sparkassenführungskräften im Internet“ durch die Fraktion der Piraten im Landtag Nordrhein-Westfalen eingebracht worden. Der Entwurf ist Gegenstand der Stellungnahme, die Helmut Siekmann für den Haushalts- und Finanzausschuss des Landtags Nordrhein-Westfalen erstellt hat. Sie stellt maßgebend darauf ab, dass die Sparkassen als Anstalten des öffentlichen Rechts einen öffentlichen Auftrag zu erfüllen haben und den Grundsätzen des Verwaltungsorganisationsrechts unterliegen. Als Teil der (leistenden) Verwaltung müssen sie Transparenz- und Kontrollansprüchen der Bürger und ihren Repräsentanten in den Parlamenten genügen.
I analyze a critical illness insurance in a consumption-investment model over the life cycle. I solve a model with stochastic mortality risk and health shock risk numerically. These shocks are interpreted as critical illness and can negatively affect the expected remaining lifetime, the health expenses, and the income. In order to hedge the health expense effect of a shock, the agent has the possibility to contract a critical illness insurance. My results highlight that the critical illness insurance is strongly desired by the agents. With an insurance profit of 20%, nearly all agents contract the insurance in the working stage of the life cycle and more than 50% of the agents contract the insurance during retirement. With an insurance profit of 200%, still nearly all working agents contract the insurance, whereas there is little demand in the retirement stage.
I numerically solve realistically calibrated life cycle consumption-investment problems in continuous time featuring stochastic mortality risk driven by jumps, unspanned labor income as well as short-sale and liquidity constraints and a simple insurance. I compare models with deterministic and stochastic hazard rate of death to a model without mortality risk. Mortality risk has only minor effects on the optimal controls early in the life cycle but it becomes crucial in later years. A diffusive component in the hazard rate of death has no significant impact, whereas a jump component is desired by the agent and influences optimal controls and wealth evolution. The insurance is used to ensure optimal bequest such that there is no accidental bequest. In the absence of the insurance, the biggest part of bequest is accidental.
Banks' financial distress, lending supply and consumption expenditure : [version december 2013]
(2014)
The paper employs a unique identification strategy that links survey data on household consumption expenditure to bank level data in order to estimate the effects of bank financial distress on consumer credit and consumption expenditures. Specifically, we show that households whose banks were more exposed to funding shocks report significantly lower levels of non-mortgage liabilities compared to a matched sample of households. The reduced access to credit, however, does not result in lower levels of consumption. Instead, we show that households compensate by drawing down liquid assets. Only households without the ability to draw on liquid assets reduce consumption. The results are consistent with consumption smoothing in the face of a temporary adverse lending supply shock. The results contrast with recent evidence on the real effects of finance on firms' investment, where even temporary adverse credit supply shocks are associated with significant real effects.
This is a chapter for a forthcoming volume Oxford Handbook of Financial Regulation (Oxford University Press 2014) (eds. Eilís Ferran, Niamh Moloney, and Jennifer Payne). It provides an overview of EU financial regulation from the first banking directive up until its most recent developments in the aftermath of the financial crisis, focusing on the multiple layers of multi-level governance and their characteristic conceptual difficulties. Therefore the paper discusses the need to accommodate cross-border capital flows following from the EU internal market and the resulting regulatory strategies. This includes a brief overview of the principle of home country control and the ensuing Financial Services Action Plan. Dealing with the accommodation of cross-border capital flows and their regulation necessarily require an orchestration of the underlying supervisory structures, which is therefore also discussed. In the aftermath of the financial crisis of 2007-09 an additional aspect of necessary orchestration has emerged, that is the need to control systemic risk. Specific attention is paid to microprudential supervision by the newly established European Supervisory Authorities and macroprudential supervision in the European Banking Union, the latter’s underlying drivers and the accompanying Single Supervisory Mechanism, including the SSM’s institutional framework as well as the consideration of its rationales and the Single Resolution Mechanism closely linked to it.
The implications of delegating fiscal decision making power to sub-national governments has become an area of significant interest over the past two decades, in the expectation that these reforms will lead to better and more efficient provision of public goods and services. The move towards decentralization has, however, not been homogeneously implemented on the revenue and expenditure side: decentralization has materialized more substantially on the latter than on the former, creating "vertical fiscal imbalances". These imbalances measure the extent to which sub-national governments’ expenditures are financed through their own revenues. This mismatch between own revenues and expenditures may have negative consequences for public finances performance, for example by softening the budget constraint of sub-national governments. Using a large sample of countries covering a long time period from the IMF’s Government Finance Statistics Yearbook, this paper is the first to examine the effects of vertical fiscal imbalances on fiscal performance through the accumulation of government debt. Our findings suggest that vertical fiscal imbalances are indeed relevant in explaining government debt accumulation, and call for a degree of caution when promoting fiscal decentralization.
We investigate the relationship between anchoring and the emergence of bubbles in experimental asset markets. We show that setting a visual anchor at the fundamental value (FV) in the first period only is sufficient to eliminate or to significantly reduce bubbles in laboratory asset markets. If no FV-anchor is set, bubble-crash patterns emerge. Our results indicate that bubbles in laboratory environments are primarily sparked in the first period. If prices are initiated around the FV, they stay close to the FV over the entire trading horizon. Our insights can be related to initial public offerings and the interaction between prices set on pre-opening markets and subsequent intra-day price dynamics.