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The purpose of this paper is to assess the impact of the impact of the single currency on the
institutional design of the banking union, through evidence on the financial integration process.
Journal of Financial Economic Policy
Banking union in a single currency area: evidence on financial fragmentation
Diego Valiante
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Diego Valiante , (2015),"Banking union in a single currency area: evidence on financial
fragmentation", J ournal of Financial Economic Policy, Vol. 7 Iss 3 pp. 251 - 274
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Banking union in a single
currency area: evidence on
fnancial fragmentation
Diego Valiante
Capital Markets Research, Centre for European Policy Studies,
Brussels, Belgium
Abstract
Purpose – The purpose of this paper is to assess the impact of the impact of the single currency on the
institutional design of the banking union, through evidence on the fnancial integration process.
Design/methodology/approach – Data analysis uses multiple sources of data on key drivers of
fnancial fragmentation. The paper starts from a snapshot the status of fnancial integration and then
identifes the main components of this trend.
Findings – Evidence shows that fnancial integration in the euro area between 2010 and 2014
retrenched at a quicker pace than outside the monetary union. Home bias persisted. Under market
pressures, governments compete on funding costs by supporting “their” banks with massive state aids,
which distorts the playing feld and feed the risk-aversion loop. This situation intensifes frictions in
credit markets, thus hampering the transmission of monetary policies and, potentially, economic
growth. Taking stock of developments in the euro area, this paper discusses the theoretical framework
of a banking union in a single currency area with decentralised fscal policy sovereignty. It concludes
that, when a crisis looms over, a common fscal backstop can reduce pressures of fnancial
fragmentation, driven by governments’ moral hazard and banks’ home bias.
Research limitations/implications – Additional research is required to deepen the empirical
analysis, with econometric modelling, on the links between governments’ implicit guarantees and
banks’ home bias. This is an initial data analysis.
Originality/value – Under market pressure, governments in a single currency area tend to be
overprotective (more than countries with full monetary sovereignty) towards their own banking system
and so trigger fnancial fragmentation (enhancing banks’ home bias). To revert that, a common fscal
backstop is an essential element of the institutional design. The paper shows empirical evidence and
theory, as well as it identifes underlying market failures. It links the single currency to the institutional
design of a banking union. This important dimension is brought into a coherent framework.
Keywords Bank resolution, Monetary union, Banking union, Bank restructuring,
Financial fragmentation, Euro area
Paper type Research paper
JEL classifcation – G21, G18, E58
The author is solely responsible for any errors. He gratefully acknowledges research assistance
fromJan-MartinFrie andhelpful comments fromThorstenBeck, StevenGreenfeld, Daniel Gros, Karel
Lannoo and Willem Pieter de Groen. This work has greatly beneftted from discussions with
participants at the 31st SUERF Colloquium and Baff Finlawmetrics Conference 2014 – Call for
Papers – Research Questions (“Money, Regulation and Growth: Financing New Growth in Europe”)
and feedback fromtwo anonymous referees.
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1757-6385.htm
Banking
union in a
single
currency area
251
Received2 October 2014
Revised21 January2015
22 March2015
Accepted1 April 2015
Journal of Financial Economic
Policy
Vol. 7 No. 3, 2015
pp. 251-274
©Emerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-10-2014-0058
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1. Introduction
As European institutions strive to strike a proper balance on burden sharing in
developing a full-fedged European banking union (EU Council, 2012), several factors
affect the breadth and depth of fnancial fragmentation in the euro area. A major one is
the single currency. This paper assesses the incentives for governments in a monetary
union with decentralised fscal sovereignty, under market pressure, to restructure the
banking sector and to manage write-downs of assets that are a legacy of the recent
fnancial and economic crisis. This paper reviews evidence in the euro area and inform
howto best devise the institutional framework of a banking union with a mechanismfor
orderly bank resolution.
A main point of confict is the extent to which national governments ought to be
allowed to bail out national banks and concurrently howmuch creditors and depositors
of the bank ought to be subject to compulsory “bail-in” procedures in the recapitalisation
process. If bank resolution is never an easy task, the additional complexities of the
European fnancial system, its legal rules and the relevant governing bodies make this
matter even thornier. European institutions have tried to make the resolution piece
match other pieces of the banking union puzzle, such as the creation of a common
supervisory mechanism that would centralise supervision of systemically important
banks under the European Central Bank (ECB), or the creation of a common deposit
guarantee scheme to replace those that so far, in countries like Italy and Spain, have
relied on unfunded government guarantees. All of them aim to shield the fnancial
system from the adverse effects of another systemic crisis and potential runs on banks
by providing an appropriate supervisory mechanism and safeguards to ensure that the
banking system functions on an equal footing for all banks involved in the process,
minimising the involvement of taxpayers’ money. Such a common system could also
revert the ongoing fnancial fragmentation in the euro area and perhaps revive the
cross-border market for banks’ mergers and acquisitions.
The frst section of this paper illustrates the evolution of the banking system in the
euro area after the 2007-2008 fnancial crisis and the link between banks and
governments. The second section discusses the single currency and its impact on euro
area governments and banks’ incentives. The last section reviews the theoretical
framework behind the creation of banking union institutions.
2. The banking system and fnancial fragmentation
Although the fnancial crisis badly hit European banks already in 2007, until the frst
Greek debt restructuring with the private sector involvement (PSI)[1] and more
remarkably the Cypriot crisis, the banking system had barely embarked on the
restructuring process, particularly in the euro area (IMF, 2013)[2]. Reasons for the delay
are manifold, but the key role of banks in the funding of European economies, both at the
periphery and within the core, played an important role.
2.1 Banks and governments
The mammoth size and interconnection of European banks with the national political
establishment and local constituencies historically tie them closely to their domestic
governments, with broader long-term implications on fscal sustainability (among
others, Reinhardt and Rogoff, 2009 and Calomiris and Haber, 2014). When systemic risk
increases, especially in peripheral countries (mainly in the formof sovereign risk), banks
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generally tend to increase the holdings of sovereign debt securities (Andritzky, 2012)
and their portfolio becomes more “home biased” (Battistini et al., 2013). This “fatal hug”
between governments and banks has materialised most prominently in two ways:
(1) Banks’ use of central banks’ “cheap” liquidity for massive purchases of domestic
government bonds, in spite of attempts by the ECB to transfer the impulse of
monetary policy to the economy via bank lending (Merler and Pisani-Ferry,
2012; Valiante, 2012; Goyal et al., 2013; EBA, 2013).
(2) The fast retrenching of banks’ international diversifcation when the fnancial
crisis hit, despite deep fnancial integration in the European Monetary Union
(EMU) (so-called “home bias”; see Manna, 2011; Valiante, 2012; Liikanen Report,
2012).
The frst development was spurred by the incentives to increase concentration of
domestic government bonds holding, so indirectly calling for massive government
intervention (through guarantees and liquidity injections) to limit the repercussions of
banks’ diffculties on each other’s fnancial situations (banks’ moral hazard; see Section 4,
Table II, for more details). The interest rate carry trade[3] between the ECB liquidity
operations, and the higher “safe” return on government bonds has helped national
governments sustain public fnances in a time of deep liquidity crises (Acharya and
Steffen, 2013). The latter outcome is a more general trend caused by frictions in the
fnancial system, and in particular for cross-border transactions in the single currency
area (see the next section). Specifcally, cross-border asset holdings have been
decreasing since the beginning of the fnancial crisis, and that tendency accelerated
when the sovereign crisis spread (see Figure 1). Most notably, cross-border securities
holdings dropped by more than 30 per cent, after reaching a historical peak in 2008.
As the sovereign crisis expanded, causing governments’ disorderly interventions to
support local banking systems, the retrogression of fnancial integration in the euro area
accelerated compared with claims against other major areas of the world. Claims of
EMUbanks versus those of other EMUcountries dropped by almost €1 trillion (or 23 per
cent), while claims of EMU banks vis-a`-vis other European counterparties dropped by a
lesser amount. Foreign claims of banks in the four biggest EMU economies (France,
Spain, Germany and Italy) versus counterparties in selected non-EMU economies only
dropped by 10 per cent since the second quarter of 2010, while intra-EMU claims for
these countries dropped by more than 15 per cent during the same period (see Figure 2
and Appendix). While fnancial integration and freedom of capital movement should
protect the fnancial system from extreme home bias in favour of domestic institutions
(Sorensen et al., 2007), idiosyncrasies specifc to the monetary union may have instead
accelerated fnancial fragmentation compared with other areas of the world (see the
following section). As a result, home bias persists despite early signs of recovery. The
UK, USA and Japan have seen a much lower drop in the foreign claims of domestic
banks since the inception of the sovereign crisis (see Appendix). For the USAand Japan,
foreign claims of domestic banks versus the rest of the world have signifcantly
increased since 2005 and have only marginally dropped versus euro-area counterparties
since the beginning of the sovereign crisis in the second quarter of 2010.
Furthermore, the cross-border interbank market for banks in some euro-area
countries remains illiquid, and trust among euro-area fnancial institutions is very weak,
which is expected when uncertainty about aggregate liquidity arises (Allen et al., 2009).
253
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Cross-border loans to other EMU monetary fnancial institutions (MFIs)[4] and MFIs’
deposits have been experiencing a steady drop since the beginning of the fnancial crisis,
which then accelerated with the sovereign crisis later on (see Figure 3).
Even before the inception of the sovereign crisis in 2010, differences among the
euro-area regions emerged also in relation to MFIs’ cross-border securities holdings,
as ring-fencing at national level (home bias) for the sake of liquidity led to a
signifcant drop of holdings of MFI and non-MFI in securities of counterparties
located in peripheral countries such as Spain, Ireland and Italy. In countries such as
Belgium, Germany and Netherlands, considered to be at the core of the Eurozone,
cross-border MFIs’ holdings of local counterparties’ securities remained at a stable
level (see Appendix). A similar picture emerges when looking at banks’ claims in
the core and the periphery. The constant decline of core countries banks’ claims on
the periphery accelerated in recent years, despite a gradual improvement of the
macroeconomic conditions and after the 2007-2008 fnancial crisis and 2010-2011
sovereign crisis (see Figure 4).
The frictions in credit markets, created by the uncertainty about the risk of banks in
peripheral countries, fuelled the so-called fnancial fragmentation process (Garcia de
Andoain et al., 2014). Since the inception of the sovereign crisis, therefore, national
liquidity ring-fencing has been fragmenting the fnancial system of the euro area along
country lines.
Figure 1.
Intra-EMU MFIs’
euro-area holdings
(€ million), 2006-2013
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2.2 Financial repression and risk aversion
On top of precarious market conditions (also affecting non-euro-area countries) and
heightened sovereign risk, public policies and market practices have contributed to
promote fnancial repression together with risk aversion (home bias), particularly in the
Eurozone. Following Reinhart et al. (2011), “fnancial repression” is a combination, on
the one hand, of tighter connection between banks and domestic governments and, on
the other hand, frictions to cross-border capital movements created by macroprudential
regulation introduced to prop up the fnancial system. In particular, the following
factors contributed to fnancial repression and greater risk aversion, creating a
structural information asymmetry in cross-border banking:
• Regulatory capital requirements and the “interest rate” carry trade;
• National resolution mechanisms and credit information sharing;
• Governance and political interference; and
• Single currency and payment system (infrastructure).
First, the purchase of domestic government bonds by local banks was strongly
encouraged by the opportunity to purchase government bonds as “risk-free assets”
under the risk-weighting provisions of current capital requirements[5], even for those
bond issuers that were not backed by a currency printer anymore (such as countries in
the euro area). These rules, which also apply outside the euro area, came on top of an
Figure 2.
Intra versus
extra-EMU (EU) and
other extra EMU
(selected)
outstanding loans
and securities other
than shares
(€ million),
? Q2-2010/Q3-2013
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interest rate carry trade created by the ECB’s cheap liquidity operations (so-called
long-term refnancing Operations, LTRO, or Targeted LTRO), in particular, from early
2012 onwards. The sharp increase in banks’ domestic holdings also increased pressure
for a pre-emptive government intervention to avoid a disorderly liquidation that would
have ultimately had repercussions on governments’ own funding resources. In effect,
between 2010 and 2014, as suggested by Figure 5(a), more than €200 billion drop in
fnancial institutions’ holdings of securities issued by foreign governments was offset
by an increase of roughly €500 billion in holdings of domestic government securities, on
top of the increase in other domestic assets precipitated by home bias.
Second, the fragmentation of national resolution mechanisms for banks and the lack
of a common system for credit information may have fuelled banks’ risk aversion
(Manna, 2011). Uncertainty regarding who would bear the costs of the resolution of
fnancial institutions, which have in the meantime built strong cross-border interests in
the euro area due to the fast integration process, played an important role in promoting
liquidity ring-fencing at the national level. In the aftermath of the fnancial crisis, this
bad mix of incentives prompted the G-20 to issue a statement about the need to have
more effective crisis management rules for banks[6]. Common rules in the European
Union (EU) were approved, but much will depend on how fast and accurately
governments transpose these rules into national law[7].
Third, banks’ management in many EU countries cultivated over the years a tight
relationship with the political establishment and local constituencies, mainly through
no-proft legal entities such as foundations (for instance, the Cajas in Spain or the
Landesbanken in Germany; see, among others, Garicano, 2012). These relationships
Figure 3.
Intra-EMU MFIs’
loans to other MFIs
and MFIs’ deposits
(€ million), 2006-2013
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Figure 4.
Intra-EMU banks’
claims on (a) core
countries and (b)
peripheral countries
(€ billion), 2005-2013
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Figure 5.
Securities other than
shares, non-domestic
(a) versus domestic
(b) holdings (€
million), 2007-2013
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with the political establishment contributed to delaying reforms that could sensibly
reduce systemic risk, yet also hurt proftability for banks’ shareholders (Calomiris and
Haber, 2014).
Finally, and perhaps most importantly, in some European countries, the introduction
of a single currency and payment infrastructure removed barriers to the circulation of
capital and introduced an exogenous constraint on governments’ ability to borrow
funds, by removing the currency risk in holding non-domestic government bonds. It also
affected the links with domestic banks that are main buyers or intermediaries for buyers
of government bonds. The following section will discuss the implications of the single
currency on the process of fnancial integration and the implications for institutional
reforms (banking union).
3. The single currency dimension
With the introduction of the single currency, capital (savings) across euro-area
countries can move freely, and investors can quickly exchange cross-border
investments in the same asset class, switching, for instance, Spanish with German
government bonds when sovereign default risk increases. Together with the
inability to monetise debt, euro area governments have a severe constraint on how
much they can actually raise from international markets and de facto have to
compete more over capital fows.
Due to this exogenous constraint, and as the fscal backstop to the fnancial systemin
the euro area is national, governments may behave strategically to avoid instability in
the banking systemthat would result in capital shifting towards safer banking systems
within the same currency area, causing a sharp increase in their own borrowing costs.
Fear of capital fight and of a quick polarisation of the Eurozone banking system (via
savings transfer) towards countries endowed with greater fscal capacity motivates
these interventions. In addition, imposing the losses of domestic banks on creditors,
including international investors and local government debt holders, might have
provoked a sell-off of domestic government bonds, thus leading to a jump in refnancing
costs. As a result, this section explores the consequences of the use of fscal power to
prop up domestic banking systems in the Eurozone, which may have served the purpose
of further national liquidity ring-fencing, ultimately delaying a much-needed
restructuring of the sector. De Grauwe and Ji (2013) suggest a causal link to this
relationship by suggesting that banks in core countries have been using the fscal
capacity of their governments to issues more subsidised debt. However, this section
suggests that governments in a currency union tend to overreact even before the banks
start to use the implicit guarantees and delay equity dilution.
Acurrency union with a decentralised fscal backstop to the banking systemactually
led to governments’ overreaction (e.g. massive state aids in the form of guarantees for
bank debt), while this appeared less signifcant for countries that did not share a single
currency and where bank restructuring during the crisis was more effective (such as the
USA; Montgomery and Takahashi, 2011). In effect, Bijlsma and Mocking (2013)
estimated that state guarantees provided banks in Europe with an annual average
funding advantage amounting to 0.3 per cent of total assets. The overreaction might
have delayed the restructuring of domestic banking systems and put off proper
management of losses on “legacy” assets (such as banks’ loans impaired due to the
fnancial and economic crisis; Benink and Huizinga 2013; IMF, 2013).
259
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This overreaction was less intense outside the euro area for two reasons:
(1) the intrinsic legal and economic barriers raised by a different currency; and
(2) the fnancial backstop that the domestic central bank can offer to provide
credibility to the fscal backstop.
Eurozone governments’ creditworthiness is therefore priced by fnancial markets
according to their actual fscal capacity, taking into account the lack of a central bank
backstop, which by statute cannot come from the ECB. Furthermore, frictions in the
banking system may have further slowed down the creation of a single market for
banks’ control, despite the low market capitalisation that several banks have today[8].
Despite the important steps in the past decade to increase fnancial integration,
cross-border equity ownership of banks has not increased much since the introduction
of the single currency (Draghi, 2014). Additional underlying legal and fscal barriers,
such as different securities laws or fscal treatment of equity instruments, hamper
equity market integration.
The banking system is therefore more important (and its fragmentation more
damaging) in a currency union with decentralised fscal policies for two reasons. First,
the scope of the single monetary policy is limited and has limited direct intervention
tools in the economy, so the banking system is the key transmission channel for
monetary policies to reach the economy (Angeloni et al., 2003; Peek and Rosengren,
2013). For instance, the ECB cannot buy government bonds for unlimited amounts or
consider alternative targets to price infation due to the redistribution effects that would
require instead greater accountability to common institutions that are not there (yet).
Second, frictions to credit markets (such as a disorderly intervention to protect local
banks) can generate negative spillover, with signifcant welfare losses in particular for
the economies in a currency union. As Bignon et al. (2013) suggest, a currency union
without a smoothly functioning credit market aggravates issues of adverse selection
because of the diffculty banks encounter in getting cross-border information on
borrowers or discounting the costs of different bankruptcy laws. Most notably, this
situation can ultimately magnify welfare losses for EMUcitizens compared to non-EMU
ones due to fear of savings fight. The lack of enforcement mechanisms for cross-border
debt repayment is one of the frictions in the working of the credit system. Conficting
bankruptcy laws or government interventions to protect local banks lead good
borrowers to borrow domestically because of the implicit guarantees that offset
potential lower costs of cross-border services (home bias). As a result, a fragmented
banking system can impose higher welfare losses in a single currency area because
capital can easily move in good times but might not be easily disinvested when a crisis
looms over. Prolonged inability to resolve these problems in the credit market may thus
have unpredictable effects on the stability of the euro area.
3.1 The banking system in the Eurozone
The banking system in the Eurozone showed much fexibility during the growth phase
of the business cycle, but it seemed sticky in the negative adjustment phase, when losses
needed to be absorbed by the system. As discussed above, assets that are the legacy of
a fnancial and economic crisis can hamper governments’ ability to raise money and so
postpone the absorption of losses by the fnancial system. Evidence in the euro area
corroborates these fndings. According to Figure 6a, U-turn in the growth of banks’ total
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assets materialised when the PSI in the Greek debt restructuring took place, in the
attempt from governments to share the burden of losses with the private sector. The
governments’ decision not to stand behind fnancial institutions at all costs,
strengthened by the Cypriot crisis and the decision to bail-in creditors and depositors
above 100,000 euros, gave a strong signal that banks needed to restructure their asset
side and write assets legacy of the on-going fnancial and economic crisis refected in
soaring non-performing loans across the borders (Makri et al., 2014).
However, the number of MFIs has only partially shrunk, mainly because of the
historical up-scaling trend of the European banking system to a single-market
dimension and the shutdown of several money market funds. Actual liquidation of
credit institutions has been a rare event, in particular, in countries where the
restructuring of the banking system was a condition for the provision of external
funding to the country. The size of total assets is also above pre-crisis levels (see
Figure 6). The reduction of the asset side, though, may not necessarily be a measure of
the ongoing restructuring of the sector and the write-offs; it can also refect an attempt to
prop up banks’ balance sheets by reducing size and, thus, limiting equity dilution. A
different situation occurred in the USA, where the joint action of the Offce of the
Comptroller of the Currency and the Federal Deposit Insurance Corporation have
scrutinised and liquidated (mostly preserving their activities) 528 deposit-based
Figure 6.
EMU banks’ total
assets (€ million) and
number of MFIs
(outstanding),
1999-2013
261
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banks[9] from2007 to 2013, including big banks like Washington Mutual, Merrill Lynch
and subsidiaries of Citigroup and Bank of America.
The initial drop in the total number of MFIs and the stabilisation of total assets
growth is slowly reversing the pre-crisis trend. However, the adjustment process
requires additional restructuring to deal properly with legacy losses, according to
estimates (Acharya and Steffen, 2014). Although the regulatory reserve capital of EMU
banks has been constantly increasing since 2008, the rise in non-performing loans and
their systemic risk may compel banks to continue efforts to dilute their equity (EBA,
2013; Acharya and Steffen, 2014)[10].
Notably, the adjustment process appeared uneven across euro-area countries. Banks’
total assets over gross domestic product (GDP) have greatly diminished in countries
where restructuring was imposed by external intervention such as through the
European Stability Mechanism (ESM), as in the case of Ireland (around 600 per cent of
GDP) and most recently Spain (around 300 per cent), or by fnancial frm bankruptcies,
as for Belgium’s Dexia and Fortis.
In either case, only the inability of both public and private sectors to raise money
directly and to avoid external intervention forced a newcourse of actions. The size of the
banking sector thus has remained stable or even bigger in euro-area countries, such as
France and Germany, where banks or governments have been able to source capital on
top of a credit relief provided by the ECB LTRO and its renewed version in June 2014.
The slow-down of restructuring also occurred in countries with well-known problems
with non-performing loans, such as Italy.
Negative GDP growth in some countries, such as Spain, has contributed to keep this
ratio stable. In Italy, for instance, the private sector has been able so far to avoid hard
restructuring decisions, raising capital fromthe country’s abundant private savings and
to less extent than other countries from public support. The German (in absolute terms)
and French banking systems are also a bigger part of the economy than their pre-crisis
levels, despite signifcant issues with legacy losses during the 2007-2008 fnancial crisis.
Massive government interventions to subsidise the banking system in these two
countries have been critical in delaying restructuring. The United Kingdom’s banks
have undergone some restructuring due to the legacy of the fnancial crisis (IMF, 2013;
Bank of England, 2014), with interventions to recapitalise banks pursued mostly via
nationalisations and hard restructuring.
3.2 Governments and moral hazard
The moral hazard of governments in putting off to future governments the costs of
restructuring the domestic banking system to avoid repercussions on their borrowing
costs resembles what happened in Japan after the unstoppable growth of its banking
sector during the 1970s, when the national economy was still fairly closed. After the
country gradually opened up, the delay in restructuring banks and corporations in the
country, driven by the interference of public policies, substantially contributed to its
stagnation over the years. These tensions depressed the economy by distorting the
proper channelling of credit into the economy and diverting it towards underperforming
sectors (Hoshi and Kashyap, 2004, 2011). The Japanese experience offers lessons about
the importance of a fexible fnancial system in an open economy, through, for instance,
solid resolution procedures that allow restructuring (and liquidation) of banks when
they suffer losses caused by a prolonged downturn in the business cycle.
JFEP
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Direct government intervention to offer guarantees or asset relief or to recapitalise
banks in the EU, especially in the euro area, has been approved under state aids rules for
signifcant amounts, as shown in Table I. State aids were approved under the
exceptional circumstances of Article 107.3.b of the Treaty on the Functioning of the
European Union[11], which allows aid to be used “to remedy a serious disturbance in
the economy of a Member State”, with conditions that have been gradually tightened as
the crisis eased. In some countries, such as Ireland and Spain, external public funding
sources – for instance, the new ESM – have provided support to governments tied to
additional conditions beyond that of the state aids framework of Article 107 that apply
to the government (generally called, “structural reforms”). Euro area countries used
more than 75 per cent of all the approved state aids in the EU (around €4 trillion) from
2008 to 2012. They have provided on average more state aids to local banks than the rest
of the EU and perhaps the rest of the world[12].
EMU countries thus have been using their fscal capacity to support the domestic
banking system, in particular, before European Commission’s state aids rules were
further tightened in August 2013 with the forced “bail-in” of bank owners and junior
creditors[13]. State aids rules have been used mostly for guarantees, which required
fewer conditions, such as no restructuring plan, than those requested for the
recapitalisation of banks with public money. Guarantees allow governments to
subsidise national banks’ issuance of credit or borrowing in the interbank market with
limited conditions (a fee, under the formula set by the Commission’s 2011 Prolongation
Communication, and a viability reviewof the bank’s business model, if total outstanding
guarantees are higher than 5 per cent of total liabilities). Only from July 2013, a
restructuring plan was made mandatory if guarantees exceed either the specifed ratio
of 5 per cent or €500 million. As a result, trillions of euros in guarantees supported the
borrowing activities of domestic banks, ultimately distorting the pricing of their credit
risk and increasing liquidity fragmentation along national lines and so frictions to the
smooth functioning of the single credit market.
Notwithstanding a robust state aids framework in the EUto protect the single market
and partly deal with moral hazard of banks and their risk-taking behaviours, these rules
were certainly not designed to deal with moral hazard of euro area governments, which
used their fscal capacity to support artifcial conditions in the local banking systemand
to avoid repercussions on their borrowing costs. Notably, in countries where the
banking systemhas been subsidised through government intervention, the propping up
of local banks via capital increases (equity dilution) made fairly modest progress (see
Figure 7; see also De Grauwe and Ji, 2013)[14].
This divergence becomes more evident when looking at the annual marginal increase
in capital and reserves as a proportion of total capital and reserves vis-a`-vis the euro-area
average, a calculation that partially neutralises the differences in the defnition of capital
among countries. Spain and Ireland, driven by the strict conditions imposed by EU
intervention, have been the only two countries that had an increase of equity above the
euro-area average in fve out of the past seven years. Countries where direct or indirect
government intervention took place have performed worse in the recapitalisation of
banks (above all, Germany, France, Italy, Belgiumand The Netherlands; see Appendix).
This also shows how limited restructuring of the domestic banking system took
place in recent years, despite banks strengthening their regulatory capital reserves
across Europe. Only Ireland and more recently Spain have implemented or are
263
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Table I.
State aids in selected
countries (by total
state aids; € billion),
total 2008-2012
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implementing plans to restructure the domestic banking system to a degree that is
unprecedented elsewhere.
Euro area banks that have been able to beneft from the credit status of the local
government have experienced a slowdown in equity dilution, a delay in restructuring
and recapitalisation and, hence, additional losses incurred on legacy assets. Countries
where restructuring/recapitalisation was imposed by external funding conditions (ESM
or other fnancing arrangements) or prompted by the fear of being forced to conduct a
hard restructuring under external funding arrangements have seen a sharper increase in
capital held by domestic banks. This divergence is relevant for euro-area countries, as
non-euro-area countries like the UKand the USAhave been more active in restructuring
their fnancial sectors. Finally, as banks in some countries choose continued reliance on
the national fscal backstop over restructuring/recapitalisation, the European
continental banking system is gradually polarising, with those countries boasting
greater fscal capacity serving as the primary destination of capital fight from
peripheral countries. As the health of the domestic banking system may affect
governments’ borrowing costs, public interference in the banking sector thus promote
liquidity ring-fencing at national level as a way for governments to protect themselves
froman acceleration in capital fights towards the countries with greater fscal capacity.
This situation increases the likelihood that citizens’ welfare in the currency union will be
undermined, driving the union into uncertain circumstances.
4. Banking union revisited
Banking union reforms in the EU in recent years are perhaps the most important
achievements stemming from the introduction of the single currency, but these reforms
Figure 7.
Capital and reserves
(% of total assets),
2007-2013
265
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still lack a solid institutional framework. The fscal coordination issues among member
states have led so far to sub-optimal responses to the problemof banks’ legacy assets. In
this respect, the design of an institutional set-up for the banking union needs to take into
account the role of the single currency in shaping these incentives, on top of the standard
market failures that are inherent in banking. As a consequence, banking union in a
single currency area (whether within a single federal state or a community of states)
faces three potential market failures: risk-taking behaviours; depositors’ runs on banks
and fnancial fragmentation (see Table II).
Risk-taking behaviours and runs on banks are universal market failures, when
dealing with the economics of banking and money (Diamond and Dybvig, 1983; Akerlof
and Romer, 1993; Stiglitz, 1993). Financial fragmentation, driven by the moral hazard of
governments that tend to postpone absorption of legacy losses instead, is a potential
market failure caused by the single currency framework with fully decentralised fscal
policies. In a common fnancial system, public (supranational and fscal) intervention
ensures that the legal incorporation of the bank (location)[15] does not affect its
borrowing costs and the funding costs of its government.
As a result, state aids may produce price distortions on bank debt/equity and
destabilise the fnancial system within a single currency area in which states maintain
sovereignty over decisions to bail out banks, so linking the price distortion to the fscal
capacity of the country, as it cannot alternatively monetise the bailout via central bank
funded intervention. Overall, this raises the question whether an exemption from the
state aids framework, under “the serious disturbance to the economy”, is ultimately
benefcial for fnancial stability in the euro area. Shall the fnancial stability of a single
country prevail over the stability of the region? State aids in a monetary union without
a common fscal backstop to the resolution of a bank can actually increase fnancial
fragmentation and instability via the postponement of banks restructuring.
Aprohibition to intervene, however, may not be credible when a crisis looms over
(Stern and Feldman, 2004) and would become unnecessary if a common fscal
backstop is put in place, i.e. a mechanism that would assess the need for
recapitalisation/resolution of a bank, taking into account fnancial stability concerns in
the single currency area, which is the actual perimeter of the fnancial system. The
common fscal backstop to a fund fnanced by banks, via ex ante and ex post levies plus
“bail-in” procedures and a concomitant partial mutualisation of losses (to deal with
banks’ moral hazard), would not be sound if a national government were to retain the
option of providing its own funding in an extreme situation when the fund is depleted. If
that situation was possible, before or after the recapitalisation/resolution mechanism
kicks in and even with a formal ex ante state aids prohibition, markets would be still
pricing the risk of the domestic banking system in the government’s funding costs and,
thus, distorting borrowing costs for domestic versus non-domestic banks.
Consequently, the common backstop to a privately sourced bank fund is credible if the
only resources available after the exhaustion of the fund in extreme situations come
from a common backstop that does not discriminate based on the nationality of the
bank. To counter the risk of a bank run by depositors, the size of the backstop in other
countries like the USA is formally limited, but de facto unlimited, as the national
treasury can actually request central bank money when all the bail-in, restructuring and
liquidation procedures have been put in place but have been insuffcient to stop the
panic. A careful institutional design of the common backstop leaves EU institutions
JFEP
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Table II.
Banking union
revisited
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with multiple options, such as access to the ESM or any other common institution that
can ultimately resort to unrestricted funding, if private or public resources raised from
open markets were insuffcient. Whether through supranational debt issuance or ECB
credit lines, the potentially unlimited funding of a European resolution mechanism
renders irrelevant the nationality of taxpayers vis-a`-vis the credit risk of their country’s
banks.
5. Conclusions
This paper discussed evidence showing how the single currency affects government
incentives to restructure domestic banks and how it needs to lead the design of the
institutional framework of the banking union. While boosting further fnancial
integration in the EU was the ultimate objective of the euro, the harmonisation of rules
for the smooth functioning of the single market neglected the breadth of the
interventions required to make the single currency area work. EU actions to build a
banking union and reverse fnancial fragmentation were unable to ensure a proper
management of banks’ legacy losses, with the risk of being ineffective and ultimately
harming the economy. The moral hazard of euro area governments, competing on
funding costs and putting off the write-downs of bank legacy assets, fostered fnancial
fragmentation (strengthening banks’ home bias) and contributed to a defationary spiral
similar to Japan. Completing the banking union by taking into account the reforms
needed for the single currency area is not just an empty Treaty exercise. Evidence shows
that “home bias” can lead an imperfect banking union to undermine citizens’ welfare
within a currency union, thus threatening its stability. To bring banking union closer to
its ideal institutional design, the resolution mechanism needs a credible common fscal
backstop, so to make member states’ possibility to bail out “their” banks and to put a
drag on the restructuring of their domestic banking system harmless for the fnancial
stability of the monetary union.
Notes
1. The initial agreement struck in July 2011 was fnalised with the Eurogroup statement of 21
January 2012, available at:http://consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/
ecofn/128075.pdf See also the statement of the Council of the European Union, available at:
www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/123978.pdf
2. “The European Union (EU) banking system restructuring is under way, but is far from
complete”. The statement comes from the IMF technical note about the progress made on
bank restructuring, March 2013 (Country Note No. 13/67).
3. In this paper, “interest rate carry trade” refers to the strategy set up by a bank in which a
certain asset, with a relatively low interest rate (also because of perspective losses), is sold or
repo-ed (e.g. at the central bank) and the funds obtained are used to purchase another asset
with higher interest rate in relation to the risk. The main purpose is to gain the difference
between the two interest rates, given no change in the exchange rate or worsening of the risk
profle.
4. According to the ECB Glossary, “Monetary Financial Institutions” are “resident credit
institutions (as defned in EUlaw) and all other resident fnancial institutions whose business
is to receive deposits and/or close substitutes for deposits from entities other than MFIs and,
for their own account (at least in economic terms), to grant credit and/or invest in securities.
JFEP
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The latter group consists predominantly of money market funds.” The full defnition is
available at: www.ecb.europa.eu/home/glossary/html/glossm.en.html#447
5. The paragraph no. 100 of the CRR No 575/2013 states: “government bonds are expected to be
assets of extremely high liquidity and credit quality”.
6. See G-20 Conclusions in Washington 2008, www.g20.utoronto.ca/2008/2008declaration1115.
html#risk, and London 2009, www.g20.utoronto.ca/2009/2009if.html
7. See more athttp://ec.europa.eu/internal_market/bank/crisis_management/
8. The three top Italian banks (by assets) had a total market capitalisation of €58.8 billion on 16
December 2013.
9. The number of scrutinised and liquidated deposit-based banks comes from the “Failed Bank
List” database of the Federal Deposit Insurance Corporation, available at: www.fdic.gov/
bank/individual/failed/banklist.html
10. For a deeper analysis of the systemic risk of EMU fnancial institutions, see the New York
University Volatility Institute at:http://vlab.stern.nyu.edu Standard & Poor’s has recently
estimated a capital shortfall of €110 billion for Western European banks; see www.scribd.
com/doc/191086580/Untitled For a recap of recent estimates, see also S. Merler and G. B.
Wolff, “Ending uncertainty: Recapitalisation under European Central Bank supervision”,
Bruegel Policy Contribution, Issue 2013/2018, Bruegel, December 2013.
11. Treaty on the Functioning of the European Union, Part 3: Union policies and internal actions,
Title 7: Common rules on competition, taxation and approximation of laws, Chapter 1: Rules
on competition, Section 2: Aids granted by states – Article 107 (e.g. Article 87 TEC).
12. This table should be looked at mainly from a cross-country comparative perspective. The
absolute level of other-than-equity state aids (such as state guarantees on bank debt) is
infated by a cumulative sum of amounts on a six-month basis.
13. See European Commission, Communication COM (2013) 216/01, entered into force on 1
August. This communication embodies the six communications of the Commission on state
aids to the fnancial system(so-called Crisis Communications). These six communications are:
the Banking Communication COM (2008) 270; Recapitalisation Communication COM (2009)
10; Impaired Asset Communication COM (2009) 72; Restructuring Communication COM
(2009) 195; 2010 Prolongation Communication COM (2010) 329; 2011 Prolongation
Communication COM (2011) 356.
14. Results would not change if the same defnitions of capital and loan provisions applied.
15. Nevertheless, the economic situation of the country where the banks is located will always
affect the quality of the assets. For instance, the real estate bubble in Spain hit the sector
whether the holder of those assets was Spanish or a foreign bank.
16. Bank for International Settlements data converted to euros with a simple average of yearly
exchange rates from 2010 to 2013 calculated by www.oanda.com/currency/average For a
defnition of “foreign claims”, see the BIS Glossary, www.bis.org/statistics/bankstatsguide_
glossary.pdf
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Appendix
–2.50%
–1.50%
–0.50%
0.50%
1.50%
2.50%
3.50%
2007 2008 2009 2010 2011 2012 2013
Germany Netherlands Belgium France Italy
UK Ireland Spain Euro area (avg)
Note: Annual average of monthly marginal increases. 2013 data are up through
October.
Source: Author from ECB.
Figure A1.
Capital plus reserves,
marginal increase as
a percentage of total
capital and reserves
compared with
euro-area average,
2007-2013
Figure A2.
Intra-EMU MFIs’ (a)
and non-MFIs’ (b)
cross-border
securities holdings
(€ million), by
country, 2003-2013
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–10.86%
–15.35%
–$600,000
–$500,000
–$400,000
–$300,000
–$200,000
–$100,000
$0
Extra-EMU Intra-EMU
Notes: Extra EMU includes Australia, Brazil, Canada, China,
Hong Kong SAR, Japan, New Zealand, Singapore, United
Kingdom, United States
Source: ECB
Figure A3.
Intra-EMU vs
Extra-EMU claims of
Spanish, French,
Italian and German
banks, Q2-2010
Q2-2013 ($ million)
$0
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
$3,000,000
$3,500,000
$4,000,000
$4,500,000
$5,000,000
USA Japan UK
Source: Bank for International Settlements
Figure A4.
Foreign claims of
domestic banks
versus the rest of the
world ($ million),
2005-(Q2)2013
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Corresponding author
Diego Valiante can be contacted at: [email protected]
For instructions on how to order reprints of this article, please visit our website:
www.emeraldgrouppublishing.com/licensing/reprints.htm
Or contact us for further details: [email protected]
$0
$200,000
$400,000
$600,000
$800,000
$1,000,000
$1,200,000
$1,400,000
$1,600,000
USA UK Japan
Source: BIS
Figure A5.
Foreign claims of
domestic banks
versus EMU
counterparties ($
million), 2005-2013
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doc_669784385.pdf
The purpose of this paper is to assess the impact of the impact of the single currency on the
institutional design of the banking union, through evidence on the financial integration process.
Journal of Financial Economic Policy
Banking union in a single currency area: evidence on financial fragmentation
Diego Valiante
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Banking union in a single
currency area: evidence on
fnancial fragmentation
Diego Valiante
Capital Markets Research, Centre for European Policy Studies,
Brussels, Belgium
Abstract
Purpose – The purpose of this paper is to assess the impact of the impact of the single currency on the
institutional design of the banking union, through evidence on the fnancial integration process.
Design/methodology/approach – Data analysis uses multiple sources of data on key drivers of
fnancial fragmentation. The paper starts from a snapshot the status of fnancial integration and then
identifes the main components of this trend.
Findings – Evidence shows that fnancial integration in the euro area between 2010 and 2014
retrenched at a quicker pace than outside the monetary union. Home bias persisted. Under market
pressures, governments compete on funding costs by supporting “their” banks with massive state aids,
which distorts the playing feld and feed the risk-aversion loop. This situation intensifes frictions in
credit markets, thus hampering the transmission of monetary policies and, potentially, economic
growth. Taking stock of developments in the euro area, this paper discusses the theoretical framework
of a banking union in a single currency area with decentralised fscal policy sovereignty. It concludes
that, when a crisis looms over, a common fscal backstop can reduce pressures of fnancial
fragmentation, driven by governments’ moral hazard and banks’ home bias.
Research limitations/implications – Additional research is required to deepen the empirical
analysis, with econometric modelling, on the links between governments’ implicit guarantees and
banks’ home bias. This is an initial data analysis.
Originality/value – Under market pressure, governments in a single currency area tend to be
overprotective (more than countries with full monetary sovereignty) towards their own banking system
and so trigger fnancial fragmentation (enhancing banks’ home bias). To revert that, a common fscal
backstop is an essential element of the institutional design. The paper shows empirical evidence and
theory, as well as it identifes underlying market failures. It links the single currency to the institutional
design of a banking union. This important dimension is brought into a coherent framework.
Keywords Bank resolution, Monetary union, Banking union, Bank restructuring,
Financial fragmentation, Euro area
Paper type Research paper
JEL classifcation – G21, G18, E58
The author is solely responsible for any errors. He gratefully acknowledges research assistance
fromJan-MartinFrie andhelpful comments fromThorstenBeck, StevenGreenfeld, Daniel Gros, Karel
Lannoo and Willem Pieter de Groen. This work has greatly beneftted from discussions with
participants at the 31st SUERF Colloquium and Baff Finlawmetrics Conference 2014 – Call for
Papers – Research Questions (“Money, Regulation and Growth: Financing New Growth in Europe”)
and feedback fromtwo anonymous referees.
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1757-6385.htm
Banking
union in a
single
currency area
251
Received2 October 2014
Revised21 January2015
22 March2015
Accepted1 April 2015
Journal of Financial Economic
Policy
Vol. 7 No. 3, 2015
pp. 251-274
©Emerald Group Publishing Limited
1757-6385
DOI 10.1108/JFEP-10-2014-0058
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1. Introduction
As European institutions strive to strike a proper balance on burden sharing in
developing a full-fedged European banking union (EU Council, 2012), several factors
affect the breadth and depth of fnancial fragmentation in the euro area. A major one is
the single currency. This paper assesses the incentives for governments in a monetary
union with decentralised fscal sovereignty, under market pressure, to restructure the
banking sector and to manage write-downs of assets that are a legacy of the recent
fnancial and economic crisis. This paper reviews evidence in the euro area and inform
howto best devise the institutional framework of a banking union with a mechanismfor
orderly bank resolution.
A main point of confict is the extent to which national governments ought to be
allowed to bail out national banks and concurrently howmuch creditors and depositors
of the bank ought to be subject to compulsory “bail-in” procedures in the recapitalisation
process. If bank resolution is never an easy task, the additional complexities of the
European fnancial system, its legal rules and the relevant governing bodies make this
matter even thornier. European institutions have tried to make the resolution piece
match other pieces of the banking union puzzle, such as the creation of a common
supervisory mechanism that would centralise supervision of systemically important
banks under the European Central Bank (ECB), or the creation of a common deposit
guarantee scheme to replace those that so far, in countries like Italy and Spain, have
relied on unfunded government guarantees. All of them aim to shield the fnancial
system from the adverse effects of another systemic crisis and potential runs on banks
by providing an appropriate supervisory mechanism and safeguards to ensure that the
banking system functions on an equal footing for all banks involved in the process,
minimising the involvement of taxpayers’ money. Such a common system could also
revert the ongoing fnancial fragmentation in the euro area and perhaps revive the
cross-border market for banks’ mergers and acquisitions.
The frst section of this paper illustrates the evolution of the banking system in the
euro area after the 2007-2008 fnancial crisis and the link between banks and
governments. The second section discusses the single currency and its impact on euro
area governments and banks’ incentives. The last section reviews the theoretical
framework behind the creation of banking union institutions.
2. The banking system and fnancial fragmentation
Although the fnancial crisis badly hit European banks already in 2007, until the frst
Greek debt restructuring with the private sector involvement (PSI)[1] and more
remarkably the Cypriot crisis, the banking system had barely embarked on the
restructuring process, particularly in the euro area (IMF, 2013)[2]. Reasons for the delay
are manifold, but the key role of banks in the funding of European economies, both at the
periphery and within the core, played an important role.
2.1 Banks and governments
The mammoth size and interconnection of European banks with the national political
establishment and local constituencies historically tie them closely to their domestic
governments, with broader long-term implications on fscal sustainability (among
others, Reinhardt and Rogoff, 2009 and Calomiris and Haber, 2014). When systemic risk
increases, especially in peripheral countries (mainly in the formof sovereign risk), banks
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generally tend to increase the holdings of sovereign debt securities (Andritzky, 2012)
and their portfolio becomes more “home biased” (Battistini et al., 2013). This “fatal hug”
between governments and banks has materialised most prominently in two ways:
(1) Banks’ use of central banks’ “cheap” liquidity for massive purchases of domestic
government bonds, in spite of attempts by the ECB to transfer the impulse of
monetary policy to the economy via bank lending (Merler and Pisani-Ferry,
2012; Valiante, 2012; Goyal et al., 2013; EBA, 2013).
(2) The fast retrenching of banks’ international diversifcation when the fnancial
crisis hit, despite deep fnancial integration in the European Monetary Union
(EMU) (so-called “home bias”; see Manna, 2011; Valiante, 2012; Liikanen Report,
2012).
The frst development was spurred by the incentives to increase concentration of
domestic government bonds holding, so indirectly calling for massive government
intervention (through guarantees and liquidity injections) to limit the repercussions of
banks’ diffculties on each other’s fnancial situations (banks’ moral hazard; see Section 4,
Table II, for more details). The interest rate carry trade[3] between the ECB liquidity
operations, and the higher “safe” return on government bonds has helped national
governments sustain public fnances in a time of deep liquidity crises (Acharya and
Steffen, 2013). The latter outcome is a more general trend caused by frictions in the
fnancial system, and in particular for cross-border transactions in the single currency
area (see the next section). Specifcally, cross-border asset holdings have been
decreasing since the beginning of the fnancial crisis, and that tendency accelerated
when the sovereign crisis spread (see Figure 1). Most notably, cross-border securities
holdings dropped by more than 30 per cent, after reaching a historical peak in 2008.
As the sovereign crisis expanded, causing governments’ disorderly interventions to
support local banking systems, the retrogression of fnancial integration in the euro area
accelerated compared with claims against other major areas of the world. Claims of
EMUbanks versus those of other EMUcountries dropped by almost €1 trillion (or 23 per
cent), while claims of EMU banks vis-a`-vis other European counterparties dropped by a
lesser amount. Foreign claims of banks in the four biggest EMU economies (France,
Spain, Germany and Italy) versus counterparties in selected non-EMU economies only
dropped by 10 per cent since the second quarter of 2010, while intra-EMU claims for
these countries dropped by more than 15 per cent during the same period (see Figure 2
and Appendix). While fnancial integration and freedom of capital movement should
protect the fnancial system from extreme home bias in favour of domestic institutions
(Sorensen et al., 2007), idiosyncrasies specifc to the monetary union may have instead
accelerated fnancial fragmentation compared with other areas of the world (see the
following section). As a result, home bias persists despite early signs of recovery. The
UK, USA and Japan have seen a much lower drop in the foreign claims of domestic
banks since the inception of the sovereign crisis (see Appendix). For the USAand Japan,
foreign claims of domestic banks versus the rest of the world have signifcantly
increased since 2005 and have only marginally dropped versus euro-area counterparties
since the beginning of the sovereign crisis in the second quarter of 2010.
Furthermore, the cross-border interbank market for banks in some euro-area
countries remains illiquid, and trust among euro-area fnancial institutions is very weak,
which is expected when uncertainty about aggregate liquidity arises (Allen et al., 2009).
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Cross-border loans to other EMU monetary fnancial institutions (MFIs)[4] and MFIs’
deposits have been experiencing a steady drop since the beginning of the fnancial crisis,
which then accelerated with the sovereign crisis later on (see Figure 3).
Even before the inception of the sovereign crisis in 2010, differences among the
euro-area regions emerged also in relation to MFIs’ cross-border securities holdings,
as ring-fencing at national level (home bias) for the sake of liquidity led to a
signifcant drop of holdings of MFI and non-MFI in securities of counterparties
located in peripheral countries such as Spain, Ireland and Italy. In countries such as
Belgium, Germany and Netherlands, considered to be at the core of the Eurozone,
cross-border MFIs’ holdings of local counterparties’ securities remained at a stable
level (see Appendix). A similar picture emerges when looking at banks’ claims in
the core and the periphery. The constant decline of core countries banks’ claims on
the periphery accelerated in recent years, despite a gradual improvement of the
macroeconomic conditions and after the 2007-2008 fnancial crisis and 2010-2011
sovereign crisis (see Figure 4).
The frictions in credit markets, created by the uncertainty about the risk of banks in
peripheral countries, fuelled the so-called fnancial fragmentation process (Garcia de
Andoain et al., 2014). Since the inception of the sovereign crisis, therefore, national
liquidity ring-fencing has been fragmenting the fnancial system of the euro area along
country lines.
Figure 1.
Intra-EMU MFIs’
euro-area holdings
(€ million), 2006-2013
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2.2 Financial repression and risk aversion
On top of precarious market conditions (also affecting non-euro-area countries) and
heightened sovereign risk, public policies and market practices have contributed to
promote fnancial repression together with risk aversion (home bias), particularly in the
Eurozone. Following Reinhart et al. (2011), “fnancial repression” is a combination, on
the one hand, of tighter connection between banks and domestic governments and, on
the other hand, frictions to cross-border capital movements created by macroprudential
regulation introduced to prop up the fnancial system. In particular, the following
factors contributed to fnancial repression and greater risk aversion, creating a
structural information asymmetry in cross-border banking:
• Regulatory capital requirements and the “interest rate” carry trade;
• National resolution mechanisms and credit information sharing;
• Governance and political interference; and
• Single currency and payment system (infrastructure).
First, the purchase of domestic government bonds by local banks was strongly
encouraged by the opportunity to purchase government bonds as “risk-free assets”
under the risk-weighting provisions of current capital requirements[5], even for those
bond issuers that were not backed by a currency printer anymore (such as countries in
the euro area). These rules, which also apply outside the euro area, came on top of an
Figure 2.
Intra versus
extra-EMU (EU) and
other extra EMU
(selected)
outstanding loans
and securities other
than shares
(€ million),
? Q2-2010/Q3-2013
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interest rate carry trade created by the ECB’s cheap liquidity operations (so-called
long-term refnancing Operations, LTRO, or Targeted LTRO), in particular, from early
2012 onwards. The sharp increase in banks’ domestic holdings also increased pressure
for a pre-emptive government intervention to avoid a disorderly liquidation that would
have ultimately had repercussions on governments’ own funding resources. In effect,
between 2010 and 2014, as suggested by Figure 5(a), more than €200 billion drop in
fnancial institutions’ holdings of securities issued by foreign governments was offset
by an increase of roughly €500 billion in holdings of domestic government securities, on
top of the increase in other domestic assets precipitated by home bias.
Second, the fragmentation of national resolution mechanisms for banks and the lack
of a common system for credit information may have fuelled banks’ risk aversion
(Manna, 2011). Uncertainty regarding who would bear the costs of the resolution of
fnancial institutions, which have in the meantime built strong cross-border interests in
the euro area due to the fast integration process, played an important role in promoting
liquidity ring-fencing at the national level. In the aftermath of the fnancial crisis, this
bad mix of incentives prompted the G-20 to issue a statement about the need to have
more effective crisis management rules for banks[6]. Common rules in the European
Union (EU) were approved, but much will depend on how fast and accurately
governments transpose these rules into national law[7].
Third, banks’ management in many EU countries cultivated over the years a tight
relationship with the political establishment and local constituencies, mainly through
no-proft legal entities such as foundations (for instance, the Cajas in Spain or the
Landesbanken in Germany; see, among others, Garicano, 2012). These relationships
Figure 3.
Intra-EMU MFIs’
loans to other MFIs
and MFIs’ deposits
(€ million), 2006-2013
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Figure 4.
Intra-EMU banks’
claims on (a) core
countries and (b)
peripheral countries
(€ billion), 2005-2013
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Figure 5.
Securities other than
shares, non-domestic
(a) versus domestic
(b) holdings (€
million), 2007-2013
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with the political establishment contributed to delaying reforms that could sensibly
reduce systemic risk, yet also hurt proftability for banks’ shareholders (Calomiris and
Haber, 2014).
Finally, and perhaps most importantly, in some European countries, the introduction
of a single currency and payment infrastructure removed barriers to the circulation of
capital and introduced an exogenous constraint on governments’ ability to borrow
funds, by removing the currency risk in holding non-domestic government bonds. It also
affected the links with domestic banks that are main buyers or intermediaries for buyers
of government bonds. The following section will discuss the implications of the single
currency on the process of fnancial integration and the implications for institutional
reforms (banking union).
3. The single currency dimension
With the introduction of the single currency, capital (savings) across euro-area
countries can move freely, and investors can quickly exchange cross-border
investments in the same asset class, switching, for instance, Spanish with German
government bonds when sovereign default risk increases. Together with the
inability to monetise debt, euro area governments have a severe constraint on how
much they can actually raise from international markets and de facto have to
compete more over capital fows.
Due to this exogenous constraint, and as the fscal backstop to the fnancial systemin
the euro area is national, governments may behave strategically to avoid instability in
the banking systemthat would result in capital shifting towards safer banking systems
within the same currency area, causing a sharp increase in their own borrowing costs.
Fear of capital fight and of a quick polarisation of the Eurozone banking system (via
savings transfer) towards countries endowed with greater fscal capacity motivates
these interventions. In addition, imposing the losses of domestic banks on creditors,
including international investors and local government debt holders, might have
provoked a sell-off of domestic government bonds, thus leading to a jump in refnancing
costs. As a result, this section explores the consequences of the use of fscal power to
prop up domestic banking systems in the Eurozone, which may have served the purpose
of further national liquidity ring-fencing, ultimately delaying a much-needed
restructuring of the sector. De Grauwe and Ji (2013) suggest a causal link to this
relationship by suggesting that banks in core countries have been using the fscal
capacity of their governments to issues more subsidised debt. However, this section
suggests that governments in a currency union tend to overreact even before the banks
start to use the implicit guarantees and delay equity dilution.
Acurrency union with a decentralised fscal backstop to the banking systemactually
led to governments’ overreaction (e.g. massive state aids in the form of guarantees for
bank debt), while this appeared less signifcant for countries that did not share a single
currency and where bank restructuring during the crisis was more effective (such as the
USA; Montgomery and Takahashi, 2011). In effect, Bijlsma and Mocking (2013)
estimated that state guarantees provided banks in Europe with an annual average
funding advantage amounting to 0.3 per cent of total assets. The overreaction might
have delayed the restructuring of domestic banking systems and put off proper
management of losses on “legacy” assets (such as banks’ loans impaired due to the
fnancial and economic crisis; Benink and Huizinga 2013; IMF, 2013).
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This overreaction was less intense outside the euro area for two reasons:
(1) the intrinsic legal and economic barriers raised by a different currency; and
(2) the fnancial backstop that the domestic central bank can offer to provide
credibility to the fscal backstop.
Eurozone governments’ creditworthiness is therefore priced by fnancial markets
according to their actual fscal capacity, taking into account the lack of a central bank
backstop, which by statute cannot come from the ECB. Furthermore, frictions in the
banking system may have further slowed down the creation of a single market for
banks’ control, despite the low market capitalisation that several banks have today[8].
Despite the important steps in the past decade to increase fnancial integration,
cross-border equity ownership of banks has not increased much since the introduction
of the single currency (Draghi, 2014). Additional underlying legal and fscal barriers,
such as different securities laws or fscal treatment of equity instruments, hamper
equity market integration.
The banking system is therefore more important (and its fragmentation more
damaging) in a currency union with decentralised fscal policies for two reasons. First,
the scope of the single monetary policy is limited and has limited direct intervention
tools in the economy, so the banking system is the key transmission channel for
monetary policies to reach the economy (Angeloni et al., 2003; Peek and Rosengren,
2013). For instance, the ECB cannot buy government bonds for unlimited amounts or
consider alternative targets to price infation due to the redistribution effects that would
require instead greater accountability to common institutions that are not there (yet).
Second, frictions to credit markets (such as a disorderly intervention to protect local
banks) can generate negative spillover, with signifcant welfare losses in particular for
the economies in a currency union. As Bignon et al. (2013) suggest, a currency union
without a smoothly functioning credit market aggravates issues of adverse selection
because of the diffculty banks encounter in getting cross-border information on
borrowers or discounting the costs of different bankruptcy laws. Most notably, this
situation can ultimately magnify welfare losses for EMUcitizens compared to non-EMU
ones due to fear of savings fight. The lack of enforcement mechanisms for cross-border
debt repayment is one of the frictions in the working of the credit system. Conficting
bankruptcy laws or government interventions to protect local banks lead good
borrowers to borrow domestically because of the implicit guarantees that offset
potential lower costs of cross-border services (home bias). As a result, a fragmented
banking system can impose higher welfare losses in a single currency area because
capital can easily move in good times but might not be easily disinvested when a crisis
looms over. Prolonged inability to resolve these problems in the credit market may thus
have unpredictable effects on the stability of the euro area.
3.1 The banking system in the Eurozone
The banking system in the Eurozone showed much fexibility during the growth phase
of the business cycle, but it seemed sticky in the negative adjustment phase, when losses
needed to be absorbed by the system. As discussed above, assets that are the legacy of
a fnancial and economic crisis can hamper governments’ ability to raise money and so
postpone the absorption of losses by the fnancial system. Evidence in the euro area
corroborates these fndings. According to Figure 6a, U-turn in the growth of banks’ total
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assets materialised when the PSI in the Greek debt restructuring took place, in the
attempt from governments to share the burden of losses with the private sector. The
governments’ decision not to stand behind fnancial institutions at all costs,
strengthened by the Cypriot crisis and the decision to bail-in creditors and depositors
above 100,000 euros, gave a strong signal that banks needed to restructure their asset
side and write assets legacy of the on-going fnancial and economic crisis refected in
soaring non-performing loans across the borders (Makri et al., 2014).
However, the number of MFIs has only partially shrunk, mainly because of the
historical up-scaling trend of the European banking system to a single-market
dimension and the shutdown of several money market funds. Actual liquidation of
credit institutions has been a rare event, in particular, in countries where the
restructuring of the banking system was a condition for the provision of external
funding to the country. The size of total assets is also above pre-crisis levels (see
Figure 6). The reduction of the asset side, though, may not necessarily be a measure of
the ongoing restructuring of the sector and the write-offs; it can also refect an attempt to
prop up banks’ balance sheets by reducing size and, thus, limiting equity dilution. A
different situation occurred in the USA, where the joint action of the Offce of the
Comptroller of the Currency and the Federal Deposit Insurance Corporation have
scrutinised and liquidated (mostly preserving their activities) 528 deposit-based
Figure 6.
EMU banks’ total
assets (€ million) and
number of MFIs
(outstanding),
1999-2013
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banks[9] from2007 to 2013, including big banks like Washington Mutual, Merrill Lynch
and subsidiaries of Citigroup and Bank of America.
The initial drop in the total number of MFIs and the stabilisation of total assets
growth is slowly reversing the pre-crisis trend. However, the adjustment process
requires additional restructuring to deal properly with legacy losses, according to
estimates (Acharya and Steffen, 2014). Although the regulatory reserve capital of EMU
banks has been constantly increasing since 2008, the rise in non-performing loans and
their systemic risk may compel banks to continue efforts to dilute their equity (EBA,
2013; Acharya and Steffen, 2014)[10].
Notably, the adjustment process appeared uneven across euro-area countries. Banks’
total assets over gross domestic product (GDP) have greatly diminished in countries
where restructuring was imposed by external intervention such as through the
European Stability Mechanism (ESM), as in the case of Ireland (around 600 per cent of
GDP) and most recently Spain (around 300 per cent), or by fnancial frm bankruptcies,
as for Belgium’s Dexia and Fortis.
In either case, only the inability of both public and private sectors to raise money
directly and to avoid external intervention forced a newcourse of actions. The size of the
banking sector thus has remained stable or even bigger in euro-area countries, such as
France and Germany, where banks or governments have been able to source capital on
top of a credit relief provided by the ECB LTRO and its renewed version in June 2014.
The slow-down of restructuring also occurred in countries with well-known problems
with non-performing loans, such as Italy.
Negative GDP growth in some countries, such as Spain, has contributed to keep this
ratio stable. In Italy, for instance, the private sector has been able so far to avoid hard
restructuring decisions, raising capital fromthe country’s abundant private savings and
to less extent than other countries from public support. The German (in absolute terms)
and French banking systems are also a bigger part of the economy than their pre-crisis
levels, despite signifcant issues with legacy losses during the 2007-2008 fnancial crisis.
Massive government interventions to subsidise the banking system in these two
countries have been critical in delaying restructuring. The United Kingdom’s banks
have undergone some restructuring due to the legacy of the fnancial crisis (IMF, 2013;
Bank of England, 2014), with interventions to recapitalise banks pursued mostly via
nationalisations and hard restructuring.
3.2 Governments and moral hazard
The moral hazard of governments in putting off to future governments the costs of
restructuring the domestic banking system to avoid repercussions on their borrowing
costs resembles what happened in Japan after the unstoppable growth of its banking
sector during the 1970s, when the national economy was still fairly closed. After the
country gradually opened up, the delay in restructuring banks and corporations in the
country, driven by the interference of public policies, substantially contributed to its
stagnation over the years. These tensions depressed the economy by distorting the
proper channelling of credit into the economy and diverting it towards underperforming
sectors (Hoshi and Kashyap, 2004, 2011). The Japanese experience offers lessons about
the importance of a fexible fnancial system in an open economy, through, for instance,
solid resolution procedures that allow restructuring (and liquidation) of banks when
they suffer losses caused by a prolonged downturn in the business cycle.
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Direct government intervention to offer guarantees or asset relief or to recapitalise
banks in the EU, especially in the euro area, has been approved under state aids rules for
signifcant amounts, as shown in Table I. State aids were approved under the
exceptional circumstances of Article 107.3.b of the Treaty on the Functioning of the
European Union[11], which allows aid to be used “to remedy a serious disturbance in
the economy of a Member State”, with conditions that have been gradually tightened as
the crisis eased. In some countries, such as Ireland and Spain, external public funding
sources – for instance, the new ESM – have provided support to governments tied to
additional conditions beyond that of the state aids framework of Article 107 that apply
to the government (generally called, “structural reforms”). Euro area countries used
more than 75 per cent of all the approved state aids in the EU (around €4 trillion) from
2008 to 2012. They have provided on average more state aids to local banks than the rest
of the EU and perhaps the rest of the world[12].
EMU countries thus have been using their fscal capacity to support the domestic
banking system, in particular, before European Commission’s state aids rules were
further tightened in August 2013 with the forced “bail-in” of bank owners and junior
creditors[13]. State aids rules have been used mostly for guarantees, which required
fewer conditions, such as no restructuring plan, than those requested for the
recapitalisation of banks with public money. Guarantees allow governments to
subsidise national banks’ issuance of credit or borrowing in the interbank market with
limited conditions (a fee, under the formula set by the Commission’s 2011 Prolongation
Communication, and a viability reviewof the bank’s business model, if total outstanding
guarantees are higher than 5 per cent of total liabilities). Only from July 2013, a
restructuring plan was made mandatory if guarantees exceed either the specifed ratio
of 5 per cent or €500 million. As a result, trillions of euros in guarantees supported the
borrowing activities of domestic banks, ultimately distorting the pricing of their credit
risk and increasing liquidity fragmentation along national lines and so frictions to the
smooth functioning of the single credit market.
Notwithstanding a robust state aids framework in the EUto protect the single market
and partly deal with moral hazard of banks and their risk-taking behaviours, these rules
were certainly not designed to deal with moral hazard of euro area governments, which
used their fscal capacity to support artifcial conditions in the local banking systemand
to avoid repercussions on their borrowing costs. Notably, in countries where the
banking systemhas been subsidised through government intervention, the propping up
of local banks via capital increases (equity dilution) made fairly modest progress (see
Figure 7; see also De Grauwe and Ji, 2013)[14].
This divergence becomes more evident when looking at the annual marginal increase
in capital and reserves as a proportion of total capital and reserves vis-a`-vis the euro-area
average, a calculation that partially neutralises the differences in the defnition of capital
among countries. Spain and Ireland, driven by the strict conditions imposed by EU
intervention, have been the only two countries that had an increase of equity above the
euro-area average in fve out of the past seven years. Countries where direct or indirect
government intervention took place have performed worse in the recapitalisation of
banks (above all, Germany, France, Italy, Belgiumand The Netherlands; see Appendix).
This also shows how limited restructuring of the domestic banking system took
place in recent years, despite banks strengthening their regulatory capital reserves
across Europe. Only Ireland and more recently Spain have implemented or are
263
Banking
union in a
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currency area
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Table I.
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countries (by total
state aids; € billion),
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implementing plans to restructure the domestic banking system to a degree that is
unprecedented elsewhere.
Euro area banks that have been able to beneft from the credit status of the local
government have experienced a slowdown in equity dilution, a delay in restructuring
and recapitalisation and, hence, additional losses incurred on legacy assets. Countries
where restructuring/recapitalisation was imposed by external funding conditions (ESM
or other fnancing arrangements) or prompted by the fear of being forced to conduct a
hard restructuring under external funding arrangements have seen a sharper increase in
capital held by domestic banks. This divergence is relevant for euro-area countries, as
non-euro-area countries like the UKand the USAhave been more active in restructuring
their fnancial sectors. Finally, as banks in some countries choose continued reliance on
the national fscal backstop over restructuring/recapitalisation, the European
continental banking system is gradually polarising, with those countries boasting
greater fscal capacity serving as the primary destination of capital fight from
peripheral countries. As the health of the domestic banking system may affect
governments’ borrowing costs, public interference in the banking sector thus promote
liquidity ring-fencing at national level as a way for governments to protect themselves
froman acceleration in capital fights towards the countries with greater fscal capacity.
This situation increases the likelihood that citizens’ welfare in the currency union will be
undermined, driving the union into uncertain circumstances.
4. Banking union revisited
Banking union reforms in the EU in recent years are perhaps the most important
achievements stemming from the introduction of the single currency, but these reforms
Figure 7.
Capital and reserves
(% of total assets),
2007-2013
265
Banking
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still lack a solid institutional framework. The fscal coordination issues among member
states have led so far to sub-optimal responses to the problemof banks’ legacy assets. In
this respect, the design of an institutional set-up for the banking union needs to take into
account the role of the single currency in shaping these incentives, on top of the standard
market failures that are inherent in banking. As a consequence, banking union in a
single currency area (whether within a single federal state or a community of states)
faces three potential market failures: risk-taking behaviours; depositors’ runs on banks
and fnancial fragmentation (see Table II).
Risk-taking behaviours and runs on banks are universal market failures, when
dealing with the economics of banking and money (Diamond and Dybvig, 1983; Akerlof
and Romer, 1993; Stiglitz, 1993). Financial fragmentation, driven by the moral hazard of
governments that tend to postpone absorption of legacy losses instead, is a potential
market failure caused by the single currency framework with fully decentralised fscal
policies. In a common fnancial system, public (supranational and fscal) intervention
ensures that the legal incorporation of the bank (location)[15] does not affect its
borrowing costs and the funding costs of its government.
As a result, state aids may produce price distortions on bank debt/equity and
destabilise the fnancial system within a single currency area in which states maintain
sovereignty over decisions to bail out banks, so linking the price distortion to the fscal
capacity of the country, as it cannot alternatively monetise the bailout via central bank
funded intervention. Overall, this raises the question whether an exemption from the
state aids framework, under “the serious disturbance to the economy”, is ultimately
benefcial for fnancial stability in the euro area. Shall the fnancial stability of a single
country prevail over the stability of the region? State aids in a monetary union without
a common fscal backstop to the resolution of a bank can actually increase fnancial
fragmentation and instability via the postponement of banks restructuring.
Aprohibition to intervene, however, may not be credible when a crisis looms over
(Stern and Feldman, 2004) and would become unnecessary if a common fscal
backstop is put in place, i.e. a mechanism that would assess the need for
recapitalisation/resolution of a bank, taking into account fnancial stability concerns in
the single currency area, which is the actual perimeter of the fnancial system. The
common fscal backstop to a fund fnanced by banks, via ex ante and ex post levies plus
“bail-in” procedures and a concomitant partial mutualisation of losses (to deal with
banks’ moral hazard), would not be sound if a national government were to retain the
option of providing its own funding in an extreme situation when the fund is depleted. If
that situation was possible, before or after the recapitalisation/resolution mechanism
kicks in and even with a formal ex ante state aids prohibition, markets would be still
pricing the risk of the domestic banking system in the government’s funding costs and,
thus, distorting borrowing costs for domestic versus non-domestic banks.
Consequently, the common backstop to a privately sourced bank fund is credible if the
only resources available after the exhaustion of the fund in extreme situations come
from a common backstop that does not discriminate based on the nationality of the
bank. To counter the risk of a bank run by depositors, the size of the backstop in other
countries like the USA is formally limited, but de facto unlimited, as the national
treasury can actually request central bank money when all the bail-in, restructuring and
liquidation procedures have been put in place but have been insuffcient to stop the
panic. A careful institutional design of the common backstop leaves EU institutions
JFEP
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1
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(
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)
Table II.
Banking union
revisited
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A
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r
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with multiple options, such as access to the ESM or any other common institution that
can ultimately resort to unrestricted funding, if private or public resources raised from
open markets were insuffcient. Whether through supranational debt issuance or ECB
credit lines, the potentially unlimited funding of a European resolution mechanism
renders irrelevant the nationality of taxpayers vis-a`-vis the credit risk of their country’s
banks.
5. Conclusions
This paper discussed evidence showing how the single currency affects government
incentives to restructure domestic banks and how it needs to lead the design of the
institutional framework of the banking union. While boosting further fnancial
integration in the EU was the ultimate objective of the euro, the harmonisation of rules
for the smooth functioning of the single market neglected the breadth of the
interventions required to make the single currency area work. EU actions to build a
banking union and reverse fnancial fragmentation were unable to ensure a proper
management of banks’ legacy losses, with the risk of being ineffective and ultimately
harming the economy. The moral hazard of euro area governments, competing on
funding costs and putting off the write-downs of bank legacy assets, fostered fnancial
fragmentation (strengthening banks’ home bias) and contributed to a defationary spiral
similar to Japan. Completing the banking union by taking into account the reforms
needed for the single currency area is not just an empty Treaty exercise. Evidence shows
that “home bias” can lead an imperfect banking union to undermine citizens’ welfare
within a currency union, thus threatening its stability. To bring banking union closer to
its ideal institutional design, the resolution mechanism needs a credible common fscal
backstop, so to make member states’ possibility to bail out “their” banks and to put a
drag on the restructuring of their domestic banking system harmless for the fnancial
stability of the monetary union.
Notes
1. The initial agreement struck in July 2011 was fnalised with the Eurogroup statement of 21
January 2012, available at:http://consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/
ecofn/128075.pdf See also the statement of the Council of the European Union, available at:
www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/123978.pdf
2. “The European Union (EU) banking system restructuring is under way, but is far from
complete”. The statement comes from the IMF technical note about the progress made on
bank restructuring, March 2013 (Country Note No. 13/67).
3. In this paper, “interest rate carry trade” refers to the strategy set up by a bank in which a
certain asset, with a relatively low interest rate (also because of perspective losses), is sold or
repo-ed (e.g. at the central bank) and the funds obtained are used to purchase another asset
with higher interest rate in relation to the risk. The main purpose is to gain the difference
between the two interest rates, given no change in the exchange rate or worsening of the risk
profle.
4. According to the ECB Glossary, “Monetary Financial Institutions” are “resident credit
institutions (as defned in EUlaw) and all other resident fnancial institutions whose business
is to receive deposits and/or close substitutes for deposits from entities other than MFIs and,
for their own account (at least in economic terms), to grant credit and/or invest in securities.
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The latter group consists predominantly of money market funds.” The full defnition is
available at: www.ecb.europa.eu/home/glossary/html/glossm.en.html#447
5. The paragraph no. 100 of the CRR No 575/2013 states: “government bonds are expected to be
assets of extremely high liquidity and credit quality”.
6. See G-20 Conclusions in Washington 2008, www.g20.utoronto.ca/2008/2008declaration1115.
html#risk, and London 2009, www.g20.utoronto.ca/2009/2009if.html
7. See more athttp://ec.europa.eu/internal_market/bank/crisis_management/
8. The three top Italian banks (by assets) had a total market capitalisation of €58.8 billion on 16
December 2013.
9. The number of scrutinised and liquidated deposit-based banks comes from the “Failed Bank
List” database of the Federal Deposit Insurance Corporation, available at: www.fdic.gov/
bank/individual/failed/banklist.html
10. For a deeper analysis of the systemic risk of EMU fnancial institutions, see the New York
University Volatility Institute at:http://vlab.stern.nyu.edu Standard & Poor’s has recently
estimated a capital shortfall of €110 billion for Western European banks; see www.scribd.
com/doc/191086580/Untitled For a recap of recent estimates, see also S. Merler and G. B.
Wolff, “Ending uncertainty: Recapitalisation under European Central Bank supervision”,
Bruegel Policy Contribution, Issue 2013/2018, Bruegel, December 2013.
11. Treaty on the Functioning of the European Union, Part 3: Union policies and internal actions,
Title 7: Common rules on competition, taxation and approximation of laws, Chapter 1: Rules
on competition, Section 2: Aids granted by states – Article 107 (e.g. Article 87 TEC).
12. This table should be looked at mainly from a cross-country comparative perspective. The
absolute level of other-than-equity state aids (such as state guarantees on bank debt) is
infated by a cumulative sum of amounts on a six-month basis.
13. See European Commission, Communication COM (2013) 216/01, entered into force on 1
August. This communication embodies the six communications of the Commission on state
aids to the fnancial system(so-called Crisis Communications). These six communications are:
the Banking Communication COM (2008) 270; Recapitalisation Communication COM (2009)
10; Impaired Asset Communication COM (2009) 72; Restructuring Communication COM
(2009) 195; 2010 Prolongation Communication COM (2010) 329; 2011 Prolongation
Communication COM (2011) 356.
14. Results would not change if the same defnitions of capital and loan provisions applied.
15. Nevertheless, the economic situation of the country where the banks is located will always
affect the quality of the assets. For instance, the real estate bubble in Spain hit the sector
whether the holder of those assets was Spanish or a foreign bank.
16. Bank for International Settlements data converted to euros with a simple average of yearly
exchange rates from 2010 to 2013 calculated by www.oanda.com/currency/average For a
defnition of “foreign claims”, see the BIS Glossary, www.bis.org/statistics/bankstatsguide_
glossary.pdf
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Appendix
–2.50%
–1.50%
–0.50%
0.50%
1.50%
2.50%
3.50%
2007 2008 2009 2010 2011 2012 2013
Germany Netherlands Belgium France Italy
UK Ireland Spain Euro area (avg)
Note: Annual average of monthly marginal increases. 2013 data are up through
October.
Source: Author from ECB.
Figure A1.
Capital plus reserves,
marginal increase as
a percentage of total
capital and reserves
compared with
euro-area average,
2007-2013
Figure A2.
Intra-EMU MFIs’ (a)
and non-MFIs’ (b)
cross-border
securities holdings
(€ million), by
country, 2003-2013
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–10.86%
–15.35%
–$600,000
–$500,000
–$400,000
–$300,000
–$200,000
–$100,000
$0
Extra-EMU Intra-EMU
Notes: Extra EMU includes Australia, Brazil, Canada, China,
Hong Kong SAR, Japan, New Zealand, Singapore, United
Kingdom, United States
Source: ECB
Figure A3.
Intra-EMU vs
Extra-EMU claims of
Spanish, French,
Italian and German
banks, Q2-2010
Q2-2013 ($ million)
$0
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
$3,000,000
$3,500,000
$4,000,000
$4,500,000
$5,000,000
USA Japan UK
Source: Bank for International Settlements
Figure A4.
Foreign claims of
domestic banks
versus the rest of the
world ($ million),
2005-(Q2)2013
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Corresponding author
Diego Valiante can be contacted at: [email protected]
For instructions on how to order reprints of this article, please visit our website:
www.emeraldgrouppublishing.com/licensing/reprints.htm
Or contact us for further details: [email protected]
$0
$200,000
$400,000
$600,000
$800,000
$1,000,000
$1,200,000
$1,400,000
$1,600,000
USA UK Japan
Source: BIS
Figure A5.
Foreign claims of
domestic banks
versus EMU
counterparties ($
million), 2005-2013
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