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Advancing the debate on opposing policy positions: Risk reduction versus risk sharing

In January 2018 a group of scientists came up with a valuable contribution analysing areas for policy reforms in the Euro area. The conclusions and proposals describe ways to solve existing problems in three main policy areas and thus also pave the way for reconciling opposing positions about risk reduction and risk sharing.

In the first policy area ‘reforms of the financial sector architecture’, the CEPR policy insight tackles crucial issues and aspects that have also been debated on previous Financial Stability Conferences, notably in the 2017, 2016 and 2015 editions, on various panels about monetary policy, macroprudential policies, Banking Union, European deposit insurane, bank resolution frameworks and captital markets union.

Here we document the CEPR policy insight as well as short summaries of selected discussions of the conferences, revealing positions from policy makers, regulators and scientists on various aspects and policy fields, for further debate and comments:

CEPR policy insight No. 91, 17 January 2018

Reconciling risk sharing with market discipline: A constructive approach to euro area reform

From the introduction of the CEPR policy insight showing its motivation and crucial reasoning:

The need to improve the euro area financial architecture to make it less vulnerable to crises and to deliver long-term prosperity to all its members remains as strong as ever. Nevertheless, no meaningful reform has been enacted since the Single Resolution Mechanism was created in July 2014 as part of the banking union initiated in 2012. This reflects a deep disagreement among euro area members on the direction that reforms should take – including between its two largest members, Germany and France. France (along with other members such as Italy) has called for additional stabilisation and risk-sharing mechanisms as well as stronger governance and accountability at the euro area level. In contrast, Germany (along with other members such as the Netherlands) takes the view that the problems of the euro area stem mostly from inadequate domestic policies, that additional euro area stabilisation and risk-sharing instruments could be counterproductive, and that what is really needed is tougher enforcement of fiscal rules and more market discipline.

This Policy Insight was written by a group of independent French and German economists with differing views and political sensitivities but a shared conviction that the current deadlock must be overcome. Reform of the euro area is needed for three reasons: first, to reduce the continued vulnerability of the euro area to financial instability; second, to provide governments with incentives that both encourage prudent macroeconomic policies and deliver growth-enhancing domestic reform; third – and perhaps most importantly – to remove a continuing source of division between euro area members and of resentment of European institutions such as the European Commission and the ECB, which has contributed to the rise of anti-euro populism and which could eventually threaten the European project itself. …

Short summaries of selected panel discussions Financial Stability Conferences in Berlin:

Panel discussion Financial Stability Conference 2017, Berlin:
How to tackle unfinished Business in a new EU political Constellation?

Discussants:  Dr. Levin Holle, Director General, Financial Markets Policy Department, German Federal Ministry of Finance; Philippe Lamberts, Member of the European Parliament, Co-Chair, Group of the Greens/European Free Alliance; Klaus Regling, Managing Director, European Stability Mechanism; Odile Renaud-Basso, Director General of the Treasury, French Ministry for the Economy and Finance; Luigi Federico Signorini, Deputy Governor, Banca d‘Italia; Emiliano Tornese, Acting Head, Resolution and Crisis Management Unit, European Commission, and Visiting Professor, College of Europe in Bruges; moderated by Prof. Alessio Pacces, Professor of Law and Finance, Erasmus School of Law, Erasmus University Rotterdam.

Alessio Pacces introduced the panel topic of unfinished business in tackling financial instability problems in Europe. In his view, this presents a threefold issue including: a) legacy problems that need to be overcome before b) moving on from national to European authorities to decide on banks, which in turn is only possible with c) a credible backstop. Emiliano Tornese started out that in terms of completing the institutional architecture of the EU and the Banking Union, the Commission’s recent Banking Union communication can be considered a landmark. It shows that eventually it is for the co-legislator to decide what important policy choices have to be made. “The Commission wants to play the role of an honest broker putting forward ideas so that the co-legislator can decide on how to move forward on the important topic of EDIS.” The communication addresses the policy objective of protecting depositors across the Euro area as well as legacy and moral hazard problems that need to be tackled in order to create a level playing field. Therefore, the Commission proposes the co-legislator to consider an EDIS which simply provides liquidity in the first phase excluding any risk of losses and continues to a second phase if need be.

Moreover, the Commission’s Action Plan for NPLs expected for spring 2018 entails the objective of creating a secondary market with price recovery and transparency. “Within this roadmap the tensions between risk sharing and risk reduction go in parallel and achieve the ultimate objective of financial stability in the Euro area.” Alessio Pacces summarised the Commission’s position to run the two agendas of reducing risk and sharing already existing risks in parallel, which is difficult to frame from an economic perspective, but might make more sense from a political standpoint.

In regards to Klaus Regling’s previous impulse, Philippe Lamberts challenged the view that the current political constellation favours the European project, as Euro-scepticism is on the rise according to political election outcomes in Germany, France and Austria. To begin with, there was a low desire among Member States to complete EDIS, and efforts by the Commission did not change that. In turn, recent actions in Italy formed the recipe for EDIS to fail, since demanding more risk reduction before taking any action presents a political deadlock. Philippe Lamberts proposed to design EDIS similar to the Euro, but with more consistent criteria that countries have to meet in order to join and to access a full co-insurance room in the next phase. “With this different approach at least you get the ball rolling, as momentum counts and I am afraid that currently we are stuck.” On the issue of political momentum, Odile Renaud-Basso opened the alternative perspective that recent political events in the US served as a strong impetus to unify and build a strong Europe at the international scene. In addition, Brexit demonstrated the value-added of being part of the EU and politically it turned the dynamics towards more integration.

Making the case for Europe, Philippe Lamberts went on to suggest that a federal currency with a European Central Bank and federal monetary rules could not function without financial solidarity mechanisms. “There is no currency union without a transfer union.” Moreover, there is no such thing as a homogenous monetary union neither on a EU nor country scale, but nonetheless fixing disparities across countries via solidarity conditioned on responsibility is vital for the Euro to sustain. There appears to be a lack of political willingness in the Council and in political campaigns to recognise cohesion between European Member States and to act accordingly. “It is not because we have the Euro that we belong together, but it is the other way around.” The benefits from the monetary union come with a price tag and there is no free lunch for neither debtor nor creditor countries.

In response, Klaus Regling insisted that in Europe significant transfers already took place through EU budgets promoting real convergence, and secondly the ESM loans represent significant transfers to receiving countries. On the issue of solidarity, Luigi Federico Signorini added that permanent transfers are no solution to economic diversity problems in Europe since they create a structure of dependency. “Compensating for different starting points through state intervention and endless permanent transfers is no way to resolve economic imbalances, but rather to entrench them.” Nonetheless, some kind of financial compensation and risk mutualisation with a larger pool to insure against risks would be advisable.

Alessio Pacces returned to the issue of risk sharing and risk reduction pointing out that someone has to pay for losses on banks’ balance sheets and posed the question whether bail-outs can be avoided. Levin Holle answered that given a properly structured system addressing legacy issues, appropriate incentives and bail-in-able buffers bail-outs can be avoided. First, as legacy issues are clearly cut so far, they present less of a concern. However, the question remains whether the right level of protection and future incentives prevail, including sufficiently high and clearly subordinated bail-in-able buffers. Given the bank-sovereign-circle, bail-ins can potentially pose a risk and the issue of risk concentration in banks’ balance sheets needs to be addressed. Finally, for the system to work, a better alignment of insolvency, corporate and tax law is required in Europe, from which banks’ balance sheets, the Banking Union and the Capital Markets Union would benefit. Odile Renaud-Basso echoed that great progress has been made with respect to substantially increased capital buffers, the demonstrated functionality of the SRB in recent events, and in spite of remaining legacy issues, one should not be overly pessimistic on bail-in.

In contrast, Philippe Lamberts argued that the bail-in approach yields a lot of uncertainty and that he is therefore in favour of banks’ capital increases with leverage ratios of ten per cent to effectively reduce risks. Whereas efficiency has been pushed harder than resilience, an appropriate balance must be found. Luigi Federico Signorini resonated with Levin Holle and Odile Renaud-Basso that for bail-in to be usable and credible it has to be prepared carefully.

“It was a mistake to not have a transition period when introducing the BRRD for the first time”, Luigi Signorini said. In its revision, a minimum of flexibility has to be accounted for as well as the transition management of aligning expectations of the bail-in-able liabilities, especially regarding subordinated debt, such that investors know what they buy. He also highlighted potential trade-offs from ex-ante incentives and avoiding moral hazard versus tackling financial stability issues. From a European perspective, risk reduction is in the interest of everybody, and so is risk neutralisation, since insurance, once it is set up, can work more efficiently and credibly with a large and diverse pool of insured units. However, to not do anything before all pending issues of risk reduction are solved is not helpful either. The ongoing progress on risk reduction should not be forgotten.

Alessio Pacces moved on towards the potential role of the ESM presenting a credible backstop to provide certainty for financial markets. However, as it is not part of EU institutions and works with unanimity as an international treaty, the question arises whether the ESM is challenged to provide such certainty. Klaus Regling concurred that the ESM’s governance works differently, which is unlikely to change in the short-term. While most Member States favour the integration of the ESM, this may, however, entail complicated legal changes in the EU treaty. “It would be easier with decisions based on qualified majorities, but during the last five years the ESM was always capable of reaching unanimous decisions.”

In the following, the alternatives of promoting solidarity and integration through a European insurance against economic shocks in contrast to increasing individual Member States’ responsibility in dealing with their own shocks was debated. Philippe Lamberts challenged the notion of country-specific shocks and instead considered shocks to be systemic to the overall EU Single Market. “As EU citizens we belong together and therefore there is a serious and conditioned degree of financial solidarity between us. It is about the balance between solidarity and responsibility and we should have both.” In turn, Emiliano Tornese articulated that risk sharing measures already entails risk reduction. Even without homogeneity across countries, it takes a homogenous EU architecture with respective tools and bail-in as the rule that is applied to all liabilities and should not be confused with solidarity. As a backstop institution, EDIS remains important to provide stability even if it just is there and not necessarily used.

Levin Holle stressed a fundamental difference between the Banking Union debate and a fiscal debate. “The Banking Union is not about organising transfers, but about creating a more stable system and having banks on the European level organise an insurance.” Moreover, the common backstop has to be fiscally neutral and serves as a liquidity source, which already exists today through the ESM with the mere difference of conditionality due to heterogeneity in banking sectors across the Union. Luigi Signorini agreed. However, he pointed out that the combination of a single monetary policy given the Banking Union with a fiscal policy characterized by distributed sovereignty generates a suboptimal constellation at the moment. On the issue of budget, Odile Renaud-Basso added that it should not be put under an issue of solidarity versus responsibility, but under the issue of a good functioning of the Monetary Union, where economic shocks may be asymmetric or have an asymmetric impact across the Union, for which appropriate instruments are required.

Finally, Alessio Pacces initiated a concluding round on whether enhanced governance of the EU is called for, considering bank regulation and supervision in the light of imbalances and differences in financial and economic stability across Europe. Odile Renaud-Basso proposed that governance is required only after necessary actions and instruments are agreed upon in the first place. Especially given economic imbalances and problems of convergence that current instruments do not address, a coordination of economic policies is needed to prevent the current gaps in terms of economic dynamics to grow even more. Philippe Lamberts opted for a new European federal constitution with simpler and less politicised treaties, a common rulebook applicable at a federal level and enforceable through federal courts, to which the European people would consent.

In contrast, Klaus Regling argued that the EU does not need a federal budget and increased transfers to survive. Levin Holle agreed. What is needed is the completion of the Banking Union to guarantee more risk sharing through the markets, a common defence budget, a common tax basis for corporate entities and targeted fiscal facilities in case of asymmetric shocks and to promote macroeconomic stability.

Emiliano Tornese suggested that the Commission might want to better explain the accomplished benefits and synergies from the Euro and Single Market in order to create consensus for future joint projects. Following this, Levin Holle recommended to first define the projects where sovereignty is best exercised at European level and then to build the corresponding structure to promote such projects. Finally, financial means have to be adjusted to effectively serve these projects. Luigi Federico Signorini noted that a large number of responsibilities have already been transferred from Member States to the European level. While matters other than economics and finance should be transferred as well, it is crucial to ensure a governance structure appropriate for this type of sovereignty transfer.

Panel discussion Financial Stability Conference 2016, Berlin:

Limiting Sovereign Bonds Exposure: Feasibility, Effects and Implications

Discussants:  Prof. Claudia Buch, Vice-President, Deutsche Bundesbank; Prof. Mathias Dewatripont, Executive Director, National Bank of Belgium; Dietrich Domanski, Head of Policy Analysis, Bank for International Settlements; Dr. Roberto Gualtieri, European Parliament, Member S&D; Erik Nielsen, Group Chief Economist, Global Head of CIB Research, UniCredit; moderated by Prof. Jörg Rocholl, President, ESMT Berlin.

Jörg Rocholl started the panel by introducing the main topic of the bank-state-nexus and specified the question of how the transfer of risk from the sovereign to the banking sector can be reduced and what the regulatory implications for sovereign debt are.

On the issue of sovereign exposure, Dietrich Domanski criticised that the current regulatory treatment of sovereign exposure in the Basel framework is “out of line with economic reality.” In this regard, Matthias Dewatripont characterised the treatment of sovereign exposure as the original sin of Basel. In this framework, several exemption rules grant preferential treatment of sovereign exposure resulting in a zero or close to zero risk weight of these bonds. In this regard, Claudia Buch emphasised the importance of acknowledging the fact that, however, government debt is not risk-free and particularly different from risk in the private sector. According to Mr Domanski neglecting this riskiness of sovereign exposures and granting preferential treatment has the negative implication of introducing distortions in risk management and in the portfolio allocation as well as contributing to systemic risk, since banks are too exposed to sovereign risk.

On the other hand, the panel concluded possible trade-offs regarding sovereign exposures, since they could also serve as liquidity buffers or as investment substitutes when there is a lack of other assets. Also governments may want banks to act as shock absorbers during recessions and as contrarian investors in sovereign bonds. However, Mr Domanski clarified that such considerations are important but not a justification to preserve the status quo of preferential treatment for sovereign bonds.

In this regard, Ms Buch pointed towards the central question of how to handle sovereign risk in current banking regulation while noting that so far neither quantity limits nor risk weighting for sovereign exposure have been applied, both of which constitute two central regulatory measures. Generally, it was noted that as the Banking Union provides better surveillance of sovereign risk, it also contributes to effectively lowering the bank-state nexus.

Furthermore, there are economic reasons for dealing with sovereign risk, which are based on empirical evidence and point towards misaligned incentives such as reduced lending to the private sector on behalf of the sovereign sector, which is particularly true for weaker banks. Erik Nielsen highlighted the crucial link between the private and sovereign sector. He called for precaution when restructuring government debt, since “the private and sovereign sectors are mirror effects of the same.” Therefore, in terms of diversification, he also called for banks to diversify their real business, which is lending to the private sector.

Generally, the panel agreed upon the need to limit sovereign exposures. In this regard, Mr Nielsen warned about the ex ante mechanisms of risk weights for sovereign bonds, since such an ascription of risk would undermine society’s belief in the government which could be potentially dangerous. Moreover, he considers such limits on the holdings of sovereign debt as a dangerous pro-cyclical instrument and recommends that instead sovereign exposure should be limited to a share of national GDP, equity, capital or a comparable measure.

Furthermore, the panel concurred that diversification of sovereign exposures across European banks is a key issue in financial regulation in order to guarantee financial stability. The main challenge is to set the appropriate incentives to induce greater diversification so that cross-border investments in sovereign bonds are increased. So far, as Mr Domanski pointed out, there is a strong home bias for sovereign debt in the Euro zone for reasons of regulation, responses to the crisis, as well as market structures.

On this point, Mr Dewatripont added that concentration of sovereign debt as “high quality liquid assets” in times of crisis or recession also constitutes a normal market phenomenon that has the perks of granting market access to sovereigns. In economically better times, a higher degree of diversification usually prevails. However, it is advisable to induce banks to invest in diverse and safe assets to stabilise the system, and maybe later it might be a good idea to introduce European safe bonds (ESB). In addition to diversification, however, Mr Domanski stressed that the fiscal soundness of the sovereign itself matters and that regulation cannot substitute for respective efforts.

In conclusion, long transition periods, complementary measures as well as greater diversification regarding sovereign exposure can be distinguished as necessary steps for the future regulatory treatment. In terms of regulatory intervention, Roberto Gualtieri raised the question of the appropriate timing of measures from a policy making perspective. Particularly, he stressed the necessity of a profound cost and benefit analysis of policy intervention. Mr Gualtieri suggested that one potential aspect of isolating banks from sovereign risk might be to put additional stress on the sovereign bonds market, which currently may not be a good idea. Instead of activism, a long transition period is needed. Moreover, Mr Domanski added that policy makers would have to “thread the fine line to get the incentives right ex ante and to retain the capacity to deal with bad outcomes.”

On market discipline on the issue of sovereign debt, Mr Nielsen commented, “the market is not the right policemen for fiscal discipline that is needed in the currency union.” In the end, markets do tend to panic and credit agencies tend to overreact irrationally.

One question from the audience regarded the issue of how to deal with subsidiaries in third countries assuming that sovereign exposure is a European issue. Mr Dewatripont responded that there is no clear policy idea on the table yet. However, for dealing with third countries and advancing diversification of not only sovereign but also country risk, it might be a good idea to look at the group instead of subsidiary level.

This could possibly induce cross-border banking especially beyond the Euro-area, since risk remains the major hurdle so far. Mr Domanski added that in many cases, cross-border and subsidiary issues are more of a supervisory nature, since regulatory frameworks already provide sufficient flexibility to address the specific ways in which international banks operate.

One remark from the audience addressed that without a European ‘super-bond’, the targeted diversification might be problematic, since small banks hold domestic sovereign bonds for liquidity reasons and are often unable to diversify to other foreign bonds. As with any regulation, Ms Buch replied that one has to account for endogenous market adjustments taking place regarding banks’ investment behaviour. Also, it is not about prohibiting sovereign bonds as risk-free altogether, but about acknowledging related risks. On the debate between small vis-à-vis large banks, Mr Gualtierti reiterated the importance of a careful cost-benefit assessment. For a complete Banking Union it remains fundamental to promote risk sharing and the Capital Markets Union. However, echoing Mr Domanski, Mr Gualtierti noted that home bias can be influenced but not radically changed by regulation. The issue of small banks will therefore persevere.

A final comment from the audience addressed the contradiction of introducing European safe bonds as an alternative to removing preferential treatment of sovereign debt, since ESB would require certain privileges as well. Mr Dewatripont responded that Basel sets merely the minimum in terms of risk weights. Therefore, soft limits regarding concentration instead of credit risk weights could be introduced as well as ESB-specific exemptions from this. On this, Mr Gualtieri pointed to consider the level playing field also on a global stage and hence a careful divergence from Basel rules.

Panel discussion Financial Stability Conference 2016, Berlin:

A Level Playing Field and EU-wide Deposit Insurance: Mission impossible?

Discussants:  Sylvie Goulard, European Parliament, Member ALDE; Dr. Levin Holle, Director General, Financial Markets Policy Department, Federal Ministry of Finance; Dr. Vincenzo La Via, Director General of the Treasury, Italian Ministry of Economy and Finance; Dr. Gerhard Schick, Deutscher Bundestag, Bündnis 90/Die Grünen; Emiliano Tornese, Deputy Head, Resolution and Crisis Management Unit, European Commission; moderated by Prof. Henrik Enderlein, Director, Jacques Delors Institut Berlin.

Henrik Enderlein opened the debate by touching on the controversial topic of the European Deposit Insurance Scheme (Edis) and introducing the panel, which he viewed as well-selected given the diversity of expertise.

Emiliano Tornese appreciated that great progress on Edis has been made already. However, political discussions with stakeholders are still necessary and part of a broader debate on how to align risk sharing and risk reduction and on how to restore confidence in the European banking sector. Adding to this, Levin Holle argued that prior to Edis, other elements of a comprehensive stability package have to be addressed. “This is a question of priorities.” Firstly, this includes a profound risk reduction in the European banking system by means of higher capital ratios and a workable bail-in regime, which requires concrete rules on bail-in-able buffers and a harmonised subordination regime to be proposed by the Commission as soon as possible. Secondly, this relates to overcoming the risk contagion from the sovereign to the banking sector.

In contrast, Vincenzo La Via was in favour of speeding up the completion of the Banking Union by promptly adopting EDIS and a common backstop as the last remaining elements. “Many risk reducing efforts on the European level have already been accomplished.” In this regard he suggested that more integration within the European banking system and the single market was needed as well as the implementation of the Capital Markets Union in order to restore the crucial confidence in the banking sector.

With respect to sovereign risk and potential solutions, Sylvie Goulard proposed that banks should be encouraged to diversify and to “adopt a European instead of a national passport”, which was well received on the panel. Regarding the measure of risk weights for sovereign bond holdings, however, Mr La Via raised the objection that unnecessary and country-specific advantages interfered with a level playing field, and that there is no single European solution, as this is inconsistent with global discussions.

On the regulatory architecture for financial stability Gerhard Schick argued that “to respect and include existing structures could help bring Edis forward and not to force too much of a change where it is not necessary.” He supported the approach of a re-insurance mechanism for the Edis design as well as a fiscal backstop, which is currently lacking, in order to make the system more credible than it is today. He also criticised that, in the concept of the bail-in regime, authorities often regard consumer protection as a side issue when really it is at the core of financial stability.

This refers to the question of who carries the risk that banks sell to their clients, and how smaller savers and private households can be protected.

Overall, the panel concurred that the transition period of the regulatory system had to be acknowledged, especially when moving from a bail-out to a bail-in regime. Ms Goulard noted: “It is a complex issue and it takes time to constitute the precise rules for member states to actually implement. We have to ensure, that what we produce can function.” Moreover, an inclusive European perspective and joint efforts on the issue of financial stability are needed instead of concentrating on single national interests blocking the project. In Ms Goulard’s view, a lack of mutual trust among the member states constitutes one reason for the Banking Union to be in the middle of formation with respect to deposit guarantee schemes and Edis. In terms of Europe’s economic prospects, Mr Holle echoed the necessity of a regulatory environment which promotes cross-border investments in future-oriented projects, since currently there is rather a problem of finding investable and future-oriented project instead of liquidity issues or funding.

In addition, different panelists agreed that the Euro area is overbanked and contains a vast number of unprofitable banks. A further rationalisation of the system via banking consolidation and mergers could provide more efficiency and credibility for the system. In order to make the European financial system more resilient towards future turbulences, the panel summarised the need for a clear commitment to implementation dates, the single currency as a starting point, a less politicised commission as well as a comprehensive stability package including clear rules and harmonisation across the Euro zone.

In response to questions from the audience on why the European Commission is pushing so hard for Edis, Mr Tornese summarised that Edis was a declared aim in order to complete the Banking Union as well as to create confidence and the respective infrastructure for financial stability. Regarding the level playing field and an overbanked Europe another question referred to whether a concrete blueprint is needed on how the EU banking sector should look like. Ms Goulard responded that such a pre-definition is not in line with a free and liberal market functioning, which might indeed entail the co-existence of small vis-à-vis large banks. On this, Mr Holle agreed that rather diversity in the banking sector and cross-border mergers are needed.

On the issue of the appropriate level regarding risk reduction in the banking sector, Mr Holle clarified that the requirements on capital levels as the first safety buffer are set by the Basel rules, while the bail-in-able buffers in terms of the TLAC standard go beyond the double of that bound in order to guarantee a bank’s recapitalisation. Then, resolution authorities can still set higher buffers if a bank appears to be more dangerous than others. In terms of sovereign debt there is a concentration risk in the balance sheets of some individual banks, a problem which has to be addressed. He further pointed out, that when a bank is running into difficulties, the bank itself, its owners and creditors have to bear a certain percentage of the bank’s liabilities as losses. In the BRRD 8 per cent was set in a political process. The precise amount is disputable, said Mr Holle, nonetheless it constitutes an important threshold, after which banks can use the resolution fund. Without such a threshold, any bank could mutualise the problems of its own mismanagement with the remaining banks in the sector, which would constitute a terrible state.

Panel discussion Financial Stability Conference 2015, Berlin:

Resolution Framework and Resolution Board: Is the work done?

Discussants:  Olivier Jaudoin, Director Resolution, French Prudential Supervisory and Resolution Authority; Dr. Elke König, Chair, Single Resolution Board; Christophe Nijdam, Secretary General, Finance Watch; Fatima Pires, Head of the Financial Regulation Division, European Central Bank; Emiliano Tornese, Deputy Head, Resolution and Crisis Management Unit, European Commission; moderated by Prof. Jörg Rocholl, President, ESMT Berlin.

Referring to Ms König’s remark on the abandonment of market economy rules, Jörg Rocholl opened the discussion by emphasising the suitability of the location (the former Staatsrat of the GDR which ESMT now uses) to debate such questions.

From there, the panel concurred that much progress has been made, particularly at the national level, in terms of resolution policy. What is still missing, however, as Emiliano Tornese highlighted, is “now that the BRRD is in place in EU member states, even those not participating in the Banking Union, it has to be made operational”. Fatima Pires echoed this sentiment, adding that the “8% bail-in requirement to access the SRF is a fundamental game-changer” in providing enough loss-absorbing capital in times of crisis to ensure continued operations. For her, introducing a common insolvency regime is an area for future work to ensure that resolution actions will work effectively across borders.

Mr Nijdam highlighted areas of perceived weakness, including the feasibility of acting quickly, with clarity, and decisively to avert a future crisis. Taking the example of EU Living Wills and 18,000 page resolution plans for some banks, he questioned: “do we know whether they can resolve an issue in a bank over a weekend?” Confidentiality remains a major stumbling block. Furthermore, he was sceptical that in practice the taxpayer would not be burdened, suggesting that bail-in-able liabilities would not be sufficient and resolution not realistic for “too big” institutions. Resolution, he argued, is impossible for the biggest institutions, especially when considering the complexity of their structures and the political environment with which and in which the resolution authorities have to operate. Ultimately member states will seek to protect their own national interest.

Elke König agreed with the concern raised by Ms Pires about the lack of harmonised insolvency laws across Europe, but stressed that what Europe does have is mutual recognition of resolution policy at an EU-level. Getting this has been a giant step for Europe. At a global level, this cooperation is voluntary, but work is being done to strengthen resolution planning beyond the eurozone, with the Bank of England, with the US, and with countries in Asia. With regards to the size of bail-inable liabilities, she was confident that it is sufficient. The 8% bail-in is a minimum requirement, and more is expected. On the question of resolving a bank over a weekend, this has to be seen in the context of longer process of dealing with a failing institution.

There are now many more checks and balances in the system. Resolution planning has to have a forward-looking dimension – working to separate critical functions and secure them.

Fatima Pires suggested that the enhanced information exchange being developed by the SSM and SRB plays a significant role here. Olivier Jaudoin reiterated this, saying that “each authority is learning to use their own tools and sharing their experience with other authorities”, and reminded the audience that the resolution is not a technical exercise but has social impact. The SRB, he said, “is unique in its position to take such a strong decision.”

A range of insightful questions from the audience picked up on the preference in Europe for private sector solutions before using the SRF; ensuring adequate liquidity provision for international banks by involving more than one central bank; and a reiteration of how beneficial it would be to harmonise insolvency laws across member states, as Fatima Pires concluded, “It would be better to find a European solution rather than a patchwork solution.”

Panel discussion Financial Stability Conference 2015, Berlin:

Crisis Prevention and Macroprudential Policy: Mission impossible?

Discussants:  Prof. Arnoud Boot, University of Amsterdam, and Co-Director, Amsterdam Center for Law and Economics; Prof. Stijn Claessens, Senior Adviser, International Finance Division, Board of Governors of the Federal Reserve System; Francesco Mazzaferro, Head of the Secretariat, European Systemic Risk Board; Dr. Rolf Strauch, Member of the Management Board, European Stability Mechanism; moderated by Prof. Henrik Enderlein, Director, Jacques Delors Institut Berlin.

Henrik Enderlein´s first set of questions to the panel addressed whether the European Systemic Risk Board has effectively managed the complicated interactions between monetary policy to ensure financial stability and macroprudential policy to ensure economic stability, and whether there is a difficulty in the ECB’s dual mandate. Francesco Mazzaferro put forward that macroprudential policy, which is so essential to the eurozone because of its varying financial cycles, is already a reality. It is being used, especially in smaller countries; as Arnoud Boot supported, though adding that there still have to be further political developments at national and European levels to ensure that macroprudential policy can be employed effectively.

On the ability of the ESRB to act decisively in times of crisis, Rolf Strauch suggested that the European Stability Mechanism (ESM) is the final in line of a number of instruments. It was created as a firewall but now serves as a firefighter – and “we have shown we can be very efficient firefighters”. Its role ongoing should be to facilitate a better monetary union, in which macroprudential policy plays a big part. As it stands, the ESM is an effective financial backstop and provides an efficient model for correcting imbalances when a country runs into trouble.

Stijn Claessen detailed the work that still needs to be done to improve the ESRB and ESM’s effectiveness and suggested that, whilst there are some lessons that can be drawn from the US (on banking mechanisms and state insolvencies, for example), many aspects of the European situation are unique, especially when it comes to the political challenges of any fiscal alignment. Mr Boot agreed that democratic legitimacy in the EU is critical. Striving for such legitimacy was in fact behind the creation of the ESRB because at the time of the financial crisis national governments could not take any further steps. This again highlights the importance of macroprudential policy for Europe in “preventing countries running off track with domestic banking systems destroying national economies”. Europe, Arnoud Boot argued, has to work towards building the right instruments to regulate a very fluid financial system.

The discussion moved on to where the next crisis might come from and whether we really are legislating against what might come in the future rather than focusing too much on the past. To this, the panel agreed that, given the size of the most recent crisis, it is essential to “leave no stone unturned” in understanding how it might have been prevented. Francesco Mazzaferro added how helpful the ESRB’s data work has been in achieving this understanding. As Mr Boot explained, this is not an argument, however, for overregulation but for smart regulation. Future crises are inevitable, there will be microeconomic imbalances, but, “we can build buffers, we can build a smart system to absorb the shocks.” Mr Strauch was of the opinion that in detecting a future crisis, “analytical tools are good but can only go so far.” The eurozone has to become as resilient as possible with effective macroprudential policy. The toolkit available to the ESRB and to national authorities requires additions. Macroprudential works on the supply side, but real estate, for example, should be addressed from the demand side. There are other systemic risks outside of banks to be considered, such as insurance companies because of the huge sums of money they invest, search for yield, and the impact any reverse in quantitative easing might have on them.

In response to questions from the audience, Arnoud Boot confirmed that the ESRB should not be considered a paper tiger because steps, such as the Banking Union and risk-sharing policies, have been taken to make it possible to act in a crisis; a point supported by Stijn Claessen, who said that it can deal with credit booms through behind the scenes interventions, as well as by Francesco Mazzaferro, who cited the recent examples of Poland, Hungary, and Croatia. All agreed that the ESRB and macroprudential policy puts Europe in a strong position to counteract future crises and shore up economic stability ongoing.

Panel discussion Financial Stability Conference 2015, Berlin:

The EU Financial System: How to better design for Growth?

Discussants:  Colin Ellis, Chief Credit Officer, Moody’s; Dr. Levin Holle, Director General, Financial Markets Policy Department, German Federal Ministry of Finance; Liz Meneghello, Head of Capital Markets Union an CCP Resolution, HM Treasury; Martin Merlin, Director Financial Markets, European Commission; Dr. Christian Thimann, Member of the Executive Committee, Axa Group; moderated by Nicolas Véron, Senior Fellow, Bruegel.

This was a stellar panel, Nicolas Véron said, for moving the discussion from stability to growth. That it is now the right time in Europe to shift the focus from stabilisation to growth was supported across the panel. Liz Meneghello gave the UK Treasury perspective, suggesting that the Capital Markets Union is a big part of this shift of focus from stability to jobs and growth. In this, it is important, she said, “to step back and check the overall coherence of the recent financial market reform for anything that might inhibit growth.” The financial system by and in itself cannot generate growth, argued Levin Holle, but it can support growth. The question now is how best to do this – one thing that’s certain is that there has to be a move to provide financing for the real economy. On whether banking regulation has become onerous, Martin Merlin stressed that the regulation framework in place has to prove whether it is fit for purpose – providing stability and helping companies in need of investment.

The panel then discussed whether the level of dependence on banks for investment is too high in Europe. Positive signs that this is changing include disintermediation, more active engagement by business angels, and a growing sector of peer-to-peer lending – improvements in part triggered by the crisis, according to Colin Ellis. Making sure high-growth SMEs, who innovate, create something new, and have the potential for rapid expansion, get access to capital is very important. Ms Meneghello added that working to address the problems and gaps in cross-border investment would help here. In response, Mr Merlin outlined the measures being undertaken by the European Commission to aid this, including co-investment activities with EU public money and private money; improvements in venture capital legislation; creating tax incentives for venture capitalists in member states; and strengthening regional financial centres rather than just looking to London, Frankfurt, or Paris for capital.

Mr Merlin emphasised that we should not be making such a clear distinction between market-based finance and banks, as the sectors are intertwined and, either way in Europe, we need to ensure more money is going into the economy. Europe, he argued, “does not need to mimic the US. Where banks provide financing well, there is no need to change the system.” For Colin Ellis, establishing a greater balance in Europe between market-based financing and banks would be good thing. Having an insolvency framework in place would help incentivise that, Ms Meneghello and Mr Merlin agreed.

To the audience question on the Cumulative Impact Assessment, Levin Holle stressed the importance of assessing the implications of the softer, more detailed regulation which the national regulatory agencies are now producing following the completion of the policy-making stage. Christian Thimann agreed that this assessment is a great initiative, but added that it is “a mistake to exclude accounting rules.” On the securitisation of SMEs, Mr Ellis responded that they represented a difficult class to classify; a point echoed by Mr Merlin because “SME loans are idiosyncratic.” The European Commission’s onus on the investor to validate the risk of their investments is disappointing, added Mr Thimann. They had hoped to see this done by a central agent – as it stands it is overwhelming in terms of detail and legal consequences.

The questions, addressed to Martin Merlin, turned to how to assess the impact of financial regulation for society at large. In response, Mr Merlin said that from the evidence he is confident that the benefits of stability and sustainability in the financial system far outweigh the costs. Due to regulation, it is now a better system. The onus now, however, is “not about fighting old battles but about identifying what does not work as it should.”