Wilton Park/Bundesbank conference report: Financial regulation in the European Union
07 May 2012
The conclusion of the conference is that the necessity to solve problems quickly – yet take account of the rest of the world – is a priority for EU policy-makers, so that Europe can reinforce and safeguard a pre-eminent position in the changing global economic order.
Please click here to listen to Graham Bishop's conference speech, entitled 'Securing the Enduring Stability of the Euro'.
Key points of the conference:
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The magnitude of changes to the regulation of the financial structure in the EU is becoming ever clearer. It may be obscured by the piecemeal approach adopted in the EU - rather than the US approach of a single omnibus high level measure. But there can be no doubt of the scale. Questions remain though over which is the best approach?
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The interaction of the EU with its global partners was a recurrent theme as the EU is now a major player on the world stage - and this would be even clearer if the EU were operating as a genuine single market. But that raised many issue about how to create a level playing field within Europe that was then applicable to outsiders - and to outsiders wishing to operate in the EU.
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There is a complex economic interaction that may be triggered by the new Basel rules on bank liquidity and capital - in combination with the Solvency II rules for insurance company investment and capital regime. The implications for economic growth of a deleveraging of the banking system are profound but there may be unintended consequences flowing from the new liquidity rules for banks.
What impact is regulation having on the European financial services sector?
24. One banking sector perspective focused on the costs of regulation and, particularly, on the resultant acceleration of deleveraging with its reduction in credit availability. This seems to be a regulatory overreaction and is now preventing the markets from continued integration. The cost could well be 1.2 per cent GDP and a 6 per cent reduction in investment – much more than the Basel Committee estimated. So the conclusion was that Europe must take advantage of the three year LTRO breathing space to restore the impetus towards financial integration.
25. Worryingly, it was then argued that deleveraging is only just starting as supervisors have focused on financial stability at the expense of growth. The reality is that only the EU will finally implement all global standards. Other participants cited further evidence of the cost of regulation, with particular concerns that the impact of Basel’s liquidity requirements has been under-estimated (see earlier comments) as there is a real risk that banks will become liability-driven, rather than asset-driven. Estimates are that banks are short of about €2 trillion to meet the eventual Net Stable Funding Ratio (NSFR) standards. So they will not make a loan until they already have on the balance sheet a term-matching liquid asset. Even worse, regulators are increasingly asking for local liquid assets – risking an even greater fragmentation of the single market.
26. Paradoxically, the result may be an expansion of the approach of “originate to distribute” – the US approach that led to such a lowering of credit standards in sub-prime mortgages. If that leads to a more general funding of corporates from the capital market, then foreign investment banks may take over many of the functions of EU banks. However, it should be possible to carry out classic and simple securitisation activities without the need for CRD III’s extra capital.
27. There was general concern about the disintegration of the single market and that planning for the collapse of the eurozone could become a self-fulfilling prophecy. If Greece is allowed to leave the euro, then, some argued, the area would break up. As a sub-set of the resultant risks, deposit guarantee schemes (DGS) need to be dealt with to avoid a fragmentation of the single market and thus a re-“nationalisation” of the banking market.
28. We cannot rely on banks being able to raise sufficient new private capital, thus risking a vicious circle of economic slowdown. Perhaps the solution will include nationalisation of some banks and a move of some of the banking system’s assets to the “other financial institutions” (OFIs). That could lead to a drastic cut in the number of banks and Spain, for example, which still has 60 banks could finish up with 10-12, or even less in the view of some.
29. The FSB approach to shadow banking will remove yet more oxygen from the financial system. Regulators are keen to cut out systemic risk in shadow banking but the FSB proposals are quite punitive and perhaps we should look for a less emotive re-naming of entities in this field. Finally, the issue of “bailing in” bank bondholders has still to be thought through fully. It could be very counterproductive for banks’ ability to fund in the longer-term markets.
Please click on the link below to access the full report.
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