Luis de Guindos: Redesigning Europe's financial landscape
Speech by Mr Luis de Guindos, Vice-President of the European Central Bank, the 6th Frankfurt
Conference on Financial Market Policy, Frankfurt am Main, 14 December 2018.
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It is a pleasure to be here today.
As you know, there is a long tradition of the ECB participating in SAFE conferences here in
Frankfurt. The second conference in 2014 was already dedicated to "Banking beyond banks"
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acknowledging important changes underway in the European financial landscape. Indeed, this
was a prescient choice of topic given the growth of the non-bank sector, which has continued
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unabated ever since. In a recent speech , I also highlighted the rapid growth of asset
management in the euro area and at the global level, and the impact this is having on the
structure of the euro area financial sector. In fact, in 2008, total assets held by investment funds
made up just 15% of banking sector assets. In 2017, these assets had grown to 42% of total
banking sector assets, amounting to €12 trillion. As the non-bank sector continues to grow, so
does the need to ensure that our supervisory and regulatory framework is fit for purpose.
At the same time, banks still play an important role in many areas of Europe's financial system,
notably in the financing of small and medium-sized enterprises (SMEs). So a healthy banking
sector remains crucial to financing the economy, and despite the progress made in improving
the resilience of European banks, some legacy issues from the crisis continue to weigh on the
system.
This has two implications for strengthening the financial pillar of Economic and Monetary Union
(EMU), which will be the topic of my speech today.
First, we need to shore up the banking sector further by thoroughly completing the
reform agenda that emerged in response to the crisis. This means taking the remaining
steps to complete the banking union - in terms of both risk reduction and risk-sharing.
Second, we need to facilitate the growing role capital markets and the non-bank sector
This requires
can play in financing economic growth in a sustainable and resilient manner.
boosting the capital markets union (CMU) agenda while ensuring that authorities are equipped to
face the new challenges of a changing financial landscape. This will require the fragmentation of
European capital markets to be overcome and the macroprudential toolkit to be extended beyond
the banking system to cover, in particular, the investment fund sector.
Finalising post-crisis reforms
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I welcome the decisions taken by the Eurogroup to continue advancing the banking union,
reforming the European Stability Mechanism and building euro area fiscal instruments.
In the financial sector - which is my focus today - the response to the crisis has centred on
addressing weaknesses in the regulatory and institutional framework. The new European
regulatory framework is making Europe's banks more resilient and gives authorities the tools to
act when risks begin to build up. Furthermore, banking union elevates the supervision and
resolution of banks to the European level.
This strategy has paid off: substantial risk reduction has been achieved, is ongoing and should
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continue. Banks now hold more and better-quality capital than in the past , and have improved
their liquidity positions and leverage. Addressing legacy issues, such as high levels of
nonperforming loans (NPLs), is progressing well. For banks under direct ECB supervision, NPL
levels fell from €958 billion when the Single Supervisory Mechanism was launched to €657 billion
in June 2018. The framework for resolution, following the introduction of BRRD and the
implementation of Minimum Requirements of Eligible Liabilities (MREL) also contribute to
increase buffers, reduce risk and thereby the scope for risk sharing.
However, the euro area's financial architecture is not yet complete.
There is some good news: there is now an agreement to make the common backstop to the
Single Resolution Fund (SRF) operational, which will instil confidence in the markets that bank
resolutions will happen in an orderly fashion. There is also a recognition that it is time to start
political discussions on the missing third pillar of the banking union - a European deposit
insurance scheme (EDIS). The high level group in charge of the discussions must be ambitious
and ensure that we live up to the agenda laid down in the roadmap on completing the banking
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union agreed by finance ministers in 2016.
The ECB has often made the point that the opposing sides of the debate - risk reduction versus
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risk-sharing, and private risk-sharing versus public risk-sharing - are in fact complementary.
Completing the institutional leg of the banking union, with the SRF and EDIS, would move us
closer to a level playing field. In a genuine banking union, banks would operate across borders
and diversify their sources of income, which would allow them to continue lending to the real
economy even when faced with localised shocks. This would create private risk-sharing across
the euro area and shield regions from localised credit crunches.
But a level playing field for banking would also enable risk reduction. Increased cross-border
competition between banks, backed by a solid system of European supervision and the winding
down of unwarranted national protections, could further incentivize banks into getting their
balance sheets in order.
At the same time, the SRF and EDIS would also constitute a form of private risk-sharing by
providing a final, powerful backstop. They enable bank resolution, limit contagion in the case of
bank defaults thereby contributing to safeguarding overall financial stability. This, in turn, would
reduce the need for public risk-sharing in the first place. Such an approach is borne out by the
experience of other advanced economies, such as the United States, where hundreds of banks
were resolved successfully by the Federal Deposit Insurance Corporation with no long-term
fiscal costs.
While the case for completing the banking union is strong, supporting EDIS is seen by some as
tilting at windmills. Indeed, three years after the initial Commission proposal, progress has been
very limited. But the potential benefits of EDIS are not the illusions of a romantic daydreamer like
Don Quixote; they are, in fact, very real. EDIS would provide uniform confidence in deposits
across Europe which would be beneficial for all European economies, as no single banking
system is immune to a potential bank default. EDIS would therefore further underpin EMU by
ensuring that a €1 deposit is just as safe, and just as valuable, wherever you are in the euro area.
Fostering the resilient and sustainable development of Europe's financial landscape
Completing the post-crisis agenda is therefore crucial, but we should not only look back. After
dealing with banking sector fragilities, we should now be shifting our attention to the steadily
growing non-banking system, which is changing Europe's financial landscape and whose
potential to contribute to growth has not been fully unlocked.
A range of banking activities is increasingly carried out by non-banks, notably insurance
companies and the investment fund sector at large. Total assets of the euro area investment
fund sector have expanded by roughly 170% between 2008 and 2017, on account of both net
cash inflows and rising asset valuations.
Deeper and more efficient bond and equity markets in Europe would permit economies of scale
and allow capital to be allocated to the most productive uses at the European level, in line with
the Single Market objectives. By enhancing cross-border private risk-sharing and consumption
smoothing through cross-border holdings of assets, CMU can reduce the need for public
risksharing.
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Developing capital markets would also alleviate the shortage of risk capital that hinders the
growth of Europe's innovative start-ups and SMEs by increasing the presence of investors with
high risk-bearing capacity. As in the case of depositors, issuers and investors should enjoy the
same legal rights in capital market activities across the EU, irrespectively of their country of
domicile. Furthermore, Brexit accentuates the need to develop and integrate the EU's capital
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markets to prepare for the likelihood that the City of London will play a reduced role in the future.
In terms of legislation, the CMU agenda has already yielded some positive results, but a more
ambitious long-term approach should be pursued.
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On insolvency frameworks, the Commission has put forward a number of proposals which aim
to enhance aspects, such as the efficiency of debt recovery procedures.
In the realm of taxation, adopting the proposal on a common consolidated corporate tax base
would help to reduce or remove the bias towards debt over equity in some Member States,
thereby facilitating the development of equity markets.
The creation of a pan-European personal pension product, for instance, would help channel
more savings into long-term investments through a portable, pan-European product.
Finally, fostering a deep and efficient CMU means reviewing the supervisory framework to align it
with the cross-border nature of capital markets, enhance supervisory and regulatory
convergence and remove possibilities for regulatory arbitrage, also crucial in the context of
Brexit.
Indeed, the non-bank financial sector may harbour leverage and liquidity risks, requiring additional
efforts to address emerging vulnerabilities at the system level.
First, the asset management sector is highly connected with other parts of the financial system
through ownership links, common asset exposures and the provision of wholesale funding to
banks.
Second, liquidity mismatches and leverage often build up slowly over time. In the euro area, we
see that investment funds have been taking on higher credit risk and duration risk in the current
market environment. And there are strong indications that liquidity risks are building up in the
sector with the share of less-liquid assets in the sector growing continuously since the global
financial crisis.
Third, the overall leverage of the sector is difficult to grasp. Alternative investment funds do not
face any binding restrictions on leverage. A tail of highly leveraged bond and hedge funds with
leverage multipliers exceeding 30 compares to an average leverage ratio for banks of below 20 in
the euro area.
As the global crisis has shown, we must remain vigilant to possible new risks that might emerge
in the financial system. We need to better understand the macroprudential dimension of risk in
the investment fund sector. And we need to further enhance the sector's resilience to
systemwide shocks.
The existing regulatory framework, with the Undertakings for Collective Investment in
Transferable Securities and Alternative Investment Fund Managers Directives as the main
building blocks, is well designed to address micro-prudential and consumer protection concerns.
However, additional tools need to be developed to address rising risks in the investment fund
sector from a macroprudential perspective.
Macroprudential policy is primarily preventive. The toolkit available to macroprudential authorities
should include ex ante tools to limit the build-up of risks associated with liquidity and leverage in
the investment fund sector, such as minimum mandatory liquidity buffers and redemption notice
periods.
The investment fund industry in the EU is furthermore highly concentrated in a few jurisdictions,
but - due to the diverse asset holdings and investor locations - the impact of adverse
developments in this sector may be felt across the EU. So we should consider elevating the
supervision of investment funds and the potential activation of macroprudential tools to the
European level. This would be also in line with the spirit of CMU.
A comprehensive, long-term European strategy for a more complete financial union
Let me conclude. Finalising EMU reforms, completing banking union and capital markets union
must stand out as unquestionable objectives. We need to pursue a comprehensive long-term
European strategy for building a more complete financial union that fosters both risk-sharing and
risk reduction, which, as I argued, are two sides of the same coin. This will strengthen the
financial system in the long run.
Achieving these objectives hinges on building a strong degree of trust between Member States
and European institutions. It fundamentally hinges on looking beyond short-term national benefits
and pursuing European goals. Europe should live up to its ambitions.
Thank you for your attention.
1
See Constâncio, V. (2014), "Beyond traditional banking: a new credit system coming out of the shadows",
speech at the 2nd Frankfurt Conference on Financial Market Policy: Banking Beyond Banks, organised by the
SAFE Policy Center of Goethe University, Frankfurt am Main, 17 October.
2
See de Guindos, L. (2018), "Coming to the forefront: the rising role of the investment fund sector for financial
stability in the euro area", speech at the Opening Conference of the 21st Euro Finance Week, Frankfurt am Main,
12 November.
3
See the Eurogroup report to Leaders on EMU deepening.
4
The fully-loaded CET1 ratio of significant institutions was 13.8% in the second quarter of this year, up by 2.6
percentage points compared with the last quarter of 2014.
5
See the press release from the European Council.
6
For example, see de Guindos, L. (2018), "Building a resilient Economic and Monetary Union", Lectio magistralis
opening the XXIX Edition of the Masters Programme in European Union law of the University Carlos III of Madrid,
5 October.
7
See AFME (2017), The shortage of risk capital for Europe's high growth businesses, March.
8
See de Guindos, L. (2018), "Promoting the stability and efficiency of EU financial markets beyond Brexit", speech
at the Deutsche Bundesbank reception on the occasion of Euro Finance Week, Frankfurt am Main, 13
November.
9
See European Commission (2018), "Proposal for a Directive of the European Parliament and of the Council on
credit servicers, credit purchasers and the recovery of collateral", 14 March.