Commentary on:


The neglected side of banking union: reshaping Europe’s financial system

by André Sapir, Guntram B. Wolff on 14th September 2013*


At the ECOFIN meeting in Vilnius, the Breugel Think Tank presented this very interesting contribution. It outlines some of the causes of - and presents some remedies to - the fragmentation of the European financial markets, in particular the banking market, that must be overcome if the Banking Union is to live up to the high expectations of its initiators.


I find little to disagree with in the authors’ analysis and will, therefore, limit my comments to an aspect that has apparently been totally overlooked and which, in my opinion, constitutes a key prerequisite for reducing market fragmentation: the question of “currency exposure”.


Within the Banking Union, this matter appears on two separate levels:  first, that of the EU participating Member States and second, within Members of the Eurozone.


At EU level, there has been some ambiguity from the start as to the integration – on a voluntary basis – of Member States that are not Members of EMU. Indeed, many of the arguments put forward in the paper for recommending the need of a Single Resolution Authority, in particular that of breaking the incestuous State/Bank interdependence should be considered differently within the context of a Member that retains full monetary sovereignty as compared with EMU Members who have abandoned it. Indeed, recourse to monetary financing, devaluation, etc. are specific “policy” options that remain available to the former but not to the latter. Under these conditions, a single “rule book” for restructuring or winding down troubled banks seems inappropriate. Similarly, the evaluation by the Regulator of “cross border” risks must take into account the “exchange risk” exposure for non EMU Members that is significantly different than for “cross border” lending within the Eurozone.


This is the reason why the references made to the FDIC as a model do not apply: the USA is a Federal State with a single currency and a Central Bank that interfaces directly with the Federal Government; this structure allows the FDIC to intervene on a “level playing field” which is far from the case within the EU. For real progress to be




made, one should abandon the hope of squaring the circle between the diverging interests of the EU 28 with the EU18; it would be preferable to limit implementing

the Banking Union to EMU Members (relying on its gradual extension as foreseen by the Treaty). In parallel it is necessary to move rapidly forward with implementation of a significant “Eurozone” budget, having sufficient “own resources” to underpin a credible autonomous borrowing capability. Thus the necessary conditions will be created for the ECB to fulfil its role both as fully empowered Central Bank and responsible Regulator while permitting separately the establishment of an appropriate SRA and a complementary Deposit Guarantee Scheme.


Let us now turn to the second question concerning the “potential” currency exposure with the Eurozone itself; I believe it has been one of the main drivers that increased dramatically market fragmentation, in particular the crash of the interbank market, in the aftermath of the financial crisis. While the measures recommended by the Breugel paper would certainly contribute to reducing market fragmentation, they are predicated on the unshakeable premise that both the Euro and its Membership are “irreversible”. If this happens to be the “dogma” voiced eloquently by President Draghi as well as the hope of all the advocates of further European integration, it is, unfortunately, not one that is shared unanimously by market participants. Indeed, many are wary of the growing appeal of euro sceptic political parties which are advocating precisely the dismantling of the single currency and a return to national currencies over which each Member would recover full sovereignty.


Regardless of the dramatic consequences of such an outcome and the irresponsibility of those who advocate it, the mere possibility of the implosion of the Euro or even the exit of one of its Members, is enough to justify prudence in evaluating Eurozone “cross border” exposures. As future “Regulator” for EMU banks, the ECB may well find itself in a conflict of interest situation having to arbitrate the level of risk involved by the geographical “mismatch” between a largely “domestic” deposit base and a diversified Eurozone loan portfolio. Similarly, internal risk management will also need to take these factors into account with Boards of directors likely to prove risk averse on these matters after the traumas of the recent financial crisis.


Advocating, as Breugel suggests, cross border mergers, further integration of European debt and equity markets to spread and diversify risk, can only happen if the question of “real” and “potential” currency exposure is addressed squarely. For that to happen, not only should the Banking Union project be implemented rapidly, at least at Eurozone level, but the Economic and Monetary Union, so successfully launched in 1999, should also be completed so that the full benefits of the single currency can be shared by all citizens and the prosperity of security of the EU insured.


Brussels, 17th September 2013


Paul  N. Goldschmidt

Director, European Commission (ret.); Member of the Advisory Board of the Thomas More Institute.



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