Opinion

The ECB’s big moment

Europe’s banking union project has had many doubters since it started to be widely discussed in the spring of 2012. What is not in doubt, however, is its transformative nature.

By: Date: January 8, 2014 Topic: Macroeconomic policy

Europe’s banking union project has had many doubters since it started to be widely discussed in the spring of 2012. What is not in doubt, however, is its transformative nature. In June 2012, EU leaders chose – in a galloping hurry, as usual – to move towards the centralization of bank supervision across eurozone countries, with this authority entrusted to the ECB. The consequences have only gradually become apparent to most and they represent both an opportunity and a risk.

The opportunity is to re-establish trust in European banks, reboot the pan-European interbank market, end dysfunctional credit allocation and start reversing the vicious circle between bank and sovereign credit. In an optimistic scenario, the ECB’s 12-month process of “comprehensive assessment,” including an asset quality review (AQR) and stress tests of around 130 credit institutions covering 85 per cent of the eurozone’s banking assets, will trigger triage, recapitalization and restructuring that financial history suggests is a prerequisite for systemic crisis resolution.

The risk is that, if the assessment fails to be consistent and rigorous, the ECB may find its reputation so damaged that the credibility of its monetary policy – and the perception of Europe’s ability to get anything done – could be affected. After all, this exercise is unprecedented in scale and scope, which means the ECB has little prior experience. At the same time, the political fallout is potentially poisonous in most of the states concerned.

Thus, much is at stake in next year’s balance sheet review, and the scene is set for an escalating confrontation between the ECB and member states in the months ahead. The ECB has pointedly made clear that it will form an independent judgment on the capital strength of the banks examined, without necessarily following the views of national supervisors.

It has also noted that the AQR can be expected to reveal significant new information – which, after all, is the whole point of it. A number of banks that, until now, had been deemed sound by national watchdogs may be found by the ECB to be undercapitalized, or even insolvent. In such cases, restructuring will inevitably be painful for the corresponding national governments, both politically and financially, leading them to plead for forbearance. The tension can be expected to generate more market volatility in Europe in 2014 than was seen in 2013.

A successful AQR and establishment of the Single Supervisory Mechanism (SSM) – EU jargon for the handover of supervisory authority to the ECB – would have structural consequences. Europe’s national and local governments often use their leverage over the publicly-regulated banking industry for industrial policy purposes, or to facilitate their own financing, a dynamic known to economists as financial repression.

Furthermore, the combination of national banking policy frameworks with the EU’s integrated single market has created powerful incentives for banking nationalism. It has led to the protection or promotion of domestic banking champions on the pan-European competitive field, both against competing foreign banks and potential new entrants and non-banks. This has often been detrimental to financial stability. The shift of supervisory authority to the ECB can be expected to gradually weaken these links and to hamper the ability of eurozone member states to engage in financial repression and banking nationalism. In particular, the “moral suasion” wielded by national authorities to persuade local banks to buy domestic sovereign bonds and ringfence funding across borders may become considerably less effective under the new regime of ECB supervision.

More generally, and even without rapid completion of a European resolution and deposit insurance framework, one can expect the centralization of bank supervision to foster market integration, cross-border bank consolidation and the emergence of a more diverse financial sector with a greater variety of banking and non-bank intermediation business models. If the transition is successful, then non-euro countries such as Denmark, Poland and even Sweden can be expected to join the SSM over a three-year horizon. This will not make the UK’s relationship with the rest of the EU simpler.

All this, of course, rests on the assumption that a credible AQR and well-handled bank restructuring will allow the ECB to establish itself as a sound, single eurozone banking supervisor. This cannot be taken for granted but appears more likely than not. Numerous and powerful interests may work against it, but an even stronger interest will probably prompt the eurozone’s leaders, starting with those of Germany, to do whatever it takes to help the ECB pass its make-or-break test.

This piece was first published in Financial World.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article More by this author
 

Opinion

European governance

Can the EU fiscal rules jump on the green bandwagon?

By and large, setting a new green golden rule would be a useful addition to the existing EU fiscal framework.

By: Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: October 22, 2021
Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read about event
 

Past Event

Past Event

Monetary policy in the time of climate change

How does climate change influence monetary policy in the eurozone? What potential monetary policy measures should be taken up to address climate risks?

Speakers: Cornelia Holthausen, Jean Pisani-Ferry and Guntram B. Wolff Topic: Green economy, Macroeconomic policy Date: October 20, 2021
Read article More by this author
 

Podcast

Podcast

Rethinking fiscal policy

A look at the past, present and future of fiscal policy in the European Union with Chief economist of the European Stability Mechanism, Rolf Strauch.

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: October 20, 2021
Read about event More on this topic
 

Upcoming Event

Nov
4
14:00

European monetary policy: lessons from the past two decades

This event will feature the presentation of “Monetary Policy in Times of Crisis – A Tale of Two Decades of the European Central Bank."

Speakers: Grégory Claeys and Wolfgang Lemke Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More by this author
 

External Publication

Global Economic Resilience: Building Forward Better

A roadmap for systemic economic reform calling for step-change in global economic governance to increase resilience and build forward better from economic shocks, prepared for the G7 Advisory Panel on Economic Resilience.

By: Thomas Wieser Topic: Global economy and trade, Macroeconomic policy Date: October 14, 2021
Read article More on this topic More by this author
 

Opinion

Letter: Declining investment may explain why rates are low

Perhaps an analysis of the causes of the declining investment rate would bring us closer to explaining why real interest rates are so low.

By: Marek Dabrowski Topic: Macroeconomic policy Date: October 1, 2021
Read article More by this author
 

Podcast

Podcast

A green fiscal pact

How can the European Union increase green public investment while consolidating budget deficits?

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: September 29, 2021
Read article More on this topic More by this author
 

Blog Post

Monetary arithmetic and inflation risk

Between 2007 and 2020, the balance sheets of the European Central Bank, the Bank of Japan, and the Fed have all increased about sevenfold. But inflation stayed low throughout the 2010s. This was possible due to decreasing money velocity and the money multiplier. However, a continuation of asset purchasing programs by central banks involves the risk of higher inflation and fiscal dominance.

By: Marek Dabrowski Topic: Macroeconomic policy Date: September 28, 2021
Read article More on this topic More by this author
 

Opinion

The pandemic’s uncertain impact on productivity

The pandemic has certainly permanently affected our way of working. Whether this is for the better remains to be seen.

By: Maria Demertzis Topic: Macroeconomic policy Date: September 28, 2021
Read about event More on this topic
 

Past Event

Past Event

How to strike the right balance between the three pillars of the pension system?

In this event panelists will discuss the future of European pension schemes.

Speakers: Elsa Fornero, Svend E. Hougaard Jensen and Suvi-Anne Siimes Topic: Macroeconomic policy Date: September 23, 2021
Load more posts