25 May 2012

ECB/Praet: European financial integration in times of crisis

In his speech Mr Praet said that, as on other occasions in European history, the crisis offered a chance to progress. Europe needs to move towards a "financial union", with a single euro area authority responsible for the supervision and resolution of large and complex cross-border banks.

The topic of Mr Praet's talk was financial integration in Europe: its meaning, its importance, recent developments, and – not least – why the ECB cares about it, and what the ECB does to preserve it. Well-developed capital markets are important – as we all know – because they channel funds from savers to investors, promote the efficient use of resources, and create more opportunities for individuals and firms, ultimately leading to higher growth. But this is not yet sufficient in a multi-country setting. A united Europe, especially one that has decided to have a single currency, needs united financial markets as well. Financial integration – that is the cohesion of financial markets and their ability to operate as a single entity – enhances these benefits and gives them a cross-country dimension. Not surprisingly, a single market for capital and financial services has been a central goal of the European Union for decades. Many policy initiatives have paved the way to greater financial integration, the most ground-breaking of which being, without a doubt, the introduction of the euro. This progress towards financial integration was interrupted and reversed by the global financial crisis and, more recently and dramatically, by the European sovereign debt crisis.

Mr Praet first talked about why integrated financial markets are important, for Europe in general and for the conduct of the single monetary policy of the ECB in particular. He then explained the role the ECB plays in this area. Next he focused on developments during the first 10 years after the introduction of the euro – which saw continuous and significant progress in the integration of European financial markets – and then on developments in more recent years, which have been marked by a dramatic reversal of this progress. Mr Praet concluded by indicating actions the ECB has taken to protect financial markets, including their integration, from the impact of the crisis, and what further actions, largely outside the control of the central bank, are needed to ensure integrated and functioning European financial markets going forward.

Financial integration has made good progress in the EU, and particularly in the euro area, and has brought with it substantial benefits. However, recently, it has been severely affected by the crisis. The effect is unfortunately proving to be pervasive and persistent. The ECB’s measures targeted at financial markets have helped to mitigate the problem, but the problem is far from solved. Hence, further action is needed.

To restore and preserve financial integration, the euro area financial stability framework needs an urgent overhaul. Despite important recent improvements, it is still marked by the cross-border openness of private financial markets and highly mobile capital flows on the one hand, and by the supervisory, regulatory and crisis management arrangements which, on the other hand, remain essentially national. This dichotomy is detrimental in two ways: it prevents, in normal conditions, a reaping of the full benefits of the removal of barriers to cross-border movements of capital and financial services; and it impedes, in crisis times, even-handed action to maintain financial stability that is consistent across the euro area. The resulting fragilities become more apparent under stress. It is now clear that these weaknesses in the EU’s crisis management framework, exposed during the crisis, are largely responsible for the partial re-nationalisation of several important financial market segments.

Significant reforms are already under way in the EU. The economic governance framework is being overhauled on the fiscal and macro-economic sides. The establishment of the European Financial Stability Facility and the European Stability Mechanism and the adoption of the “six-pack” are important milestones. Also, financial supervision has undergone significant, though still partial, reform: three European Supervisory Authorities were established, and the European Systemic Risk Board now adds a macro-prudential perspective. Regarding financial regulation, the current reforms address the need for stronger resilience, better infrastructure, and greater harmonisation of rules. The Commission has also announced proposals in the area of crisis management and resolution.

While these are important steps, more is needed for the euro area to break the link between fiscal imbalances, financial fragmentation and financial instability. Europe needs to move towards a “financial union”, with a single euro area authority responsible for the supervision and resolution of large and complex cross-border banks. This authority should also be responsible for a euro area deposit insurance scheme. With bank resolution and deposit insurance funded primarily by private sector contributions, taxpayers would be shielded from picking up the bill for future banking crises. Essentially, Mr Praet envisions an authority similar to the Federal Deposit Insurance Corporation in the United States.

Full speech

© BIS - Bank for International Settlements