24 April 2013

Bundesbank/Weidmann: Challenges for banking regulation and supervision in the monetary union

To achieve its full potential, the single supervisory mechanism needs to be augmented by a single resolution mechanism (SRM). As in the case of the SSM, a solution that satisfies the requirements of European law ultimately calls for an amendment of the EU treaties. This has been quite rightly been emphasised by Federal Minister of Finance.

Essentially, the SRM is an important embodiment of the principle of liability. After all, liability also means that, in case of doubt, it should be possible to resolve banks without significant economic harm to the economy as a whole – and to see this through if the worst comes to the worst.

Resolving and closing a bank is by no means a cure-all and it is certainly not an easy task. Where possible, things should not be allowed to go that far in the first place. And that is where strict capital requirements, effective supervision and deposit business shielded from riskier business lines come into play.

The banking union also needs to be supported by an appropriate regulatory structure. In other words, banks must be required to hold sufficient capital for claims on government and not be allowed to accumulate them on too large a scale in future. It would be dishonest to assert that all these measures will make it impossible for banks to get into difficulties in the future. Therefore, if that actually does happen at some time, having a reliable procedure in place that creates planning certainty will be all the more important.

With this in mind, the main task of the single resolution mechanism that is currently being developed is to ensure the correct sequence of liability is applied in such a process. If a bank is to be restructured or resolved, equity investors should be the first port of call, followed by the providers of debt capital, and only then the depositors, taking due account of deposit guarantees in the respective Member States. National and European taxpayers should only be called upon as a very last resort.

If public funds are used, the question arises as to how liability is to be apportioned between the European level and the Member States. Joint liability of all Member States can only exist at EU level for those institutions directly supervised by the SSM. In such a case, it is also appropriate, however.

Having said that, it is unclear whether the Member States are to be discharged of all liability or whether a certain percentage of the costs is still to be apportioned to them. The latter is suggested by fact that, in the current framework of monetary union, Member States are still able to exert a perceptible influence on financial stability through their national economic and financial policies – say, encouraging the emergence of a real estate bubble through special tax benefits.

This should be kept separate from the treatment of balance sheet burdens that arose while the various banking systems were still under national supervision. If the unity of liability and control is also taken seriously on this point, too, the Member States in question should themselves also be liable for these burdens as well. As the case of Spain shows, the ESM is ready to step in if raising the necessary funds on the capital market proves difficult.

Ultimately, what to do with legacy debts is a supervisory problem, not a question that has to be answered by politicians. If politicians actually do decide to communitise legacy debts, it will be nothing other than a financial transfer. Transparency for members of the general public and taxpayers then also requires that this transfer be disclosed as such.

The single resolution mechanism reduces uncertainty and mitigates the risk of contagion effects. The discretionary approach taken in the case of Cyprus is therefore not a blueprint for similar situations that may arise in other countries. Events in Cyprus have shown that a bail-in is possible. But they have also highlighted the importance of establishing a clear sequence of liability and an orderly procedure, especially if turbulence due to depositor uncertainty is to be avoided. After all, the debate on to the extent of depositor involvement has caused major uncertainty – in other countries, too. This was all the more the case as there was discussion about the possibility of using deposits that were actually protected by the Cypriot deposit guarantee scheme.

In connection with the security of customer deposits at banks, the question of whether a banking union should not include a single Europe-wide deposit guarantee scheme is also regularly under of discussion. The German Savings Bank and Giro Association has repeatedly expressed its very critical stance regarding a single European deposit guarantee scheme. And, indeed, it is important not to put the cart before the horse in tackling such projects.

Given the current degree of integration among Member States and financial systems, a single Europe-wide deposit guarantee scheme would not be practical. Even more than is the case for the costs of resolution and restructuring, it is true to say that bank balance sheets reflect economic developments in the individual Member States that are currently beyond European control. Otherwise, taxpayers who are not involved would be made liable for mistakes in other countries without being responsible for those mistakes. It is much more important to set up the single supervisory mechanism and single resolution mechanism and put them on a firm footing.

Conclusion

In summarising my thoughts, I would like to stress that, yes, reforming financial market regulation is still a major task, but it is making headway, both in Europe and internationally. This means that, step by step, we are approaching the goal of bringing about an overall reduction in the risks to individual economies and the monetary union which stem from the financial systems without undermining their efficiency.

A key task in designing specific reforms is to give a more scope again to the principle of liability. The Bundesbank is diligently pursuing this aim by bringing its expertise to bear and, if it is necessary, is in for the long haul.

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