Europe needs bet­ter bank rules

“We also need a com­mon set of rules that clar­i­fies cap­i­tal re­quire­ments and pro­ce­dures for the re­cov­ery and res­o­lu­tion of dis­tressed banks.”

The Pak Banker - - Front Page - Gun­nar Hok­mark

THE Euro­pean Union's col­lec­tive econ­omy is the big­gest on the globe, larger than the US or China, yet it is be­ing held back by the frag­mented na­ture of its mar­kets. This has to change. If Europe is to stim­u­late the com­pe­ti­tion and growth that are es­sen­tial for it to emerge from the cur­rent eco­nomic cri­sis, then the world's largest econ­omy must also be­come the world's largest sin­gle mar­ket.

That's why the grow­ing dis­cus­sion of how to cre­ate a so- called mul­tispeed EU of in­ner and outer cores, in­clud­ing the pro­posal for a new euro-area bank­ing su­per­vi­sor within the Euro­pean Cen­tral Bank, of­fers the wrong an­swer to Europe's troubles. We need to stick to­gether and de­velop the union that we have, and that in­cludes build­ing a sin­gle fi­nan­cial mar­ket for all 27 mem­ber states.

For such a pan-Euro­pean fi­nan­cial mar­ket to work, we do need bet­ter bank su­per­vi­sion and safer sys­tems for de­posit guar­an­tees. We also need a com­mon set of rules that clar­i­fies cap­i­tal re­quire­ments and pro­ce­dures for the re­cov­ery and res­o­lu­tion of dis­tressed banks.

As the Euro­pean Par­lia­ment's rap­por­teur on bank­ing res­o­lu­tion, this is my point of de­par­ture for the work that's now un­der way to cre­ate rules on how to re­cover or safely dis­solve trou­bled banks, a cen­tral part of the dis­cus­sion on how to cre­ate a bank­ing union. The Euro­pean Com­mis­sion is­sued a draft di­rec­tive in June, and it is our job in Par­lia­ment to amend it and later ne­go­ti­ate the fi­nal text with the Coun­cil of Min­is­ters. We hope to reach a fi­nal agree­ment next spring.

In my pro­posal for the di­rec­tive, cur­rently up for con­sid­er­a­tion in the Par­lia­ment, I have laid out the set of prin­ci­ples that I be­lieve should be fol­lowed.

First, re­cov­ery and res­o­lu­tion need to re­store the ba­sic rule of cap­i­tal­ism that own­ers should not only be en­ti­tled to prof- its but also bear po­ten­tial losses. That means not us­ing pub­lic money to res­cue bank own­ers when the au­thor­i­ties are try­ing to pro­tect the fi­nan­cial sys­tem or its crit­i­cal func­tions. Share­hold­ers must risk losses, and fail­ing banks must run the risk of liq­ui­da­tion.

Sec­ond, man­age­ment of dis­tressed banks must be de­signed in a way that forces cred­i­tors to scru­ti­nize the cred­it­wor­thi­ness of those to whom they lend. Cred­its should not be granted on the ba­sis that a pub­lic backup sys­tem for res­cu­ing fail­ing in­sti­tu­tions ex­ists, but be­cause of trust in the bank's abil­ity to re­pay its debt on com­mer­cial terms.

The com­mis­sion's pro­posal states that reg­u­la­tory au­thor­i­ties -- whether na­tional or supra­na­tional -- should in­ter­vene and force banks that get too close to sol­vency and liq­uid­ity prob­lems to change di­rec­tion or man­age­ment. In my re­port, I set out ex­plicit rules for when au­thor­i­ties should be al­lowed to in­ter­vene in or­der to re­duce the risk of ar­bi­trary or pre­ma­ture in­tru­sion. I have also ex­cluded liq­uid­ity as a trig­ger for in­ter­ven­tion and in­stead sought to pro­vide quan­ti­ta­tive cri­te­ria on the ba­sis of the EU's fu­ture rules on cap­i­tal re­quire- ments. Liq­uid­ity-re­lated trig­gers could fur­ther sys­temic risk, as the mere ex­pec­ta­tion that an in­sti­tu­tion may end up in res­o­lu­tion might pro­voke a liq­uid­ity cri­sis and thus be self-ful­fill­ing. Equally, se­vere liq­uid­ity prob­lems of­ten rapidly de­velop into cap­i­tal prob­lems and would then be cov­ered any­way.

The com­mis­sion has also pro­posed that the res­o­lu­tion au­thor­i­ties should be able to in­ter­vene when a bank is in a cri­sis by: forc­ing the in­sti­tu­tion's sale to a third party; sep­a­rat­ing good and bad as­sets; set­ting up a bridge bank and bail­ing in longterm cred­i­tors, for ex­am­ple by con­vert­ing bonds they hold to eq­uity; or writ­ing down the no­tional value of bank li­a­bil­i­ties.

Each of these tools is rel­e­vant for the man­age­ment of in­di­vid­ual banks in cri­sis, but they may not be suf­fi­cient if an eco­nomic and fi­nan­cial cri­sis were to hit the bank­ing sys­tem. So, I've pro­posed a clear dis­tinc­tion be­tween what is re­quired when an in­di­vid­ual bank is in trou­ble, and what might be needed when a cri­sis threat­ens the bank­ing sys­tem.

In the first ex­am­ple, it is of­ten bad man­age­ment or an in­fe­rior busi­ness model that has led to ex­ces­sive risk-tak­ing. In such cases, lost as­set and col­lat­eral val­ues will prob­a­bly not be pos­si­ble to re­store. Pub­lic money should not be spent and the in­sti­tu­tion should be wound down.

In the case of a sys­temic cri­sis, by con­trast, banks will have ended up in smaller or big­ger dif­fi­cul­ties de­pend­ing on how their man­age­ments re­sponded to chal­lenges in the macroe­con­omy. In most cases ex­ter­nal fac­tors, such as an over­all eco­nomic shock or the burst­ing of an as­set price bub­ble, will have caused the bank­ing sys­tem's cri­sis.

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