Financial Stability in a Monetary Union
Speech on the occasion of the conference of the University of Tübingen in
cooperation with Deutsche Bundesbank (Regional Office in
BadenWürttemberg)
27.10.2022 | Tübingen | Claudia Buch
1 Cyclical risks and structural change in the real economy shape the financial stability
outlook.
2 Macroprudential policy in a monetary union needs to balance responsibilities of the
national and the supranational level.
3 Macroprudential policy in Europe addresses cyclical and structural risks.
4 Summing up
5 References
6 Figures
Ladies and gentlemen,
thank you very much for inviting me to this conference. [1] The title of the conference
suggests that central banks have a crucial role to play in preventing and managing
crises. This relates, first and foremost, to its core mandate, price stability.
But central banks have, over the past decade, also been assigned an explicit role in
contributing to financial stability. The significance of financial stability for economic
growth and prosperity has been clearly acknowledged by Nobel Prize Committee's
decision to award the prize to Ben Bernanke, Douglas Diamond, and Philip Dybvig.
Their work focuses on the role banks play for the economy and society - as well as on
the costs of bank failure and the need for regulation. [2]
While much of the discussion today and tomorrow is and will be about the interaction
between monetary and fiscal policy, I will focus on financial stability. In Europe, we have
quite a unique setting: the ECB (European Central Bank)'s Governing Council takes
monetary policy decisions for the whole euro area. Financial stability is a joint
responsibility of the national and the supranational level: Both surveillance of the
financial system and addressing risks to financial stability are, to a large extent, national
tasks. Responsibility for other key policies affecting financial stability - such as fiscal
policy - resides at the national level. The supranational level plays an important role in
the surveillance of risks due to cross-border spillovers, and addressing a possible
inaction bias at the national level.
Effective macroprudential policy complements the Stability and Growth Pact. It supports
monetary policy in its ability to fulfil its mandate of safeguarding price stability. A strong
macroprudential policy framework is a key ingredient of a stability-oriented monetary
union. This tends to be overlooked in current policy discussions that rightly stress the
importance of sound fiscal policies. Without adequate safeguards against excessive
public sector borrowing, monetary policy may be facing issues of fiscal dominance. In
other words, unsustainable levels of debt may affect monetary policy decisions.
But sustainable levels of private debt are at least equally important. This is a key lesson
we have learned from the global financial crisis of the years 2007/08: High levels of
private sector debt and inadequate bank capitalisation can put the stability of the
financial system at risk. Fiscal policy has often come to the rescue of failing financial
institutions, bailing out private creditors, thereby pushing up levels of public debt. In
response to such experiences, macroprudential policy has been established as a new
policy field.
The Bundesbank defines financial stability as the ability of the financial system to
perform its core functions even during periods of financial stress and during times of
structural change. The key policy tools to safeguard financial stability are preventive in
nature: Sufficient capital in the financial system to ensure resilience to structural and
cyclical risks reduces the likelihood and severity of financial crises. In addition, the
macroprudential toolbox includes instruments, notably resolution tools, that are needed
in acute crisis situations.
Let me explain the policy environment, the role of central banks, and the priorities for
future work by developing three arguments:
First, cyclical risks and structural change in the real economy shape the financial stability
outlook.
Second, macroprudential policy in a monetary union is the first line of defence against
financial stability risks, and it requires balancing national and supranational
responsibilities.
Third, macroprudential policies and sufficient resilience in all parts of the financial
system are needed to manage risks to financial stability going forward.
1 Cyclical risks and structural change in the real economy shape the
financial stability outlook.
Currently, cyclical risks and high inflation are weighing on markets. Going forward, we
are also facing a period of accelerated structural change. The energy transition,
digitalisation, and changing patterns of globalisation require massive economic
adjustments. Structural change is not confined to the real economy: digitalisation of
financial services, including the modernisation of payment systems, are putting pressure
on incumbent financial institutions. We thus need a financial system that is not only
resilient enough to deal with the current challenges. We also need a financial system
that is able to finance the necessary transition without excessive risk-taking.
During the past year, we have witnessed a sea change in global economic conditions.
For more than two decades, global inflation rates declined, dropping to historically low
levels. Growth was fairly stable. In Germany, corporate insolvencies have been declining
for years, even throughout the COVID-19 pandemic (Figure 1).
This "great moderation" of the past decade has now come to an end. Inflation and
market interest rates have picked up markedly. In the euro area, inflation rates are at
their highest level since the introduction of the euro: inflation is projected to peak at
8.1% this year, before falling to 5.5% next year and 2.3% in 2024, according to
ECB (European Central Bank) forecasts (ECB (European Central Bank) 2022a). In
Germany, the increases in consumer prices reached levels that have not been seen in
decades: Inflation stood at 8.8% in August and 10.9% in September; according to the
Bundesbank's experts, double-digit inflation is likely to persist in Germany over the next
few months (Deutsche Bundesbank 2022a).
Economic growth has slowed down, and the economic outlook has weakened. The
IMF (International Monetary Fund) expects the world economy to grow by 3.2% in
2022, and the global growth outlook for the year 2023 has been lowered to 2.7% (
IMF (International Monetary Fund) 2022a). According to recent forecasts for the euro
are, real GDP (gross domestic product) growth is expected to fall from 3.1% in 2022 to
0.9% in 2023 (ECB (European Central Bank) 2022a). Uncertainty and downside risks are
high.
In Germany, we may expect a recession in the sense of a marked, broad-based and
longer lasting decline in economic output. Downside risks to macroeconomic
development are increasing in Germany, which is reflected in recent declines in the
growth-at-risk measure (Figure 2). While baseline scenarios project a comparatively mild
recession of -0.3 to -0.4% in 2023 (BMWK 2022, IMF (International Monetary Fund)
2022a), adverse scenarios such as a rationing of gas supplies during the winter could
lead to a significantly larger contraction of economic activity (Deutsche Bundesbank
2022b). Bundesbank staff are expecting real GDP (gross domestic product) to decline
markedly in the fourth quarter of 2022 and the first quarter of 2023, driven by weaker
foreign demand as well as subdued private consumption and corporate investment
(Deutsche Bundesbank 2022a).
The significant and persistent energy supply shock is a key driver. Global energy prices
have risen steadily since mid-2021 as pent-up demand spurred by the post-pandemic
recovery fuelled considerable tightness in the energy market. Russia's invasion of
Ukraine and the discontinuation of Russian energy exports added pressure, in particular
for energy-intensive industries.
Within Europe, the German economy is particularly affected due to its reliance on
imports of Russian natural gas. In 2021, natural gas covered more than one quarter of
Germany's consumption of primary energy, while about 95% of the gas was imported
(Statistisches Bundesamt 2022, Umweltbundesamt 2022). In September 2022, energy
in Germany was 44% more expensive than a year earlier, and 41% dearer in the euro
area. [3] The sharp rise in energy prices is also reflected in the terms of trade, i.e. (that is)
the relation of export to import prices. A decline in this ratio implies an increase in real
import costs. In Germany, the terms of trade fell by more than 10% in August 2022
compared with the previous year, mainly driven by higher expenditures for energy
imports. [4]
The pandemic and Russia's war against Ukraine placed stress on the global economy.
So far, the financial system has weathered these recent crises relatively well, not least
because the financial regulatory reforms of the past decade increased resilience. Fiscal
and monetary policy measures played an important role. Fiscal policy helped dampen
the real economic effects of the past two recessions: the global financial crisis and the
pandemic.
The fiscal policy response to the global economic crises of the past decade led to surges
in debt (Figure 3). Growth in private sector debt and in bank lending was particularly
strong in the run-up to the global financial crisis and during the pandemic. This could
hamper the economic recovery (IMF (International Monetary Fund) 2022b). During the
global financial crisis, higher public debt prevented negative repercussions from a
distressed financial system to the real economy. During the pandemic, fiscal policy
prevented spillovers from a distressed real economy to the financial system. Similarly,
governments have adopted fiscal policy measures to dampen the real economic impact
of the current rise in energy prices on enterprises and households. From a financial
stability perspective, the measures have reduced default risks in the real economy and
shielded the financial sector from macroeconomic risk.
Yet, these episodes also differ along one key dimension. [5] The global financial crisis
was not a purely exogenous event. Fault lines had been building up in the global
financial system (Rajan 2011). Banks were heavily undercapitalised, given the amount of
risk they had loaded onto their balance sheets. Ex-ante insurance failed because of
overly optimistic expectations concerning the financial system' ability to absorb adverse
shocks. When the crisis hit, fiscal policy support for banks helped preserve financial
stability, but it also ran the risk of inducing significant moral hazard. The COVID-19
pandemic and the current energy crisis are exogenous shocks that hit rather
unexpectedly. Ex ante insurance mechanisms for the private sector were hardly
available. In this sense, fiscal policy measures function like an ex-post insurance
mechanism.
The major shifts in the macroeconomic environment are challenging the German
financial system. Over the past years, vulnerabilities to adverse macroeconomic
developments continued to build up. The financial cycle is a metric that can be used to
assess emerging vulnerabilities in the financial system. It tracks movements in financial
variables over the medium term, which distinguishes it from the real economy's shorter
term business cycle. Even throughout the pandemic, the German financial cycle was
expanding due to high credit growth and a booming real estate market. For instance,
the momentum in the credit-to-GDP (gross domestic product) gap has been stronger in
Germany than in other European countries over the past years (Figure 4). Recently, the
upswing in the financial cycle has levelled off.
Several indicators suggest that future macroeconomic risks have been underestimated
during the past years. One example are banks' internal risk models. These models are
used to compute risk factors that guide credit allocation and risk-based capital
requirements. However, these models are currently calibrated based on time series
which insufficiently reflect normal business cycle conditions. During the past two
recessions in Germany, corporate insolvencies have been lower than in most other
postwar recessions (Figure 5). Within banks' credit portfolios, there has been a shift towards
relatively weaker firms in terms of their financial soundness indicators. [6] In a recent
speech, the Chair of the Supervisory Board of the ECB (European Central Bank), Andrea
Enria therefore stressed that banks should not project the currently low levels of
defaults into the future (Enria 2022). More generally, all financial contracts that were
written in the past years have assumed macroeconomic conditions that are more
benign than what may lie ahead for the German economy. This exposes the financial
system to macroeconomic risks.
Adverse scenarios could bring these vulnerabilities in the financial system to the surface.
A resilient financial system and sufficient loss-absorbing capacity are thus essential. In
September 2022, the European Systemic Risk Board (
ESRB (Europäische Ausschuss für Systemrisiken)) issued its first general warning on
vulnerabilities in the European Union financial system (
ESRB (Europäische Ausschuss für Systemrisiken) 2022a). It particularly highlighted
commercial real estate risks as well as risks due to high levels of government debt, the
energy crisis, and tightening financial conditions. The ESRB therefore called on all actors
in the European financial system to prepare for adverse scenarios, and to preserve and
further enhance resilience in the financial sector. The ESRB also called for close
coordination between relevant authorities and prudent risk management practices
across all financial sectors.
German authorities already responded to increased cyclical risks in January 2022. The
Federal Financial Supervisory Authority (
BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht)) decided on a package of
macroprudential measures aimed at preserving and enhancing the resilience of the
German banking system. It raised the countercyclical capital buffer (
CCyB (Countercyclical Capital Buffer)) to 0.75% on domestic exposures. In order to
specifically address vulnerabilities related to mortgage lending, it activated the sectoral
systemic risk buffer at a level of 2% on exposures secured by domestic residential real
estate. The German Financial Stability Committee (AFS (Ausschuss für Finanzstabilität))
welcomed the measures to address cyclical risks in the banking system (
AFS (Ausschuss für Finanzstabilität) 2022a).
The CCyB (Countercyclical Capital Buffer) is a preventive capital buffer which increases
resilience in the banking system. Decisions to adjust the buffer are taken with a view to
the banking system as a whole, not individual institutions. The buffer can be raised if
cyclical vulnerabilities build up in the banking system. It can be lowered if vulnerabilities
decline, and it can be released in times of stress. This would be the case if large losses
have materialized or are imminent in the banking system, resulting in balance sheets
constraints become binding and the risk that aggregate credit supply is restricted
excessively. Releasing the buffers would enable banks to maintain their capacity to lend,
thereby lowering the risk of a strong reduction in lending amplifying the initial shock.
The systemic risk buffer targets specific sectors such as residential real estate.
At the current juncture, it is important to preserve and build up resilience in the German
banking system. Should the system, in a period of acute stress, become capital
constrained, the buffers can be released, i.e. (that is) "if and when risks materialize and
negatively impact credit institutions' balance sheets ", in the words of the
ESRB (Europäische Ausschuss für Systemrisiken)'s general warning (
ESRB (Europäische Ausschuss für Systemrisiken) 2022a). Even though the
macroeconomic environment has deteriorated, this condition is not met at the current
juncture. Current developments are monitored carefully, and
BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht) can adjust buffers at short
notice if required. [7] Monitoring also includes assessing potential negative side effects
of the implemented measures such as impairments of credit supply, for which there is
no evidence (AFS (Ausschuss für Finanzstabilität) 2022b).
2 Macroprudential policy in a monetary union needs to balance
responsibilities of the national and the supranational level.
Recent macroprudential policy actions illustrate how the institutional framework works
in practice. For instance, BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht)'s
decision to activate the countercyclical capital buffer exemplifies the national response
to elevated cyclical risks in the domestic financial system. At the supranational level, the
ESRB (Europäische Ausschuss für Systemrisiken) has issued a general warning about
heightened risks to financial stability in Europe (
ESRB (Europäische Ausschuss für Systemrisiken) 2022a, 2022b).
In general, macroprudential policy complements microprudential and monetary policy.
Microprudential policy, the classic supervision of financial institutions, ensures the safety
and soundness of individual financial institutions. Monetary policy has the objective of
ensuring price stability, and the monetary policy transmission process requires a stable
financial system. This interdependence between price and financial stability has been
explicitly acknowledged in the ECB (European Central Bank)'s 2021 strategy review. [8]
Macroprudential policy aims to safeguard the stability of the financial system as a
whole by limiting the build-up of systemic risk. Systemic risk in the financial system can
arise through various channels. Financial institutions can be too big to fail, they can be
too connected to fail, but they can also be too many to fail by being exposed to the
same macroeconomic risk factor. Macroprudential policy thus reduces the probability
and impact of systemic financial crises, and it improves the management of financial
crises that have actually happened.
Macroprudential policy is preventive in nature. [9] It enhances resilience in the financial
system at an early stage and thereby mitigates structural and cyclical systemic risks.
Macroprudential capital buffer requirements are an important policy tool in this respect:
The CCyB (Countercyclical Capital Buffer) helps to dampen negative shocks rather than
amplifying them. Capital surcharges for large financial institutions internalise the
negative externalities that these institutions impose on the financial system. The
macroprudential toolbox also includes instruments, notably resolution tools, that are
needed in acute crises.
Macroprudential policy is the first line of defence against spillovers of risk between the
private and the public sector. In the absence of adequate buffers, risks may shift from
the private to the public sector. The stability of public finances can come under threat if
public funds are used to rescue failing financial institutions. In the case of the 2007/08
financial crisis, fiscal policy played a role in limiting contagion from the failure of
individual banks to the banking system. But this stabilising role came at the cost of a
significant increase in public debt and of potential expectations of future bailouts.
Through the conversion of implicit subsidies for the financial sector into explicit ones,
unsustainable levels of private debt can thus spill over into the public sphere.
High levels of debt can lead to fiscal or financial dominance. The Stability and Growth
Pact is an important instrument for aligning stability-oriented fiscal and monetary
policies. But excessive private sector debt can be equally destabilising. Private debt
levels that deviate from economic fundamentals may lead to financial dominance
(Brunnermeier and Sannikov 2014). Monetary policy may come under pressure to
tolerate inflation above its price stability target in order to alleviate the real burden of
private debt (Lewis and Roth 2018).
The policy environment in the euro area is quite unique (Figure 6). We have a single
monetary policy, but responsibility for the implementation of fiscal and financial sector
policies resides largely at the national level. This has implications for the institutional set
up of macroprudential policies:
Macroprudential policy at the national level is needed to address vulnerabilities that are
rooted in country-specific preferences and institutions. This holds particularly in a
monetary union with economies that are highly integrated financially (Figure 7), but
heterogeneous along important dimensions that can significantly affect financial
stability risks. For example, different legal systems for dealing with insolvencies affect
how firms' and banks' balance sheets evolve in times of stress. [10] The national level
thus needs to ensure that domestic vulnerabilities are identified and addressed. In
Germany, for instance, the Bundesbank plays a key role: By law, it has the mandate to
analyse risks to the stability of the financial system. [11]
But the supranational levels has an equally important responsibility for financial
stability. The national level might act too late if risks to financial stability emerge, and it
may insufficiently take cross-border spillovers of risks to financial stability into account.
The supranational level thus plays an important role in monitoring spillovers, ensuring
best practices, and establishing effective mechanisms to mitigate a potential inaction
bias. Spillovers of financial stability risks across borders provide a strong rationale for
supranational cooperation (Cecchetti and Tucker 2015).
Risks to financial stability do not stop at national borders. Exposures to common shocks
and cross-border activities of financial institutions, but also regulatory arbitrage can
lead to spillovers of risk. During the global financial crisis and the European sovereign
debt crisis, shocks quickly transmitted across borders. Adjustment was painful: in a
monetary union, the channel of adjustment to shocks is internal through changes in
domestic wages and prices. The scope for external adjustment through changes in
exchange rates is limited, as exchange rates are fixed among the members of a
currency union.
The institutional set-up of macroprudential policy in Europe strikes a balance between
responsibilities at the national level and those at the supranational level. Most policy
instruments are in the hands of national institutions, but the surveillance of risks is
coordinated at the supranational level (Figure 8).
At the national level, macroprudential authorities are tasked with the surveillance of
risks to financial stability, and they implement macroprudential policy measures.
Multiagency financial stability committees have been set up, which are responsible for
monitoring and mitigating systemic risks as well as implementing macroprudential
policies. However, their institutional set-ups vary across countries. This may also have an
effect on their propensity to implement macroprudential policy. Liang and Edge (2020)
find that national financial stability committees with stronger governance mechanisms
and fewer agencies are more likely to use the CCyB (Countercyclical Capital Buffer), for
example.
At the supranational level, the ESRB (Europäische Ausschuss für Systemrisiken) has the
task of overseeing the entire financial system within the European Union. The
ESRB (Europäische Ausschuss für Systemrisiken) was established in 2010, and it
contributes to containing systemic risks and preventing financial crises by means of its
macroprudential supervision. The ESRB can issue warnings or recommendations
addressed in particular to the European Union as a whole, to EU (European Union)
Member States, to European supervisory authorities (ESAs) or to national authorities.
The ESRB monitors the implementation of recommended measures. Recipients inform
the ESRB and the European Council of the actions they have taken. They also provide
appropriate explanations for any inaction ("comply or explain" mechanism).
The ECB (European Central Bank) coordinates macroprudential policies in the banking
union. The ECB (European Central Bank)'s Governing Council is responsible for taking
macroprudential decisions, such as the power to top up national macroprudential
measures. For instance, the ECB can set higher capital buffer requirements than those
implemented by national authorities. These decisions apply to all countries and banks
covered by the Single Supervisory Mechanism (SSM (Single Supervisory Mechanism)).
Decision-making is supported by the Financial Stability Committee (
FSC (Financial Stability Committee)), which comprises representatives of the
ECB (European Central Bank), national central banks and supervisory authorities.
3 Macroprudential policy in Europe addresses cyclical and structural risks.
In Europe, the countercyclical buffer has been actively used over the financial cycle. [12]
The CCyB (Countercyclical Capital Buffer) increases resilience to vulnerabilities along the
financial cycle and helps to mitigate an excessive restriction of credit supply in times of
acute stress. It is not a tool for macroeconomic management of credit demand or even
the business cycle. It has been activated in boom periods, and was released in many
countries during the COVID-19 pandemic. Member States are currently re-activating the
buffer in response to increasing vulnerabilities (Figure 9). These decisions are partly
rulebased, but they also have a discretionary component: the credit-to-
GDP (gross domestic product) gap guides them to some extent, but some countries also
have higher CCyB (Countercyclical Capital Buffer) rates than suggested by this indicator.
Furthermore, some countries introduced a "neutral rate" with a positive
CCyB (Countercyclical Capital Buffer) rate in normal periods.
Similarly, capital buffers addressing structural risks to financial stability have been
deployed differently. Other systemically important institutions (O-SIIs) are banks that,
due to their systemic importance, are more likely to create risks to financial stability if
they are under stress or at risk of failure. The O-SII buffers mitigate these too-big-to-fail
externalities. In the EU (European Union), O-SII buffers are set based on
institutionspecific scores of systemic importance. While the scoring methodology has been largely
harmonised through EBA (European Banking Authority) guidelines, the calibration of
buffers is at the discretion of national authorities. The buffer imposed can be as high as
3% to 4% of risk-weighted assets in some countries, whilst others are not using this
buffer at all. [13]
Heterogeneity within the EU (European Union) can partly be attributed to the
characteristics of the EU (European Union) banking systems. Systemic importance scores
are calculated in relation to the size of the national banking system. Therefore, the
scores of institutions from different Member States are not directly comparable, and the
buffers vary significantly across EU countries (Figure 10). However, the observed high
variation in O-SII buffer rates cannot be fully explained by different levels of systemic
risk (EBA (European Banking Authority) 2020). The European Banking Authority (
EBA (European Banking Authority)) suggested extending the existing
ECB (European Central Bank) floor to the EU level (EBA (European Banking Authority)
2020). This would be a first step towards harmonisation and preventing a race to the
bottom.
The macroprudential policy tools discussed so far are a first line of defence in the
goingconcern case. They make banks sufficiently resilient so that they are able to continue
operating, even if they incur losses. Bank resolution, in turn, limits contagion from the
failure of an individual bank to the financial system. Resolution can therefore also be
viewed as a macroprudential tool, operating in the gone-concern world.
A credible resolution framework prevents excessive risk taking. Resolution tools ensure
that banks can exit the market in case of failure without disrupting the financial system.
In this way, a credible resolution framework lowers the expectation of implicit
government guarantees. This strengthens market discipline and creates incentives for
banks to avoid excessive risk-taking and to become "too big to fail" (TBTF).
Banks that are too-big-to-fail have indeed been a risk to public finances for much of the
history of modern financial markets. While the TBTF problem will never be eliminated
altogether, we have still come a long way in terms of mitigating this risk by setting up
frameworks for bank resolution. In Europe, the Single Resolution Mechanism (
SRM (Singe Resolution Mechanism)) and the Single Resolution Board (
SRB (Single Resolution Board)) have been established in the context of the banking
union in 2016.
So far, the new resolution frameworks have not been tested in a situation of systemic
stress. Our knowledge of its functioning is thus only indirect. Estimates of implicit
funding subsidies are a good indicator of whether the TBTF reforms were successful
and whether resolutions regimes are deemed credible by markets. If creditors believe
that systemically important banks can still count on public support, these banks might
enjoy lower funding costs compared to their smaller peers. The Financial Stability Board
(FSB (Financial Stability Board)) found evidence in market data that implicit funding
subsidies have indeed declined since the implementation of resolution reforms - but are
not yet negligible. [14] This suggests that resolution regimes are not perceived as being
fully credible in the eyes of market participants.
Resolution regimes need to be not only operational on paper, but also credible in
practice. During a crisis, it ultimately requires political will to implement rules and plans
that were made ex ante. Removing obstacles to resolution can tilt the balance and
enhance credibility. Evaluations by the FSB (Financial Stability Board) and, more recently,
by the SRB (Single Resolution Board) inform us about the gaps in resolution frameworks
that remain (FSB (Financial Stability Board) 2021b, SRB (Single Resolution Board) 2022).
The reports show that resolution reform has made significant progress over the past
decade, and the system is moving into the right direction. But gaps remain in terms of
further removing obstacles to resolution, improving relevant information, and
enhancing monitoring of resolution regimes.
Closing the remaining gaps and being prepared to use the new frameworks needs to
go hand in hand. The ongoing review of the crisis management and deposit insurance
framework in the EU (European Union) (CMDI review) provides a good opportunity to
improve the resolution framework. [15] The following steps are, in my view, necessary
to make resolution more credible and effective:
First, competent authorities should intervene earlier and more effectively. Resolution
authorities face a dilemma: Declaring a bank failing or likely to fail (FOLTF) too early
may lead to the market exit of a viable institution. Declaring it too late bears the risk
that liquidity has dried up and losses have accumulated, leaving fewer resources
available for resolution. Experience with resolution cases in Europe shows that, if
anything, such declarations have taken place rather late (Deutsche Bundesbank 2017).
The dilemma could be avoided if early intervention were used more actively by
competent authorities so that a failure becomes less likely. If a FOLTF is still needed, it
should be taken promptly (European Court of Auditors 2021). This can be promoted by
clarifying the objective elements that are required for a FOLTF decision and by
strengthening the role of the resolution authority.
Second, discretionary scope in the crisis management framework needs to be reduced.
A critical element is the public interest assessment (PIA) conducted by the resolution
authorities. It determines whether a failing bank will be resolved or whether a national
insolvency procedure is preferable. At present, incentives are such that national
insolvency proceedings may be used in order to exempt creditors from loss absorption
and to grant public support to prevent adverse effects on financial stability.
EU (European Union) State aid rules have to be taken into account if aid is granted in
the context of national insolvency proceedings. Yet, the assessment of effects on
financial stability in the P