Before joining HEC, he was a Eurozone forecast manager for the ministry of finance, a French Government department that covers the main crucial fields of economic governance, and an economist at the National Institute for Statistics and Economic Studies (INSEE).
When crisis strikes, financial institutions may well pick up the phone to David. He has reported to the French Prime Minister since the crash of 2008 when François Fillon appointed him to the Conseil d’Analyse Economique – the Council of Economic Analysis.
He writes a monthly column in the French economic newspaper Les Echos. And just two years ago, David was awarded Best Young Researcher in Finance by the Europlace Institute of Finance.
But his biggest concern? The banking system, which is, seemingly, still troubled. Europe is still feeling the effects of the financial crisis. The cost of the last credit crunch was 3 per cent of global GDP and government bailouts saw up to 30 per cent of GDP transferred from taxpayers to bank stakeholders, he points out.
The effect on the MBA jobs market was felt. “There are less opportunities, for sure, it’s not like in 2006-2007. There are less people taking finance majors,” David says. “However for good [MBA] programs that are well run and well managed, there are still no problems and there shouldn’t be any problems with opportunity.”
But demand for more banking regulation has never been stronger. Before the crisis of 2008, regulation was insufficient. “It led to two problems: bank runs and excessive leverage. Which led to more risk taking, and the credit crunch,” David says. “This was addressed by regulation – deposit guarantees and capital requirements, such as Basel I & II.”
David has just stepped inside Exane BNP Paribas, in London’s Mayfair. He has come to the UK to deliver a keynote talk to HEC alumni, prospective MBAs and the French bank’s financiers.
Wednesday’s talk was all about the banking system, David’s view of key developments since the financial crisis and his roadmap for banking regulation.
The crisis that engulfed Europe in 2008 has created banking interdependence, says David, through asset holdings and short-term funding. It is a key change in the financial system. “Banking interdependence is a key development because it has increased coordination failures. And not just across borders.” he says.
This has also given rise to the shadow banking system, he says, particularly in the United States. Yet it is an unfortunate tag for loan sharks and secret societies, which economists say covers credit transactions outside the formal banking system by trust companies, microcredit firms and kerbside lenders.
Despite fears, the shadow banking business appears to be thriving. A 2012 study by Standard & Poor’s, the ratings agency, put shadow banking credit at $3.7 trillion. There is increased risk taking in the U.S shadow banking system, says David. And that could spill over into banks, although he skipped much of the controversial topic, to the disappointment of some members of the audience.
Liquidity dry-ups since the crash have correlated with bank distress. David points to a study of haircuts to Italy’s bonds and the capital needed to keep the same leverage – meaning banks had to sell off their assets.
That results in contagion, he says. “Asset stress spread through markets and banks, through deleveraging,” David says. “We can make strong assumptions, then, of how banks liquidate assets in response to shocks, which assets they liquidate and how asset prices respond to liquidation.”
He applied the model to data on the asset holding of 90 banks in the European Union. And it produced “systemic risk and indirect vulnerability”; banks are hurt by the deleveraging of other banks.
Policies that can address this, David says, are capping the bank's size, reducing leverage and pooling sovereigns into a "Eurobond", among others. “It sounds crazy but central bankers found it [the model] reasonable,” he says. “The ECB (European Central Bank) is currently implementing it.”
David points to the repo market. He says that the banking crisis caused a sovereign crisis. “One reason is banks’ refinance using sovereign bonds as collateral,” he says. This causes the cost of funding to go up, and more distress for the banking system.
Regulatory authorities then push up Central Clearing Counterparties (CCPs), which takes a counterparty risk, meaning that sovereign stress should not count anymore.
The rise of CCP since the crisis has been unfounded, helped no doubt by the Lehman Brothers insolvency. Since 2008, the G20 has reformed the world’s derivative markets and increased regulation – and ultimately improved stability.
Today’s future bankers – many of them MBA students – need to be educated more thoroughly in regulation, David says, although he stops short of calling for more corporate social responsibility teaching.
“Looking at how finance institutions were, it’s important to make people aware of why regulations exist, why they are firm and why people should think of them as being legitimate. And not just ways of preventing them from making more money,” David says. “It’s a mind-set we need to put MBA students in.”
David adds that the interbank market is both a curse and a blessing, but the repo market strengthens the government-bank nexus. “Sovereign default becomes more unlikely, and ultimately we could see a return to fiscal dominance,” he says.
Shadow banking will continue to grow if banks shrink, he adds. “It satisfies demand for money, but there is a need for the same regulation,” David says. “There needs to be regulation against bank runs and against excessive leverage.”
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