Conference: The New Financial Architecture in the Eurozone - Pierre Werner Chair, Robert Schuman Centre for Advanced Studies, European University Institute By: Christos Hadjiemmanuil, University of Piraeus & London School of Economics

1. Is the BU as Stable & Resilient as it Looks?
EUI RSCAS conference on
‘The New Financial Architecture in the Eurozone’
Villa Schifanoia, Fiesole, 23 April 2015
Professor CHRISTOS HADJIEMMANUIL
University of Piraeus & London School of Economics

2. State of the banking industry: exiting the crisis?
• Some repair has already taken place:
– Deleveraging: assets down from €33.5 tr at 2008 to €26.8 tr at 2013
– Asset structure: increased share of loans and receivables; limited role of
trading assets, but greater in large banks (19%), large economies (25%)
– Liability structure: greater reliance on deposit funding (52%); wholesale
funding has declined from 36% to 23% at end-2013
– Improved capitalization: median Tier 1 capital stands at 13%; the ECB’s
comprehensive assessment exercise did not unearth significant capital
shortfalls in SIBs
– Gradual normalization of interbank market
• Indifferent performance / profitability
– Due to low interest rates, bad assets & restructuring costs
– In an environment of weak, fragile growth

3. • Systemic stability?
– Market indicators of systemic stress down to pre-crisis levels
– But the banks remain fragile
– The sovereign-debt issue has not been addressed
• Wide cross-country differences in state / performance of banks
• Structure of the banking industry
– Consolidation: fewer banks and banking groups; but M&A activity subdued,
mainly domestic transactions, often intragroup (internal group restructuring)
– Increased market concentration at the national level: rationalization or
byproduct of official choices in the context of crisis management?
– During the crisis, modest decrease of foreign bank presence, but very large
decrease of cross-border investment flows
– Wide cross-country differences in terms of size of sector, concentration,
domestic v foreign control of assets

4. Continuing fragmentation along national lines
• Structural fragmentation along national lines
– Domestic consolidation / increased market concentration
– In certain cases, accentuation of the TBTF aspect / potential fragility
systemic fragility; impediment to cross-border risk-sharing
• Continuing impairment of interbank cross-border wholesale lending
– Following the crisis: break down of cross-border interbank market
– Drivers: credibility of the national safety net; exposures to sovereign debt
– ‘Renationalization’ of monetary & credit conditions
– Highly divergent credit conditions, with grave implications for the financing
of non-financial enterprises in peripheral economies
• More generally, limited market integration / reversal of prior gains
– Retail sector had always been a problem
– Bond & equity markets’ gradual return to pre-crisis integration levels
– Structurally reduced level of cross-border lending to corporates
– Gradual, non-uniform improvement in money market

5. A road (not) taken? The ‘Bruegel’ approach
• Note by Sapir & Wolff, presented at the informal Ecofin, 14 Sep 2013:
– Three-step strategy for ensuring integration / better risk-sharing
• SSM & strict stock-taking through the comprehensive assessment;
• SRM & forceful restructuring, prioritizing cross-border sales & mergers;
• in the longer run, extensive integration of euro area bond & equity
markets, based on unification of company, insolvency & tax law
– When the situation has improved, introduction of limits on banks’ exposures
to sovereign debt
• Despite apparent similarities, actual European policies do not move
exactly in that direction:
– SRM: through its procedural &, in particular, funding arrangements, unlikely
to severe problem banks’ domestic linkage
– Capital Markets Union: as envisaged by the Commission, not quite the same
think; more timid initiative, along the lines of the FSAPs

6. Regulatory & supervisory reform
• With SSM, improved supervision
– Streamlining, through the assumption of supervisory functions by ECB
– Improvement in the supervisory incentives: less room for national
politicized decision-making / forbearance
• Single Rulebook: strengthened regulatory environment
– Significant strengthening of capital requiremes
– Proposed MREL (in the context of resolution planning): major step forward
– Stress testing, dynamic provisioning, macroprudential capital buffer:
increasing focus on dynamics / early detection of emerging risks
– More robust approach to resolution (at least in principle): BRRD / SRM Reg
– Problem of collateral liquidation spirals / effects of close-out netting &
insolvency ‘safe harbours’ partially mitigated through the introduction of
mandatory administrative stay in resolution
– But the new liquidity requirements are unconvincing
– No progress with structural regulation

7. Crisis management & resolution in the BU
• Promise v reality of the BU:
– From the intended mutualisation of public safety nets to a system aimed at
entrenching robust and quasi-automatic private risk-sharing?
• Violation of the ‘principle’ of alignment of control & liability (cf debate on
legacy assets
– All but unified supervisory framework; but
– No mutualisation of DGSs; and – Residual national fiscal responsibility
– Prolongation of the underlying fragmentation of the banking system!
– Perverse incentive for forbearance, if the home country is fiscally weak
• Complexities of resolution process
– Possibility of national influence over the resolution decisions
– Discretionary elements in the burden-sharing cascade
– Unconvincing backstops; and – Effective national vetos in ESM

8. Monetary & banking policy in the BU
• Crisis containment
– BU: its announcement was more effective in quelling turbulence than its
actual implementation
– ECB: since 2012, it has played the primary role in stabilizing the situation
• Overburdened monetary policy?
– Wide scope / objectives: the Eurosystem as ultimate backstop for
macroeconomic; banking; sovereign debt; balance-of-payments; and even
asset markets problems?
– Broad range of unconventional tools: QE (PSPP); LTROs, ELA; OMT; Target
credits; relaxed collateral eligibility standards, ABSPP, CBPP3
– Overstretching the mandate? OMT case! ‘No monetary financing’ clause
– Longer-term financial stability risks from accommodative policies?

9. Forbearance & moral hazard: still with us?
• Conflicting objectives / responsibilities?
– Reversal of traditional assumptions about the tension between monetary &
supervisory functions: this time, reregulation / supervisory demands have
put the break on a monetary policy with expansionary objectives
– Stabilizing effects of monetary expansion v longer-term moral hazard
• New forms of the classic dilemma:
– TBTF not the only example of moral hazard; system-wide policies may also
undermine market discipline
– Time inconsistency: ex ante v ex post optimal insolvency approach
– Public interventions to contain banking crises (moral hazard) v market
discipline
– Time inconsistency may also affect the actual application of the BRRD’s
resolution mechanism (e.g. the scope of exceptions from bail-in)

10. Thank you for your attention
CHRISTOS HADJIEMMANUIL
Professor of Monetary and Financial Institutions, University of Piraeus
Visiting Professor of Law, London School of Economics
Attorney at law, ABLaw, Athens
e-mail: c.hadjiemmanuil@ablaw.gr
tel: +30 6936 161770