European Parliament, MEP, ALDE Coordinator for the Economic and Monetary Affairs Committee
Danmarks Nationalbank, Governor
Single Resolution Board, Board Member, Director of Resolution Planning and Decisions
European Banking Authority, Chairperson
Bank of Finland, Governor
Crédit Agricole S.A., Deputy Chief Executive Officer
Preamble: The benefits of a single banking market
The euro area needs an institutional framework that allows euro area banks to reap the benefits of a genuine single banking market. In the context of a monetary union, a single banking market would notably improve the allocation of capital - that is credit allocated efficiently and without reference to location. That would not necessarily mean that the Portuguese SMEs would borrow at the same cost as German SMEs; but that Portuguese SMEs would borrow at the same cost from Portuguese banks as they do from German banks if the balance sheets of these banks are of equal quality.
Better EU financial integration should also enhance competition and broaden the access of customers to credit and new financial products. In addition, better integration would lead to enhanced risk diversification. Thus, EU banks would benefit from eliminating legislative differences and harmonizing supervisory practices. Moreover a single banking market would improve private risk sharing – that is if banking markets are integrated in such a way as to help companies and households cushion domestic bank shocks.
A representative of a public authority stated that the issue of risk sharing is critical; there must be a clear separation between financial markets and public authorities. One of the main aims of a single European financial market is for financial markets to share a larger amount of risk, as happens in the United States. As such, this speaker does not understand why some politicians are against creating a single market of financial services; this would promote risk sharing in the European area and make political leaders’ positions easier, whereas if these developments do not occur, risk remains the responsibility of their country’s taxpayers. A true single market with strong European authorities and clear legislation makes it possible to have Europe wide institutions that operate across borders, and can also share risks. If this is not permitted, the taxpayers in their member states remain responsible.
Another public authority representative added that if Europe wants to increase public risk sharing instruments and share taxpayers’ money (i.e. temporary fiscal transfers), doing so will remain difficult for a very long time, and can only be envisaged on a case by case basis. However, if the goal is to develop private risk sharing mechanisms – i.e. an attractive EU banking and financial environment including efficient insolvency legislation and practices – there will be true risk sharing, and this is easily feasible. In this perspective, the breaking of the sovereign bank loop will notably be required to improve the integration of the EU banking market, and more will need to be done to diversify banks’ holdings of sovereign debt, in order to have a truly single system.
The public authority representative added that they envision Europe reaching the point of being a true single market, with more cross border banking than presently exists. They hope that Europe can create a solid banking system whereby banks are decoupled from their national sovereigns, but also one in which banks fail and are resolved on a regular basis, because that is the proof that a competitive market exists. This representative commented that they wish that Denmark was part of this grouping, including the SSM and Europe, but achieving political consent for this may take some time.
Reversing fragmentation would be an additional expected benefit from the single market potential. This “de-fragmentation” would contribute to breaking the ‘vicious circle’ between banks and sovereigns, and improve the resolution of banks, which would therefore reduce the risk of taxpayers’ money being involved in bail outs. These are the reasons why the priority is to make the Banking Union effective and to keep the development of supervisory practices in the Banking Union well connected with the EU-wide convergence agenda.
The Chair stated that they are glad to be able to moderate a panel on this subject: fragmentation remains an important issue in relation to the financing of Europe’s economy. Whenever the Chair takes the floor at Eurofi, they always attempt to give the audience a sense of where public opinion stands, and is always struck by the fact that many of Europe’s citizens do not believe that European institutions have done much to frame banking activity and make it useful to the real economy. When the Chair is not at Eurofi, they are defending the necessity of having a sound finance sector, but this is an important issue; in some countries, it is felt that what Europe has done has not been appropriate.
Europe tackles issues step by step; the first step in this context has been the de Larosière report. First the authorities were created, then the SSM, and then the resolution layer was added. The CMU project is also related to how the relationship between banking intermediation and markets is conceived, but an element might be missing from this. This is the broad, strategic vision of the direction that Europe wants to go in, and the Chair would encourage participants to take a perspective that allows them to reflect, and maybe to go back and consider what has been done.
Participants were also encouraged to look at the future from a medium and long term perspective: not what is going to happen, and what is in the European Commission’s pipeline, but what kind of strategy they want to develop. Enough people will focus on the flaws and the difficulties, but the Chair would invite panel members to be positive and make proposals, looking at the future as something that they share and in which they will want to do things in common. Even if Brexit means that a part of Europe is leaving, the rest of the EU 27 aim to stay together.
From a neutral, legal perspective, Brexit changes a lot. The Chair stated that they remember when they were one of the rapporteurs on the SSM and the Resolution Board; it was clear that the tendency to make a distinction between the ‘ins’ and the ‘outs’ of the euro area was very strong. Now, all 27 EU member states are legally committed to join the euro, apart from Denmark, and Denmark is very close to the euro, as the krone is linked to it.
1. Much has been achieved
A representative of a public authority noted that, 10 years ago, Malta was fully in the process of preparing itself to join the euro; it adopted it on 1 January 2008. Turbulence occurred in August 2008, and uncertainty remained even once the ECB and the Federal Reserve had provided liquidity to the banks. In September, following an informal Ecofin meeting and evening dinner, Jean Claude Trichet informed everyone present that a meeting would take place at midnight; this had been when Lehman Brothers had been in difficulties. It has since become clear that Jean Claude Trichet called Tim Geithner early on the Monday morning, and had asked him whether the Federal Reserve had ‘lost their minds’, having let Lehman Brothers fail and risking a global panic. Tim Geithner’s attitude had been that they had not done so on purpose, but had come up against the limits of their authority and the fears of British regulators.
In the summer of 2012, a summit took place, wherein European leaders demonstrated enormous commitment and a long term vision in the decision to create the banking union, including the SSM, the SRM, and Deposit Insurance. The European Commission, the Parliament and the Council worked with extreme intensity and effectiveness to conclude these projects. Also in 2012, Mario Draghi gave a famous speech during the London Olympic Games; the ‘Whatever it takes’ speech’.
It now needs to be asked what has been achieved since 2012. Firstly, the banks are better capitalised. In 2012, many banks’ real capital stood at about 2% of their balance sheet, but now, these amounts are three, four or five times higher. Banks have more liquidity, which is a major change.
Secondly, everybody agrees in principle that no bank should be too big to fail, and while it is possible that not enough has been done in this respect, a lot has been done. Major steps have indeed been taken at unprecedented speed over the past years to establish the Banking Union. After a comprehensive assessment of all significant credit institutions in the Banking Union, the Single Supervisory mechanism was fully established in 2014 and the Single Resolution Mechanism has become operational in 2016.
Thirdly, macroprudential schemes are now functioning in all countries. This is not enough, but it represents a lot of progress.
2. Making the Banking Union a reality
2.1. Fragmentation is still an issue and the cross border banking activities have not been restored
An industry representative stated that since 2008, two developments have stood out: the first is the dislocation in the European market. From an examination of the figures, it is obvious that the flows from European banks to foreign entities outside their own country have declined quite markedly. Cross border operations in the banking sector have declined, and are still declining. Without the ECB acting as they did, Europe would have suffered even more, as occurred in 2011. At this time, there were huge spreads in interest rates between the different countries, and SMEs in Spain, Italy, Germany and France were suffering from very large differentials in interest rates. This has been reduced thanks to the ECB’s intervention, but has only been achieved by extreme measures. There is still a question of fragmentation; the issue is how to resolve it.
A representative of a public authority added, regarding fragmentation, that there are clear signals that in around 2011 to 2012, there was a significant deterioration in all the indicators of integration, price and quantities: i.e. cross border flows and interest rate differentials. To some extent, following banking union, these reduced in their price dimension, but cross border flows are still not present. There has been a significant retrenchment, and cross border banking has not yet returned.
2.2. EU cross- border groups do not operate in a single market
2.2.1 The lack of single-jurisdiction status
An industry representative stated that the lack of single-jurisdiction status – or the multiple national jurisdictions – penalises banks operating across the Eurozone and impedes greater risk diversification. Cross border banks can face additional liquidity and capital charges on their subsidiaries located in the euro area. These additional prudential requirements imposed by national authorities ring-fence national markets and are very detrimental. They fail to recognise the new EU financial architecture and fail to recall the mistakes made during the 2008 crisis: opacity, complexity and fragmented supervision worsened the crisis.
2.2.2. The example of the NSFR
The industry representative continued, taking the example of the calibration of the NSFR. The first question is whether Europe should translate the NSFR into its legislation if the United States do not. The second question that has puzzled this speaker is the proposal to translate NSFR into European legislation not on a consolidated level, but on a solo basis. This indicates that Europe does not believe that cross border banks are able to transfer liquidity from one country to another in less than a year, and therefore sends the message that although Europe claims to be in a Banking Union, it is not in practice. The industry representative also asked why a solo basis approach is being imposed on EU regulation that has in principle to be done at the consolidated level: MREL or Pillar 2 requirements.
2.2.3. Additional capital charges for systemically important banks regarding their cross-border Eurozone exposures
The industry representative added that another symptom is the treatment of additional capital charges for systemically important banks related to cross-border euro area exposures, which are still considered as international exposures from a regulatory perspective and which hinder cross border consolidation. Although Europe claims that it wants cross border activities and pan European banks, politicians’ minds are not made up; they say they want these things, but do not deliver them in the regulation and in the legislation, because national governments want to pre position loss absorbing buffers in their countries.
From past experience, the industry representative believes that some supervisors and regulators will respond to his statements by claiming that they are exaggerating, as the possibility exists to grant waivers on a case by case basis. The speaker would like this logic to be inverted: it should be assumed that no solo requirements applies within the Banking Union for consolidated banking groups unless there was a compelling reason otherwise, with the burden of proof on supervisory authorities’ side. As a G SIB, the speaker’s institution is penalised because of its presence in different Eurozone countries, which the industry representative does not understand: JP Morgan is not penalised due to its presence in both New York and Los Angeles. To achieve a true Banking Union, there does not need to be any legal change, or transfer of sovereignty or money between countries, but it does require a clear and voluntary approach to be taken by all the authorities present. They are sure that this willingness will materialise.
2.2.4. Internal MREL in the euro area: an obstacle to cross-border banking
According to a public decision maker, internal MREL arises from two different topics. In the case of the Eurozone, as there is a single resolution authority, decisions on resolution do not need to be coordinated by individual member states. However, there are other reasons to set the internal MREL, such as whether something is related to the resolvability of the entity and the existence of subsidiaries. If a particular bank only had branches in Europe, then given the existence of a single resolution authority, there would be no need to set internal MREL. The problem is that this bank also has subsidiaries, and there is a need to comply with the requirements of upstream losses and downstream capital in the event that there is a problem with an entity. There is also a need to comply with the ‘no creditor worse off’ principle, so that the creditors of the parent cannot be worse off as a result of resolution than in liquidation. This is not only a problem of authority, but a more complex problem.
The industry representative replied that these are good arguments, but ultimately, Europe needs to decide whether it wants cross border banking or not. They understand the technical reasons why their institution has a Pillar 2 on its subsidiary in Italy and on its activities in France, but there comes a point at which Europe has to take a step forward, trusting other countries and relying on the authorities that have been set in order to resolve the problems.
Regarding the NSFR, there are a lot of good arguments, but what is underlying these arguments is the desire of national authorities to maintain their role. As a banker, this industry representative wants the Eurozone to be considered as a single constituency; otherwise, it is not clear why so many efforts to move towards a single monetary union and banking market were made, if companies will not be able to realise the benefits of doing so.
The Chair added that one simple point that is worth emphasising: what is often presented as national interest might actually be the interest of a small group of people in European countries, fighting against the general interest of the population at large.
2.2.5. Subsidiaries or Branches: does one size fit all?
A representative of a public authority stated that they will take the points made by the industry representative on board. They added that there needs to be more simplicity within the euro area: they are from a country that has seen ‘branchification’, because two banks have had subsidiaries systemically imposed on them and have been operating in Finland. Now, they are moving subsidiaries into branches, and their headquarters are outside the euro area, but they are systemically important inside the euro area. As such, this issue should be able to be solved within the euro area, where the same supervisory and resolution mechanisms exist, but entities that have headquarters and branches outside the euro area complicate this issue.
Another public authority representative stated that the main impediment to applying the same rules that exist for subsidiaries to branches is the complexity of legal structures, which need to be fixed. Simplification is a growing issue: there are a lot of complexities in the system. If banks were very well capitalised, with a resolution system that they trust and implement, then regulators do not need to run the business of banks to the same extent as they do today, with lots of detailed rules and red tape. Europe has not reached this stage yet, but part of regulators’ vision for the future is to move in that direction.
2.2.6. Pillar 2 capital add-ons are still used by national supervisors, notably to address macro prudential risks, which contributes to financial fragmentation
A public authority representative stated that they are very sympathetic to many of the arguments that the representative from the industry made. Macro prudential tools is an area that is of concern; they believe that, when the de Larosière report proposed macroprudential policies and tools, this was on the basis that these policies need to be different in different locations, but they could be done at the European level. There could be a common European system in which the tools and levers to be pulled in the event of a build up of risks in a certain region of the economy are defined.
But , in reality, having 28 macroprudential authorities has meant that several types of risk, such as the build up of a bubble in the real estate market, would be tackled using very different tools, including higher risk weights or floors to Loss Given Defaults (LGDs) in internal models and requests for loan to value ratios. To some extent, this also generates a problem with the functioning of the single market, even in such an area as the comparability of ratios across countries. Europe needs to now come up with some streamlining that is more ‘European' minded’.
The Chair noted that the revision of the ESAs will come soon, which will be a good opportunity to act on this.
3. The causes of fragmentation
3.1. At the beginning of the crisis, Europe has chosen to go the national route, which has generated segmentation
A public authority representative stated that the main drivers of fragmentation have been the decisions that have been taken in the European Union; they are particularly thinking of two instances. The first took place in 2008, when the financial crisis represented a systemic crisis for the whole of the European Union. At the time, there was a proposal from the Dutch finance ministry to set up a common European bail out fund, but this proposal was rejected, as the prevailing thinking was to deal with this on a national level. There has been a clear decision to take a national approach to dealing with the crisis.
The second moment was when the European Financial Stability Fund began to intervene during the sovereign debt crisis. It was decided not to have an intervention to support the restructure of the banks at the European level, but to give the money to the member states and to have national initiatives to restructure the banks. The consequence of this was that the restructuring occurred mainly on a domestic basis.
There is now a third stage: Europe now must deal with the cleaning up of the banks’ balance sheets, and with legacy assets and the NPL issue. The public authority representative has tried to put forward a proposal to take a European approach to these challenges, but it is their understanding that this will be difficult; national solutions will probably be opted for. At every stage at which the legacy of the crisis has had to be addressed, Europe has chosen to go the national route, which has generated segmentation.
Mutualisation of losses has never been proposed. An interesting paper has been produced by Daniel Gros, which compares the way in which the banking crisis has been resolved in Puerto Rico and Nevada in the US, and in Greece and Ireland in the EU. These are very similar in terms of size and the types of problems they faced; however, in the US, the FDIC entered the banks, identified the losses, and then sold the liabilities and the good assets to banks from other states, which was exactly the private risk sharing that is required in a resolution. Customers did not even notice that this had happened. In the European Union, however, this was done entirely at a national level, and it is therefore unsurprising that the EU is exiting the crisis with in a more segmented environment than it started with.
Another public authority representative stated that they, and others, struggled to prevent what happened during the crisis before it took place. Since this time, this person has been very impressed by the institutional changes that have taken place, particularly in relation to two issues. At the time of the crisis, frank discussions took place between honest people about whether or not risk diversification was a good thing; the argument against was that, with a lot of risk diversification, there would also be a risk of contagion. This demonstrates the extent to which the thinking was on a national level, in terms of supervision and resolution. Other people, including the speaker, argued against this perspective, and now, they do not hear many people question the need for more diversification.
The second issue is that Europe pretended to have a resolution system, called ‘constructive ambiguity’. However, this was neither constructive nor ambiguous: there was only one way to resolve a bank, and that was via a bailout, as banks could not be allowed to go bankrupt. This creates too many distortions in markets, and Europe did not have at the time the equipment that it has today, with ordinary resolution and bail in tools.
3.2. Problems related to legacy assets are increasing, because the right measures were not taken on time
A representative of a public authority stated that there is also an issue with market fragmentation and the different attitude of authorities. In Europe, some authorities tackled the problem of the banking crisis in 2008; others did so in 2012, and others are trying to do so now, or in the coming years. Problems related to legacy assets are increasing, and this is probably because the right measures were not taken on time.
4. Short term priorities
4.1. Completing the Banking Union and simplifying the EU macroprudential regulatory framework
A representative of a public authority stated that there remain steps to take; the first is to complete banking union, and the European Deposit Insurance Scheme (EDIS) will be critical to this. A common EU backstop for the Single Resolution Fund (SRF) also be secured if Europe wants to reap the economic, financial and political benefits of a Banking Union. This means de risking in parallel, so that all parties are on the same level. NPLs also need to be reduced to make sure that everyone is on the same footing. The legislation that was accepted at the time also needs to be reviewed: much of it is extremely complicated, with too many options and possibilities for national discretion. If there is to be a truly European financial market, this requires everybody to work to the same rules. Europe should also simplify its macro prudential regulation, and the EU Commission should make proposals in this respect.
If this can be achieved, it will mean the creation of the Deposit Insurance Scheme in the long term, the reduction of NPLs, and the simplification of legislation that will create incentives and possibilities for the true single European financial markets. This also requires European banks and financial institutions that operate across borders. Although this is the short term agenda, there is no need to be shy in describing how much Europe has achieved over the course of the past nine or 10 years. When the speaker was in Brussels in the 1990s, the largest move towards a single market came into effect in 1993: the Delors programme, which dated back to 1986. The issue of Banking Union is the second biggest step that the EU has ever taken, but it needs to be seen through to completion.
4.2. The quicker Europe can address the NPL challenge, the better
An industry representative stated that resolving the issue of NPLs is crucial in order to restore a well functioning monetary union and single market. The proposals made by a previous speaker would be steps in the right direction, but the main issue is that of timing. NPLs is a legacy issue in a lot of countries, and the quicker Europe can address this, the better. Europe is at a point at which its economy may rebound, and this seems like a good opportunity to solve this problem as quickly as possible. Doing it at the national level may not be the ideal solution, but is the more rapid solution, and the industry representative commented that they have no ‘vested interest’ in this. They hope that the national authorities involved in the process – the European Commission, the ECB, and the resolution authority – will find the necessary flexibility to deal with this issue.
Part of the problem also arises from the division of labour, which has been too high between the different levels and authorities (SSM, SRB, EU Commission, and National Authorities). Rules, and in particular the bail-in rules, have been applied too rigidly and are somewhat rigid themselves. Political impetus, trying to bring all these authorities together and put pressure on them to solve this issue as quickly as possible, would be welcomed.
A representative of a public authority noted that they had previously believed that the biggest remaining issue in banking is NPLs, but having listened to the previous day’s discussion on the “Priorities for relaunching the eurozone and the EU-27 projects”, they have become convinced that finalising and implementing a resolution system may be even more important. Without a comprehensive resolution system, Europe will remain fragmented; there will be a very strong link between national governments and banks, and there will not be any risk sharing because, if Europe has a system that relies on bail outs, there can be no risk sharing other than that shared by the domestic taxpayer. This will not lead Europe in the direction of elevation. A lot of progress has been made: Europe has created legislation, and communicated that a solid system is in place, but there is reluctance to implement this in full. The public authority representative noted that they are not talking about specific cases, but the way that people talk about the BRRD is of concern.
Regarding the question of NPLs, there are a lot of issues, but one of the most important is that of insolvency regimes and how efficient these are. If the administration problem with NPLs was contained to the banks, benefits might arise from selling the bad loans to an asset management company, if they had a greater capacity to deal with these issues than the banks themselves. It could be asked whether the banks should continue to be banks if they are not capable of managing NPLs: bank lending is a normal feature of doing banking business, and banks should be capable of managing this.
However, if the problem is the judiciary system and its efficiency, selling off these loans will not necessarily be very helpful, for two reasons. The first is that the asset management companies will obviously price these loans at a very low rate; otherwise, they cannot recoup their outlays. The second reason is that, even if banks were to sell off their NPLs, if it is clear that the judiciary system is inefficient, this is a broader issue than just the legacy: questions arise of who will provide lending from within the country, out of the country and from cross border banks if access to collateral is extremely difficult or slow. These insolvency regimes are a significant part of the issue.
4.3. The implementation of the EU harmonised resolution framework would reduce the level of fragmentation.
A public authority representative stated that if the topic is market fragmentation and NPLs, the regulatory framework already exists to tackle all these topics within the BRRD and the SRM regulation. The challenge now is to comply with these regulations, and to implement the measures included within them. A previous speaker mentioned the problem with NPLs; Europe now has a resolution tool, the asset segregation tool, which it can use for the purposes of resolution if necessary. The best way to combat market fragmentation is to decouple the sovereign banking loop: i.e. not to use public money in the bail out of banks. In reality, there are cases for resolution that do not employ the measures and tools included in the BRRD. Europe has a way of avoiding the use of public money and delinking the banking and sovereign loop. However some authorities prefer to use different instruments and public money.
A very large problem at the present time is that of the credibility of the regulations, the frameworks, and the resolution framework that was approved three or four years ago. Europe needs to bear in mind the consequences of a reversion to the banking and sovereign loop.
The Chair commented that they sometimes wonder whether Europe actually accepted the bail-in agreement: the debate in some member states shows that the decision has been taken to move ‘from bail out to bail-in’. Taxpayers do not want their money to be used anymore, but some people want their minister to intervene nevertheless, if there is a problem.
4.4. Europe needs to demonstrate that the single banking market can be delivered for the EU as a whole.
A public authority representative noted that, in the event of a crisis, it is the national taxpayer or national policy choices that are relevant, which gives strong incentives to national authorities to try to maintain the capital and liquidity available in their jurisdiction, rather than to allow these to flow freely within the single market. It is therefore necessary for Europe to deal with this issue; the first interventions, which have put the emphasis on the resolution side, have been the correct approach. There is a need to fix the link through recovery and resolution planning and create a credible method for failing firms to exit the market. Once credible means exist of dealing with a cross border group in a crisis, there should exist an incentive to begin retrenching the prudential measures that now require European states to lock capital and liquidity into individual jurisdictions. This is a high priority, because Europe needs to demonstrate that the single market can deliver for the EU as a whole.
Both in the resolution and in the supervision area, the speaker has seen a number of people indicate that they wish to maintain even pre positioning of a loss absorbing capacity in individual entities and Pillar 2 requirements on individual entities, sometimes even within the euro area, which is ‘puzzling’ from a long term perspective. There is also a need to reconsider the way in which Europe takes decisions; for instance, the speaker’s board has engaged in a lot of mediation, and some discussions regarding the breach of union law, but these issues are ultimately decided by all of the national authorities taking a final decision.
All of the mediation cases that the public authority representative has dealt with have been positive, but given the way that the legal framework is set up, the host authorities can always take their own decision. This means that, in mediation, sometimes there is an agreement to crystallise segmentation or to let everybody take the actions that they think are required in their own jurisdictions. With these decisions, Europe should try to have more decision making take place on the European level, rather than allowing this to be only in the remit of the national authorities, although the EBA should not necessarily decide; there could be an independent panel, for instance. Joint decisions should work more for the single market, but this has not yet been achieved.
The Chair added that European decision making processes need to include a national level, but not everyone should be locked into a national perspective.
4.5 Recognizing risk diversification in the EU banking regulatory framework.
An industry representative stated that when an entity acts as an insurer when present in different countries, it has lower capital requirements, as a result of the benefits of diversification. When it acts as a banker when present in different countries, it is penalised, because it is believed that it will be more difficult to resolve, and therefore more capital is required of it. The industry representative would like some progress to be made in this area.
Regarding the issue of ‘transition’ versus ‘steady state’, one public authority representative agrees that resolution legislation is generally well done. This will be ideal for the steady state, when there is a well functioning supervisory mechanism and resolution regime, but transition is not easy; it represents a significant change, and very often in European legislation, there is have a transition period and a steady state. Although authorities should act swiftly, there need to be special national efforts to put all the banks and international institutions on the same footing, to progress ahead with European integration.