Today (Tuesday November 13th) the European Commission closes its consultation on the proposals by a high level expert group to reform the structure of European banks. In early October the group, chaired by Erkki Liikanen, Governor of the Finnish central bank, published a complex package of proposals for bank restructuring which struggle to articulate a convincing rationale or to offer evidence of net benefit. Now it falls to the Internal Market Commissioner, Michel Barnier, to decide on next steps.
As the Commission weighs its options on Liikanen, it should reflect on two broader questions. First, what is Europe seeking to achieve through financial reform? And second, where does financial reform fit in the wider strategy to solve Europe’s economic crisis?
On the first point, the key goals of the financial reform programme were agreed by the G20 in 2009. The G20 agreed clear priorities globally: increasing capital, reducing leverage, increasing liquidity, regulating derivatives, reforming compensation structures and ending too-big-to-fail.
In Europe, this agenda has become four legislative pillars. Derivatives reform has been agreed and is being implemented. But the other vital elements of the package – Basel III implementation, bank resolution and capital market reform – are still under negotiation. They risk being delayed as other initiatives such as structural reform absorb regulatory resources and political attention.
Policymakers must stay focused and stay the course. They will have the firm support of the banking industry in doing so.
Agreement and implementation of the Basel III framework for banking is vital. In Europe, the market and banks themselves are preparing for a Basel III world and have made much of the necessary adjustment. Now they need regulatory certainty. So we support the Commission in its push to agree the legal text this year.
Widespread reform of the capital markets is also being implemented, through MiFID. Elements of the MiFID proposals do not yet achieve a workable balance between promoting transparency and safeguarding market liquidity in equity and bond markets. But with continued dialogue with policymakers, we are hopeful of progress.
Effective bank resolution is another key pillar in the new financial architecture. But this pillar could be seriously weakened if the European Parliament maintains a defence for taxpayer bail-outs of the banking sector. How the Commission and the Council of Ministers respond will be crucial. They must ensure that Europe learns, reforms and moves on from the crisis. Protecting taxpayers from future bank failures is an essential element.
While these core legal texts remain open, much of the work of reform to stabilise banking is being done by the market itself – in reducing leverage, rebuilding capital and renewing business models.
Significant progress has been made. And once the key legislative reforms are in place, Europe will have mapped the outlines of a new and sustainable regulatory settlement. That should give the industry confidence to move ahead and offer greater certainty to investors and other stakeholders.
However even the right regulatory framework cannot on its own address the core challenge for Europe: economic growth. Without growth, the challenge of rebuilding from the financial crisis is made much harder. And without growth, there remains the risk that weaknesses in the real economy will spill over into Europe’s financial sector.
The banking union initiative is welcome and has our strong support. But for banking union to work over the long term, we need economic recovery. Breaking the link between banks and sovereigns achieves little if recession continues to erode both sets of balance sheets.
This brings us to the strategic choice for Europe’s policymakers. One option is to embark on a further wave of financial regulation, including complex structural reform and the introduction of a financial transaction tax (FTT) as 11 EU member states are proposing. There is no positive vision to guide this course, nor a logical endpoint. But there is a clear risk of overreach and of negative consequences for markets and the real economy.
The other option in Europe is to pause to survey the new map of regulation which is being drawn, and to try to reach a coherent set of boundaries. The main outlines of the new settlement were already framed in the financial reform programme agreed by the G20. Europe is close to concluding this package. And once complete, it will free policymakers to focus on the fundamental challenges ahead: restoring growth and strengthening Economic and Monetary Union.
Europe needs a strong and viable financial sector to act as a platform for recovery. Much of the necessary reform is already in place, for which both regulators and firms deserve credit. Now we need to move quickly to complete the reform agenda, and focus firmly on promoting growth.
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