Stricter financial regulation can help contain future asset bubbles and reduce macroeconomic imbalances
14 December 2010
As part of the effort to broaden macroeconomic surveillance, the Quarterly Report on the Euro Area investigates the extent to which financial supervisory and regulatory reform can help avoid future harmful credit and asset price booms, for instance in housing markets.
Stricter financial supervision can help directly reduce risks to financial stability by keeping banks' leverage in check and by establishing more stringent lending standards. Further topics in this issue highlight the effect the crisis has had on cross-border banking integration in the Euro Area. Furthermore, the sovereign debt crisis of 2010 is shown to complicate the ongoing process of balance sheet repair. Finally, the freezing of interbank markets in 2008 has caused non-financial corporations to switch to greater bond issuance, thereby diversifying away from their traditional bank-based funding.
Turning to the set of special topics in this edition, the report examines the impact of the financial crisis on the Euro Area banking sector, in particular on cross-border integration of financial institutions through bank mergers and acquisitions (M&A). The results show that the process of market integration is still ongoing, although at a slower pace as a consequence of the crisis and the ensuing restructuring of the banking sector. The process of market integration is however not uniform across countries, as smaller economies are integrating internationally more quickly than larger ones, for whom M&A activity is predominantly domestic. But irrespective of country size, the crisis has led to a clear slowdown of M&A activity and a refocusing on domestic activities for almost all Euro Area countries.
This edition further investigates the effects of the sovereign debt crisis on the recovery process in the Euro Area financial sector. The deterioration of investors' perception of sovereign risk has contributed to a negative feedback loop between public finances and financial market developments. Challenging fiscal positions have raised funding costs for banks in some Member States in the Southern and Western periphery, while rising banking sector guarantees and implicit liabilities to the public sector have increased the perception of sovereign credit risk. This negative spiral can complicate the process of banks' balance sheet repair. The emergence of some sovereign bonds as risky assets has segmented the investor basis and led to higher funding costs for some sovereigns, despite falling benchmark interest rates. This illustrates that the pace of recovery in the financial system is highly dependent on the strength of recovery in the real economy.
Finally, this issue shows that the Euro Area corporate sector's traditional reliance on bank lending (rather than capital markets) may be changing. The surge in bond issuance by non-financial corporations in 2009 and the persistently high share of bonds in corporations' external funding in 2010 suggest that the Euro Area corporate sector may have responded to the financial crisis and the tightening of bank credit conditions by diversifying its sources of external funding. If persistent, this diversification process would make part of the Euro Area corporate sector – mostly large companies – less reliant on banks. At the same time, it may free up greater lending capacity in banks, which could be directed towards SMEs, for whom bond issuance is typically not feasible.
© European Commission
