Enhancing banking consolidation without major legislative change in Europe

Contribution by Elizabeth McCaul, Member of the Supervisory Board of the ECB, published in the Eurofi Magazine, February 2022

3 March 2022

Ring-fencing is an important explanation behind the scarcity of cross-border bank mergers in the euro area. Over the last two decades, an average of thirty to forty bank mergers occurred each year, including a small number of cross-border ones. The costs of ring-fencing practices are difficult to quantify, but we know they can be substantial. For an individual banking group, ring-fencing reduces the economies of scale and impedes the efficient allocation of capital and liquidity that can be realised in cross-border mergers and acquisitions (M&A).

At a sector level, cross-border M&A activity can address overbanking and inefficiencies in the euro area banking sector, improving profitability and strengthening resilience. While consolidation must be a market-driven process and it is not for the ECB to promote specific types of consolidation, sector consolidation delivering efficiencies means that European banks will be in a stronger position to finance important green and digital transformations towards sustainable business models.

Capital and liquidity ring-fencing of subsidiaries occur primarily in host countries, which fear that their deposit insurance schemes and/or taxpayers will be at risk, if in times of crises the support of the foreign parent company stays away. Ring-fencing could be avoided by further steps in establishing the banking union, especially a European Deposit Insurance Scheme, and by creating possibilities for intragroup cross-border capital waivers. More integration can also be achieved within the existing EU framework with smaller legislative changes.

A first route is through establishing a more solid basis for competent authorities to grant waivers for liquidity requirements of subsidiaries with a stronger mechanism to enforce intragroup liquidity support facilities linked to the group recovery plan. Banks generally perceive that market entry is easier through the acquisition of a local entity especially for retail operations. Yet subsidiary-based group structures can face impediments when it comes to the central management of capital and liquidity. A legislative change could facilitate integration by empowering supervisors to enforce intragroup liquidity support included in the group’s recovery plan at an early stage in the event of a crisis. This would allow for more efficient liquidity management at the group level, however the extent of the possible use of such waivers is limited owing to national limits on large intragroup exposures in certain jurisdictions. Internal calculations show that the combination of liquidity requirements for individual subsidiaries and national rules on large exposures means that around €250 billion worth of liquidity is currently prevented from moving freely in the banking union. Even if full waivers were granted, €140 billion would still not be freely transferable because of national large exposures rules that would continue to apply.

A second route for cross-border banking is via corporate reorganisations from subsidiaries to branches. We have seen a number of examples of banks in various Member States transformed into cross-border branches of a bank incorporated in a single Member State, including some of the Brexit banks. Significant benefits emerged in some of these cases, in particular through the elimination of intragroup capital requirements, efficient allocation of capital and liquidity, simplified legal and corporate governance structures, annual accounts savings and centralised risk and control functions. But branchification also comes with sizeable upfront costs, for example for IT integration, as well contributions to deposit guarantee schemes especially for banks with a large deposit base. The latter could be addressed with a second legislative change, and here I am referring to Article 14(3) of the Deposit Guarantee Schemes Directive, which only allows contributions made in the preceding 12 months to be transferred to a new deposit guarantee scheme (DGS). All contributions made before that period are lost when a subsidiary is transformed into a branch of a credit institution established in another Member State. This provision seems counter-intuitive, at least from an economic point of view, because the transfer of insured deposits also reduces the overall risk of reimbursement of the original DGS. The ECB is in favour of a legislative change proposed by the European Banking Authority (EBA) in 2019, where the EBA will specify the methodology for calculating the contributions to be transferred, without the current limitations. This could lead to a more balanced approach concerning the allocation of resources between the DGS of origin and the receiving DGS.

Adoption of the full banking union is the goal, but smaller legislative changes can support cross-border reorganisation, increase efficiency of euro area cross-border banking groups and contribute to the international competitiveness of the European economy as a whole.