To complete the Banking Union and break the "doom loop" between sovereign debt and the banking industry, Luis Garicano (Renew Europe, Spain) suggests acting simultaneously on the banks by introducing a more secure approach in terms of sovereign bonds investment and on the ‘resolution’ aspect of the euro area Banking Union by amending the powers of the Single Resolution Board (SRB) so that it can intervene more effectively in the event of the failure of a systemically important bank.
My fear is that Banking Union in the euro area is “agonising”, Garicano said on Thursday 20 February at an event organised by the Bruegel think-tank. He argued that the doom loop observed during the financial crisis of 2008 - where the difficulties of one State led to the national banking industry being forced to ask for support from the same State, with the consequence of increasing public debt - was still a reality ten years later.
By autumn 2019, the average level of banks' exposure to their home country's sovereign bonds reached an average of 60% of the sovereign bonds held, with exposure as high as 70% in France, almost 80% in Italy and Spain and up to 95% in Cyprus, according to figures presented at the event.
What is interesting is that "you don’t see a lower trend", said the Spaniard.
Safe portfolio approach. The first of the two proposals made by the coordinator of the Renew Europe group in the European Parliament's Committee on Economic and Monetary Affairs (ECON) aims to bring about greater diversification in the portfolios of sovereign bonds held by banks.
While efforts have focused on introducing a prudential risk associated with holding a sovereign bond and/or setting maximum thresholds for exposure to a government's public debt, the MEP emphasises a safe portfolio approach.
This portfolio would be considered safe when the sovereign bonds held by a bank correspond to the ECB's capital key. Additional capital requirements would be introduced for banks whose sovereign bonds portfolio deviates from this allocation key and the higher the distance from the allocation key, the higher the level of requirement.
By diversifying their investments in government bonds to bring the trading portfolio into line with the ECB's capital key, the additional capital requirements imposed on a bank would decrease.
At a later stage, sovereign securitisations will be made easier and cheaper as the ECB develops its electronic platform initiative to facilitate the exchange of sovereign bonds (EU debt distribution instrument or EDDI).
"Economically, we have diversification and we eliminate a source of contagion and the political advantage is that there will be an EU market for sovereign bonds", said the Ciudadanos party MEP.
SRB+. The second proposal put forward is to strengthen the powers of the Single Resolution Board (SRB), the European authority responsible for resolving a large failing bank in the euro area.
"We are proposing to create an SRB+ that would resemble the FDIC", Garicano said, referring to the U.S. Federal Deposit Insurance Corporation. And he added: bank resolution should be for the many and not for the few.
Mr Garicano's objective is for the SRB to decide more often that intervention at European level is necessary following a public interest assessment of the economic impact of a possible bank failure.
The European authority would manage a European Deposit Guarantee Fund. This would take place only after full exhaustion of the national bank deposit guarantee schemes of the countries where the bank under resolution is active. In a first step, the European Fund would cover the liquidity problems of a resolving bank and, in a second step, would also cover losses.
Mr Garicano referred to ECB support for the idea of introducing a variable level of bank deposit coverage across Member States, as national bank guarantee funds are of different sizes and national deposit guarantee schemes still have different characteristics due to minimum harmonisation at the European level.
See Mr Garicano's proposals: http://bit.ly/32cnWG1 (Original version in French by Mathieu Bion)