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October 2008 may well be seen by historians as a pivotal moment in the development of the European project. This was the month when the initial response to the financial crisis looked ragged and more like a disparate collection of nation states. By the end of the month, the EU has achieved a cohesive reaction that has crossed several important hurdles to developing a common economic policy. That is not to deny that many difficulties remain in the months and years ahead!
The political conclusions include the following:
Ø For the first time, the euro area made policy decisions as an entity defined by participation in the single currency.
Ø The EU showed the ability to take executive and legislative action promptly in a crisis – perhaps the hallmark of a genuine political entity.
Ø The euro area set the agenda for the EU’s decision to call for global action, including a
Ø The de la Rosiere Group will report in the spring initially, and begin the process of re-shaping the EU’s financial framework that will be followed through by the next Parliament and Commission in 2009/14.
Ø The Heads of Government also decided to take EU-level action on issues directly affecting a class of individual citizens – the remuneration policy of bankers!
However, there were also a raft of apparently more mundane decisions – but the common thread is that the EU moved quickly as a group – though in some areas as the Eurozone rather than the EU. There are legitimate criticisms that these moves were made rapidly and that some of the proposals did not seem to have the agreement of all stakeholders. Some examples:
Ø The proposed actions on Credit Rating Agencies have been widely and heavily criticised for failing to understand some of the technical mechanics. A final proposal is imminent and should be a good test of the Commission’s willingness to listen to practical issues so that the legislation produces the right results in the longer term.
Ø The proposal on deposit guarantee schemes removes the concept of co-insurance, raises the thresholds and proposes that pay-outs occur within three days. The
Ø Accounting standards were amended very quickly to give a level playing field with US standards. In particular, the details of the mark-to-market and fair value accounting system were “clarified” so that bank’s management can apply their own pricing to some of the distressed assets they hold. The bankers may have been satisfied, but the investors who own these companies were rapidly pointing out that the accounts were about to become opaque at the vital moment when outside investors are trying to assess the genuine worth of these securities. As such observers also include counterparties trying to asses the riskiness of a bank, this may turn out to be counter-productive. However, CEBS is monitoring the transparency of banks’ accounts and will report if there is any backsliding in such standards.
The opacity of banks’ accounts is particularly important as the ECB is changing its collateral arrangements from the end of October. That will be a crucial test of whether the range of policies can achieve the desired goal of normalising inter-bank interest rates so that monetary easing is actually transmitted though the banking system to citizens and businesses (especially small ones). At present, there are only two groups who can tell the financial condition of a bank at the moment of a potential transaction: the board of directors and the regulators. If the transparency of accounting is reduced, presumably even the regulators might also lose a full understanding of the situation. Time will tell if many banks make a major use of the new guidance on accounting standards that is now applicable. If they do, should we expect a surge in write-ups that offset some of the previous write-downs? In that case, will there have been such a pressing need for re-capitalisations of banks that reported quite reasonable levels of capital adequacy until the
The ECB has decided to broaden its range of acceptable collateral and reduce the minimum acceptable rating. This seems entirely consistent with the oft-repeated, public commitments at the highest levels of Government that no systemic bank is going to be allowed to fail. If the authorities have oversight of the accounts and believe the bank is indeed solvent, then there seems little point in the central bank being unwilling to lend directly against any collateral that contributes to that solvency. (There is an interesting contrast with the non-euro area Bank of England’s convoluted schemes to swap assets in a way that invites outsiders to question why the central bank will not take the credit risk of commercial banks that the UK authorities say are now solvent – and perhaps massively so once the new accounting treatment is applied.) The answers to these questions will be seen in the near future if interbank rates do not normalise in the
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All three EU institutions - Council, Parliament and Commission - are also thinking about the medium term issues. Importantly, Parliament approved overwhelmingly a proposal that “reiterates their calls on the Commission to propose measures to strengthen the EU regulatory and supervisory framework and EU-level crisis management, including on banks, credit rating agencies, securitisation, hedge funds, leverage, transparency, winding-up rules, clearing for over-the-counter markets and crisis prevention. The Lamfalussy process should be strengthened, including colleges of supervisors for cross-border institutions and a clearer role and legal status for the Level 3 committees (which bring together all the Member States' banking, securities and insurance supervisors). Parliament also wants to see proposals drawn up for effective cross-border crisis management.”
Doubtless, the proposed Internal Market Commissioner will be tested on their views on these topics at the confirmation hearing next year.