Frankfurt European Banking Congress 2013:

How to face the biggest challenge since 2008

This year’s 23rd European Banking Congress in Frankfurt wasunlike previous European Banking Congresses characterized by a remarkable nervousness and tension. This was reflectedin the speeches as well as in the panel discussions. The Banking Congress which took place under the title “The future of Europe” made clear that Europe standsat a decisive cross road. The tasks which lie ahead for the European Banking Sectorinclude stabilization, the elimination of “toxic” papers and the formation of the planned Banking Union. During one of the panelsthe Co-Chairman of Deutsche Bank Jürgen Fitschenstated that the European Banking Sector “is facingthe biggest challenge since the financial crisis in 2008.”

The Banking Congress revealed a certain dilemma: While on the side it is clear that the social and economic consequences of the 2008 financial crisis can’t be solved by “pure monetary policy”, it is also clear thatthose who play with “national reflexes” in response to the crisis within the Eurozone, don’t offer a viable solution for the future of Europe either. A striking example for this was given by a digital vote which was taken during the first panel from the participants. At one point the approximately 200 bankersparticipating at the Banking Congress were asked where they saw the most worrisome problems for Europe in the future: The overwhelming majority (66%) answered that right now the biggest problems isFrance, followed by 25% who saw problems in Italy, 11% located the problems in Spain and 5% in Germany.

The core question debated in Frankfurt among the participants such as ECB chairman Mario Draghi,Commerzbank Chairman Martin Blessing, Deutsche Bank Co-Chairman Jürgen Fitschen,Board member of the Bundesbank Executive Andreas Dombret, German Finance Minister Schäuble, the Belgian economic scientist and former advisor of the European Commission under Romani Prodi, André Sapir et al.was how to shape the future of Europe and turn the Eurozone into a zone of robust growth. Within the next two years the European banks have to pass a “stress test” in order to prove their “capital soundness”.This includes the plan by ECB chairman Draghi to introduce as of 2014 the European Banking supervision, a “Single Supervisor Mechanism” which in paving the way for a European Banking Union and obliges banks to a stress test, followed by a resolute“Restructuration mechanism” for ailing banks.

The key conflict as Bundesbank chairman Jens Weidmann(who this time did not personally attend and was replaced by executive board member of the Bundesbank Andreas Dombret) statedrecently in a speech in Harvard, is how to react to the consequences which a restructuration of insolvent banks will imply,i.e. howto solve the “vicious circle” between insolvent banks and heavily indebted states. Will it imply an automatic European ECB assistance and will ECB assistance become an incentive for undermining necessary national reforms or will nation states be held responsible to do the necessary steps in cooperation with the ECB and ESM?

Two statements reflect the concern which was expressed by many: One is the statement by Deutsche Bank Co-Chairman Fitschen who said that “the European banking sector is facing the biggest challenge since the 2008 financial crisis”.The other statement was the one given by German Finance Minister Schäuble who in his speech “The future of Europe” underlined that the ECB monetary policy is not to guarantee sustainable growth, that this is the business of politics. He further warned of too hasty steps toward a European Banking Union and mentioned that the restructuration mechanism for insolvent banks mustinvolve the nation states and respectively national restructuration funds.

The way to a European Banking Supervision

European Central Bank (ECB) chairman Mario Draghi in his speech at the Frankfurt Banking Congress outlined three essential tasks which the ECB wants to solve within the next two years:1.the need to create a “Single Supervisory Mechanism”(SSM) which according to Draghiwould become the first “genuine European supervision” and reduce fragmentation in the Euro area; 2.the need to create a“Single Resolution Mechanism (SRM)”; 3.the need to create a functioning EuropeanBanking Union.

In an indirect rebuff to the criticism which was raised by financial representatives against the ECB policy Draghi stated: “I have already reacted to the nationalistic concern that this has provoked in some recent commentary. In their deliberations on decisions, Governing Council members are neither German, nor French, nor Spanish, nor Italian but acting as Europeans in pursuit of a European mandate.”

In his outline about the “Single Supervisory Mechanism”he emphasized that “it offers a tremendous opportunity to move from different national approaches to the treatment of banks ‘to a genuinely European perspective’. That is to take collective responsibility for our banks consistent with the single financial market in which they operate.”In order to achieve transparency for the banks what is needed in the next months, according to Draghi is: a“supervisor risk assessment”, an “asset quality review” and “a stress test”.This supervision will cover 128 banks and about 85% of the assets of countries participating in the SSM.It will be centrally led with a rigorous common methodology. “By end of January 2014”, Draghi stated, “we expect to announce the key parameters of the stress test exercise together with the European Banking Authority (EBA).The key is to gather high- quality information (portfolio selection) from national supervisors and banks.” Under the SSM all supervisors will have the same rules, standards and decision making procedures. As such a supervisory assessment from the SSM that a bank is healthy will be a “seal of quality” that is valid from one country to the next”.

Single Resolution Mechanism as an essential complement

The real hot potato, as many observers stated, is the SRM(Single Resolution Mechanism) following the European banking supervision SSM,which must be agreed by governments. According to Draghi it would encompass all banks established in member states participating in the SSM. It would require a Single Resolution Authority that can act evenly across all countries and take decisions in the Europeaninterest. He recommended the implementing of the “bail- in” tool well before 2018, adding that in the futuresystem the taxpayer would not have to pay,nor would it be a bailout or “mutualisation of the debts”.

Which way to go in Europe?

Yet, as it became clear during the Banking Congress, it is precisely the definition of the SRM which has created some resistance.While Bundesbank chairman Jens Weidmann has repeatedly stated that it is necessary to break through the “vicious circle” of ailing banks and highly indebted states, GermanFinance Minister Schäuble in his speech “The future of Europe” underlined that while he was agreeing in principle with the ECB policy,nonetheless certain qualifications must be made.

TheMinister stated that there has been an increasing lack of confidence which citizens express towards politics; on the other side he expressed optimism with respect to the Eurozone, underlining that due to the effective crisis response mechanism by the ESM, the “infection danger in the Eurozone is gone and parameters of the Eurozone have improved.”(As an example he mentioned the fact that by the end of this year Ireland and Spain will leave the ESM mechanism, that Labor and Social systems are further getting reformed and that small and medium sized enterprises like is illustrated in Germany get credit support from the State Credit Institute KreditanstaltfürWiederaufbau).The key task, he said,  is to “recreate confidence in all directions” so as to “regain confidence among banks with each other and with the citizens, as well as ensure structural reforms and sustainable growth.”

Schäuble however also expressed certain reservations concerning the question of “collective liability” for ailing banks:“Monetary policy alone can’t create sustainable growth. This is not the mandate of the ECB, it’s the tasks of politics”,Schäuble stated. He cautioned that the monetary policy of the ECB could be understood by some European countries as a “false incentive”, not to deploy the necessary reforms.“The ECB itself says that monetary policy cannot create sustainable growth, it can buy time for reforms, but it cannot solve the fundamental problems.” At the same time he made clear that the “taxpayer” can’t become liable for ailing banks and that the “Single Resolution Mechanism”suggested by ECB chairmanDraghi which is supposed to intervene when a bank is insolvent,makes no sense without a “European Restructuration Fund”, i.e. a network of national funds.” Member states, he said, can’t be freed from liability(responsibility). If there is no direct capital assistance from countries, then and only then the ESM is the only lender of last resort.”

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