The European crisis: institutional response and the ECB role Central Banking Series Event: Madrid May 13, 2015
José Manuel González-Páramo
Index 1
Banking union 1.0
2
Towards banking union 2.0 and the capital markets union
3
Towards a fiscal union?
4
Main conclusions
Page 2
Banking Union 1.0
Page 3
Banking union is the key for the euro 2.0
EU
1993
EURO 1.0
EMU
EMU
EU
EU
1999 +
Banking union 1,0
2014-2016
BANKING UNION 2,0 =
Banking union 2,0
EMU
Fiscal & economic union
EU
?
EURO 2.0 Page 4
Why a banking union? Financial fragmentation
Why fragmentation? Sovereign-bank doom loop
Composite measure of EZ financial fragmentation
Bank and sovereign spreads in the Eurozone (bp)
Source: BBVA Research and Bloomberg
Source: Bloomberg and BBVA Research
6,00 5,00 4,00
400
Summer 2012: • •
4 Presidents Report Whatever it takes
350 300 250
3,00
200
2,00 150
1,00 100
0,00 50
-1,00
EA 5Y Sovereign (Itraxx sovereign west)
May-15
Jan-15
Sep-14
May-14
Jan-14
Sep-13
May-13
Jan-13
Sep-12
May-12
Jan-12
Sep-11
May-11
Jan-11
Sep-10
May-10
Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15
-2,00
Jan-10
0
Fin. Senior
High fragmentation levels and sovereign-bank doom-loop : incompatible with the single currency Page 5
Rationale for the banking union THE PROBLEM: financial trilemma
THE SOLUTION: centralization of powers
Financial stability
BANKING UNION Fiscal backstop
Financial trilemma Schoenmaker (2011)
Financial integration
National Financial policies
Single supervision
Single resolution
Single DGS
Single rulebook SINGLE SUPERVISION: no more national bias SINGLE RESOLUTION: from bail-out to bail-in with mutualization of costs Page 6
The new institutional setting is complex albeit operational Eurozone
SRM
SPAIN
DGS
EU
Supervisory colleges
SSM
BRUSSELS
FRANKFURT
SPAIN
SRF
Resolution colleges
Page 7
BU 1.0 is a great leap forward Banking union 1.0: a predictable and clear framework
I
II
III
REDUCE PROBABILITY OF FAILURE
REDUCE EVENTUAL RESOLUTION COSTS
DEPOSIT PROTECTION
SSM
ESAs
CRDIV
SRF
SRM
BRRD
DGSD
BRRD
Covered deposits <100.000€
Other (depo preference)
Page 8
BU 1.0 is free of legacy burdens… 2014
2014-2015
QUANTIFICATION OF LEGACY PROBLEM AQR+Stress test
Pending RECAPITALIZATION State Aid rules
BANKING UNION 1.0 SSM SRM
How?
How?
ECB’s comprehensive assessment exercise
1.Private solutions 2.Partial Bail-in (State Aid) 3.National resolution funds 4.Fiscal Backstops: 1.National 2.European 1.ESM indirect recap 2.ESM direct recap (on a case by case + full bail-in)
1.AQR (8%CET1) 2.Stress test (8%/5.5% CET1
€24.6 bn shortfall, but just €9,5bn “pending”
Page 9
The SSM scope: EMU+ Direct ECB oversight over the most significant banks
EMU 19 ECB Delegated to NSAs • Rest of banks • Specific tasks
opt-in clause (eg Denmark)
any of those
ECB DIRECTLY • Top banks (85%) • Ultimate responsible for the whole system
ECB direct oversight: 123 EMU banks
Non € Member States
• Total Assets> €30bn • Assets /GDP> 20% •
Significant cross border activity • Domestic SIFI •
Bailed out with EU money
At least 3 banks per country ECB: manual, framework, step-in clause EBA: Single rulebook + handbook
Page 10
The SSM at work Governing Council of the ECB Positive silence
Supervisory Board Intermediate Level DGs
Joint Supervisory Teams
I
JST Coordinator *
IV II
Significantt Medium
JST Sub-Coordinators* National supervisory authorities
The ECB has a pivotal role as the single supervisor (legal base, prestige, independence, know-how as CB). It also raises the flag in resolution processes.
III
Horizontal
Less Significant
* NOT from the bank’s country Page 11
The new supervisory review process (SREP) SREP: Supervisory Review and Evaluation Process
CAPITAL
LIQUIDITY
• RAS
• RAS
• ICAAP • ICAAP
• ILAAP
GOVERNANCE
RAS
BUSINESS MODEL
RAS
STRESSED
Arrival point: SREP score: from 1 (no-risk to 4 (high risk) to F (Failed or about to fail)
SUPERVISORY MEASURES: CAPITAL, LIQUIDITY, OTHER
Risk Assessment System (RAS) On-going evaluation by ECB Internal Adequacy Assessment Process (ICAAP/ILAAP) Annual, banks with ECB appraisal Pillar 2 supervisory dialogue key to ensure consistency Resolution Page 12
The new resolution framework in the EU
BRRD
A new loss absorption framework under which bail-in will be the new normal and bail-outs become the exception
1. OTHER RESOLUTION TOOLS: private solutions, bridge bank, asset management company 2. BAIL-IN: shareholders, subordinated debt, senior debt & corporate deposits, SME & retail deposits, Deposit Guarantee Scheme 3. RESOLUTION FUND: after at least 8% of bail-in liabilities, with 5% cap and in compliance with State Aid rules 4. PUBLIC FUNDS, subject to compliance with State Aid rules
Page 13
With a single resolution authority in the EMU+ Main responsibilities Complex decision-making process, but still able to resolve a bank over a weekend
The Single Resolution Board (SRB) is the new resolution authority but Commission and/or Council can reject /modify some SRB decisions sometimes
Developing the first resolvability assessment Preparatory powers in 2015 Full powers in 2016 Developing coordination guidelines with national resolution authorities, supervisory authorities and third country authorities
Prepare the Single Resolution Fund (start in 2016) MREL Provide a single interpretation of the BRRD
Page 14
With access to a single resolution fund • Mutualization only 100% in 2023: but 60% already by 2018 • Fully funded with €55bn (1% covered depos) only in 2023, but: • Better capitalized banks
PREDEFENSES New paradigm
(AQR/Stress, CRDIV, better supervision) • Better plans (RRPs) • Bail-in
EX-POST leverage
•
Ex-post contributions
•
Private borrowing
•
Public backstop
• No common fiscal backstop until 2023, but last resort ESM direct recap • Requires IGA ratification by all signatory Member States before 1 Jan 2016! Page 15
Towards B.U 2.0 and the capital markets union
Page 16
A lot has already been achieved with BU 1.0 A new genuinely European institutional setup
1. Single Rulebook
Better regulation Level playing field: CRDIV BRRD, DGS
2. Single Supervision
Single interpretation of CRDIV No supervisory ring-fencing Confidence in banking sector
3. Single Resolution
Single interpretation of BRRD Predictability in resolution Cross border resolution Resolution costs mutualized
Still, complex setting and further harmonization in key concepts still required: RWA, NPL, national discretionalities, model validation, etc Page 17
Fragmentation is certainly down… Composite measure of EZ financial fragmentation Source: BBVA Research and Bloomberg
6,00
June-July 2012: • BU announcement • Draghi’s Whatever it takes
5,00
ECB provided the anchor to the BU process
4,00 3,00 2,00 1,00
?
Financial fragmentation has gone down but the problem still persists
0,00
By how much? We don’t know but we are not there yet
-1,00
May-03 Nov-03 May-04 Nov-04 May-05 Nov-05 May-06 Nov-06 May-07 Nov-07 May-08 Nov-08 May-09 Nov-09 May-10 Nov-10 May-11 Nov-11 May-12 Nov-12 May-13 Nov-13 May-14 Nov-14
-2,00
• •
The banking union has helped moderating the contagion of banking crises (Greece) Fragmentation has considerably eased but credit conditions still depend on location Page 18
…but the arrival point is no doom-loop • •
Banking union 2.0 •
•
Fiscal and economic union •
Capital Markets Union
Further harmonization (e.g soft capital) Completion of BU 1.0 with EMU safety net (Single DGS and Common public backstop) Main hurdle: requires fiscal union and common insolvency law New Four President’s report (June’15): will it stick to its original integrative spirit? Not sure…but It probably should Main hurdle: no political will for fiscal union and Treaty change required.
•
New Commission’s flagship project
•
Main hurdle: resistance to hand over sovereignty on insolvency law, tax law, corporate governance law, etc
Hand in hand
Elements needed to break bank-sovereign doom loop
Page 19
The capital markets union is a good complement to the banking union CMU and BU are different in nature and scope but mutually reinforcing • BU is a vital asset for CMU to advance further towards free flow of capital • CMU will also help underpin integration and financial stability
Banking Union
Capital Markets Union
1 EUROZONE +
1
EU 28 (ESMA scope- New authority? )
2 BANKS
2
ALL FINANCIAL ACTIVITIES EXCEPT BANK CREDIT INTERMEDIATION (includes all other bank activities too)
3 CENTRALIZATION: regulatory driven
3
HARMONIZATION: mostly market-driven, bottom up approach Broader and deeper EU capital markets • barriers to free movement of capital • investment in the EU and from abroad • market finance in the EU economy
4
•
Break fiscal-bank doomloop through unified bank rules and supervision
•
Restore confidence in European banks
4
Page 20
With the goal to achieve a deeper, broader and more integrated EU Capital markets Short-term agenda
Some quick-wins in finance for growth
Long-term agenda
Structural shift in EU funding pattern towards more market finance
1. Lift regulatory barriers to bank lending: high quality securitization
1. Diversify supply: attract institutional, retail and international investors
2. Develop standard EU instruments: covered bonds, private placements, Prospectus regime,
2. Better access to finance: promote new ways of funding (crowdfunding, P2P, covered bonds, etc)
3. Improve access to finance for SMEs (credit scores), infrastructures (ELTIF, Juncker Plan)
3. Remove barriers: improve market infrastructure (CCPs resolution, etc), legal harmonization (insolvency, corporate governance, taxation, securities law). Page 21
CMU is long term and banks will still be key Competition is always good but it should compete under the same rules
Alternative sources of funding should be subject to adequate regulation and oversight to avoid new sources of vulnerabilities and protect consumers It is a long term project. Bank credit will remain a critical part of the economy’s financing Banks do more than just give credit: critical role in capital markets : market making, underwriting, securitization, private banking, etc.
Page 22
To break the doom-loop, a complete banking union is required Elements needed to have an optimal/complete banking union 2.0 Single Resolution Fund
Common fiscal backstop Single Resolution Board (SRB)
BOTH MISSING ELEMENTS REQUIRE SOME FORM OF FISCAL UNION but no political will right now…
BU 2.0
Could an accident in Greece catalyze progress towards a timber fiscal union? If so, what would the ESM’s role be?
Single supervisor (SSM)
Single DGS Limit national discretions Single rulebook Page 23
Towards fiscal union
Page 24
What features of fiscal union? 1) Common budget (implying also revenues!)
Equalization system
Politically difficult; it already exists at small scale (EU funds)
Small common budget to counter asymmetric shocks
For normal crises, current deficit rule is flexible enough. For systemic crises, it is useless.
2) Common independent fiscal authority
Common independent fiscal authority at EU level
It would help to avoid problems of hidden debt (Greece), unify methodologies for structural deficits, build institutional fiscal trust among members, etc.
Page 25
What features of fiscal union? 3) Risk sharing, common instrument for monetary transmission
M o r e
I n t e g r a t i o n
Public backstop for banking union
ESM with borrowing capacity from markets might be enough in the short-term
Eurobills
Politically more feasible Symbolic value. Embryonic value.
Debt redemption fund
To deal with legacy debt
Eurobonds, common and several liability
Politically difficult
Common Treasury, common issuance
Politically even more difficult: Countries to cede sovereignty
Page 26
Eurobills: main features Short-term bills with joint and several liability to finance European or national budgets A safe a liquid asset Limits the extent of mutualization in first years, but can grow up as confidence returns
•
Fiscal discipline: Exclusion rules: It can be linked to fulfillment of deficit and debt rules • Extra cost can be linked to fulfillment of fiscal targets
Can be implemented without Treaty change if they are introduced as temporary Strong symbolic value; lower political cost Only short-term term bonds, small quantities at the beginning Page 27
Debt Redemption Fund. How would it work? The case of Italy Italy: Debt Redemption Fund/Pact (% of GDP) Source: BBVA Research
140
Debt above 60% of GDP is transferred in three years into a European fund that would issue bonds‌
50 %
130 120 110
‌ to cover refinancing requirements of participating countries
100
30 %
90 80
20 %
70
Countries enter into repayment obligations to repay its transferred debts within 25 yrs
60 50 40 30
Annual payment would bear the (lower) interest costs arising for the bonds issued by the fund and would also repay the debt
20 10
Government debt outside ERP as % of GDP
2038
2036
2034
2032
2030
2028
2026
2024
2022
2020
2018
2016
2014
0
Government debt in ERP as % of GDP
Page 28
Debt redemption fund: main features Temporary mutualization, not a permanent fiscal union Introduces a mechanism to reduce high initial debt (legacy problem) Complements the monitoring setup: strict rules, coordination and multilateral surveillance, avoiding moral hazard If countries respond to the fund’s debt with joint a several liability, it requires a Treaty change Lower interest payments for the country for the transferred debt There is an European asset that can be used for monetary policy operations Requires a compromise of high primary surpluses for many years (debt reduction), lacking flexibility Page 29
The fund size to reduce debt up to 90% of GDP is close to â‚Ź 1 trillion Debt Redemption Fund Size (â‚Źbn) Source: BBVA Research
3500
3000
We consider all countries (also Ireland and Portugal) with debt above certain thresholds
2500
2000
1500
Depending on the maturity structure and redemption payments, only a part of the fund should be guaranteed
1000
500
0 ESM
90% With Greece
75%
60%
Without Greece
Page 30
Tumpel-Gugerell report: options of DRF and eurobills DRF
Stabilizes government debt markets, supports monetary policy transmission, restores the conditions for no-bailout clause Economic and moral hazard risks
Eurobills
Stabilizes debt markets, supports monetary policy transmission, first step towards permanent mechanism
Treaty reform can be avoided if there is no joint and several liability, and certain protection against moral hazard
Better wait to see the efficiency of current setup (BU, 6-pack, 2-pack) LOW PRIORITY OPTION: The recovery in Europe and QE reduce the need to stabilize markets; Greek “bad example� of moral hazard Page 31
Wrap up
Page 32
Concluding remarks Banking union 1.0 is a milestone: fragmentation levels have considerably eased
but the arrival point is no doom-loop: we need a BU 2.0 with a sound common saftey.net
The ECB has provided the anchor to the whole BU process: whatever it takes, new single supervisor, raise the resolution flag, macroprudential (ESRB, SSM)
It has done everything it can to support the European project and has committed to continue to do so going forward. The ECB credibility is at stake
BU 2.0 will go hand in hand with other steps towards further integration
Fiscal union, economic union, capital markets union They will all underpin the ECB action and credibility
The arrival point is having no doom-loop at all: advances towards fiscal union are required
A market in which consumers and corporates operate with EZ banks without regards of where their headquarters are located Page 33
Annex 1. AQR/stress test results were robust and credible Capital needs resulting from comprehensive assessment (before mitigating measures)
Positive valuation
Source: BBVA Research based on ECB 12.000
7%
10.000
6% 5%
8.000
Manageable capital needs: capital shortfall of €25bn corresponding to 13 banks (€9,5bn when corrected by mitigating measures),
4% 6.000 3% 4.000 2% 2.000
Millions (LHS)
Cyprus
Greece
Portugal
Italy
0%
Slovenia
Ireland
Austria
Belgium
Germany
France
Spain
Slovakia
Netherlands
Malta
Latvia
Luxembourg
Lithuania
Finland
Estonia
-
1%
The first European stress test preceded by an AQR: The harmonization of non-performingloans entailed a reclassification of €81bn after projections
% RWA (RHS) Page 34
Annex 2. Financial firepower of the resolution fund: will it suffice? All banks in the EZ should contribute
Progressive mutualization of contributions to the SRF 120%
100%
Ex-ante €55bn (1% covered depos)only in 2023, but together with a new paradigm • More vigilance • Better plans (RRPs) • Bail-in
80%
60%
40%
And also ex-post financial power: • Ex-post contributions • Private borrowing • Public backstop
20%
0% 2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
Page 35
Annex 3.The MAPO dimension of the BU •
Macroprudential policies need to complement monetary policy. Decisions must be taken at the same level of financial stability and integration objectives (back to financial trilemma)
•
The ECB has a key role to play (complementarities) but MS will still keep the control
•
Coordination between the SSM, the CB and MS will be key in the transition
BEFORE THE BU
National
National mandates and tools
ESRB (comply or explain) EU
BU 1.0
BU 2.0 + fiscal/economic union
National mandates. EU tools (CRDIV)+national tools (eg LTV) • •
ESRB (comply or explain) ECB (SSM) can toughen some CRDIV tools (asymmetry)
Enough?
• • •
SSM: Eurozone mandate Authority: ECB/ESRB? Tools: CRDIV+ SSM
Page 36