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Too political to fail

It is more than probable that the tbtf-problem will accompany us well in the future, simply because we do not see a fair and honest political willing to end it. Introducing checks and balances as well as refraining political power from interference will thus stay another field of engagement towards effective regulation.

Martin Aehling
24 June 2014

Politicians, regulators and experts unanimous stress that „we have to end too-big-to-fail“. So far, little action has proved this willingness and one may tend to suppose that it is somehow wishful thinking and in part a rhetoric saying which doesn´t become more true by simply iterating it. One may also admitt on the other hand that the regulatory reform process in the European Union is a difficult balancing of diverging interests while also taking in mind that things are complicated and somewhat captured in complexity. The answer on where we are as regards this aspect of regulatory reform can therefore be quite different depending on the viewpoint and the trust in the political process at national and at the European level. To address this problem in practice is crucial and will be a litmus test for the conviction of the political elites to finally move forward on real bail-in and restore fundamental principles of competition in the banking sector.

But times have become harder to go forward. After formally completing the so-called European Banking Union enthusiasm is shrinking. The proposal of Commissioner Michel Barnier on structural reform of the EU banking sector from January 2014 was more a fig leaf to appease the public than a sincere and practicable project, instrumental in addressing, amongst other measures, the tbtf-problem. Barnier himself said that the blueprint for structural reforms is a “cornerstone” of the EU’s fight against too-big-to-fail lenders. Having addressed it at all, even in this watered-down form, it entered heavy criticism not only from the industry. German finance minister Wolfgang Schäuble said that Germany has its own laws in this respect. An obvious sign of lobbying activities were some statements on the occasion of the Eurofi Conference in Athens April 2014. Germany, France, Sweden, Poland and the Czech Republic were among countries to take issue with parts of the Barnier blueprint.

It remains to be seen how the discussion on this proposal is running during the new legislature term of the European Parliament and the European Commission. At the moment it seems to be questionable if there will be any agreement on this at all on the European level. As regards German law, customer related trading is exempted, meaning that all trading is allowed because there is no clear cut distinction between proprietary and customer related trading.

More important, what is still missing is a level playing field in the financial services sector accross the EU. So far we did not see much cleaning up, no consolidation and diversification, but ongoing zombification hindering real competition. Will the Banking Union become a redistribution scheme on these grounds where unsustainable banks are profiting and healthy suffering? Will the thinking of competitors in form of national banking champions and a regulatory appeasement policy (saying nice words about achieved reforms, but not much happening in real terms except loosing in complexity and details) still prevail, the prospect for ending the tbtf-problem becomes not more than a scarce hope or an illusion. We shall bear in mind: 15 of the largest EU banks grew in total assets from 2000 to 2011 from 7.000 to 20.000 billion assets. As regards type and scope of activities this share has been with about 60% in market related activietes not relating to the economy and real customer business. These 15 biggest banks account for 43% of the market. They benefit most from an implicit state guarantee, which reduces diversity and distorts competition.

The same is true that we are missing a real Banking Union in practice. The interdependencies between sovereigns and the banking sector will not diminish in the future, albeit all well-meant assertions. The incentives simply are set wrongly, and politicians do not want to change them looking at the refinancing needs of European governments debt. Some sort of support comes from regulators with the no-risk-weighting and the ECB fueling banks investments in sovereign debt. Such policy might be to some extent necessary for the time being, but it stays an oxymoron how to get out of these dependencies, apart from the fact that nonviable business models are fed by this. More threatening to stability is the interconnectedness in the banking system itself. A big part of the balance sheets of big banks is related to other banks. And there is little effort to reduce these interdependencies. This all hinders creating a level playing field, which would be a precondition for a real „Banking Union“. It´s still far at the horizon.

But gains on the regulatory agenda are not achieved with a pessimistic outlook. Perhaps this is the positive aspect of iterating unfinished reforms while fighting growing indifference, complexity and oblivion. Clear cut analysis is another ingredient. For example a report of the European Systemic Risk Board Advisory Scientific Committee asking whether Europe is overbanked. The relevance arisis from the fact, that even during the crisis big banks became bigger, thus aggravating the tbtf-problem, in contrast to the official regulatory and political aiming. The report in its first part says that according to all indicators, the European banking system is abnormally heavy and has expanded beyond the point where it makes positive contributions to the real economy. The authors further point out that Europe’s overbanking problem reflects various causes such as government support and inadequate prudential supervision which have exacerbated banks’ moral hazard problems as well as the promotion of “national champions” by politicians in some countries. They describe the European banking system as a bloated system which has the potential to cause and exacerbate banking and sovereign debt crises.

Against this background it is more than probable that the tbtf-problem will accompany us well in the future, simply because we do not see a fair and honest political willing to end it. Introducing checks and balances as well as refraining political power from interference will thus stay another field of engagement towards effective regulation.