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: Macroeconomic policy

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 article
 

External Publication

European Parliament

Don't let up - The EU needs to maintain high standards for its banking sector as the European economy emerges from the COVID-19 pandemic

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

By: Rebecca Christie and Monika Grzegorczyk Topic: Banking and capital markets, European Parliament Date: October 21, 2021
Read article More on this topic
 

Blog Post

How have the European Central Bank’s negative rates been passed on?

Negative rate cuts are not that different from ‘standard’ rate cuts. Like them, they reduce banks’ margins, but this effect does not appear to be amplified below 0%.

By: Grégory Claeys and Lionel Guetta-Jeanrenaud Topic: Macroeconomic policy Date: July 7, 2021
Read article More on this topic More by this author
 

Opinion

What to expect from the ECB’s monetary policy strategy review?

Emphasis will be placed on greening monetary policy and clarifying the ECB's price stability objective, but is this enough?

By: Maria Demertzis Topic: Macroeconomic policy Date: June 23, 2021
Read article More on this topic More by this author
 

Blog Post

Inflation!? Germany, the euro area and the European Central Bank

There is concern in Germany about rising prices, but expectations and wage data show no sign of excess pressures; German inflation should exceed 2% to support euro-area rebalancing but is unlikely to do so on sustained basis.

By: Guntram B. Wolff Topic: Macroeconomic policy Date: June 9, 2021
Read article Download PDF More by this author
 

External Publication

European Parliament

What Are the Effects of the ECB’s Negative Interest Rate Policy?

This paper explores the potential effects (and side effects) of negative rates in theory and examines the evidence to determine what these effects have been in practice in the euro area.

By: Grégory Claeys Topic: Banking and capital markets, European Parliament, Testimonies Date: June 9, 2021
Read article
 

Blog Post

European governance

Emergency Liquidity Assistance: A new lease of life or kiss of death?

Use of Emergency Liquidity Assistance to prop up euro-area banks needs to be more transparent; available evidence suggests its use has not always been within the rules.

By: Francesco Papadia and Leonardo Cadamuro Topic: European governance, Macroeconomic policy Date: May 28, 2021
Read article
 

Opinion

European governance

The ECB needs political guidance on secondary objectives

While EU Treaties clearly stipulate that the ECB “shall support the general objectives of the European Union”, it is not appropriate to simply stand by, wishing that the ECB will use its discretionary power to act on them. Political institutions of the EU should prioritise the secondary goals to legitimise the ECB’s action.

By: Pervenche Béres, Grégory Claeys, Nik de Boer, Panicos O. Demetriades, Sebastian Diessner, Stanislas Jourdan, Jens van ‘t Klooster and Vivien Schmidt Topic: European governance, Macroeconomic policy Date: April 22, 2021
Read article
 

Blog Post

European governance

Urgent reform of the EU resolution framework is needed

In this blog, the authors argue that two aspects of the European resolution framework are particularly in need of reform – the bail-in regime and the resolution mechanism for cross-border banks – and propose a reform of both.

By: Mathias Dewatripont, Lucrezia Reichlin and André Sapir Topic: Banking and capital markets, European governance, Macroeconomic policy Date: April 16, 2021
Read article More on this topic More by this author
 

Opinion

European governance

More Europe or less Europe?

Europe is often a ship with multiple captains. The boat moves forward in calm seas, but when the slightest wind puts it off course, it is not easy to steer that boat. It is not so much a question of more Europe rather than less, but of achieving ‘one Europe’. A ‘more-or-less Europe’ is an invitation to go nowhere.

By: Maria Demertzis Topic: European governance Date: April 14, 2021
Read about event More on this topic
 

Past Event

Past Event

An alpine divide? Comparing economic cultures in Germany and Italy

A discussion of Italian and German macro-economic cultures and performances.

Speakers: Thomas Mayer, Patricia Mosser, Marianne Nessén, Hiroshi Nakaso, Francesco Papadia, André Sapir and Jean-Claude Trichet Topic: Macroeconomic policy Date: April 13, 2021
Read about event More on this topic
 

Past Event

Past Event

Presentation of the Euro Yearbook 2021

Join us for the launch of the eighth edition of the 'Euro Yearbook'

Speakers: Maria Demertzis, Fernando Fernández, Fiona Maharg-Bravo, Antonio Roldán and Jorge Yzaguirre Topic: Macroeconomic policy Date: March 12, 2021
Read article More on this topic More by this author
 

Opinion

Central banks don’t have to pick winners and losers to fight climate change

Disclosures and financial regulation don’t get enough respect as tools to reduce emissions.

By: Rebecca Christie Topic: Banking and capital markets Date: March 11, 2021
Load more posts