microeconomic financial stability and economic performance...

Microeconomic financial stability and economic performance in

Europe

Jérôme Creel Paul Hubert

Fabien Labondance

FESSUD Research Project Amsterdam

17th to 19th October 2013

Motivations (1)

n  New EU regulations endorsing bank reforms (banking union) in order to improve financial stability

n  Financial stability is a public good (Boyer, Dehove, & Plihon, 2004)

n  After each financial crisis (banking crisis, ER crisis or financial crisis), new regulations are proposed to supervise and frame the financial system to preserve its properties as a public good (Cartapanis, 2011)

n  New interest for these research questions at the ECB, IMF, World Bank

n  To fight contagion towards other banks that may foster a systemic impact, financial stability has to be preserved q  Idiosyncratic shocks have the potential to become systemic through different

links: contractual, informational or psychological (Borio, 2003) q  Lehman Brothers’ bankruptcy in October 2008

FESSUD-‐Amsterdam 2

Motivations (2)

n  Financial stability in the EU Treaty as an objective of the European Central Bank : Article 127(2) “to smooth the conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system”

n  We showed elsewhere (deliverable 9.01) that controlling for

consumer price inflation may impede financial stability

n  The next question is: how do shocks to financial stability impinge on macro performance?


Outline

n  Related literature q  Finance and economic performance q  Financial stability

n  Data and Empirical Methodology

n  Results q  Financial depth and economic performance q  Microeconomic and macroeconomic financial stability q  Robustness tests

n  Conclusion


Related literature – Finance and economic performance (1)

n  Until recently the most prolific literature highlighted a positive causal

relationship between financial development and economic growth (Rajan & Zingales, 1998; Beck & Levine, 2004; Levine, 2005; Ang, 2008 )

q  Financial sector acts as a lubricant for the economy, ensuring a

smoother allocation of resources and the emergence of innovative firms.

q  These lessons were derived from models of growth (especially endogenous) and have been confirmed by international comparisons, in particular with regard to developing countries with small financial sectors.



n  Some more skeptical authors believe that the link between finance and economic growth is exaggerated (Rodrik & Subramanian, 2009)

q  De Gregorio & Guidotti (1995) argue that the link is tenuous or even non-existent in the developed countries and suggest that once a certain level of economic wealth has been reached, the financial sector makes only a marginal contribution to the efficiency of investment.

q  Beck (2012): o  The financial sector has abandoned its role as a facilitator of

economic growth in order to focus on its own growth. o  This generates the development of large banking and financial

groups that are “too big to fail”, enabling these entities to take excessive risks under the assumption that they will be covered by public authorities.

o  Their fragility is then rapidly transmitted to other corporations and to the economy as a whole. The subprime crisis clearly showed the power and magnitude of the effects of correlation and contagion.



n  In an attempt to reconcile these two schools of thought, a nonlinear relationship between financialization and economic growth has been postulated by a number of studies, including in particular Arcand, Berkes & Panizza’s (2012); Cecchetti and Kharroubi (2012) : q  Using a dynamic panel methodology (as Beck & Levine), they

explain per capita GDP growth by means of the usual variables of endogenous growth theory (i.e. the initial GDP per capita, the accumulation of human capital over the average years of education, government spending, trade openness and inflation) and then add to their model credit to the private sector and the square of this same variable in order to take account of potential non-linearity.

q  They find a concave relationship between economic growth and credit to the private sector.

q  The relationship between finance and growth is positive up to a certain level of financialization, and beyond this threshold the effects of financialization gradually starts to become negative.

q  The threshold (as a percentage of GDP) lies between 80% and 100% of the amount of loans to the private sector



n  While the level of financialization in the developed economies is above the thresholds, these conclusions point to: n  the marginal gain in efficiency that financialization can have on an

economy n  the need to control its development.

n  Our objective is thus:

q  To apply the Beck & Levine methodology only to EU countries and assess the relationship btw finance development and economic performance in this area

q  To include a wide scope of financial (in)stability variables to complement Beck & Levine (or Arcand et al.) earlier results


Related literature - A definition of financial stability (1)

n  Many academics and policy makers proposed definitions

n  Schinasi (2004) : financial stability represents the capacity of a financial system to absorb smoothly the different shocks this system has to face

n  but this definition includes a lot of different aspects that makes it impossible to reduce financial stability to a single indicator (Fleuriet & Lubochinsky, 2006)

n  A polymorphous concept

n  Micro/macro



n  At a micro level

q  markets structures (a high degree of concentration reinforces the contagion risks from a bank to another)

q  the financial institutions themselves (if their business model requires more or less risk)

n  At a macro level q  monetary stability

q  vigorous debate about the impact of monetary stability on financial stability. Some argue that monetary stability eliminates numerous sources of financial stability such as a wage-price spirals (Woodford, 2012). But some others argue that monetary stability can lead to financial instability as it sometimes allows low interest rates (« cheap money ») that favor projects with a high level of risk (Leijonhufvud, 2007)

q  functioning of the payment system q  domains organised and supervised by Central Banks, supervisory

authorities and private firms that ensure the well functioning of the payment system between the financial institutions. Failures in the supervision or in the payment system can lead to financial instability.



The complexity to define financial stability also involves practical difficulties. Schinasi (2004): 1.  Financial stability and financial instability cannot be summarized

in a single quantitative indicator; 2.  Financial instability is difficult to forecast; 3.  Because of exogenous shocks and because policy instruments only

impact indirectly on financial stability, developments in financial stability are only partly controllable;

4.  Financial stability policies are often viewed as a trade-off between resilience (stability) and efficiency .


Related literature - How to measure financial (in)stability? (1)

n  It is difficult to measure financial stability with a single indicator.

n  Gadanecz & Jayaram (2008) proposed a classification of these indicators according to six main sectors where instability can come from. q  real sector can be described either by the GDP growth (it indicates the extent to

which a country can create wealth); or fiscal position of the government (it shows the ability of the country to finance its policies), or various measures of inflation (it indicates the competitiveness of the country).

q  corporate sector if it is unable to reach its obligation in reimbursing its debt. It could trigger a contagion effect. Indicators: debt to equity, corporate liquidity, exposure to foreign exchange or corporate defaults.

q  household sector can be described by various indicators that measure its ability to react to economic downturns. We can measure its consumption, its debts or its assets.

q  external sector, change in competitiveness that affect the domestic debt sustainability. Indicators: real exchange rate, foreign exchange reserves and current account.

q  financial sector (banks, financial institutions). Indicators: real interest rate, monetary aggregates, and risk measures of the banking sector.

q  financial markets. Indicators: equity indices, corporate spreads, liquidity premia and volatility.



n  Composite/aggregate indicators

q  IMF, “financial soundness indicator” (from (at best) 2006 q1) q  ECB, “composite indicator of systemic stress in the financial

system” (only for EA)


.0

.1

.2

.3

.4

.5

.6

98 99 00 01 02 03 04 05 06 07 08 09 10 11

CISS_IDX


n  Banking indicator of financial stability (Uhde & Heimeshoff, 2009)

q  Bank z-score (source: Bankscope): probability of default of a country's banking system. Z-score compares the buffer of a country's banking system (capitalization and returns) with the volatility of those returns.

(ROA+(equity/assets))/sd(ROA)


-10

0

10

20

30

40

50

98 99 00 01 02 03 04 05 06 07 08 09 10 11

Z_AT Z_BE Z_BGZ_CY Z_CZ Z_DEZ_DK Z_EE Z_ESZ_FI Z_FR Z_GRZ_HU Z_IE Z_ITZ_LT Z_LU Z_LVZ_MT Z_NL Z_PLZ_PT Z_RO Z_SEZ_SI Z_SK Z_UK


n  Banking indicator of financial stability

q  Non performing loans: Ratio of defaulting loans (payments of interest and principal past due by 90 days or more) to total gross loans (total value of loan portfolio) “asset quality”


0

4

8

12

16

20

24

28

32

98 99 00 01 02 03 04 05 06 07 08 09 10 11

NONPERFLOANS_AT NONPERFLOANS_BE NONPERFLOANS_BGNONPERFLOANS_CY NONPERFLOANS_CZ NONPERFLOANS_DENONPERFLOANS_DK NONPERFLOANS_EE NONPERFLOANS_ESNONPERFLOANS_FI NONPERFLOANS_FR NONPERFLOANS_GRNONPERFLOANS_HU NONPERFLOANS_IE NONPERFLOANS_ITNONPERFLOANS_LT NONPERFLOANS_LU NONPERFLOANS_LVNONPERFLOANS_MT NONPERFLOANS_NL NONPERFLOANS_PLNONPERFLOANS_PT NONPERFLOANS_RO NONPERFLOANS_SENONPERFLOANS_SI NONPERFLOANS_SK NONPERFLOANS_UK


n  Financial markets indicator of financial stability

q  Volatility Volatility of stock price index (Vix) is the 360-day standard deviation of the return on the national stock market index. (source: Bloomberg) q  Stock market capitalization to GDP Total value of all listed shares in a stock market as a percentage of GDP. q  Market capitalization growth rate


Related literature - What economic performance?

n  Following Stiglitz, Sen, & Fitoussi (2009), we intend to analyze

various indicators of economic performance

n  The most obvious is the per capita GDP growth rate.

n  Stiglitz, Sen, & Fitoussi (2009) indicate that two other aggregate indicators are more relevant to explain economic performance: q  Real disposable income q  Household consumption


Data & Empirical Methodology (1)

n  Following Beck & Levine (2004), we assess the relationship btw economic performance and microeconomic financial stability in a panel regression. We use the GMM estimators with the 2 steps-procedure developed by Arellano & Bond (1991) (endogenous problems, FE, autocorrelation, small T & larger N)

q  i and t represent respectively country and time period, q  yi,t is our dependent variable of economic performance, q  yi,t-1 is its lagged value, q  Xi,t is a set of explanatory (endogenous-growth related)

variables, q  Zi,t includes explanatory variables of financial stability and q  εi,t is the error term that includes country-specific effect and

time-specific effect


Data & Empirical Methodology (2)

n  Annual data from 1998 to 2011

n  27 EU countries n  Sources: Eurostat,

UN &World Bank (plus the sources of above-mentioned financial (in)stability indicators)


Results - Financial depth and economic performance


!"#$%&'(&)%*+,-"./&01*"-2+&3"*%$&4562-"627*5&Economic Performance

GDP per capita Growth rate

Consumption per capita Growth rate

Disposable Income per capita Growth rate

(1) (2) (1) (2) (1) (2) Private Credit -0,001

[0,640] -0,001* [0,000]

-0,001 [0,001]

-0,001 [0,001]

-0,001 [0,001]

-0,001 [0,001]

Turnover Ratio 0,000 [0,000]

-0,001 [0,001]

0,000 [0,001]

Initial Economic Performance

-0,145** [0,066]

-0,101* [0,053]

0,146*** [0,044]

-0,122** [0,049]

-0,109 [0,102]

-0,082 [0,146]

School 0,063 [0,161]

0,094 [0,100]

0,011 [0,076]

0,035 [0,065]

0,070 [0,199]

0,021*** [0,145]

Government Consumption

-0,354*** [0,128]

-0,384*** [0,125]

-0,095 [0,181]

-0,139 [0,154]

0,328*** [0,125]

-0,320*** [0,118]

Inflation rate 0,001 [0,005]

0,001 [0,006]

0,006 [0,006]

0,006 [0,006]

0,009 [0,008]

0,009** [0,004]

Trade Openness 0,358** [0,180]

0,279* [0,143]

0,327** [0,130]

0,301** [0,117]

0,260 [0,237]

0,223* [0,133]

Constant 1,065* [0,640]

0,995* [0,533]

0,465 [0,650]

0,418 [0,540]

0,971 [0,642]

0,964 [0,696]

Sargan test 16,94 16,23 16,89 15,86 17,51 15,32 p-value 0,99 0,99 0,99 0,99 0,98 0,99

AR1 -2,05 -2,31 -1,99 -2,00 -2,33 -2,26

p-value 0,04 0,02 0,05 0,04 0,01 0,02

AR2 -1,35 -1,20 -0,81 -0,75 -2,17 -2,68

p-value 0,18 0,22 0,42 0,45 0,03 0,00

Countries 27 27 27 27 26 26

Obs 246 246 243 243 223 223

Robust standard errors in brackets. * p<0.1, ** p<0.05, *** p < 0.01. Data source: World Bank & Eurostat.

Results - Microeconomic and macroeconomic financial stability


!"#$%&'(&)*+",-.&/"+%$&%01-,"1-2+03,".42%.2+2,-.&5-+"+.-"$&-+01"#-$-1*&Economic Performance

GDP (1) (2) (3) (4) (5) (6) (7) (8) Systemic Stress -0,057**

[0,026] -0,51**

[0,0245] -0,069** [0,033]

-0,054** [0,026]

Systemic Stress (-1)

-0,008 [0,049]

0,064 [0,043]

-0,036 [0,053]

0,034 [0,047]

Private Credit -0,001 [0,001]

-0,000 [0,001]

-0,001** [0,001]

-0,001** [0,001]

Turnover Ratio -0,000 [0,000]

-0,000 [0,001]

-0,000 [0,000]

-0,000 [0,000]


-0,256*** [0,073]

-0,123** [0,057]

-0,254*** [0,052]

-0,112*** [0,037]

-0,292*** [0,088]

-0,136** [0,066]

-0,257*** [0,078]

-0,119*** [0,036]

School -0,002 [0,172]

0,015 [0,110]

0,096 [0,149]

0,039 [0,104]

-0,015 [0,118]

0,035 [0,108]

0,074 [0,128]

0,099 [0,090]


-0,227 [0,161]

-0,337*** [0,113]

-0,290* [0,156]

-0,349** [0,142]

-0,278 [0,170]

-0,412*** [0,110]

-0,306 [0,191]

-0,439*** [0,115]


0,004 [0,005]

0,007 [0,007]

0,002 [0,005]

0,004 [0,005]

0,004 [0,006]

0,003 [0,007]

0,003 [0,004]

Trade Openness 0,504*** [0,159]

0,318** [0,136]

0,456*** [0,141]

0,316*** [0,112]

0,503** [0,218]

0,346*** [0,128]

0,436* [0,237]

0,301** [0,099]

Constant 1,238* [0,641]

1,028* [0,566]

1,405** [0,581]

0,926 [0,697]

1,796*** [0,627]

1,267*** [0,390]

1,613* [0,842]

1,206** [0,481]

Sargan test 18,34 16,80 18,05 15,32 18,43 13,86 17,76 12,67 p-value 0,98 0,99 0,99 0,99 0,98 0,99 0,99 0,99 AR1 -2,46 -2,16 -2,69 -2,31 -2,34 -2,20 -2,54 -1,95 p-value 0,01 0,03 0,00 0,02 0,02 0,03 0,01 0,05

AR2 -2,51 -1,52 -2,32 -1,73 -1,92 -0,91 -2,19 -1,20

p-value 0,01 0,13 0,02 0,08 0,05 0,36 0,03 0,23

Countries 27 27 27 27 27 27 27 27

Obs 270 246 270 246 270 246 270 246 Robust standard errors in brackets.* p<0.1, ** p<0.05, *** p < 0.01. Data source: World Bank, ECB & Eurostat.



Economic Performance

GDP (1) (2) (3) (4) (5) (6) Non performing loans

-0,012*** [0,002]

-0,012*** [0,002]

-0,010** [0,004]

-0,011*** [0,003]

-0,011*** [0,001]

-0,010** [0,004]

Systemic Stress -0,021 [0,025]

-0,043** [0,021]


-0,001 [0,001]

0,000 [0,000]

Turnover Ratio -0,001* [0,000]

-0,001 [0,001]

-0,001* [0,000]


-0,242*** [0,046]

-0,220*** [0,048]

-0,152*** [0,046]

-0,138*** [0,052]

-0,227*** [0,071]

-0,126** [0,056]

School 0,039 [0,107]

0,098 [0,154]

0,137 [0,216]

0,161 [0,162]

-0,021 [0,172]

0,166 [0,169]


-0,427*** [0,108]

-0,458*** [0,117]

-0,420*** [0,154]

-0,399** [0,169]

-0,303** [0,134]

-0,447*** [0,099]


0,004 [0,005]

0,003 [0,005]

0,003 [0,007]

0,005 [0,007]

0,006 [0,007]

Trade Openness 0,409*** [0,105]

0,333** [0,157]

0,227 [0,198]

0,210 [0,173]

0,414** [0,209]

0,159 [0,190]

Constant 2,005*** [0,415]

2,089*** [0,352]

1,626 [1,102]

1,502** [0,735]

1,622*** [0,353]

1,668*** [0,483]

Sargan test 16,69 19,64 20,82 18,09 22,99 17,17 p-value 0,96 0,97 0,96 0,99 0,92 0,99 AR1 -1,84 -1,94 -2,44 -2,07 -1,96 -2,24 p-value 0,07 0,05 0,01 0,04 0,05 0,03 AR2 -1,46 -1,25 -1,26 -1,31 -1,25 -1,39 p-value 0,14 0,21 0,21 0,19 0,21 0,16 Countries 27 27 27 27 27 27 Obs 241 241 219 219 241 219

Table 6: Dynamic Panel estimations- non performing loans macroeconomic financial instability

Robust standard errors in brackets.* p<0.1, ** p<0.05, *** p < 0.01. Data source: World Bank, ECB &

Eurostat.



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Economic Performance

GDP (1) (2) (3) (4) (5) (6) z-score 0,001

[0,001] 0,001

[0,001] 0,001

[0,001] 0,000

[0,000] 0,000

[0,001] 0,000

[0,000] Systemic Stress

-0,039 [0,027]

-0,040 [0,028]

Private Credit

-0,001 [0,001]

-0,000 [0,000]

-0,000 [0,000]

-0,000 [0,001]

Turnover Ratio

-0,000 [0,000]

-0,000 [0,000]

-0,000 [0,000]


-0,301*** [0,076]

-0,277*** [0,091]

-0,133*** [0,051] -0,123**

[0,053]

-0,125*** [0,046]

-0,114*** [0,038]

School 0,015 [0,184]

0,056 [0,174]

0,051 [0,124]

0,058 [0,104]

0,028 [0,094]

0,069 [0,112]


-0,338** [0,167]

-0,388** [0,162]

-0,371*** [0,095]

-0,388*** [0,149]

-0,314*** [0,112]

-0,368*** [0,112]


0,006 [0,007]

0,001 [0,005]

0,001 [0,059]

0,003 [0,004]

0,003 [0,004]

Trade Openness

0,494** [0,206]

0,437 [0,281]

0,336** [0,149]

0,322** [0,158]

0,321*** [0,101]

0,282*** [0,099]

Constant 2,031*** [0,545]

2,076*** [0,559]

1,108* [0,568]

1,107* [0,621]

0,952* [0,497]

1,064* [0,551]

Sargan test 17,82 18,20 16,06 16,69 12,96 13,69 p-value 0,99 0,98 0,99 0,99 0,99 0,99

AR1 -2,21 -2,49 -2,02 -2,12 -2,02 -2,05

p-value 0,03 0,01 0,04 0,03 0,04 0,04

AR2 -1,99 -1,91 -1,31 -1,18 -1,73 -1,64

p-value 0,05 0,05 0,19 0,24 0,08 0,10

Countries 27 27 27 27 27 27

Obs 269 269 245 245 245 245

Robust standard errors in brackets.* p<0.1, ** p<0.05, *** p < 0.01. Data source: World Bank, ECB & Eurostat.



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Robust standard errors in brackets.* p<0.1, ** p<0.05, *** p < 0.01. Data source: World Bank, ECB & Eurostat!

GDP (1) (2) (3) Volatility 0,001

[0,001]

Capitalization -0,000 [0,001]

Capitalization growth -0,007 [0,015]


-0,055** [0,024]

-0,062* [0,037]


-0,001 [0,001]

-0,000 [0,000]



-0,089* [0,050]

-0,162** [0,070]

-0,128** [0,058]

School 0,098 [0,128]

-0,016 [0,109]

0,018 [0,113]

Government Consumption -0,371*** [0,110]

-0,288* [0,147]

-0,333*** [0,129]


0,001 [0,007]

0,003 [0,005]

Trade Openness 0,268* [0,156]

0,424** [0,166]

0,324** [0,144]

Constant 0,829 [0,616]

0,895* [0,529]

1,035* [0,596]

Sargan test 14,91 16,53 16,71 p-value 0,99 0,99 0,99 AR1 -2,28 -1,98 2,19

p-value 0,02 0,04 0,02 AR2 -2,65 -1,72 -1,57

p-value 0,00 0,08 0,12

Countries 26 27 27

Obs 206 246 246

Results - Robustness


!"#$%&''(&)*#+,-.%,,&%,-/0"-/*.,123."0/4&5".%$&%,-/0"-/*.,16&3%"7,&87*9-:&Economic Performance

GDP (1) (2) (3) (4) Non performing loans

-0,008*** [0,002]

-0,009*** [0,003]


-0,116*** [0,041]


-0,001 [0,001]

-0,001 [0,001]

-0,001 [0,001]


-0,001 [0,001]

-0,001 [0,001]

-0,001 [0,001]


-0,232*** [0,055]

-0,201*** [0,046]

-0,167*** [0,050]

-0,067 [0,083]

School 0,411* [0,232]

0,511* [0,271]

0,407** [0,183]

0,587*** [0,174]


-0,376*** [0,141]

-0,345*** [0,119]

-0,283* [0,152]

-0,291** [0,137]

Inflation rate -0,001 [0,016]

-0,005 [0,017]

0,003 [0,011]

-0,014 [0,014]

Trade Openness 0,148 [0,109]

0,142 [0,105]

0,064 [0,079]

-0,020 [0,096]

Constant 1,968*** [0,525]

1,373** [0,539]

1,436** [0,612]

0,474 [0,663]

Sargan test 16,84 20,38 16,51 19,31 p-value 0,21 0,12 0,28 0,19 AR1 -1,683 -2,05 -1,59 -2,78

p-value 0,09 0,04 0,11 0,00

AR2 -0,42 -0,49 -1,02 -0,81

p-value 0,67 0,62 0,31 0,42

Countries 27 27 27 27

Obs 73 73 67 67


Results - Robustness


!"#$%&'()&*+#,-./%--&%-.01".0+/-&234/"105&6"/%$&%-.01".0+/-27&4%"8-&98+:.;&Economic Performance

GDP (1) (2) (3) (4) Non performing loans

-0,004*** [0,001]

-0,004*** [0,001]

Systemic Stress 0,006 [0,043]

0,008 [0,034]


-0,001 [0,001]

0,000 [0,000]

-0,000 [0,001]

Turnover Ratio -0,001* [0,001]

-0,001** [0,001]

-0,001* [0,000]

-0,001 [0,001]


-0,123*** [0,017]

-0,127*** [0,023]

-0,099*** [0,078]

-0,103*** [0,020]

School 0,141 [0,098]

0,146 [0,091]

0,141* [0,078]

0,141* [0,083]


-0,181** [0,083]

-0,187** [0,082]

-0,237*** [0,082]

-0,235*** [0,086]


0,006 [0,013]

-0,003 [0,010]

-0,004 [0,009]

Trade Openness 0,166* [0,086]

0,171** [0,081]

0,059 [0,082]

0,059 [0,086]

Constant 0,829 [0,525]

0,843* [0,460]

1,194*** [0,411]

1,223*** [0,446]

Sargan test 15,32 14,18 11,78 11,57 p-value 0,05 0,11 0,23 0,32 AR1 -1,03 -1,02 -1,79 -1,67

p-value 0,29 0,31 0,07 0,10

AR2

p-value

Countries 27 27 27 27

Obs 53 53 52 52


Conclusions

n  We assess the links between financial stability and economic performance

n  We replicate a “seminal” methodology to the EU

n  Main results: q  No relationship between finance depth & economic

performance in the EU countries q  But, both indicators of macro and micro financial stability have

a significant and negative effect on economic performance q  The introduction of non performing loans permits to identify

how important the bank lending channel can be

n  Extensions q  Introduction of other indicators of economic performance q  Introduction of interaction terms q  Other financial stability indicators


Policy implications

n  Preliminary results confirm the necessity of dealing with:

q  The link btw micro and macro prudential policies (crucial question of the banking union)

q  The argument of various banking lobbies, i.e. that regulating the size and growth of the financial sector would negatively impact the growth of the economies in question, as it is not supported by the data in the case of the EU countries


microeconomic financial stability and economic performance...

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