The banking union’s unfinished business

Contribution by Kerstin af Jochnick, Member of the Supervisory Board of the ECB, for Eurofi Magazine

10 September 2024

In a previous contribution, I outlined how better regulation, more efficient supervision, well-capitalised banks and strong institutions had led to a more resilient banking sector during the first ten years of European banking supervision.^[1] However, in the context of a monetary union and a single supervisor, one area which has fallen short of expectations is bank integration. While we have seen a fair amount of banking consolidation within national borders over the past decade, cross-border mergers have been more the exception than the rule.

As a result, despite the progress made in several areas, the European banking system remains closer to being a collection of national banking sectors than a truly integrated market. This is problematic because overcoming the fragmentation of the financial system along national lines was one of the main objectives political leaders had in mind when establishing a banking union.

In the following, I will discuss the reasons behind this lack of cross-border integration and what could be done to remedy it in the future.

The importance of the (missing) third pillar

Banks looking to expand beyond national borders have to deal with an array of different regulations across European countries, including in tax, accounting and insolvency regimes as well as in securities markets. Fostering bank integration would therefore require increased harmonisation on these fronts.

While such convergence could take years, perhaps the single largest deterrent to cross-border bank mergers is European rather than national legislation. This is because cross-border capital waivers are not an option under current EU law, so banking groups cannot freely move capital between their subsidiaries in multiple jurisdictions. EU law does provide for cross-border liquidity waivers, however, and the ECB has tried to create an environment in which banks can use this limited leeway in the legislation to this end.^[2] But the take-up of this initiative has been lukewarm as some host country authorities still fear that local subsidiaries could be put at a disadvantage compared with their parent entities if the latter experience financial distress. This is where the lack of progress on the third pillar of the banking union – a common insurance scheme for bank deposits – appears to be a major obstacle.

It is therefore safe to say that if such a common deposit insurance scheme were in place, some national authorities would be more likely to allow the free movement of capital and liquidity across borders, which would in turn increase banks’ appetite for cross-border mergers.

Harmonising the macroprudential stance

Beyond legal convergence across countries and the creation of a true safety net for bank deposits, prospects of a unified banking market in Europe would also benefit from a more harmonised macroprudential stance in the banking union as a whole. The pandemic brought the question of the usability of banks’ buffers to the forefront of the policy agenda. The lessons from that episode appear to have been partly heeded, as national macroprudential authorities have tended to take a more proactive stance towards building banks’ buffers in recent years so that they could be released in a countercyclical manner.

However, this increased policy activity has brought about some new challenges. First, there are the level playing field issues, as banks of a similar size and footprint for the banking union as a whole may be subjected to different buffer requirements by their home macroprudential authorities. And second, there is the growing complexity of the framework, because some countries have opted to activate systemic risk buffers (whether across the country or just for specific sectors), while others have not. This has raised some difficult questions about the degree to which macroprudential measures taken in one country should be “reciprocated” by third countries for cross-border banking exposures or exposures through bank branches.

Therefore, a union-wide perspective is needed in the macroprudential framework to ensure that this approach is consistent across Member States and potential overlaps are minimised. This can be done without altering the existing balance of competencies between national authorities and the ECB, for example by updating the commonly agreed methodologies for determining banks’ macroprudential buffer requirements.

Conclusion

Taken together, the absence of a common insurance scheme for bank deposits and the lack of a union-wide perspective in macroprudential policy have significantly contributed to strengthening the national character of banking systems in recent years. A more concerted policy effort by the different stakeholders will be required if the promise of a truly unified banking market is to be fulfilled.