16 January 2014

Bundesbank/Weidmann: Outlook for 2014

Weidmann looked at how the crisis in the euro area could be overcome on a lasting basis, highlighting the important balance between liability and control to ensure financial stability.

Reforming the operational framework of monetary union

If the monetary union is to be placed on a sound long-term basis, the adjustment measures in the problem countries are a necessary condition but not a sufficient one. Only by restoring a harmonious balance in the institutional framework of monetary union will the euro area be able to put the crisis firmly behind it.

In its current configuration, the operational framework is somewhat skewed. The fiscal assistance measures have put elements of mutualised liability in place, but the attendant powers of intervention have not been granted to the community. Blending mutualised liability with decentralised decision-making powers on debt would be the wrong way forward. Policymakers might see this as an attractive "quick fix" for the crisis, but it is anything but a sustainable configuration for a monetary union. In fact, it provides an additional incentive for member states to run up debt without providing any effective control instruments.

The debate on choosing the right path towards a more stable monetary union is an important one. At the end of the day, far-reaching political decisions will need to be taken. For instance, a credible no bail-out regime would need to be backed by a codified insolvency regime for member states which can be implemented without jeopardising the financial stability of the community as a whole.

Three years ago, the Bundesbank proposed reforming the standardised terms and conditions for sovereign debt with the aim of strengthening investors' individual responsibility, limiting the total liability for countries providing assistance and winning time for structural reforms. The Bundesbank suggested that a clause should be hard-wired into the terms and conditions for the issuance of euro area government bonds that would automatically extend the maturity of a given country's bonds by three years if that country received loans from the ESM fund. Automatically extending bond maturities in this manner would buy time for crisis countries to resolve their problems without private creditors withdrawing their capital. Thus, it would massively reduce the funding which the ESM would have to provide - and which the taxpayers of other Member States would have to guarantee - to the level of net new borrowing. It would buy time to gauge, with a higher degree of certainty, whether the country in question was experiencing solvency or liquidity problems. This would allow a better balance to be struck between liability and control.

On the European Banking Union

Banking supervision is to be based at the ECB and will be launched in the autumn of this year. Before the launch of the single supervisor, a comprehensive balance sheet assessment will be conducted for the 128 "significant" banks that will, in future, be supervised directly by the ECB. If this assessment reveals that recapitalisation is needed, this is to be remedied before the launch of the SSM, primarily using private funds. Or, if that is not possible and the bank has a sustainable business model, by the respective government.

The second pillar of the Banking Union is the single resolution mechanism to deal with future bank failures. The fund is to be built up over a period of 10 years and reach a volume of €55 billion. Before the fund is fully capitalised, bank resolutions would be financed out of national "compartments", which we welcome in the interests of a balance between liability and control.

In the long term, Europeanisation of liability with a centralised supervisor is appropriate. However, as long as other factors with a key impact on the quality of bank balance sheets remain under national control - for instance tax legislation, insolvency rules or economic policy - it makes sense for some liability to stay at the national level.

Another essential prerequisite for a more stable monetary union is, however, stricter financial market regulation. At the beginning of this year, the Basel III capital rules became effective in Europe, which will gradually improve the quantity and quality of banks' capital. Moreover, rating agencies have been placed under supervision, inappropriate compensation systems have been corrected, computer-driven high-frequency trading subjected to stricter regulation and trade in highly speculative financial derivatives has been rendered more transparent and thus safer.

In order to break the disastrous nexus of banks and governments, the regulatory treatment of government bonds will, however, also have to be changed: credit ceilings and risk-based capital backing would be a sensible way of breaking the nexus - that would basically mean applying similar rules to those for bank loans to private-sector debtors. Such rules would also promote bank lending to enterprises.

Full speech

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