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Vice President of the European Commission responsible for Competition Policy
Europe’s banking sector after the crisis: Oversight, regulation and responsibility
23rd World Savings Banks Institute Congress
Marrakech, 10 May 2012
Ladies and Gentlemen,
When I received the kind invitation to address the WSBI world congress, I accepted without hesitation because policy makers and the banking community need to carry out a serious debate on the banking models of the future, and it was clear to me that this would be the perfect venue. I thank the organisers for giving me this opportunity and also for giving me the opportunity to come back to beautiful Marrakech, which is a city I am fond of.
The crisis started almost five years ago, when many of us heard for the first time the phrase ‘subprime mortgages’. We have seen it mutate from a financial crisis into a deep economic contraction and – since 2010 – into a sovereign-debt crisis shaking the pillars of the euro area. In its latest stage, the crisis has been hitting Europe’s economy in particular: unemployment in the EU is at its highest levels; there are no clear signs of a return to robust GDP growth; fiscal positions and external current accounts still need serious adjustment; and the financial sector remains fragile.
Europe’s predicament – and the troubles of the euro – are a matter of concern for the rest of the world. There are worries that it may slow down the global recovery and many people wonder why it has been so difficult for us to take the decisions needed to put our house in order. I will try to address these concerns focussing my presentation on the main current issues for the EU and especially for the euro area.
To start with, let me tell you that we are fully aware of our challenges; and it seems to me that Europe has been far from inactive over the past four years or so. Regarding banking, financial and monetary policies, since 2008 we have been quick to introduce a set of financial rescue and restructuring rules for banks in distress; we have set up a new Europe-wide supervisory system, and the ECB has been increasingly active as a factor of financial stabilisation – the recent €1 trillion LTRO being the latest example. In addition, financial regulation is being overhauled – in parallel with our international partners – to limit risk and improve the transparency and resilience of the markets.
On the fiscal policy side, ambitious consolidation strategies are being implemented and the governance of the EMU is being reinforced. Therefore, as in the past, this crisis is pushing the EU towards higher levels of integration. Although not all of the decisions we have been taking will bring immediate results, and some of them had to overcome serious resistance before being adopted, I am convinced that a stronger Europe is emerging from the crisis.
Let me retrace the main steps of the crisis to see how banks have fared in these difficult times. In a context of cheap money and price stability, financial innovation – and in particular the 'originate and distribute' practice that generated a massive securitisation of debt – flooded the market with structured products and derivatives that were little understood but enthusiastically purchased. And not only by investment banks and sophisticated traders. Enormous amounts of risk were accumulated and the links between financial institutions grew so tight that practically every large entity became vital for the whole system. Let me add in passing that public authorities have their share of responsibility here, because all this happened with little or no regulatory supervision.
Soon after the collapse of Lehman Brothers, it became apparent that retail banking – traditionally a conservative sector – had not sheltered its business from the storm. Many retail banks in Europe were on the verge of collapse. How was this possible? The reasons are many and vary from one country to another. One common cause is the drive to seek higher returns than those produced by their traditional operations, which pushed many institutions to assume too much risk. As a matter of fact, the practice of financing long-term credits with short-term funding, or substituting deposits with wholesale funding, became quite common throughout the banking sector. This was made possible by the enormous amount of cheap liquidity available in the financial system.
In real terms, money was cheaper in the periphery of the euro area where inflation rates were higher. This state of affairs encouraged both the public and the private sectors to pile up excessive levels of leverage and debt. However, until 2010 the markets treated the euro area as a single economic zone, and therefore almost no risk premium was attached to these countries. Eventually, the levels of public and private debt in some of the Member States led investors to raise awkward questions on the sustainability of public accounts and even on the solvency of some countries.
What was initially a financial crisis linked to certain risky conducts and bubbles, turned into serious liquidity and, in some cases, solvency problems affecting weaker entities, and eventually into a sovereign-debt crisis, in which investors raised the risk premia associated to sovereigns in some countries. This weighed heavily on the balances of the retail-banking sector. The banks that had relied on sovereign bonds as their safest assets suddenly saw some of these assets degrade, creating fresh problems for them.
This is the context for the long and difficult process of rescuing and restructuring the financial institutions endangered by the crisis; a process in which the European Commission has been deeply involved since the beginning. The Commission was given the task to make sure that the public bailout of banks would be carried out under the same conditions throughout the internal market with the objective to return the banks to long term viability – or, failing that, their orderly resolution. Our rules would also address the moral-hazard issue and lay down the conditions for the competitive functioning of the sector in the medium term.
As I said earlier, we responded to the call swiftly introducing special rules for State aid to banks in 2008 and 2009. Under these rules, we have decided on the viability, restructuring or liquidation of 43 banks, and are still working on more than 20 other cases. The emergency regime has given guidance on the pricing, duration and type of liabilities that national authorities across the EU can guarantee for a bank. It has also provided common criteria on how banks must remunerate the government for recapitalisation and impaired-asset measures. Finally, it set out the terms for the restructuring or orderly liquidation of aided banks, depending on the size of the support received and on the soundness of a bank’s business model.
On the basis of these rules, the Commission has been acting as a de facto crisis-management and resolution authority at EU level, also addressing the structural problems that had been affecting many banks well before the crisis. The conditionalities we impose on banks which need to restructure fall under three main headings:
• First, the bank needs to restructure to return to long-term viability without any need for further aid. If this is not possible, we ask for an orderly liquidation of the institution;
• Second, the capital holders – shareholders and hybrid-capital holders – should contribute adequately to the cost of the rescue and restructuring to limit the aid and the cost to the taxpayer; and
• Third, to limit competition distortions, we ask the aided banks not to expand on the back of State support to the detriment of unaided competitors.
In practice, to address the structural problems, we are asking some banks to move away from unsustainable business models. Significant restructuring efforts will have to continue in the future in Ireland, Greece and Portugal – the so-called programme countries. We are also looking for adequate solutions for some banks that were rescued long time ago in other EU countries.
As to Spain, State aid is being used not only to rescue individual banks, but also to help restructure the sector of savings banks – the Cajas – badly hit by the collapse of the property market. We are working with the Spanish authorities as they promote the transformation of savings banks into commercial banks and the integration of weaker banks. This is a much needed consolidation process. Some of the weaker and smaller Cajas have been restructured, partly resolved and privatised. Others – such as Bankia/BFM – are following this restructuring path.
Ultimately, the goals of our State aid control are the same in every EU country, regardless of the special characteristics of their banking sectors; we want a leaner, cleaner and healthier banking system centred on the financing of the real economy. The restructuring should also be seen as an opportunity for more efficient and competitive banks to expand, acquire activities and assets, turn them around, and provide better and cheaper services to customers. We can no longer afford zombie banks as we struggle to generate growth.
Ladies and Gentlemen:
What remains to be done to put our house in order? In my opinion, there are four main steps to follow:
• Breaking the vicious circle between public debt and banks’ balance sheets;
• Reaching adequate levels of best-quality capital for banks;
• Completing the restructuring, and pursuing orderly liquidation where necessary; and
• Putting Europe’s banking industry in the best possible conditions to finance the real economy.
I will say a few words on each of these closely interrelated points.
Breaking the vicious circle between sovereigns and banks is the most urgent task. Both the European Banking Authority and the European Central Bank have taken action to address it: the EBA, with its request that banks reach a 9% Core Tier 1 capital ratio by the end of June; and the ECB, with its Long Term Refinancing Operations, or LTROs.
The LTROs, in particular, removed the risk of an imminent funding crisis and eased tensions in the sovereign debt markets in the early months of the year. But these operations were not a silver bullet. We should continue to explore the conditions to set up and use the appropriate firewalls, which would ring-fence the European sovereign debt form speculative attacks, so that it is considered again as a risk-free asset in banks’ balances. We need to use the breathing space provided by these measures to design and introduce a new regulatory framework for the long run, and the Commission has been quite active on this front.
As to my second point – regarding the levels of capital – we have proposed two changes to follow up the Basel III agreements; the Capital Requirements Directive – or CRD 4 – and the Capital Requirements Regulation. The CRD 4 is currently being discussed in the ECOFIN Council and the European Parliament. The main issue at stake – among others – is the degree of flexibility that national supervisors might have to set capital buffers. Taking into account the significant cross-border spillovers, this is a sensitive issue which must be considered carefully and where a broad consensus is needed. At the ECOFIN level, a compromise is now being prepared by the Danish Presidency and there is every indication that an agreement will be reached when ministers meet next week.
These measures are putting pressure on banks as they continue their process of deleveraging. We should keep in mind that deleveraging is primarily driven by the need of banks to eliminate funding gaps, the most important of which are mismatches between long-term assets – such as loans – financed by short-term funding. This is one of the key measures that banks must take to return to a healthy condition. For the moment, banks are selling non-core assets and getting rid of risky loans in an orderly way. The role of supervisors is to ensure that the measures taken by banks to reach higher capital buffers do not lead to a contraction of lending to businesses and households, which would have dire consequences for the economy at large.
Moving on to my third point – restructuring – let me mention another element of the regulatory and supervisory architecture that we are putting in place: the new EU-level resolution framework. The crisis showed that when problems hit one bank, they rapidly spread across the system regardless of national borders. It also showed the lack of a mechanism to manage financial institutions in distress – again, especially across borders. To address these issues, the Commission is working on a proposal for an EU framework for crisis management to tackle bank failures at the earliest possible time and avoid or limit the cost to the taxpayer.
Amid the large public interventions in the financial sector, we must not lose sight of our main tasks, the integration of Europe’s financial markets, the preservation of a level playing field and the need to put the sector on sound footing. Clearly, State aid interventions carry the risk of a renationalisation of banking markets – and that must not come to pass. This is why I will not loosen competition and State aid rules during the crisis. I will also continue to insist that the banks remunerate the public support that they receive, and that they eventually repay taxpayers’ money to the state.
The effect of the measures I have just described will be to prepare the ground for the financial markets that will emerge from the crisis. In this new environment, banks will be more transparent, more resilient to withstand stress, and more focussed on their core business – which is providing finance to the real economy. This, the fourth step in my brief analysis is really the point of the whole exercise.
Ladies and Gentlemen:
2012 will be a critical year for Europe’s economy and financial system. On the sovereign-debt front, we need to implement the stronger budgetary surveillance rules we have agreed. And at the same time, after the years of austerity it is time to shift to a concerted action to relaunch economic growth in Europe. To days ago, the Commission discussed – and President Barroso announced – a substantial package of initiatives that we have been proposing to our Member States to complement stabilisation efforts with the growth-enhancing measures needed to reurn to a sustainable growth path.
Millions of citizens have been making enormous efforts to contribute to the resolution of this crisis; wages are being lowered, jobs are being lost, public services are being cut, and taxes are going up. All this is necessary – of course – but it’s taking its toll on our people; there is a risk that their patience will soon run out. Growth and jobs should come as a consequence of the impressive adjustments and reforms going on in many countries.
In this context, let me tell you that banks and other financial institutions should live up to their responsibilities. They owe it to the society that their business models are sound; their supervisors are well informed; and the regulation that oversees them includes adequate safeguards to control risk. Above all, I believe that they should bear a fair share of the cost of the resolution of their own problems.
European and national authorities, on their part, will continue to work together to build a sounder, safer and more efficient financial sector in Europe. I call on the banking community – and today on the retail and savings banks you represent here – to join us in our efforts to stabilise the financial sector and relaunch the economy.