Jose paramo

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 bankâ&#x20AC;&#x2122;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 economyâ&#x20AC;&#x2122;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

â&#x20AC;˘

Fiscal discipline: Exclusion rules: It can be linked to fulfillment of deficit and debt rules â&#x20AC;˘ 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 bondsâ&#x20AC;Ś

50 %

130 120 110

â&#x20AC;Ś 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 fundâ&#x20AC;&#x2122;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&#x201A;Ź 1 trillion Debt Redemption Fund Size (â&#x201A;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 â&#x20AC;&#x153;bad exampleâ&#x20AC;? 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