Financial Disintegration In Europe

Planned Chaos

By Jeff Harding

Here are some recent research notes from DB Research of Deutsche Bank Group. I noticed that Thomas Mayer, the former Chief Economist for Deutsche Bank no longer is listed as the author of these notes. In fact, he has been replaced as Chief Economist and is now listed as “Senior Economic Advisor” to the bank. My guess: he was gently fired, they pay him the balance of his contract, and he gets to do “academic research.” I originally carried his commentary when he announced he was “Austrian” but upon further probing I discovered he was not really. Maybe he has time now to read some Mises.

Still, these research notes represent some of the best thinking in Germany about the Eurozone’s economic crisis, and that’s important to know. The Financial Disintegration note is quite interesting (disturbing). Weren’t they supposed to be integrating?

July 2, 2012

Banking supervision in Euroland: What exactly was decided?!

Euro-area leaders agreed to present proposals, by year-end, for a “single supervisory mechanism”. They stipulate that such a mechanism is the precondition for the ESM to recapitalise banks directly, subject to conditionality and the conclusion of a programme. A decision is to be taken by finance ministers on July 9th.

The positive element in the decision is to confirm the link between financial support and control. Also helpful is the declaration of the EU summit to preserve, no matter what the “mechanism” will look like, the Single Market in Financial Services. Less helpful is that it is unclear what leaders have actually decided: It is telling that they speak of a “mechanism” while leaving open the institutional form. There is also confusion about the role of the ECB: The communiqué simultaneously refers to Art 127(6) of the Treaty, which allows for a transfer of specific (sic!) supervisory powers to the ECB, and of merely “involving the ECB”. Rather than the establishment of a common euro-area banking supervision apparatus this suggests a far more limited role. Finance ministers must hence sort out several issues: (i) What is the scope – all banks or cross-border ones only? (ii) What is the purview – day-to-day supervision or crisis-related action only? (iii) What is the relation with EBA and how will activities in non-euro area markets (read: London) be covered? (iv) How can ECB independence be reconciled with accountability and contestability of supervisory interventions? Too much for merely 10 days of deliberations and too important for more fudgy wording!

July 16, 2012

Financial disintegration in Europe

The combined effect of the sovereign debt and financial crises is that cross-border linkages in the EU are now significantly weaker than a few years ago, reversing a lot of the progress made pre-crisis. 1) European banks’ claims on other western European countries have slumped by 28% since peaking in early 2008. 2) Bonds issued by foreign non-banks in other EU countries declined from 45% of euro-area banks’ total bond portfolio in 2007 to just 27% at the end of 2011. Holdings of foreign sovereign bonds fell from 22% to 11%. 3) Funding from foreign banks fell from 12.7% of EU-15 banks’ total assets in 2007 to 7.5% in 2011. 4) Domestic securities now account for two-thirds of the collateral used in ECB refinancing operations, compared with 49% in 2007. 5) Within Germany, foreign banks’ market share in lending to the manufacturing industry has declined steadily from 16.3% at end-2008 to 11.7% now.

Financial disintegration in the EU is the result of market forces as much as regulatory and political influences and, ironically, is unfolding as policymakers discuss the creation of a European banking union. Whether the latter will be able to halt or even reverse the former will be crucial for the survival of the single market in financial services.

EU banking union: The dangerous rush to make quick fixes.

Different messages are emerging as to how quickly the proposed banking union can be established, with Germany rightly emphasising that this is a complex and hence medium-term project. There are, however, suggestions that the urge to be seen to be doing something will result in quick fixes being sought. They would include (i) selling slightly modified versions of the long-winded legislative proposals on reform of deposit guarantee schemes and resolution regimes as new, breakthrough initiatives and (ii) using Art. 127(6) TFEU to transfer limited supervisory powers to the ECB, e.g. by mandating it to monitor capital cushions of the largest institutions.

It appears that the EU will, in the end, indeed succumb to the temptation of quick fixes rather than devising well-thought-out designs. This is deplorable: banking union is needed, but only if there is a consistent institutional framework that preserves the single financial market, financial stability and the euro. The EU has wasted decades trying to get financial supervision right; there is no need to rush now. Specifically, member states should think twice before plumping for the option of endowing the ECB with even more powers, simply because the Treaty offers that option and every other avenue is more complicated. Not only would the ECB run the risk of potentially competing mandates and reputational damage, but as central bank, supervisor, and de facto macro prudential supervisor, the ECB would be dealer, policeman and judge all in one. This is undesirable, particularly with an eye on the challenge of establishing sufficient democratic accountability for an independent central bank exercising supervisory powers.