Level of democracy is high in Hungary - Orbán / economy - 2016, október 14 - 08:40
The level of democracy is high in Hungary, Prime Minister Viktor Orbán told public radio MR1 on Friday morning. He addressed the recent amendment of the constitution he initiated so that the...
Kategóriák: Economy

ECB bank supervision cannot tackle debt restructuring single-handedly

Bruegel - 2016, október 13 - 16:41

In mid-September the ECB’s supervision arm issued draft guidelines on banks’ management of NPL portfolios.  In principle, by next year the most significant Eurozone banks may have to:

  • Comply with targets for NPL reduction in individual asset classes, which will be set for different time horizons;
  • Establish strategies and operational plans for NPL resolution, through better staffing of workout units and their integration in management structures, and IT systems that facilitate loan quality monitoring and portfolio sales;
  • Account annually to the ECB supervisors on progress in NPL reduction.

NPL resolution will now figure prominently in the ECB’s regular discussions with the 129 significant banks that it directly supervises. Ultimately, similar standards may be implemented for smaller banks where direct supervision lies with national authorities. In the near future this guidance will only inform discussions with systemic banks that have a persistent and excessive NPL stock. But binding ECB supervision might follow for those banks that fail to comply.

This is a welcome further step in the long-running attempt to cleanse balance sheets from the legacy of the financial crisis. To date, euro-area banks have made no more than a small dent in the NPLs which stood at over € 1 trillion in 2015, according to latest IMF assessment.

As the ECB has again pointed out in their latest Financial Stability Review, high levels of NPLs remain a key obstacle to a recovery in lending. This traps capital in loss-making enterprises and as credit supply is stifled, investment suffers across all sectors, aggravating debt distress further.

The NPL overhang is particularly serious in the euro area countries that have undergone sharp financial contractions (see the table below). In Spain and Ireland NPLs are now falling, but this process remains in the early stages in Italy, Portugal and Slovenia, and Greece.

Given cross-border linkages between banking sectors, NPLs will complicate lending relationships throughout the single capital market, and also undermine the effectiveness of the ECB’s more aggressive monetary easing (a recent paper by V. Acharya and co-authors underlines the scale of credit misallocation). So a consistent effort in cleansing distressed loans from bank balance sheets, and preventing their re-emergence, will be essential for confidence in the banking union.

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New standards on loan quality were adopted by the European Banking Authority (EBA) in 2013. In the 2014 comprehensive review these enabled a first glimpse of true asset quality based on a common standard. Forbearance – the modification of loan terms in the expectation of the recovery of the borrower’s capacity to repay – was clearly defined and inadequate restructuring, in the spirit of ‘extend and pretend’, has become more difficult since then.

The ECB guidelines seem a significant extension of the scope of supervision, beyond ensuring compliance with prudential norms and addressing the deeper causes of weak capital coverage that lie in business models and organisational structures. Some may see this as a regime change for banks that are already confronted with a significant compliance burden. Nevertheless, the ECB’s mandate clearly allows examination of banks’ internal organisational structures, and this mandate has already been used to constrain banks’ risk management practices.

Banks that work throgh an excessive backlog of distressed loans will need to acquire additional skills and reform internal capacity and management structures. ECB supervision has now established transparent benchmarks, and will in future encourage convergence to best practices. The workout of distressed loans is rarely a glamourous business line within a financial organisation. Senior management will need to provide more resources for this effort and offer appropriate incentives to their workout teams. Ultimately, this should reassure investors and depositors.

IMF analysis suggests that only very few European countries successfully reduced NPLs,  either where they benefitted from a pickup in external demand or where there was a concerted effort to clean up bank balance sheets in parallel with corporate debt restructuring. The banks under ECB supervision will account for the best part of banking system assets. In other words, setting NPL targets for individual banks will in effect amount to system-wide deleveraging. To be successful, ECB supervision therefore need to be flanked by a number of supporting policies:

  • In an initial step the ECB will need to determine how much restructuring and sales of distressed portfolios the system as a whole can, or should, manage. Under-provisioning, capital coverage and slow replenishment from earnings will of course constrain this process. Responsibility for systemic or macro-prudential supervision is shared between the ECB and national central banks, which should spell out this path clearly.
  • This judgement on aggregate deleveraging capacity should then guide NPL reduction targets for individual large banks. Such targets would need to be carefully defined and communicated. There is a risk they could give rise to poor restructuring practices, to moral hazard among borrowers, and could be mis-perceived by the public and investors. The only comparable experience comes from Ireland in 2013. In that instance the national central bank was closely involved in setting targets, which related to two specific asset classes (residential mortgages and SME loans). These targets were made public, and where there was a clear definition of what amounted to sustainable restructuring solutions.
  • There should be a clearer encouragement of market-based restructuring solutions. At present, the ECB guidance seems indifferent about alternative options. In reality, banks’ internal workout units are rarely sufficiently empowered to oversee a costly restructuring of large enterprises. Restructuring is a cyclical activity, and skills are rarely in sufficient supply. By contrast, investors in distressed assets or specialist restructuring firms are more likely to recover value in viable enterprises, though will also extract a price given the risks in the legal environment and in loan servicing provisions.
  • Where banks remain in the lead, coordination with other creditors will need to define restructuring solutions that maximize value recovery in large enterprises. The enforcement of collective restructuring principles is a task for a national central bank or government.
  • An assessment of framework for restructuring and market-based solutions will need to inform the engagement with the banks. The ECB last month also published an assessment of national restructuring frameworks in eight countries that spells out many shortcomings. This analysis underlines how governments need to raise standards in insolvency frameworks, build capacity and provide conditions for the entry by investors within appropriate regulation.

Tackling legacy assets and pre-empting the reflow or re-emergence of new debt distress should be a core element of bank supervision and the ECB has rightly broadened the scope of its policies. But this effort needs to be framed within a realistic deleveraging path for each banking system. For now, this work is aimed at key bank groups in the euro-area but should of course be coordinated with the supervisors of other EU countries where these institutions control significant subsidiaries, all with their own NPL problems.

In the euro area’s multiple NPL crises this process will need to be supported by national central banks and governments. There have been some reforms in national insolvency regimes, such as in Italy. But legal reforms will take time, and will only be effective if adequate capacity is built up, within the courts and among restructuring professionals more broadly.

Kategóriák: Economy

State-owned bank launches HUF 44 bn loan programme for hotel business / economy - 2016, október 13 - 15:59
The state-owned Hungarian Development Bank (MFB) is to launch a 44 billion forint (EUR 143.6 mn) interest-free loan programme for “viable catering companies and projects with sound income...
Kategóriák: Economy

Hungary ties with Latvia in EU rankings of steepest housing price increases / economy - 2016, október 13 - 15:27
The prices of residential property purchased by households rose by 4.0% year on year on average in the second quarter of 2016, whereas the increase in the euro area was 2.9%, the Eurostat, the...
Kategóriák: Economy

Codetermination in Germany – a role model for the UK and the US?

Bruegel - 2016, október 13 - 15:17

Codetermination or “Mitbestimmung” – the German term for worker participation in a company’s decision making – has recently attracted attention as UK Prime Minister Theresa May and US presidential candidate Hillary Clinton promised to strengthen workers’ rights and interests. The latter has called for rewriting “the rules so more companies share profits with their employees”. Mrs May has repeatedly stated her intention to reform corporate governance such that workers and consumers are represented on boards, to “reform capitalism so it works for everyone – not just the privileged few.” Many commentators have interpreted the Brexit vote also as a rejection of the current globalized economic system from which “the rich are gaining at the expense of the poor” (see e.g. here). While codetermination does not only exist in Germany, several authors (see here and here) have wondered whether it could be a role model also for the UK and the US. This blog provides a short overview of the characteristics of codetermination in Germany and evidence from academic literature.

What is codetermination?

Codetermination is deeply rooted in the tradition of German corporate governance and has existed in its current form since the Codetermination Act of 1976. It has an explicit social dimension: as the German Constitutional Court ruled, codetermination on the company level is meant to introduce equal participation of shareholders and employees in a firm’s decision making and shall complement the economic legitimacy of a firm’s management with a social one. Codetermination is therefore about a democratic decision making process at the firm level and the equality of capital and work (Page 2009). Furthermore, according to Kommission Mitbestimmung (1998), the main aims of codetermination consist in making investments in human capital profitable, and “rewarding” employees’ loyalty towards the firm with participation rights.

Codetermination could be viewed as an institution enhancing workers’ representation and participation rights in a firm’s corporate governance. There are two levels through which employees are given codetermination rights to participate in a firm’s decision making: the work council (“Betriebsrat”,establishment or “shop-floor” level) and the supervisory board (“Aufsichtsrat”,company level).

The work council is generally elected in firms with more than 5 employees and many of its members are also members of German trade unions. The council is endowed with far-reaching information and consultation rights that enable it to exert influence on working conditions, pay principles, working time etc.  Employers must negotiate with the work council if changes affecting the workforce take place, e.g. the dismissal of employees.

Codetermination at the company level, on the other hand, consists in the participation of employees or their representatives in the supervisory board. Germany was one of the first countries to introduce a two-tier system, meaning that the law requires firms to have an executive board, composed by executives and chaired by the CEO, and a supervisory board, composed by non-executives, which are shareholder and employee representatives (including union representatives). Note that workers are thus represented on the supervisory board – not the (executive) board. The number of employee representatives depends on the size and legal type of the firm: one-half of the members of the supervisory board are employee representatives for firms with staff of more than 500 for limited liability corporations (“GmbH”) and more than 2000 for stock corporations (“AG”), and one-third for stock corporations with between 500 and 2000 staff. The chairman of the supervisory board, who is elected by shareholders, has an extra vote in case of a tie.

The supervisory board is generally involved in the appointment of the management board members, monitoring of business operations overseeing the activities of the management board and, in a subcommittee, determining the compensation of its members. With the supervisory board approving major strategic decisions, ultimate corporate power resides with it (FitzRoy and Kraft 2004) and thus also with employee representatives.

Finally, it should be noted that codetermination and wage negotiations are separate as usually unions and employers’ associations bargain with each other. However, there are close personal links between unions and institutions of codetermination as work councillors and thus employee representatives on the supervisory board may be union members (FitzRoy and Kraft 2004).

Codetermination and its effects

Corporate governance is characterized by the interplay between managers and owners of a firm. While the latter wish to maximize the value of the firm in the long run, executives maximize their own utility, for which compensation, prestige, power etc. are relevant. Codetermination introduces a third interest group, employees, to the supervisory board and thus to the firm’s decision making process. The question is whether the interests of each group overlap or are in contrast with each other, and which benefits and costs employee representation entails.

Shareholder vs labour interests, efficiency, and the supervisory board

Some authors have questioned why codetermination should be made mandatory. If it was beneficial, firms would have introduced it themselves and its presence may therefore be inefficient (Jensen and Meckling 1979). There may be rent seeking on part of labor at the expense of shareholders. Indeed, studies have found that equal representation on the supervisory board (versus one-third representation) reduces the market-to-book ratio – a measure of firm performance – by 31% on average (Gorton and Schmid (2004). The authors conjecture that “labor succeeds in altering the objective function of the firm – away from maximizing shareholder wealth”, e.g. by resisting lay-offs and thus using their voting power as an insurance for employees in response to negative shocks. They also find evidence for high staffing levels and thus potential overstaffing in equal-representation firms.

On the other hand, employees might have a similar objective function as shareholders (or their representatives) aiming at the long-run survival of the firm, in which case employee representation could actually be beneficial for shareholders. One such overlap in employees’ and shareholders’ interest would be to prevent managers from pursuing overly risky projects, maximizing short-term profits, or engaging in expansion by mergers and acquisitions. The shareholders as members of the supervisory board can change the managers’ compensation structure to incentivize them to act according to their interest. Dyballa and Kraft (2016) find evidence that employee representation is beneficial in that regard.

Furthermore, there may be benefits due to an improved flow of information between board and workers. Due to their knowledge of a firm’s operations and processes, employees are good at monitoring managerial performance and bring first-hand knowledge to the board’s decision making (Edwards et al 2009, Fauver and Fuerst 2006). The latter find that codetermination can increase firm efficiency and market value. This finding is not necessarily incompatible with Gorton and Schmid (2004) as they do not stipulate that one-half representation is optimal but simply that a positive number of employee representatives is beneficial. The optimal level of labor representation might thus be below parity. They argue that their finding holds in particular for “industries that require more intense coordination, integration of activities, and information sharing such as trade, transportation, computers, pharmaceuticals, and other manufacturing”.

Information flows and work council presence

Beyond worker representation on boards, work councils as the other pillar of codetermination institutionalize cooperation between workers and employers. Workplace representation in Germany takes place mainly through work councils rather than unions (see Addison 2005 for a survey of the academic literature). These institutions aggregate information and preferences of workers and thus may help determine the social demand for public goods such as better working conditions. Work councils may also be beneficial in relation to workers’ input of effort, reducing exit behaviour (quits, absenteeism) and increasing firm-specific investments in human capital. Other benefits may be due to work councils’ information rights – by, e.g., verifying management claims and avoiding costly disputes -, consultation rights – leading to new solutions and creative discussion – and by encouraging workers to take a longer-run view of the firm by providing them more job security, a point also raised by Kommission Mitbestimmung (1998) further above. On the empirical side the findings are quite mixed, however. Most recent studies find neutral or small, positive effects on productivity, innovation, and investment. One study argues that the functioning of work councils also depends on its age, i.e. there is a learning effect (Jirjahn et al 2011). For example, the authors find that adversarial relationships between work councils and the management are decreasing, and productivity increasing, with its age.

Codetermination and equality

Finally, as the system of codetermination is also mentioned in the context of “democratic capitalism” and is meant to be an inclusive framework, it seems natural to wonder whether this also shows up in numbers. For obvious reasons, macroeconomic effects are hard to measure seriously. Nevertheless, Vitols (2005) looks at 25 EU countries and finds that countries with stronger worker participation rights perform better in terms of labor productivity, R&D intensity, and had lower strike rates, although this group of countries performed worse in terms of GDP growth. Hörisch (2012) looks at the association between codetermination and income inequality (measured using the Gini index) in OECD countries and finds that it is negative – i.e. higher income equality in countries with codetermination.

To conclude, there is plenty of evidence that the German stakeholder system of codetermination has been a positive experience, although there are also strong doubts about whether it is efficient or optimal. There are several other particularities of the German economic system – interaction between firms and other social partners, ownership structure of German firms etc – that are important to bear in mind when thinking about whether codetermination can also work elsewhere.


Dyballa, K. and K. Kraft (2016) ‘How do Labor Representatives Affect Incentive Orientation of Executive Compensation?’. IZA Discussion Paper No. 10153.

Edwards, J. S., Eggert, W., and A.J. Weichenrieder (2009) ‘Corporate Governance and Pay for Performance: Evidence from Germany’. Economics of Governance, 10(1), 1-26.

Fauver, L. and M.E. Fuerst (2006) ‘Does Good Corporate Governance Include Employee Representation? Evidence from Germand Corporate Boards’. Journal of Financial Economics, 82.3 (2006): 673-710.

FitzRoy, F. and K. Kraft (2004) ‘Co-determination, Efficiency, and Productivity’. IZA Discussion Paper No. 1442.

Freeman, R.B., and J.L. Medoff (1984) ‘What do unions do.’ Indus. & Lab. Rel. Rev. 38 (1984): 244.Gorton, G. and F.A. Schmid (2004) ‘Capital, labor and the firm: a study of German codetermination’. Journal of the European Economic Association Vol.2, No. 5

Hörisch, F. (2012) ‘The Macro-economic Effect of Codetermination on Income Equality’. MZES WP No. 147, 2012.

Jensen, M. C., & Meckling, W. H. (1979). Rights and production functions: An application to labor-managed firms and codetermination. Journal of Business, 469-506.

Jirjahn, U., Mohrenweiser, J., and U. Backes‐Gellner (2011) ‘Works councils and learning: On the dynamic dimension of codetermination’. Kyklos, 64(3), 427-447.

Kommission Mitbestimmung (1998) ‘Mitbestimmung und neue Unternehmenskulturen – Bilanz und Perspektiven‘. Bertelsmann Stiftung, Gütersloh.

Lazear, E.P., and R. Freeman (1995).‘An economic Analysis of Works Councils’. In: Works Councils: Consultation, Representation, Cooperation. University of Chicago Press for NBER ; 1995. pp. 27-50.

Page, R. (2009) ‘Co-determination in Germany – A Beginner’s Guide’. Hans Böckler Stiftung, Arbeitspapier 33.

Vitols, S. (2005)‘Prospects for Trade Unions in the Evolving European System of Corporate Governance’.

Kategóriák: Economy

Hungarian bonds sell like hotcakes / economy - 2016, október 13 - 12:13
Hungary’s Government Debt Management Agency (ÁKK) raised the allotted volume to the maximum on all three maturities at its biweekly auction on Thursday. The average yields, however, did not...
Kategóriák: Economy

Aldi to build 50-60 new stores, logistics base if gov't does not hamper plans / economy - 2016, október 13 - 10:03
The grocery chain Aldi plans to build 50 or 60 new stores and a logistics base in Hungary provided there are no government measures impeding it, the managing director of Aldi Magyarország Élelmiszer...
Kategóriák: Economy

Hungary is burning its FX reserves the quickest / economy - 2016, október 12 - 17:12
The steepest drop in foreign currency reserves since 2013 was in Hungary, J.P. Morgan said in a research note on Wednesday. The process is not necessarily damaging, since this was the period foreign...
Kategóriák: Economy

Income inequality through decades and books

Bruegel - 2016, október 12 - 17:03
Frequency of using the word “income inequality” in Google’s text corpora in English, 1900-2008.

Source: Google Ngram Viewer. Note: No reliable data after 2008.

The amount of online content has increased enormously in the last decades, nevertheless we can observe that these has been a steep increase in inequality-related content from 1970-1980, followed by flat and/or declining trend throughout the following decade from 1980-1990.

However, starting from 1990s, the trend has quickly rebounded and continues to increase. Such a trend demonstrates that the discussions on inequality, distribution and fairness is likely to stay as an important topic, which in turn has large implications on directions of research and policy agenda.

Kategóriák: Economy

OECD map shows huge disparity between Hungarian regions / economy - 2016, október 12 - 16:53
The Organisation for Economic Co-operation and Development (OECD) has published a report on Hungary’s seven regions, revealing how they fared in terms of the different development indicators. ...
Kategóriák: Economy

Hungary cenbank ready to further limit 3-m deposit facility - minutes / economy - 2016, október 12 - 15:34
The Monetary Council of the Hungarian central bank (MNB) stands ready to apply a stronger limitation to its 3-month deposits if monetary conditions need to be loosened further to meet the inflation...
Kategóriák: Economy

Hungary debt manager puts off press conference, changes subject / economy - 2016, október 12 - 15:17
Contrary to original plans, Hungary’s Government Debt Management Agency (ÁKK) will hold a press conference on Friday instead of Thursday, and the subject of the event has also been changed, a...
Kategóriák: Economy

Masterpieces of Hungarian art are waiting for bidders / economy - 2016, október 12 - 15:05
Hungarian art is becoming more and more canonized both in art history and in auctions, however it still has affordable prices that could sign great investment for collectors. Therefore this week...
Kategóriák: Economy

Hungary seen revealing new debt management plans on Thursday / economy - 2016, október 12 - 14:51
György Barcza, chief executive of Hungary’s Government Debt Management Agency (ÁKK), is to hold a press conference on Thursday morning titled “New era in debt management", an emailed...
Kategóriák: Economy

Italian PM urges hardline stance on EU members rejecting relocation quotas / economy - 2016, október 12 - 14:09
Italy’s Prime Minister Matteo Renzi urged to take an “extremely tough stance" on European Union member states that have been the recipients of large EU funds yet they are trying to dodge...
Kategóriák: Economy

Political risk premium fading in Hungary, end-year EURHUF seen at 310-315 / economy - 2016, október 12 - 12:09
The Hungarian forint seems to have found some resistance to its recent appreciation trend (following a rating upgrade back into investment territory in September) around levels of EUR/HUF 305. With...
Kategóriák: Economy

ANALYST VIEW - Hungary: still a sweet spot for easing, but caution is needed - BofA-ML / economy - 2016, október 12 - 11:15
The National Bank of Hungary will continue to make strong efforts to push the 3-month Bubor lower towards 60 basis points by the end of the year, Bank of America Merrill Lynch said in a research note...
Kategóriák: Economy

Hungary's industry fares poorly in summer, but autumn brings improvement / economy - 2016, október 12 - 09:01
Hungary’s industrial production grew by 1.6% month on month in August 2016, in line with the preliminary data, the Central Statistical Office (KSH) reported on Wednesday. This is good news in...
Kategóriák: Economy

Want to know how Hungary would have fared without EU funds? / economy - 2016, október 11 - 15:55
The investment supported to Hungary is estimated to have increased GDP in 2015 by just over 5% above the level it would have been in the absence of the European Union funding provided, a European...
Kategóriák: Economy

Want to know how Hungary would have done without EU funds? / economy - 2016, október 11 - 15:55
The investment supported to Hungary is estimated to have increased GDP in 2015 by just over 5% above the level it would have been in the absence of the European Union funding provided, a European...
Kategóriák: Economy