02 December 2013

ECB/Constâncio: Banking Union and the future of banking

Let me begin by recalling why Banking Union – which includes the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) – is an essential complement to monetary union. There are three main reasons:

First, monetary union implies increasing integration between financial institutions and markets, be it through internationally active banking groups, bilateral trading exposures, or presence in the same market segments. Such financial integration also creates what Dirk Schoenmaker has termed a 'financial trilemma': it is impossible to maintain the level of integration required for monetary union while practicing national supervision, without putting European financial stability at risk.

A second reason why Banking Union is essential to monetary union is that it supports the implementation of the single monetary policy. The even transmission of monetary policy across all member countries of the euro area requires a level of financial integration that ensures well-functioning cross-border money markets. Yet we have seen during the crisis that without a euro area-wide approach to financial governance, financial markets can end up re-nationalising.

The third reason that justifies the Banking Union has to do with the effects of unsupervised cross-border lending on real economic developments. Contrary to the “it’s mostly fiscal” view of the crisis, financial sector developments largely explain the build-up of unsustainable current account and competitiveness positions in peripheral countries before the crisis.

The SSM and the practice of banking in Europe

• I expect the SSM to implement the most advanced supervision of banks. This means, of course, using all the modern methods to be forward-looking and risk-based, focusing on the viability of banks’ business models, the robustness of their balance sheets to shocks and the evolution of their liquidity and funding positions over time.

• The SSM will have to address the problems created by the heterogeneity in the way that banks calculate risk-weighted assets.

• The SSM will lead to a harmonised treatment of non-performing exposures and provisioning rules, which at present vary between jurisdictions and are not directly comparable for investors.

• As a result of these changes, the SSM will create the conditions for further integration of the European banking market. On the cost of doing business, compliance costs for cross-border banks should be reduced by the development of the EU single rulebook and the single supervisory model within the SSM.

• The SSM might open a period of restructuring in the European banking sector, in particular through more mergers and acquisitions.

That said, there are also frictions that create obstacles to closer bank market integration. These include different legal systems, corporate governance structures and tax regimes that exist in Europe, as well as different insolvency procedures. Further integration is needed in these areas if we are to gravitate towards a true single market in capital in the euro area.

Looking further ahead, I expect this period of structural change in the banking sector to also have a permanent effect on the structure of intermediation. In the euro area, banks have historically played an important role in financing the real economy. I expect the future of banking to involve some rebalancing away from such high levels of bank-based intermediation and towards more capital market-based intermediation.

However, while I see some advantages for more disintermediation in the euro area, I do not think we should go too far in the opposite direction and replicate the US model. A predominance of capital markets in financing the economy opens opportunities but brings also more volatility. A balanced funding mix between banks and capital markets is best for financial stability – and close bank-firm relationships in several countries are simply part of the fabric of the euro area economy. But this implies that we need to have profitable, viable and stable banks in the euro area. 

For this reason, I expect Europe to keep its universal banking model, with some limits on high-risk proprietary trading as we have seen in the recent German and French legislation, inspired by the Liikanen Report. Radical separation of retail and investment banking functions, eliminating the European concept of balanced universal banks would go too far, especially when we know that Europe’s universal banks have faired relatively well throughout the crisis and returned to profitability more quickly than others.

Full speech

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