Certain Uncertainty? the Response of Venezuelan Banks to a Political Dilemma”
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Master in Specialized Economic Analysis: Economics of Public Policy “Certain uncertainty? The response of Venezuelan banks to a political dilemma” Mary Armijos and Guillem Cuberta Hannes Mueller and Ada Ferrer i Carbonell June 20,2019 ABSTRACT This paper studies how policy uncertainty and political connection has affected Venezuelan banks’ performance and lending activities. We use monthly microdata from the Venezuela’s Superintendence of Banks and we construct two indices to exploit its variation. We find that in period of high economic policy uncertainty politically connected banks are willing to assimilate taking more risks and thus they give out more loans. Complementarily, the amount of provisions held for potential loses is also higher for connected banks during high uncertainty periods. Nevertheless, we find that having a political connection, during times of high uncertainty, damages the profitability compared to non-politically connected banks. Our study provides new insights for the scarce literature on this field, especially on the measure of the variables of interest. It also highlights relevant information for Venezuelan economy. It's noteworthy to mention that although political connection benefits some banks, it's not possible to achieve a full competitive advantage over non-politically connected banks. This might be due to the current state of the country's economy and financial markets. RESUMEN Este documento estudia cómo la incertidumbre política y la conexión política ha afectado el desempeño y las actividades crediticias de los bancos venezolanos. Utilizamos microdatos mensuales de la Superintendencia de Bancos de Venezuela y construimos dos índices para explotar su variación. Encontramos que en un período de alta incertidumbre en la política económica, los bancos conectados políticamente están dispuestos a asimilar más riesgos y, por lo tanto, otorgan más préstamos. Así mismo, la cantidad de provisiones mantenidas para pérdidas potenciales también es mayor para los bancos conectados durante períodos de alta incertidumbre. Sin embargo, encontramos que tener una conexión política, en tiempos de alta incertidumbre, perjudica la rentabilidad en comparación con los bancos no políticamente conectados. Nuestro estudio proporciona nuevas ideas para la escasa literatura sobre este campo, especialmente sobre la medida de las variables de interés. También destaca información relevante para la economía venezolana. Cabe mencionar que, aunque la conexión política beneficia a algunos bancos, no es posible lograr una ventaja competitiva completa sobre los bancos no conectados políticamente. Esto podría deberse al estado actual de la economía y los mercados financieros del país. KEYWORDS IN ENGLISH (3): Political Connection, Economic Policy Uncertainty, Venezuela KEYWORDS IN CATALAN/ SPANISH (3): Conexión Política, Incertidumbre de Política Económica, Venezuela Certain uncertainty? The response of Venezuelan banks to a political dilemma. Armijos M., Cuberta G. Abstract This paper studies how policy uncertainty and political connection has affected Venezuelan banks’ performance and lending activities. We use monthly microdata from the Venezuela’s Superintendence of Banks and we construct two indices to exploit its variation. We find that in period of high economic policy uncertainty politically connected banks are willing to assimilate taking more risks and thus they give out more loans. Complementarily, the amount of provisions held for potential loses is also higher for connected banks during high uncertainty periods. Nevertheless, we find that having a political connection, during times of high uncertainty, damages the profitability compared to non-politically connected banks. Our study provides new insights for the scarce literature on this field, especially on the measure of the variables of interest. It also highlights relevant information for Venezuelan economy. It's noteworthy to mention that although political connection benefits some banks, it's not possible to achieve a full competitive advantage over non politically connected banks. This might be due to the current state of the country's economy and financial markets. Keywords: Political Connection, Economic Policy Uncertainty, Credit Supply, Performance, Venezuela JEL classification: G21; D81; 1 1. Introduction Uncertainty is all among us. Different fields like physics, biology, robotics, economics and so on, study uncertainty, its effects and ways to smooth it. The concept of uncertainty in economics was first introduced by Knight in 1921, who defined it as people’s lack of ability to predict the likelihood of an event occurrence. All economies around the world struggle with this, however, developing countries usually experience it more, for two main reasons. First, they are regularly more exposed to domestic political shocks, which are usually caused by bad governance that lead to riots and protests of people that disagree with the government decisions. Second, their economies tend to depend on a few primary products that have volatile prices (e.g., oil, gold, copper). Bloom (2014) emphasizes this and shows that countries in regions like Africa and South America experience approximately one third higher macro uncertainty. Furthermore, the political connection phenomenon in developing countries has been growing besides uncertainty levels. Political favoritism worsens any uncertainty situation as it leads to an asymmetry of information that just benefits the ones that are related to the ones in power, leaving the rest out. For instance, the principal problem of petrostates like Venezuela, whose government income is deeply reliant on the export of oil and natural gas, is that they are usually characterized by a highly concentrated economic and political power in an elite minority, weak political institutions, and widespread corruption. Various researchers argue that the cause of Venezuela’s downfall is the discordance of economic and political decisions and strategies. (Pearson, 2016; Di John, 2011) Also, these countries are vulnerable to experience what is known as the “Dutch disease” and the curse of natural resources. What happens is that other sectors, such as agriculture and manufacturing (which provide more employment than the oil sector, that uses more machines than people), become less important and the government sector rises. Hence, oil dependency combined with bad governance could lead a petrostate to fail and experience a severe crisis. That is the case of Venezuela, once one of the richest and most developed countries in Latin America, that is now living one of the worst crises in the last century. 2 Oil sales in Venezuela constitute 98 percent of total exports and 50 percent of GDP, yet oil production has been declining. The decline in production and the abrupt changes on oil prices in recent years have caused the GDP to decrease by over 10% for the third year in a row, which has led to Venezuela defaulting and owing billions of dollars. On top of that, the inflation rate has been over 50% since 2014 and now is increasing at more than 2 million% (OPEC, 2018). There’s a growing autocracy, the government control of prices on basic goods and the rise of the black-market cause impromptu fluctuations of the prices, causing severe food shortages. Additionally, there is an increase in crime, political uncertainty and instability, and decreasing international trust. (Ascher, W., & Mirovitskaya, N., 2012; Doocy et al., 2019). Because of this, various sectors of the economy have been affected, such as the banking sector. Our work focuses on the analysis of the Venezuelan banks, which have become more vulnerable. The main causes of this vulnerability have been oil price shocks, political instability, pro-cyclical monetary conditions (i.e., interest rates), low level of financial intermediation, changing structure (e.g., consolidation, closure or nationalization), non-traditional bank transactions, high exposure to the public sector, and government intervention in their operations. (Blavy R., 2014) Hence, studying the response of banks to policy uncertainty becomes relevant. But even more important, in Venezuela’s context, would be to ask: do banks respond differently to uncertainty if they are politically connected? To address this question, we construct two indices: policy uncertainty index and political connection index. Our uncertainty index is in a monthly basis and bank-invariant; it is developed following the work previously done by Baker, Bloom, and David, on the Economic Policy Uncertainty Index (EPU Index) and by Ahir, Bloom, and Furceri, on the World Uncertainty Index (an extension of the EPU). Similar to Xu and Zhou (2008),for the case of political connection index, which is bank specific and time-invariant, we define the dummy variable connected bank equal one based on whether it is a state-owned bank or , in case it is a private one, if at least one of the board members has any type of connection with someone from the government. We adapt this criteria to the information there is available from Venezuela. Apart from looking if the bank board of directors is composed of someone that has relatives on the government, we specifically look if one of the members is part of the ‘bolibourgeoisie’,a combination of the words Bolivarian and bourgeoisie (term used to classify the businessmen and public officials linked to the government). 3 For our dependent and micro control variables (i.e., bank characteristics) we use monthly data from 2006 to 2018