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Risk reduction and risk sharing – two sides of the same coin

Speech by Danièle Nouy, Chair of the Supervisory Board of the ECB, Financial Stability Conference 2018, Berlin, 31 October 2018

“One money, one market” was a common slogan when the euro was first discussed. A single currency was seen as a means of supporting the single market. But the reverse is also true: a single currency needs support itself, the support of a single financial market. “One market, one money”.

And indeed, once the euro was introduced, financial markets in the euro area started to knit more closely together. But the fabric was frail, and when the crisis hit in 2008, it started to tear apart. Markets began to fragment along national borders, showing that more was needed to keep the fabric intact.

It became clear that only a strong institutional framework could support the integration of financial markets. The idea of a banking union was born. And four years ago, almost to the day, we started to supervise banks at the European level. This is the first pillar of the banking union. The second, ensuring the orderly resolution of failing banks at the European level, was erected in 2016.

Over the past four years, European banking supervision has made banks safer and sounder. But it has done more than that. It has also deepened the integration of the banking sector. It has devised harmonised supervisory standards and methods and has helped to harmonise the regulatory framework too. All this has contributed to levelling the playing field for banks. And a level playing field is a core feature of an integrated market.

So European banking supervision has helped to reduce risks in the banking sector. It has boosted the sector’s resilience and brought it closer together.

A vision for the European banking sector – safe, sound and diverse

Much has been achieved, but we still need to push forward. First of all, there are still things that can be improved. And second, what has been achieved so far might prove fragile unless it is further consolidated.

The weaknesses revealed by the crisis triggered the euro area’s journey towards a banking union and its decision “to cross a river”. We have left national supervision and resolution behind but we have not yet reached the other side. We are now in the middle of the river and that is not a good place to be when the flood comes. We have to make it safely to the other side.

Our goal, our vision, should be a truly European banking market – a market that is closely integrated but still comprises different kinds of banks. Such a market would have room for all types of banks: small and large, specialised and universal, listed as well as mutual and cooperative.

After all, no specific type of bank has a monopoly on success. From the beginning of European banking supervision, we have seen that about two dozen banks constantly and consistently outperform their peers. Are these banks all the same? No. Their size, business models and financial structures are different, and they come from different countries. The one thing they have in common is that they are able to take the right decisions and implement them. As we supervisors would say: the boards and the senior management of these banks combine better steering capacity with good execution capacity.

So, striving for a truly European banking sector does not take away from diversity. A diverse European banking sector would be home to all types of banks and serve companies and households across the entire continent. Customers could choose from a wide range of banks, while banks could tap into a large pool of customers.

Such a market would offer many benefits, ranging from economies of scale to faster innovation. And it would offer new ways to deal with old problems.

One of the most serious problems that European banks are facing is a lack of profitability. A number of banks still do not earn their cost of capital. And this is certainly not a sustainable situation.

One path that could provide a way out of this situation is consolidation. A truly European banking market would make it easier to take this path. As banks could more easily reach across borders, they would have a wider choice of potential partners for mergers.

Such cross-border mergers would also create a few large European banks – let us call them “European champions” – which could then successfully compete on the global stage. They will be able to support European companies in exporting their goods and services around the world. It would not be safe if large European companies had to rely solely on non-European financial actors to meet their investment banking requirements.

So, our vision is to have a truly European banking market. But we are not there yet. In 2017, 86% of euro area bank lending to firms and households was domestic.[1] That is not an integrated market, in my view. So what is preventing us from turning our vision into reality?

Stumbling blocks – what is preventing our vision from becoming a reality?

There are three main stumbling blocks in the way of a truly European banking sector. First, the fragmented nature of the regulatory framework. Second, the prevalence of ring-fencing. Third, complacency.

Let’s first look at the regulatory framework. I have spoken many times about the issue of national options and discretions, for instance, and about the 19 different ways in which EU directives are transposed into national law. I don’t need to repeat myself here.

But there are other examples of regulatory fragmentation. One relates to the European framework for crisis management that was set up after the crisis to deal with banks that run into difficulties. Naturally, European banking supervision plays a role here, and it is an important issue for us.

The question is: how European is this “European framework” in reality? The answer: much less European than one would have expected.

There is the Single Resolution Mechanism, of course – the second pillar of the banking union. At its core is the Single Resolution Board, which is a European institution. But in the process for dealing with a troubled bank, it is only the very first step that is a European one. And that step is deciding whether it is in the public interest to resolve a bank that was declared failing or likely to fail.

If the SRB decides that it is in the public interest, it will resolve the bank. But it will do so in line with one of the 19 national resolution manuals. This results from the 19 national transpositions of the relevant EU directive, the Bank Resolution and Recovery Directive, BRRD for short. So, banks from different countries will be resolved in different ways. There is no genuinely European approach.

And what if the SRB decides that it is not in the public interest to resolve the bank? Well, then the national authorities will step in. They will liquidate the bank under national bankruptcy laws – provided the bank can be liquidated. And this cannot be taken for granted, as we have recently seen.

On top of that, there is also some uncertainty regarding a key point for investors: bail-ins. More specifically, there is uncertainty about the exact hierarchy of liabilities. It might differ from country to country, depending on the national legal arrangements. In the event of a bank failure, investors would face different risks of being bailed in. Uncertainty has a price, and this price is paid by the banks. They have to offer higher coupons to investors who buy instruments that contribute to the bank’s total-loss absorbing capacity or minimum requirement for own funds and liabilities.

And, even more importantly, the uncertainty created by a fragmented legal framework is likely to trigger overreaction by market participants, hence reducing the banking sector’s resilience in times of crisis.

But as I said, regulatory fragmentation is not the only stumbling block on our path towards a European banking market. There is also the issue of ring-fencing, which became more prevalent during the last crisis.

At that time, it was deemed reasonable to fence off national banking sectors. But such a territorial approach comes at a cost, and not only for banks. It harms efficiency across the entire system, and an inefficient financial system puts a burden on the economy. So, the fences should be removed; they are out of place within a banking union where the concept of home and host supervisors has disappeared and where the supervisors of the 19 euro area countries take supervisory decisions together in a single European supervisory board.

And last but not least, there is a third stumbling block, a psychological one: complacency. The crisis has passed, and many reforms have been undertaken. While these are good reasons to be happy and proud, there is not a single good reason for us to rest on our laurels. There is still much to do, and the best time to act is while the sun is still shining.

Crises do happen, and it is just a question of time before the next one strikes. But it will then be too late to prepare. We must act now if we want to be ready for the next crisis. My message at the beginning of this year was: “if not now, when?”. This is still a pertinent question.

Removing the stumbling blocks

But where do we start? Well, the first thing would be to remove the stumbling blocks I have just discussed.

First, we should deal with regulatory fragmentation, in particular regarding crisis management. Why not change the BRRD from an EU directive into an EU regulation to allow it to be applied directly in all Member States? There would then be a single version of the BRRD instead of 19 different ones. And we can develop this train of thought still further: lawmakers should generally rely more on regulations and less on directives.

Let’s move now from the European to the global level, where fragmentation also remains an issue. We must aim to avoid further fragmentation of global regulation. It is crucial that Europe adheres to what it committed to in international fora. It must faithfully implement the final Basel agreements, such as the fundamental review of the trading book.

As for the issue of ring-fencing, I already mentioned that, in a banking union, there is much less need to ring-fence national banking markets. And there will be even less need to do so once we have a European back-up for the Single Resolution Fund as well as a single European Deposit Insurance Scheme, EDIS for short. But already today, supervisors should be able to grant cross-border waivers for solvency, liquidity and large exposures. They should be able to do so whenever it makes sense, and with appropriate conditions attached.

Liquidity waivers are a case in point; they already lie in the hands of the supervisors, who can grant them subject to certain conditions. But the supervisors’ power is limited because the large exposure waivers on intragroup lending are in the hands of the national legislators, who have no incentive to authorise them. And this leads back to national options and discretions. The option to set up large exposure limits should be left to the national supervisory authorities, hence to European banking supervision.

That might be an easy win with a big impact. After all, intragroup lending accounted for 70% of cross-border lending in the euro area in 2017.[2] By putting an end to ring-fencing, we would help to promote a truly European banking market that could better support the European economy.

To bring about a European banking market, we need to build the right institutional framework. Some parts of that framework are already in place: European banking supervision and resolution, for instance. And a more harmonised rulebook would also fit in neatly and make the framework more stable.

But a big part of the framework is still missing. I am referring to European deposit insurance, the third pillar of the banking union. This is the element of solidarity that we still need to introduce.

Almost everyone agrees that the euro area needs EDIS. However, some argue that it should start with a clean slate. The idea is to first reduce risks in the banking sector before starting to share them.

I agree, of course. But the question is: when are the risks low enough? In my view, we have reduced risks enough for EDIS to start. Now is the right time to set it up. It’s time to consider some solidarity.

And in the end, it’s not just about sharing risks through a common deposit insurance. It’s also about enjoying the benefits of a single jurisdiction – benefits that will, in my view, more than make up for the money that might have to be spent through EDIS.

At the same time, a degree of solidarity will make the next crisis less costly – the “European bill” is likely to be much smaller. And it is just not realistic to assume that a “European bill” can be avoided by postponing institutional solidarity. We have seen many crises in which countries were not able to handle their problems on their own. And Europe then still had to pick up the bill, only it was higher – probably much higher – than it would have been if some solidarity agreements had been put in place upfront. He who pays the piper, calls the tune; in other words, Europe would have been better equipped to prevent such crises from happening.

And finally, we have to align liability and control. When it comes to banking supervision, control now lies at the European level. But it’s still the national deposit insurances that would have to bear the costs of a crisis. Liability and control are out of balance. Introducing EDIS would restore that balance by placing both control and liability at the European level.

But it’s not just about risk-sharing through deposit insurance. A major feature of any integrated market is that it supports many positive risk-sharing channels. Banks could further develop cross-border lending, and investors could further invest in shares of foreign companies, for instance. This would help to diffuse shocks that hit one country or region and make the market more stable.

And here, Europe still needs to catch up. By comparison with the United States, risk-sharing through such channels is still quite limited. The European capital markets union is thus another important project.


Ladies and gentlemen,

To sum up, let me highlight two things. First, European countries need to strike a balance. They need to strike a balance between sharing some of each other’s risks and enjoying the benefits of a single jurisdiction. And by that I mean a truly European banking market that is able to reliably serve the economy.

Second, speed is of the essence. For Europe, the biggest risk may be doing too little too late. This would not only make another crisis more likely; it would also make it more costly. Reasonable, well-designed and timely solidarity, on the other hand, is not only likely to reduce the costs of crises. In good times, it will also increase the benefits of a union.

Then, one stable money would be paired with one stable and efficient market.

Thank you for your attention.


European Central Bank

Directorate General Communications

Reproduction is permitted provided that the source is acknowledged.

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