Vítor Constâncio: Banking Union and European integration
Speech by Mr Vítor Constâncio, Vice-President of the European Central Bank, at the OeNB
Economics Conference, Vienna, 12 May 2014.
* * *
Ladies and gentlemen,
I thank the Oesterreichische NationalBank for inviting me to Vienna to make this address on
the Banking Union and European Integration at the occasion of one more of its prestigious
Economic Conferences. As Vice-President of the ECB, I have been involved in the Banking
Union project from the start and it is with great pleasure that I now see it beginning to come
into place. By the start of next year, we will have an operational Single Supervisory
Mechanism (SSM) and Single Resolution Mechanism (SRM). It is undoubtedly the more
important and far reaching reform in the European Union since the creation of the euro.
As many other European institutional innovations, the project was born in connection with the
crisis management effort of trying to sever the bank-sovereign nexus that was contributing to
financial fragmentation. The idea of launching the SSM emerged during the June 2012
European Council meeting. It was a consequence of the decision that the ESM could directly
recapitalise weak banks, thus taking some fiscal pressure off sovereigns. But if the European
level were to assume liability for European banks, it also logically had to assume control:
hence the need for a European supervisor. It was only later that the concept of a fully-fledged
Banking Union emerged, which would contain a SRM and a possible Deposit Guarantee
Scheme, which has meanwhile been postponed.
Rationale and objectives of Monetary Union
The absence of European supervision and resolution had however already been identified by
many analysts as an initial design flaw of monetary union. As the crisis developed, this
became clear. The high degree of interconnectedness, in the euro area in particular, implies
that the impact of supervision affects not only the domestic banking sector but also, as an
externality, other countries. This has been captured by the so-called "financial trilemma". The
concept of the trilemma illustrates the impossibility of achieving simultaneously three
objectives in an environment with linked financial markets. These objectives are financial
stability and financial integration while preserving supervision at national level.1
The reasoning behind this is the following: with increasing financial integration, pursuing
national financial policies will generally not lead to financial stability, because national
policies seek to benefit national welfare, while not taking into account externalities of national
supervisory practices in other countries.2 This leads to an under-provision of financial stability
as a public good.3 A correction of this flaw addresses the first objective of Banking Union.
A second objective for Banking Union4 stems from the evidence that keeping supervision at
national level in both creditor and debtor countries contributed to the large imbalances that
developed before the crisis. Without unified supervision, it was impossible to contain the
build-up of such imbalances in the pre-crisis period. National supervisors had to respect the
single market rules and lacked the macro-prudential tools to offset the effects of large capital
inflows. As I have often underlined, private debt intermediated by the banks, more than
public indebtedness, was at the heart of developments in peripheral countries.5 By
introducing supervision at the European level, the Banking Union now offers a possibility to
better pre-empt such developments in the future - and therefore to better protect the real
economy and financial stability in the whole area.
A third objective of the Banking Union is the contribution it can provide to financial
integration, by separating banks' robustness from sovereigns and consequently reduce
markets' fragmentation.
The fourth objective is closely connected with the third one. Imperfect financial integration in
a currency union directly complicates the task of the central bank. It becomes harder to
achieve a smooth transmission channel of monetary policy and to ensure similar levels of
interest rates across countries. Thus, the tendency towards less financial integration induced
by both the financial crisis and institutional shortcomings has undesirable effects also for the
conduct of monetary policy.
A final objective of Banking Union is to increase the efficiency of the banking system which is
the dominant source of finance for the European economy. This will be achieved in different
ways. First, the SSM will be a strong and independent supervisor, enforcing supervision
consistently across the participating Member States. With supervision at a European level,
the focus of supervisory activities will be aligned with the activities of cross-border banks and
the area-wide financial sector, thus less subject to domestic considerations.
With a micro-prudential task and an extensive set of powers, the SSM should be able to
monitor risks faced and stemming from individual banks in the system and address them in a
timely fashion. This is supported by the macro-prudential task conferred to the ECB entailing
the monitoring and addressing of risks from a system-wide perspective. The fact that the
ECB has been given power over the direct application of macro-prudential instruments as
well as a coordinating role among all member states, is an important innovation of the new
Regulation that will improve financial stability in the euro area. Furthermore, the SSM will
have a European focus and support the development and effective application of the single
rulebook, the harmonisation of supervisory practices and procedures, creating a level playing
field and reducing compliance costs. The SSM, coupled with the other elements of the
Banking Union should be conducive to ensuring the most efficient allocation and transfer of
intra-group capital and liquidity. Therefore, it should contribute to the creation of truly
panEuropean banks and enhance cross-border banking integration which will reduce transaction
and compliance costs and bring efficiency gains.
On the other hand, the new framework may lead down the road to a period of consolidation
in a not much concentrated European banking sector. In fact, there is scope for further
consolidation without reinforcing the so-called "too-big-to-fail" problem and for reaping the
benefits of efficiency-driven consolidation. The present weak profitability in the banking
sector and the existence of over-capacity in certain areas of the European market suggest
that some efficiency gains could be achieved.
Besides these fundamental goals, Banking Union also involves two practical aspects of more
immediate concern that I will now address: (i) the repairing of banks' balance sheets to
unclog the impaired credit channel and consolidate the on-going mild economic recovery;
(ii) the reduction of the bank-sovereign loop in order to further mitigate the remaining
financial fragmentation6. I will complete my remarks by addressing the role of the SRM as the
necessary complement to the SSM in the Banking Union and finally, by dwelling upon the
broader implications of Banking Union for European Integration. I will only briefly touch upon
the SSM as my colleague Danièle Nouy will elaborate on SSM issues during her speech later
today.
Bank recapitalisation and the economic recovery
In the past few years, one could hear many voices urging European policy makers to repair
the balance sheets of banks so that these could again lend to the real economy and jump
start GDP growth. There will be no growth without finance, the narrative goes. In this vein,
the fact that the U.S. has returned to robust economic growth faster than Europe has been,
to a large degree, attributed to policy-makers acting quickly to repair the balance sheets of
U.S. banks.
This narrative, while intuitively compelling, is missing two crucial points. The first is that euro
area bank balance-sheet repair has started for some time already. As I recalled recently7,
since the onset of the global financial crisis, the top 20 European banks have increased
capital, net of share buy-backs, by higher amounts than the corresponding top 20 American
banks: USD 289 billion by EU banks against USD 179 billion by U.S. banks. And according
to the FDIC, the leverage ratios of the biggest European banks, calculated according to the
same accounting standards, are very close to their American peers8. Furthermore, since
midlast year in particular, European banks have implemented write-offs and increased provisions
and capital, partly anticipating the Comprehensive balance-sheet Assessment that the ECB
is conducting this year. Our estimates based on public information indicate that SSM banks
(comprising 128 institutions) have, from July 2013 to April 2014, strengthened their
balancesheet by EUR 104 billion. Measures taken include: EUR 34 billion through issuance of
quoted shares (implemented and publicly announced), EUR 15 billion through the issuance
of contingent capital hybrids or EUR 19 billion relating to additional provisioning. As a result,
confidence in the euro area banking sector has improved and since the first quarter of last
year, banks' stock prices have risen at almost double the rate of the market average growth.
But even if we were to agree that completing the strengthening of European banks is a
necessary condition to consolidate the recovery, it is far from being a sufficient condition for
jump starting growth in Europe. I caution that even a complete rehabilitation of the euro
area's banking system (which is well on its way thanks to the various policy steps related to
the Banking Union) will not guarantee a quick return to high growth and low unemployment.
In fact, there are a number of challenges, both immediate and particularly medium-term
ones, that the euro area economy is facing and which are potentially more difficult to
overcome than repairing the banking sector. Let me name a few: in spite of the confirmed
ongoing economic recovery, investment is still 20% below its 2007 level; there is a general
weakness of demand and medium-term challenges to introduce structural reforms necessary
for a quantum leap in total factor productivity are compounded by negative demographic
developments. In fact, in the near future, the European workforce will start declining by 0.6%
a year until 2030.
Of course, this is not to say that financial sector weaknesses are not important, or sufficiently
recognised. The broad Comprehensive Assessment that we have started reflects precisely
the importance of balance-sheet repair. My point is rather that while the on-going
deleveraging in the banking sector certainly plays an important role in the inadequate current
levels of credit supply to the real economy, factors related to the demand side may play an
even more important role. The weak demand outlook combined with the slack in industrial
capacity is the most important explanation for the drop in private investment since the crisis,
and the most relevant limiting factor for future investment. In addition, the protracted period
of low inflation and consequent low nominal growth will increase the burden of the debt
overhang of households and governments, further complicating the recovery process.
The separation of banks from sovereigns
As I mentioned before, the goal of separating the fortune of banks from that of the sovereigns
and vice-versa through direct European recapitalisation of weak banks via the European
Stability Mechanism (ESM) was present in the embryo of what later became the Banking
Union project. Somewhat ironically, however, this widening of the focus caused the initial
objective to become obscured. The question of European direct recapitalisation - for which a
framework has still not been published- ceased to be the main focus of attention. In the view
of many commentators, the SRM became the expected instrument to achieve the separation
between banks and sovereigns. But I think this is a somewhat misleading view as I will
explain later.
The SSM and the SRM, both components of the Banking Union thus contribute to reducing
the negative feed-back loop between banks and sovereigns. One important objective of the
SSM Regulation is to improve the quality of supervision and to ensure strong homogenous
supervisory standards across the euro area. The essential contribution that European
supervision can give to the separation of banks and sovereigns is the build-up of trust in the
robustness of banks as stand-alone entities, so that enhanced confidence by their peers can
help normalise interbank markets and overcome financial fragmentation.
The establishment of the SRM also addresses the problem of breaking the bank-sovereign
nexus because the orderly resolution of banks, even large ones, helps to avoid costly
rescues by sovereigns that may endanger their own finances.
In practice, however, the SSM and SRM may not be sufficient to completely sever the ties
between sovereigns and their domestic banks. The effect of SSM and harmonised
supervision on trust among banks may be more limited than expected, while the SRM,
important for organising orderly resolutions, is limited in the amount of resources it can
contribute to recapitalisations.
The Bank Recovering and Resolution Directive (BRRD) is in my view the most crucial
regulatory change in Europe in relation to breaking the bank-sovereign nexus. It represents a
true paradigm change, ending the culture of bail-out and ushering in a culture of bail-in. As of
2016, in all resolution cases, the BRRD will require a bail-in of shareholders and creditors
equal to at least 8% of total liabilities of a given bank, including own funds. Only after the
8% threshold of bail-in is attained can money from the resolution fund be used and for a
maximum amount of 5% of total liabilities (including own funds) of the concerned bank.
Public money for recapitalisation, either national or European, can thus only be considered at
the very end of the process after the other two sources of remedial action have been used.
Furthermore, the "government financial stabilisation tools" that the Directive introduces is an
instrument of last resort after having assessed and exploited the other resolution tools to the
maximum extent possible.
The amount of 8% is very substantial compared to the losses banks faced in the recent
crisis. To give you an idea, between 2008 and 2010 only one bank had losses exceeding the
8% threshold, and the average for all other banks was slightly less than 3%. Thus, under the
BRRD, the injection of public money into banks, either from national governments or from
direct European recapitalisation, will happen only in quite rare occasions. Bail-in of
shareholders and creditors plus the use of the Resolution Fund should in most conceivable
cases be enough to cover the losses incurred by a failing bank. Consequently, part of the
debate about direct European recapitalisation and about the role of the SRM in delinking
banks and sovereigns, was post-factum somewhat misplaced.
The implications of this Directive are therefore far-reaching. Participant countries in the
Banking Union are shedding considerable sovereign power. In fact, large countries with
strong public finances are effectively renouncing their ability to provide domestic banks with
the implicit subsidy of public support that would reinforce their advantages in increasing their
market share. The strength of these banks when competing in the European market will be
reduced as the new situation will be progressively reflected in their ratings and funding costs.
Similarly, countries with vulnerable public finances and smaller banks will no longer be able
to support and possibly not be able to keep their national champions. In accepting the
transfer of supervision and resolution of banks to the European level, euro area countries are
committing to a remarkable sharing of sovereignty which could be a positive sign of their
willingness to deepen European integration in general.
It is worth mentioning that the BRRD rules about bail-in enter into force only in January 2016.
They will therefore not apply to the recapitalisations in the context of the Comprehensive
Assessment that the ECB is conducting and to be implemented this year and the next. The
bail-in rules that will be then in place stem only from the European Commission's
communication on "State Aid rules to support measures in favour of banks in the context of
the financial crisis" of July 2013, which establishes that any public support to banks
considered as State Aid should be preceded by bail-in of bank shares, capital hybrids and
subordinated debt. The text contemplates that exceptions "can be made where implementing
such measures would endanger financial stability or lead to disproportionate results". For
specific cases at the end of the Comprehensive Assessment, it may be adequate to invoke
such principles.
On a more general note, it is clear that to avoid moral hazard, any public interventions should
penalise shareholders and managers appropriately, as was done in the exemplary case of
the Nordic banking crisis. Here financial and economic collapse was avoided with, in the end,
virtually no costs for taxpayers when the restored banks were sold. Thus, after the
misbehaviour of several institutions that triggered the recent crisis - which by the way is still
being uncovered - I fully support the change of culture from easy public bailouts to a new
culture of private bailing-in. The burden of proof should be put on those who want to invoke
exemptions to the new approach.
Yet, we need to bear in mind that it is not only direct public support for banks that has a cost
for taxpayers, but also financial instability - indeed, the costs of the latter may be higher.
Compare the worldwide costs for taxpayers stemming from the absence of public
intervention to rescue Lehman Brothers, with the zero cost for taxpayers following the US
TARP 700 billion dollars injection into US banks in 2008 which have by now been totally
repaid by the banks. In other words, financial instability can have a meaningful cost to
taxpayers even if it is not visible in the very short term - a notion that all policy makers
should keep in mind.
The new European legislation does allow, as a last resort, for interventions that can
safeguard financial stability in a Member State or in the area as a whole. I trust that this
legislation will be applied by the competent authorities with rigour, wisdom and a sense of
proportion in the aftermath of our Comprehensive Assessment.
SRM as a necessary complement to the SSM
My remarks about the SRM - as a mechanism less relevant than the BRRD rules for the
severing of the bank-sovereign nexus - do not aim to belittle the crucial importance of the
SRM for Banking Union. To begin with, the implementation of the BRRD bail-in rules will be
done by the SRM at the European level. The credibility of the SSM as supervisor is also
dependent on the existence of a credible mechanism to proceed swiftly, orderly and
efficiently in the resolution of banks that have attained the point of non-viability.
The crisis showed that the cooperation and coordination between national resolution
authorities is often incapable of taking swift and efficient decision on cross-border bank
failures. In past cases, national interests tended to prevail, even if resolution costs became
larger. In the SRM, the Single Resolution Board will take the resolution decisions for all
cross-border banks and all banks under direct ECB supervision. Resolution decisions can be
taken under a common interest, in swift and unbiased fashion, notably in the case of
crossborder cases, while taking into account spill-overs and contagion risks.
A robust SRM, as a complement to the SSM, will address all these shortcomings. The ECB
has always been of the view that a robust SRM should contain key essential features for
effective resolution, namely: (a) a single system, (b) a single authority with efficient
decisionmaking procedures (c) a single fund and (d) a backstop facility for bridge financing. We have
stated this in our opinion on the SRM proposal as well as in many speeches. I am therefore
very pleased that the agreed SRM regulation broadly fulfils these criteria.
A single system
To begin with, the SRM follows an integrated approach, in which all banks of EU Member
States that participate in the SSM fall under the SRM. Any Member State outside the euro
area which opts to join the SSM will thus automatically also fall under the SRM.
The powers of the SRM will embrace all resolution tasks, e.g. from assessing the
resolvability of banks and drawing up resolution plans, to deciding on resolution schemes for
failing banks and whether to make use of the Fund in such cases. These tasks are shared
between the Board at the European level, which is directly responsible for all banks under
direct ECB supervision and all cross-border banks, and the national resolution authorities,
which are responsible for the other banks.
However, the Board may at any time decide to directly exercise all the relevant powers under
the Regulation with regard to any of the indirectly supervised banks. In addition, the Board
also becomes directly involved whenever a resolution of an indirectly supervised bank will
make use of the Fund. Finally, there is also an option for Member States to choose that the
Board will be responsible for all banks in their jurisdiction. These features make the SRM a
single system.
The Single Resolution Board
At the centre of the SRM there needs to be a single authority with operational independence
and sufficient decision-making authority to take resolution action in the interest of the euro
area and of the Union as a whole. This is achieved with the setting up of the Single
Resolution Board.
The Board will meet in two different compositions: the plenary and the executive sessions.
The executive session will consist of a Chair, four independent full-time members and two
observers from the Commission and the ECB, respectively. The plenary session will
encompass all members of the SRB, which - on top of the ones just mentioned - will include
one member appointed by each participating Member State, representing the national
resolution authorities.9
The fact that the ECB will be an observer in the Board, with no voting rights, is supported by
the ECB. This accurately reflects the need to have the supervisor involved in resolution
matters, while maintaining the necessary separation of institutional responsibilities between
the supervisory and resolution function in the Banking Union.
The decision-making within the Board is designed to enable taking resolution action in the
interest of stability within the euro area and of the Union as a whole. In particular, decisions
in the executive session should be made by consensus. If the executive session is not able
to reach a joint agreement by consensus, the Chair and the permanent members will take a
decision by a simple majority. By reaching a decision either by consensus or by a majority,
efficient a European decision-making should be ensured.10
Decision-making in resolution
It is important that the decision-making process in the SRM allow for timely and efficient
decision-making, if necessary, within a very short time such as a weekend. It is therefore
welcomed that the decision-making process in the SRM is capable of this, in spite of the fact
that it may involve both the Commission and the European Council. Let me describe this
process as simply as I can.
If all the conditions for resolution are met, the Board will adopt a resolution scheme for the
institution or group in question, which is thereafter transmitted to the Commission. This may
be fairly straight-forward if the scheme is based on agreed and adequate ex-ante resolution
planning for the institution or group in question, and preparations for resolution had been
taken prior to the triggering point.
The Commission can approve the resolution scheme from the Board in two ways: approving
it upfront or raising no objections within 24 hours. After this, the resolution scheme is adopted
and can be implemented by the national resolution authorities as instructed by the Board. It
is an important feature of the final text that the European Council only becomes involved in
the decision-making at the explicit request of the Commission.11
9
The plenary session will take decisions by simple majority when it discusses issues of a general nature, such
as the annual work programme, the budget, or the rules of procedure. Each member will have one vote, and in
case of a tie the Chair will have the casting vote. The executive session will prepare all decisions concerning
resolution procedure and adopt those decisions. When deliberating on the resolution of a bank or group, the
executive session will also involve the members of the directly concerned Member States in the
decisionmaking process. Each member, including the Chair, will have one vote. In neither session will the observers
have a vote.
10
There are exceptions to this division of responsibilities between the plenary and executive sessions. First,
whenever a resolution scheme would require the use of the Fund above certain thresholds, which levels
depend on what the Fund's means will be used for, a member of the plenary can within a strict deadline
request the plenary session to decide. In such a case, the decision will be taken by a simple majority of the
plenary members, but the majority must also represent certain levels of contributions to the Fund. Second, any
decision which would involve the raising of ex post contributions from the banks or voluntary borrowing
between financing arrangements, among other things, will also be taken by the plenary session. During the
transitional period, such decisions require a majority of 2/3 of the plenary members, representing at least 50%
of contributions to the Fund. In the steady state, after eight years, the same majority share of the plenary only
need to represent at least 30% of contributions to the Fund to take such decisions.
11
This would be the case when the Commission does not agree with the scheme adopted by the Board. In such
case, within 12 hours from receiving the resolution scheme from the Board, the Commission may propose to
the Council to either: (i) object to the resolution scheme on grounds that there is no public interest of
resolution, or (ii) approve or object to a material modification of how much the Fund is used in the resolution
scheme. In such a case, the Council should, still within these first 24 hours, either approve or object to the
Commission's proposal by a simple majority decision. In other words, they cannot amend it, only approve or
The Single Resolution Fund
Turning to the Fund, the Board's control of a common resolution fund is an essential element
of the SRM. The Fund will be key to ensure adequate resolution financing without drawing on
public funds and for taking swift actions, since it eliminates the need for protracted
burdensharing discussions for cross-border banks.
Although the SRM Regulation set up the Fund, the order by which bank contributions are
raised at national level and pooled at EU level are detailed in accordance with an
Intergovernmental Agreement on the transfer and progressive mutualisation of those
contributions into a single fund. According to the political agreement reached, the target level
for the Fund will be 1 % of the amount of covered deposits of all banks authorised in the
participating Member States. This target should be reached in eight years, with the gradual
mutualisation being frontloaded with 40% of the total in the first year.
During the transitional period of eight years, the contributions collected at national level will
be allocated to separate national compartments corresponding to each participating Member
State. These national compartments will be subject to progressive mutualised usage and will
cease to exist at the end of the transition period. If there is a need to draw on the Fund in the
transition period, the Intergovernmental Agreement lays out a funding pecking order, which
should be used by the Board.12
Surely, one cannot rule out that situations may arise where the means available in the Fund
are insufficient, e.g. because it they are currently being tied up in an on-going resolution
case, and where ex post contributions cannot be accessible in a timely manner. For the
credibility of the Fund, and thereby the SRM and the Banking Union as a whole, it will be of
paramount importance that effective and sufficient financing of the Fund is ensured.
The ECB pleaded for the creation of a credit line to be made available as it is the case the
American FDIC or that, in alternative, that the Fund could go to the financial markets to raise
resources with the guarantee of Member States. In the end, the final text only mentions that
there is an obligation of the Board, in cooperation with the participating Member States, to
take the necessary steps to develop the "appropriate methods and arrangements" that will
boost of the borrowing capacity of the Fund by the date the SRM will be applicable.
Nevertheless, it is somewhat encouraging that in addition the Inter-governmental Agreement
specifies that a common backstop will be developed during the transition period of the Fund.
Such a backstop will undoubtedly facilitate borrowings by the Fund. Let me be clear,
however, that in an event that the credit line to the backstop would temporarily be drawn
upon, it will be subject to the principle of fiscal neutrality, i.e. the banking sector will ultimately
be liable for repayment by means of contributions in all participating Member States,
including ex post contributions.
reject to it. If the Council approves the proposal of the Commission, the Board must modify the resolution
scheme accordingly within 8 hours.
12
In the first instance, national compartments of the directly affected Member States will be used, up to a
predefined limit set for each year in the transition period. This limit will decrease during the transition period.
Starting at 100% in the first year, it will decrease to 60% and 40% for the second and third year, respectively.
Thereafter the limit will decrease linearly for the subsequent years. As a second step, only if the first step was
insufficient, available means in all compartments - including the ones just used - will contribute up to another
predefined limit, also set for each year in the transition period. As I mentioned earlier, the pace of
mutualisation is substantially frontloaded, starting at 40% in the first year. It will increase to 60% in the second
year and thereafter increase linearly for the subsequent years until it reaches 100%. As a third step, to be
used if the previous steps were insufficient, any remaining resources in the national compartments of the
directly affected Member States will be used. If these three steps are still insufficient, ex post contributions
from the institutions authorised in the affected Member States will be used. However, if such contributions are
not immediately accessible, including for reasons relating to financial stability, the Board may exercise its
power to contract borrowings or other forms of support for the Fund, or to make temporary transfers between
national compartments.
Banking Union and European Integration
I mentioned before that the Banking Union complementing Monetary Union will have
farreaching implications for European integration in general as it implies a vast sharing of
sovereignty. European construction is still under the grips of the Jean Monnet functional
method of integration: at each new reform step, other become logical and pressing.
Regarding Banking Union itself, the other element that should complement centralised
supervision and bank resolution in a banking union concerns a centralized deposit insurance
scheme.
Such a scheme would have several benefits. It would be commensurate to the centralized
supervisory regime, and ensure that decisions that are taken on a centralized level affect
depositors in all countries in the same way, thus ensuring a level playing-field. Depositors
would be treated in a uniform way across countries, independently of their location and the
location of the bank to whom they have entrusted their savings.13
What was achieved in December 2013, when the co-legislators agreed on the Deposit
Guarantee Scheme Directive (DGSD) was only a little part of what i