In a nutshell
Following the outbreak of the financial crisis, no other requirement was higher on the political agenda than the stabilisation of the financial markets. IWH has conducted extensive research into the impact of these rescue packages and their political consequences.
Our experts on Financial Stability
Both the US and European governments launched a number of support and regulatory measures that were intended to meet the requirement for increased stability in the financial sector. But today, over eight years after the onset of the crisis, the impact of these actions is often in question: what was the effect of increasing banks' deposit protection, for example? Have they reduced the knock-on effects of crises, as governments hoped? Did the colossal acquisition of banking shares distort the market? Deposit protection schemes are a high-profile way of regulating a financial system. If a bank becomes insolvent, these systems guarantee that a certain amount of money will be paid out. This is intended to prevent large numbers of bank customers reclaiming their private deposits from the bank because they fear losing their assets. Actually, no bank is in a position to repay the amounts it holds to all its customers at once. Such a bank-run must therefore be prevented at all costs. But raising deposit protection in the US from USD 100,000 to USD 250,000 did not result in increased security. In fact, exactly the opposite occurred: banks began to operate in much more risky business areas. There is a simple reason for this: “If a bank successfully operates in high-risk areas, such as commercial property, it earns significantly more than in less risky areas. If it miscalculates, however, the deposit protection scheme automatically bears the bank's liability,” explains Felix Noth, Financial Market Expert at IWH. “In order to stabilise the financial system in the short-term, long-term increased risk incentives for banks are therefore accepted. And this can potentially lead to the next financial crisis.”
The usefulness of deposit protection schemes is mainly in question, because there has been a range of other measures aimed at stabilising floundering banks. Such as the Troubled Asset Relief Program (TARP) of 2008, for example, one of the largest stabilisation measures in the US, with a budget of USD 475 billion. IWH calculations for all US banks suggest, for example, that competition between those banks that received money from the TARP Program and those that did not benefit from TARP, did not suffer any long-term damage as a result of this rescue package. 112% of the funds paid out by the US Government to rescue the banks were also repaid – so American tax-payers even made a profit from rescuing the banks.
The financial crisis of recent years has primarily revealed the possible knock-on effects of various financial systems. It showed, for example, that the turmoil in Europe and the US had an impact on lending and regional employment in Latin and South American countries. But it's not only overseas funding that determines whether a bank is in foreign hands or not - its corporate structure also plays a part. Banks financed from overseas, for example, extended their loans to a much greater extent than those that belonged to overseas institutions – and therefore made a significantly greater contribution to stability.
Banks can have varying influences on systems in their native markets or in the whole of the EU. Although a single regulatory body in Europe would be desirable – how would this work? There are now many proposals for increased stability in the financial sector, ranging from a central EU Authority or national monitoring, to the separation of investment banking and deposit business. The establishment of the European banking union is a welcome first step. But current developments in the European financial market clearly show that there is still much work to be done.
Publications on "Financial Stability"
Physical Climate Change Risks and the Sovereign Creditworthiness of Emerging Economies
in: IWH Discussion Papers, No. 8, 2020
I show that rising temperatures can detrimentally affect the sovereign creditworthiness of emerging economies. To this end, I collect long-term monthly temperature data of 54 emerging countries. I calculate a country’s temperature deviation from its historical average, which approximates present day climate change trends. Running regressions from 1994m1-2018m12, I find that higher temperature anomalies lower sovereign bond performances (i.e. increase sovereign risk) significantly for countries that are warmer on average and have lower seasonality. The estimated magnitudes suggest that affected countries likely face significant increases in their sovereign borrowing costs if temperatures continue to rise due to climate change. However, results indicate that stronger institutions can make a country more resilient towards temperature shocks, which holds independent of a country’s climate.
Transmitting Fiscal Covid-19 Counterstrikes Effectively: Mind the Banks!
in: IWH Online, No. 2, 2020
The German government launched an unprecedented range of support programmes to mitigate the economic fallout from the Covid-19 pandemic for employees, self-employed, and firms. Fiscal transfers and guarantees amount to approximately €1.2 billion by now and are supplemented by similarly impressive measures taken at the European level. We argue in this note that the pandemic poses, however, also important challenges to financial stability in general and bank resilience in particular. A stable banking system is, in turn, crucial to ensure that support measures are transmitted to the real economy and that credit markets function seamlessly. Our analysis shows that banks are exposed rather differently to deteriorated business outlooks due to marked differences in their lending specialisation to different economic sectors. Moreover, a number of the banks that were hit hardest by bleak growth prospects of their borrowers were already relatively thinly capitalised at the outset of the pandemic. This coincidence can impair the ability and willingness of selected banks to continue lending to their mostly small and medium sized entrepreneurial customers. Therefore, ensuring financial stability is an important pre-requisite to also ensure the effectiveness of fiscal support measures. We estimate that contracting business prospects during the first quarter of 2020 could lead to an additional volume of non-performing loans (NPL) among the 40 most stressed banks ‒ mostly small, regional relationship lenders ‒ on the order of around €200 million. Given an initial stock of NPL of €650 million, this estimate thus suggests a potential level of NPL at year-end of €1.45 billion for this fairly small group of banks already. We further show that 17 regional banking markets are particularly exposed to an undesirable coincidence of starkly deteriorating borrower prospects and weakly capitalised local banks. Since these regions are home to around 6.8% of total employment in Germany, we argue that ensuring financial stability in the form of healthy bank balance sheets should be an important element of the policy strategy to contain the adverse real economic effects of the pandemic.
How Does Economic Policy Uncertainty Affect Corporate Debt Maturity?
in: IWH Discussion Papers, No. 6, 2020
This paper investigates whether and how economic policy uncertainty affects corporate debt maturity. Using a cross-country firm-level dataset for France, Germany, Spain, and Italy from 1996 to 2010, we find that an increase in economic policy uncertainty is significantly associated with a shortened debt maturity. Specifically, a 1% increase in economic policy uncertainty is associated with a 0.22% decrease in the long-term debt-to-assets ratio and a 0.08% decrease in debt maturity. Moreover, the impacts of economic policy uncertainty are stronger for innovation-intensive firms. We use firms‘ flexibility in changing debt maturity and the deviation to leverage target to gauge the causal relationship, and identify the reduced investment and steepened term structure as transmission mechanisms.
Capital Account Liberalisation Does Worsen Income Inequality
in: IWH Discussion Papers, No. 7, 2020
This study examines the relationship between capital account liberalisation and income inequality. Adopting a novel identification strategy, namely a difference-in-difference estimation combined with propensity score matching between the liberalised and closed countries, we provide robust evidence that opening the capital account is associated with an adverse impact on income inequality in developing countries. The main findings are threefold. First, fully liberalising the capital account is associated with a small rise of 0.07-0.30 standard deviations in the Gini coefficient in the short-run and a rise as large as 0.32-0.62 standard deviations in the ten years after liberalisation, on average. Second, widening income inequality is the outcome of the growing income share of the rich at the cost of the poor. The long-term effect of capital account liberalisation includes a reduction in the income share of the poorest half by 2.66-3.79 percentage points and an increase in the income share of the richest 10% by 5.19-8.76 percentage points. Third, the directions and categories of capital account liberalisation matter. Inward capital account liberalisation is more detrimental to income equality than outward capital account liberalisation, and free access to the international equity market exacerbates income inequality the most, while foreign direct investment has an insignificant impact on inequality.
Freihandel, Protektionismus und das stabile Genie
in: Wirtschaft im Wandel, No. 3, 2019
Protektionismus ist schlecht, aber vielleicht nicht ganz so schlecht, wie ihn viele Leute machen. Zölle sind kurzfristig nichts anderes als Umverteilung: von vielen Konsumenten zu einigen wenigen inländischen Produzenten und deren Mitarbeitern. Denken Sie zum Beispiel an Zölle auf Stahl: Die Konsumenten leiden, weil Autos, Maschinen und alles, wofür es sonst noch Stahl braucht, teurer wird. Allerdings profitieren die im Vergleich zu den ausländischen Wettbewerbern ineffizienteren inländischen Stahlhersteller.