Much More Remains To Be Done With European Bank Reforms


A decade after Lehman Brothers declared bankruptcy, many problems of the European financial system remain unresolved.  Reforming banks and other financial institutions in Europe is pressing especially in light of current economic challenges in Turkey and Italy. According to Dr. Paola Subacchi, Senior Research Fellow at Chatham House and author of The People’s Money: How China is Building a Global Currency, “Turkey is problematic for European banks, especially for southern European ones  from Spain and Italy. BBVA has some holdings in Turkish banks, Garanti and Unicredit. France’s BNPParibas also has exposure to Turkey.”  Tukey’s economic crisis is not the only challenge to European banks. Dr. Subacchi points out that “Italy could trigger the perfect storm for Europe: the spread has widened by 150 basis points since May and continues to widen. Recent data suggest a slowdown in the demand for Italy’s 10-year bonds, making refinancing less smooth. Italian banks are significantly exposed to Italy’s sovereign debt, and this has been reflected in the stock market. Capital outflows have increased significantly in recent months. German, French and Spanish banks also hold Italy’s debt as does the European Central Bank.”

Mesdames Gabor and Subacci and Messrs. Barkey and Veron see more scope to improve upon existing European financial reform.Courtesy of Mesdames Gabor and Subacchi and Messrs. Barkey and Veron

When asked what have been the greatest regulators’ achievements in the last ten years in Europe, Nicolas Véron, Senior Fellow at Bruegel and at the Peterson Institute for International Economics responded “the European banking union and the related introduction of a bail-in model for a bank crisis resolution (BRRD).” However, he explained that there are regulatory weaknesses that still need to be addressed.  The most immediate weakness is “that the banking union remains unfinished. There needs to be proper regulation for concentrated sovereign exposures, a European deposit insurance scheme, and phasing out geographical ring-fencing of capital and liquidity within the euro area.” Véron also pointed out that there are neglected areas such as market conduct. Anti-money laundering problems have been spectacularly illustrated this year.”

For Ralf W. Barkey, Chief Executive Officer, Genossenschaftsverband – Verband der Regionen e. V., a big concern is that “EU legislators, who are responsible for most of the banking regulations in Germany, don’t differentiate sufficiently between large and small banks.” Barkey explained that “Unlike the United States, the EU has implemented the Basel rules for all banks irrespective of size. This imposes an unnecessary burden on small, sound and low-risk local banks and creates incentives for European banks to grow bigger and become Too Big To Fail.” He recommends that “banking regulations in the EU should be tailored to both the size and the business model of each bank.”

Much like in the United States, small local banks provide a far above-average proportion of all Small Medium Enterprise (SME) loans in Germany. “The Volksbanken and Raiffeisenbanken, which are organized as co-operatives, provide more than 30% of all SME loans, while their share of the total assets of the entire banking industry is only about 15%.”  Therefore, “a fair regulatory environment for small local banks would be the best way to help them support Main Street. This is why the EU needs greater tailoring in banking regulation and supervision.”

Barkey is concerned that the “Too Big To Fail” problem still persists in Germany and Europe. “Since 2008, the five largest banks in the Eurozone have increased their share of the total assets of the entire banking industry from 44% to 48%. In Germany, the market share of the five biggest banks grew from 23% to 30%.”  Moreover, “implicit subsidies for “Too Big To Fail” banks remain in place as well. Since creditors continue to believe that those banks would get bailed out in a crisis, they can borrow at lower interest rates than smaller banks.”

University of the West of England Professor Daniela Gabor and co-author of The Digital Revolution in Financial Inclusion believes that UK legislators still have to do to make banking safer for ordinary individuals on the High Street, what in the US would be called Main Street.  The UK is implementing the Vickers reforms which requires ring-fencing investment banking activities within the banking group, so that only retail banking benefits from state support in the form of deposit guarantees. “This is a timid move in the right direction,” stated Professor Gabor. “It does not solve the too-big-to-fail problem nor the incentives to aggressively pursue risk.” According to Gabor “The next step, a full separation along the Glass Steagall lines, was on the cards for the entire European Union, and the UK would have had to implement it, but that European Initiative is now dead. The UK High Street remains exposed to contagion from investment to retail banking through channels that are difficult to predict.”

Gabor is also concerned about the shadow banking system.  If reforms of banking have not gone far enough, “there is even less progress on shadow banking. We still don’t regulate global shadow banks as systemically important (see Blackrock). The rules for systemic shadow markets – securitization and repo markets – are a pale version of the original ambitions.”  This matters for banks as well, “because large banks, however properly ring-fenced, have a large footprint in shadow markets, and will be affected by a crisis there.”

Unfortunately, financial reform in Britain is made more complicated by Brexit, the process of Britain leaving the European Union. According to Gabor “We already live in a world where there is reform fatigue, and that may impact the post-Brexit scenarios for finance.” She believes that there are two scenarios. “In one finance is scaled down and reoriented towards the domestic economy. In the other, finance promises to be a key anchor of external competitiveness, just as it did during the 1980s.” This is likely to be a difficult political bet for any government, including Jeremy Corbyn’s, to follow the first scenario. The second scenario “means a return to the pre-2008 world of globalized finance, of banks working closely with shadow banks to pursue quick profits, and persuading governments to treat them as ‘national champions’ that need support to be globally competitive.” Gabor’s fear is that “This race to the bottom brought us the global financial crisis, and it will bring another one.”



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