Blog Post

Criteria for entry into the ERMII and the banking union: the precedent from Bulgaria

In its bid to join the single currency Bulgaria has made commitments on financial supervision but also wider structural reform which set a precedent for future applicants for participation in the exchange rate mechanism ERMII. Most conditions, though not all, are justified by the additional demands of the banking union. But the envisaged timeline seems ambitious, and verification will not be straightforward.

By: Date: August 29, 2018 Topic: European Macroeconomics & Governance

The Eurogroup in July clarified Bulgaria’s path into the European Exchange Rate Mechanism (ERMII). This will be preceded by a close cooperation with the ECB in the context of the banking union, which in turn will depend on fulfilling a number of commitments on financial sector supervision and structural reform. Once ERMII entry has been agreed there will be no option by other currency union members to veto euro adoption. Bulgaria would then become the first EU country to accede to the economic and monetary union (EMU) since Lithuania did so in 2015.

Following a devastating debt and banking crisis, Bulgaria has successfully operated a currency board since 1997 with a rate irrevocably fixed to the German mark and the euro. It would seem that exchange-rate stability can be easily maintained.

But there have been persistent doubts about the quality of banking supervision in Bulgaria. Membership in the banking union is therefore desirable and has been actively promoted by Bulgaria (see the previous Bruegel research and blog on this topic). Three-quarters of Bulgaria’s banking sector are foreign-owned, but in 2014 the country saw runs on its locally owned third- and fourth-largest banks, and the collapse of the latter. Only last year, indictments were brought against the main owner of that bank, and senior central bank managers.

Common supervision will now be prepared over the coming year, including a stress test of the banks. In addition, Bulgaria has made a number of wide-ranging commitments – including on governance, legal and judicial reforms – which it seeks to implement over the coming months.

These commitments seem desirable in their own right – but which are essential for participation in the banking union, and can they realistically be implemented within the short timeframe that is envisaged?  The conditions can be summarised under five headings:

  • Strengthen bank and systemic supervision. This is an essential addition to the euro-entry criteria and, in light of Bulgaria’s recent crisis, clearly very relevant. Within Bulgaria’s currency board regime the national bank is experienced in applying ‘macroprudential’ supervision and has already had some success in stemming a credit boom ahead of the financial crisis. The two conditions seem well defined, realistic and desirable for entry into the banking union.
  • Strengthen supervision of the non-bank financial sector. It is less clear why this is essential for entry into the banking union, within which a common standard of bank supervision and procedures for bank resolution have been established. As in most new EU Member States, Bulgaria’s non-bank sector is small, accounting for about a quarter of system assets. A recent review flagged problems in the capitalisation of some insurance companies and risks to benefits accruing from pension funds. The supervisor is outside the central bank, and may have failed in some of its tasks. While these are important issues in financial supervision, the relevance for bank soundness and potential resolution costs within the banking union is less clear.
  • Strengthen the anti-money laundering framework. This seems a timely and sensible addition to the requirements for banking union membership. As was clear in the recent banking crisis in Latvia, even a hint of operational and conduct risk can have immediate consequences across the banking system. The implementation into law of the latest EU Directive should be straightforward to verify, and could be done swiftly. Empowering the independent financial crimes unit and establishing the information exchange with the supervisor may prove to be more protracted processes.
  • Address gaps in the insolvency framework, and strengthen the judiciary. Poor insolvency regimes and inefficient judiciaries are a key reason for the slow pace of non-performing loan (NPL) resolution in many Member States, where provisioning is often inadequate. Different creditor rights and problems with enforcement will limit integration between national financial markets. In the case of Bulgaria, an extensive report flagged a large number of shortcomings relative to best practice in the World Bank’s insolvency standards. The average time to resolve insolvency is over three years, though this is by no means the worst in the euro area. Best practice in insolvency law is easy to define and clearly desirable for a well-functioning and open financial system. But implementation will crucially depend on the reform of the judiciary, which will be much harder to monitor.
  • Align legislation with the OECD Guidelines on corporate governance of state-owned enterprises (SoEs). This seems the most ambitious of the conditions, and the one least relevant to membership in the banking union. It sets a high hurdle for other future applicants in emerging Europe with traditionally extensive state sectors, importantly for Croatia as another likely applicant. There is a sizable sector consisting of about 800 state enterprises in Bulgaria, accounting for about 6% of output. This is large, though not necessarily out of line compared to others in the currency union. In its country assessments the Commission has pointed out weak performance in the sector. It does not follow that the state sector poses a direct risk to financial stability, and in fact this issue is scarcely mentioned in the latest IMF assessment. It is no doubt possible to reflect the OECD standards in national legislation in the coming months, but implementation within the administration could be lengthy. For instance, a state-ownership agency will need to be resourced and empowered. Governance practice within enterprises will likely lag such standards for some time.

Bulgaria’s recent banking crisis underlined important shortcomings in financial supervision. This is now to be addressed relatively swiftly, and a full stress test should give further confidence. But since EU accession in 2007 there has been a long history of delayed structural reforms, which the Commission has tracked through its so-called Cooperation and Verification Mechanism.

As the Eurogroup expects to follow a similar approach with other Member States seeking to join ERMII, it should be mindful that structural and governance obstacles to deep financial integration cannot be overcome quickly.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

Dec
1
13:45

The state strikes back

COVID-19 has caused a resurgence of the role of the state. State ownership can help reduce effects from shocks to the economy but state-owned firms often suffer from weak governance and lack of innovation. What role should state owned firms and banks play and how can their management be improved?

Speakers: Beata Javorcik, Katarina Mathernova and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Past Event

Past Event

How to keep a competitive environment while engaging with non market economies?

How can we ensure fair competition between European firms and Chinese state-backed players?

Speakers: Julia Anderson, Helge Berger, Michiel Boots, Alicia García-Herrero, Carles Esteva Mosso, Frédéric Jenny, Georgios Petropoulos, Cian Ruane, Hylke Vandenbussche and Guntram B. Wolff Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 19, 2020
Read about event More on this topic
 

Upcoming Event

Dec
2
14:00

The forthcoming reform of EU Anti-Money Laundering Policy

At this event John Berrigan will be in discussion with Nicolas Veron and an invited-audience on how to create an strategy for countering money-laundering in Europe.

Speakers: John Berrigan and Nicolas Véron Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article
 

Blog Post

Europe’s banking union should learn the right lessons from the US

In revived discussions on European banking union, some have suggested a new regime to deal with failing banks, alongside existing ones, drawn from parts of the United States’ bank resolution framework. This fragmented approach could be counterproductive. Europe should adopt a unitary regime, like the US, that applies to all banks irrespective of size.

By: Anna Gelpern and Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: October 29, 2020
Read article More on this topic
 

Blog Post

Growth uncertainty, European Central Bank intervention and the Italian debt

European Central Bank intervention provides a buffer against the uncertainty faced by European Union economies in the face of COVID-19. For the time being, this intervention has alleviated concern about Italy's debt, but without it Italy is vulnerable to a debt crisis.

By: Andrea Consiglio and Stavros Zenios Topic: European Macroeconomics & Governance Date: October 28, 2020
Read about event More on this topic
 

Past Event

Past Event

Completing the banking union in the age of Next Generation EU

Invitation only event to discuss the banking union.

Speakers: Tuomas Saarenheimo and Nicolas Véron Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: October 27, 2020
Read article Download PDF
 

External Publication

How Can the European Parliament Better Oversee the European Central Bank?

This paper, written at the request of the Committee on Economic and Monetary Affairs, assesses how the European Parliament holds the European Central Bank accountable. The same exercise is done for the Bank of Japan, in order to identify possible lessons for the ECB and the European Parliament.

By: Grégory Claeys and Marta Domínguez-Jiménez Topic: European Macroeconomics & Governance, Global Economics & Governance Date: September 23, 2020
Read article More by this author
 

Opinion

The EU’s Opportunity to Turn Its Markets Toward the Future

Meeting the fiscal demands of COVID-19 will require the European Union to borrow on capital markets more than ever, and for European pension funds and households to look more widely for ways to build their nest eggs safely. The EU should take the challenges of the pandemic and Brexit as a chance to get its financial infrastructure house in order.

By: Rebecca Christie Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: July 16, 2020
Read about event More on this topic
 

Past Event

Past Event

Tackling too-big-to-fail banks: have the reforms been effective?

Evaluation of the global reforms implemented to deal with "too-big-to-fail banks".

Speakers: Alexandre Birry, Claudia M. Buch and Nicolas Véron Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 9, 2020
Read article Download PDF More on this topic
 

Policy Contribution

Should Denmark and Sweden join the banking Union?

Though outside the euro area, Denmark and Sweden could benefit from joining the European Union’s banking union. It would provide protection in case of any need to resolve at national level a large bank with a Scandinavian footprint, and would mark a choice in favour of more cross-border banking. But joining the banking union would also involve some loss of decision-making power.

By: Dirk Schoenmaker and Svend E. Hougaard Jensen Topic: Finance & Financial Regulation Date: June 24, 2020
Read article Download PDF
 

Policy Contribution

Is the COVID-19 crisis an opportunity to boost the euro as a global currency?

The euro never challenged the US dollar, and its international status declined with the euro crisis. Faced with a US administration willing to use its hegemonic currency to extend its domestic policies beyond its borders, Europe is reflecting on how to promote it currency on the global stage to ensure its autonomy. But promoting a more prominent role for the euro is difficult and involves far-reaching changes to the fabric of the monetary union.

By: Grégory Claeys and Guntram B. Wolff Topic: European Macroeconomics & Governance, Global Economics & Governance Date: June 5, 2020
Read article More on this topic
 

Opinion

The Independence of the Central Bank at Risk

The ruling of the German Federal Constitutional Court (GFCC) of May 5 on the ECB’s monetary policy affects not only the relation of Germany to the European Central Bank (ECB) and the Court of Justice of the European Union (ECJ) but also the constitutional foundations of monetary policy.

By: Peter Bofinger, Martin Hellwig, Michael Hüther, Monika Schnitzer, Moritz Schularick and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 2, 2020
Load more posts