Great Financial Crisis Aerdt Houben Director Financial Markets DNB - - PowerPoint PPT Presentation

Financial structure and monetary policy changes in the wake of the Great Financial Crisis

Aerdt Houben

Director Financial Markets DNB Professor of Financial Policies, Institutions and Markets at the University of Amsterdam

1985

• Charles Goodhart appointed Professor Banking and Finance

2

2019

• Mary Pieterse-Bloem appointed Endowed Professor Financial Markets

More than 30 years…

Key take-aways

• Financial structure matters for the economy
• Financial structure not that relevant for conventional monetary policy
• Financial structure very relevant for unconventional monetary policy
• Europe requires a more balanced and integrated financial structure

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Financial structure and the economy

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Bank-dominant economies

• Higher severity of negative bank supply shocks
• Less room for markets as an alternative source of financing
• Higher output costs in financial crises
• Higher systemic risks

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Implications: GDP growth

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Source: Gambacorta, Yang and Tsatsarnos (2014)

Implications: Output costs

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Source: Gambacorta, Yang and Tsatsarnos (2014)

Implications: Systemic risks

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0.01 0.02 0.03 0.04 0.05 1 2 3 4 5 6

Systemic risk

Bank over market debt and equity financing

Minimized

Source: Bats and Houben (2017)

US EMU

Financial structure and conventional monetary policy

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Conventional monetary policy

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Financial structure not that relevant

• Price stability as the main objective
• Interbank interest rates as the intermediate operational target
• Interest rates for non-financial sectors follow (monetary transmission)

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Interbank overnight interest rate

• 1

1 3 5 7 9 11 13 15 1970 1977 1984 1991 1998 2005 2012

German European: EONIA

Monetary transmission

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1 2 3 4 5 6 7 2007 2008 2009 2010 2011

Interest rates

Interbank overnight Bank loans NL sovereign 2-Yrs

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Effective lower bound

• 0.4
• 0.2

0.2 0.4 0.6 0.8 1 1.2 2009 2011 2013 2015 2017 2019

Interbank overnight interest rate

Unconventional times

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• Negative interest rates
• Forward guidance on interest rates
• Long-term refinancing operations
• Large-scale asset purchases

Financial structure and unconventional monetary policy

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Large-scale asset purchases

• Extract duration and credit risk
• Lower market term premia
• Increase demand for market debt
• Portfolio rebalancing effects to other debt and bank loans

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Asset purchases: financial structure matters

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Portfolio rebalancing effects are smaller when

• Capital markets are less developed
• Banks hold less market debt
• Banks primarily extend bank loans
• Banking market competition is low

Bank dominance requires a different instrument

Long-term refinancing operations

• Reduce bank funding uncertainty and costs, especially in liquidity crises
• Lower term premia and increase bank credit demand
• Stimulate bank lending

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Asset purchases versus refinancing operations

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Real economy Market debt Bank loans

Refinancing

• perations

Asset purchases

Direct effect Direct effect Portfolio rebalancing effects

Financial structure matters

• Mostly affects market financing

(bonds, equity)

• More effective in market-based

economies

Asset purchases

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• Mostly affects bank financing (loans)
• More effective in bank-based

economies and during liquidity crises

Refinancing operations

ECB versus FED

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Bank dependence in Europe…

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20 40 60 80 100 EMU USA

Private credit to non-financial sector (% of GDP)

Bank credit Market credit 20 40 60 80 100 120 140 160 180 US EMU

Stock market capitalization (% of GDP)

US EMU

… and heterogenous European markets…

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0.0 0.2 0.4 0.6 0.8 1.0 1999 2002 2005 2008 2011 2014 2017

Quantity-based indicator Price-based indicator

Financial integration indicators eurozone

…required continued ECB refinancing…

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0.0 0.5 1.0 1.5 2.0 2.5 200 400 600 800 1000 1200 1400 1600 1800 2007 2010 2013 2016

Allotted amount in billions (lhs) Euro area Libor-OIS spread in % (rhs)

Low market stress

…in contrast to the FED

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0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 500 1000 1500 2000 2500 3000 2007 2010 2013 2016

Allotted amount in billions (lhs) US Libor-OIS spread in % (rhs)

Balance sheets

26 1000 2000 3000 4000 5000

2003 2006 2009 2012 2015 2018

Balance (US dollars billinos)

FED

Lending All other assets 1000 2000 3000 4000 5000

2003 2006 2009 2012 2015 2018

Balance (EUR billions)

ECB

Lending All other assets

Continued refinancing has drawbacks

• Reliance on (public) central bank refinancing
• Discouragement of (private) market funding for banks
• Reduced incentives for bank discipline

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The way forward

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Balanced financial structures in Europe

• Reduce European bank dependence
• Integrate European capital markets
• Provide alternative financing through European markets

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Benefits

• Facilitate central bank intervention in crisis times
• Limit incentives for long-term refinancing operations
• Facilitate economic recovery
• Cushion bank supply shocks and lower systemic risk
• Share financial risks privately

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How to get there?

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Complete the Banking Union

• Consistent application of resolution rules
• European Deposit Insurance Scheme

Strengthen the Capital Markets Union

• Convergence in tax treatment of finance
• Streamline IPO prospectus regimes and reporting requirements
• Harmonize covered bonds regulation
• Convergence of European insolvency law