10 September 2013

BoI/Visco: The exit from the euro crisis – Opportunities and challenges of the Banking Union

"The key to success will be a shared determination to advance towards a fully-fledged European Union. In the current stage, the test of our resolve is the building of an effective Banking Union."

A serious crisis of confidence in the very survival of the single currency ensued, with adverse consequences for the real economy. The situation deteriorated most severely in the banking systems of the countries most directly affected by the tensions, whose perceived credit standing soon aligned with that of their sovereigns; wholesale funding conditions deteriorated sharply, cross-border interbank lending all but dried up. There emerged a perverse loop between fragile public finances, weak economic performance, and deteriorating bank conditions.

To ensure stability over the longer run, the effort to reform the European governance has been stepped up. The subsequent stages are outlined in the report Towards a Genuine Economic and Monetary Union and in the Blueprint for a Deep and Genuine Economic and Monetary Union published by the Commission last November. Both documents envisage a banking union, the introduction of autonomous fiscal capacity for the whole euro area, and a common budget; they set the scene for the eventual political union. A keystone of institutional reform, Banking Union is crucial to break the perverse feedback loop between sovereigns and domestic banking systems. It has three key components: a single supervisor, a single bank resolution mechanism, and a single deposit insurance scheme.

In the summer of 2012 the European leaders decided to give priority to the construction of the first component, the Single Supervisory Mechanism. The SSM comprises the ECB and the national supervisory authorities. For the largest banks it will be based on strict integration of European and national structures. For the others, it will involve the direct responsibility of national authorities, under common guidelines; the ECB will retain the right to take over direct supervision responsibilities where circumstances warrant. This far-reaching institutional innovation will require an organisational adaptation as far-reaching and at least as complex as that leading to the single monetary policy. The delicate launch phase will require substantial investment in human resources and technical infrastructure. The national supervisory authorities’ workload will not diminish, as there is aim to build a unitary new mechanism from frameworks that differ in many respects. The preparatory work is proceeding at the greatest speed compatible with the challenges of the task.

Building on the technical experience and reputation of national authorities, the SSM will have to ensure a supranational vision. Supervisory practices within the euro area are quite heterogeneous. It is vital to avoid any lowering of standards and instead to converge on the best practices in supervisory methodology, modelling and assessment of banking risks. This will ensure early warning of emerging instability at individual banks and at systemic level. It is attached special importance to aspects that are a fundamental part of the tradition of the Bank of Italy, such as the central role of on-site inspections, methodologically robust quantitative analysis, and close interaction with banks.

If successfully managed, the SSM will bring substantial benefits to the single market: it will improve the effectiveness of monetary policy transmission, counter the ring-fencing trends observed in the last years, thus fostering financial integration, facilitate comparison between banks and banking systems in different countries, and in this way improve the monitoring, control and mitigation of vulnerability factors.

Work is also continuing on the single resolution mechanism (SRM), the second component of the banking union. This is indispensable to align the responsibilities for supervising banks and handling crises. The Bank Recovery and Resolution Directive is intended to harmonise the heterogeneous national practices, rules and tools for bank crisis management and keep rescue operations from being financed with public funds. The Directive lays down a number of preventive measures, together with rules for timely intervention and resolution, including the bail-in of bank creditors. A fund to be financed by the banks themselves will be earmarked for bank resolution. The European Commission recently issued a proposal for a Regulation – which should be fully operational in 2015 – to institute an SRM under a single resolution authority and with pooled resources. Concerning the third component of the Banking Union, a draft directive has been prepared to implement a common network of national deposit guarantee schemes by the end of this year.

The institution of the SRM must proceed expeditiously, with appropriate negotiations between national and Community authorities. Once the mechanism is fully operational, the availability of adequate resources will allow the cost of crises to be divided between the bank’s shareholders, creditors and the banking system as a whole.

During the transition to the SRM, the risk of a vicious circle between a fiscally weak sovereign state and its fragile domestic banks persists. The ESM will only be able to directly recapitalise banks – with the aim of restoring their viability and obtaining a remuneration of the capital invested – after the effective entry into operation of the SSM. There remains the possibility of using ESM funds indirectly, by means of loans to member states, but this would bear on the public debt of the countries concerned, bringing the bank-sovereign loop back into the picture.

Full speech

© BIS - Bank for International Settlements