Completing Banking Union Nicolas Vron Senior Fellow, Peterson - - PowerPoint PPT Presentation

Completing Banking Union

Nicolas Véron Senior Fellow, Peterson Institute for International Economics (Washington DC) and Bruegel (Brussels) LUISS Rome – June 21, 2019

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“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

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Banking Union

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Breaking the Vicious Circle

Sovereign exposures Erosion of guarantees

Sovereign Domestic banks

Direct Linkages

including deposit insurance

Indirect Linkages

Guarantees (implicit + explicit),

Domestic Economy

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Breaking the Vicious Circle

Sovereign exposures Erosion of guarantees

Sovereign Domestic banks

Direct Linkages

including deposit insurance

Indirect Linkages

Guarantees (implicit + explicit),

Domestic Economy

Cross-border bank integration Public guarantees equalized & pooled at European level Diversify sovereign exposures

• 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

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Trio of Reforms

Sovereign Exposures

Concentration Risk /

• Sov. Concentration Charges

Acyclical Doesn’t foster fragmentation International level playing field: no capital charge if exposures are diversified No risk assessment Addresses home bias Credit Risk /

• Sov. Risk Weights

Procyclical Fosters fragmentation Puts euro-area banks at International competitive disadvantage Reliance on risk assessment, e.g. rating agencies Doesn’t address home bias

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• 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

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Policy Linkages

8 Sovereign exposures Erosion of guarantees

Sovereign Domestic banks

Direct Linkages

including deposit insurance

Indirect Linkages

Guarantees (implicit + explicit),

Domestic Economy

End national ring-fencing single regime for unviable banks + EDIS + ESM tools Sovereign Concentration Charges

Sovereign exposures is the policy bottleneck

Breaking the Deadlock

• “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

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Two Misleading Narratives

• 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

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Urgency & Feasibility

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Policy Specifics

(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
• Sov. exposure ratio = sovereign exposure to a given member state / Tier-1 capital

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SCCs: Blueprint

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SCCs: Expected Impact

Exposure ratio (%) Marginal SCC Average SCC Capital impact (bp) (Tier-1 ratio = 10%) Capital impact (bp) (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)

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SCCs: Potential Reallocation

Country Number of banks in sample Coverage of country's SIs (by assets) Total domestic exposures of domestic banks in sample Domestic exposures of domestic banks above 33% of Tier 1 Domestic exposures of domestic banks above 100% of 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 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 Slovenia 2 80% 2,650 2,045 816 Finland 1 25% 1,755 Malta 2 65% 1,335 1,142 772 Luxembourg 1 23% 731 242 Total 63 83% 1,159,298 843,055 417,638

• 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

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Restrictions on Nat. Support

(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

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EDIS: Fine-tuned Incentives

• 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?

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ESM Toolkit

• 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?

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Cross-Border Disincentives

Thank You For Your Attention

Nicolas Véron nicolas.veron@gmail.com Twitter @nicolas_veron

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