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Is Bigger Really Better? Moral Hazard Issues in Expanding Financial Safety NetsGlobal Solutions SummitBerlin 18-19 March 2010
Peter BofingerUniversität Würzburg and CEPR
Topics
Ten years after: Where do we stand?
Small is beautiful: The German „Three Pillar System“
Moral hazard and safety nets: Better inventives for bank managers
What has changed since 2007? Private sector deleveraging, high public deficits
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esIta
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azil
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a ¹
Swed
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stria
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man
yN
ethe
rland
sJa
pan
Chin
aSw
itzer
land
Private net financial balances (% of GDP)
2007 2018
Private net financial balances = Current account minus Fiscal balance (Source: IMF)
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mFr
ance
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epub
licPo
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Italy
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riaSo
uth
Afric
aN
ethe
rland
sSl
oven
iaBe
lgiu
mG
erm
any
Irela
ndSw
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land
Cana
daCh
ina
Spai
nAu
stra
liaSw
eden
Kore
aN
ew Z
eala
ndRu
ssia
Icel
and
Finl
and
Fiscal balances (% of GDP)
2007 2018
Bank lending stagnant with the exception of China
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Bank lending to private non-banks (percent of GDP)
Emerging markets All countries Advanced economies China G20 Euro area United States
Source: BIS
Business models have become more conservative
2 The height of each bar shows the aggregated capital shortfall considering requirements for each tier (ie CET1, Additional Tier 1 and Tier 2) of capital for the major internationally active banks monitored by the BCBS (BCBS (2018)).Source: BIS Annual Report 2018
NPL declining, but still high in Southern Europa
Source: ECB, Financial Stability Review November 2018
Expanding Safety Nets?
• Lender of Last Resort is already unlimited for countries indebted in their own currency
• Global dimension: Presentation by Helene Schuberth• Considerable progress in extending the safety nets of the euro area:• ELA (Emergency liquidity) : Country specific lender of last resort• European Stability Mechanism (500 billion Euro): Lender of last resort for
member state governments indebted in a „foreign currency“.
• Single Resolution Mechanism (SRM), backed by Single Resolution Fund (SRF). ESM serves as backstop for SRF
• Work in progress: European Deposit Insurance Scheme (EDIS) with a targetsize 0.8 percent of deposits is grossly overrated
Small is beautiful: Germany‘s
„3 Pillar System“
Is bigger better? The German „Three pillar system“
23%
12%
10%16%
12%
3%5%
16%3%
Total Assets
Big Banks
Regional Banks
Landesbanken
Sparkassen
Credit cooperatives
Mortgage Banks
Foreign Banks
Banks with specialpurposes
15%
15%
10%
24%
17%
5%3%
8% 3%
Loans to non-banks
Big Banks
Regional Banks
Landesbanken
Sparkassen
Credit cooperatives
Mortgage Banks
Foreign Banks
Banks with specialpurposes
Source: Deutsche Bundesbank
Smaller is more profitable
Advantages of the smaller banksØLong-term orientation due to
independence from capitalmarkets
ØLocal anchoring combined withcentralized service centers
ØSupport of social and culturalactivities at the local level
1.852.88
5.28 5.49
9.18 9.3910.13
Land
esba
nken
Big ba
nks
Regio
nal b
anks/
other
comm
. ban
ks
Mortg
age b
anks
Build
ing an
d loa
n asso
ciatio
ns
Savin
gs ba
nks
Cred
it coo
perat
ives
Return on equity (2017)
Who is saved by financial safety nets?
Source: Presentation Edward J. Kane
Profits private, losses social?
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Stock prices of German Banks and DAX (14 May 2007=100)
DEUTSCHE BANK COMMERZBANK HYPO REAL ESTATE HLDG. DEAD - 14/10/09 DAX 30 PERFORMANCE - PRICE INDEX
Setting the right inventives for bank mangers(Dudley-Proposal)
Compensation
ImmediatelyDeferred
(5-10 years)
Equity Debt
Unsecured Debt
Performance bonds:
Security deposit for
fines
William C. Dudley: Enhancing Stability by Improving Culture in the Financial Services Industry, New York, October 2014
Summary
The world has changed dramatically since 2007
• Net private lending has almost vanished (China is the exception)• Bank business models have become more conservative• No obvious need for expanding safety nets
The German experience: Diversified banking systems (“Three Pillar”) with small banks provide stability and to low costs for customers (=low profitability of banks)
The problem is not that banks were safed, but that themanagers were not held responsible for their mistakes
• Share holders made huge losses• Instead of increasing capital requirements to prohibitive levels,
change the compensation of bank managers (Dudley Proposal)• Responsible divers are better than more and speed limits
Why we need strong banks
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