Under the headline ‘National Banking Policies and the new EU Political Landscape: Stuck between Reform Ambitions and Disintegration Tendencies’ supervisors, academics and experts discussed how current changes in the political landscape impact financial markets integration and resilience; the implications of surging national banking policies on competition, harmonisation and diversity; and the issue with regulatory ring-fencing and the use of options and national discretions.
Financial Stability Conference 2019
28 October 2019
Panel I – Discussion
National Banking Policies and the new EU Political Landscape: Stuck between Reform Ambitions and Disintegration Tendencies
with Prof. Arnoud Boot, Professor of Corporate Finance and Financial Markets, University of Amsterdam; Giorgio Gobbi, Head, Financial Stability Directorate, Bank of Italy; Dr. Korbinian Ibel, Director General Microprudential Supervision IV, European Central Bank; Johannes Pockrandt, Head of Government and Public Affairs Germany, Deutsche Bank; Christian Stiefmüller, Senior Research and Advocacy Advisor, Finance Watch; moderated by Prof. Elena Carletti, Professor of Finance, Bocconi University, and Scientific Director, Florence School of Banking and Finance
Panel I – Discussion
Elena Carletti opened the panel by introducing the panelists and outlining the discussion topics on tensions between the promotion of national champions versus pan-European banks, national discretions versus European integration and the European elections and Brexit as obstacles to integration.
In his introductory remark, Arnoud Boot observed a strong preference among European policymakers for pan-European banks and cross-border mergers and acquisitions (M&As). These mergers are beneficial as they can potentially break the nexus between local banks and their domestic governments and provide necessary risk sharing within the Euro area and the EU. Complementary recommendations point towards completing the Banking Union (BU), which besides the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) should include a pan-European deposit insurance. Regarding this agenda, Arnoud Boot identified the problems of political legitimacy and prioritization given that cross-border mergers result in overly complex and too-big-to-fail (TBTF) institutions while the track record of successful mergers is typically dismal. Banks‘ legacy issues regarding their government connections and the physical as well as technological infrastructure contribute to this issue, especially because banks are entrenched in society.
Arnoud Boot argued that Europe‘s political institutions failed to understand that banking is about politics. Banking is not a technocratic exercise and therefore technocratic solutions will fail if they do not take into account the political realities, he said. Banks should not be pressured by policy makers into taking over a large established foreign institution, but instead, they should gradually expand by buying up smaller maybe even technological institutions across Europe, which could give them a foothold in the upcoming digitalization that will change the market structure endogenously. Finally, the Capital Market Union (CMU) with persistent cross-border flows of long-term debt, equity and foreign direct investments can provide adequate integration against an overly bank dependent financial sector. Quality financial integration will not come from the banking sector, because streams of capital between countries via highly-leveraged financial institutions are by definition unstable, he underlined.
Banking is not a technocratic exercise and therefore technocratic solutions will fail if Europe`s political institutions do not take into account the political realities.
Giorgio Gobbi considered cross-border M&As in Europe to be beneficial for financial integration, especially for retail banking, where currently no common intermediaries offer the same financial services across Europe. However, underperformance of European banks presents a less noble reason for cross-border mergers. In the past, national mergers were the safest way to reduce over-capacity, but this is no longer a viable solution because the banking sectors in some Member States are already highly concentrated and further mergers would be undesirable for competitive reasons. On the other hand, banking performance varies hugely across countries, for which some jurisdictions have to increase competition in some previously sheltered segments. While pan-European banks remain debatable, respective obstacles for the BU should be removed nonetheless, which include the lack of political legitimacy and a Single Rulebook in contrast to excessive National Options and Discretions (NODs) due to banking rules formulated as directives instead of regulations.
Banking performance varies hugely across countries, for which some jurisdictions have to increase competition in some previously sheltered segments.
It can also be criticized that not Europe but national industries are considered a relevant jurisdiction when identifying G-SIBs and that regulatory treatment under Basel III does not recognize geographical diversification of banks. How TLAC and MREL measures are applied to subsidiaries constitutes another obstacle. Moreover, there is an asymmetry given that the ECB can supplement macro-prudential policies by national authorities if they are insufficient to cope with stability risks in the European Monetary Union. However, there is no guarantee against nationally decentralized macro-prudential policies being used in favor of national champions and thus there is no well-defined objective to preserve the single market for banking. Still, there are several pragmatic steps to overcome these market barriers given an adequate level of political will. On a final remark, Giorgio Gobbi referenced a recent study that by looking at price-to-book ratios found investors to penalize diversification in the current political framework. This implies that investors evaluate the cost of complexity for pan-European banks higher than advantages from diversification.
Korbinian Ibel identified the balance between European and national interests and regulatory ring-fencing as core issues. The European banking market is subject to low rates of market capitalization, a high cost basis, low profitability, over-banking, unhealthy competition, entering bigtechs and public support for only a few market exits. Excessive NODs and different regulations across countries prevent cross-border mergers and hence much-needed economies of scale. Besides language barriers at the national level of public administration authorities and tax issues, the yet missing EDIS is especially problematic, because supervision and resolution measures need to be aligned at a common European level for the right incentives to avoid bail-outs using taxpayer money.
Excessive national options and discretions and different regulations across countries prevent cross-border mergers and hence much-needed economies of scale.
All of these issues need to be solved jointly in order to overcome barriers to cross-border mergers. Some progress has been made with the fit and proper assessments for banks’ board members, but as they do not constitute a regulation, requirements differ across countries. Capital and liquidity waivers have been introduced, but there is a lot of blockade leading to excess liquidity and reduced market efficiency. And while over 100 NODs were harmonized in a 2016 SSM project, Member State options need to be addressed even further. Finally, Korbinian Ibel pleaded for the European idea and for moving forward on integration, because it is the only way to achieve economies of scale, lower costs for customers and increased welfare. Especially in view of global market forces, the EU with its huge market potential has a greater chance to succeed compared to isolated Member States. Imagine a vision where not the US but the European banking market is strong. We have all the elements to actually get there. We just need to be brave enough to do it and take mutual trust, he said.
Christian Stiefmüller recapitulated that the financial crisis was the major driver behind creating the BU in 2012 and it showed that financial stability and the eurozone‘s survival could only be achieved if all Member States implement robust rules so that banks‘ balance sheets are no longer underwritten by blank checks from the taxpayer. In the EU‘s unique cross-border set-up, fragmentation and ring-fencing, which for some embodies the notion that the BU is held back by excessive regulation, arguably present the original state of affairs. Whenever a bank consists of more than two legal entities it is fragmented and if those entities are located in different jurisdictions and subject to different regulators they are effectively ring-fenced. Ring-fencing is widely accepted when the BRRD requires resolution authorities to ensure a bank‘s critical functions are set up to survive its failure or if regulators oblige banks to structurally separate plain vanilla deposit-taking and lending from other high-risk activities. Hence, for the BU to work, a more differentiated perspective and vocabulary are needed, for instance, the concept of a level playing field implying that regulators, customers, depositors and taxpayers across Europe can expect banks to be prudent in their lending and deposits to be safe.
As long as Member States insist on rescuing their banks when politically convenient there is no level playing field.
But in contrast, significant over-capacity prevails and the expectation that poorly performing banks exit the market under the BRRD has not been fulfilled at any scale while banks continue to be bailed out with public funds. As long as Member States insist on rescuing their banks when politically convenient there is no level-playing field, he said. It is questionable whether Europe‘s systemically important and TBTF banks are resolvable or rely on implicit home country guarantees. Regulators object to further consolidation that concentrates even more market power and systemic risk in a handful of systemically important financial institutions.
For a horizontally integrated market, in which banks of different sizes and with different business models compete for vertical customers segments, the playing field needs to be leveled further by harmonizing regulation, especially bank insolvencies and liquidation at the national level according to the BRRD. For a European banking landscape to be united in diversity, other measures include reducing over-capacity, removing poorly performing banks from the market, addressing the TBTF conundrum and ensuring the resolvability of all systemically important banking groups financially via sufficient MREL and structurally via legal setups that allow resolution. We need to keep up the fight for political legitimacy and muddle through in that quest, Stiefmüller said.
Johannes Pockrandt expressed concern over considering European integration and legislation for financial services as not legitimized given the clear majority for more integration in the recent EU elections. The agenda of political parties in Brussels is to increase integration in a structured and visionary manner instead of muddling through, even though compromises might be more difficult in a now fragmented European Parliament. Especially when focusing on investors, customers and savers the example of Brexit clarified that fragmentation is to be avoided by all means and integration is the way forward. In the wake of Brexit, the EU is fortunate to depart from a situation with a strictly identical rulebook, greater financial stability, potent tools and equivalence assessments to contain fragmentation as good as possible. In contrast to Christian Stiefmüller‘s notion of fragmentation and ring-fencing as the natural state of affairs, fragmentation used to exist due to the lack of trust between supervisors and government authorities.
The agenda of political parties in Brussels is to increase integration in a structured and visionary manner instead of muddling through.
Elena Carletti summarized the panel‘s agreement on the over-capacity and low profitability problem in European banking and asked how to efficiently solve it considering market exit versus domestic consolidation. Secondly, digitalization presents an opportunity for banks but also requires them to invest and overcome legacy issues raising the question of whether banks have enough time. Finally, how can trust be rebuilt in the light of fragmentation due to national discretions, ring-fencing and distrust among the Member States.
On market exit versus consolidation, Giorgio Gobbi responded that despite the BRRD‘s and SRM‘s accomplishments, a credible system with sensible rules for an orderly market exit of weak institutions, minimizing the use of public funds in the process, still needs more fine-tuning. To deny any use of public money in a systemic event is simply not credible, when in fact it is the last resource to be used. Thus, a credible exit strategy would allow for the much-desired market contestability and new entries. Market diversity should originate from what banks‘ customers demand, instead of preserving the already existing diversity and thereby protecting small incumbents. Christian Stiefmüller noted that, despite benign conditions and being warranted by market over-supply, no market exit occurred over the last years. While cost and revenue synergies, economies of scale, lower funding costs and reduced overhead present low hanging fruit for domestic M&As, they are notoriously tricky in a mature market. Instead, it is much harder for banks to seek better asset quality, risk management, better controls and more attractive and innovative products. Korbinian Ibel clarified that on the flip side of over-capacity and over-banking, low margins and non-profitable banks also benefit customers in terms of cheap banking products.
A credible system with sensible rules for an orderly market exit of weak institutions, minimizing the use of public funds, still needs more fine-tuning.
On the opportunity of digitalization, Arnoud Boot noted that banks still have time but a long way ahead to overcome digital legacy issues and the overall progress is slow. However, in the example of the Dutch banking market, some fairly rapid adaptations took place due to enormous pressure on incumbent institutions to lower their cost base in the competitive environment of digital banking. Korbinian Ibel highlighted the importance of solving banks‘ legacy systems, especially as many banks and their critical functions depend on end-of-life systems with ceased technical support by the IT industry, which makes them vulnerable to cyber attacks. Johannes Pockrandt criticized that under current deductibility conditions, European banks are being penalized for making costly investments into software, which is especially problematic in the context of global competition.
On the issue of trust, Korbinian Ibel put forward that the idea of a trustworthy regulatory banking system differs across countries, with tough rules and market exit on the one hand and customer protection and creditor orientation on the other. In this regard, trust can be generated by learning from one another‘s different regulatory approaches while being open-minded and considerate about country-specific needs. In contrast, Christian Stiefmüller characterized trust to be an emotional category, whereas he would prefer to see whether policy makers buy into the common rules that they helped drafting. As for political legitimacy, the rules and their country-specific implications for customers and depositors should be communicated honestly to recipients. Johannes Pockrandt insisted that despite trust being an emotional category it is nonetheless at the core of how individuals and ergo institutions interact.
Moreover, a high level of trust is essential, since national regulators will always demand flexibility on the time frame to implement regulations and on issues, which they consider insufficiently addressed by international standards. Currently, a great lack of trust between home and host supervisors can be observed given a crisis situation, in which sometimes the accomplishments of policy institutions and tools created post-crisis appear to be forgotten.
Currently, a great lack of trust between home and host supervisors can be observed given a crisis situation, in which sometimes the accomplishments of policy institutions and tools created post-crisis appear to be forgotten.
Finally, Arnoud Boot warned against regulation to overly standardize banks‘ business models such that they confront stability, legacy and digitalization challenges in a similar way, because this would reduce some much-needed diversity and create systemic risks while contestability of markets is key. Korbinian Ibel replied that when regulation cuts off certain edges from banking business models, which were unhealthy and contributed to the 2008 financial crisis, then the issue of greater uniformity might be negligible, especially when these measures ensure stability through liquidity coverage ratios, long-term funding or rules on banks‘ governance. Along these lines, Christian Stiefmüller argued that regulation does not reduce diversity, but instead it places greater emphasis on incumbent banks to think harder about their customers, revenue base, business propositions and innovations.
Regulation should not overly standardize banks‘ business models because this would reduce some much-needed diversity and create systemic risks.
The first remark from the audience referred to the case of the German Nord LB and whether its recapitalization by state-owned banks given the lack of private investors can be considered state-aid, which might impact the European debate on circumvention of resolution rules and the BRRD. Giorgio Gobbi responded that as long as there is no solution to the issue of European banks living internationally but dying nationally, the current policy set-up will continue to generate struggles over existing rules until they are properly fine-tuned. Another more provocative question asked why not simply let US banks take over European banks, for which Johannes Pockrandt considered the problem of a level playing field for European banks as the core issue. Insights from corporate clients show that international banks have withdrawn from markets other than their home in the wake of the financial crisis, which implies that Europe still has a long way to go towards a more level playing field.
Korbinian Ibel welcomed competition induced by US or other global banks but noted that their predominance would entail more issues of home-host and who eventually pays than within the euro area, where there are one supervisor and one resolution authority. On the risk of having more TBTF banks due to more concentration, Korbinian Ibel replied that TBTF was a relative term given that pan-European banks should not only be considered as home banks in their small domestic country, in which by comparison they might be TBTF, but rather as European banks relative to and supported by a European GDP.
On the question of how banks deal with protests from consumer associations against increased prices due to greater concentration, Christian Stiefmüller suggested that consumers do violently complain when prices increase due to unjustified and hidden charges, that is for transfers within the EU, against which they need to be protected by the regulator. However, most customers and borrowers would understand when loans are being repriced to realistic levels. Arnoud Boot admitted that it is difficult to implement cost-based prices for customers in a banking system where clients are accustomed to having bank accounts for free except for defined fees, since banking is deeply entrenched in society.
Finally, on the controversy around greater diversity in European banking, Johannes Pockrandt suggested that given the high degree of diversification in European banking, with 1.600 banks in Germany alone, there is no risk of losing diversity anytime soon. Christian Stiefmüller agreed that even though at the moment there is no shortage of diversity in European banking regarding banks‘ size, business model or their customer base, it is important that this continues to be the case..
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