Completing Banking Union Nicolas Véron Senior Fellow, Peterson Institute for International Economics (Washington DC) and Bruegel (Brussels) LUISS Rome – June 21, 2019 1
Banking Union “ We affirm that it is imperative to break the vicious circle between banks and sovereigns. The Commission will present Proposals on the basis of Article 127(6) for a single supervisory mechanism shortly. We ask the Council to consider these Proposals as a matter of urgency by the end of 2012. When an effective single supervisory mechanism is established, involving the ECB, for banks in the euro area the ESM could , following a regular decision, have the possibility to recapitalize banks directly . This would rely on appropriate conditionality, including compliance with state aid rules, which should be institution-specific, sector-specific or economy-wide and would be formalised in a Memorandum of Understanding.” Euro area summit statement, 29 June 2012 “What we call the banking union is, in fact, a series of actions taken to decouple sovereign risk from the financial variety, with the aim of restoring the monetary union’s stability and credibility.” Fernando Restoy, “The European banking union: achievements and challenges”, BIS, 22 November 2018 2
Breaking the Vicious Circle Sovereign exposures Erosion of guarantees Sovereign Domestic banks Direct Linkages Guarantees (implicit + explicit), including deposit insurance Indirect Linkages Domestic Economy 3
Breaking the Vicious Circle Diversify sovereign exposures Sovereign exposures Erosion of guarantees Sovereign Domestic banks Direct Linkages Guarantees (implicit + explicit), including deposit insurance Public guarantees equalized & pooled at European level Indirect Linkages Domestic Economy Cross-border bank integration 4
Trio of Reforms 1. Diversify sovereign exposures – Sovereign Concentration Charges 2. Pool & equalize public guarantees at the European level – Genuine EDIS – ESM tools to ensure financial stability – Single regime for unviable banks – Restrictions on national support 3. Cross-border banking integration – Elimination of geographical ring-fencing – Acknowledge geographical risk diversification 5
Sovereign Exposures Credit Risk / Concentration Risk / Sov. Risk Weights Sov. Concentration Charges Procyclical Acyclical Doesn’t foster fragmentation Fosters fragmentation Puts euro-area banks at International level playing International competitive field: no capital charge if disadvantage exposures are diversified Reliance on risk assessment, No risk assessment e.g. rating agencies Doesn’t address home bias Addresses home bias 6
Policy Linkages • No end of ring-fencing without pooling of guarantees – Ring-fencing will continue as long as national authorities in charge of “protecting national deposits” – Reasoning extends to any expected public financial impact of future crisis management • No pooling without fixing home bias – Access to guaranteed deposits may be used to give preferential financing to home-country sovereign • Single moment of decision to break deadlock – No sequencing, but transitional arrangements 7
Breaking the Deadlock Sovereign Concentration Charges Sovereign exposures Erosion of guarantees Sovereign Domestic banks Direct Linkages Guarantees (implicit + explicit), including deposit insurance single regime for unviable banks + EDIS + ESM tools Indirect Linkages Domestic Economy End national ring-fencing Sovereign exposures is the policy bottleneck 8
Two Misleading Narratives • “Risk sharing only after further risk reduction” – Mostly heard in the North – Follows earlier version “risk -sharing should not cover legacy risks [incurred before banking union started]” – Progress made; impossible aim of full risk equalization • “The promised third pillar is missing” – Mostly heard in the South – EDIS was not “promised” (ESM direct recap was) – EDIS is necessary, but not sufficient 9
Urgency & Feasibility • Current lack of action is reckless – Unbroken bank-sovereign vicious circle – Regime for unviable banks not working as intended – Mismatch of European discipline vs national protection – Undermines international role of the euro – Major policy promise not delivered upon • Possibility of progress – Better understanding of issues linkages – Realism: no treaty change, no fiscal union – Improved condition of European banking sector – New European Commission 10
Policy Specifics 11
SCCs: Blueprint (Paper published by European Parliament, November 2017) • Pillar-1 instrument – Pillar 2 remains apt for credit risk: e.g. Greece 2015 • Add to RWAs in capital ratio denominator • SCC coefficient increases with concentration – Pain threshold in the 100-200% range • Preparation, long phase-in, grandfathering 12 Sov. exposure ratio = sovereign exposure to a given member state / Tier-1 capital
SCCs: Expected Impact Capital impact (bp) Capital impact (bp) Exposure ratio (%) Marginal SCC Average SCC (Tier-1 ratio = 10%) (Tier-1 ratio = 15%) 50% 15% 5% -3 -6 100% 30% 18% -17 -38 150% 50% 28% -41 -90 200% 50% 34% -63 -138 250% 100% 47% -105 -225 300% 100% 56% -144 -301 350% 200% 76% -211 -430 • Diversification within euro area, not reduction of aggregate euro-area exposures – Exact portfolio rebalancing patterns hard to predict – Not disruptive if well prepared (≠ credit risk weights) 13
SCCs: Potential Reallocation Domestic Domestic Total domestic Coverage of exposures of exposures of Number of banks exposures of Country country's SIs (by domestic banks domestic banks in sample domestic banks in assets) above 33% of above 100% of sample Tier 1 Tier 1 France 6 93% 349,773 249,763 119,467 Germany 15 92% 301,538 242,432 155,080 Italy 6 78% 179,626 145,040 74,820 Spain 3 67% 135,978 92,143 23,634 Belgium 4 65% 51,844 43,675 27,091 Netherlands 4 95% 48,498 14,744 0 Portugal 4 85% 25,105 19,772 11,502 Austria 6 95% 22,511 13,243 2,596 Greece 4 100% 19,676 9,463 1,175 Ireland 3 89% 15,498 9,061 686 Cyprus 2 58% 2,779 291 0 Slovenia 2 80% 2,650 2,045 816 Finland 1 25% 1,755 0 0 Malta 2 65% 1,335 1,142 772 Luxembourg 1 23% 731 242 0 14 Total 63 83% 1,159,298 843,055 417,638
Restrictions on Nat. Support • Reform of regime for unviable banks – Harmonization of “normal insolvency proceedings” – SRM authority for P&A or liquidation – SRB execution of resolution schemes • State aid control / Banking communication • Supervision of mutual support arrangements – Institutional Protection and other schemes • Privatization of banks nationalized in crisis • Transfer of ELA to ECB 15
EDIS: Fine-tuned Incentives (Blog co-authored with Isabel Schnabel, April 2018) • Fully integrated institutional framework (SRB) – Mandatory national schemes phased out • Compartments – National compartments sized by total covered deposits – Network-specific compartments (e.g. Sparkassen), with conditions to prevent abuse – Voluntary top-ups left outside, can remain unchanged – Waterfall structure backstopped by ESM • Fee add-ons based on nat. credit policies • Comprehensive assessment of LSIs 16
ESM Toolkit • Unconditional ESM backstop of SRF+EDIS – ESM involvement in SRB governance – Long-term challenge of SRF vs EDIS interests? • Additional ESM instruments – Precautionary recapitalization: TARP-like scenarios – Liquidity & liability guarantees for going-concern banks (BRRD Art. 32(4)(d)(i/ii)) – Guarantee of ECB liquidity in resolution • Financial system surveillance (à la ESRB) • ESM capital increase? 17
Cross-Border Disincentives • Phasing out of national ring-fencing of capital and liquidity • Rewards for geographical risk diversification – Capital calculations (asset correlation parameter in IRB) – Stress test scenarios – Intra-euro-area linkages in G-SIB determination – Discounts on deposit insurance fees? • Too-Big-To-Fail safeguards – TLAC, higher leverage ratio (cf. Basel III finalization) – Cross-border M&A: problem or solution? 18
Thank You For Your Attention Nicolas Véron nicolas.veron@gmail.com Twitter @nicolas_veron 19
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