Banks, before and after the crisis: a retrospective overview

MIT Press is republishing the seminal book “Microeconomics of Banking”, by Professor Xavier Freixas

The global financial crisis of 2008 marked a turning point for many industries, but particularly in the banking sector. “There was previously less regulation, and banks had more power, both internationally and in terms of the non-banking sector. However, the crisis highlighted the fragility of banks and the need to regulate them. There have also been lots of mergers, in what we refer to as the consolidation of the sector. There are fewer banks and branches than before, so those that have survived have greater market power”, explains Professor Xavier Freixas, the Director of the UPF-BSM’s official Master in Finance and Banking.

Moreover, we have seen the rise of the unstoppable phenomenon of digitization. “We now have to deal with cryptocurrencies, APIs,  crowdfunding and other innovations that compete with banking products. There has also been a boom in startups offering financial products with the efficiency provided by new technologies such as robotics and AI. Naturally, banks can also buy out these companies and offer their products, but they have to compete with small independent companies that are offering the same thing. Whatever happens, bank margins will have to decrease in the future”, predicts the Professor.

Digitization has also led to a significant reduction in the role of bank employees and branches. “Obviously, they are not as important as they were 30 years ago, which means that banks now hire more staff to advise than to conduct ordinary operations, which are now fully automated”, explains Professor Freixas. “Many of us will not have stepped foot in a branch for years now. I certainly haven’t. We do it all online”.

“Microeconomics of Banking”

All in all, we find ourselves in a very different world from the one we lived in not so long ago. This fact is reflected in the third edition of the book “Microeconomics of Banking”, co-written by Xavier Freixas with the Professor of the Toulouse School of Economics, Jean-Charles Rochet. Published by MIT Press, the book gives a comprehensive vision of the evolution of banking theory and the volatile world of financial intermediation, analyzing its keys aspects, while also providing the tools required to understand how these aspects have been formed.

“We used to think that it was only banks that managed risk”, explains Xavier Freixas. “But the book summarizes a series of insights into the sector that highlight the existence of ‘Asymmetrical information’: when a customer asks the bank for a loan, in fact, they know far more than the bank about the project that they want to finance. This is a really important factor in the decision to grant a loan, how long the repayment period should be, and what collateral to ask for. For this reason, markets work really differently from how they used to”.

Comparing the new edition of the book to the first edition in 1997, which gave an overview of all the accumulated knowledge of the field, Professor Freixas emphasizes that “our strategy has been to provide new insights. Nowadays, we have far more information and lots more data, which has enabled us to pick the theories that are backed up by the empirical evidence”.

In effect, after the 20028 crisis, “assets that we thought were safe and liquid proved not to be anymore. Nowadays, an asset is only safe and liquid if other investors think it is safe and liquid. Then, suddenly, there is a general consensus that something is no longer safe and liquid, which triggers a crisis of confidence, just like happening with the mortgage securitization crisis, which were not as safe as they had seemed”.

As well as its three editions, “Microeconomics of Banking” has been translated into several languages, has registered 5,000 quotations on Google Scholar, and is recommended on doctoral programs in finances and macroeconomics around the world, because “it integrates and condenses a lot of previously disperse knowledge, which is great for anybody who wants to gain an in-depth understanding of this field, whether with a view to doing a PhD or working in a central bank, as it shows researchers what to do before undertaking an empirical analysis”.