128th BRE-CASE Seminar: The Political Origins of Banking Crises and Scarce Credit

During the 128th BRE-CASE seminar, which took place on October 3rd, 2013, Professor Charles Calomiris discussed the political roots of a banking crisis.
“Banking systems are in fact a deal between governments, investors and also the political electorate,” said Prof. Calomiris. According to the expert, it is this deal that determines the rules of the game, a phenomenon which he calls the “Game of Bank Bargains”. The rules of the game that govern entry into banking, the competitive structure, the flow of credit and its terms and the allocation of losses when banks fail, are mainly a result of political factors, that is, of the deal or the forged coalition which decides on the structure and outcomes of the banking system.

The expert argued that in centralized, authoritarian systems there is a group of people sharing profits amongst themselves. A classic example of this phenomenon is Mexico, except during the civil war period when each investment could have been taken over by soldiers. Brazil, on the other hand, is a completely different type of authoritarian system, argued Calomoris, since the Brazilian government never succeeded in fully controlling the economy and certainly never succeeded in collecting taxes.

In liberal democracies such as Canada, the rules of the “game” prevent all three social groups from taking control of the banking system and using the system to take over other groups’ assets, continued Prof. Calomiris. Simultaneously, in a populist democracy like the United States, the governing coalition uses the banking system to take over the assets of other social groups, which then leads to a lowering and destabilization of credit. In general, shifting assets means giving loans to acquaintances on preferential terms.

According to Prof. Calomiris, the analysis of banking history in the UK, Canada and the United States shows that, when the democratic state encounters problems with financing its expenditures (in particular during wars), the banking system, if needed, is used to serve the national interest. Hence, for example, banking in Great Britain was underdeveloped for over a century.

Furthermore, Prof. Calomiris argued, the history of banking proves that in a populist democracy access to credit will be lower and less stable.

The shape and functioning of banking systems in various countries may be understood by studying and analyzing political processes taking place in these countries. Moreover, he argued, the strengths and weaknesses of a banking system may be explained through the analysis of pacts, deals and rules of the game set by the groups that decide on how banks should be organized, how credit is given, and how losses are allocated when banks fail.

Economists focus their debates on regulations, argued prof. Calomiris, thus often drawing us away from the main problem of determining the real beneficiaries of particular regulations.

According to the expert, in a democratic country, when debating about the outcomes of the banking system, we should ask ourselves if we are not the ones seeking preferential conditions and, thus, participating in a deal that takes over others’ assets, resulting in an unevenness of the banking system.

Prof. Calomiris’ presentation and the main points of the discussion will be included in the 128th BRE Bank-CASE seminar proceedings. The video of the seminar is available at Bankier.TV

The lecture was based on the book by Charles W. Calomiris and Stephen H. Haber Fragile by Desing: The Political Origins of Banking Crises and Scarce Credit. More information on the book is available at the Publisher’s website.