Finance: Research, Policy and Anecdotes

There is no end to conferences that take the 10th year anniversary of the Lehman Brothers’ failure as motivation to discuss financial stability and the regulatory reforms of the past decade.  One of the highlights has certainly been a conference on Managing Financial Crises: Where Do We Stand?, at the National Bank of Belgium, co-organised by the ECB, Solvay Brussels School of Economics and Management, Toulouse School of Economics , which I had the pleasure and honour to participate in.  While split into five panels, the same topics came up again and again – how to make the Eurozone and its financial system more resilient. There has been enormous progress in strengthening banking regulation after the Global Financial Crisis and the Eurocrisis, but more is needed to make the Eurozone a sustainable currency union.  The 7+7 proposal of combining more risk-sharing with more market discipline was the starting point for several discussions during the conference.  It is clear that while politically risk sharing (in the form of, e.g., a common unemployment reinsurance and a Eurozone level deposit insurance) and market discipline (help for countries in dire fiscal position only with conditionality) are seen as contrasts, in reality they complement and reinforce each other.  Market discipline can only be enforced if credible and it can be more credible with risk sharing. In this context one important consensus that came up again and again was that the banking union has to be completed, with common deposit insurance and a backstop for the resolution fund.  Similarly, fiscal and capital market risk-sharing are not substitutes but can very much complement each other.

But when will these reforms be undertaken? On the one hand, there is a reform fatigue and political stand-off related to Italy – which speaks against any political action soon. There is also nothing like a crisis to focus minds. But “we should not build a boat again in a storm” as Herman Van Rompuy (former President of the European Council) admonished   And the next crisis might not be too far away as Vitor Constancio pointed out – if it is not Italy then the next recession might hit soon, with Eurozone authorities not having enough tools available.

I participated in a panel on bail-in vs. bail-out. I have written about this before. While Europe has moved from costly bail-outs to a framework of bail-in, in reality we are still very much in between both corner solutions and the question is whether we really should get to a corner solution where only bail-ins are allowed.  For me the challenge comes down to legacy problems vs. forward-looking. State aid restrictions were temporarily lifted in 2008 to allow bank recapitalisation but not after the Eurozone crisis, resulting in bank fragility not being addressed and the can being kicked down the road.   As Mathias Dewatripont pointed out: “‘when bailout is out and bail-in is not in, denial is the only option left’ and procrastination is also very costly for growth and thus taxpayers.”. Non-performing assets continuing to depress bank lending in several periphery countries and bail-inable debt not built up yet undermines the application of the bail-in tool as clearly seen in recent instances. It also undermines the push towards a European deposit insurance and backstop to the resolution fund as creditor countries fear that they are being asked to pay the tab for legacy losses. A solution to this problem, however, is above the paygrade of regulators and has to be resolved on the political level. Without going into recent development in German politics, let me just say that this seems rather unlikely to happen soon.

7. Nov, 2018