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I. Continued strong vigilance is needed to navigate through an increasingly uncertain world
a. Persistent threats
Against a backdrop of intense geopolitical uncertainty and a less favourable macroeconomic environment than expected, the financial industry faces a combination of very "traditional" risks and some relatively new ones.
Since the summer, there has been a series of negative surprises: a resurgence of trade tensions between the United States and its partners, notably China; tensions surrounding the Italian budget; the British parliament's rejection of the Brexit deal; and, closer to us, the scale and duration of the so called gilets jaunes movement. [...]
In light of these complex and interconnected risks, and the fact that a significant portion of them are new, financial intermediaries and supervisors need to exercise vigilance in order to understand the exact nature and impacts of the threats, and take appropriate steps to contain and manage them. For the SSM, this vigilance requirement has led to the establishment of three supervisory priorities for 2019:
c. What role can macroprudential policy play?
Macroprudential policy can play a complementary role alongside microprudential supervision by following a more preventive approach that addresses the financial system as a whole.
Macroprudential policy can play a preventive role with regard to debt trends and to the financial cycle: the current phase of the cycle is conducive to greater risk-taking, and the French macroprudential authority, the Haut Conseil de stabilité financière, has taken steps to limit this and/or prevent negative consequences in the event of a financial shock.
The HCSF therefore keeps a close eye on markets or activities where exuberance is more likely to emerge. Over the past quarters, it has made public its concerns about developments in the commercial real estate market (i.e. the market where real estate is an asset class for financial investors), trends in debt levels among highly indebted corporations or, more recently, leveraged finance activities (especiallythe debt incurred by companies participating in LBOs, which is frequently sold off by originators to other financial investors).
The HCSF has also formally intervened to curb risk-taking: at the end of 2017 it decided to cap bank exposures to large and highly indebted corporations at 5% of their capital.
In addition, to limit the negative consequences for banks of increased risk-taking in the event of a financial shock, the HCSF decided in June 2018 to raise the countercylical capital buffer to 0.25% - in other words, to require banks to set aside more capital to cover their risk exposure toward the French economy.
As a countercyclical tool, this buffer is designed to be put in place preventively, when credit constraints are low, i.e. when the economic "cost" of such an additional requirement is limited.
It forces banks to build up some room for manoeuvre that can then be used to prevent credit rationing if they incur higher-than-expected losses after a shock or turnaround in the financial cycle. Immediately releasing the buffer would allow banks to tap into this capital reserve and support the supply of credit, especially to small and medium-sized enterprises which are the most reliant on bank financing. [...]
II. The euro area needs to continue strengthening its financial integration
b. Improving the functioning of the Banking Union...
One of the main steps towards this integration has been the Banking Union. However, its functioning needs to be adapted and improved.
The most visible aspect of Banking Union has been the implementation of a single supervisory mechanism under the aegis of the ECB.
Constructed in record time to address the main weaknesses in our banking system - the doom loop between government debt and bank debt, the disparity in national banking rights, the national bias in supervision - the Single Supervisory Mechanism is now a tangible reality that has completely transformed the way the euro area banking industry is regulated.
After just over four years of existence, the SSM today constitutes a unique and efficient model, based on the application of the EU Single Rulebook (under the direction of the European Banking Authority - EBA), close cooperation between the ECB and national authorities on all levels (ECB Supervisory Board, Joint Supervisory Teams, on-site inspections teams), and the principles of subsidiarity and proportionality (the ECB directly supervises 119 of the largest banking groups while all other institutions are supervised through national authorities).
The SSM represents a major institutional step forward and the initial results are real.
Banking supervision practices have been harmonised upwards and are now aligned with the highest international standards (for example, the methodology for the supervisory review and evaluation process or SREP).
Europe's banking industry is today significantly more robust than before the crisis: the biggest banks' CET1 ratio has increased by more than 3 percentage points since 2014 (from 11.3% to 14.6% at end-2017) and their balance sheets have largely been cleaned up (through a reduction in the NPL ratio from 7.6% to 4.9% over the same period).
The industry's resilience was confirmed in the stress tests organised by the ECB and EBA in 2018, which simulated the impact of financial shocks on the solvency of the largest banks: in an adverse scenario, the average CET1 ratio for the sample would come out at 9.9% - or 1 percentage point higher than in the previous exercise in 2016.
That said, we still have not reaped the full benefits of more harmonised regulation and more integrated supervision, and we need to make sure that we consolidate and build on the progress already made.
From a regulatory perspective, aside from transposing the Basel Accords into EU law (the CRR 2-CRD 5 package introducing new prudential requirements such as the NSFR and the leverage ratio), we need to advance further on the application of uniform regulations. We also need to pull down all the barriers to euro area banking integration by removing all regulatory obstacles to cross-border transactions - in terms of solvency, liquidity or large exposures - and by adjusting the calculation of capital requirements for systemic institutions. In short, we need to recognise that the euro area must be treated as a single jurisdiction where a single rulebook is enforced.
In terms of supervision, the priority now is to bring the largest investment firms within the scope of the SSM. We also need to increase cooperation between national authorities for the oversight of cross-border institutions (home-host relations), and for anti-money laundering and countering the financing of terrorism - the importance of which is recurrently driven home by the news.
To complete the Banking Union, we also need to render its second pillar, the Single Resolution Mechanism or SRM, fully operational.
The euro area has had a common resolution mechanism in place for banking crises since 2015. Like the SSM, the SRM is based on a common regulatory framework (the BRRD Directive and the SRM regulation), and is structured around a Single Resolution Board and joint resolution teams.
Although the SSM and the SRM have both been successful in managing the first bank liquidations or resolutions (i.e. those concerning the Veneto banks and Banco Popular), the second pillar still has to be finalised. Achieving this goal is essential, both to prevent the contagion of banking crises and to ensure the continuity of critical banking functions.
In this regard, France has worked hard for the creation of a common backstop, the main features of which were decided just a few months ago. Three issues still need to be addressed however: the duration of the credit lines provided by the backstop; the creation of a rapid decision-making process in the event of an emergency; and the provision of liquidity to banks in resolution.
Once these matters have been resolved, we can hope, and at the Banque de France it is our firm belief, that a pragmatic compromise can be found on the third pillar - the deposit guarantee scheme.
c. - and building a Capital Markets Union to create a true Financing Union
Evidently, financial integration is not just about achieving banking union. Ensuring the balanced and sustainable financing of the economy also implies deeper integration of capital markets, which fosters greater geographical diversification in savings and meets corporate firms' financing needs - notably equity financing. It also means making better use of the savings entrusted to insurers and pension funds, to ensure the long-term financing of the European economy. Which is why France supports an ambitious review of the regulation in the sector. These overall goals for mobilising savings are also why the European Commission's 2015 project for a Capital Markets Union has garnered such a broad support.
The Commission has already implemented a significant number of measures (revision of the Prospectus Directive, creation of European long-term venture capital funds - EuVECA and ELTIF), and discussions are well underway on other topics (pan-European personal pension product or PEPP, plan for sustainable finance, plan for fintechs).
It is clearly vital that the future European Commission, European Parliament and European Council all follow through on this action plan and complete the regulatory work.
But financial integration also requires initiatives from economic and financial actors, who need to assimilate the regulatory framework and bring it to life: we cannot develop markets for green bonds, private debt and securitisation without the issuers, investors and arrangers that make them thrive.
More importantly, a Capital Markets Union would be meaningless if, alongside the Banking Union and the Juncker Plan, it is not part of a longer-term project to create a Financing Union for Investment and Innovation.
Financial integration is therefore essential for the euro area and must form a core part of all projects relating to the financing of European economies. However, as these projects imply a profound transformation, we can only make progress with a strong commitment of all actors: legislators and regulators, European and national authorities, private and public agents. [...]