In its study on "Asymmetries in the new European banking regulation: analyzes and proposals", the CER economic research center highlighted how the current regulatory system of the European banking industry is marred by various problems. In particular, various asymmetries were found in the implementation of banking rules, which concern both the European Banking Union and the adoption of the international Basel Accords.
In this context, it appears very unlikely that in the medium to long term Europe will actually be able to equip itself with a single banking market that pursues two general principles: i) the elimination of the segmentation present between the various markets; ii) the reduction of risks on financial instability. As Dirk Schoenmaker pointed out, after overcoming the most critical phase of the financial crisis, "governments have started to shop selectively on the Banking Union list". Reducing financial segmentation would, on the other hand, also have important effects on the growth prospects of the entire European Union.
In order to achieve these two fundamental objectives, according to the ERC, various other interventions are necessary, which are listed below. So here are the ERC's proposals to change European financial regulation.
REVIEW OF CENTRAL SUPERVISION
The sizing approach adopted within the Single Supervisory Mechanism to identify banks supervised by the ECB should be reviewed.
It should be avoided that in the most fragmented systems a significant portion of the market is not subject to supervision by the ECB, remaining instead subject to domestic supervision with the related problems of adopting non-homogeneous supervisory methods.
To achieve these objectives, a minimum share of the domestic banking market that must be subject to centralized supervision by the ECB should be established. Thus the number of directly supervised banks would increase for fragmented banking systems until the minimum threshold is reached.
STRENGTHENING OF THE SINGLE RESOLUTION FUND
As highlighted in paragraph 1.2, the Single Resolution Fund needs greater financial resources if it is actually to act as a bulwark against the occurrence of systemic banking crises.
De Groen and Gros estimate that an optimal size of the Fund should be between 58 and 101 billion euros, taking into account both the participation in losses by shareholders and other creditors and the maximum intervention limit of the Fund of 5% of the total of liabilities.
Looking at past experiences, and in particular the S&L crisis, a suitable endowment should be set at a value 20 times higher than the amount that the Fund will reach in 2024. In other words, more than a trillion euros would be needed to have such resources in order to stop any systemic banking crises in the bud.
One way to increase the endowment of the Fund could be to impose forms of contribution also to non-bank intermediaries. For example, investment funds and large non-bank issuers of financial securities may be required to contribute annually to the Fund based on some measure of their degree of risk.
Alongside the strengthening of the private resources available to the Fund, the possibility of opening an unlimited credit line with the ECB, in concert with the European System of Central Banks, should also be envisaged. In situations where the systemic risk could be very high, so as to put at stake the survival of the entire European and international financial system, there would in fact be a need for a lender of last resort. Only an institution with potentially unlimited "firepower", such as the ECB, could effectively play the role of financial backstop in Europe.
MANAGEMENT OF THE PRESENCE OF THE STATE IN THE BANKING CAPITAL
The presence of public capital in many European banks constitutes a market distortion. On the one hand, in fact, several studies have highlighted how publicly controlled banks are more inefficient and cause greater risks to financial stability than private banks. On the other hand, the imperfect implementation of the European Banking Union, with a load of financial risks poorly distributed among the member countries, determines asymmetries in treatment between the systems that implemented significant state aid before the Banking Communication and those which political opportunity, also given the public finance conditions, have not implemented the same interventions.
In fact, in the former, the Government can intervene to help banks in difficulty, which it has already helped previously, without triggering sanctions and above all without having to initiate the bail-in in advance. In the latter, on the other hand, the room for maneuver to help one or more banks that find themselves in serious difficulty is much more limited.
To overcome this different treatment, the European Commission should set a medium-term target on the tolerable percentage of participation in the capital of banks by the public sector. Systems that have participation levels above the target should progressively reduce their share. Conversely, in systems that are below the target, more flexibility should be granted in intervening in the banking market without triggering sanctions for the violation of state aid, much less activating the bail-in clauses.
IMPLEMENTATION OF THE UNIQUE DEPOSIT GUARANTEE SCHEME
The absence of the third pillar of the Banking Union is a factor that destabilizes the entire system of European rules. Launching the Banking Union before having fully defined all its pieces is perhaps the most serious mistake made by the European legislator.
Without the third pillar, with a single resolution fund endowed with scarce resources and in the absence of a financial backstop, the risks are very high that the failure of a large operator could determine the spiraling of the crisis which could also lead to a bank run. As highlighted by Peter Praet “A European Deposit Insurance Scheme would enhance overall depositor confidence […]. This is the very foundation of insurance: by pooling resources and risks across a larger and more diverse group, the overall shock-absorbing capacity of the system increases. In this sense, risk sharing turns into risk reduction”.
Every banking system should be required to pay a fee in order to participate in the single deposit guarantee scheme. To avoid loading the burden directly on the banking system, a single European taxation system could be envisaged on financial assets, modulated according to the degree of riskiness and opacity of the assets. Each country should contribute based on the risk underlying its banking system, the fundamental parameters of which should be the level of financial leverage (also calculated on the shadow banking system) and the texas ratio, i.e. the ratio of non-performing loans to capital and to the resources set aside for loan losses.
In line with US and Japanese experiences, the Deposit Guarantee Fund should be merged with the Resolution Fund. The unified fund should then have access to potentially unlimited forms of financing (backstop), as already highlighted in point B above.
Compared to the proposal for the implementation of EDIS put forward by the European Commission, the transition period towards full insurance should also be reduced.
DEPOSIT GUARANTEE FOR BANKS SUBJECT TO DIRECT SUPERVISION
Given the resistance from some countries, one could proceed step by step in the establishment of a single guarantee for depositors. One hypothesis could be to activate a deposit guarantee fund limited, in an initial phase, to the 130 banking groups subject to direct supervision by the ECB. In this way the major continental operators would start a process which over time could gradually involve smaller credit institutions.
ADOPTION OF A GENERAL CRITERION ON THE LEVERAGE RATIO
Internal risk assessment models, used for the purpose of calculating capital absorption, have demonstrated all their limitations over time. The revision proposals discussed in the context of Basel IV go precisely in the direction of reducing the role of internal models, excluding their application in the case of exposures to banks, other financial institutions and large companies (so-called large corporates) and imposing the adoption of minimum thresholds of the parameters in order to ensure a minimum prudential level for the remaining part of the assets.
A new approach should be to shift the emphasis from capital ratios based on risk-weighted assets to simpler ones linked to balance sheet assets and off-balance sheet items. In other words, more weight should be given to the leverage ratio, imposing minimum levels much higher than the 3% imposed by Basel III. A reasonable level could be 6%.
Furthermore, constraints on financial leverage should also be applied to non-banking operators to avoid the excessive growth of the shadow banking system.
From this point of view, the emphasis with which the press and the Italian banking industry celebrated the decision to postpone the discussion on Basel IV to a date to be defined, thanks above all to the pressure exerted by the countries of Northern Europe, appears out of place. As discussed above, internal risk assessment models are mainly applied by large European banks, those operating mainly in the Nordic countries. Limiting the possibility of continuing to use these approaches, with great savings in terms of capital absorption and, at the same time, with a serious risk for the financial stability of the Eurozone, was an opportunity that was not to be missed, above all in the interests of the banks not large in size.
DIVERSIFICATION OF GOVERNMENT BONDS
If we were to go in the direction proposed in the previous point, the debate about the introduction of a risk weighting also on government bonds would lose relevance.
One problem that should in any case be tackled is that relating to the excessive concentration of the government securities portfolio in the issuer constituted by the bank's country of origin.
To achieve this objective, constraints should be set in terms of the minimum required diversification, to be achieved in a period of time long enough to reabsorb the repercussions of the euro area sovereign bond crisis. By way of example, it could be envisaged that the portfolio of Government bonds to tend cannot be constituted for more than a certain threshold by a single issuer.
CREATION OF A EUROPEAN BAD BANK
Cleaning bank balance sheets of problem credits in the euro area is still a long way off, especially when compared to that of the USA where the financial crisis began.
The situation becomes even more critical if the range of assets of uncertain value is extended to include financial assets, and in particular derivatives.
Given the pressures on the profitability of European banks, above all due to the very low level of interest rates and the disappointing growth dynamics, the banking industry does not have, and presumably will not have, the strength necessary to clean up its balance sheets autonomously.
It would therefore be appropriate to create a bad bank at European level that can quickly clean up the balance sheets from toxic assets.
The ESM, the so-called bailout fund, could provide part of the capital needed to set up the bad bank. Another part could be provided by the private sector. The bad bank could then finance itself on the market through the issue of bonds, then purchased on the secondary market by the ECB as part of the quantitative easing.
NATIONAL BAD BANKS, BUT WITH COMMON COORDINATION
An alternative to the European bad bank could be to impose in every European country, among those that have not already done so, the creation of a systemic bad bank that buys domestic toxic assets. However, national bad banks should have a common coordination in order to facilitate the development of a sufficiently large market for securitized securities, not necessarily only bad ones. The European Commission should facilitate this step by providing for derogations from the rules on state aid. Furthermore, the ECB could provide a financial stimulus to national bad banks by expanding the pool of securities underwritten under quantitative easing to include liabilities issued by these operators.
