Title: Fragile Banks, Durable Bargains: Why Banking is All About Politics and Always Has Been
1Fragile Banks, Durable Bargains Why Banking is
All About Politics and Always Has Been
- Charles Calomiris
- and
- Stephen Haber
- Presented at World Bank Financial Structures
Conference - June 16, 2011
2The Puzzle to be Explained
- Why is it so hard to create banking systems that
are efficient and stable?
3This is especially puzzling because there is a
causal relationship between finance and growth
- Evidence from economic history (Gerschenkron
1962 Cameron 1967 Sylla 1975, 2006, 2008 North
and Weingast 1989 Neal 1990 de Vries and van
der Woude 1997 Rousseau and Wachtel 1998
Rousseau 2003 Rousseau and Sylla, 2003, 2004). - Evidence from cross-country regressions (King and
Levine 1993 Levine and Zervos 1998 Beck et. al,
2000). - Evidence from cross-regional studies (Jayaratne
and Strahan 1996 Black and Strahan 2002 Guiso,
Sapienza, and Zingales 2004, Cetorelli and
Strahan 2006 Dehejia and Lleras-Muney
2007Correa 2008). - Studies of finance dependent industries (Rajan
and Zingales 1998 Wurgler 2000 Cetorelli and
Gamberra 2001 Fisman and Love 2004 Beck,
Demirguç-Kunt, Laeven, and Levine 2007).
4More puzzling still considering that
- Banking crises are not in the interest of
politicians or bankers. - Banks are highly regulated and closely
supervised.
5Nevertheless, crises are endemic
6Many countries are under-banked
7And they tend to be the same countries
8Even more puzzling Crisis prone countries have
slower rates of credit growth
9And causality is not running solely from crises
to under-banking
10A very troubling implication
- Many under-banked economies repeatedly supply
credit imprudently - After a crisis is resolved, banks appear to once
again misallocate scarce credit.
11How do we resolve these paradoxes?
- In order for there to be a banking system, three
property rights problems have to be mitigated - Bank insiders, minority shareholders, and
depositors must be protected from expropriation
by the government. - Depositors and minority shareholders must be
protected from expropriation by bank insiders. - Bank insiders, depositors and minority
shareholders must be protected from expropriation
by debtors.
12Solving these property rights problems requires
institutions
- To solve problem of government expropriation,
institutions must be created that limit the
authority of government (veto points in
legislatures), or that compensate bankers for the
risk of expropriation (limits on competition to
raise rates of return). - To solve problem of expropriation of depositors
and minority shareholders, institutions must be
created that punish fraud and tunneling
(prudential regulation)-- or that compensate
depositors and minority shareholders for the risk
that they will be expropriated (limited
liability, deposit insurance, and limits on
competition). -
- 3. To solve problem of expropriation by
debtors, institutions must be created that allow
bankers to damage debtors reputational capital
(credit reporting), repossess physical collateral
(property registers, commercial and bankruptcy
law, courts and police)--or compensate bankers
for the possibility that they will be
expropriated (limits on competition to raise
rates of return, limited liability).
13Virtually all of these institutions involve the
government, which
- Allocates bank charters
- Supervises and regulates the banks.
- Enforces bank accounting standards.
- Enforces debt contracts.
- Runs the deposit insurance system.
14This creates a dilemma
- Any government strong enough to regulate banks,
protect against fraud and tunneling, and
adjudicate contracts is also strong enough to
expropriate the banks.
15Worse, the government is not a disinterested party
- The parties that control the government may have
their own financial interests. - The parties that control the government
simultaneously borrow from the banks and regulate
them. - The parties that control the government
simultaneously enforce debt contracts and may
need the political support of debtors. - The parties that control the government
simultaneously liquidate failed banks and
allocated the losses--but they may need the
political support of depositors.
16Even worse, the parties that control the
government have multiple margins for opportunism.
They can
- Expropriate banks outright.
- Monetize debt by printing money.
- Borrow from the banks and then renege on the
loans. - Raise reserve requirements and force the banks to
hold those reserves in government bonds that
yield negative interest rates. - Force banks to direct loans to government
enterprises. - Force banks to direct loans to politically
crucial constituencies. - Force banks to forgive or reschedule debts.
- Insure depositors beyond statutory limits.
- Show regulatory forebearance towards bank
insiders. - Rescue or bailout bank insiders, minority
shareholders, depositors, and debtors at the
expense of taxpayers.
17Worse still, economic actors cannot easily
monitor every margin
- Both the intent of reforms and their actual
economic consequences can be difficult to
determine ex ante. - This is especially the case if the government is
simultaneously reforming multiple institutions,
some of which potentially enhance the value of
property rights and some of which reduce them.
18Nor can economic actors rely on cross monitoring
- The incentives of bank insiders, minority
shareholders, depositors, debtors, and taxpayers
are not aligned. - This means that parties in control of the
government can exploit those differences in
incentives for their own ends.
19The Implication Its the politics, stupid
- The property rights institutions that underpins
banking systems are the product of political
deals. - These deals are about the creation and
distribution of economic rents and the
maintenance of political power. - The deals determine which laws are passed, which
judges are appointed, who bears the risk in the
event of loss, and which groups of people have
which licenses to contract with whom, for what,
and on what terms.
20All deals are not created equal
- Some political coalitions will generate deals
that produce a financial crisis. - Some political coalitions will produce a stable
banking system, but credit will be allocated
narrowly and growth will be constrained. - Some political coalitions will produce a stable
banking system, in which credit will be allocated
efficiently
21The basic autocratic deal
- A coalition can be formed between the parties in
control of the government and bank insiders to
create rents by limiting entry, compensating the
insiders for the risk of expropriation through
super-normal returns. - Minority shareholders are compensated for the
double-risk of expropriation by super-normal
returns. - The governments incentives are aligned through
loans and corruption. - Everyone else is a source of rent.
22Democracy changes the calculus, but it is not a
panacea
- Debtors can vote, making it harder to block entry
in the long run. - The authority and discretion of the parties in
control of the government are more limited,
meaning that insiders and minority shareholders
face lower expropriation risk. - But, mass politics creates a special problem
unless the owners of capital can exert influence
beyond their numbers, they are going to be
subjected to expropriation by debtors. - Their best move may be to pass the burden of
expropriation on to taxpayers.
23In order to study these coalitions and the deals
they generate, welook at what actually happened
- Our approach is to study the history of politics,
bank regulation, the structure of the banking
industry, and its performance over long time
spans for six cases - Scotland, England, USA, Canada, Mexico, Brazil
24A stable deal under autocracy Porfirian Mexico,
1876-1911
- The political system an autocracy that needed
to create a banking system for its own political
survival. - The deal
- A. Regulated entry and segmented
monopolies. - B. Special privileges for two banks.
- C. Credit for the federal and state
governments. - D. Rent sharing with politicians.
- E. Tunneling and fraud mitigated by
interlocking - directorates and high capital
ratios. - The coalition political elites, bank insiders,
and minority shareholders. - The outcome A stable banking system, a source of
public finance, but credit distributed very
narrowly.
25Mexicos Banking System Grew
26With a concentrated competitive structure
27Bank Shareholders Earned Rents
28And mostly lent to themselves
- Percent of non-government loans made to banks
own boards of directors - Banamex 1886 to 1901
100 - Mercantil de Veracruz 1898-1906 86
- Coahuila, 1908
72 - Durango, 1908
51 - Mercantil de Monterrey, 1908 31
- Nuevo León, 1908
29 - Source Maurer and Haber 2007.
29Limits on bank entry created barriers to entry in
downstream industries
30When Porfirian political institutions fell apart,
the banks were expropriated
31The subsequent regime could not generate a
coalition--so most credit had to come from
state-owned banks
32When deficits grew, the government expropriated
the banks
33When the banks were re-privatized the coalition
that was formed produced a banking crisis
34PRI leaders, bank insiders, and depositors
jointly expropriated minority shareholders and
taxpayers
35The initial coalition in the U.S. was between
federalists, bank insiders, and minority
shareholders
- At the state level, bank insiders received
charters and shared rents with state
governments--who in turn granted few charters. - These banks did not lend to all comers.
- The Bank of the United States was the
governments bank, the largest commercial bank,
and the only bank allowed to branch across state
lines. - In short, the U.S. banking system was made up of
segmented monopolies.
36This coalition was not stable given Americas
political institutions
- State-chartered bankers pressured their
Congressional delegations to not renew the
charters of the Banks of the United States. - State governments also had counter-incentives
- The need to finance public works
- Political demands to expand access to banking
services - State governments responded to these
counter-incentives - Political demands could be channeled through
suffrage and party competition - Suffrage expanded because of competition between
states
37An example Pennsylvanias Omnibus Banking Act
- Until 1814, Pennsylvania had only 4 banks, all
located in Philadelphia and owned by
Federalists--who only lent to Federalists. - The 1814 act (passed over the objections of the
states governor) ended the oligopoly, dividing
the state into 27 banking districts, and
allocated at least one bank to each district. In
all, it chartered 42 new banks. - Butreform meant creating monopolies in each
district! And they had to share rents with the
state government!
38The basic history of US banking
- Demands by debtors create smaller and smaller
monopolies through unit banking. - Unit bankers form a coalition with debtors and
parties in control of the government to block a
more competitive structure. - In short, the system of segmented monopolies not
broken down until the 1990s! - But even then, politics intervenes. It is
possible to get a coalition of bank insiders,
minority shareholders, and debtors expropriating
depositors and taxpayers.
39Conclusions and ImplicationsNo banking systems
outside of politics
- There are systematic differences in banking
systems between authoritarian and democratic
governments. - But parliamentary democracy, in and of itself,
does not necessarily produce efficient credit
markets. - Banking is a fragile plant.