29 November 2013

ECB/Mersch: Mastering the crux of defragmentation

Mersch listed competitiveness, deleveraging and institutional barriers as 'evident pitfalls', but said that with prudent action and the necessary safeguards the crux would be manageable.

As a first encouraging step forward in the climb out of the crisis, we see that fragmentation of financial markets in the euro area has come down significantly since its climax in the early summer of 2012. This process of receding fragmentation of financial markets I want to refer to as defragmentation. Defragmentation does not happen overnight. It proceeds gradually, supported by lower risk aversion, and requires time to feed through to the financial system and, finally, to the real economy. I see three main pitfalls that may slow down the process of defragmentation or even reverse it:

• competitiveness differentials across Member States,
• public and private deleveraging, and
• institutional barriers in financial markets.

Competitiveness differentials within the euro area – but also globally – are a challenge because they can lead to macro-economic imbalances. In this respect I see remarkable progress in some areas. All periphery countries have recaptured some of the losses in competitiveness that had been incurred previously. Overall, it is important to realise that one reason for the need to implement adjustment measures was a lack of action in the time before the crisis. It is not "austerity" that leads to weak growth, but structural weaknesses and low growth potentials caused the need for consolidation. Meanwhile we can see encouraging signs that these measures are bearing fruit.

At the same time, I want to note our efforts to reduce competitiveness differentials should not lead to a loss of competitiveness of the euro area as a whole. Competitors elsewhere in the world are not sleeping. The model of the euro area is to match the best rather than converging to the average.

Persistently high debt levels could severely delay the process of defragmentation. At the moment, deleveraging is underway with varying progress. In the financial sector, balance sheet adjustments have started. In many Member States impaired assets have been transferred to asset management companies. Nevertheless, confidence in the health of bank balance sheets has not yet been fully restored. In the run-up to the SSM, the ECB will conduct a Comprehensive Assessment of banks’ balance sheets. This assessment will increase transparency by enhancing the quality of information that is available concerning the conditions of banks. It will hence further support defragmentation.

I believe that institutional barriers between national financial markets also remain one of the key pitfalls in the quest to secure defragmentation.

In the crisis the institutional responsibility for dealing with bank problems was exclusively with the individual EU countries. In addition, the incentives of national supervisors were often not aligned with the European financial stability objective. Some supervisors, motivated by uncertainty, engaged in defensive actions such as national ring-fencing of liquidity and national asset-liability matching. This may have been rational given their mandates, but it reinforced fragmentation of financial markets.

One very important precaution that fragmentation does not return is currently in the making: The Banking Union. It will encompass the euro area as well as other EU Member States that may wish to participate. In our opinion, two elements of the Banking Union are key: a Single Supervisory Mechanism (SSM) and a Single Resolution Mechanism (SRM).  

The process leading to the SSM has already started. After a pilot phase during which the ECB called for – and subsequently integrated – feedback from the banks, the ECB recently sent out the templates for data collection. In this context, let me also touch upon the treatment of sovereign credit risk in the comprehensive assessment. In line with the current legal situation in CRDIV/CRR the point-in-time balance sheet assessment will apply a 'zero risk' weighting for banks' sovereign debt holdings. However, in the medium term it makes sense from a prudential point of view that assets are being weighted according to their riskiness and not according to conventions which might not reflect reality.

The second issue that I wanted to bring up in the context of the establishment of the SSM is the separation of monetary policy and supervision. Starting next autumn, both monetary policy and banking supervision in the euro area will fall within the remit of the ECB. This situation brings several possible conflicts of interest between supervision and monetary policy.

Furthermore, the SSM will also have its own accountability procedures towards the European Parliament, the Council and national parliaments. Accountability will be rendered by the Chair of the SSM’s Supervisory Board and not by the ECB’s President. This is intended to avoid any confusion among the two sets of roles and to safeguard the ECB’s independence.

The euro area is early on in the climb out of the crisis. The summit is still far and covered in fog. And the euro area has to master the crux of defragmentation. Evident pitfalls are between us and the rewarding view from the mountain top. These pitfalls are competitiveness, deleveraging and institutional barriers. But at the same time I believe we are on the right track. If we act prudently and put in place the necessary safeguards, this crux before us is manageable. In this regard, the establishment of Banking Union represents an exceptional opportunity that will support further defragmentation and ensure financial stability in Europe.

Full speech

© ECB - European Central Bank