05 October 2018

ECB's Guindos: Building a resilient Economic and Monetary Union

Completing the banking union with confidence-building measures

Instead of finalising the banking union to reap all its benefits, we have come to what seems to be a fork in the road, with some saying we should focus primarily on risk reduction, while others are emphasising the importance of risk sharing.

Both approaches have valid arguments, and I would argue that both paths can be followed at the same time.

The advocates of risk reduction argue that the underlying vulnerabilities in the banking sector which triggered the crisis need to be forcefully tackled. In particular, there should be an assurance that the resources pooled at EU level in the banking union are not used to pay for the fallout of past policy mistakes.

And we have made progress on that front: banks are now more resilient due to their increased levels and quality of capital and liquidity buffers. MREL requirements are gradually being met, as envisaged. Progress in tackling legacy problems, such as the high levels of non-performing loans, is ongoing and should continue.

On the other hand, the advocates of risk sharing rightly argue that mechanisms are needed to build confidence in the resilience of the financial sector as a whole and that such measures are also indispensable to consolidate trust in the euro area.

Trust that, in turn, is vital to effectively reduce risks.

Cases-in-point include the establishment of a credible backstop for the Single Resolution Fund (SRF) and of a European deposit insurance scheme (EDIS).

Establishing a credible backstop for the SRF will instil confidence in the markets that resolution will happen in an orderly fashion, thus helping resolution authorities to perform their tasks while avoiding financial stability risks.

Similarly, a fully mutualised EDIS would contribute to making sure that bank failures do not trigger financial instability, as depositors will trust that their deposits are safe, regardless of the location of the bank in question. EDIS and the backstop for the SRF are thus not only risk-sharing but also confidence- building mechanisms contributing to risk reduction.

And to foster confidence that funds pooled in EDIS will not lead to systematic transfers between banking sectors, banks’ contributions to the deposit insurance fund can be designed to reflect the relative riskiness of banks, following a polluter-pays principle.[3]

There are some who believe that public backstops should remain a national responsibility. But for both institutional and economic reasons this cannot be the answer.

Given the reality of the banking union, it would make little sense for national governments to individually backstop the financial sector without having the responsibility or tools for much of its supervision and resolution. Moreover, as long as national authorities are responsible for bearing the costs of crises, they will be inclined to keep resources within their borders, or ring-fence them, which in turn will undermine cross-border financial integration.

But also economically, the crisis demonstrated beyond a doubt how costly and difficult it is for national governments to manage banking crises that are ultimately international in origin and often beyond their control. Pooling of resources at European level to deal with the failure of cross-border and of significant banks is much more efficient.

Both EDIS and the backstop for the SRF would ultimately increase confidence and reduce the likelihood and the cost of a bank failure. Risk reduction and risk sharing should thus not be seen as contradictions. They complement each other and should thus move forward in parallel, reinforcing each other so as to achieve the common aim of a resilient euro area.

All in all, there cannot be a single “risk reduction” indicator which would prove that we are “safe” enough to complete the reforms of our monetary union. Similarly, there should be no false expectations that EDIS and the SRF backstop will firmly establish our Economic and Monetary Union in all its dimensions.

Revamping the fiscal rules and creating stabilising instruments to enhance EMU resilience

Private risk sharing through financial markets is essential to absorb shocks. But market-based adjustment cannot properly cope with large shocks, when the private sector as a whole contracts. In such a scenario, fiscal policies have to be activated to maintain stability, without over-burdening monetary policy. This, in turn, also ensures a stable macroeconomic environment for banks.

There can be no question that the top priority in this area is for national policymakers to build up fiscal buffers to ensure policy space for future downturns, just as bank supervisors now expect banks to build up capital buffers in good times. This is particularly important in countries where government debt is high and for which full adherence to the Stability and Growth Pact is critical for safeguarding sound fiscal positions.

But Europe has a role to play in reinforcing national fiscal policies.

In contrast to the banking union, stronger integration in the fiscal realm did not result in the establishment of effective fiscal instruments and institutions at European level to ensure stability. That’s why, as a second priority, work needs to continue on designing a more complete fiscal architecture.

Despite many reforms, the common fiscal rules that should deliver this outcome have lost traction.[4] Europe, therefore, needs to regain faith in its fiscal rules by having a frank discussion on how to make them more effective and anti-cyclical.

The rules themselves will, however, not always be enough because sound domestic policies are not always enough. Markets do at times overreact and penalise sovereigns over and above what may be needed to restore a sustainable fiscal path. This is why there is also a need for public risk sharing through a stabilisation capacity.

Designing a stabilisation instrument for the euro area is neither straightforward nor easy. But that should not be an excuse for avoiding such a discussion and for taking concrete steps towards establishing it.

Proposals have already been put on the table, for example in the form of a fiscal capacity with a direct focus on stabilisation in the shape of investment protection or an unemployment insurance mechanism. Other suggestions refer to a common budget that can provide public goods through spending on joint investment projects or the broader political aims of the European Union, such as defence.

Regardless of the exact form, it is vital that any euro area fiscal instrument comes with powerful incentives to counteract moral hazard, avoid permanent transfers and ensure sound policymaking at national level.

Bolstering long-term growth through structural reforms and allocative efficiency

The elements I have discussed so far – notably, more stable financial integration and common fiscal instruments – can provide a shield against events that trap countries in downward spirals. Long-term economic growth, however, is ultimately derived from increased allocative efficiency and innovation, which can only be achieved by modernising the euro area’s economies.

Looking at the last 15 to 20 years, euro area countries with sound economic structures from the outset have shown much higher long-term real growth and are more resilient. Some euro area countries adopted ambitious reforms during the crisis and they have also seen good results afterwards – and the full effects are still materialising.

Nevertheless, over the past five years, structural reform implementation in the euro area has overall been sluggish at best. Very few reforms identified at the European level have been substantially implemented in the last few years. Reversing this trend and putting our economy on a higher convergence trajectory is thus a priority.

As structural reforms remain essentially in the hands of national governments, those governments should be the first ones to step up their efforts. Nevertheless, European policies, if further developed, can be a significant catalyst and provide a strong engine for both growth and employment, in various ways.

First, there is scope for a better use of the EU’s budget. The discussions on the 2021-27 multiannual financial framework offer a vital opportunity to enhance its role in addressing Europe’s structural challenges.

Second, the Single Market as an engine for convergence should be used to its fullest potential.

For consumers, the Single Market has already boosted competition in markets across the EU yielding large benefits for consumers.[5] But also on the supply side, the Single Market provides large productivity dividends by encouraging the integration of European value chains into global chains. These chains have resulted in higher wages at all skill levels.

How can these positive effects of the Single Market be further harnessed? For one, by completing it and expanding its reach into new policy areas, notably services. Services make up over 70% of total EU GDP but only 5% relate to cross-border services.[6]Expanding the market will drive economic progress, to the further benefit of consumers, businesses and the economy as a whole. [...]

Full speech

© ECB - European Central Bank