Speech by Panicos Demetriades, Governor of the Central Bank of Cyprus, at the Informal EU Financial Services Attachés Meeting
Nicosia, 18 September 2012
Ladies and gentlemen,
Let me first welcome you all to Cyprus and wish you a pleasant stay on the island.
Today the Economic and Monetary Union (EMU), a cornerstone of the European Union (EU), is facing a fundamental challenge. It is incomplete and needs to be strengthened to ensure economic and social welfare.
Boosted by the single currency and the single market, the EU banking sector has grown and has become increasingly interconnected. Many banks have developed cross-border activities and have outgrown their national markets. The recent financial crisis has demonstrated how quickly and powerfully problems in the banking system of one country can spread to another. This is especially the case in a monetary union.
Given pooled monetary responsibilities in the euro area and closer economic and financial integration, there are specific risks in terms of cross-border spill-over effects in the event of banking crises. Coordination of national banking supervision is no longer an option for the euro area. A move to an integrated supervisory system is necessary.
There is also a need to break the vicious link between sovereigns and banks, which has led to over €4,5 trillion of taxpayers’ money being used thus far to rescue banks in the EU. In the future, bankers' losses should no longer become the taxpayers' debt, putting into doubt the financial stability of whole countries.
I take the example of my own country, Cyprus. The significant problems facing domestic banks, stemming mainly from the losses incurred on their sizeable Greek sovereign debt holdings as well as their high exposures to the Greek economy, have led to a series of credit downgrades for banks and the sovereign. This eventually led to a loss of access to international financial markets, while the need for recapitalising problematic banks has been the main reason behind the decision of the Cyprus government to ask for financial assistance from the EFSF/ESM. Although the exact size of the banks’ capital shortfall is expected to be determined by December 2012 following a diagnostic study, it is more than evident that a significant support package will be needed to bail out banks.
The Van Rompuy Report of 26 June 2012 on strengthening the EMU proposed a vision based on four essential building blocks. The first one referred to an integrated financial framework to ensure financial stability in particular in the euro area and minimise the cost of bank failures to European citizens. At the European Council and the euro area summit of 28-29 June 2012 that followed, EU leaders agreed to deepen the EMU as one of the remedies of the current crisis. A European banking union is envisaged to be one of the main drivers towards such deeper integration.
The banking union rests on the completion of the programme of substantive regulatory reform underway for the single market for financial services, namely the single rulebook. These rules will have to be applied in the same way across the whole EU and will constitute a common foundation across the single market on which the banking union proposals can build. Based on the single rulebook, the banking union should have three crucial elements: a single supervisory mechanism (SSM), a common resolution framework and a unified deposit guarantee scheme.
Single supervisory mechanism
The Commission proposals for a SSM for banks in the euro area published last week are an important first step in creating a banking union. In the new single mechanism, ultimate responsibility for specific supervisory tasks related to the stability of all euro area banks will lie with the European Central Bank (ECB). National supervisors will continue to play an important role in day-to-day supervision and in preparing and implementing ECB decisions.
This new system, with the ECB at the core and involving national supervisors, will help restore confidence in the supervision of all banks in the euro area. Banking supervision needs to become more effective in all European countries and we have to make sure that single market rules are applied in a consistent manner. A mechanism has been proposed to separate banking supervision from monetary policy within the ECB as well as make the ECB accountable to the European Parliament for supervisory decisions. Thus, the European Parliament will also have a crucial role to play in ensuring democratic oversight. This will also pave the way for any decisions to use European backstops to recapitalise banks.
The ECB will cooperate with the EBA within the framework of the European System of Financial Supervision. The role of the EBA will be similar to today: it will continue developing the single rulebook applicable to all 27 member states and make sure that supervisory practices are consistent across the whole EU.
Common bank resolution framework
Global financial integration and the EU single market have enabled the banking sector in some member states to outgrow national GDP many times over, resulting in institutions which are "too-big-to-fail" and "too-big-to-save" under existing national arrangements. Cyprus is a prime example of that. On the other hand, experience shows that the failure of even relatively small banks may cause cross-border systemic damage. Furthermore, bank runs across borders can critically weaken national banking systems, further damaging the fiscal standing of the sovereign, and hastening funding problems for both.
Reinforced supervision within the banking union will help improve the robustness of banks. If a crisis nonetheless occurs it is necessary to ensure that institutions can be resolved in an orderly manner and that depositors are assured their savings are safe. Against this background, a banking union should include a more centralised management of banking crises.
Therefore, a single resolution mechanism, which would govern the resolution of banks and coordinate the application of resolution tools to banks within the banking union, is needed. This mechanism would be more efficient than a network of national resolution authorities, in particular in the case of cross-border failures, given the need for speed and credibility in addressing banking crises. It would also entail significant economies of scale, and avoid the negative externalities that may derive from purely national decisions.
Unified deposit guarantee scheme
The third element that should complement the integrated supervision and common bank resolution frameworks in a banking union concerns a unified deposit insurance scheme. Such a scheme would have several benefits. It would ensure that decisions that are taken at the supranational level affect depositors in all countries in the same way, thus ensuring a level playing-field: depositors would be treated in a uniform way across countries, independently of their location and the location of the bank with which they have entrusted their savings. The scheme would thereby also foster financial integration. To achieve this, the setting up of a euro area wide deposit protection agency would be needed. In times of widespread financial instability, deposit insurance payoffs depend not only on the legal framework they are based on, but also on the ability of the deposit insurance fund to cope with large-scale banking failures. Doubts on this ability, for instance due to concerns on the fiscal health of the sovereign, could easily reinforce (local) bank runs.
Conclusions
The careful design of the different elements of a banking union is indispensable for its success. Together, the various components that integrate the concept of a banking union constitute a solid and consistent framework that will foster financial integration and be supportive of EMU. Their implementation will partly address the current crisis by helping to sever the link between sovereigns and banks and reverse the on-going fragmentation of markets along national borders.
At the same time, there are a number of issues in the Commission proposals on the SSM that warrant further discussion and deliberation. These include, inter alia, issues concerning the perimeter of supervision, the geographical scope and the modalities of the participation of non-euro area members that would voluntarily join the SSM, the role of the EBA and its cooperation with the ECB and national supervisors, the operational and governance structure within the ECB to be set up to deal with the new supervisory tasks as well as the transparency and accountability arrangements.
The current crisis demands that we move decisively forward. Although the timetable for implementation of the Commission proposals on the SSM sounds quite ambitious, every effort should be made to move ahead as quickly as possible based on a phasing-in approach due to the urgency of the matter, especially as the set-up of the SSM has been made a precondition for the possible direct recapitalisation of banks by the ESM. Work should also be taken forward in a speedy manner on common resolution and deposit insurance.