Commissioner Olli Rehn: Reducing systemic risk in the financial system
30 November 2010
Speaking at the AFME conference, he stressed that no EU sovereign has defaulted on its debt. Instead, the EU Member States have put up massive resources to back up any Member State facing liquidity problems.
On capital requirements, he said that some voices in industry seem to have apocalyptic views about the costs of higher equity capital, and they warn of increased lending cost and a reduction in credit supply to the economy.
He presented the following counterarguments:
· First, if you have a lot of debt, that makes each euro of equity very risky, because the creditors are first to be paid from the bank's revenues. If the debt level is high, shareholders want a high risk premium. Reducing leverage from high levels (by putting in more equity capital) should reduce the required risk premium.
· Second, higher equity capital can also lower the cost of debt funding. The debate around the stress tests illustrates this well. What the market now demands from banks in order to provide debt funding to them are capital ratios above the regulatory limits. In other words, reducing leverage by injecting equity lowers the risk to the bank's creditors and gives the bank better (less costly) access to funding.
· Third, the social cost of high leverage – that is, the too low levels of equity capital – has surfaced in the present crisis and needs to be part of any cost comparison.
· Fourth, there are transitional periods. New capital does not have to be raised at once. Some new regulatory measures will have a phase-in period to see how they perform.
He also presented the following key principles and features of the European Stability Mechanism:
· First, its financing will be based on the principles of the current EFSF.
· Second, the participation of private sector creditors will be decided case-by-case, fully in line with the IMF rules.
· Third, a distinction is made between liquidity and solvency problems, based on the debt sustainability analysis done by the Commission and the IMF in liaison with the ECB.
· Forth, to facilitate the process of negotiations between the creditors and the debtor country, standardized and identical collective action clauses will be included in all new Euro Area government bonds as of June 2013.
· The private sector involvement in the resolution of sovereign debt problems will not apply before the new system will be in place as of mid-2013.
© European Commission
