Portugal Central Bank Statement

Author: | Published: 5 Sep 2017
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The banking union is an important – indeed indispensable – complement of Economic and Monetary Union. However, like any major institutional reform, the success of the banking union will rest upon its design, its implementation and the transitional arrangements.

This is where a major cause for concern emerges.

While the Single Supervisory Mechanism (SSM), the banking union's supervisory pillar, was successfully set up in record time, the resolution pillar (SRM) is still unfinished and a common deposit guarantee scheme remains a mirage.

Also, not enough attention has been paid to the path of transition from where we are to a new steady state.

The legacy assets problem is a European systemic problem that calls for a European approach. The high levels of non-performing loans (NPLs) pose risks of cross-border spill-overs, impair banks' profitability and jeopardise their ability to support the economic recovery in the European Union. Addressing the currently high stock of NPLs in a sustainable and effective way is thus a prerequisite towards the deepening of the Economic and Monetary Union.

In normal times, banks lacking sufficient capital would be considering, and able to, raise it in the markets to cover the losses associated with the carving out of NPLs and improve their profitability and price-to-book ratio. In the current context of low profitability, supervisory and regulatory requirements for capital and other loss absorption instruments, these banks will need a public backstop to do it. However, the harsh conditions for any state intervention imposed by the Bank Recovery and Resolution Directive (BRRD) and state aid rules deter them from resorting to any public support in light of the ensuing losses to be absorbed by the relevant stakeholders and the restructuring commitments they would be subject to.

This status quo is an obstacle likely to generate significant transfers of wealth with the destruction of economic value that risks undermining investors and depositors' trust, putting financial stability at risk. This is happening at a time when financial stability is still mostly a national responsibility, despite the much more limited ability for the use of national tools to safeguard it.

All of this speaks in favour of carefully but urgently fine-tuning the current EU regulatory framework together with the setting up of a public backstop by the European Stability Mechanism (ESM) to provide capital for banks' carving out of NPLs under a temporary exemption from current BRRD and state aid rules. Additionally, some complementary measures are highly desirable to reward banks that are actively reducing their NPLs stock, namely the immediate revision of their regulatory capital through a swifter decrease in Pillar 2 requirements. Moreover, in order to preserve economically viable firms, adequate restructuring of their liabilities is needed and access to fresh money should be facilitated. The channeling of public funds (including those of the Juncker plan) in the form of equity, quasi-equity and subordinated instruments should be made possible in order to promote firms' capacity to attain a sustainable financial position.

A subsequent step will necessarily be the completion of the banking union by setting up a backstop for the Single Resolution Fund and a European deposit insurance scheme.




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