26 February 2013

Bank of Denmark/Rohde: The European crisis and the development of the European Union

Governor Lars Rohde said it was important to address macro-economic imbalances in time to prevent systemic risk. The financial crisis and the sovereign debt crisis have revealed a clear need to strengthen political cooperation between euro area Member States.

In recent years, the EU Member States have adopted a series of new rules aimed at addressing these weaknesses, including the Fiscal Compact, which tightens the requirements for fiscal discipline. In addition, the EU Member States have adopted rules for surveillance of macro-economic imbalances, under which the European Commission is to  monitor whether a Member State is building up excessive imbalances. There is now more focus on systemic risk, and a European Systemic Risk Board, ESRB, has been set up. In Denmark, we have introduced the Systemic Risk Council.

Although Denmark has, in many ways, navigated the financial crisis better than many other countries, we have generally had to learn the same economic policy lessons as others. In Denmark, too, fiscal policy in the pre-crisis years reinforced the boom rather than dampening it. Among other things, this led to higher wage inflation and weaker competitiveness. As a result of the procyclical fiscal policy, the downturn was more severe than it would otherwise have been.

But the underlying fiscal policy was sounder than in the Member States now experiencing problems. This is true both in terms of cyclical stabilisation and long-term fiscal sustainability, although we lost focus in the pre-crisis years. The conclusion to be drawn from developments in the 2000s, not only in Denmark but throughout the EU, is that if fiscal policy is procyclical in a boom, it will have to be procyclical also in the subsequent downturn.

Fiscal developments have raised concerns about these Member States’ ability to continue to support the banking sector. This has had a negative impact on the banks’ access to funding and reinforced the tendency for banks to reduce their lending. Since lower lending volumes may further curb economic activity, the economic challenges become even greater.

In the short term, the banking union represents an attempt to break the negative interaction between governments and banks. The vision behind the banking union is to prevent crises like the one seen in recent years and to mitigate the impact if a crisis should, nevertheless, arise. The aim is to shield developments in the financial sector from developments in public finances in individual Member States – and vice versa – and increase financial stability. In the  longer term, a banking union is to help support financial integration in the EU, and hence the single financial market.

Vulnerable euro area Member States are facing major challenges in relation to both public finances and the financial sector. A banking union does not necessarily address these challenges. The reforms required in these Member States will undoubtedly be costly and have real economic implications. It is imperative to find a solution to existing challenges in vulnerable states and banks so as to bring them back on the right track without undue delay.

Denmark's Nationalbank supports the overall vision for a banking union. A banking union makes good sense in an integrated financial market, where financial institutions are free to operate across national borders.

The single market for financial services has contributed to strengthening competition and the supply of credit, to the benefit of both the Danish financial sector and its customers. Integration within the European financial sector increased until 2007, but has since the onset of the financial crisis been decreasing. Like the other EU Member States, Denmark has an interest in a well-functioning single financial market. I see merit in the current discussions on the establishment of a banking union as a mechanism for supporting financial integration in the EU.

Developing the individual elements of a banking union will be a huge task. If the vision is to be realised, the banking union must comprise at least three elements: (1) a single supervisory mechanism, (2) a single resolution mechanism for failing banks, and (3) a single deposit guarantee scheme.

Overall, I believe that it would be an advantage for Denmark to participate in the banking union once the remaining two legs – the deposit guarantee scheme and the resolution mechanism – are in place. Therefore it is important to remain firmly seated at the negotiation table and contribute to ensuring a robust and effective set-up which Denmark may join if we choose to do so.

Full speech

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