A Financial Union for the Euro Area

IMF News, September 14, 2018

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A Financial Union for the Euro Area

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Bibliographic details

• Published: September 14, 2018

Vision for a more-complete economic and monetary union

• End-goal: a euro area architecture equipped with a full complement of public and private risk-sharing mechanisms.
• Fiscal: adoption of a modestly sized yet potentially powerful central macroeconomic stabilization capacity.
• Financial sector: put in place a common deposit insurance scheme and a common backstop for both bank resolution and deposit insurance.
• Design principle: every step toward greater risk-sharing must be accompanied by parallel steps toward greater risk-reduction to ensure incentive compatibility and to balance individual responsibility with solidarity.

Fiscal risk-sharing — IMF proposal and rationale

• Proposal: a central fiscal stabilization capacity that explicitly links central support for economic stabilization to fiscal risk-reduction (better compliance with the rules).
• Key features described:
  • Regular contributions from all euro area countries to encourage saving and buffer-building by member states with limited fiscal space.
  • Transfers conditional on compliance with the fiscal rules.
  • Transfers triggered automatically by a readily observed cyclical indicator linked to unemployment to smooth macroeconomic shocks.
• Quantified example: a fund financed by a relatively modest annual contribution from member states—say, about one-third of one percent of euro area GDP—could act as a powerful stabilizer.
• Complementarity: such a fund would not substitute for national fiscal responsibility nor completely offset large shocks; ex post official assistance (provided by the ESM subject to policy conditionality) would remain relevant in large crises.
• Political assessment: bridging risk-reduction and risk-sharing is essential; the proposal is positioned as a politically feasible bridge though consensus may take time.

Assessment of past banking integration and the post-crisis shift

• Pre-crisis model: heavy reliance on passporting with national supervisors responsible for cross-border branches, creating scope for national favoritism and excessive risk-taking.
• Funding dynamics described: core banks attracted retail savings, petrodollars post-9/11, and transatlantic wholesale funding (including U.S. credit markets), channeling cheap euro liquidity to other euro area countries and helping finance lax lending that inflated local asset price bubbles.
• Crisis trigger noted: Lehman Brothers filing ten years ago (described as a Monday) precipitated global wholesale funding freezes, trade finance collapse, and emergency taxpayer support across jurisdictions.
• Post-crisis outcome: rapid home bias and cross-border fragmentation; preference for cross-border subsidiaries over branches; much of this fragmentation persists.

Progress since 2012 and remaining gaps

• Achievements since the June 2012 apex decision:
  • Creation of the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM).
  • ECB now has a formidable banking supervision arm; the Single Resolution Board is operationalizing SRM Regulation and BRRD.
  • Greater emphasis on bail-in and private stakeholder loss absorption rather than taxpayer bail-outs.
• Persistent impediment: ring-fencing — national authorities still erect barriers to protect domestic economies and taxpayers, limiting cross-border capital and liquidity flows.
• Causes of ring-fencing:
  • Lack of full trust in SSM and SRM capabilities.
  • Dependence of SSM and SRM on national resources and fragmented national rules.
  • Specific regulatory frictions (examples cited):
  • Inability to allow capital relief at subsidiary level even with explicit parent solvency guarantees.
  • Refusal in some jurisdictions to relax large exposure limits for cross-border intragroup transactions.
• Consequences: reduced private risk-sharing, impeded cross-border mergers and acquisitions, and potential higher costs for banking groups and customers.

Two axes to address ring-fencing

• Axis 1 — Reduce ability to ring-fence by strengthening supervision and harmonizing the rulebook:
  • Remove remaining national fragmentation from the single rulebook (Capital Requirements Regulation, Capital Requirements Directive, BRRD, Deposit Guarantee Schemes Directive, and attendant technical standards).
  • Empower the ECB with more direct powers in areas such as classification and provisioning of legacy assets, corporate governance oversight, imposing penalties, and approval of major acquisitions.
  • Technical fixes can be achieved within current political consensus without Treaty change, though resistance from national and private vested interests is expected.
• Axis 2 — Reduce incentives to ring-fence by improving and harmonizing resolution arrangements:
  • Ensure sufficient loss-absorbing liabilities (the BRRD’s “minimum requirement for own funds and eligible liabilities” or MREL) for larger, complex banks so undercapitalization can be remedied without burning senior unsecured debt or uninsured deposits.
  • Use common resources of the Single Resolution Fund to provide public support, where needed, to protect insured depositors.
  • Address variation in national insolvency and liquidation procedures and close the state-aid “loophole” that permits national taxpayer support in ways less exacting than BRRD burden-sharing requirements.
  • Specific political objective: secure the common backstop to the Single Resolution Fund; desirable design is large, automatic, and available to the Single Resolution Board at short notice and without condition (the back-of-the-envelope assessment suggests it would be called upon only in a severe crisis).
• Deposit insurance: IMF strongly supports early adoption of the European Deposit Insurance Scheme (EDIS), but recognizes political obstacles:
  • Concerns from strong banks about subsidizing weak banks.
  • Concerns from fiscally stronger governments about EDIS becoming de facto state-to-state transfers.
  • In principle, risk-based insurance premia can address these concerns.
  • Progress on EDIS may require parallel progress on reducing home bias in banks’ holdings of home-country sovereign securities.

Capital markets union and nonbank finance

• Scope: nonbank finance spans financial market infrastructure, securities underwriting, insurance, UCITS, harmonized financial reporting, corporate insolvency harmonization, SME securitization, and more.
• Comparative observation: U.S. capital markets and regulatory architecture (e.g., distinct mandates and federal powers of the SEC and CFTC) may provide lessons for Europe’s capital markets union.
• Regulatory distinction emphasized:
  • Banking oversight mandate: ensure safety and soundness; reduce the likelihood of failure via prudential supervision and ex ante limits on risk-taking.
  • Capital markets oversight mandate: focus on conduct-of-business rules, truth, transparency, and disclosure; ex post enforcement rather than reducing failure likelihood.
• Institutional question posed: whether Europe needs a centralized financial markets agency (a “super-ESMA” with broad, pan-European regulatory powers). The speaker notes that answers are not obvious and merit further study.
• Caution: guard against overreach and heavy-handed regulation—allow intermediaries to fail to preserve market discipline; ensure market regulation is proportionate and fit for purpose, especially as the UK exits the EU.

Key policy recommendations and actionable steps

• Use scarce political capital on achievable wins in finance that can be advanced without Treaty change, through technical expert negotiation and rulebook harmonization.
• Banking-specific recommendations:
  • Systematically remove national fragmentation from the single rulebook to maximize supervision and reduce excessive risk-taking.
  • Strengthen ECB supervisory powers in targeted areas (legacy asset treatment, governance, penalties, major acquisitions).
  • Complete and activate a common backstop to the Single Resolution Fund with automatic and rapid access for the SRB.
  • Ensure widespread adoption of MREL across larger, complex banks.
  • Advance EDIS with calibrated risk-based premia and parallel measures to reduce sovereign home bias.
• Nonbank finance recommendations:
  • Study the U.S. model and the role of centralized market regulators as part of the capital markets union debate.
  • Prioritize oversight focused on truth, transparency, and disclosure; maintain proportionate regulation and permit market discipline by allowing intermediaries to fail where appropriate.
• Overarching theme: pair greater risk-sharing with stronger risk-reduction to ensure incentive compatibility and sustainability.

Closing assessment

• The speaker advocates focusing on finance as an area where meaningful progress is within reach and largely achievable within the current political consensus.
• Vision: over time, reduced fragmentation and increased trust will lower the preference for subsidiarization and defensive national measures, allowing a return toward cross-border branching embedded in robust prudential and resolution frameworks—“back to the future,” but with prudence preventing past forbearance and arbitrage.

Source: Speech "A Financial Union for the Euro Area" by the Director, European Department, International Monetary Fund, Conference of the Belgian Financial Forum (BFF) in cooperation with SUERF, National Bank of Belgium, September 14, 2018.

References

• Poul M. Thomsen
• United States and the IMF
• Speeches
• PRESS CENTER
• https://www.imf.org/en/home