Zusammenfassung
The previous chapter outlined the main theoretical underpinnings that will inform this approach to the political economy of banking regulation. This chapter wants to complement this with a first look at the formation of regulatory preferences for financial stability policy. The infamous insight of economics that “there is no such thing as a free lunch” also applies to financial stability policy, as I argue.
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Notes
- 1.
This terminology of ‘capture’ is used to reflect the concept of the role of private interests in regulation, which is theoretically very well-developed by the regulatory economics literature and dates back to the work by George Stigler (1962; for an overview of his impact see Peltzman, 1993). However, it is not to imply that regulators across the Euro Zone are engaged in fraudulent or corrupt activity – instead it is my view that is the channels of intellectual and political capture are much the drivers of ‘captured’ behaviour. It is in this way that I employ the term to avoid “devaluing the efforts of many overworked and underpaid public servants around the world” (Davies, 2010a).
- 2.
Empirical reality bears this argument as the European case evidences: In the aftermath of the financial crises the new stricter regulatory initiatives in the European Parliament found so much resistance in the form of lobbying and information provision on the likely costs to competitiveness, that parliamentarians organized a counter-balancing lobby themselves. As the Financial Times reports (Hönighaus, 2010), parliamentarians of all parties complained that the horror scenarios on the likely consequences of regulation were not matched with data and information on the benefits. The fact that this perception is no singular incidence is evidenced by the fact that the new expert group on banking matters at the European Union consisting of 40 members contains 37 representatives from the financial industry (Tagesspiegel, 2010). To overcome such collective action and resulting information problems, parliamentarians have therefore themselves initiated a lobby group themselves by the name of “Finance Watch”, which is supposed to provide them with balancing information (Frankfurter Allgemeine Zeitung, 2011), indicating the relevance of private interests in the objective function of legislators and, thus, likely also the regulators.
- 3.
For a rebuttal of these views see Admati, DeMarzo, M. Hellwig, and Pfleiderer (2010).
- 4.
This view was emphasized in interviews with a former senior regulator as well as a former chief economist from leading regulatory and financial stability bodies in major G8 counties, who both emphasized that mandates are always relative and only partially insulate an institution from relevant and organized interests beyond that mandate. One interview partner describe them rather as “fig leafs” to hide behind on specific occasions but as insufficiently strong for doing so n a continuous basis.
- 5.
The legitimacy of interpreting the mention of such considerations as an indication of them being an implicit objective of the regulator is supported by the fact that regulators themselves look to mandates and documentation of other central banks as indications of their priorities. A speech by the Fed’s Vice Chairman at the time Roger Ferguson (Ferguson, 2002) on the role of financial stability as an objective makes reference to the same kind of approach by comparing other countries’ implicit objectives to the ones of the Fed.
- 6.
This debate is embedded in a more general and ongoing discussion of how to best organize banking regulation, covering issues such as the degree of independence from ministries of finance (MoF), legitimacy, and the design of the regulatory institutional structure. I will discuss these issues, when I analyze the role of national institutional structure in regulatory credibility in Chapter 4.
- 7.
In fact Wim Duisenberg commented on this in 1999 in relatively clear words: “The ECB’s contribution to financial stability, and in particular the question of the provision of emergency liquidity to financial institutions in distress, is another issue upon which the interest of the European Parliament is focused. Allow me to explain some of the main considerations in this regard. The main guiding principle within the Eurosystem with reference to the provision of emergency liquidity to individual financial institutions is that the competent national central bank would be responsible for providing such assistance to those institutions operating within its jurisdiction. The ECB does, however, have to be informed of this in a timely manner. In addition, in operations of relevance to the single monetary policy, the decision-making bodies of the Eurosystem will be involved in assessing the compatibility of the envisaged operations with the pursuit of monetary stability. In the case of a general liquidity crisis resulting from a gridlock in the payment system, for instance, the direct involvement of the Eurosystern could be expected.” See Vives (2001, p.63).
- 8.
For a practitioner’s perspective on the limited role of central banking in financial stability see the speech by Fed Vice Chairman Ferguson (2002), who reflects in a very similar fashion as Bernanke and Gertler about this issue.
- 9.
As the 2010 sovereign debt crisis in Europe and the involvement of the ECB through its purchase of Greek and Irish government bonds on the secondary market has shown, this concern about its perception as an independent, credible inflation fighter has indeed split central bankers from politicians, who demanded a higher involvement of the ECB.
- 10.
For instance the creation of a European Systemic Risk Board (ESRB) is a direct consequence of the analysis of the weaknesses of the European supervisory system by the de Larosiére Group, which found that macro-prudential oversight of the financial system within the Community in order to prevent or mitigate systemic risks was required (European Commission, 2009b).
- 11.
Author’s interview with a former senior regulator from one of the major national regulatory bodies.
- 12.
The fact that progress was made then, in political economy terms can be attributed to the influence of large, competitive, international banks, which allied with domestic decision-makers and the supranational Commission to drive financial integration forward despite resistance from small, non-competitive, domestic banks, which had most to loose from integration. The Commission, as the engine of integration against a background of competition from U.S. banks and with the support of European large banks, put financial market integration on the agenda.
- 13.
Thus, whilst due to the tendency towards consensus decision-making the preferences of each country are relevant, it is likely that countries will ally in group sizes of similar preferences to ensure that their cumulative voting power will influence the final outcome in case of the required QMV decision-making mode.
- 14.
There is of course also a valid argument for fiscal policy as a long-run driver of financial stability as unsustainable government debt can drive instability. Fiscal policy however is controlled by very different actors and its use evaluated under very different considerations. It is thus not the focus of this analysis of regulatory and central banking action.
- 15.
The specific impact that each type of policy instrument has is of course subject to intense debate, as many contributions on the monetary and banking regulatory nexus already prior to the financial crisis (Garcia Herrero & del Rio, 2005; Oosterloo & de Haan, 2005; Padoa-Schippoa, 2002) but in particular after the crisis as part of a whole new debate about the future of central banking discuss (Davies, 2010b; B Eichengreen, El-Erian, Fraga, & Ito, 2011; Levine, 2010).
- 16.
Of course these mandates with the sole focus on maintaining price stability have also only evolved over time, as an excellent historical analysis of central banking by Charles Goodhart (2010) shows.
- 17.
For a summary discussion of the empirically proven impact of monetary policy on real economic variables such as output and inflation see Walsh (2003).
- 18.
For a survey of the variation in European financial structure at the time and a discussion of its monetary policy implications see Kashyap and Stein (2002) and Hartmann, Maddaloni, and Manganelli (2003)
- 19.
The literature on asset prices and credit has already developed prior to the financial crisis with major contributions by authors more skeptical (Ben Bernanke from the U.S. Fed) and more enthusiastic (e.g., Claudio Borio from the BIS) about the benefit of a more financial stability-oriented monetary policy (B. S. Bernanke & Gertler, 2000; Borio & Lowe, 2002; Kindleberger & Aliber, 2005).
- 20.
With the costs to instability having been evidenced so dramatically in the financial crisis of 2007–2009, the latter view has gained more support and research has focused on the how monetary policy could potentially be transformed to work towards financial stability. Today the conventional vie is thus under pressure, as central banks have had to realize 1) the costs of ‘writing a put’ on financial activities by (implicitly or through ‘constructive ambiguity’) guaranteeing to inject liquidity and buying up distressed assets; 2) seeing their the ability to conduct monetary policy for price stability objective impaired due to the higher variability in inflation outcomes and the threat of persistent deflation (E. W. Nier, 2009). Pre-financial crisis however such frameworks were not in place in either the Euro Zone, the UK or the US.
- 21.
There is a second important differentiation with respect to the degree of intervention that the available regulatory tools represent (Crockett, 2001). Empirical research has shown a higher reliance on prudential norms and supervision rather than crude intervention in recent years (Barth et al., 2006). As such, we would expect to see variation in these tools over time reflecting the respective thinking and preferences in banking regulation. For now the focus is more so on the actual regulatory instruments (high degree of intervention) and less on the norms of supervision, mainly because the latter are more complex to observe. Differences with respect to the way that these tools are exactly applied in the supervisory practice, how they are shaped by overarching paradigms (such as for example the ‘light touch regulatory style’ practiced in the UK), and how they are employed across countries also give a good clue as to the variation in regulatory paradigms, indicating varying preferences as well. I will come back to this at a later point.
- 22.
The political economy of this impact was already discussed as the regulatory dilemma by Kapstein (1992).
- 23.
Hellwig (2010) stresses this point: “Higher equity capital requirements do not mechanically limit banks’ activities, including lending, deposits taking and the issuance of liquid money-like, informationally-insensitive securities. Banks can maintain all their existing assets and liabilities and reduce leverage through equity issuance and the expansion of their balance sheets. To the extent that equity issuance improves the position of existing creditors and/or it may be interpreted as a negative signal on the bank’s health, banks might privately prefer to pass up lending opportunities if they must fund them with equity. The “debt overhang” problem can be alleviated if regulators require undercapitalized banks to recapitalize quickly by restricting equity payouts and mandating new equity issuance.”
- 24.
See Allen and Herring (2001) for an in-depth discussion of these instruments.
- 25.
In a BIS survey with 33 central banks a large number of practitioners still find macro-prudential policy to be murky and proved to have very different definitions of what macro-prudential policy contained. However, the importance of macro-prudential policy was underlined in its most wide application of measures to limit credit supply to sectors prone to excessive credit growth. For an overview of current application see Borio ( ) and Bank for International Settlements (2010). (Borio, 2010)
- 26.
The above mentioned list of instruments is not necessarily exhaustive, yet, it reflects the most important instruments that have been debated post-financial crisis. A very prominent and coherent approach to macro-prudential regulation has been suggested by Hanson, Kashyap, and Stein (2010) and contains six elements. At the heart of these proposals are in most cases automatic mechanisms that make capital charges more anti-cyclical, create new sources of capital such as contingent capital, and that consider the other systemic risks such as the shadow banking system and the real economy.
- 27.
The Tinbergen principle simply states that every policy objective has to be matched with a policy tool.
- 28.
For an example of this line of argument see a study commissioned by the German bank lobby Frenkel and Rudolf (2010).
- 29.
There are three specific reasons that merit such a depiction of the trilemma as a dilemma: Firstly, the trade-off, as is shown, exists between the stability objective and each of the private interest objectives, respectively, – not between the specific type of private interest objectives themselves. Thus, the real implications of this trade-off can still be derived when reducing the objective function to the two components. Secondly, the trilemma implies that countries will have to make a choice for two of these goals at the expense of another policy goal, making the two-dimensional objective function adequate for the analysis. Thirdly, the economics behind the policy objectives link the two private interest objectives in a very clear and direct way, thus making a combination of them in one variable sensible: Bank competitiveness derives from bank profitability, which relies either on higher margins or higher volumes of bank activities. Since regulators in an open market can only influence leverage by allowing higher volumes of lending, there is a direct link between bank profitability and credit access to the economy. These objectives therefore can be subsumed under a single variable for the sake of the formal argument.
- 30.
This also reflects the specification of other existing models, all of which have a varying combination of these two objectives with some measure of preferences (see for instance Schüler, 2003b).
- 31.
This excursion on the role of banks is inserted to illustrate the mechanism through which capital adequacy regulation and regulatory stringency operate. It reflects the conclusions of similar models such as the one by Dell’Ariccia & R. Marquez (2006), who also show that banks will only hold the absolute minimum amount of capital required.
- 32.
This assumption goes back to the fact that in the financial sphere the Miller-Modigliani-theorem does not hold. The theorem states that the actual source of funding (equity or loans) should not matter, since lenders will adjust the interest rate for the additional risk they take on in the case of higher leverage, which will yield the same costs of funding. However, due to the limited liability that banks in effect have in the presence of deposit insurance and government bailouts that save lenders, equity is the scarcer factor, as equity does run the risk of being wiped out in the case of failure. See Goodhart (2010; p.13ff) for this as a reason for declining capital in the 1980s; see Bebchuk and Spamann (2009) for how this increased risk-taking as bankers were taking out larger amounts of bonuses in the phase of 2000–2008.
- 33.
Of course the Basel regime has made some effort towards harmonizing this decision across countries. However, since there is discretion under Basel I and II in setting both the level of capital adequacy requirements as well as the definition of what constitutes capital, this in essence can be regarded as a sovereign decision by each regulator.
- 34.
This logic of prioritizing amongst three conflicting policy trade-offs is also applied in other policy areas. For social and employment policy see for instance Torben Iversen’s work (2005).
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Scherf, G. (2014). Trading off financial stability: A political economy perspective on European banking regulation. In: Financial Stability Policy in the Euro Zone. Springer Gabler, Wiesbaden. https://doi.org/10.1007/978-3-658-00983-0_3
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