Safer financial system will improve channelling of credit to the economy

The role of banks in the financing of the Union's real economy and financial intermediation remains high, but the capital market will become relatively more important. Further reforms should accompany this transformation and improve the tools of the capital market, especially for SME sector - says Mario Nava from the European Commission.

CE Financial Observer: Can you imagine that a too-big-to-fail European bank could be put under orderly resolution on the basis of the BRRD provisions?

Mario Nava: Definitely yes. We should not forget that the BRRD puts an emphasis on the planning stage of resolution where resolvability assessment is a key element. Within that assessment, the resolution authority will assess the extent to which an institution is resolvable on the basis of a series of criteria specified therein; those criteria relate precisely to the feasibility and credibility of resolving the institution. If the institution is not deemed to be resolvable the resolution authority has a wide range of powers to request and take any necessary measure on its own to make the institution resolvable (like requiring the institution to divest specific assets, cease certain activities, require changes to the legal or operation structure of the institution, etc).

Is the Single Bank Resolution Fund big enough to resolve efficiently a big institution?

The Fund will operate in a new regulatory framework. We are talking about an environment where banks are subject to new prudential requirements, to enhanced supervision by the ECB and to the obligation to prepare recovery plans. In addition, the BRRD and the SRM have changed the paradigm from bail-out to bail-in, i.e. from public to private money. The BRRD and the SRM make it mandatory where resolution is initiated that shareholders and creditors are the first to pay for the ailing bank. The Fund would only intervene, where necessary, after the bail-in tool has been applied. The SRM Regulation does not establish a common backstop at this stage, but the Fund may borrow on the markets. Also, the SRM foresees that the Board, together with the Member States, develops methods to enhance the borrowing capacity of the Fund.

Are decision-making procedures for the Single Resolution Board, in their current form, effectively enough to ensure rapid and efficient action?

Decision-making is presented as very complicated. But in reality can be very simple. The system will be based on a strong Resolution Board. Between the moment the Board decides upon a resolution scheme and the moment the scheme is final – following its endorsement by the Commission or the Council – there would be between 24 and 32 hours. The role of each actor involved is clearly defined and tight deadlines are set to allow for swift decisions.

The Council has the power to object to a resolution scheme adopted by the Board, only on proposal by the Commission. So, if the Commission agrees with the Board, a resolution scheme would enter into force within 24 hours after its adoption by the Board. Even where the Council objects, the total length of the process is 32 hours.

As regards the decision-making within the Board, the process should be swift as most of the resolution decisions will be taken by the executive session. The role of the plenary session – where all national resolution authorities of the Banking Union Member States are represented – would be limited to specific cases (i.e. cases that involve a high use of the Resolution Fund or where the Board decides to raise ex post contributions or to borrow on the market).

Is the regulatory package (CRD IV/ CRR, BRRD, SSM, DGS) a chance to break the vicious circle between fiscal and financial instability?

The Banking Union and the new financial regulatory framework will ensure a more integrated credit market so that Europe’s banks return to their primary function, which is lending to businesses and individuals. The SRM would contribute to breaking the link between sovereigns and banks and would ensure a harmonised approach in its use in resolution cases regardless of where the falling banks are located.

The EU governments may still be obliged to bail-out failing banks, at least in the build-up period of the Single Bank Resolution Fund or when the Fund will not be fully mutualised. Does this not deepen the vicious circle between banks and sovereign?

First of all, it must be recalled that the Resolution Fund is to be used only after bail-in and the bail-in threshold has been set at 8 pct. of bank liabilities. Losses up to this level will be absorbed by shareholders and creditors before the use of the Resolution Fund. The 8 pct. threshold is very significant compared to the actual losses that banks faced during the financial crisis. Between 2008 and 2010 only one bank had losses exceeding the 8 pct. threshold, and the average for all other banks was about 3 pct. Therefore, the likelihood of the use the Resolution Fund is not high.

Moreover, it should be added that before it is sufficiently capitalised and mutualised, the Single Resolution Fund could, if necessary, levy additional funds from the banking sector. It could also borrow funds on the market. For this purpose, the SRM Regulation foresees that immediately after its entry into force, Member States participating in the Banking Union and the Single Resolution Board work on developing modalities to enhance the borrowing capacity of the Fund.

In the transition period, bridge financing could also be available from national sources, backed by bank levies, or from the ESM in line with agreed procedures. This financing will be fully repaid with ex-post contributions from the banking sector and will therefore not have any effect on taxpayers.

Are banking regulations enough to stop bank deleveraging and increase credit supply to the economy?

Indeed, a resilient and well-regulated banking system is an important factor in ensuring credit supply to the real economy. Therefore, it was important that European policy makers took determined steps towards strengthening the banking system and ensuring the confidence of investors and depositors. The legislative proposals of the Commission have been accompanied by impact assessments that sought to gauge the effect of regulation on economic growth. The Commission as a rule evaluates the impact of regulation on the economic cycle. Particular attention is being directed to the availability of financing for long-term investment.

Both Basel III and CRD/CRR do not change the rules allowing banks to valuate risk on the basis of internal models. However, many economists are of the opinion that the Basel II rules on this were the root of the credit bubble, which led to excessive public and private debt in the countries of the South, and to the crisis. Don’t we need to change it?

The main concern that has been raised about allowing banks to use internal models has always been that, in view of the degree of freedom that they are given in terms of specifying the models’ designs, banks would try to manipulate the models in a way that would result in lower capital requirements. The recent financial crisis is sometimes presented as validating those concerns.

I would not necessarily agree with such conclusion. After all, at the time the financial crisis started to unfold, banks were still not using internal models for the purpose of calculating their capital requirements (EU rules on the use of internal models became applicable only at the beginning of 2008).

Very significant efforts have been made both in the EU and internationally to better understand how banks use internal models and how consistent the outcomes of those models are (i.e. what capital requirements are produced by those models).

And let’s not forget that with the advent of the SSM all internal models of banks under the SSM will be approved by the same supervisor, which should also allay the abovementioned concerns.

Similar concerns are expressed with regard to a zero risk weight for government debt. What is your opinion?

First, it should be noted that the zero risk weight is not an area specific to the EU. This is a Basel rule that the EU applies.

Banks hold government debt for a variety of reasons, and I do not think that risk weights are the main determining factor of bank behaviour in this regard. Nevertheless, I do think that an encompassing approach to the bank-government nexus also requires looking into the regulatory treatment of government debt. This will require a careful and holistic approach, which takes account of all aspects of bank risk management, including concentration and liquidity risk. In recital 84 of the CRD Directive, the legislator recalls that controlling concentration risks is more effective than risk weighting those exposures, given their size and the difficulties in calibrating own funds requirements. Moreover, possible implications for the wider financial system have to be kept in mind.

What are the next steps the Commission could take to increase the safety of the financial system in the EU and to ensure the transfer of credit to the real economy?

A safer and more stable financial system will go a long way to ensure a better channelling of credit to the economy. A more stable system means also that the banks will be less able to leverage – their role in financing the economy will remain paramount, but will inevitably diminish from the current levels (75-80 pct. of financial intermediation). We have to accompany this transformation and develop more capital market based financing. We have to make capital markets more attractive for SMEs, and make SMEs more attractive to investors. And we have to develop common tools to allow the capital markets to work better, like for instance high quality securitisation.

What are the arguments for countries such as Poland, remaining outside the euro area, to join the Banking Union?

Banking Union is an area of financial stability and strength. And strength of the banking sector is paramount for EU growth.

In the Banking Union, banks are supervised and resolved centrally at European level. This ensures that the single rulebooks on supervision and resolution are applied in the same manner to credit institutions in the euro area and those non-euro area Member States that choose to participate in the Banking Union. Being part of the Banking Union ensures the adoption of consistent internal models, consistent bank supervision, as well as predictable, consistent and impartial decisions as the resolution powers are concentrated in the hands of a single authority, the Resolution Board. Moreover, as it relies on a Single Resolution Fund, the firepower of the Single Fund is much higher than that of a national resolution fund.

The rules of the SRM are designed in such a way to apply potentially to all 28 Member States. Concretely, this means that once a non-euro area Member State decides to join the Banking Union, it would be treated in the same manner as the Member States that have been part of the system since day one. Not less than 26 Member States (8 of which outside the euro area) have signed the relevant protocol.

Mario Nava is a Director for financial institutions in the European Commission.

Interview by Jacek Ramotowski

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