Bankers and financial services professionals often baulk at the tens of billions of euros the industry pays for tighter financial supervision, compliance and the EU’s comprehensive new framework for financial stability. Now that markets are in turmoil because of the war in Ukraine, that tone is different.
During the turbulent and volatile market days that have followed Russia’s invasion of Ukraine, financial supervisors’ heads have remained cool as market participants knew what to expect when markets entered choppy waters. Even as oil prices and other commodities near record levels, financial stability was being maintained. For now.
“We are now better, much better placed to handle market risk,” said a Luxembourg-based asset manager with 55 billion euro under management. “The post-2008 crisis framework has given us the confidence that we can weather this crisis. The costs, the compliance costs we have faced, now are paying off through increased confidence.”
”Some call this past decade the lost decade, but instead let us see the past decade as one where tough lessons were learnt, and robust solutions were put in place, putting our financial system on a much better footing than before the crisis,” Elke Konig, Chair of the EU’s Single Resolution Board, told the European Parliament in December, “The jigsaw that is the European response… is still not complete. That said, we have come a long way.”
What’s more, Europe’s experience in mitigating the consequences of the pandemic again proves valuable. When first signs emerged last week of Russia’s imminent financial collapse following the international sanctions, Luxembourg’s financial supervisor CSSF quickly made clear its Corona-era liquidity guidance for funds “remains valid in the current context”.
Tight European network
“National competent authorities”, as national financial supervisors like CSSF are described in regulation, are part of a tight European network of supervisors that includes the European Banking Authority (EBA), the European Securities and Markets Authority (Esma) and Eiopa, the European pensions and insurance authority.
The European Central Bank (ECB) is involved after the EU’s post 2008-crisis package forced it to extend its scope beyond monetary policy and also become the body to directly supervise the EU’s biggest banks. Supervisors now work from the Eurotower in downtown Frankfurt, while the other colleagues took occupancy in the central bank’s new premises on the Main river in 2015.
The tightening of financial supervision stems from the package that the EU introduced to prevent a repeat of the 2008 collapse of Lehman Brothers and of the US housing market. That crisis exposed vulnerabilities in the European financial system, specifically in banking. One by one, European banks tumbled like domino’s, eventually creating a liquidity crisis that even brought countries to their knees.
Package costs near 40 billion euro per year
That total EU package, which includes some 16 regulations and directives including AIFMD, Ucits, BRRD and Mifid has imposed one-off costs of 39.1 billion euro on the financial sector, and recurring, annual costs of approximately 37.0 billion euros, according to a 290-page European Commission study released in 2019.
The 2008 financial meltdown in Europe laid bare a key difference between Europe and the US economy. In the US, businesses largely depend on market finance, gaining access to funding by issuing equity. In Europe, for historical reasons, debt finance is king. Businesses depend on banks that grant them loans. In a bank-financed economy like Europe, non-performing loans remain on the banks’ books when things go wrong.
EU ambitions to create a “Capital Markets Union”, known as CMU, still seeks to boost the equity component in Europe’s economy. So far these have only led to improvements in securitisation laws, establishing clearer rules on how to turn collateralised debts into financial products. But Europe still lacks the investment culture that underpins US financial markets.
Banking Union almost completed
Banking Union can be declared a success, even though its final, fourth pillar remains to be put in place with a single European system for deposit guarantees. For now, guarantees are harmonised in national laws, protecting individual savers up to 100,000 euro per deposit. Germany, fearing it will have to pay for collapsed banks in southern European countries, still blocks a truly European guarantee system.
But in place is more effective supervision, cross-border cooperation between regulators, harmonised rules - and costs - for financial institutions, and a Single Resolution Board, known as the SRB, which holds the keys to a 52 billion euro resolution fund to which European banks are required to make regulator, hefty ex-ante contributions. The SRB requires every bank to have a resolution plan ready. Contributions to the resolution fund account for about one third of the 37 billion euro in recurring regulation costs.
The target size of the Single Resolution Fund is expected to eventually exceed 70 billion euro, based on 1 percent of total bank deposits by the end of 2023.
”We have a good crisis framework, however, there is room for improvement,” said a spokesperson for the SRB. “At the moment we are operating in a way where many national solutions need to be found. This leads to different outcomes depending on the country, which is hardly conducive for the development of a European internal market.”
The SRB is a Brussels-based institution that only makes headlines when things go wrong. Like last week, when the European subsidiaries of Russia’s Sberbank collapsed. The SRB resolved the problem by forcing the transfer of Sberbank’s Croatian and Slovenian subsidiaries to two other banks.
EU resolution still far from perfect
No resolution was necessary for Sberbank Europe AG, which now is subject to insolvency procedures under Austrian law, SRB said. And under the EU’s harmonised deposit insurance system, the eligible deposits up to 100,000 euro were protected by the Austrian deposit guarantee system.
“We acted to protect the public interest and ensure financial stability,” said Elke König, Chair of the SRB, last week. “All of this has been done without having to use public funds, so not only are Sberbank’s customers protected, the taxpayer is too.”
One SRB watcher however said the EU’s bank resolution system is still far from perfect because it still depends on national systems to executive solutions, even when the existing legal framework offers room for more EU-level solutions. “The SRB still has some issues to address. Its organisation still depends heavily on national execution, while problems remain to be addressed with liquidity, the backstop and coordination with the ECB,” said Willem Pieter de Groen, head of financial markets at Brussels-based think tank CEPS.
Nevertheless, if Europe had not introduced EU-level systems for supervision and resolution post 2008, a relatively upbeat statement from a top EU regulator like König would not have been possible. Without the comprehensive framework, the market turmoil could already have triggered major ripple effects in Europe’s banking system and the economy. For now, Europe is able to maintain financial stability, even when its new financial framework has yet to deliver its complete potential.