ECB Banking Supervisor Seeks to Overcome Fragmentation in the Banking Sector

In a guest commentary published in «Handelsblatt» on Tuesday, the head of European banking supervision (housed within the European Central Bank, ECB) assessed the current state of the European banking sector.

The diagnosis and the therapy that Claudia Buch provides and prescribes are of particular interest against the backdrop of the Italian UniCredit’s attempt, ongoing for months, to gain control of Germany’s Commerzbank. But readers from Switzerland can of course also draw certain conclusions for the local financial industry with its last major bank, UBS.

Banking sector is «currently in quite good condition»

As befits a public official, Buch’s commentary contains much that is self-evident and obvious, such as the observation that well-functioning banking markets are essential for a healthy economy. Buch also attests that the banking sector is «currently in quite good condition». Institutions are better capitalised, more liquid, and enjoy greater confidence in the markets as a result of the reforms following the financial crisis.

The global financial crisis is also the reason why European banking supervision exists in the first place. ECB banking supervision, which began its activities in 2014, is limited to the largest banks in Europe (currently 113) and works closely with national supervisory authorities within the framework of the Single Supervisory Mechanism.

Need for action with a «forward-looking» perspective

However, Buch does not leave it at stating that the banking sector is in good shape. «A careful diagnosis must therefore go beyond a mere stocktaking. It must be forward-looking, consider depositor protection, financial stability and the role of banks for the economy, and in this way adopt a broader societal perspective.»

And this more comprehensive diagnosis shows a need for action. «The European single market for banking services is only insufficiently integrated. Around 80 percent of bank loans are granted domestically, only about two percent of deposits are invested in other countries. Cross-border mergers have developed little dynamism in recent years, and market concentration has tended to increase in some markets.»

Fragmentation as a risk for financial stability

This fragmentation could make efficient risk-sharing more difficult and limit banks’ investments in digital business models, as these often only pay off with sufficient business volume, Buch criticises. Such a market structure could weaken resilience in the future, impair stability and restrict the competitiveness of banks.

Against this background, Europe’s top banking supervisor outlines «a clear treatment plan to make the sector fit for the future.». This is based on three pillars.

  • European integration and cross-border competition should be better promoted. «Different legal regulations make it expensive for banks to operate outside their home market. Harmonised rules would therefore promote the single market.» Obstacles to the free flow of capital and liquidity within cross-border banking groups should also be removed. In addition, Buch advocates completing the banking union with a European deposit insurance scheme and «a further strengthening of European crisis management» (which likely implies more resources and personnel for the ECB and other EU authorities). Moreover, non-viable banks must be able to exit the market.

  • Resilience and financial stability must remain protected, because only financially and operationally resilient banks are prepared for a geopolitically uncertain environment and can withstand negative shocks. Prevention is decisive, as it reduces the risk of contagion from less strongly regulated areas of the financial system.

  • Regulation and supervision should be simplified without weakening resilience. «Complex rules and overlapping reporting requirements tie up resources that banks could better use for their risk management and improved services.» Buch’s reform agenda for European banking supervision: «We are making our supervision more efficient, more effective and more risk-oriented – proportionate to the relevant risks.»

With her remarks, Claudia Buch makes it clear that Commerzbank and the German government cannot expect support from ECB banking supervision in their dispute with UniCredit, although the German economist does not comment on the individual case. Her arguments are likely more in line with the views of UniCredit CEO Andrea Orcel, who also sees his move as a contribution to European integration in the banking sector.

Reform agenda as a model of Finma?

And some local banking representatives would, for once, probably be grateful if Switzerland were to follow the EU model and if Finma adopted the reform agenda of European supervision. However, the same applies here: commitment to general principles such as efficiency and proportionality is easy; the crux lies in interpretation and concrete implementation.

Switzerland has gained experience with this tension between theory and practice during the Credit Suisse crisis. The solution originally intended for this purpose—resolution and thus the market exit of the major bank—proved not to be politically feasible. Instead, UBS absorbed Credit Suisse, which, as is well known, led to the current debate on the appropriate regulation of the last major bank and of (systemically important) banks in general, which is being conducted publicly with unusually hard-fought arguments for Switzerland.