Too much finance?
I was invited this week to give a keynote lecture at the Too Much Finance conference in London. Here a quick summary of my remarks, which I hope to turn into a paper at some point.
First, when discussing ‘too much finance’ the focus is often on advanced countries; the paper that gave the name to this literature (Arcand, Berkes and Panizza, 2015) showed that beyond a rather high level of financial development, the finance-growth relationship turns negative, a level, which is only achieved in high-income countries. The finance-growth literature, however, has either focused on early economic development in advanced countries (e.g., Alexander Gerschenkron) or on the developing countries of the 20th century (e,g., Ronald Mckinnon). The first cross-country empirical paper showing a positive relationship between financial development and economic growth (King and Levine, 1993) was product of a broader World Bank research project on the determinants of economic growth in developing countries.
Second, while we often discuss identification challenges related to reverse causation and omitted variable, measurement bias is discussed much less. A key issue in this debate is how we measure "finance" or “financial development". Many researchers rely on Private Credit to GDP (claims by financial institutions on domestic non-financial sectors, relative to economic activity) as proxy indicator for financial development. While useful given easy data availability and cross-country comparability and consistency, this is a crude measure to capture the concept of financial development. What we want to capture is a financial system that is efficient, competitive, and inclusive, offering diverse instruments and products and that fulfils the function of intermediating effectively and providing liquidity insurance. Given that we do not have such indicators, we use proxy variables such as Private Credit to GDP. There is nothing wrong with doing so, but it is important to keep in mind that there is not a one-to-one mapping between this variable and the concept of financial development. There is also the issue that theory suggests a long-term relationship between financial development and economic growth, but researchers often use annual or five-year frequencies, thus possibly capturing short-term business cycles relationships rather than a long-term relationship.
Third, when asking whether there can be ‘too much finance’, there are actually three questions to be asked.One, can there be too much credit? This question has been answered positively by the credit cycle and the financial crisis literatures - rapid credit growth is a significant predictor of systemic banking distress and the longer and faster credit booms develop, the more likely a credit boom turns into a bust and crisis.
Two, can the financial sector grow to large at the expense of the real economy?This question has also been answered positively by several papers. In a paper with Hans Degryse and Christiane Kneer we show that a larger financial sector (as measured by its value added in GDP) might be in the short-term associated with higher growth, but also with higher volatility in GDP growth, while having no long-term effect on economic growth. Cecchetti and Kharoubi (2012) show a negative relationship between the growth in private credit and productivity growth and Kneer (2013 a.b) provides evidence for a crowding out effect through a brain drain from a financial sector that grows too large.
Three, can there be ‘too much financial development’? Here a critical question has been to who are the recipients of credit by the banking sector.Over the past decades, the banking sector in most high-income countries has shifted from providing credit to the real economy, including manufacturing to providing credit to households, mostly in the form of mortgage loans. Lending to households, especially for housing, doesn't robustly link to economic growth in the same way that lending to enterprises does. And credit-fuelled housing booms can even crowd out commercial lending, hindering productive investment. Further, boom-bust periods linked to housing and non-tradable (often construction-related) credit have much deeper negative repercussions of economic growth than boom-bust periods linked to tradable industries (Mueller and Verner, 2024).
So, can there be too much finance? Yes, there can! The more important question is to understand the anatomy of ‘too much finance’ and the channels and mechanisms through which it has a negative effect on economies and societies, to thus inform policymakers.
15. January 2026
Turmoil in the editorial world of finance journals
Christmas brought turmoil into the world of finance research journals, with 12 retractions across several third-tier journals, the reason being that the handling editor was a co-author of the papers in questions, clearly raising conflict of interest concerns.
This incident raises an important question: is this common practice across academic journals? And are there rules for editors publishing in ‘their’ journals? As I was editor across three journals for a total of 11 years, I can certainly speak to this (and clearly say NO). And given that the journals in question are also published by Elsevier, let me focus on the Journal of Banking and Finance (JBF, also published by Elsevier), the last journals where I was an editor. A few years before I joined, the JBF had come out of a ‘rough period’, with an editor who supposedly forced authors of accepted papers to add citations to other JBF papers to thus artificially increase the impact factor of the journal and supposedly combined conference invitations as keynote speaker with special issues in the JBF for the conference papers (in one case he was even given an award in return for a special issue). I don’t have formal confirmation but I have been told by several independent sources that ultimately even Elsevier realised that this editor was seriously damaging the reputation of the journal, appointing a second editor and then easing out the ‘doubtful’ editor from his responsibilities.
Maybe not surprising, given this history, we had relatively strict rules in place at the JBF while I was serving as editor. In several occasions, I was invited as keynote speaker at conferences; in several instances, upon accepting the invitation, the request to have a special JBF issue followed within a few days. I always declined the request to avoid any conflict of interest! I did not submit any papers to the JBF during my editorial tenure; submissions by co-authors and PhD students were always handled by other editors So no, the behaviour that led to the retractions mentioned above is NOT the norm in finance journals!
The retractions have caused quite some reactions on LinkedIn, mostly civilised, though some misinformed, but also some (rather nasty) reactions on our profession’s online cesspit (aka econjobrumors.com). Personal insults and all kind of accusations show how some valid debates can easily turn ugly!
The journals where these retractions happened are part of the Elsevier ecosystem, created in 2019 and described in this paper. While the JBF has participated in the journal transfer system, it is not part of this ecosystem, which is characterised by overlapping editorial appointments. Carol (former co-editor of mine at JBF) and co-authors show that ecosystem journals benefited from an increase in impact factors (which is based on citation records) after the creation of the ecosystem; more specifically, four journals benefitted most, among them the ones where the articles mentioned above were retracted. Moreover, these four journals have a notable number of authors with more than ten papers published in the four years following the establishment of the ecosystem,There is a remarkable number of cross-citations between a few of these authors, some of whom are also editors of the same journals. Now, the authors of the paper are very careful in their interpretation, but they do conclude “that the ecosystem gave rise to more interlinked and networked citations among authors and editors in these ecosystem journals.” Less diplomatic interpretations of these results would point to an editorial citation cartel; and as self-citations (i.e., citation to articles in the same journal) are no longer part of the impact factor, the ‘problem’ is solved by intentional cross-journal citations.
Journals are being judged by impact factors and ranking lists.The journals mentioned above have seen an incredible increase in impact factors over the past few years, but not really in rankings and journal classification systems (which go beyond impact factors). This is yet another example of Goodhart’s Law - once a metric becomes a policy instrument, it loses its usefulness - in this case, driving up impact factors artificially through citation ‘patterns’ (to put it carefully) does not really improve the standing of a journal.
Impact factors are not just important for journal editors but also for publishers and here the motivation of profit-maximising publishers such as Elsevier unfortunately goes against research ethics. It seems they have not learned the lesson from the above-mentioned JBF editor and have allowed this citation cartel to go on for too long, even lauding the practice, making the person at the centre of this cartel a keynote speaker of the first Elsevier finance conference. While at the JBF, my co-editors and I raised the issue of the finance journal ecosystem several times, I am glad that after many years, action is finally taken and the editors have been shown the door.
The world of academic publishing is not perfect and will never be, for one simple reason - reviewers and editors are humans.One reason of why we tell junior researchers to attend conference is for networking purposes. The researcher community is based on personal interactions. While most of us strive for objectivity, the human factor will never disappear. The critical challenge is to put in place guardrails that avoid conflicts of interest even as we act with human instincts.
Beyond having proper guardrails in place, there is a more general issue of junkification and enshittification of research, as described in this paper.The publish and perish system has resulted in perverse incentives. Academic research is increasingly commodified, helped by commercial publishers, resulting in “a system emerges where scholars increasingly bear the costs of low-esteem publishing that limits genuine scholarly contributions”. There is a lot more to be said about this sad and destructive trend, but I will leave this for some other time.
8. January 2026
Venezuela - short-term gain, long-term pain?
On Saturday, the dictator of Venezuela, Nicolas Maduro, was captured by the US in a surgical operation and will face criminal charges in New York City. It is a fitting end for a cruel ruthless dictator and head of a racketeering chain.Under his ‘leadership’, Venezuela has lost 80% of GDP and a quarter of its population to migration. Venezuela - once an upper-middle income country (and richer than neighbouring Colombia) - is today a poor country. He clearly lost the last elections to the opposition, bur rather than gracefully bowing out, doubled down on suppression of any dissent.So, good riddance!
Having said this, the attack is clearly in violation of international rules and norms. I am not a legal scholar and will leave detailed analysis of the legal implications of the US action to others, but just note that the current US administration feels much less bound by the rules-based international system than previous administrations. This action certainly sets a dangerous precedent! As important, however, is there a long-term strategy underpinning this action?T his is where I have serious doubts and the lack of such a strategy will certainly spell trouble for Venezuela but also the region at large.
After the removal of Maduro, the obvious question is: what next? Will the US ‘run Venezuela’ as the US president seemed to indicate? And if yes, how? Here is one possible scenario:The US will leave the current Chavista leadership in place (let’s please not call them ’socialist’, it is an autocratic and kleptocratic regime), but will pressure them to open up the oil sector to US interests. I doubt the current US administration cares about democracy in Venezuela. It is also clear that the US administration does not care about drug trade; otherwise the former Honduran president Hernandez, convicted just a few years ago for his role in drug trafficking, would not have been set free by the Trump administration. The Venezuelans celebrating in- and outside Venezuela might soon be disappointed!
The current calculus of the US administration seems to be: the Chavista clique is allowed to continue their racketeering game in Venezuela as long as they allow oil exploitation by US interests (possibly also linked to interests of the Trump family). The extraction of Maduro was a clear warning signal to the Chavista clique - if you do not play ball, you will suffer the same fate as him. Proceeding like this avoids the pitfalls of the neocon state building attempts that failed so spectacularly in Afghanistan and Iraq. Whether it will work out as envisioned by the US administration, is questionable, however. However, one thing is clear: a return to democracy in Venezuela is a long way off, as is economic recovery.
There are also broader geopolitical implications. The Monroe doctrine has evolved into the “Donroe doctrine”: - the Americas are the US’ backward and are thus to be controlled by the US. Friendly governments are being supported (e.g., El Salvador and Argentina) and hostile governments threatened (e.g., Colombia and Brazil). Beyond this, the US administration seems to want to be willing to split the world into three interest spheres - Americas for the US, Asia for China and Europe for Russia.
Where does this leave Ukraine and Europe? On the one hand, Maduro’s support for Putin and his aggression against Ukraine makes Ukrainians happy to see him meet his fate; further, reducing supply of oil for Russia through the US’ embargo weakens Russia and might provide some relief for Ukraine. On the other hand, the geopolitical implications mentioned above indicate that the US administration is willing to leave Europe to Russian expansion. A focus on Venezuela and Latin America might weaken the US’ support for Ukraine further.
As worrisome as this is in the short- to medium-term for Ukraine, as worrisome it is for Europe in the medium- to long-term: the champion of rules-based international relations experiences another violation from its former partner, the US. The clear disrespect for democratically elected governments across the globe, open support for fascist parties in Europe, and the nonchalant attitude towards Russian aggression (if not outrightly supporting it as argued above) reinforces the need to Europe to be able to stand on its own. While 2026 has started with one dictator less in place, the geopolitical turmoil continues.
4. January 2026
Looking back, looking forward
At the end of last year I wrote that “2024 might look like the calm before the storm” and that certainly turned out to be true.It is always difficult to mark current events as historic - something better left to future historians - but 2025 has certainly marked a big change in the geopolitical and geoeconomic situation for Europe.You have a US administration that is openly hostile to 80 years of North American-European cooperation, openly hostile to the European Union (as individual smaller countries are either to bully than the EU) and openly cooperating with Russia in creating new geopolitical realities. At the same time, Putin has made it clear that it he will not stop with Ukraine but aims to a larger zone of influence that goes further West. While Russia has not openly declared war against the European Union, it has committed open hostilities over the past decade - from undermining democracy with disinformation wars over open attacks such as (attempted) murders in Salisbury and Berlin to hybrid warfare with cyberattacks and cutting undersea cables.
Open liberal democracy is clearly under threat across the globe, from the US to Georgia and as clearly seen in military coups in Western Africa (often supported by Russia). It is also under threat by the techno-oligarchs who see democracy and open markets as not compatible, sometimes described as conservative libertarianism sometimes as techno-fascism.
The change in geopolitical conditions comes with a change in geoeconomic conditions, though this seems to be somewhat more slowly moving.Trump’s trade war has clearly not had the negative effects that many economists (including myself) expected, to some extent due to the TACO effect, where Trump steps back from the biggest threats once the damage for the US economy (and his voters) becomes clear. Also, the fact that the EU has not retaliated has somewhat limited the damage, though the political impression of weak Europe might have been strengthened. There are also concerns about the role of the USD as global reserve currency, though here again, the worst has not come to happen - introducing capital controls in the form of taxes on US treasuries held by foreigners.However, the open support for stablecoins by the US administration, to foster demand for US Treasuries, might be a harbinger of the weaponisation of finance still to come.
What are we to do in Europe?I have written before about the concept of defensive democracy - adopted in Germany after the catastrophic end of the Weimar Republic, which enabled its enemies. There are clearly enemies within and outside - take the example of the Putinist AfD in Germany who wants to force government authorities to share details on defence structures, so they can be promptly passed on the Moscow. And the only way to address the geoeconomic changes is to strengthen the Single Market in Europe and complete the Savings and Investments Union, both to boost economic growth and create strategic autonomy in as many sectors as possible.
Economists are terrible in predicting the future and I am no better in it.But for the moment one can hope that the geopolitical and -economic situation does not deteriorate further and that Europe will rise to the new global challenges.
Happy New Year!
31.12.2025 / 1.1.2026
Review of capital requirements in New Zealand
On Wednesday, the Reserve Bank of New Zealand published its review of capital requirements for banks.I was one of the three external experts (together with Sir John Vickers and Elena Carletti) and our reports were published at the same time as the decision. As you can see from my report, I am sceptical of their decision to lower capital requirement. In 2019, New Zealand had raised capital requirements beyond Basel III, which seemed to have led to some frictions with the Treasury and the banking sector. However, the 2019 decision was based on a clear benefit-cost analysis of capital requirements in terms of economic growth, which resulted in the ‘optimal’ probability of a banking crisis of 0.5% (one every 200 years); the capital requirements were calibrated accordingly.
The revision of the capital requirements has a lot to speak for them - a replacement of AT1 capital with a mix of CET1 and Tier 2 (though I would have preferred CET1); a more granular calibration of risk weights under the standardised approach, while maintaining minimum requirement for risk weights under the internal model (with an output floor and scalar). On the other hand, capital requirements are being lowered compared to 2019. And while the introduction of Loss Absorbing Capacity (LAC) for the largest four banks (all subsidiaries of Australian parent banks) as additional buffer for a possible going-concern resolution shows a focus on how to manage the possible failure of large institutions beyond taxpayer support, the necessary crisis management framework will only be put in place in the next few years.
There is the hope that lower capital requirements will lead to lower borrowing costs and possibly more competition. The former depends on the pass-through - as banks seemed to have complained about high funding costs in the New Zealand market, it is doubtful there will be much of a pass through to lower borrowing costs. And as I argue in my comments, there is not a clear link between capital requirements and competition; there seem to be better levers to foster more competition in the banking market.
The decisions to lower capital requirements is part of a broader global tendency of ‘deregulation’ and links also back to the debate on simplification, mentioned in my previous blog entry. It is clear that the regulatory cycle has shifted; one can only hope for the best and that the lessons of 2008 do not get forgotten too quickly.
As a final positive note, I was impressed by my interactions with RBNZ staff and stakeholders; in these highly politicised times, it is good to have informed discussions on financial stability topics; something we used to take as given only a few years ago, but not necessarily the case in every circumstance.
19. December 2025
Simplification - more thoughts
As coincidence has it, I gave a talk last week at DG Fisma in Brussels on simplification exactly at the same time, as the ECB Vice President Luis de Guindos presented the proposals of the High-level Task Force on Simplification(HLTF) of the ECB. Obviously, his presentation was more interesting and will have broader implications, but I will nonetheless mention some of the points I made during my presentation at DG Fisma. Some of these points match what I had discussed a few weeks ago, also in Brussels, at a workshop on the complexity of the EU banking regulatory framework. The following also expands on some thoughts I had posted in late November.
First, whenever we discuss regulatory reform, we have to remind ourselves of why we subject banks to such a rigorous regulatory framework. This is because the failure of banks causes externalities. That is ultimately why we have a financial safety net, consisting of licensing requirements, regulation and supervision, lender of last resort, bank failure management, and deposit insurance. No single element of financial safety net is perfect; we need for multiple lines of defence. It also means that any cost-benefit analysis of regulation should be done on the societal level, not the bank or even the banking system level.
Second, when discussing reforms to the financial safety net we have to consider all the different dimensions and their interactions. Take the example of bank failure management and bank regulation/supervision. The US seems much more comfortable not only with idiosyncratic bank failures, but also systemic banking crises; something not the case in Europe where we struggle with the fall-out from bank failures and systemic banking distress. This would imply a tighter regulatory and supervisory framework for Europe than in the US. Regulation and supervision also interact: a bare-bone regulatory framework might have to rely more on supervisory monitoring and action; conversely, having no Pillar 2 capital requirements as part of the supervisory process might imply higher Pillar 1 regulatory capital requirements. However, an overly complex regulatory framework can also undermine effective supervision, as supervisors will have to focus on interpreting and explaining Level 2 and 3 regulations rather than focusing on the ‘big picture’.
Third, why is the regulatory framework so complex for banks? There are several reasons. First, politics - Basel 3 was a political compromise between different countries, while CRR and CRD in the European Union were results of political compromises between member states. In addition, the CRD was not necessarily translated in the same way into national legislation (which is why the HLTF calls fore more regulation rather than directives in the area of bank regulation). Second, banking is complex, and it is therefore not surprising that bank regulation is complex. A third reason (suggested by a participant in last week’s seminar) might be that the different regulatory frameworks (micro-pro, macro-pru, resolution) have been developed in silos, without anyone considering the ‘big picture'.
Fourth, when thinking about a conceptual framework for the complexity vs. simplification, resilience of banks and the banking system at large should be the top priority. So, simplification is really about compliance costs not necessarily funding costs of banks; though as pointed out by a seminar participant, an overly complex regulatory framework might make bank decision taking more opaque for investors and thus also result in higher funding costs. Then there is a trade-off between simplicity of the framework (easy to implement and monitor, and predictable) and flexibility of the toolbox (its usability of different tools across different banks, across countries and over time). Take the example of risk-weighted vs. unweighted capital-asset ratios. The risk-weighted capital-asset ratio is to make bank’s pricing risk-based and allow for a buffer (and thus also skin-in-the-game) consistent with the bank’s risk-taking. This buffer is complex and might be subject to manipulation and might be pro-cyclical; that’s why it has been complemented with the unweighted version, also known as leverage ratio - which is simpler and guarantees that there is always enough capital, even if and when risk weights are low. It is not clear that it is always the same ratio that is binding, neither across banks nor across the cycle. But the trade-off between simplicity and flexibility is reflected in having both these ratios in Basel III.
Turning to specific elements of the regulatory framework that one might be able to simplify, a lot of discussion has focused on the capital stack, with both complexity within individual stacks and across different stacks, with overlaps between buffers also resulting in limited buffer usability when released during downturns (as described in this ESRB report). Several suggestions, including by the ECB HLTF, have been made to merge different buffers together: "a non-releasable buffer (merging the capital conservation buffer and the higher of the other systemically important institutions (O-SII) and global systemically important institutions (G-SII) buffers) and a releasable buffer (merging the countercyclical capital buffer and the systemic risk buffer).” The HLTF also points to the doubts of AT1 as going-concern capital and suggests replacing it with CET1 (a proposal, which will most likely result in a lobbying war with the banking industry). Similarly, proposals have been made to disentangle capital and resolution stacks. Here the HLTF proposal does not go as far as other proposals that call for a complete separation of going and gone concerns capital stacks.
Another way towards simplification would be a strengthening of proportionality, by allowing small and non-complex institutions to opt out of Basel 3 and be subject to a less complex regulatory framework. Given the experience with Silicon Valley Bank, which was outside Basel 3 but grew rapidly (and thus would eventually have turned into a Basel 3 bank but with a transition period and thus too late), it is important that these institutions do not grow rapidly. Also a small institution in one country might considered a mid-sized institution in another country, so that country-level size threshold would have to be applied - politically difficult! A special challenge are the the small banking groups in Germany and Austria, connected to each other though the Institutional Protections Schemes (IPS); a regulatory and supervisory approach that recognises the small size of the individual banks while focusing on the systemic importance of the groups is such, is called for!
One rather low-hanging fruit in my view, also recommended by the HLFT, is to "establish a fully integrated reporting system at European level for statistical, prudential and resolution purposes”. Such a platform should reduce reporting costs for financial institutions by having to report only once all relevant information, to which then different regulatory and supervisory authorities have access (though not necessarily all to the overall data universe). There might be legal constraints for this, but it would already be an important contribution to simplification.
The most constraining factor for the complexity in European banking regulation, however, seems to be national divergence in rules, already referred to above., There are national exemptions and gold-plating and still attempts at ring fencing, even within the euro area, by national authorities, which ultimately undermine the Single Market in Banking as well as cross-border banking mergers. On the other hand, macroprudential policies have to be designed and implemented on the national level given non-synchronised credit cycles and different market structures (e.g., in the residential housing market). However, given that the fall-out from credit cycles does not stop at national borders, especially within a currency union, it is not clear why the decision power on the national macroprudential policy decisions should be exclusively on the country-level; while the ECB has top-up powers for capital buffers, it has not used them; while the ESRB serves as coordination mechanism for macroprudential policy within the EU, its powers are limited. There is certainly a role for more supranational coordination and maybe even decision powers, including in macroprudential policy.
In sum, the low-hanging fruits for simplification are in making the reporting life for financial institutions easier; the mid-hanging fruits consist of simplifying (but not reducing) capital buffers, while the high-hanging fruits but also the most important contribution to reducing complexity of the prudential framework is to move from co-existing national and European rules to a European framework.
15. December 2025
Interesting research in bank supervision and financial stability
As part of the cooperation between the EUI’s Florence School of Banking and Finance and ECB Bank Supervision, we have launched a Working Paper Series in Bank Supervision(though very broadly defined) to foster research in this area. This week saw the second event at the ECB in Frankfurt where three of recently published working papers were presented, all three of them very interesting.
Anni Noring and Eva Keralaassess the effectiveness of the counter-cyclical capital buffer in Germany using the recent raise from zero to 75 basis points. Using AnaCredit loan-level data they show that this capital tightening has resulted in German banks reducing the volume of corporate loans and increasing the price of new loans. Interestingly, the effect comes after announcement, rather than after implementation 12 months later. Less surprising, the reduction in credit availability affects primarily small and medium-sized enterprises, but not large enterprises (consistent with an older paper by Meghana, Sole and Iwhere we look at cross-country data and more generally at macro-pru policy).
Peter Claeys and co-authorsrevisit the sovereign-bank doom loop, at the core of the euro debt crisis 10 to 15 years ago. The home bias, i.e., banks primarily holding sovereign banks of their own sovereign, is still strong in Europe and elsewhere, but they argue that the effect on fiscal policy might depend on the depth of financial systems. Using a standard fiscal reaction function, which measures how governments set budgets in response to economic and political objectives, they find that countries with high home bias do not necessarily suffer less fiscal discipline. In fact, countries with a high home bias typically have a sufficiently large banking system that absorbs public debt that allows them to let automatic stabilisers operate and adopt counter-cyclical fiscal policies, including during big crises, such as the Global Financial Crisis or the Pandemic. This effect is stronger in countries with deeper financial systems. However, the structure of the banking system matters. While entry of foreign banks appears to support fiscal sustainability by diversifying debt placement, a higher share of state-owned banks reduces fiscal discipline and increases sovereign risk exposure.
A cross-border bank’s systemic importance can be partly judged by the volume of activity outside the domestic market. However, financially autonomous bank subsidiaries, which finance their local assets with local liabilities in the same currency, might be less affected by international funding market fluctuations and economic changes in other countries. Mikel Bedayo and Eva Valdeolivasthus study whether a high proportion of local claims in local currency affects the variation of foreign claims differently across the credit and business cycle. Using data on the world’s largest 76 banking groups and data primarily from the BIS Consolidated Banking Statistics, they find that, indeed, banking systems with higher local claims ratios experience a smaller reduction in foreign claims and thus seem better equipped to withstand systemic crises and economic volatility.
11. December 2025