13 September 2023

ECB's Enria- Eurofi interview: The integration of the EU banking sector and the challenges of global competition

The situation did not change significantly after the establishment of the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM): the banking sector is still, by and large, a collection of national banking sectors.

Does the fragmentation of banking markets in the euro area provide some sort of risk? Is the sovereign doom-loop still a financial stability issue? To what extent does the lack of private risk sharing in the euro area raise a problem for financial stability?

The fragmentation of the euro area banking sector along national lines is still a cause for concern. The situation did not change significantly after the establishment of the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM): the banking sector is still, by and large, a collection of national banking sectors. One of the foremost rationales for the establishment of the banking union was to break the so-called doom-loop between banks and sovereigns, but after almost ten years two key elements of the banking union are still missing. First, there is a need to establish a European Deposit Insurance Scheme (EDIS), which would complete the transfer of the whole safety net to the European level. At the moment, the general perception is that in a crisis the credit standing of banks would still reflect the strength of the respective national deposit guarantee scheme and of the sovereign providing the ultimate backstop. Second, there has been a lack of progress in the cross-border integration of banking business. This reduces the potential for private risk sharing in the European banking market, and thus increases risks to local financial stability rather than reducing them. In fact, the integration of the banking sector plays a significant role in smoothing local shocks. As the former president of the ECB, Mario Draghi, well summarised in a speech some years ago, retail banking integration de-links the capital of local banks from local credit supply. “Because local banks are typically heavily exposed to the local economy, a downturn in their home region will lead to large losses and prompt them to cut lending to all sectors. But if there are cross-border banks that operate in all parts of the union, they can offset any losses made in the recession-hit region with gains in another and can continue to provide credit to sound borrowers”^[1]. Also, if a crisis occurs, an integrated market would support smoother resolutions of failing banks, as their assets and liabilities could be more easily transferred to a larger set of potential bidders, including those from other Member States. This would be similar to what we see in the United States, with cross-state mergers and acquisitions.

The two aspects are linked: without EDIS, national authorities are more reluctant to support cross-border integration, fearing that in a crisis, their national safety net would have to support banks failing because of strategic decisions taken elsewhere. On the other hand, without more integration, crises are more likely to occur because of the limits to private risk sharing and resolving them is more challenging due to the segmented nature of the market. But we need to make progress in parallel on both fronts. I would strongly reject the argument that we cannot move towards greater integration without a fully integrated safety net....

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