11 March 2013

ECB/Constâncio: The nature and significance of Banking Union

It is helpful to think through how a genuine Banking Union in Europe could have helped both prevent and mitigate the crisis.

Preventing the crisis

The key point for this discussion was that all of these private flows were being intermediated by the banking sector, which had become much more integrated as a result of monetary union. Hence the official bodies best placed to identify these growing risks, and act to prevent them, were national bank supervisors both in lending and borrowing countries. However, they lacked both the cross-border perspective and also the instruments to do so. After all, their mandates were national and did not extend to systemic risks building up for the euro area as a whole. European financial integration went far ahead any European oversight and financial stability and as a result financial stability was unwittingly sacrificed.

Mitigating the crisis

What about the role of Banking Union in mitigating the crisis? Here I can see two key ways in which it would have been instrumental.

First, it would have lessened the so-called “bank-sovereign loop” that drags down the fiscal sustainability of sovereigns. This loop is driven by bank bailouts or just by the expectation that sovereigns will have to bail-out struggling banks, which then increases borrowing costs for sovereigns and further drives up funding costs for banks. A Single Resolution Mechanism would avoid this by resolving banks rather than saving them and by making the private sector rather than the taxpayer pick up the bill. Moreover, any residual fiscal burden on sovereigns would be distributed across the euro area through the common fiscal backstop.

Second, a Banking Union would have reduced the fragmentation in financial markets that holds back bank lending and economic growth. At present, market fragmentation is severely disrupting the transmission of the ECB’s monetary policy. In some countries, changes in our main interest rate are being passed on fully by banks; in others, because bank funding is tight, interest rate changes are being passed on hardly at all. This is making credit very hard to come by or unduly expensive in some parts of the euro area.

Banking Union would limit financial fragmentation in a number of ways. An impartial supervisor conducting credible stress tests would lessen fears that banks are hiding bad assets in some countries. Depositors’ confidence would be mitigated by harmonising deposit guarantee schemes. And a supervisor with a truly European focus would never undertake actions that can encourage fragmentation, like insisting on national asset and liability matching.

On the five elements of a genuine Banking union, progress is currently positive on all fronts – but it is also uneven.

First, the single rulebook to a large extent already exists, and will be complemented by the agreement on the Capital Requirements Directive IV expected in the next months. This will contribute significantly towards making the banking sector in Europe more robust and creating a level playing field.

Second, a Single Resolution Mechanism will hopefully be proposed by the Commission in the second half of this year. In the meantime, the Bank Recovery and Resolution Directive should be adopted by the middle of this year, which will provide a better framework for coordinating resolution of cross-border banks and provide national authorities with new resolution powers. These new powers – like writing down capital instruments and bailing-in creditors – should help ensure that the financial sector, rather than taxpayers, bears the burden in future bank resolution.

Third, the creation of a common backstop is already underway with the on-going discussions on direct bank recapitalisation by the European Stability Mechanism (ESM). This is an important tool for the near term to help break the bank-sovereign loop and exit the crisis. In the longer term, the fiscal backstop to the Banking Union could perhaps replicate the successful arrangements we see in the US where the Treasury provides a credit line to the FDIC, which is repaid over time through additional levies on the financial sector.

Fourth, the establishment of a common system of deposit protection will begin with the adoption of the Commission’s proposal on deposit guarantee schemes, expected by mid-2013. This provides a harmonised framework and should help shore up confidence in national schemes – particularly, in my view, if there is a “depositor preference” rule in situations where banks are resolved. This means that a single European scheme is not an essential component of Banking Union in the short term.

Finally, there is of course the Single Supervisory Mechanism, or SSM. As you know, progress here is already well advanced: the Regulation setting up the SSM has already been approved by Council and is now being discussed by the European Parliament. So what are its key features?

Above all, the SSM will be one system. Some commentators have claimed that, because the SSM is decentralised, nothing will change and supervision will remain essentially national. This is not correct. The ECB will be the legally competent supervisor for all banks in participating countries. It will have direct supervisory powers over large, systemic banks, which we estimate to number around 140. We will not directly supervise the thousands of remaining smaller banks, because this would be inefficient when national supervisors are already in place with the necessary knowledge and technical skills. But the ECB and the national supervisors will act as a single system.

Benefits for the non-participating Member States

The SSM is open to the participation of all EU Member States, including those that have not adopted the euro and perhaps many will do so. How will those states that do not participate in the SSM be affected by Banking Union?

It is important to stress here that the playing field really will be level. There will be no disadvantage for banks in countries like Britain that stay out of the SSM. Banking Union will benefit all Member States that are part of the single financial market. And as the leading provider of financial services in Europe, I can see only advantages for Britain from its creation.

First, Banking Union will facilitate the completion of the single financial market by simplifying supervisory and regulatory practices, which will facilitate wider market access for banks and investors across Europe.

Second, Banking Union will reduce the scope for coordination failures between national supervisors, which will in turn allow for more effective implementation of the single rulebook and convergence of supervisory practices. In this way, the presence of the SSM can be seen as reinforcing the coordination function of the European Banking Authority. The SSM will operate in full compliance with EBA guidance and actively contribute to its work.

Third, Banking Union will enhance financial stability in the Europe – and this, more than anything, is what is required for the single market in financial services to thrive. This would bring huge potential benefits for all Member States in terms of enhancing financing for the real economy, managing risks and pooling the resources of investors from European and elsewhere.

Full speech

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