The Euro Area: Creating a Stronger Economic Ecosystem
IMF News, March 28, 2019
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- Authors: Christine Lagarde
- Published: March 28, 2019
Introduction
- Speech by Christine Lagarde, IMF Managing Director, Banque de France, Paris, March 28, 2019.
- Context:
- Celebrating the 20th anniversary of the euro and looking toward the next 20 years.
- The euro area has 19 member countries and represents the world’s second-largest economy.
- The euro is the world’s second-most traded currency.
- Key outcomes over two decades:
- Real GDP per person in the euro area has increased by more than 60 percent over the past two decades.
- Public support indicators: three in five euro area residents say that the euro is good for their country; three-quarters say that the euro is good for the European Union.
- Persistent challenges:
- One in four young people in the euro area is at risk of being in poverty.
- Economic activity in the euro area is slowing and risks are rising.
- Framing question: Is the euro area better prepared for unexpected economic storms? Short answer given: yes, but not resilient enough.
The Current State of the Financial System
- Broad assessment:
- The Single Market in goods and services achieved substantial integration; comparable financial integration remains incomplete.
- Europe’s financial system is characterized as an underdeveloped irrigation system—delivering some but not enough financial “nutrients” to support full growth potential.
- Imperative: “Now is the time to give euro area finance another big push.”
a) Banking Union
- Historical dynamics:
- Before the crisis: significant cross-border bank lending combined with national supervision and weak underwriting standards.
- Crisis dynamics: core banks pulled liquidity back home, contributing to credit crunches, asset-price collapses, and the euro area debt crisis.
- Current metrics and concerns:
- Cross-border lending between banks in the euro area is back at 2005 levels.
- Firms in some euro area countries pay more than twice as much for credit than comparable firms in other euro area countries; similar disparities exist for households.
- Dispersion in borrowing costs has increased since 2009—described as the cost of fragmentation in finance.
- Reforms implemented since the crisis:
- Creation of a single supervisor for banks.
- Higher capital buffers inside banks.
- Introduction of a new framework for handling bank failures and crises.
- Result: taxpayers are now less likely to be on the hook for massive bank bailouts than a decade ago.
- Remaining issues and pressures:
- Persistent “home bias” in European banking.
- Higher capital has reduced returns on equity, prompting banks to pursue leaner business models.
- Competition from fintech firms poses new pressures on profitability and potential incentives to ease lending standards.
- Policy prescription (explicit recommendation):
- Establish common deposit insurance funded by banks (not taxpayers).
- Member countries need to agree on a mutually acceptable balance between risk-sharing and risk-reduction—between trust and accountability.
- Urgent call for euro area leaders to reignite discussions, negotiate in good faith, and make difficult compromises to complete the banking union.
b) Capital Markets Union
- Rationale:
- Greater diversity of financing sources makes the financial ecosystem more resilient.
- Comparative data point: in the United States, the corporate bond market accounts for more than two-fifths of GDP, compared with only one-tenth in the euro area.
- Households in the euro area store 40 percent of their financial assets as bank deposits, leaving them exposed to the banking sector and over-reliant on banks for savings and investment financing.
- Benefits of an integrated capital market:
- More uniform cost of funding for firms across countries.
- Higher returns on savings for households via diversified portfolios including other countries’ stocks and bonds.
- Greater ability for savers (e.g., Italian savers, German savers) to invest beyond domestic bank deposits.
- Key reform areas to unlock capital markets union (three highlighted priorities):
- Transparency of information:
- Capital markets require high-quality public information, strong audits, and readily comparable data.
- Example: the standard for securitization that gives preferential regulatory treatment to simple, transparent, and standardized (STS) instruments; after a transition period, only these standardized securitizations will be eligible as ECB collateral.
- More efficient insolvency regimes:
- Faster and smoother insolvency processes free up capital for productive investment.
- Example metric: resolving a corporate insolvency in Greece takes about nine times longer than in Ireland.
- Taxation of cross-border investments:
- Withholding tax rules and divergent national treatments discourage cross-border investment.
- Recommendation: simplify and harmonize withholding tax rules so investments in other euro area countries are treated more like domestic investments.
- Strategic ambition:
- Planting new “trees” in the capital markets to promote a Single Market in finance and transform Europe into a more vibrant, robust economy.
- Reference estimate: the Single Market for goods and services has raised GDP in the EU by an estimated 9 percent.
Conclusion
- Restated prescription: complete the banking union and the capital markets union to strengthen the euro area’s economic ecosystem.
- Closing quotation and metaphor:
- Molière: “The trees that are slow to grow bear the best fruit.”
- The euro area, after 20 years, should show new resolve to complete the financial ecosystem so it can harvest benefits now and in the future.
- Final plea: Europe’s courage, creativity, and perseverance should be trusted to deliver further integration and resilience.
Speech by Christine Lagarde, IMF Managing Director, Banque de France, Paris, March 28, 2019.