Daniela Gabor

The (impossible) repo trinity: the political economy of repo markets

ABSTRACT In its capacity as debt issuer, the state has played a growing role in financial life over the last 30 years. To examine this role and connect it to shadow banking, the paper develops the concept of the ‘repo trinity’, which captures a set of policy objectives that central banks outlined after the 1998 Russian crisis, the first systemic crisis of collateral-based finance. The repo trinity connected financial stability with liquid government bond markets and free repo markets. It further reinforced the dominance of the US government bond market as institutional template for states adjusting to a world of independent central banks, market-based financing and global competition for liquidity. Central banks and the Financial Stability Board recognized the impossible nature of the trinity after 2008, attributing cyclical leverage (financial instability) and elusive liquidity in collateral markets to deregulated repo markets, markets systemic to shadow banking. The new approach triggered radical changes in crisis central banking but has not powered significant regulatory interventions in the absence of an alternative mode of organizing government bond markets.

The digital revolution in financial inclusion: international development in the fintech era

ABSTRACT This paper examines the growing importance of digital-based financial inclusion as a form of organising development interventions through networks of state institutions, international development organisations, philanthropic investment and fintech companies. The fintech–philanthropy–development complex generates digital ecosystems that map, expand and monetise digital footprints. Its ‘know thy (irrational) customer’ vision combines behavioural economics with predictive algorithms to accelerate access to, and monitor engagement with, finance. The digital revolution adds new layers to the material cultures of financial(ised) inclusion, offering the state new ways of expanding the inclusion of the ‘legible’, and global finance new forms of ‘profiling’ poor households into generators of financial assets.

De)Financialization and Crisis in Eastern Europe

This paper investigates how financialization pressures in Eastern Europe shaped vulnerabilities to the 2007 global deleveraging and to what extent policy responses to crisis have sought to reinforce or delink from financialization. It explores the technical devices underpinning financialization, linked to the dominance of carry-trade strategies in foreign-owned banks and nonresident investors, validated by a set of central bank practices that changed the relationship between wholesale money markets and currency markets. Three distinct periods in the timeline of crisis show that central bank interventions were crucial in resuscitating financialization and that attempts to re-embed finance cannot be successful if public debt dynamics are neglected.

Managing Capital Accounts in Emerging Markets: Lessons from the Global Financial Crisis

Abstract The global financial crisis forcefully highlighted the importance of curbing the impact of large and volatile capital inflows on growth and financial stability in developing countries. It led the IMF to reconsider its long-standing rejection of capital controls. Yet its new ‘macroeconomic policy first’ approach has to be reconciled with the hybrid nature of banking activity and its role in transmitting global shocks. A consideration of dominant actors and strategies of intermediating capital inflows offers distinct policy options, ranging from carefully designed central bank strategies to institutional changes that realign bank incentives towards longer horizons and sustainable growth models.

The Return of Political Risk: Foreign-Owned Banks in Emerging Europe

Political risk—risk that investments are damaged by policy action of authorities—increased during the financial crisis due to controversies about the distribution of accumulated losses among stakeholders. Authorities interconnected by cross-border banks considered unilateral policies that minimised losses for domestic stakeholders at the expense of their foreign counterparts. This is at odds both with the assumption behind financial integration which presumes multilateral responses to cross-border shocks and with the typical definition of political risks that ignores the fact that not only host-country, but also home-country authorities can create such risks. This paper recasts the definition of political risk and reviews instances when political risk materialised within the EU banking market between 2007 and 2011. The analysis reveals that the EU regulatory framework needs to be enhanced to contain resurgent political risks systematically rather than through ad hoc interventions of the EU and international bodies.

The Power of Collateral: The ECB and Bank Funding Strategies in Crisis

This paper explores the importance of geographies of bank funding for the design of central banks’ crisis interventions in financial markets. It first distinguishes between market-based and bank-based measures to then focus on the collateral management strategies of European banks, in the context of an increasing reliance on secured market funding, to discuss a crucial policy challenge in monetary unions with integrated funding markets: banks’ ability to access market funding depends on existing portfolios of marketable collateral – in Eurozone mainly sovereign bonds. The constraints on the central bank’s ability to stabilize markets for collateral may thus worsen banks’ funding conditions through ‘coordinated risks’ between counterparty (bank) and collateral (sovereign). Since bank-based crisis policies cannot offer effective solutions for preserving the role of sovereign bonds as marketable collateral, the dilemma of how to stabilize funding markets within the existing European institutional architecture remains unresolved.

Learning from Japan: the European Central Bank and the European Sovereign Debt Crisis

What shapes central banks’ learning from the policy experiments of their peers? Both economic ideas and organizational interests play important roles. Thus, New Keynesian ideas led central banks to interpret Japan’s experience with quantitative easing through the impact on risk spreads, although the Japanese central bank never intended such effects. In turn, scholars and policy-makers alike ignored one critical lesson: successful policy innovations depend on banks’ funding models. I argue that this was a crucial omission because the shift to market-based funding impairs the effectiveness of the traditional crisis toolkit. Central banks must intervene directly in asset markets of systemic importance for funding conditions, as the Bank of Japan did by buying government bonds. Hence, market-based finance engenders a trade-off between financial stability and institutional stability defined through central bank independence. During critical periods, central banks cannot preserve both. The ECB illustrates this trade-off well. Early in the crisis, it outsourced financial stability to a (largely) market-dependent banking system to protect its independence. With the introduction of Outright Monetary Transactions in September 2012, the Bank recognized that the market-based nature of European banking required outright purchases of sovereign bonds. This new instrument gave the ECB additional powers to shape national fiscal decisions in the name of an independence that no longer has theoretical justifications.

The political economy of shadow banking

When most political economists talk about finance they mean the conventional banking sector that is subject to reserve requirements and other regulations but enjoying the safety nets offered by central banks. Yet this is not where the main drivers of the Great Financial Crisis were located. Instead, they were situated mostly in the non-bank part of the financial system, in the so-called shadow banking, where looser regulations and thinner public safety nets for financial institutions were the norm. Indeed, it was only at the 2007 Jackson Hole conference that Paul McCulley, a senior partner at one of the world’s largest asset managers (PIMCO), set off the alarms about the fragility of ‘unregulated shadow banks that fund themselves with uninsured short-term funding, which may or may not be backstopped by liquidity lines for real banks’. Since then, the literature on shadow banking tried to find a compromise between the position that highlights the role of shadow entities (e.g. highly levered off-balance sheet vehicles set up by conventional banks, broker-dealers, private equity firms, structured investment vehicles, money market funds or hedge funds, as in Pozsar, 2008) and the position that highlights shadow activities (securitization and secured funding markets, as in Adrian and Shin, 2010; Mehrling, 2012; Mehrling et al., 2013; McIntire, 2014; Claessens et al. 2014; Gabor and Ban, 2016). Today, the most influential view integrates shadow entities and activities into a system. Thus, the Financial Stability Board (FSB) famously defined shadow banking as the entire system ‘of credit intermediation that involves entities and activities outside the regular banking system’ (FSB, 2011; see also IMF, 2014).

Shadow Interconnectedness: The Political Economy of (European) Shadow Banking

Political economy approaches to shadow banking should take into account interconnectedness. Rather than tracing institutions crossing porous regulatory perimeters, analytical efforts would be better placed to theorize collateral networks, the institutions that act as key nodes in those networks, and the common exposure they generate. The paper argues that the collateral intensive nature of shadow banking generates two mechanisms of interconnectedness: the risk management framework and the re-use/re-hypothecation channel. Both have systemic implications, together generating an important political conflict for the management of shadow banking because private leverage is born in, and can destabilize, government debt markets. Collateral-intensive finance thus confronts central banks and governments with a deeply political question: what governance arrangement is best suited to manage the systemic risks generated through shadow activities that blur the lines between financial stability policy and fiscal policy? Institutional innovations that ensure coordination between the central bank and government work best to manage ‘shadow’ interconnectedness.

Fiscal Policy in Financialized Times: Investor Loyalty, Financialization and the Varieties of Capitalism

This paper argues that scholarship on the varieties of capitalism could provide a more complete understanding of fiscal policy convergence in the Eurozone after 2010 if it better examined the interdependencies between banks and sovereigns. Recently, this scholarship has explained fiscal convergence through a global imbalances framework. While the interaction between coordinated and liberal capitalisms, and their distinctive macroeconomic policy preferences, generates global imbalances, rebalancing can only occur if the incentives governing national polities change dramatically. In Europe’s case, sudden stops in capital inflows from coordinated capitalisms triggered an asymmetric response, forcing deficit (liberal and mixed) economies to address such imbalances. As wage-setting institutions could not restore exchange rate competitiveness a la Germany, governments were compelled to adopt the conservative macroeconomics of the coordinated economies in an institutional setting ill adapted to such policies. In contrast, our account highlights the constraints that financial actors in sovereign bond markets place on the conduct of fiscal policy. Drawing on recent contributions in the literature on financialization, we introduce the concept of the ‘collateral motive’ – investors’ demand for government bonds to meet their funding needs – and link it to the shift to transnational, market-based, collateral-intensive banking models. We show how this becomes a pivotal mechanism for fiscal consolidations as the singular response to the ongoing Eurozone crisis. The implication of our argument is that recent fiscal policy in the Eurozone cannot be adequately understood without analyzing the process through which the collateral motive ignited a run on peripheral sovereign bond markets which in turn compelled states to stabilize these markets through austerity.