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Saturday,
December 15, 2018 07.44AM / By Luis De Guindos, ECB
. Image Credits: The Telegraph
Being a
speech by Luis De Guindos, Vice-President of the ECB at the 6th Frankfurt
Conference on Financial Market Policy, Frankfurt, 14 December 2018
It is
a pleasure to be here today.
As you
know, there is a long tradition of the ECB participating in SAFE conferences
here in Frankfurt. The second conference in 2014 was already dedicated to
“Banking beyond banks” acknowledging important changes underway in the European
financial landscape.[1] Indeed, this was a prescient
choice of topic given the growth of the non-bank sector, which has continued
unabated ever since. In a recent speech[2], I also highlighted the rapid growth of
asset management in the euro area and at the global level, and the impact this
is having on the structure of the euro area financial sector. In fact, in 2008,
total assets held by investment funds made up just 15% of banking sector
assets. In 2017, these assets had grown to 42% of total banking sector assets,
amounting to €12 trillion. As the non-bank sector continues to grow, so does
the need to ensure that our supervisory and regulatory framework is fit for
purpose.
At the
same time, banks still play an important role in many areas of Europe’s
financial system, notably in the financing of small and medium-sized
enterprises (SMEs). So a healthy banking sector remains crucial to financing
the economy, and despite the progress made in improving the resilience of
European banks, some legacy issues from the crisis continue to weigh on the
system.
This
has two implications for strengthening the financial pillar of Economic and
Monetary Union (EMU), which will be the topic of my speech today.
First,
we need to shore up the banking sector further by thoroughly completing the
reform agenda that emerged in response to the crisis. This means taking the
remaining steps to complete the banking union – in terms of both risk reduction
and risk-sharing.
Second, we need to facilitate the growing role capital markets and the non-bank sector can play in financing economic growth in a sustainable and resilient manner. This requires boosting the capital markets union (CMU) agenda while ensuring that authorities are equipped to face the new challenges of a changing financial landscape. This will require the fragmentation of European capital markets to be overcome and the macroprudential toolkit to be extended beyond the banking system to cover, in particular, the investment fund sector.
I
welcome the decisions taken by the Eurogroup[3] to continue advancing the banking
union, reforming the European Stability Mechanism and building euro area fiscal
instruments.
In the
financial sector – which is my focus today – the response to the crisis has
centred on addressing weaknesses in the regulatory and institutional framework.
The new European regulatory framework is making Europe’s banks more resilient
and gives authorities the tools to act when risks begin to build up.
Furthermore, banking union elevates the supervision and resolution of banks to
the European level.
This
strategy has paid off: substantial risk reduction has been achieved, is ongoing
and should continue. Banks now hold more and better-quality capital than in the
past[4], and have improved their liquidity
positions and leverage. Addressing legacy issues, such as high levels of
non-performing loans (NPLs), is progressing well. For banks under direct ECB
supervision, NPL levels fell from €958 billion when the Single Supervisory
Mechanism was launched to €657 billion in June 2018. The framework for
resolution, following the introduction of BRRD and the implementation of
Minimum Requirements of Eligible Liabilities (MREL) also contribute to increase
buffers, reduce risk and thereby the scope for risk sharing.
However,
the euro area’s financial architecture is not yet complete.
There
is some good news: there is now an agreement to make the common backstop to the
Single Resolution Fund (SRF) operational, which will instil confidence in the
markets that bank resolutions will happen in an orderly fashion. There is also
a recognition that it is time to start political discussions on the missing
third pillar of the banking union – a European deposit insurance scheme (EDIS).
The high level group in charge of the discussions must be ambitious and ensure
that we live up to the agenda laid down in the roadmap on completing the
banking union agreed by finance ministers in 2016.[5]
The
ECB has often made the point that the opposing sides of the debate – risk
reduction versus risk-sharing, and private risk-sharing versus public
risk-sharing – are in fact complementary.[6]
Completing
the institutional leg of the banking union, with the SRF and EDIS, would move
us closer to a level playing field. In a genuine banking union, banks would
operate across borders and diversify their sources of income, which would allow
them to continue lending to the real economy even when faced with localised
shocks. This would create private risk-sharing across the euro area and shield
regions from localised credit crunches.
But a
level playing field for banking would also enable risk reduction. Increased
cross-border competition between banks, backed by a solid system of European
supervision and the winding down of unwarranted national protections, could
further incentivize banks into getting their balance sheets in order.
At the
same time, the SRF and EDIS would also constitute a form of private
risk-sharing by providing a final, powerful backstop. They enable bank
resolution, limit contagion in the case of bank defaults thereby contributing
to safeguarding overall financial stability. This, in turn, would reduce the
need for public risk-sharing in the first place. Such an approach is borne out
by the experience of other advanced economies, such as the United States, where
hundreds of banks were resolved successfully by the Federal Deposit Insurance
Corporation with no long-term fiscal costs.
While
the case for completing the banking union is strong, supporting EDIS is seen by
some as tilting at windmills. Indeed, three years after the initial Commission
proposal, progress has been very limited. But the potential benefits of EDIS
are not the illusions of a romantic daydreamer like Don Quixote; they are, in
fact, very real. EDIS would provide uniform confidence in deposits across
Europe which would be beneficial for all European economies, as no single
banking system is immune to a potential bank default. EDIS would therefore
further underpin EMU by ensuring that a €1 deposit is just as safe, and just as
valuable, wherever you are in the euro area.
Completing
the post-crisis agenda is therefore crucial, but we should not only look back.
After dealing with banking sector fragilities, we should now be shifting our
attention to the steadily growing non-banking system, which is changing
Europe’s financial landscape and whose potential to contribute to growth has
not been fully unlocked.
A
range of banking activities is increasingly carried out by non-banks, notably
insurance companies and the investment fund sector at large. Total assets of
the euro area investment fund sector have expanded by roughly 170% between 2008
and 2017, on account of both net cash inflows and rising asset valuations.
Deeper
and more efficient bond and equity markets in Europe would permit economies of
scale and allow capital to be allocated to the most productive uses at the
European level, in line with the Single Market objectives. By enhancing
cross-border private risk-sharing and consumption smoothing through
cross-border holdings of assets, CMU can reduce the need for public
risk-sharing.
Developing
capital markets would also alleviate the shortage of risk capital[7] that hinders the growth of
Europe’s innovative start-ups and SMEs by increasing the presence of investors
with high risk-bearing capacity. As in the case of depositors, issuers and
investors should enjoy the same legal rights in capital market activities across
the EU, irrespectively of their country of domicile. Furthermore, Brexit
accentuates the need to develop and integrate the EU’s capital markets to
prepare for the likelihood that the City of London will play a reduced role in
the future.[8]
In
terms of legislation, the CMU agenda has already yielded some positive results,
but a more ambitious long-term approach should be pursued.
On
insolvency frameworks, the Commission has put forward a number of proposals[9] which aim to enhance aspects, such
as the efficiency of debt recovery procedures.
In the
realm of taxation, adopting the proposal on a common consolidated corporate tax
base would help to reduce or remove the bias towards debt over equity in some
Member States, thereby facilitating the development of equity markets.
The
creation of a pan-European personal pension product, for instance, would help
channel more savings into long-term investments through a portable,
pan-European product.
Finally,
fostering a deep and efficient CMU means reviewing the supervisory framework to
align it with the cross-border nature of capital markets, enhance supervisory
and regulatory convergence and remove possibilities for regulatory arbitrage,
also crucial in the context of Brexit.
Indeed,
the non-bank financial sector may harbour leverage and liquidity risks,
requiring additional efforts to address emerging vulnerabilities at the system
level.
First,
the asset management sector is highly connected with other parts of the
financial system through ownership links, common asset exposures and the
provision of wholesale funding to banks.
Second,
liquidity mismatches and leverage often build up slowly over time. In the euro
area, we see that investment funds have been taking on higher credit risk and
duration risk in the current market environment. And there are strong
indications that liquidity risks are building up in the sector with the share
of less-liquid assets in the sector growing continuously since the global
financial crisis.
Third,
the overall leverage of the sector is difficult to grasp. Alternative
investment funds do not face any binding restrictions on leverage. A tail of
highly leveraged bond and hedge funds with leverage multipliers exceeding 30
compares to an average leverage ratio for banks of below 20 in the euro area.
As the
global crisis has shown, we must remain vigilant to possible new risks that
might emerge in the financial system. We need to better understand the
macroprudential dimension of risk in the investment fund sector. And we need to
further enhance the sector’s resilience to system-wide shocks.
The
existing regulatory framework, with the Undertakings for Collective Investment
in Transferable Securities and Alternative Investment Fund Managers Directives
as the main building blocks, is well designed to address micro-prudential and
consumer protection concerns. However, additional tools need to be developed to
address rising risks in the investment fund sector from a macroprudential
perspective.
Macroprudential
policy is primarily preventive. The toolkit available to macroprudential
authorities should include ex ante tools to limit the build-up of risks
associated with liquidity and leverage in the investment fund sector, such as
minimum mandatory liquidity buffers and redemption notice periods.
The
investment fund industry in the EU is furthermore highly concentrated in a few
jurisdictions, but – due to the diverse asset holdings and investor locations –
the impact of adverse developments in this sector may be felt across the EU. So
we should consider elevating the supervision of investment funds and the
potential activation of macroprudential tools to the European level. This would
be also in line with the spirit of CMU.
Let me
conclude. Finalising EMU reforms, completing banking union and capital markets
union must stand out as unquestionable objectives. We need to pursue a
comprehensive long-term European strategy for building a more complete
financial union that fosters both risk-sharing and risk reduction, which, as I
argued, are two sides of the same coin. This will strengthen the financial
system in the long run.
Achieving
these objectives hinges on building a strong degree of trust between Member
States and European institutions. It fundamentally hinges on looking beyond
short-term national benefits and pursuing European goals. Europe should live up
to its ambitions.
Thank
you for your attention.
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