A Banking Union more relevant than ever

Silvia MERLER

Affiliate Fellow at Bruegel

Ever since the 2008 financial crisis, the European Union (EU) has been in a continuous process of reforming its financial sector policy. The EU’s supervisory framework underwent a complete overhaul with the establishment of three European Supervisory Authorities (ESAs) for banking, capital markets and insurance and pensions, as well as the European Systemic Risk Board (ESRB) for monitoring of macro-prudential risks. The euro crisis brought additional change, with the decision to move towards a Banking Union (BU) with centralised supra-national supervision and later with the decision to create a Capital Markets Union (CMU), in order to overcome European firms’ over-reliance on bank loans, which slowed the recovery. This rapid and radical change was bound to create frictions where the legacy of the past had not been properly addressed, and nowhere has this friction been more evident than in Italy.

The Italian banking sector has been in the spotlight for several years now. Italian banks were resilient to the first wave of global financial crisis in 2008 – not being exposed to US subprime products – but when the global financial crisis turned into a euro crisis in 2010, the health of the Italian banking sector started to deteriorate due to a combination of growing bad loans, high structural costs, and sectoral inefficiencies. While Spain in 2012 was forced by market pressure to ask for a joint EU/IMF financial assistance programme which deeply restructured the financial sector, Italian banks could escape the deep monitoring and restructuring process that was undertaken in programme countries. After banking supervision was centralised with the Single Supervisory Mechanism (SSM), the long-lived banking weaknesses emerged. In 2015, the need to find a solution became inescapable, but meanwhile, the regulatory environment had undergone a major shift, becoming stricter on the use of public funds in bank rescues. The Bank Recovery and Resolution Directive (BRRD) attempted to limit the cost and incidence of banks’ bailouts by introducing tougher conditions for the use of public money. Shareholders and junior debtholders are now required to contribute to the cost of banks rescues, but this demand was particularly problematic in the Italian context, due to the fact that banks had been selling junior debt instrument to retail clients who were often unaware of the real risk of their investment. As a result, the political economy of the Italian banking crisis has been characterised by a tendency to delay solutions to long-standing and well-known issues, while trying to limit or compensate the hit to junior bondholders.

The fact that centralisation of supervision helped shedding light on the remaining troubles of the Italian banking sector shows the relevance of Banking Union, as well as the importance of its completion. The European financial system is today safer than it was before the crisis, and the policy change has been major, but there is still some unfinished business. The latest turn of events in the Italian banking sector saga, for example, highlights the need for an EU-level discussion on the harmonisation of insolvency regimes as a necessary complement to BRRD. The Juncker Commission has recently expressed the will to reform the ESFS to further strengthen and integrate EU financial market supervision, reinforcing the coordination role for all ESAs and giving new direct supervisory powers to the European Securities and Markets Authority (ESMA). This is an important proposal, in view of the objective to create a well-functioning and well-integrated CMU. Moreover, it may be the occasion to equip the EU to deal with the challenges of a financial sector that is increasingly intertwined with technology – the rise of so-called “fintech” – and is evolving globally. As the financial sector evolves, the EU supervisory framework should rightly change with it, continuing the process of reform that has been set in motion by the global financial crisis.

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