December 12, 2018
Volker Wieland, IMFS und Sachverständigenrat
"Setting the right course for economic policy"

The German Council of Economic Experts has lowered its growth forecast for the German economy to 1.6 percent in the ongoing year. The German economy is maintaining one of its longest upswings. However, the pace of expansion is slowing down. As an open economy, Germany is highly sensitive to global developments, Prof. Volker Wieland warned at the presentation of the Council’s recent annual report entitled “Setting the right course for economic policy”. The title already implies that there are several approaches in order to prepare the German economy for the anticipated downturn. “Due to its extremely high ratio of foreign trade to GDP, currently at 84 percent, Germany is particularly affected by the risks caused by US trade policy,” Wieland explained.

Besides the uncertain future of the global economic order, the demographic change represents a domestic challenge for the German economy. The old-age dependency ratio that is the ratio of people aged over 65 to those between 20 and 64, which is around 35 percent at present, will rise dramatically after 2025 to more than 50 percent in the year 2050, Wieland illustrated. Therefore, in the Council’s view, it is absolutely necessary to adjust the retirement age to the rising life expectancy and to increase the potential labor force. Here, Wieland referred to measures such as the flexibilization of working time and the expansion of part-time employment in combination with all-day childcare. Another crucial aspect are the chances offered by digitalization, Wieland emphasized. According to the Council, the reduction of regulation and the growing acceptance among the population are more important than expanding broadband access.

Slides (PDF)

Prof. Wolf-Georg Ringe, University of Hamburg
"The Dark Side of Bank Resolution: Counterparty Risk Through Bail-in"

The bail-in of financial institutions has been praised as one of the most significant achievement after the financial crisis since the losses are imposed on creditors instead of taxpayers. In his lecture, Prof. Georg Ringe, Chair for the Economic Analysis of Law at the University of Hamburg, argued that the effects of the bail-in tool actually might be counterproductive.

Based on the recognition that traditional bankruptcy laws weren’t an appropriate framework, after the collapse of the investment bank Lehman Brothers the idea was “to reintroduce normal market discipline into the banking sector”, Ringe explained. However, a bail-in of creditors is only possible if the holding company holds enough capital. Therefore, the Bank Recovery and Resolution Directive (BRRD) contains the rulings regarding MREL, the Minimum Requirement for Own Funds and Eligible Liabilities, and the Financial Stability Board (FSB) issued the final Total Loss-Absorbing Capacity (TLAC) standard for global systemically important banks (G-SIBs).

In the new regulation, the systemic risk is externalized via counterparty selection. “But how effective a bail-in is depends on who those counterparties are”, Ringe said. Based on the Securities Holdings Statistics (SHS) by the European Central Bank (ECB), he found that after 2016, banks were increasing their holdings in banks’ securities whereas non-banks were reducing them. In his opinion, these interconnections between banks may exacerbate the propagation of systemic risk. “Banks have an interest in investing in other banks as this interconnectedness may help them when suffering small shocks”, Ringe explained. In large shocks, this situation is reverse, according to Ringe. “With large shocks, the regulators may actually shy away from doing something because of the interconnectedness”. Hence, Ringe advises against any ex-ante prescriptions. “Transparency is the key and the optimal risk design really depends on the type of systemic risk”.

Peter Lutz, Federal Financial Supervisory Authority (BaFin)
„Brexit: Challenges for Banks and Supervisors - A Supervisor's Perspective“

Four and a half months before Brexit, the treatment of derivate contracts is the area of most concern for Peter Lutz of the Federal Financial Supervisory Authority (BaFin). In his speech in the Working Lunch series, the Head of Department Coordination & Supervision of Foreign Banks described the potential cliff effects as the BaFin is trying to ensure the proper functioning and stability of the German financial system when the United Kingdom will leave the European Union at the end of March 2019.

As banks in the UK have to decide whether to wind down their business or get a new licence for a European country, the BaFin is dealing with more than 40 applications for a licence. Three to four people cover a case, Lutz said. In this regard, the BaFin strives to avoid arbitrage, making an effort to finalize the approval process in time. “In the pre-application phase, we try to come closer with the banks in our explanations what we want to see. When the plans become clearer we involve the ECB”. An issue that is discussed in the great detail is the operating model. Here, the BaFin underlines that letterbox firms are not allowed. Adequate management and staffing is a prerequisite according to Lutz. On the other hand, the question of dual hatting also arises. Can the same person act as a manager of the bank and the investment firm of an institution? Besides, only for a certain time does the BaFin tolerate that banks use services in London or still provide business from London to a bank in a EU27 country. Internal risk models that have been already approved by the British Prudential Regulation Authority (PRA), a division of the BoE, can be used within a limited timeframe. The BaFin is trying to keep a supervisory balance between maintaining a level playing field and making allowances for Brexit being an external effect, Lutz explained. Also the authorities have to cooperate. “The day the UK will become a third county a Memorandum of Understanding is needed”.

However, Lutz pointed out that some issues such as the treatment of derivative contracts cannot be solved by the national authorities. Therefore, he ended the lecture with a plea to the banking sector. “What we want to see is some movement in the industry, not only waiting for legislation”.

The slides of the lecture.

May 5, 2018
Tobias Adrian,
International Monetary Fund
"The Current Global Financial Stability Assessment"

Although financial conditions are easy in every major region of the world, the economy is facing “a bumpy road ahead”. This is the punchline of Tobias Adrian’s Working Lunch talk. Adrian, who is an IMFS Research Fellow, is Director of the Monetary and Capital Markets Department of the International Monetary Fund (IMF) and Financial Counsellor to Christine Lagarde.

As a result of easy financial conditions persisting for many years, a lot of risk has been building up, Adrian who is also responsible for the IMF’s Global Financial Stability Report (GFSR) explained. This report assesses the key risks facing the global financial system. Whereas one year into the future conditions still look good, Adrian emphasized that the situation is totally different for a three-year horizon: “In the medium-term we see a lot of risk”. In comparison with the year 2000, those medium-term estimates for global GDP growth are even at a lower range.

According to Adrian, there are various aspects of underlying vulnerabilities: First of all, the global equity rally has pushed valuations higher worldwide. Markets are not pricing in a significant likelihood of sharply higher inflation.

Regarding credit quality, Adrian warned that underwriting standards keep deteriorating. The demand for risky assets has compressed credit spreads. On the other hand, the global reach for yields has driven investor flows to private equity funds. “The leveraged loans market is at an all-time high, private equity funds are important players,” he pointed out. As a consequence of the weakening credit quality, the nonbank investor base is growing.

With regard to emerging markets and low-income countries, Adrian cited the situation in China, which accounts for a considerable proportion of the 400 percent increase in total financial assets to GDP. In contrast to this, China has only five big banks and some small and medium-sized banks. This in turn has led to a very large shadow banking sector in China where a lot of risk is embedded, similar to the Chinese insurance sector, which he also considers very risky.

According to Adrian, another important source of vulnerability lies in the banking sector. Although banks are much safer than before the global financial crisis, having a higher level of liquidity, they end up pooling a lot of assets in US dollar, Adrian warned. Therefore, “we urge regulators to also look at the currency level”.

In Adrian’s view, the risky situation is intensified by the political environment. “Trust in political institutions is eroding around the world, which generates a lot of risk.” In this case, neither historical data nor models help. “We don’t know where this will end up,” Adrian concluded.

Download the presentation (PDF, 2,73 MB)

February 22, 2018
Stephen L. Schwarcz,
Professor of Law & Business, Duke University School of Law
"Central Clearing of Financial Contracts: Theory and Regulatory Implications"

Modern financial regulation requires that derivatives contracts be cleared and settled through central counterparties, such as clearing houses affiliated with derivatives and commodities exchanges, in order to try to reduce systemic risk. In his Working Lunch, Stephen Schwarcz, Professor of Law at Duke University, examined whether regulators should also require the central clearing of non-derivative financial contracts.

In the aftermath of the financial crisis, the Financial Stability Board (FSB) felt that derivatives were inherently risky, given that fact they are debt and volatile. Therefore, by concentrating it on a CCP, the overall systemic risk should be reduced. However, as Schwarcz pointed out, the net counterparty exposure on non-derivative financial contracts greatly exceeds that on derivatives contracts. He raised the question whether derivatives were truly riskier than other types of financial contracts.

As he further pointed out, CCP often started out as special purpose entities (SPE). As they have expanded their tasks, Schwarcz claimed they should be ringfenced as a way to protect other clearing members against the accumulated risk. However, according to Schwarcz, it is very hard to formulate specific laws to achieve this. Typically, regulators don’t direct major financial institutions how to control their risk. He came to the conclusion that even the multi-lateral netting of non-derivative financial contracts does not systematically reduce risk.

February 2, 2018
Robert Kaplan, President,
Federal Reserve Bank of Dallas
"A Discussion of U.S. Macroeconomic Trends and Their Implications for U.S. Monetary Policy"

For Robert Kaplan, President of the Federal Reserve Bank of Dallas, technology-enabled disruption is one of the major economic trends, which will shape the future. However, in his opinion the recent drop at the stock market is likely to be a healthy correction instead of the beginning of a new crisis. In his talk at the IMFS Working Lunch, Kaplan shared his insights on macroeconomic trends in the United States, comparing it to the economic development in Germany with Volker Wieland as his interview partner.

With regard to the emergence of dominant technology companies in the United States, such as Google or Amazon, Kaplan pointed out the importance of soft factors. “Apart from investment, you need an ecosystem for such companies”, referring to infrastructure, education and universities. These conditions were abundant in California as well as in the Boston area. However, “passion is the rocket fuel for innovation, not money”, Kaplan concluded. In this context, he also emphasized the importance of education and life-long training. “In the US, we’re lagging behind in helping people getting trained for middle-skill jobs”.

In his opinion, technology-enabled disruption is one of the permanent economic developments in the US, together with the slowing workforce growth and rising government debt. As for the demographic development, Kaplan said that 50 per cent of the workforce growth in the last twenty years was due to immigrants and their children. He expects the demographic situation to limit the way the central bank will apply fiscal policy in the future. Since September 2015, Kaplan has served as President of the Dallas Fed. He is a non-voting member of the Fed’s policy committee.

Regarding the implications for monetary policy, Kaplan told the audience that higher wages in the United States will not necessarily lead to faster inflation. Although the United States were nearly at full-employment – one of the goals forming the Fed’s mandate – Kaplan was not convinced that this would translate into higher prices because businesses had much less pricing power due to technological advances. According to Kaplan, the Fed should continue to tighten monetary policy. “If you have significant enough overshoot of full employment, history shows that usually other excesses and imbalances build up”, he warned.

Photo Gallery of the event