Finance: Research, Policy and Anecdotes

What a nice quiet week the Easter week was!  No action in the House of Commons, only few if any new crazy Brexit proposals. And at least here in London, attention has been drawn to the real future problems of our planet! Just before the Brexit craziness starts again tomorrow and the campaign for the European Parliamentary Elections will turn ugly, a few notes on the longer-term perspectives on Brexit.


First, Northern Ireland: the murder of journalist Lyra McKee has shown yet again the fragility of the peace process in Northern Ireland. While no one would accuse Brexiters of any direct responsibility, the uncertainty on the future of the border in Northern Ireland caused by Brexit plays directly into the hands of extremists! It is sad to see that 21 years after the Good Friday Agreement peace cannot be taken as granted anymore! And it reminds us what damage nationalism can do in Europe!


Second, the future of banking in London. My colleagues Barbara Casu and Angela Gallo found in a recent report that London continues to have competitive advantages as financial centre, even as banks shift some staff and activities to the continent. Different corporate forms are discussed to continue providing financial services into the EU after Brexit, but the bigger picture prediction is certainly that in the near future, London will not lose its status as global financial centre. This is also consistent with recent research by Sascha Steffen and co-authors that the reduction in syndicated lending after Brexit is mostly due to reduced lending to domestic firms and by domestic banks.


This brings me to the broader point of the future economic structure of UK after Brexit.  I really enjoyed this insightful piece by Martin Sandbu on Brexit and the Future of UK Capitalism. One of the main messages is that “both in high‐value manufacturing and services, the best performers are successful precisely because their activities pool resources from all of Europe and sell to all of Europe. They are not good British jobs as much as good European jobs located in Britain.” I think this last sentence really drives home the point how the four freedoms hang together and are hard to disentangle even on the economic level.  The harder Brexit, the more likely are these jobs to disappear. However, a Brexit from the Single Market will hit manufacturing more than services (which are already oriented more toward non-Europe), so that “a hard Brexit will not only ensure the most loss of growth in aggregate, but stands to exacerbate the polarising characteristics of the UK's existing economic model and harshen the social tensions to which it has given rise.” Scary thoughts!


On a final note, and before we all get drawn back into the daily Brexit chaos, I really enjoyed this film about the Barnier team – it shows a human side to the negotiating team. And without rubbing it too much to the British side, it makes clear that the EU team went about the negotiations in a systematic and rational way.


Now, let me get the popcorn and get ready for tomorrow’s first episode of the new season of Brexit – the soap opera.

I am escaping the Brexit craziness for a few days.  First, for the April version of the Economic Policy Panel in Tallinn. As always, exciting set of papers, including one on the European Deposit Insurance, showing that such a scheme does not necessarily lead to cross-subsidisation as often feared in Germany.   We also have a special issue coming on the economics of automation and jobs, with exciting papers, discussing if and under which circumstances labour-saving technology can boost employment; how technology has changed the composition of labour demand toward more skilled, older and male employees; how competition from China pushes investment into automation; and how technology drives the falling labour share of income. We will also have a public session together with the Bank of Estonia on automation, with short presentations and a panel discussion later today.  More to come…

I am just coming back from Mumbai from an exciting conference on financial intermediation in emerging markets, jointly organised with Franklin Allen, Manju Puri and Co-Pierre Georg and co-sponsored by the Brevan Howard Centre at Imperial College and CAFRAL at the Reserve Bank of India.  This was the third in a series of BRICS conferences, which started with a conference in Rio de Janeiro in 2015, followed by a conference in Cape Town in 2016.  We hope for a repeat event in China, Russia or another major emerging market in the next few years.


India is certainly an appropriate place to host such a conference, given the rich and varied history of financial sector policies the country has gone through. As deputy governor N.S. Vishwanathan discussed in his policy keynote, there was an ongoing learning process, which resulted in policy experimentation over the decades and which has also been used as identification strategy  by researchers in research papers, such as myself in this paper (currently under revision). And there is now also exciting research work going on in CAFRAL in banking and finance.  


Tarun Ramadorai gave a keynote address on household finance in emerging markets and presented fascinating statistics based on detailed household surveys across different emerging markets on households’ balance sheets.  The most striking findings were that households hold much more real estate assets (rather than financial assets) in emerging markets than in advanced countries, while at the same time they have less secured (mortgage) debt. Estimates also show that shifting from such a rather inefficient balance sheet to more financialisation could bring quite a boost in income growth. Not surprisingly, Tarun’s finding match with my own work on financial sector structure in develolping countries (limited mortgage loans, focus on short-term lending) and to work showing that more efficient financial markets have an important growth benefit for developing and emerging markets. An interesting challenge that arises out of this work is for researcher to focus more on middle classes (20th to 80th percentiles of income distribution, in statistical terms) and a fuller set of financial services than we often do when focusing on the bottom of the pyramid. 


There was an exciting set of papers covering countries as diverse as Bolivia, China, Greece and Rwanda.  In the following I will only point to a few that looked especially interesting to me.


Mrinal Mishra and co-authors use the Bolivian credit registry to test the impact of the entry of new arms-length consumer lenders on credit access by costumers of relationship-focused microfinance institutions (MFIs).  They find that loans disbursed by new entrants to borrowers who switch from incumbents turn out to be riskier driven primarily by adverse selection. The incumbent MFIs, in turn, react with an “arms race”, offering better loan terms to these customers, ultimately resulting in overindebtedness.


Ioannis Spyridopoulos and co-author identify strategic default by mortgage borrowers in Greece, using  the introduction of a foreclosure moratorium and a new personal bankruptcy process in 2010 as identification strategy.  Specifically, borrowers that took advantage of the foreclosure moratorium but did not declare personal bankruptcy (which would have implied giving up other assets) are identified as strategic defaulters. Ioannis shows that 28% of all defaulters were strategic, contributing three percentage points to the NPL stock in Greek banks.  Strategic defaulters are more likely to be self-employed, to have higher educational levels and to work in finance or law.  What these findings show is that loan modification programmes – often an important component of crisis resolution strategies - have to be better targeted.


My former PhD student Andre Silva and co-authors examine the impact of a large-scale microcredit expansion program in Rwanda. Not surprisingly, a higher share of previously unbanked people gain access to credit. The more interesting part is that a large share of first-time borrowers subsequently switch from these microfinance institutions to commercial banks, which cream-skim low-risk borrowers and grant them larger, cheaper, and longer-term loans.  Powerful evidence how a credit registry including information on loans from all financial institutions can allow borrower to climb up the ladder of financial institutions.


Finally, Tianyue Ruan sheds light on entrusted loans in China, inter-firm loans arranged by banks. She finds that such loans are more prevalent and more profitable in cities with a tighter supply of bank loans than in other cities (due to a loan-deposit ratio cap introduced by regulators).  And it is banks with excess cash that function as lenders, suggesting that this type of lending might pose fewer financial stability risks (than if these firms raised money to on-lend).


What these four papers (and others in the conference) have in common is that they use unique data – either credit registry data, loan-level data from a specific bank or hand-collected data. This is clearly the future of research in finance and development – micro-data on transactions or survey-based. I am very much looking forward to the next edition of this conference… stay tuned….

What a week! The week when Theresa May declared that no deal is better than a bad deal, just not on 29 March 2019, allowed her party members to vote in favour of taking no deal off the table for 29 March, but then changed course and told them that no deal is still supposed to be a viable option (just not at the end of this month), just to be defied by large numbers of her own party (including government ministers). Confused? No worries, this soap opera has a rather sophisticated plot.


The week where we finally found out who will be thrown under the train in the case of a no-deal Brexit (b/c in this populist soap operate someone has to “die” after all) – the Northern Irish farmers. The week where we found out how a no-deal Brexit will solve the Brexit Trilemma – by giving up on all red lines ever drawn by Theresa May. Eventually, border controls will be necessary between Northern Ireland and the Republic of Ireland; given differential tariff regimes between the Irish border and all other UK borders, controls have to be imposed in the Irish Channel and the new tariff regime will undermine UK’s ability to get any new free trade deals (complete loss of trustworthiness being the top reason). A very odd way of taking back control!


The week where the government got finally downgraded to the status of caretaker government as it has lost its majority in parliament. The week where the leader of the opposition finally looked more prime ministerial than the prime minister (never thought I would write this about Jeremy Corbyn). The week where we are closer to the season finale, but still have no clue how this season will end (just that there are many more seasons to come).


As in any good soap opera, there was lots of excitement and “action”, but little substantive change in the underlying plot and no sign of resolution. Theresa May is still trying to push through her deal and her chances might have actually increased as the alternatives have been reduced.  The playing field has tilted even more against the UK as the EU has to agree unanimously to extend Article 50. If there will be any more negotiations in Brussels it will be no longer about backstops but about the terms of extension. 


In case you cannot wait until the next week’s episode, I can promise you replays over the weekend. Well informed sources have told me that Brexiteers will insist that no deal should still be part of the British negotiating position (even though there is no one left to negotiate with – Brussels has made that clear). There are also rumours that Brexiteers might have identified yet another obscure GATT or WTO article they can mis-interpret in their favour.  And we will hear yet again, ad nauseam, to “just get on with it…” – Brexiteers have promised that the moon is made of cheese, so we have to get on with it….

I cannot help but comment on the latest episode of “Brexit – The Never-ending Soap Opera”.  It is true, ratings of the series might have come down (Brexit is boring), as people cannot really follow the plot anymore (neither in the UK nor in Brussels nor anywhere in the world, it seems). The British government, however, is trying its best to bring back up its rating by choosing an ever shriller tone. The Prime Minister has now decided that it is really the EU’s fault that she has not been able to solve the Brexit Trilemma. In the meantime, ministers of her government are competing on who can make the most stupid comment.   And the clock is ticking….


Next week will (supposedly) see votes in the House of Commons on (i) Theresa May’s deal, (ii) a no-deal and (iii) and the request for a possible extension of the Article 50 process. I will not join in any predictions, except that next week’s episode of the soap opera might actually be quite interesting.  And we might actually find out whether and for how many more seasons it will be extended (rumours have it that the name will change to: “Brexeternity – The Sequel”).  In the meantime, I will get myself some popcorn and a nice drink and relax for the weekend.  Cheers!