30 July 2012

German Council of Economic Experts publishes English version of special report

Summary

66. The European banking and financial sector is in an acute crisis that calls for swift action by policymakers. At the same time, delayed financial sector reforms are now hampering crisis management. Essentially, the statement of the 29 June 2012 summit rightly focuses on the inter-linkages between banks and sovereigns. What will be decisive are the concrete measures to be taken and the speed with which the necessary reforms are implemented. In the opinion of the Council of Economic Experts, policymakers should take their cue from a Three Point Plan that contains the following elements:

1) Acute crisis management 

67. A solution to the problems in the Spanish banking sector cannot wait until a long-term regulatory framework for the European banking system has been established. That said we need clarity as quickly as possible on how the funding Spain has applied for will actually be used to recapitalise banks. The focus must be on avoiding the mistakes of past crises. Recapitalisation and restructuring must follow  clear criteria: On the basis of a thorough audit of banks’ balance sheets with the  assistance of outside experts, banks’ capital requirements should first be defined. Only if these cannot  be covered from private or national sources should EFSF or ESM loans be granted to the Member State, which then proceeds to use public funds to recapitalise the banks. In any case, the government should provide additional equity capital, and it should assume the associated control functions. The goal must be to restructure banks in such a way that they in future have sustainable business models. It will be necessary to closely involve European institutions and specifically the European competition authority in the process. 

68. In order to reduce the scope for delayed solutions to banking sector problems and for forbearance, the ECB should be granted improved access to supervisory information such as to enable it to judge the status of banks. It can then link the terms for refinancing operations to the soundness of the bank in question and in this way pressurise national supervisors into tackling banking sector problems at an early stage.  

Should it be necessary to resort to the ESM to recapitalise banks, then this should initially only be effected via the state in question. The conditions stipulated in the 29 June 2012 statement by the EMU heads of state and government allow for direct recapitalisation to banks only if a European supervisory mechanism has been established. This is unlikely to be met in the foreseeable future. Moreover, supervision at the European level does not in itself suffice. 

Instead, powers of restructuring and resolution must also be transferred to a European-level body. 

2) Make up for lost time 

69. In the long term, an effective supervisor at the European level should ensure that the probability and the scale of crises decline. Higher bank capital will play a key role in this context because this will enhance their ability to bear risk. Parallel to this, mechanisms for restructuring and winding-up banks need to be established. Should it be necessary to use common financial resources to restructure banks, then common supervisory and resolution mechanisms have to be implemented.  

70. More than four years have passed since the financial crisis broke out, and during this time key European reforms for the financial markets have been discussed intensively. However only a few have been initiated. Coherent implementation is still missing. At present, finding a comprehensive solution to the European debt crisis is complicated by the absence of effective and European-wide procedures for restructuring and winding-up banks, in particular large credit institutions that have cross-border activities. Priority should therefore be given to reforms in these areas.  

3) No overhasty moves towards a banking union 

71. Establishing a banking union will take a considerable amount of time. Key issues to be clarified include the location and tasks of the banking supervisor, the introduction of uniform processes for winding-up and restructuring banks, deposit insurance, and not least the attendant financing questions. A long-term system in which liability and supervision are in one and the same pair of hands requires not least that national sovereignty is partly given up. This will invariably take some time; it is therefore all the more important that progress is made now on introducing the regulatory changes required.

Full Report

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