Competition And Regulation In The Financial Sector

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Competition and Regulation in theFinancial SectorXavier VivesIESE Business SchoolBanque de France, G7April 8, 2019

Can we have both competitionand stability in banking?

Proportion of countries withbanking crises: 1900-2008Weighted by their share of world incomePercent of countriesThe GreatDepressionThe First Global Financial Crisisof 21st CenturyEmerging Markets, Japan,the Nordic Countries, and US (S&L)World War IThe Panicof 1907Source: Figure 1 in Reinhart & Rogoff (2008), “Banking Crises, An Equal Opportunity Menace”, NBER WP 14587.3

Will we ever learn?Regulatory failure andregulatory cycle

Outline Regulatory failure and the competition-stabilitytradeoff The changing banking business,concentration, and profitability Digital disruption

Why is it so difficult? Financial innovation and shadow banking Political Economy Market failures and second best principle

Competition and stabilitytrade offsTwo channels through which competition may increaseinstability:By exacerbating coordination problems ofdepositors/investors and fostering runs/panics(externality).By eroding charter values, increasing incentives to takerisk and raise failure probabilities (asymmetricinformation, limited liability, insurance, TBTF).Xavier Vives

Summary of evidenceComplex trade-off between competition and stability Liberalization without adequate regulation leads tocrises. Average positive association of market power andbank-level stability but with country variation andsome indications that an intermediate level ofbank competition maximizes bank stability. Mixed results on association of aggregateconcentration and stability.Xavier Vives8

Bank concentration and performanceduring the 2008 crisisSource: Ratnovski (2013)9

Can we regulate away thecompetition-stability trade-off?Regulatory boundary problem,example of US mortgages post-crisis: Market share of shadow banks (with high fintech %)almost tripled in 2007-2015. 85% of shadow bank mortgages were sold to GSEsafter origination.Xavier Vives

The changing banking business Liberalization and technological change Increase in competition from shadowbanks/fintech/bigtech Erosion of bank market share in the eurozone Result in increase in concentrationXavier Vives

Eurozone financial system assetsby sector (%, 2007-17)100%9090%807070%6060%5050%4040%Trillion of US DollarFraction of Intermediation by n-bank Intermediaries20112012201320142015Insurance Corporations and Pension Funs20162017Total IntermediationData Source: FSB, 201712

Low bank profitability Legacy of crisis (bad assets, contrastUS/Europe). Low interest rates, flat yield curve. Increase in compliance costs. Technological change and new competitors:shadow banks, fintech, bigtech.Xavier Vives13

Bank Price-to-Book RatiosSource: IMF, Global Financial Stability Report, October142018

Digital disruptionImpact of new competitorsFinancial stability implications

Impact of digital entrants General increase in efficiency and service. Incumbents have to update their technological platformsin a low profitability environment and improve standardof service. Competition: New entrants, bigtech in particular, willraise competition in the short term but reducecompetition in the long term?– Platform envolvement strategy to monopolize customer interface Level playing field?– “Open banking”: asymmetry in customer information sharingrequirements between PSD2 and GDPR.Xavier Vives16

Financial stability implications New entrants may be lower risk since they have lessleverage. But increased competitive pressure and cherry pickingby entrants will decrease profits of incumbents whichmay react by increasing risk taking. New source of systemic risk: Banks may be dependenton systemic data providers.Xavier Vives17

Challenges for regulators Improve regulation so that we can have morecompetition without endangering stability. Coordinate prudential regulation and competitionpolicy. Adapt to the digital world:– Keep a level playing field protecting financial stabilitywhile allowing the benefits of innovation to permeatethe system.– Tools: Regulation by activities but entities are those that fail Sandboxes for grown ups?Xavier Vives18

A question of balanceXavier Vives20

Competition and Regulation in the Financial Sector Xavier Vives IESE Business School Banque de France, G7 April 8, 2019. Can we have both competition . Eurozone financial system assets by sector (%, 2007-17) 12 Data Source: FSB, 2017 0 10 20 30 40 50 60 70 80 90 0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

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