25 January 2014

WEF 2014: Rebuilding banking in Europe

With capital flows sharply in reverse, how should Europe's banking system be reformed? Speakers at the WEF on this topic included Wolfgang Schäuble, Lord Turner, Olli Rehn and Jeroen Dijsselbloem.

The Issue

Market trust in European banks was undermined by the eurozone crisis that began in 2009. Recent initiatives have been undertaken by Europe’s banking sector to address some of the systemic and regulatory issues that led to the crisis. Foremost among those initiatives are an asset quality review, being a strictly regulated review of bank asset and collateral valuations; and stress tests that are designed to test a banks’ financial resilience in the face of simulated difficulties.

Full European Banking Union is seen by many as a path towards a better regulated, more transparent and resilient eurozone banking sector, though concerns remain about the Single Resolution Mechanism, by which the union would be governed. 

The Consequences

Anshu Jain, Co-Chief Executive Officer, Deutsche Bank, Germany, expressed his optimism for the progress within the European banking sector. “There was widespread talk about the possible failure of the Eurozone. We have come an enormous distance in a very short time", he said.  But, he went on to say there were still many problems to be faced. “The sovereign picture looks a lot better", Jain added, “but lending is down. Unemployment is unacceptable. The banking sector is in better share but nonetheless much more needs to be done".

Olli Rehn, Vice-President, Economic and Monetary Affairs of European Commission, also expressed his cautious optimism. “The existential threat to the euro is over", he said, going on to say he believed 2012 had been a turning point. 

On the question of whether or not stress tests would be effective, Rehn was clear: “We now have clear rules in place if a bank fails a stress test", he said. “The difference between the 2010 stress test and the stress test now is that [2010] national supervisors had an incentive to hide problems, a form of financial nationalism. But stress tests now will be led by the European Central Bank.” Rehn believes the resolution mechanism for a European Banking Union was effective. “It is much less complex than reported in the Anglo American media", he said.

Lord Turner, Senior Fellow at The Institute for New Economic Thinking (INET), also described ongoing challenges. “There has been a turn around in the market perception of risk, and that is all a very good story", he said, “but that is not converting into increased levels of lending". He also pointed to further roadblocks on the path to reform, such as necessary changes to legislation. “A treaty specific to the eurozone will be needed to construct a single banking market", he said. “There is further to go in terms of reform.”

Lord Turner also highlighted concerns about the implementation and ramifications of stress tests. “The stress test element is more important than the AQR", he said, “What happens after the stress test? The crucial lesson was that the US had a clear plan to deal with banks that failed the stress tests. Banks had a certain number of months to raise money privately and if the money couldn’t be raised it was raised publicly.”

Jeroen Dijsselbloem, the chairman of the Eurogroup of eurozone finance ministers, said he hopes this year's asset quality review and stress tests of European banks will reveal some bad news to give the process credibility. "Actually I rather hope it's going to unveil some unpleasantness because that will give us confidence that things are being done properly", he said.

While signalling progress on improving capital ratios, improving liquidity and improving leverage, Federico Ghizzoni, Chief Executive Officer, UniCredit, Italy, also pointed to challenges in the Italian banking sector. “It is obvious that due to the recession the quality of assets has been deteriorating", he said. “The real challenge for the Italian banking system is to restore profitability. There is a lack of trust in the market. The AQR must be tough and transparent. Once we have completed the AQR and the creation of the union we can move to improving our business processes.”

Wolfgang Schäuble, Federal Minister of Finance of Germany, was keen to point out that not all problems rely on the banking sector. “We have to solve the problems by fiscal discipline and by structural reforms", he said. “We must not rely too much on monetary policy. It is an incentive not to do what is needed with structural reforms.”

He also stressed that Germany’s economic performance supported Europe and that Germany is an anchor of stability and engine for growth. Video - The Germany Outlook

Full summary

Further reporting © Reuters

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