Vice President of the European Commission responsible for Competition Policy
The Economic and Monetary Union, the euro and the financial crisis
Barcelona Graduate School of Economics Inaugural Lecture
22 October 2012
Honorable Conseller d'Economia i Coneixement
President de la Barcelona Graduate of School Economics,
Autoritats, Senyores, Senyors,Amics,
Moltes gràcies per haver-me convidat avui a aquesta inauguració.
Es habitual comenzar este tipo de intervención expresando la suerte que representa el poder dirigirse a una audiencia tan distinguida como ésta.
Pero para mí, es sobre todo un enorme motivo de satisfacción haber sido invitado a pronunciar por segunda vez la lección inaugural de la Barcelona GSE.
A lo largo de estos años, y a pesar de seguir su actividad desde la distancia de Bruselas, mi interés y entusiasmo por este proyecto, que considero como algo muy cercano, ha ido en constante aumento. Siempre que puedo, me precio de ser su Presidente de Honor.
Porque la Barcelona GSE es hoy una institución académica del más alto nivel y prestigio mundial. Añade aún más valor al enorme capital acumulado por las Universidades y Centros de Investigación radicados en Barcelona. Y a su vez, el atractivo y la calidad de vida de Barcelona contribuyen a reforzar aún más el prestigio de la Escuela.
I will now turn to English to deliver the inaugural lecture of the academic year 2012-2013.
Europe and its problems make the headlines very often these days and I’m afraid they will continue to do so for a while. We repeat that more Europe is the solution, but recently some have argued that Europe is in fact at the origin of many our current troubles. So, has the solution become the problem? Of course not. But the answer to this question is not as straightforward as before the crisis.
This is why today I want to touch upon what the EU is doing to tackle the consequences of the economic troubles that started in 2008.
We are facing complex and difficult challenges. There are no more pressing issues today for the Union than to relaunch the economy. And to succeed in this endeavour, we must first solve the euro crisis once and for all.
At the same time, we must give the Union adequate governance institutions and policy instruments to take it out of the recession and create the conditions for sustainable growth.
These are our top goals. Millions of people in every corner of the EU and beyond share the same concerns. After five years into this crisis, we must put an end to this permanent state of uncertainty, and find clear and realistic prospects for a solution.
This is not an easy task. We are witnessing the worst crisis since the Great Depression that preceded World War II; we are again at an historic turning point in the way our economies and societies work.
And this poses a big challenge to the European integration process, for which the crisis constitutes the most serious risk since its creation more than half a century ago. The uncertainty around the euro and the EU is deeply affecting millions of Europeans in their everyday lives.
The most urgent task for Europe’s political representatives and democratic institutions is setting the right priorities and, immediately after, taking the decisions to fix the problems identified and explaining the ultimate goals of our action.
Where we are now?
I feel that the consensus about what must be done to overcome the crisis is growing.
We need to regain trust in the euro; correct the macroeconomic imbalances; and continue with the structural reforms to create the conditions for an economic and social revival in Europe. But there the difficulties emerge. To do so, we should be ready to adopt and implement all the measures that are needed. Words and deeds must be very consistent in this difficult period. And this is not always the case.
But this is the only way to maintain and improve our standards of living; give fair opportunities to the young; and hand down good prospects of economic and human development to the future generations.
Ladies and Gentlemen,
We are not at the end of our way out of the crisis yet, but the work to achieve these objectives is in progress.
Notwithstanding the difficulties we all know, the European Commission, the 27 Member States, and the European Central Bank, have devoted considerable energies to tackling the challenges of the Economic and Monetary Union since 2008.
The shock sent around the world by the failure of Lehman Brothers tested the stability of our legal and policy framework. Let us not forget that the Lisbon Treaty – at the time still under ratification by the Member States – had introduced very few innovations in the economic governance of the European Union adopted at the beginning of the 90’s in Maastricht.
Before September 2008, the conventional wisdom was that the toolbox of the EMU was well equipped to cope with the financial turmoil that was brewing in the US. But this perception was completely wrong. What has been achieved so far is quite impressive, but – we must admit – still not enough.
As the crisis turned from financial to fiscal and as its centre moved from the US to Europe, it soon became apparent that the EU – and especially the EMU – did not have adequate institutions and policy tools to weather the storm.
The first and most urgent need was preventing the collapse of Europe’s financial system. The control provided by our State aid rules – adapted to the new situation – gave us the breathing space we needed to discuss, agree and introduce some of the changes required to face unprecedented challenges. We were able to address the root causes of the financial turmoil and put in place preventive measures to minimise the risks that something similar could happen again.
I will come back later to the role played by State aid control in the unavoidable rescue and restructuring of banks in distress. But first let me briefly review the huge regulatory work that has been done as the crisis evolved.
Our financial-regulation systems have seen important changes. Two different legal initiatives are meant to make more open and transparent the markets for derivatives – indicated by many as major factors of instability. The legislative proposals adopted on credit-rating agencies pursue similar goals.
To give banks better safety buffers, we have proposed changes to the Capital Requirements Directive IV and Capital Requirements Regulation, following the international agreements known as Basel III.
The financial system also needed a genuine EU-level supervision. Based on the De Larosière report, three European financial regulatory agencies and the European Systemic Risk Board were established. Since January last year, these bodies have been working with national authorities to supervise cross-border groups and large national financial institutions.
At the same time, a number of measures have been taken to better co-ordinate fiscal policies within the EU and strengthen fiscal and macroeconomic surveillance in the euro area. The European Semester, introduced for the first time last year, responds to the latter objective while changes in the Stability and Growth Pact and the new Treaty for the so-called Fiscal Compact responds to the former.
To these measures, we should add the non-conventional measures adopted by the ECB, from providing long-term liquidity to banks to the new programme of bond buying announced in September.
In addition, the Member States of the euro area set up backstops to provide funding to support countries that face serious difficulties to access the debt market. The European Stability Mechanism has recently come into force to replace the original EFSF.
The crisis had its origin in the financial sector. Thus the exit strategy necessarily begins by tackling the roots of the problems in financial markets. The recession that followed the financial turmoil affected the balance sheets of banks, dragged by toxic assets which in most of the cases were the by-products of housing bubbles.
The fall of Lehman Brothers closed down financial markets. Those banks stuffed with toxic assets and non-performing loans had to re-price them, which generated losses, pushing liquidity and capital needs up.
Obviously, at the time, the only way to obtain fresh capital was to sell assets. This triggered a perverse spiral in which markets were flooded with assets, prices went further down, thus pushing capital needs further up, which needed to be filled with more asset sales.
The result is that capital markets dried out and the recapitalisation of banks could only be made through public resources. This pushed up deficits and debt levels in some countries, thus putting public finances on unsustainable paths, undermining the confidence of investors in the ability of countries to service debt.
In other countries, where the financial system was perceived as sound, a wrong diagnosis of the crisis led to a typical countercyclical fiscal expansion, whereas the real problem had a structural nature. In our country, the permanent shrinking of the housing sector and its induced effects on other activities were taken as cyclical, so that the cyclical expansion, far from tackling the problem, aggravated it by putting pressure on the sustainability of public finances.
Unsustainable fiscal paths, especially in countries with gloomy growth prospects, undergoing a profound structural adjustment, made investors to re-price the originally risk-free sovereign debt which was assigned growing risk premia, thus adding to other risk assets in the banks’ balances and affecting their solvency.
This was much more evident in countries of the euro area. The lack of confidence in the EMU triggered a trend towards the re-nationalisation of public-debt markets. This means that banks in the indebted countries began to hold growing amounts of their sovereign bonds – and this has further weakened them.
We need to break the vicious circle between banks and sovereigns that is paralysing the EU economy. This is what the European institutions are determined to do with their proposals to establish a new banking union and to complete the EMU. Last week’s European Council reaffirmed the need to move towards an integrated financial framework and established as a matter of priority to agree on the legislative framework of a single supervisory mechanism for the euro area by the end of the year. Once adopted, the single supervisor will open the doors to the direct recapitalisation of euro-area banks by the ESM.
But, apart from the deadline accepted for the Single Supervisory Mechanism to be operational, the banking union will not be complete until there are in place a common deposit-guarantee scheme and a single banking resolution authority endowed with the necessary powers and means. These are all necessary measures to break the spiral of the latest stages of the crisis in the euro area.
But, again, they will not be enough. The long-term sustainability of the EMU requires bolder steps towards a fiscal, economic and political union. Europe’s leaders are fully aware of that. The Council gave to the four presidents of the Commission, the Council, the Eurogroup and the ECB the mandate to draw a roadmap that can take us to higher levels of integration.
Their first proposals, presented in June, are articulated in four building blocks for an integrated financial framework, an integrated budgetary framework, an integrated economic-policy framework, and more democratic legitimacy and accountability. Hopefully, the European Council will take further steps in this direction at its next meeting in December.
Ladies and Gentlemen:
Let me explain now in some detail how the European Commission has been using the instruments of State aid control to push towards the restructuring of banks since 2008. When the crisis erupted, State aid was the only available means at EU level that could be quickly deployed to control the massive public bailout of banks in distress – and this will still hold true until the broader solutions I have illustrated become operational.
Between October 1st 2008 and end of 2010, about €1.6 trillion were actually used to support banks. In fact, the initial amount of resources pledged was three times bigger. Most of the support took the form of government guarantees on banks' liabilities and other liquidity support, accounting for over 9% of EU GDP, while recapitalisations and impaired-asset support together represented over 3% of EU GDP, about €300 billion.
From the Commission’s perspective, apart from the huge risks supported by taxpayers’ money, these figures can give us a good idea of the potential distortions of these interventions in the Single Market. But what does it mean that the European Commission controls the public bailouts of banks in distress?
It is our general responsibility to make sure that government support occurs under the same conditions across the Single Market. But in this case our rules had to be adapted to the exceptional conditions created in the financial system by the crisis.
In 2008 and 2009, four Communications were adopted which formed a body of guidance for assessing the various measures taken by EU governments. In all cases, our objective is to return all banks to viability and guarantee that they will never need public support again. Of course, we also make sure that taxpayers’ money is used by the banks to restructure, and not to go back to business as usual.
The cases we have handled so far fall under four main categories.
The first includes banks affected early by the crisis which are implementing their restructuring plans – such as Royal Bank of Scotland, Lloyds and Northern Rock in the UK, a number of German Landesbanken, KBC in Belgium or ING in the Netherlands, to name a few.
The second category covers Greece, Ireland and Portugal – the three euro-area countries receiving financial assistance under a programme. Here the action has a broader scope and includes not only the restructuring of their banking systems but also macroeconomic and financial-stability conditionality.
Then we have the very few cases that we can regard as unfinished business. One particularly complex case in this group is that of Dexia, which is still being discussed.
The fourth and last category comprises Spanish banks, which are being restructured and recapitalised with money lent by the EFSF/ESM. To that end, Spain and the Eurogroup signed a Memorandum of Understanding in July, which detailed the conditions under which such process must be conducted.
After the memorandum was agreed, an independent stress test of the 14 most important banks was carried out and its results were published on the 28th of September representing 90% of Spain’s banking system. The memorandum foresees that – as a result of the exercise – the analysed entities could be allocated between four groups.
The first one, actually called Group zero, would include those entities that already had at least a Core tier 1 capital ratio of 9% of their risk-weighted assets and that would keep a capital ratio of at least 6% even under a drastic stress situation. The stress tests have revealed that seven entities (Santander, BBVA, CaixaBank, KutxaBank, Unicaja, Sabadell and Bankinter) do not have any additional capital needs. Banks in this group are thus excluded from the recapitalisation and restructuring process.
The next group, or Group 1, includes the four already nationalised entities, controlled by the FROB: Bankia, Catalunya Caixa, Nova Caixa Galicia and Banco de Valencia. We knew at the outset that these entities had heavy capital needs even in the central scenario, without stress.
The third group, or Group 2, would include those entities that would not be able to reach the necessary 9% capital ratio in the market, thus needing public support.
The final group, or Group 3, includes the entities which, having capital needs, would present a recapitalisation plan that shows they can get the money from the market, thus not needing public support.
The stress tests found that the banks in groups 1, 2 and 3 have aggregate capital needs of about €60 bn, without taking into account tax effects and possible mergers.
Since the capital needs of the banks in Group 1 were broadly known already at the moment of signature of the MoU, the Bank of Spain, the Commission and the management of the four entities have been working on their restructuring plans during the summer, and the Commission will take a decision approving them by the end of November. At that moment, the ESM will transfer the necessary funds to the FROB, which, in turn, will inject the necessary capital.
Banks in Group 2 – including entities such as CEIS, BMN, Liberbank and Caja3 – have already started working on their respective restructuring plans, which have to be approved by the Commission before the end of the year. By then, as with group 1, the banks will receive the necessary capital.
Those banks that consider that would be able to raise the capital from the market must present recapitalisation plans by the end of this month. If the plans are convincing, the banks will have until the end of June 2013 to obtain the capital. If they have not been able to get the capital they need by then, these banks will be recapitalised with public funds after presenting a restructuring plan; otherwise no further action will be needed. Apparently, Banco Popular would be in this category, and may not be the only one. We will know the details before the end of the month.
With a view to reassure markets on the solvency of Group 3 banks during the period until their full recapitalisation, the FROB will use ESM money to inject the so-called “CoCos” – debt instruments convertible in equity under given circumstances – in case their capital needs represent more than 2% of the risk-weighted assets.
The restructuring plans for the banks in groups 1 and 2, plus those in group 3 that have received CoCos, will be prepared and assessed case by case, but the process will have a few common features.
First, the restructuring plans of banks in Groups 1 and 2 will include the full absorption of losses by private capital, while part of the hybrid capital will also absorb losses and the rest will be converted in the new capital. Therefore the burden sharing of current shareholders and hybrid-asset holders will reduce the need of public money and, thus, the contribution of the taxpayer.
Second, once the restructuring plans are approved, banks will start transferring impaired assets to the SAREB – the bad bank created last week. This bad bank will be set up and operational in December. The profits of the bad bank depend on the transfer price of the assets: the lower the price, the higher the likelihood of selling the asset at a profit.
Third, the restructuring plans of the intervened entities will include all the necessary structural measures that, together with the transfer of the bad assets to the SAREB, will guarantee the viability of the entity. This usually entails a significant reduction of the size of their balance sheet and the implementation of a sustainable and sound business plan. Restructuring plans will also include a series of behavioural commitments, such as acquisition bans or bans on price leadership aiming at minimising the competition distortions induced by the public support received.
Of course, the transfer of assets to the SAREB involves State aid and therefore adds to the compensatory measures. So any banks transferring assets to the SAREB will be subject to the same restructuring obligations and the same conditionality as other banks that receive public capital, in proportion to the amount of aid received.
The objective of these conditions is twofold. On the one hand, to guarantee that banks will not require more public capital under a foreseeable scenario. On the other hand, to minimise the amount provided by the taxpayer.
Taken together, these two conditions maximise the likelihood that the taxpayer recovers most of the investment once the public participations in the entity are sold at market prices. According to this calendar, the whole Spanish financial system will be fully capitalised by mid-2013 at the latest.
Ladies and Gentlemen,
I said at the start that as we analyse the causes of the crisis and ponder its solutions we should never forget for a minute the impact it is having on the lives of millions of Europeans. As you can see, Europe’s challenges are complex and do not afford simple – let alone simplistic –solutions. However, if policy makers and experts allow the debate to be hijacked by its own complexity, more and more people would probably begin to wonder what we are talking about and, not surprisingly, will become disaffected.
This is a serious danger for Europe and for our democracies. It must not come to pass. Nothing can be decided without the informed consent of the people as guaranteed by our democratic processes and institutions. It is the responsibility of political authorities to illustrate clearly the policy options to the citizens and argue their decisions – and experts and academics should be fully involved in this effort. The civil society, on its part, has the right to hold the decision-makers accountable for the options they choose.
The problems are there for everyone to see and everyone agrees on the need to find adequate and sustainable solutions. But there is always more than one way to get there, and this is where a genuine democratic debate is needed. The sacrifices required to consolidate a public budget is the most obvious and pressing example.
Almost everyone agrees that the fiscal authorities will have to reduce spending or raise revenues – or both. But there are many policy options to reduce the debt and each will have its own implications; fiscal and budgetary decisions affect income distribution one way or another.
Now, in our advanced democracies people expect a public debate on things like these and I believe they have every right to see that their expectations are met. And it would be disingenuous for a government to claim that certain spending cut or tax hikes were demanded by this faceless centre of power called Brussels. That is simply not the case. Every major decision taken in our common EU institutions is the result of agreements involving all Member States and their democratic institutions.
The crisis has produced painful consequences for our people so far, and the efforts still required to overcome it are huge. Europe is the place where these efforts can be better managed and fairly distributed. It is possible that some mistakes were made in Brussels or Frankfurt. But to put in danger European integration – and the Economic and Monetary Union built around the euro – would be a tragic error.
Vull reiterar la meva més sincera enhorabona als nous alumnes i a tot l'equip docent i administratiu de la Barcelona Graduate School of Economics: molts ànims per al nou curs, molta sort i molts èxits!