Portugal Central Bank Statement

Author: | Published: 19 Oct 2018
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The post-crisis financial sector reforms were designed to strengthen financial stability. At European level, the firm, cohesive commitment towards Banking Union (BU) helped counter financial fragmentation. However, the political will to complete the architecture waned as policymakers got stuck in the risk-reduction vs. risk-sharing debate, losing sight of the final objectives.

The present state of BU is characterized by a critical flaw: supervisory and resolution decisions are mostly European, whilst the ultimate guarantor of financial stability remains national, with limited tools to act. The stabilising elements are missing.

In parallel, the new regulatory framework – which should ensure well capitalized institutions without favouring business models – entered into force without taking into account the timings of the crisis and institution-specific characteristics of certain countries. Regulatory-driven consolidation has become imminent. Only larger banks are likely to be able to comply with increasingly complex regulation and potentially disproportionate requirements, thereby potentially fostering the comeback of too-big-to-fail.

As the political will to move forward is insufficient, policymakers and co-legislators need to fine-tune the regulatory framework to provide the Member States with tools to preserve financial stability – a public good – in view of the existing challenges:

  • Without the European deposit insurance scheme (EDIS) is there the need and space for alternatives? As banks in which there is no public interest at a European level are 'national in death', exit models and the strengthening of supervisory powers of host authorities need to be discussed.
  • The approach adopted in the EU regarding total loss-absorbing capacity (TLAC) (known as the minimum requirement for own funds and eligible liabilities (MREL)), combined with a set of other regulations, may challenge the dominant role of the banking sector as collector of savings in the European financial model.
  • The ability to manage the social and economic impacts ensuing from the failure of a bank with systemic relevance at local level must be ensured as harmonising EU banks' liquidation regimes is not the solution.

Without completing BU, the ultimate objective, should we not discuss:

  • the application of the Bank Recovery and Resolution Directive (BRRD) in its current form only to banks that are eligible for the European safety net?
  • the revision of the BRRD and State aid requirements for medium-sized banks with systemic relevance for the cases where national authorities, in order to safeguard financial stability, are willing to engage in the burden sharing without distorting competition?
  • alternative ways of ensuring the exit of medium and small-sized banks from the market while preserving value and protecting creditors and non-financial borrowers?
  • special insolvency proceedings as an alternative to the 'atomistic' liquidation regime with a limited usage of public funds as a bridge to safeguard financial stability?

While the absorption of losses by private stakeholders should be the norm, flexibility should be preserved as the financial system's network structure is fundamental in deciding whether there is the need for a government to intervene.

A comprehensive approach across legislation and stakeholders' interactions analysing cross-implications is thus required to minimise moral hazard and vested interests, while preserving the necessary market discipline.