Bank Behaviour and Resilience

The Effect of Structures, Institutions and Agents

C. Bakir

• Publisher: Palgrave Macmillan
• Year: 2013
• ISBN:
  9781137308160
• Topic: Economia
• Subtopic: Politica economica

This book provides new interdisciplinary and comparative answers as to why banking sectors in 'liberal' and 'coordinated' market economies operated under a shared set of rules during the Global Financial Crisis. Exploring the role of complex interactions among interdependent structures, institutions and agents defines this banking behaviour.

1

Sources of Bank Behaviour and Institutional Change: Interactions among Structures, Institutions and Agents

1.1 Introduction

Bank behaviour shapes the fate of national financial systems and national welfare. The global financial crisis (GFC) has reminded us that the nature of bank behaviour is crucial for systemic stability, national output, employment, economic growth and development in any economy. Specifically, financial system resilience and fragility are outcomes which are often the result of bank behaviour. This book offers a typological theory that distinguishes the conditions under which conservative and opportunistic types of bank behaviour may lead to these outcomes. Conservative behaviours favour prudent bank decisions and actions that increase the resilience of financial systems to weather domestic and/or international crises. Opportunistic behaviours refer to excessive risk-taking in bank decision and actions that reduce the resilience of financial systems to weather such crises. This book identifies minimal within-type variance and maximum between-type variations of these types of bank behaviour.

Conventional wisdom about varieties of capitalism (VoC) holds that liberal market economies (LMEs), which have capital market-based financial systems (i.e., impatient capital), and coordinated market economies (CMEs), which have bank-based financial systems (i.e., patient capital), have ‘different types of political-economic systems’, and ‘the different institutional arrangements and behavioural “logics” that sustain them’ (Thelen, 2001: 72). Hence, the emphasis is on explaining the divergence in socioeconomic outcomes between LMEs such as the United States (US), United Kingdom (UK), Australia, and Canada and CMEs such as Germany and Japan (Hall and Soskice, 2001; Aoki, 1994, 2001). This distinction, as the argument goes, “offers a useful way to compare these national varieties and to analyse their interactions” (Tate, 2001: 442).

The GFC opens an empirical and theoretical window of opportunity (or critical juncture) to punctuate this well established academic equilibrium in VoC literature. Indeed, it exposed striking diversity within and among LMEs and CMEs in terms of bank behaviour and the resilience of financial systems where the distinction between LMEs and CMEs became obsolete. For example, Australian, Canadian and Japanese banks adopted risk-averse behaviour, whilst some of the US, UK and German banks adopted risky behaviour which generated systemic instability in their home markets and contributed to the GFC. The US lost three of the world’s largest independent investment banks (Lehman Brothers was liquidated, Bear Stearns and Merrill Lynch disappeared) and the remaining two became commercial banks (Goldman Sachs and Morgan Stanley) by the end of October 2008. The UK lost its fifth (HBOS), eighth (Northern Rock), and twelfth (Bradford and Bingley) largest banks; and one of its largest banks (Royal Bank of Scotland) was rescued by the government. In a similar manner two state-owned German banks (IKB Deutsche Industriebank and Sachsenbank) were rescued. Unsurprisingly, in 2008, there were massive government capital injections and asset purchases in the US (4.9 per cent of gross domestic product (GDP)), the UK (2.6 per cent of GDP) and Germany (4.8 per cent of GDP), respectively (BOE, 2008: 33). In May 2010, the volume of the governments’ rescue programs amounted to 24 per cent of 2008 GDP in Germany, and 26 per cent of GDP in the US (Stolz and Wedow, 2010: 24). The US and UK have been the hardest hit countries in the Western world with their worst GDP declines of 3.5 per cent and 4.4 per cent, respectively, and highest unemployment rates of over 9 per cent in 2009. In contrast, the Australian and Canadian governments did not inject capital into their banks, whilst they purchased financial assets, residential mortgages in particular, reaching only 0.5 per cent and 1.3 per cent of GDP, respectively (BOE, 2008:33). The Japanese government did not announce such interventions to the banking sector.

As these examples suggest, bank behaviour matters. Broadly speaking this book has two main concerns. The first is to understand the similarities and differences in bank behaviour and banking outcomes within and among LMEs and CMEs. My concern is with the sources of bank behaviour that affect the resilience of national financial systems. This book shows that the nature of bank behaviour is crucial to the resilience of national financial systems in advanced capitalist economies which cannot be understood in terms of the types of financial systems and capacities of individual states. Instead, this book argues that banks’ adoption of conservative or opportunistic behaviour can be understood with reference to interdependent processes among structures, institutions and agents that condition the nature of the behaviour and its outcomes. The second concern of this book is about how multiple interactions among these variables influence institutional change and persistence in financial services industries which are omitted in comparative studies in banking and financial systems (Coleman, 1996; Allen and Gale, 2000; Deeg, 2010).

How are these concerns addressed in this book? This book introduces inductively derived variables of deviant cases. In doing so, the variety of casual structural, institutional and agency-level variables that can lead to investigated outcomes are identified, and how and under what conditions they influence these outcomes are specified. I will introduce an ecclectic paradigm and a typological theory of this book in the next section. There are three cases which focus on bank behaviour, institutional change in prudential regulation and institutional persistence in competition regulation in Australia from a comparative perspective. The Australian banking experience and institutional outcomes are the primary focus because they offer an opportunity to examine what went right? Specifically, the Australian banking sector was more resilient than virtually any other OECD country during the GFC. It has the strongest financial soundness ratios in the sample (see Table 3.4). As the world’s attention shifts from financial rescue to financial reform in the post-GFC era, the success story of Australia deserves at least as much attention as the spectacular failures. There is no doubt that policymakers who are aware of multiple causes of different types of bank behaviour are better able to diagnose emerging risks for public interest and take preemptive measures.

This book refutes much conventional wisdom in the VoC literature in an effort to fill empirical and theoretical gaps. It addresses the question of divergence within and convergence among developed market economies that remains largely unanswered. Let me first start with several interesting empirical conundrums to resolve in bank behaviour: Why were some LMEs and CMEs with similar financial systems, operating under the same set of global rules, less affected than others in the GFC? Why did the Australian banks, like Canadian and Japanese banks, not take on the increased degree of risk that led to the downfall of so many well-known institutions in the US, UK and Germany? Why was it that the Australian government and central bank have not had to provide capital injections to banks, nationalise lenders or buy toxic assets to prevent insolvencies, as has been the case in most overseas countries? Were Australian bankers, regulators, politicians and investors smarter than their counterparts in the US, UK and Europe? Or was this because multiple and interdependent structural and institutional complementarities and agency-level enabling conditions reinforced and compensated one another for prudent borrowing, lending and investment practices in Australia, Canada and Japan, whilst they reinforced and compensated each other for opportunistic bank behaviour in the US, UK and Germany? (Chapter 3). These questions are at the centre of this book. The answers to these questions also pinpoint drivers for institutional change and persistence in national financial systems.

There are also two interesting theoretical incongruities of the VoC approach following the GFC. First, there are diversions in bank behaviour and banking outcomes within LMEs and CMEs which are assumed to have similar institutional configurations in the financial services industry. Second, there is convergence in bank behaviour and its outcomes among some of the LMEs and CMEs which are assumed to have different institutional configurations in financial systems. In short, the distinction between coordinated and liberal market economies does not shed light on the sources of resiliency and fragility of financial systems within and among these economies. As we shall see, this book intends to explain these differences as well as similarities in bank behaviour and outcomes.

To date, scholars of banking, international/comparative political economy and comparative public policy have neglected these multiple sources of bank behaviour and financial system resilience following the GFC. This neglect may reflect the fact that the authors of banking studies have paid little attention to the interactions among structural and institutional complementarities and agency-level enabling conditions, and how they inform bank behaviour and institutional outcomes. The consequence of these intellectual silos is an important gap in current literature: both groups have largely overlooked the importance of such complex interactions that inform bank behaviour and institutional change and persistence.

Indeed, it is striking that the sources of bank behaviour and their impact on the resilience of the national financial systems, interestingly, received no direct attention in past studies on banking, VoC and comparative analyses of financial systems. For example, ‘bank behaviour’ has been omitted in the content of The Oxford Handbook of Banking (Berger, Molyneux and Wilson, 2010). In the VoC approach, the configuration of national financial systems is a causal variable in explaining, for example, varieties in non-financial firms’ behaviour and socioeconomic outcomes among LMEs and CMEs (Hall and Soskice, 2001). Scholars of VoC argue that capital-market-oriented financial systems in LMEs have ‘impatient capital’ or ‘stock market capitalism’ where incentive arrangements throughout the financial system are based on short-term gains, whereas bank-oriented financial systems provide long-term ‘patient’ capital in CMEs. This dichotomy is used to explain divergent socioeconomic outcomes among LMEs and CMEs (see Chapter 2). However, VoC literature does not have bank behaviour and national financial systems as objects of its analysis (Hall and Soskice, 2001; Aoki, 1994, 2001). In regards to corporate governance, it is widely held that the possibility of hostile takeovers discipline managers, and contribute to high corporate performance and better socioeconomic outcomes (Allen and Gale, 2000: chapter 4; Hall and Soskice, 2001). Instead, it contributed to excessive risk-taking behaviour in the US and UK as the GFC has shown. It is also puzzling that the Australian and the Canadian banks did not adopt this behaviour despite their liberal financial systems. There are also confusing results for CMEs. In VoC literature, coordinated financial systems in Germany and Japan with their bank-centred financial system have ‘patient capital’ where significant concentrations of cross ownership among companies serves as a barrier to hostile takeovers and to pressure bank managers to respond to short-term market pressures (Hall and Soskice, 2001: 22–24; Aoki, 1994). Thus, it is assumed that bank executives in these countries do not have a strong incentive to take extreme risks to boost asset growth and share prices. However, as the German episode shows, lack of market discipline did not prevented some of the German banks from adopting excessively risky behaviour. We certainly need new theoretical frameworks to address these issues.

Further, current research on comparative analysis of financial systems examines how different financial systems (i.e., market-based and bank-based) emerge and evolve with special reference to their advantages and disadvantages, and how crucial they are for the allocation of resources in their respective national economies rather than the causes and consequences of such divergences and convergences in bank behaviour and banking outcomes (Zysman, 1983; Coleman, 1996; Allen and Gale, 2000; Deeg, 2010). Comparative public policy scholars, for example, focus on the types of policy networks that dominate national financial systems and whether states have strong (proactive) or weak (reactive) capacities in the financial services industries to adopt challenges posed by financial globalisation (Coleman, 1996). It is also argued that financial globalisation produces institutional and policy convergence. Specifically, the convergence towards a capital market-based financial system, as the argument goes, is still taking place in a distinct national path in national financial services industries. However, with the experience of the GFC behind us, we now see this observation neither hold true nor tells us much about the divergent bank behaviour and the levels of resilience in financial services industries in these countries.

This book calls for abandoning these dichotomous bank-based or market-based approaches to national financial systems for multiple interactions among structural, institutional and agency variables shaping the type of bank behaviour that contributes to national socioeconomic performance and systemic stability. Similarly, the type of policy network that dominates the national financial systems or whether a state has a strong or weak capacity in the financial services industry does not by itself offer an explanation for divergent bank behaviour and outcomes observed among nation-states. The central issue in national financial systems is not whether they are bank-based or capital-market-based varieties or that a state is strong or weak to develop strategies of action to respond to challenges posed by financial globalisation, but how interdependent and dynamic processes among structures, institutions and agents affect the nature of bank behaviour, financial system resilience and institutional outcomes. To illustrate this argument, I give throughout the book a variety of empirical examples of bank behaviour and institutional outcomes in the US, UK, Australia, Canada, Germany and Japan.

This book also confronts, rectifies and complements the existing literature on the causes of the GFC. Specifically, most studies of the banking sector, in particular, and financial services industry, in general, have exclusively focused either on structures, institutions or agents (organisational and individual actors) or a combination of two of these interdependent variables as the most important causal factors that led to the GFC to explain what went wrong? Studies emphasising the causal role of structures focus on unsustainable global macroeconomic imbalances and the global liquidity bubble (Keeley and Love, 2010; Greenspan, 2010; Obstfeld and Rogoff, 2009; Schwartz, 2009; Dunaway, 2009; Wolf, 2008); technical and technological innovations in the financial services industry (Patterson, 2010), and ideological faith in self-regulatory and efficient markets (Skidelsky, 2009; Krugman, 2009; Cioffi, 2011; Mugge, 2011; Gamble, 2009, chapter 3). Scholars also emphasise the causal role of institutional complementarities (Campbell, 2011), failures in the financial market governance (Barth, Caprio, and Levine, 2011; Stiglitz, 2010; Griffith-Jones, Ocampo, and Stiglitz, 2010; Bliss and Kaufman, 2010) and corporate governance (Bebchuk, 2010; Kirkpatrick, 2009). Other scholars have focused on agency behaviour guided by opportunistic investment banking culture and the political influence of powerful financial firms over regulators and politicians (Morgenson and Rosner, 2011; Lewis, 2010; Augar, 2010; Mason, 2009; Tett, 2009; Brummer, 2008; Johnson and Kwak, 2009).

Yet these various perspectives focusing on either structural, institutional, or agency-related causal factors have difficulty in explaining why these factors generate reckless bank behaviour in one country but not in another. To illustrate, the global imbalances thesis holds that ‘imbalances between savings and investment in the major world economies reflected in large and growing current account imbalances did indeed play a major role in creating the current crisis [GFC]’ (Dunaway, 2009: 3; Keeley and Love, 2010; Wolf, 2008; Greenspan, 2010). It is assumed that the capital inflows into the US as a result of her current account deficit were the key factor driving foreign purchases of US toxic assets, and hence the sub-prime crisis. In contrast, despite its being a current account deficit country like the US and UK, foreign capital inflows did not lead to opportunistic bank behaviour in Australia.

Regulatory failures are also mentioned among the causes of the GFC (FSA, 2009; G-30, 2008, 2009). In regards to prudential regulation, it is interesting to note that all advanced market economies noted above had Tier One capital ratios and prudential capital ratios substantially higher than minimum Basel II requirements of 4 per cent and 8 per cent, respectively (see Chapter 3). Banks of these countries should have entered the GFC in a sound position and could have been resilient to the crisis due, in part, to this stringent capital regulation. However, it is puzzling that some of the American, British and German banks, which faced higher capital requirements than Australian and Canadian banks, did not weather the GFC. This was mainly due to the conservative discretion taken by Australian and Canadian prudential supervisors. These examples also challenge another conventional wisdom that ‘[t]he higher capital requirements restrict rapid balance sheet expansion that may lead to reckless investments’ (Ratnovski and Huang, 2009: 16). It seems that micro-prudential regulation based on capital adequacy is a necessary but not a sufficient condition to make individual banks and the financial system as a whole safe. Thus, we need a framework to understand the sources and consequences of divergent enforcement of the spirit and the letter of such regulations across countries.

Formal institutional arrangements in financial regulation have also been mentioned as one of the main sources of institutional failure, since they became obsolete to keep pace with major changes in financial markets, firms and products (Barth, Caprio and Levine, 2011; G-30, 2008, 2009). But literature is silent about why a ‘twin peaks’ approach worked well in Australia but not in the Netherlands (see, for example, Kremers and Schoenmaker, 2010), and why an integrated approach worked well in Canada and Japan but not in the UK and Germany. As such, the regulatory failure issue is less to do with bank regulation or the regulatory model adopted by a nation where national regulators are guided by the same formal institutional legal practices devised by Basel capital requirements. In short, current literature that emphasises national institutional failures in financial regulation and supervision as the...

Table of contents

• Cover
• Title
• 1  Sources of Bank Behaviour and Institutional Change: Interactions among Structures, Institutions and Agents
• 2  Institutional Theory and Varieties of National Financial Systems
• 3  The Sources and Consequences of Bank Behaviour
• 4  The Political Economy of Prudential Regulation in Australia
• 5  The Political Economy of Competition Regulation in Australia
• 6  Conclusion
• Notes
• References
• Index