The Banking Union: pros and

cons
The European banking sector in figures – selected countries
BANK REGULATORY CAPITAL TO RISK-WEIGHTED ASSETS, %
Stress tests: update 19.06.2012 - Assumptions
Stress tests: update 19.06.2012 - Assumptions
Stress tests: update 19.06.2012 - Results
Regulatory tsunami: what future for
banks?
Key regulatory initiatives
Financial
Transaction /
Activity Tax
Corporate
SIFI Governance
and
Remuneration
Policies

CRD IV/
Bank Basel III Revision of
Recovery and
MiFID and
Resolution
Market Abuse
Directive

Deposit
Guarantee and
Investor Consumer
Compensation Protection
Schemes

9
 Background
 Response to the crisis
 AIM - strengthen the resilience of the banking sector → reduce
the probability and severity of future financial crises and remove
current regulation shortcomings
 RISKS:
 Adoption of measures that would not be taken in a more
stable period.
 Adoption under time pressure raises doubts about the proper
calibration, timing and globally consistent implementation.
 Limiting the banks ability to grant credits to individuals and/or
companies and/or governments → negative impact on real
economy.
 Our (banks’) opinion
 Not absolutely against new regulation initiatives - but
more regulation may not equal to better regulation.
(Even strong) regulation is ineffective without proper
supervision.
 Level playing field - to avoid regulatory arbitrage.
 No complex impact study of all initiatives.
 Regulatory changes will reduce the profitability of
both assets and capital; the consequences thereof will
fall upon not only shareholders but also clients, and
thus, in the broader context, upon the entire economy.

11
 Our (banks’) opinion (ctd)

As our economy is almost fully financed through bank

loans maintaining the lending capacity of banks is vital.
Banking sector, mainly consisting of subsidiaries and
branches of banks domiciled in other EU Member
States, is likely to be affected more by secondary
impacts than by primary ones (e.g. by parent banks
approach to management of their groups, slower
growth in Western Europe).

12
 How many unions for the EU?

(Monetary, Banking, Fiscal, Political?

…)
 Questions
• Is the eurozone a monetary union with all necessary
attributes?
• Is the institutional framework of the union sufficient?
• Is there enough co-ordination of economic policies?
• Is the eurozone an Optimum Currency Area?
• If the answer to those questions is negative, what is
needed to strengthen the eurozone?
• Is the Banking union THE answer?
 Answers …
• The single market in the EU is quite developed, but barriers
and limits remain
• Even if institutional, legal and technical barriers disappeared,
there will be national specifics and natural limits (language,
cultural diversity, different habits etc ..)
• The rule-based fiscal framework has clearly failed to support
the stability of the monetary union
• After more than 10 years of its existence, the Eurozone is still
not an Optimum Currency Area, divergences across the
regions have actually increased, rigidities prevail and policies
have not been adapted to provide for an common policy
framework …
• Clearly, fiscal policies are on the top of agenda for eurozone
reformers
 Fiscal policy for a monetary union

• The rule-based approach has failed

• Ideally, fiscal policies would be centralised at
least as much as in federations (ex: the US):
this is, however, not likely to happen any time
soon in the EU
• So, we are searching for a solution in between
these two concepts
 Elements of fiscal policies „in between“

• ESM (European stabilisation mechanism): an

inter-governmental agreement outside of the
EU legal framework
• The fiscal compact (treaty of fiscal
responsibility): outside of the EU legal
framework
• Eurobonds?
 The new fiscal compact
• The process has been reversed: the sanction,
imposed by the EC comes first, the discussion second
(that is a major change compared to the excessive
deficit procedure)
• Automatic initiation of corrective fiscal action if fiscal
discipline breached
• Commitment to insert those rules in national
legislation (controlled by the European Court of
Justice)
 The Banking Union

Banking Union

Single EU Common
Single EU deposit resolution Single
supervisor guarantee authority rule book
scheme and fund
 ECB as the Single Supervisor: our doubts and
questions …
 All banks in the Euro area – Is it manageable and practical?
 Non-Euro Member States can opt-in
 Fair balance between obligations and powers?
 Perception of banks supervised by ECB and banks supervised by
national supervisors?
 ECB to carry out the tasks in close cooperation with national
supervisors – Any bright line or overlaps, double requirements?
 The group interest and view prevails: this is our key concern: when
action to support supranational groups is undertaken, the
stability of the group will get the priority (over and to the
detriment of stability of daughter companies (national markets)?
 Single EU deposit guarantee scheme and
Common resolution authority and fund
• mutualisation of deposit guarantee schemes and future
resolution funds: money of national depositors can be used
across the boarder (possibly even without consent of national
authorities)
• this is a matter of depositors´ confidence and political
consideration (taxpayers´ money moves across the boarder)
• The Common resolution authority can over-rule the
competencies (and responsibilities) of national authorities
(for example imposing intra-group transfers)
Decision authority and responsibility separated
 The single rulebook
• This is fine, we believe in the level-playing
field
• National discretions lead to perverse
regulatory competition and incentives for
regulatory arbitrage
• Yet, the rules should allow for diversity of
national financial markets (which is a major
source of resilience and stability)
Liikanen group – next step of
banking sector regulation?
 General background
• The Liikanen group has been established with the
mandate to review the need for structural reforms of
the banking industry in the EU
• Would such reforms increase the resilience, financial
stability of the sector, improve the efficiency of
business and strengthen the consumer protection?
• If yes, the group should make proposals as to the
content of necessary initiatives
• Final report was delivered at the beginning of
October 2012
 Sources of inspiration and stated purpose

• Volcker rule (some activities prohibited), Dodd-Frank

act (limitations on size), Vickers report (ring-fencing
some activities)
• Purpose:
– Limit aggregate risk in the banking system
– Limit risk of contagion in case of individual failure
– Reduce moral hazard (bankruptcy of large entities possible
because of reduced implicit state guarantees)
– Promote market competition
– Maintain integrity of single market
 The Vickers report (UK Independent
Commission on Banking)
1. Loss absorption capacity
- More capital (tier 1 at least at 10%, primary absorption
capacity at 17% to 20%, including bail-in bonds)
- Stricter leverage ratio requirements

2. Structural changes
- retail ring-fencing (separation from „wholesale
banking): separation legal, economic and operational
- regulatory requirements apply to ring-fenced part of
business, links to the rest of group to be considered as third
party exposure
 The (US) Volcker rule

• Separation of some investment activities from

commercial banks:
– Proprietary trading limited
– Limit on acquisitions of hedging funds and private equity
funds
• Size limitation:
– No institution should be „too big to fail“
– The FRB (Federal Reserve Board) must not approve
mergers or acquisitions if the resulting entity should
represent more than 10% share of the respective market
Liikanen report (published on October the 2nd)
1. Legal separation of certain particularly risky financial
activities from deposit taking banks
2. Role of Recovery and Resolution frameworks further
increased (= wider separation as in 1) if required by the
resolution authority)
3. Amendments to provide more clarity to the bail-in
instruments
4. More robust risk weights for the determination of capital
requirements on trading assets and real estate related
loans
5. Further corporate governance reforms
 Liikanen report (assessment)
1. Ring fencing of risky activities: probably not an issue for us
(quantitative thresholds sufficient)
2. Additional ring fence ditto
3. Bail-in instruments: might have an impact on the cost of
funding (differentiated across our region)
4. Impact likely, will need further evaluation
5. Corporate governance reforms: probably not the central
issue for us given the business models applied in our region
 Discussion: arguments of supporters
The key aspect is in the „too big to fail“ argument,
consequences:
- asymmetry of funding cost distribution to the benefit of big
players, distorting the financial market
- distortions in risk management of portfolio (excessive risk
taking), suppression of the basic function of banking (=
maturity transformation), deviation from value added
financing towards „casino“ type behaviour
- distorting regulatory rules in favour of big players
- out of 29 world wide SIFIs (Systematically Important
Financial Institution), 17 are located in Europe
- the size of European SIFIs has come well in excess of any
national authority to manage bank's resolution …
 Selected group of European banks: structure of portfolio
(= all banks traded on stock exchanges)
Total 32 banks

of which: 10 larger

36 % 36 %

of which: 10 smaller

9% 75 %

There are in total cca 8000 banks in EU: the difference in the above indicator
would be even greater since even the 10 smaller banks belong to the 0,5 % of the
larger EU banks
 Arguments of opponents

• The European financial sector is very diversified both in terms of structure

and the business models used, however universal banks prevail
• No specific component of the market was source of the recent crisis (or
hit more particularly by it): it this therefore not possible to conclude that
the European market would be facing a structural problem
• Actually, the opposite is true: this diversity is source of resilience:
administrative intervention could weaken resilience
• In addition, the EU economy is more dependent on banking
Intermediation than, for instance, the US one
• The single market argument: cross-boarder transactions are source of
diversity: administrative intervention could weaken resilience
Banking assets to GDP represent 150% in the USA
Assets of commercial banks in EU and in USA

(thousands of billions USD)

 In addition …

• There can be no retail activity without investment activity,

examples:
– Interest and exchange rate hedging to corporate clients
– Dtto to public entities (state or municipal bonds …, infrastructural
projects like PPPs)
– Individuals (hedging mortgages …)
• It is not easy (=it is almost impossible) to distinguish the
purpose of investment transactions (helping financing the
economy as opposed to „casino“ transactions)
• If the underlying purpose is to help financing economy, then
banks need to cover their own risk (otherwise this may
(always will) have an impact on their stability)
 A fundamental argument …

• So far, the approach to regulatory reforms (the Basel regulation in all its
stages) was aimed at improving the identification of risks and stimulating
the banks to better control (manage) risk
• The philosophy of Vickers, Volcker … and possibly Liikanen is different and
introduces a totally different regulatory paradigm)
– No more risk management, but risk elimination (pushing it out of parts of the
financial system)
– Achieved using administrative tools (no more stimulations)
• However, risk is inherent component (and driving force) of any business
activity (including the basic banking function: transformation of
maturities): we, coming from where we come, should say a word about
risks of administrative inrtervention into economy …