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‘Herding Behavior is Particularly Worrisome in the Banking Sphere’

On the 18th of November, Professor Arnoud Boot from the University of Amsterdam gave a public lecture at the inaugaral ICEF International conference. Its title was ‘Banking at the Crossroads: How to deal with Marketability and Complexity?’

Professor Arnoud Boot, a well-known European scholar who conducts research on Corporate Finance and Financial markets, is also the Director of the Amsterdam Center for Law & Economics (ACLE) and Research Associate of the Center for Economic Policy Research (CEPR) in London.

The objective of the lecture was to address some key issues affecting the stability of financial institutions. Professor Boot focused on the microeconomics of banking: what type of incentives do financial institutions have in the current landscape? And what does this imply for regulation and supervision?

The analysis was motivated by the proliferation of financial innovations and their impact on the financial services industry. A fundamental feature of more recent financial innovations is their focus on augmenting marketability. Marketability has led to a strong growth of transaction-oriented banking (trading and financial market activities). This is, at least in part, facilitated by the scalability of this activity (contrary to relationship banking activities). ‘It is argued, - Professor Boot pointed out, - that the more intertwined nature of banks and financial markets induces opportunistic decision making and herding behavior. The latter refers to the tendency to follow current fads. In banking, herding is particularly worrisome because it could create systemic risk – meaning, when all institutions make the same bets, risk exposures become more highly correlated and a simultaneous failure of institutions might become more likely’.

Building on this, Professor Boot launched a discussion on the incentives of individual financial institutions. This included such issues as the friction between relationship banking and transaction activities that are more financial market focused, ownership structure issues, the impact of the cost of capital, the effectiveness of market discipline, and what configuration of the industry can be expected.

Arnoud Boot supports the idea that the current ‘eurocrisis’ is very much a banking crisis. The intertwined euro/bank arrangements have enormously complicated the eurozone problems, and no easy solutions are available.

The lecture concluded with proposals for institutional and regulatory changes that might be needed to deal with the complexity of financial institutions.

Valentina Gruzintseva, HSE News Service

Photos by Nikita Benzoruk

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