"The great divide and beyond: financial architecture in transition" and "Law enforcement, fiscal res

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"The great divide and beyond financial
architecture in transition"and"Law enforcement,
fiscal responsibility and economic
development"byErik Berglof and Patrick Bolton

• Discussion by
• Renato Filosa
• Bank for International Settlements
• renato.filosa_at_bis.org
• Sveriges Riksbank-IIES Conference on "Monetary
  policy and financial markets in an enlarged
  European Union"Stockholm, 17-18 May 2002

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Main conclusions of the papers

• Great Divide visible in most measures of economic
  and financial performance
• Great Divide originates from differences in
  ability to pursue macrostability and the
  enforcement of laws
• Remarkable differences in policies followed by
  ATEs and yet remarkable similarity in their
  financial architecture
• Weak link between growth and financial development

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Similarities in financial structures

• Financial sector dominated by large and
  foreign-owned banks
• High concentration of banking sector
• Concentrated ownership of corporates and low
  turnover of shares
• "Low and stable" banks' spreads
• Financial markets will play an important role
  only at a more advanced stage of development

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Modelling successful transition

• Main requirements
• "middle class consensus" (ie limited ethnic and
  wealth inequalities and ex-post return)
• existence of "financial markets" where
  households/investors/median voters can borrow

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Discussion

• Why is the link between growth and financial
  development weak?
• Why have financial systems evolved they way they
  did?
• Are ATEs' financial systems really homogeneous?
• How would financial systems evolve in the future?

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Explaining the Solow residual

• Stock market liquidity and banks predict growth
  even after controlling political economy factors
  (Levine-Zervos (1998))
• Financial development failures and successes
• wrong upstream linkages with corporates
  Kreditanstalt and German banks (1930s), Chile
  (1982), Asia (1990s)
• right upstream linkages with corporates German
  banks pre-WWI and post-WWII
• Czech wrong voucher policy
• too liberal policy of banking licensing

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Why have financial systemsevolved the way they
did?

• The US principle of equitable subordination
• The "legal pragmatism" in the US and the European
  acceptance of cartelisation and government
  ownership
• "Closed information systems" vs "open information
  systems"
• (Bisignano 2001)

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Why have financial systems in ATEs evolved the
way they did?

• Regulatory regime inspired by EU framework
• Legal system
• (a) strong rights of shareholders and weak rights
  of creditors relative to EU countries
• (b) law enforcement uniformly below EU median
• 2. Regulatory and supervisory regime
• capital adequacy weaker than EU
• formal powers of supervisors very strong but low
  enforcement and high forebearance
• market discipline low but perfectly matching EU
  systems

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Weak link between growth and financial
development?

• One strong conclusion of the model development
  of capital markets promotes establishment of rule
  of law
• This seems to reverse causation between capital
  market growth and institutions' building
• "One must presumably have a policy of generating
  such a judicial and police system, and a body of
  contract, anti-trust and bankruptcy law which are
  regarded as fair, efficient and enforceable"
  (Diaz-Alejandro (1985))

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Why move to (more) market-based systems?

• The issue is not intermediaries vs markets but
  intermediaries and markets (Allen Gale, Merton
  and Bodie).
• To make financial markets more complete (reduce
  mismatches and allow for hedging of certain
  exposures)
• Concentration of intermediation in banks
  increases vulnerability
• Improve transmission mechanism of monetary policy

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How to facilitate evolution towards
intermediaries and markets

• Financial systems are "path dependent" inherited
  regulation, entrenched habits and customs,
  financial standards prevent innovation to take
  root. Changes in regulations happen in a backward
  manner
• The role of active policies (besides law
  enforcement)

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Complete financial systems do not emerge
spontaneously

• Coordination of debt management and monetary
  policy
• Setting-up of primary dealers system
• Broadening the investor base
• Developing benchmarks to avoid fragmentation in
  securities markets

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Complete financial systems do not emerge
spontaneously (ctd.)

• Promoting mark-to-market practices to increase
  trading
• Taxation
• Market transparency
• Allowing securities lending and borrowing