COEURE Workshop on Financial Markets By: Thorsten Beck, Elena Carletti, and Itay Goldstein Discussion by Evren Örs (HEC Paris)

1. Financial Institutions, Markets and Regulation:
A Survey
by Thorsten Beck, Elena Carletti, and Itay Goldstein
Discussion by Evren Örs (HEC Paris)
COEURE Workshop on Financial Markets
European University Institute
Florence, June 6, 2015

2. Beck, Carletti and Goldstein (2015) discussion by Örs 1
Introduction
- A survey of a vast literature on banking & its regulation
- A major undertaking giving the multi-faceted nature of the subject
- Interaction between theoretical work, empirical findings, and the emerging
regulatory environment
- With a focus on European research
- A very valuable undertaking for the understanding of the
effectiveness of the new EZ regulatory framework being adopted
- Regulatory arbitrage is assured to show its head in the new environment
- Very important to understand the strength and weaknesses of the new system in
an ever-changing financial environment where rule avoidance is common
- Banking theory and empirical evidence help us to the extent they
provide tools for a critical assessment for the question at hand:
- The ever changing nature of banking, shadow banking (and their interaction) and
their regulation while financial innovation keeps on evolving
- What’s at stake is European tax payers’ money

3. Beck, Carletti and Goldstein (2015) discussion by Örs 2
Outline of the Review
1. Introduction
2. What types of market failures does financial regulation tries to address?
2.1 Panics vs. fundamentals related crises
2.2. Inefficient liquidity in the interbank markets
2.3. Interbank interconnectedness, systemic risk, and contagion
2.4. Incentives, bubbles and crises
3. Financial Regulation
3.1. Capital regulation
3.2. Liquidity requirements
3.3. Safety nets: CB interventions and deposit insurance
4. Regulatory reforms: What has been done in the EZ and the EU?
4.1. Capital and liquidity requirements
4.2. Banking union, resolution frameworks, and bail-in instruments
4.3 Activity restrictions
5. The traditional financial system in Europe six years after the Crisis
5.1 Banks vs. markets? A new financial structure debate
5.2. Complexity and globalization

4. Beck, Carletti and Goldstein (2015) discussion by Örs 3
Outline of the Review
6. Financial innovation: regulatory arbitrage & fragility or financial deepening?
7. Regulatory perimeter: Fragility in banks vs markets
8. Creating arbitrage-safe regulatory frameworks
8.1 Complexity vs. simplicity
8.2. Complementary micro- & macro-prudential regulation
8.3. Focus on resolution
8.4. A dynamic approach to regulation
9. Looking forward: what is known, not known, and should be known
9.1. Complexity vs. simplicity
9.2. Complementary micro- & macro-prudential regulation
9.3. Focus on resolution
9.4. A dynamic approach to regulation

5. Beck, Carletti and Goldstein (2015) discussion by Örs 4
First set of comments
- An ambitious project:
- Very timely and very valuable undertaking given the new regulatory
frameworks that are being adopted in the EU and the EZ
- We would like to know how the newly adopted regulations will perform in the
dynamic environment in which banks and shadow banks operate
- Ambitious because the Review spans a large set of inter-related research areas
that need to be related to each other in a limited number of pages
- The authors cover theory and empirical papers, but the balance and the
interactions between the two sets could be improved
- An excellent initiative!
- There is a lot of good research by European researchers that is highly relevant
for public policy that this survey aims to highlight
- We need more resources (funding and data) to contribute further

6. Beck, Carletti and Goldstein (2015) discussion by Örs 5
First set of comments
- Very important topic:
- Lucas, Schwaab & Zhang (2015):

7. Beck, Carletti and Goldstein (2015) discussion by Örs 6
First set of comments
- The structure of the Review
- Currently:
Review of the theoretical literature followed by a coverage of
the empirical evidence, followed by the description of the new
regulatory environment and finally by an assessment of the
new rules and tools.
- An alternative could be:
-Start with a brief description of the new regulatory
environment in the EU/EZ,
-review the literature that’s pertinent/related with each of the
new areas of regulation,
-and then provide a critical assessment of the strengths and
weaknesses of the new set of rules and tools
-what could go wrong in this set-up given what we know from
theoretical and empirical evidence in the literature?

8. Beck, Carletti and Goldstein (2015) discussion by Örs 7
An alternative outline for the Review
1. Introduction
5. The traditional financial system in Europe six years after the Crisis
5.1 Banks vs. markets? A new financial structure debate
5.2. Complexity and globalization
4. Regulatory reforms: What has been done?
4.1. Capital and liquidity requirements
4.2. Banking union, resolution frameworks, and bail-in instruments
4.3 Activity restrictions
8. Creating arbitrage-safe regulatory frameworks
6. Financial innovation: regulatory arbitrage & fragility or financial deepening?
8.1 Complexity vs. simplicity
8.2. Complementary micro- & macro-prudential regulation
8.3. Focus on resolution
8.4. A dynamic approach to regulation

9. Beck, Carletti and Goldstein (2015) discussion by Örs 8
An alternative outline for the Review
3. Financial Regulation
3.1. Capital regulation
2.1 Panics vs. fundamentals related crises
2.4. Incentives, bubbles and crises
3.2. Liquidity requirements
2.2. Inefficient liquidity in the interbank markets
3.3. Safety nets: CB interventions and deposit insurance
7. Regulatory perimeter: Fragility in banks vs markets
2.3. Interbank interconnectedness, systemic risk, and contagion
9. Looking forward: what is known, not known, and should be known
8.1. & 9.1. Complexity vs. simplicity
8.2. & 9.2. Complementary micro- & macro-prudential regulation
8.3. & 9.3. Focus on resolution
8.4. & 9.4. A dynamic approach to regulation

10. Beck, Carletti and Goldstein (2015) discussion by Örs 9
Second set of comments
1. More balance is needed between theory papers vs. empirical work
- Initial parts of the Review are almost exclusively focused on theoretical papers.
- A more blended approach: theory and empirics complement each other
2. Some of the potential sources of new financial risks that might arise
are not in the Review
- LIBOR scandal
- ETFs
- Insurance industry
- Clearing Houses (Centralized Counterparties)
3. Some of the historical facts that are provided not very pertinent to
the EU context, others more relevant could be covered in more detail
- Some of the US history can be shortened,
- Some of the EU context can be further explained/highlighted (with respect to
the US context, for example the case of EZ deposit insurance)

11. Beck, Carletti and Goldstein (2015) discussion by Örs 10
1. More balance between theory and empirical papers
In the interest of time, I’ll just provide some examples:
-Pros & cons of financial integration through banks on real economy
-Morgan, Rime & Strahan (2004), Kerr & Nanda (2009), Michalski & Ors (2012,
2014), Acharya, Imbs & Sturgess (2011)
-Financial crisis affects bank lending to the real sector
Campello, Graham & Harvey (2010), Duchin, Ozbas & Sensoy (2010), Ivashina &
Scharfstein (2010), Cornett, Marcus, McNulty & Tehranian (2011), Puri, Rocholl &
Steffen (2011), Berger & Roman (2015b)
-European integration
-Empirical evidence by Bekaert, Harvey, Lundblad & Siegel (2013), Laeven &
Tressel (2014)
-European banking integration (M&As) and regulatory arbitrage
-Carbo-Valverde, Kane & Rodriguez-Fernandez (2008, 2012)

12. Beck, Carletti and Goldstein (2015) discussion by Örs 11
2. More balance between theory and empirical papers
- Regulatory structures involving banking unions
- US federal vs state bank regulators by Agarwal, Lucca, Seru & Trebbi (2014)
- Theoretical work by Colliard (2015)
- Price of bank liquidity in the EU
Fecht, Nyborg & Rocholl (2011), Cassola, Hortaçsu & Kastl (2013)
- Empirical evidence on flight to quality by investors
- For ex., Baele, Bekaert, Inghelbrecht & Wei (2015)
- (Removal of) government guarantees and bank behavior
- Fischer, Hainz, Rocholl & Steffen (2104), Körner & Schnabel (2013)
- Banks’ risk management and derivative use
- Theoretical work by Vuillemey (2015)

13. Beck, Carletti and Goldstein (2015) discussion by Örs 12
2. More balance between theory and empirical papers
- Sovereign-bank loop/spiral
- For ex., Gray (2014), Kallestrup, Lando & Murgoci (2014), Black, Correa,
Huang & Zhou (2013)
- Effectiveness of liquidity provision through discount window (TAF)
- Berger, Black, Bouwman & Dlugosz (2014)
- Government aid and distortion of bank competition (TARP)
- Berger & Roman (2015a)
- Depositor + firm runs (credit line draw-downs) & bank liquidity risk
- Ippolito, Peydro, Polo & Sette (2015)
- Bank stress tests

14. Beck, Carletti and Goldstein (2015) discussion by Örs 13
2. New problems and sources of risk in the financial system
- Different definitions of shadow banking system, the one I like:
- “Shadow[y] banking is financial activity that is engineered to extract implicit
subsidies from government safety nets. … [It] may also be called Safety-Net
Arbitrage” Kane (2014)
- ETFs
- $ 2.6 trillion in assets worldwide
- In the EU from € 40 billion in 2005 to almost € 400 billion at the end of 2014
!(approx. 50% of the EU market belongs to one company !! )
- Ben-David, Franzoni and Moussavi (2014), Hurlin, Iseli, Pérignon, and Yeung
(2015), Cheng, Massa and Zhang (2015)
- LIBOR scandal: importance of transparency
- $4 trillion LIBOR indexed loans, derivative notional of >$300 trillion
- Duffie, Dworczak and Zhu (2014), Duffie and Stein (2014), Duffie, Skeie and
Vickery (2014), Eisl, Jankowitsch and Subrahmanyam (2014)

15. Beck, Carletti and Goldstein (2015) discussion by Örs 14
2. New sources of risk in the financial system
- Central Counterparties (CCPs) or Clearing Houses
- Duffie, Scheicher & Vuillemey (2015), Boissel, Derrien, Ors & Thesmar
(2015)

16. Beck, Carletti and Goldstein (2015) discussion by Örs 15
Emphasis and de-emphasis
- Given the imposed page limit:
- Some of the US-related historical background could be reduced
- Reg. Q and interest ceilings when covering MMMFs
- Instead, some of the EU-related coverage could be increased
- Deposit insurance differences across EU
- Cross-country DI studies:
Anginer, Demirguc-Kunt, and Zhu (2015),
Demirguc-Kunt, Kane and Laeven (2008),
Demirguc-Kunt and Kane (2002),
Demirguc-Kunt and Detragiache (2002).

17. Beck, Carletti and Goldstein (2015) discussion by Örs 16
Conclusion
- Review paper combines theoretical and empirical papers to help us
better understand that major changes and challenges in EU banking
- Additional critical (and unresolved) issues:
- Harmonization of Deposit Guarantee Systems, pan-EZ DI, ex ante risk-
based premiums, …
- Rapidity with which bank cease & desist orders and resolutions can be
accomplished (SRM/BRRD vs EC-DG Comp, non-representation of
non-CB supervisors in CB Governing Council, political horse-trading), …
- BRRD does not include insurance or CCPs
- National vs EZ resolution trusts/failed asset management companies
- This Review, which is in a preliminary stage, could make an
important contribution for the assessment of the banking union
- Additional resources (funding and data) would further research in
these crucial areas of public policy