Thorsten Beck
Financial services and economic development
Finance – why do we care?
ALB
ARG
AUS AUT
BDI BEL BENBHR BGR BGD
BLZ
BOL
BRA
BRB
BRN BWA
CAF
CAN
CHE CHL
CIV CMR COG
COL CRI
CYP DNK DEU
DZA
ECU EGY ESP
EST FIN
FJI FRA
GAB
GBR
GHA GRC GMB
GTM
GUY HKG
HND
HUN
IDN IND
IRL
IRN ISL
ITAISR
JAM JOR
JPN
KEN KOR
LKA LSO
LUX
LVA
MAR
MEX
MLI MLT MOZ
MRT MUS
MWI
MYS
NER NLD NOR
NPL
NZL PAK
PERPAN
PHL PNG
PRT
PRY ROM
RWA
SAU SDN
SEN SGP
SLE
SLV SWE SWZ
SYR
TGO
THA
TTO
TUN TUR
URY
VEN USA
ZAF
ZMB
-0.04 -0.02 0.00 0.02 0.04
GDP per capita growth
-2.00 -1.00 0.00 1.00 2.00
Private Credit to GDP
Finance – why do we care?
ALB
DZA BGD
BOL
BWA BRA
BGR
BFA BDI
CMR CHL
COL
CRI CIV HRV
DOM ECU
EGY ETH SLV
GMB GHA
GTM
GUY HND HUN IDN
IRN
JAM KEN LAO
LSO
MKD MDG
MWI
MYS MLI
MRT MEX MNG
MAR NPL
NIC NER
NGA
PAK PAN
PRY PER
PHL ROM POL
RWA
SEN
SVN
ZAF LKA
THA TTO
TUN TUR
UGA
URY VEN
VNM YEM
ZMB ZWE
-0.40 -0.20 0.00 0.20
Growth in headcount
-2.00 -1.00 0.00 1.00 2.00
Private Credit to GDP
Financial intermediation and growth
Finance is pro-growth and pro-poor
Provides payment infrastructure for real economy
Intermediates savings from savers to private and public sector
Allocation function is critical!
Impact through productivity growth and reallocation of capital more important than through capital accumulation
More firm entry and firm growth to optimal size
More innovation and better capture of growth opportunities
Positive impact through governance
Pro-poor effects through indirect channels, including labor market, migration etc.
Important non-linearities: effect strongest for middle- income countries; effect more through enterprise than household credit
The dark side of finance
Fragility is at core of intermediation function
Risks both on funding (bank run, market freeze) and asset side (agency problems)
Opacity of banks’ balance sheets
Free-rider problem undermines market discipline
Externalities of bank failure for rest of financial system and real economy
Domino, hostage, fridge problems
Externalities of bank failure lead to establishment of (implicit or explicit) financial safety net
(subsidy)
…with disastrous repercussions for society
Output losses relative to potential output;
Source: Laeven and Valencia (2010)
What role for financial globalization?
Different modes
Cross-border equity investment (direct, portfolio etc.)
Cross-border lending (to banks, to customers)
Foreign direct investment by financial institutions
Access to financial services in other countries
Focus on foreign bank entry
To which extent can foreign banks contribute to financial deepening and economic growth/poverty reduction through the channels outlined above?
To which extent can cross-border banking undermine stability?
Domestic vs. foreign banks – the theory
Foreign banks can bring
New resources (especially after crisis)
Bring more competition (but not always)
Help upgrade technology and regulatory standards
Thus ultimately help deepen financial systems
…but can also
Increase volatility
Cherry pick clients and crowd out banks that serve low-end clients
Thus increase shallowness and fragility
But what about reality?
Stability – mixed - mitigating against local real-sector shocks, but can propagate home-country shocks
Efficiency – mostly positive, unless in non-competitive environment
Benefits contingent on contractual and information framework in economy, competition etc.
Access – ambiguous results, with important regional variation
Central/Eastern Europe – overall positive effect, helped build up financial markets, served as macroeconomic disciplining tool
Latin America – mixed – consider Mexico
Africa – hampered by other constraints
Critical differences according to size of subsidiary/branch
Cross-border banking is changing face, with regional banks gaining importance
Important stability concerns
Failure of cross-border bank imposes costs on foreign stakeholders that are not taken into account by home country supervisor; too lenient approach vis-à-vis global banks
Contagion effects through common asset exposures, fire sale externalities, informational contagion,
interbank exposures etc.
Within-in monetary union: additional externalities
Close link between monetary and financial stability
Lack of exchange rate tool exacerbates impact of asymmetric shocks
Common lender of last resort leads to tragedy of commons problem, as in Eurozone
Regulatory arbitrage possible
Summary
Finance is critical for modern market economies and economic growth
How to harness the best of financial globalization while minimizing risks?
Competition, diversification, infrastructure as necessary conditions for reaping benefits of cross- border banking
Sound and effective supervision and resolution framework on national level
Better supra-national framework needed for regulation and resolution of cross-border banks
Example: banking union in Europe as first step into right directions
Example: Living wills for G-SIFIs
