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"
Comments on “Consultation BCBS discussion paper on the regulatory treatment of sovereign exposures”
in: One-off Publications, 2018
The BCBS discussion paper on the regulatory treatment of sovereign exposures addresses a so far hardly touched topic as concerns capital regulation. While the regulatory framework has been changed substantially over recent years including the establishment of the European Banking Union, risk weights on sovereign exposures have remained mostly unchanged and sovereign exposures of banks benefit from a favourable capital treatment. This applies despite the fact that the recent European sovereign debt crisis has revealed the potential of a doom loop between bank and sovereign risk and demonstrated that sovereign exposures are by no means “risk-free”. The paper is thus an important proposal how to change the risk evaluation of banks’ sovereign exposures.
Welche Faktoren verzögern die Umsetzung der Bankenunion?
in: Wirtschaft im Wandel, No. 1, 2018
Die Europäische Kommission hat weitreichende Reformen zur Regulierung und Überwachung des europäischen Bankensektors beschlossen, um die Stabilität europäischer Banken zu gewährleisten. In den meisten Mitgliedsländern verzögert sich allerdings die Umsetzung der zugrunde liegenden Richtlinien der Europäischen Kommission. Dieser Beitrag geht den Gründen für diese Verzögerung nach. Es zeigt sich, dass insbesondere bereits existierende Regulierungen und institutionelle Rahmenbedingungen das Tempo der Umsetzung entscheidend bestimmen. Entgegen populären Meinungsäußerungen sind die Struktur der Bankensektoren in den Mitgliedstaaten und politische Faktoren hingegen von nachrangiger Bedeutung.
Flooded Through the Back Door: Firm-level Effects of Banks‘ Lending Shifts
in: IWH Discussion Papers, No. 4, 2018
I show that natural disasters transmit to firms in non-disaster areas via their banks. This spillover of non-financial shocks through the banking system is stronger for banks with less regulatory capital. Firms connected to a disaster-exposed bank with below median capital reduce their employment by 11% and their fixed assets by 20% compared to firms in the same region without such a bank during the 2013 flooding in Germany. Relationship banking and higher firm capital also mitigate the effects of such negative cross-regional spillovers.
Sovereign Stress, Banking Stress, and the Monetary Transmission Mechanism in the Euro Area
in: IWH Discussion Papers, No. 3, 2018
In this paper, we investigate to what extent sovereign stress and banking stress have contributed to the increase in the level and in the heterogeneity of non-financial firms’ financing costs in the Euro area during the European debt crisis and how both have affected the monetary transmission mechanism. Employing a large firm-level data set containing two million observations, we are able to identify the effect of government bond yield spreads (sovereign stress) and the share of non-performing loans (banking stress) on firms‘ financing costs in a panel model by assuming that idiosyncratic shocks to individual firms are uncorrelated with country-specific variables. We find that the two sources of stress have increased firms’ financing costs controlling for country and firm-specific factors. Moreover, we estimate both to have significantly impaired the monetary transmission mechanism.
IWH Report "2014-2016"
in: One-off Publications, 2017
The Halle Institute for Economic Research (IWH) – Member of the Leibniz Association is an independent economic institute. Since its founding in 1992, it particularly focuses on structural change. This broad field is highly relevant to the future of the economy at both national and international levels – from issues of growth and alignment between East and West, dealing with the role of the financial system, with crises at the European level, and labour market and education issues.