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Is the BU as Stable & Resilient as it Looks? | The New Financial Architecture in the Eurozone

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Conference: The New Financial Architecture in the Eurozone - Pierre Werner Chair, Robert Schuman Centre for Advanced Studies, European University Institute

By: Christos Hadjiemmanuil, University of Piraeus & London School of Economics

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Is the BU as Stable & Resilient as it Looks? | The New Financial Architecture in the Eurozone

  1. 1. Is the BU as Stable & Resilient as it Looks? EUI RSCAS conference on ‘The New Financial Architecture in the Eurozone’ Villa Schifanoia, Fiesole, 23 April 2015 Professor CHRISTOS HADJIEMMANUIL University of Piraeus & London School of Economics
  2. 2. State of the banking industry: exiting the crisis? • Some repair has already taken place: – Deleveraging: assets down from €33.5 tr at 2008 to €26.8 tr at 2013 – Asset structure: increased share of loans and receivables; limited role of trading assets, but greater in large banks (19%), large economies (25%) – Liability structure: greater reliance on deposit funding (52%); wholesale funding has declined from 36% to 23% at end-2013 – Improved capitalization: median Tier 1 capital stands at 13%; the ECB’s comprehensive assessment exercise did not unearth significant capital shortfalls in SIBs – Gradual normalization of interbank market • Indifferent performance / profitability – Due to low interest rates, bad assets & restructuring costs – In an environment of weak, fragile growth
  3. 3. • Systemic stability? – Market indicators of systemic stress down to pre-crisis levels – But the banks remain fragile – The sovereign-debt issue has not been addressed • Wide cross-country differences in state / performance of banks • Structure of the banking industry – Consolidation: fewer banks and banking groups; but M&A activity subdued, mainly domestic transactions, often intragroup (internal group restructuring) – Increased market concentration at the national level: rationalization or byproduct of official choices in the context of crisis management? – During the crisis, modest decrease of foreign bank presence, but very large decrease of cross-border investment flows – Wide cross-country differences in terms of size of sector, concentration, domestic v foreign control of assets
  4. 4. Continuing fragmentation along national lines • Structural fragmentation along national lines – Domestic consolidation / increased market concentration – In certain cases, accentuation of the TBTF aspect / potential fragility systemic fragility; impediment to cross-border risk-sharing • Continuing impairment of interbank cross-border wholesale lending – Following the crisis: break down of cross-border interbank market – Drivers: credibility of the national safety net; exposures to sovereign debt – ‘Renationalization’ of monetary & credit conditions – Highly divergent credit conditions, with grave implications for the financing of non-financial enterprises in peripheral economies • More generally, limited market integration / reversal of prior gains – Retail sector had always been a problem – Bond & equity markets’ gradual return to pre-crisis integration levels – Structurally reduced level of cross-border lending to corporates – Gradual, non-uniform improvement in money market
  5. 5. A road (not) taken? The ‘Bruegel’ approach • Note by Sapir & Wolff, presented at the informal Ecofin, 14 Sep 2013: – Three-step strategy for ensuring integration / better risk-sharing • SSM & strict stock-taking through the comprehensive assessment; • SRM & forceful restructuring, prioritizing cross-border sales & mergers; • in the longer run, extensive integration of euro area bond & equity markets, based on unification of company, insolvency & tax law – When the situation has improved, introduction of limits on banks’ exposures to sovereign debt • Despite apparent similarities, actual European policies do not move exactly in that direction: – SRM: through its procedural &, in particular, funding arrangements, unlikely to severe problem banks’ domestic linkage – Capital Markets Union: as envisaged by the Commission, not quite the same think; more timid initiative, along the lines of the FSAPs
  6. 6. Regulatory & supervisory reform • With SSM, improved supervision – Streamlining, through the assumption of supervisory functions by ECB – Improvement in the supervisory incentives: less room for national politicized decision-making / forbearance • Single Rulebook: strengthened regulatory environment – Significant strengthening of capital requiremes – Proposed MREL (in the context of resolution planning): major step forward – Stress testing, dynamic provisioning, macroprudential capital buffer: increasing focus on dynamics / early detection of emerging risks – More robust approach to resolution (at least in principle): BRRD / SRM Reg – Problem of collateral liquidation spirals / effects of close-out netting & insolvency ‘safe harbours’ partially mitigated through the introduction of mandatory administrative stay in resolution – But the new liquidity requirements are unconvincing – No progress with structural regulation
  7. 7. Crisis management & resolution in the BU • Promise v reality of the BU: – From the intended mutualisation of public safety nets to a system aimed at entrenching robust and quasi-automatic private risk-sharing? • Violation of the ‘principle’ of alignment of control & liability (cf debate on legacy assets – All but unified supervisory framework; but – No mutualisation of DGSs; and – Residual national fiscal responsibility – Prolongation of the underlying fragmentation of the banking system! – Perverse incentive for forbearance, if the home country is fiscally weak • Complexities of resolution process – Possibility of national influence over the resolution decisions – Discretionary elements in the burden-sharing cascade – Unconvincing backstops; and – Effective national vetos in ESM
  8. 8. Monetary & banking policy in the BU • Crisis containment – BU: its announcement was more effective in quelling turbulence than its actual implementation – ECB: since 2012, it has played the primary role in stabilizing the situation • Overburdened monetary policy? – Wide scope / objectives: the Eurosystem as ultimate backstop for macroeconomic; banking; sovereign debt; balance-of-payments; and even asset markets problems? – Broad range of unconventional tools: QE (PSPP); LTROs, ELA; OMT; Target credits; relaxed collateral eligibility standards, ABSPP, CBPP3 – Overstretching the mandate? OMT case! ‘No monetary financing’ clause – Longer-term financial stability risks from accommodative policies?
  9. 9. Forbearance & moral hazard: still with us? • Conflicting objectives / responsibilities? – Reversal of traditional assumptions about the tension between monetary & supervisory functions: this time, reregulation / supervisory demands have put the break on a monetary policy with expansionary objectives – Stabilizing effects of monetary expansion v longer-term moral hazard • New forms of the classic dilemma: – TBTF not the only example of moral hazard; system-wide policies may also undermine market discipline – Time inconsistency: ex ante v ex post optimal insolvency approach – Public interventions to contain banking crises (moral hazard) v market discipline – Time inconsistency may also affect the actual application of the BRRD’s resolution mechanism (e.g. the scope of exceptions from bail-in)
  10. 10. Thank you for your attention CHRISTOS HADJIEMMANUIL Professor of Monetary and Financial Institutions, University of Piraeus Visiting Professor of Law, London School of Economics Attorney at law, ABLaw, Athens e-mail: c.hadjiemmanuil@ablaw.gr tel: +30 6936 161770

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