BGA Cable: Euro Area

Euro area: saving banks 

After almost a 6 months absence German policy making finally resumed, leaving ministers limited time to pick up their briefs ahead of the G20 and the EU summit this week. While the lengthy German collation has already delayed in the euro area reform project to June, matters are complicated further by the political stalemate created by the Italian election that is expected to last for several months.

The unexpected election results in Germany and Italy have severely curtailed the once ambitious French reform plans for the euro area, which will now be reduced mostly to modifications of existing arrangements as treaty changes remain as elusive as during the crisis despite the much better economic outlook.

Without any realistic chance of treaty changes, ESM reform will have to stay within the current intergovernmental framework, which means that national governments and parliaments will continue to directly influence decision making without going through the Commission or the EU Parliament.

While this will appease Germany and other Northern countries, which worry that the ESM will turn into a fiscal transfer tool, it means that the ESM’s decision making in the next crisis will remain deeply immersed in conflicts of interest among its members.

By extension, the emphasis on national budget powers also implies that the far more ambitious plans for a centralised European fiscal policy stance will have to be shelved. While this will again satisfy the fiscal conservatives, it means that the burden of future macroeconomic crisis management rest squarely with the ECB, which is already struggling to stay within its mandate.

While most governments will continue supporting the creation of a European Monetary Fund in the long-term, short-term measures will probably be contained to providing a €50-60bn backstop to the euro area’s single resolution fund (SRM). Members can probably agree to an expanded role for the ESM in defining conditionality for sovereign bail-outs and bank recap programs, though that will have to be alongside the Commission, which is unlikely to surrender its existing authority under European treaties.

To placate the ECB, who is not part of the negotiations, there will be a push for more flexible, short-term fiscal support mechanisms run by the ESM or indeed the Commission’s own budget to deal with asymmetric shocks that affect member countries, e.g. the impact a disorderly Brexit on Ireland. This will raise more than a few eyebrows in fiscally conservative countries and again these decisions are unlikely to go beyond the planning stage for as long as the economic picture is positive across the euro area.

With fiscal integration effectively on hold, policy makers’ primary focus will therefore be on adding a centralised backstop for European deposit insurance, in short EDIS. Again, this will be met by stiff resistance in core European countries in view of the sheer amounts involved (there are €10tn of deposits across the euro area) and the fact that these deposits can be used to refinance sovereign bonds without any capital charges as well as NPLs without adequate provisioning.

To appease critics, the EU Commission since last week requires banks to provision proactively on new loans, but there remains a stock of legacy loans in certain jurisdictions (Greece, Cyprus, Italy, Portugal to name a few) that has yet to be dealt with. Enforcement of collateral and the required insolvency regimes will be another key item on the agenda, though, given the legal complications, this can only move at glacial speed. Separately, the SRM will roll out much higher requirements for bail-in debt (MREL) in addition to existing capital requirements under CRDIV.

Ironically a credible backstop for bank deposits would greatly reduce any systemic risk concerns and improve the ability of the ECB and the EU’s single resolution mechanism to close down banks and effect burden sharing among uninsured creditors without the risk of a bank run.

Thus, an EU-wide solution would benefit financial stability but reaching consensus will involve very significant horse trading between core countries, whose banks hold the bulk of euro area deposits, and periphery countries, whose banks hold most of the risk and will have trouble raising any meaningful amounts of bail-in debt at short notice.

Ring fencing of national deposit insurance schemes will play a key role in the negotiations as will harsher regulatory treatment of sovereign exposures and supervisory enforcement of NPLs. The incremental costs of any euro area wide system will also be a key consideration as banks are already suffering from a flat yield curve and negative policy rates in their core intermediation activity.

BGA Experts

Jan Kallmorgen

Jan Kallmorgen

CEO and Founder
Jan's Bio

Jan is BGA’s Founder and CEO combining a background in finance, foreign policy and international public affairs. He advises clients on complex investment situations and transactions and has a strong transatlantic focus.

He has worked at Goldman Sachs, the German Council on Foreign Relations, the European Group for Investor Protection, Bohnen Kallmorgen & Partner and the global public affairs firm Interel Group. Jan is also founder & chairman of the non-profit think tank Atlantic Initiative and a regular speaker at international conferences and universities. See him in action

Jan holds a Master’s in history and international relations from Freie Universität Berlin and from Georgetown University’s School of Foreign Service in Washington, DC. He is an alumnus of several transatlantic Young Leader programs.
Dierk Brandenburg

Dierk Brandenburg

Managing Partner
Dierk's Bio
Dierk is Managing Partner at BGA following a 25 year career in asset management, banking and financial regulation.  As senior analyst and director of research at Fidelity Investments for more than 13 years, Dierk led fixed income research for US and European financial sector and sovereign strategy.

Before Fidelity, he worked for Deutsche Bank in London and as Deputy Head of Credit Risk for the BIS in Basel, where he advised central banks and regulators on bank capital and risk management.

Dierk holds a PhD in public finance from the London School of Economics (LSE).



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