Building mutual trust is crucial to the future of European banking
Europe's member states need to trust that both they and the region's banks have the necessary risk reduction in place if the banking union is to succeed, writes Timothy Buenker of the European Banking Federation.
As the current European legislative period is nearing its end with elections in May 2019, banks are eagerly awaiting the conclusion of the final regulatory elements agreed by the G20 in the form of the risk reduction measures (RRM) package.
In the RRM package, banks are still calling for prudential recognition of the European single market and the banking union as a single jurisdiction. They are hoping to take advantage of consolidated supervision and reporting to be able to manage capital and liquidity centrally. This would greatly facilitate an efficient free flow of capital and avoid trapped pools of liquidity in times of stress, as well as alleviating the immense regulatory burden of supervisory reporting to multiple authorities.
After all, it must be borne in mind that the international post-crisis reform agenda – including the liquidity coverage, net stable funding and leverage ratios – were only intended by the Basel Committee to apply to large cross-border banks on a consolidated basis.
Minority rules
European banks already meet the Basel III capital and liquidity requirements and the banking union is now well established and up and running with a Single Supervisory Mechanism and a Single Resolution Board. But recognising the banking union as a single jurisdiction through automatic waivers for consolidated supervision is still being resisted by a blocking minority of EU member states in the council.
Member states who oppose automatic waivers point to the European Deposit Insurance Scheme (EDIS) for the eurozone as the critical third pillar missing from the banking union, while others are not yet ready to move forward on EDIS. These member states argue that there must be further risk reduction in some banking sectors before risk sharing can begin.
This sentiment is largely rooted in the fear of some banks still holding legacy bad assets from the financial crisis on their balance sheets. These non-performing loans (NPLs) have in turn impacted sovereign debt levels and ratings – in some states more than others. While the volume of NPLs in the eurozone and EU28 has reduced significantly from the immediate post-crisis level, a wide divergence of levels across member states remains.
The impasse to institutionalise trust between member states in the EU single market and the eurozone seems therefore unlikely to be overcome with the current RRM package. To achieve greater trust between authorities and further the banking union project, European policy-makers are looking to further reduce risks. It is vital that trust is placed in banks and the banking union to manage the inherent risks.
When it comes to reducing problematic NPLs, banks should not be restrained from holding NPLs on their balance sheet, as this would be counterproductive to reducing them. Instead, banks need to be trusted to remain part of the process to manage and extract value from and provide market liquidity to maintain competitive pricing for NPLs.
In order to move closer towards completing the banking union, a first step to create EDIS within the eurozone could realistically be in reach if the system was to be limited to the role of a liquidity facility between national deposit guarantee schemes. Fears of disproportionate loss sharing could be countered with sufficient safeguards such as a targeted asset quality review, risk-based contributions and a first right to recoveries and contributions from jurisdictions benefiting from EDIS.
ECB participation
The European Council already agreed in June that the European Stability Mechanism would provide a common backstop to the Single Resolution Fund. However, the eurozone, unlike other jurisdictions, still lacks the commitment of the European Central Bank (ECB) to act as a lender of last resort for banks in resolution. Banks advocate that the ECB should play this critical role by providing a resolution liquidity facility under strict conditions – banks should be sufficiently well re-capitalised, and penalty rates should be applied in order to incentivise private sources of liquidity. The assurance by the ECB alone would be instrumental in generating market confidence for a bank that has come out of a resolution process.
Finally, in the absence of automatic waivers, national authorities need to continue to build mutual trust in supervisory and resolution colleges to make better use of the existing waivers for centralised capital and liquidity management. This will require closer co-operation and more intensive information sharing in colleges.
Relying and trusting on future investment returns and properly assessing risk is at the heart of the business of banking. Because banks trust in the future and manage risks, they remain instrumental to financing businesses and households. If member states and central banks in turn are not willing to put their faith into the banking union and the EU single market, it will be hard to convince others. Making the EU single market and banking union a blossoming reality for the wider European economy, including its banks, therefore ultimately requires developing mutual trust and recognition from all member states.
Timothy Buenker is senior adviser for banking supervision at the European Banking Federation.
