12 July 2013

ECB/Constâncio: The role of Europe in global rebalancing

The ECB VP emphasised two specific channels where developments in the euro area could have an important impact on the global economy, saying that Banking Union would help the euro area banking sector to become more stable.

What I would like to do in my remarks today is to emphasise two specific channels where developments in the euro area could have an important impact on the global economy.

Channel one: rebalancing towards sustainable growth

The first channel is related to the structural adjustment taking place within euro area economies which could, in time, correct the imbalances internal to the euro area thus overcoming a major European vulnerability allowing Europe to make a contribution to global demand and hence global rebalancing.

Euro area countries are currently taking a series of policy measures both to raise their growth potential and to make growth more sustainable. Policy measures are underway at the European level that could help expedite this rebalancing process. These include initiatives by the European Investment Bank to boost lending to SMEs, and the possible introduction of contractual programmes with financial incentives to underpin structural reform implementation in stressed countries. A proposal by the European Commission on the latter is expected before the end of the year.

Channel two: a stable financial system through Banking Union

The second channel through which euro area developments can have a global impact is the process of building a genuine Banking Union in order to ensure a robust banking sector.

Even today, the total stock of euro area bonds and equities currently held by US investors is worth around €1 trillion, while euro area investors hold US bonds and equities worth more than $2 trillion. All this means that the situation of the financial sector in Europe has major spillovers for the global economy. And therefore the process of stabilising and strengthening the European banking sector, which Banking Union represents, has very important international implications.

The transposition to the European level of financial sector policies through building a strong Banking Union can play a pivotal role in rebuilding trust in the euro area banking sector. Banking Union has for now two key components: the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM). The creation of a European Guarantee Scheme which the third component has been postponed for the medium term. The creation of the SSM, which we expect to be operational next year, should increase confidence in the euro area banking sector through two main channels.

First, the SSM will provide reassurance to investors that supervision is consistent and effective across all participating countries. The SSM will operate as a single system, with a common supervisory manual applying to all participating banks. The ECB will directly supervise large, systemically relevant banks. While it would be inefficient for the ECB to supervise directly the thousands of remaining smaller banks, we will have the authority to take over supervision of any small bank or group of banks at any moment if deemed necessary. This means there will be no “blind spots” from which financial instability could emerge.

Second, the implementation of the SSM should reduce concerns about hidden losses on banks’ balance sheets. In accordance with the SSM regulation, the ECB will conduct a “comprehensive assessment, including a balance-sheet assessment” of all banks supervised directly. This will apply to around 130 banking groups operating in the euro area, which account for around 85 per cent of euro area banking assets.

The assessment will involve a Balance Sheet Assessment including an Asset Quality Review to be conducted by the ECB. This will then feed into the overall stress test to be conducted by EBA, in cooperation with the ECB. The results of both exercises should be ready before we start actually supervising the banks next year.

We want this assessment to be as rigorous as possible after two previous stress tests failed to remove doubts about asset quality. Consequently, we are prepared for the fact that it may reveal capital needs. If so, the first responsibility is for banks to raise capital themselves. But there may be a public dimension as well, which is why the European Council on 27-28 June addressed the need for backstops to be in place before the exercise is completed. Without these financial backstops being in place the ECB does not advice to complete the whole set of balance sheet assessment and stress tests.

However, investors will not be fully confident in the euro area unless they believe that banks can fail without causing financial instability. Otherwise, they will expect supervisors to practice forbearance. This is why the SSM needs to be accompanied by a Single Resolution Mechanism. The European Commission announced on Wednesday a proposal for a Single Resolution Mechanism based on the concept of a an agency with wide of autonomy and ultimately dependent on the Commission for the crucial decision of putting a bank into resolution. Several institutional setups could be conceived but the existence of a SRM is a key priority for Europe and I am very pleased to see that the envisaged timeline takes this into account, with the entry into force foreseen for mid-2014 and operations commencing in January 2015. This aligns with the entry into force in 2015 of the new legal framework for resolution in Europe, the Bank Recovery and Resolution Directive (BRRD), which will provide a harmonised framework of resolution powers and tools.

While it is still too early to provide an in-depth assessment of the Commission proposal and a more detailed assessment will be published in our ECB legal opinion, I would like to welcome, from a personal point of view, some important points contained in the Commission's proposal. First, the Authority will have the capacity for truly European decision-making with no veto powers for national authorities. In my view this is key for dealing swiftly and impartially with large cross-border banks, although the proposal appropriately applies to all banks of the participating countries in the Single Supervisory Mechanism, thus ensuring a cohesive system.

Second, the Authority would own a Single Resolution Fund which would be financed by ex ante risk based contributions to be complemented by ex post contributions both paid inby the industry. Although not specified, the proposal stipulates that the Fund would be able to borrow from both private and public alternative funding means. These borrowings would subsequently recouped from the industry, thus ensuring fiscal neutrality in the medium-term. I would have preferred, however, that the proposal would have considered explicitly the issue of a public backstop for the resolution fund in the form of a credit line that would have to be repaid afterwards, as it is the case with the US FDIC.

The ECB strongly has strongly advocated an SRM comprising of these three elements: a single system, a single authority, and a single fund. The proposal contains these three elements and consequently reduces the harmful effects of sovereign-bank interactions by diminishing the importance of implicit sovereign guarantees.

The SRM will operate in the legal framework established by the Bank Recovery and Resolution Directive (BRRD), which was recently agreed by Member States’ Governments. This Directive foresees that bail-in becomes the first line of defence in dealing with banking crisis – indeed, 8 per cent of liabilities will have to be bailed-in before resolution funds or other public funds can be used, with depositors of persons and SME being given the highest preference. Nevertheless, the full bail-in tools that includes the possibility of burning senior bank bonds and uninsured deposits will entry into force only at the end of 2018. Before that date only shareholders capital and subordinated debt can be used to resolve a bank. Insured deposits, secured borrowing (including repos and covered bonds) are exempt from bail-in. I think that the bail-in principles approved by the Member States and the respective timeline until 2018 are appropriate to allow a transition period that is helpful to ensure stability in the bank bond market.

These new rules should support the work of the SSM by strengthening incentives in the financial sector to exercise market discipline on problematic banks.

To sum up, the euro area banking sector is becoming more stable overall, and given the euro area’s central role in global financial intermediation, this creates positive spillovers for the global economy. Banking Union will take this process forward by increasing confidence in supervision and ensuring that banks that need to be wound down, can be. To the extent that this supports credit growth to the private sector, this will also generate higher growth in the euro area and help the global economy through that channel, too.

Full speech

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