Banking union and fiscal union in Europe: outlook and implications for global partners

Asia-Europe Economic Forum 13 January 2013

John Berrigan, DG ECFIN

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Outline

• Consequences of crisis for EMU construction

• Reinforcing EMU (focus on Banking Union)

• Implications of Banking Union for participants and partners

Consequences of crisis for EMU construction (1)

• EMU construction unique: single monetary policy, with co-ordinated but decentralised fiscal/structural policies

• Conventional wisdom that deep political integration required for durable currency union

• Was EMU construction flawed from the outset?

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• Economic logic of EMU reflected both direct benefits of euro (e.g. macro-stability, lower transaction costs, enhanced financial-market liquidity) and indirect benefits (i.e. incentives for structural reform)

• Euro removed option of devaluation as means to avoid reform

• EMU construction ensured cost of "non-reform" could not be shifted to supra-national level

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Consequences of crisis for EMU construction (2)

• In retrospect, several pre-conditions for the effective functioning of EMU construction…

o Member State compliance with a comprehensive rules-based policy coordination framework

o Financial-market discipline to support policy co-ordination

o Integrated financial stability architecture

o Capacity to pool fiscal resources in support of monetary policy in response to specific shocks, notable financial shocks

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Consequences of crisis for EMU construction (3)

Consequences of crisis for EMU construction (4) • …but EMU launched in coincidence with "Great

Moderation"…

o Policy co-ordination framework proved inadequate

o Market discipline absent amid mispricing of risk

o Too slow progress in completing financial-stability architecture

o Concept of burden-sharing remained undefined in operational terms

• … resulting in deficiencies in crisis prevention and management

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Reinforcing EMU (1) • Medium-term dimension of EA crisis response focused on

reinforcing the EMU construction

o Policy co-ordination framework strengthened and expanded

o Acceleration in completing financial-stability architecture – Banking Union

o Establishment of crisis management instruments: EFSF/EFSM/ESM

o First steps toward "fiscal capacity" at EMU level

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Reinforcing EMU (2) – Banking Union

• Key reinforcement of EMU is the creation of Banking Union (BU)

• Rationale of BU is to address negative feedback loop between banks and national sovereigns via

o Neutrality in oversight

o Readiness to resolve and allocate losses among private creditors

o Possibility to mutualise remaining financial costs via common fiscal backstop

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Fiscal – Financial interdependence: CDS spreads of sovereigns versus banks (bps)

Source: Bloomberg.

9

0

500

1,000

1,500

2,000

2,500

3,000

2007 2008 2009 2010 2011 2012

IE SovereignBank of IrelandAllied Irish BanksIrish Life and PermanentAnglo Irish Bank

0

200

400

600

800

1,000

1,200

1,400

1,600

2007 2008 2009 2010 2011 2012

PT SovereignCGDBanco ComercialBanco Espirito SantoSantander TottaBPI

0

100

200

300

400

500

600

700

800

900

2007 2008 2009 2010 2011 2012

IT SovereignUnicreditIntesa SanpaoloBMP SienaBanco PopolareUBIBNL

0

100

200

300

400

500

600

700

800

2007 2008 2009 2010 2011 2012

ES Sovere ignSantanderBBVACaja MadridLa CaixaBco Sabadell

Brussels, 16 October 2012

Financial sector fragmentation in the EA

Interest rates on mortgages, %

Note: Data for new loans. Source: European Central Bank.

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Cyprus, 8 October 2012 Fiscal–financial interdependence

Interest rates on loans to SMEs, %

• Main components of BU are inter-related...

o Single Supervisory Mechanism/Single rulebook

o Common resolution framework with private funding

o Common deposit insurance framework (later)

o ESM as common backstop

• ... and all are required to ensure coherence

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Reinforcing EMU (3) – Banking Union

• Substantial progress on Single Supervisory Mechanism

• MS have reached general agreement that

o SSM focused on euro area but open to all MS o ECB conferred with specific tasks within SSM and directly supervises

significant banks; o Strict separation of ECB monetary and supervisory responsibilities o National supervision of remaining banks integrated into SSM o Role of EBA will be preserved o SSM to be in place by March 2014

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Reinforcing EMU (4) – Banking Union

• Proposal for SSM will now be agreed with European Parliament

• Council and EP will proceed with co-decision procedures on Commission proposals relating to bank capital requirements and bank restructuring/resolution

• COM will bring forward legislative proposal for Single European Resolution Mechanism

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Reinforcing EMU (5) – Next Steps

• BU a pooling of national sovereignty among participants

• Responsibility for effective prudential oversight, crisis management and associated fiscal costs will be shared

• Full co-operation among MS essential at all levels of BU

• Fiscal burden sharing is key to align MS incentives to co-operate, so must have agreement on "bailing-in" to limit potential size of burden

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Implications of Banking Union for participants

• More resilient EMU within global financial system eases current crisis and reduces probability of future crises

• BU consistent with existence of Single Market, but not neutral in its effect

• Pooling of sovereignty in BU may imply changes in approach to risk management among public and private actors

• Any changes in dynamics of EU financial integration must be managed within Single Market

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Implications of Banking Union for partners

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Thank you for your attention

Presentation by John Berrigan, European Commission

21 January 2013