Pros and Cons of Banking Union Participation: Insights from NEPR Conference
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Svend E. Hougaard Jensen, Ph.D.
Professor, ECON, CBS
Director, PeRCent, CBS
Chairman, Scientific Council, Bruegel
Member, The Systemic Risk Council
Structure
–
Rationale
–
Orders of magnitude
–
EUNEZ, mind the gap…
–
AOB
Rationale
•
The academic literature has for long pointed to the need for a
banking union
when there is cross-border banking.
•
Papers include
Folkerts-Landau and Garber (NBER,
1992); Schoenmaker
(Kluwer, 1997); Vives (JFSR, 2001).
•
The ”trigger” is similar to the ”
inconsistent quartet
” in int’l finance: free trade,
capital mobility, fixed/managed exchange rates, and monetary policy
independence (Padoa-Schioppa, 1982)
•
Here’s a
financial trilemma
, stating that the three objectives of financial
stability, cross-border banking and national financial polices cannot be achiéved
at the same time (Schoenmaker, 2011)
•
More generally, the interests of
home
and
host
countries of cross-border banks
are likely to deviate in distressed situations.
•
Interestingly, this point is listed by KE as a potential benefit of a banking union.
Coordination failure
Rationale
•
Suppose country A is not only the
home
country of banks from
country A but also
host
country of banks from country B.
•
In order to provide financial stability in country A, the
authorities in country A would need information (about capital
and liquidity positions of distressed banks) from the
supervisory authorities of country B.
•
However, country B may have reasons to hold back such
information.
•
Failure to get this information, fully and on time, might
(seriously) jeopardize the possibility for country A to deliver
financial stability in country A.
•
So, there’s a need for a supranational authority.
Cross-border banking
Rationale
•
The actual trigger for introducing banking union in 2012 was the
perceived need to avoid that tax payers are stuck with the bill when
banks are rescued…
•
KE refers to Farbi and Tirole (2018) as an academic contribution
showing how the risk of a doom loop may create a rationale for
centralized supervision.
•
The rationale for centralized supervision in this analysis arises partly
because of cross-border externalities from sovereign default that are
sufficiently large to justify transfers from foreign countries.
•
For MU members, the MU can be at stake…
•
For for small stand-alone countries the risk may be much smaller, as
they aren’t constrained in the same way to act as LOLR vis-à-vis the
government.
Doom loop
EUNEZ
•
P3: “
In this article, I am going to discuss the
pros
and
cons
of being a member of the
banking union, mainly from the perspective of
a country that is not obliged to participate
because of its adoption of euro as its
currency”
.
•
Effectively, the focus of the paper is a study of
whether it would pay for Sweden (and
Denmark) to join the banking union…
Ins vs Outs
Cross-border penetration of European banking
EU; % of total banking assets
Banking systems across three regions: BU, EU and
US
End-2014
Cross-border banking penetration in non-euro
area Member States
End-2014
Top 10 banks in non-Banking Union
2014
Mind the gap
•
Preparatory (SSB) vs. ultimately (ECB). This is an important discussion
of the location of the supervisory authority.
•
So, EUNIZ has a problem here, by having NO representation on the
ECB’s governing council…
•
DK has two decades of experience with taking part in such an
arrangement, by being
de facto
in the EZ when it comes to MP but
not being in the governing council…
•
KE advocates in favour of letting SSB decide. Or establishing SSM
outside of the ECB. Right?
•
But: MP and FP are intertwined, as KE notes…
•
Is there as ”threshold” of cross-border banking: if above, EUNEZ
should join BU…?
SSM
Mind the gap
•
How about BRRD (Bank Recovery and Resolution
Directive) – which
applies to all EU countries
?
•
“In principle, the introduction of a common framework
for bank resolution through BRRD should reduce the risk
of inefficient outcomes regarding cross-border banks in
financial distress.”
•
So, there may be a way out through BRRD – without
joining the BU? How far is BRRD from producing
outcomes similar to those of BU?
SRM
Mind the gap
•
If EUNEZ joins BU, it will have to transfer an amount
of contributions to the SRF corresponding to what it
would have transferred if it had participated in the
SSM and SRM at the outset.
•
But if EUNEZ decides to leave, will the contributions
transferred to the SRF be transferred back?
•
Has it been finally agreed to use the ESM as a
backstop for SRF? And if EUNEZ joins BU, is the
treatment the same as for EZ members?
SRM
Mind the gap
•
Clearest economic benefit of enlarging the
banking union is the prospects of more
efficient resolution of cross-border banks.
•
But how are the gains distributed?
•
Cherry picking countries (DK; SE)
•
Could “flexible” membership be considered
(“LIFO?)
Why it’s difficult to persuade the Scandinavian EUNEZ
Non-performing loans ratios
(%)
in the banking union
Q2 2019
Mind the gap
•
“Clearest cost is the loss of regulatory and supervisory independence”. However, the
size of that cost may be small in a world where financial markets are highly
integrated.” Well, should perhaps be counted as a benefit.
•
“The SSM has significant resources and will over time gain extensive experience in
supervising different types of institutions (Beck, 2019). The fact that it is located far
from most of the institutions that it supervises may also reduce the risk of regulatory
capture.”
•
To me, this may be a key benefit of joining the BU – perhaps the most important one!
•
The SSM, based in the ECB, would be able to not only attract talent and develop
seniority, having a team of very experienced, highly professional and well-paid staff.
•
FSAs in smaller EUNEZs typically have high turnover rates, with the best and most
ambitious staff moving to the private financial sector.
•
But supervision is complex, and make heavy demands on skills to match the expertise
available in commercial banks etc.
SSM
Discussion by Svend E. Hougaard Jensen on the paper by Karolina Ekholm regarding the advantages and disadvantages of joining the banking union, focusing on issues such as cross-border banking, coordination failure, and the doom loop. The paper analyzes the tensions between financial stability, cross-border policies, and national interests in the context of a banking union.
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Discussion of paper by Karolina Ekholm: Pros and cons of taking part in the banking union NEPR conference on Financial Regulation and Macroeconomic Stability" Ministry of Finance, Helsinki, 12 December, 2019 Svend E. Hougaard Jensen, Ph.D. Professor, ECON, CBS Director, PeRCent, CBS Chairman, Scientific Council, Bruegel Member, The Systemic Risk Council
Structure Rationale Orders of magnitude EUNEZ, mind the gap AOB
Rationale Coordination failure The academic literature has for long pointed to the need for a banking union when there is cross-border banking. Papers include Folkerts-Landau and Garber (NBER, 1992); Schoenmaker (Kluwer, 1997); Vives (JFSR, 2001). The trigger is similar to the inconsistent quartet in int l finance: free trade, capital mobility, fixed/managed exchange rates, and monetary policy independence (Padoa-Schioppa, 1982) Here s a financial trilemma, stating that the three objectives of financial stability, cross-border banking and national financial polices cannot be achi ved at the same time (Schoenmaker, 2011) More generally, the interests of home and host countries of cross-border banks are likely to deviate in distressed situations.
Rationale Cross-border banking Suppose country A is not only the home country of banks from country A but also host country of banks from country B. In order to provide financial stability in country A, the authorities in country A would need information (about capital and liquidity positions of distressed banks) from the supervisory authorities of country B. However, country B may have reasons to hold back such information. Failure to get this information, fully and on time, might (seriously) jeopardize the possibility for country A to deliver
Rationale Doom loop The actual trigger for introducing banking union in 2012 was the perceived need to avoid that tax payers are stuck with the bill when banks are rescued KE refers to Farbi and Tirole (2018) as an academic contribution showing how the risk of a doom loop may create a rationale for centralized supervision. The rationale for centralized supervision in this analysis arises partly because of cross-border externalities from sovereign default that are sufficiently large to justify transfers from foreign countries. For MU members, the MU can be at stake For for small stand-alone countries the risk may be much smaller, as
EUNEZ Ins vs Outs P3: In this article, I am going to discuss the pros and cons of being a member of the banking union, mainly from the perspective of a country that is not obliged to participate because of its adoption of euro as its currency . Effectively, the focus of the paper is a study of whether it would pay for Sweden (and
Cross-border penetration of European banking EU; % of total banking assets
Banking systems across three regions: BU, EU and US End-2014
Cross-border banking penetration in non-euro area Member States End-2014
Mind the gap SSM Preparatory (SSB) vs. ultimately (ECB). This is an important discussion of the location of the supervisory authority. So, EUNIZ has a problem here, by having NO representation on the ECB s governing council DK has two decades of experience with taking part in such an arrangement, by being de facto in the EZ when it comes to MP but not being in the governing council KE advocates in favour of letting SSB decide. Or establishing SSM outside of the ECB. Right? But: MP and FP are intertwined, as KE notes
Mind the gap SRM How about BRRD (Bank Recovery and Resolution Directive) which applies to all EU countries? In principle, the introduction of a common framework for bank resolution through BRRD should reduce the risk of inefficient outcomes regarding cross-border banks in financial distress. So, there may be a way out through BRRD without joining the BU? How far is BRRD from producing outcomes similar to those of BU?
Mind the gap SRM If EUNEZ joins BU, it will have to transfer an amount of contributions to the SRF corresponding to what it would have transferred if it had participated in the SSM and SRM at the outset. But if EUNEZ decides to leave, will the contributions transferred to the SRF be transferred back? Has it been finally agreed to use the ESM as a backstop for SRF? And if EUNEZ joins BU, is the treatment the same as for EZ members?
Mind the gap Why it s difficult to persuade the Scandinavian EUNEZ Clearest economic benefit of enlarging the banking union is the prospects of more efficient resolution of cross-border banks. But how are the gains distributed? Cherry picking countries (DK; SE) Could flexible membership be considered ( LIFO?)
Non-performing loans ratios (%) in the banking union Q2 2019
Mind the gap SSM Clearest cost is the loss of regulatory and supervisory independence . However, the size of that cost may be small in a world where financial markets are highly integrated. Well, should perhaps be counted as a benefit. The SSM has significant resources and will over time gain extensive experience in supervising different types of institutions (Beck, 2019). The fact that it is located far from most of the institutions that it supervises may also reduce the risk of regulatory capture. To me, this may be a key benefit of joining the BU perhaps the most important one! The SSM, based in the ECB, would be able to not only attract talent and develop seniority, having a team of very experienced, highly professional and well-paid staff. FSAs in smaller EUNEZs typically have high turnover rates, with the best and most ambitious staff moving to the private financial sector. But supervision is complex, and make heavy demands on skills to match the expertise
