Yesterday Gunnar Hökmark attended the Swedish Bankers’ Association’s annual summit “Bankmötet” in Stockholm where he gave a speech on the topic of bank recovery and resolution as well as the causes of the sovereign debt crisis in Europe.Below you will find the main points.
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Twenty years following the fall of the Berlin Wall, Europe and the US not only dominate the global economy; we also dominate the global crisis.
The extensive problems facing us today are, primarily, a result of deficient responsibility on budgetary policies, especially so in Southern Europe, and lack of growth and competitiveness promoting reforms in the EU as a whole.
The productivity boost provided by the spreading of information technology contributed to a global economic boom in the world 2003-08 which helped conceal the deep problems building up in Southern Europe. Some 500 million cost-effective Chinese workers were further added to the global labour supply during the 1990s (alongside a few hundred million Indians) which helped keeping production costs and thereby inflation pressures low. This lead to a historically low interest rate environment in the entire world economy as well as an overall positive risk sentiment.
Instead of pursuing a proper reform agenda promoting a dynamic and innovative European economy we have wasted our energy on endless paper tigers such as the Lisbon strategy and EU2020, accompanied by bombastic oration. Speaking about growth has become an alibi for not acting. This was possibly fine whilst the economy was in bloom but has proved fatal during the last four years.
The statistics bear witness of a very poor result in many Member States; weak growth in spite of the very favourable environment with real GDP growth per year 1999-2011 averaging at 0,7 per cent in Italy, 1,0 in Portugal and 1,7 in Greece. Sweden, as a benchmark, grew at 2,7 per cent annually:
Meanwhile, inflation has been high in many of the Southern Member States; according to Goldman Sachs, the deviation from the inflation target of below but close to 2 per cent has been positive for Italy, Spain, Greece and Portugal more or less ever since the establishment of the common currency. This is one of the explanations for the severely increased unit labour costs in these countries. The deviation for Germany has, on the other hand, been negative at 0.45 per cent. This has exacerabted the imbalances accumulated in the euro zone.
Concealed by the favourable interest rate environment, Member States, especially in Southern Europe, let their public sectors expand at an unsustainable rate. Greece has had an annual average current account deficit of 8.3 per cent which has been financed by an ever increasing public debt (from 94 per cent in 1999 to 145 per cent in 2010). This can be compared with Estonia which has had a current account deficit of the same size as Greece but a public debt marginally increasing from 6.5 to 6.7 per cent (the capital inflow has instead been financing private investment).
Heritage Foundation publishes an index whereby the economic freedom of the countries of the world is ranked. Hong Kong is at the top of this year’s list, followed by Singapore and Australia. An unweighted average for EU Member States results in place 64, which is below countries like Rawanda, Albania and Mexico. Although this is a somewhat unscientific method, it clearly illustrates Europe’s competitiveness problem.
The price today is most dearly paid by those in Greece, Italy, Spain and Portugal where lack of political will has been most significant. However, their problems affect us all.
At this stage, the debate on budget consolidation versus a continued debt-financed stimulus policy has taken quite a shift following the election of Francois Hollande in France but also among financial market commentators such as Martin Wolf of the Financial Times. Disregarding the fact that financial policy stimulus seldom have proven to be efficient due to the time lags involved there are practical realities to consider as the debt level of many EU Member States are approaching or have passed 90 per cent. Leading American economists and financial crises experts Carmen Reinhart and Kenneth Rogoff have shown through extensive empirical research that when the debt level passes 90 per cent it is associated with a significant negative effect on GDP growth.
Response to the crisis has from the European institutions and its largest Member States has so far directed more attention to setting up new institutional structures rather than carrying through with structural reforms at the ground. This only served to deepen the crisis and delay the recovery.
These imbalances are one of the main causes of today’s financial crisis, which has brought problems of existential proportions to Europe’s banking system and laid bare the urgent need to establish a framework for how to deal with failing financial institutions.
One of the fundamental preconditions for a free market economy is that firms and owners of the firms do not only ripe the profits of their efforts but also face losses when they occur.
Every business must in this sense face the threat of bankruptcy if the product or service they provide is of inferior quality – otherwise the incentives for that business will be severely distorted. Large and sometimes small banks deemed too big and too interconnected to fail have been exempt from this reality.
This is precisely what the Recovery and resolution directive is about: to make sure that banks and financial institutions and their owners are the one to carry responsibility and bear losses in the event of bad performance.
This directive is therefore, if you allow me, very much about reinstating capitalism in the financial services industry. In any event, I am pretty certain all of us can agree that banks and bank owners have not born losses to the extent they should have during this and previous financial crises.
I have, therefore, very much welcomed the Commission’s initiative in this field, although I would have preferred to have the proposal presented even earlier as the Parliament requested many times.
Nevertheless, I consider, as I said in our first exchange of views, the proposal presented by the Commission to have been very properly drafted and addressing most of the central issues related to this subject.
Alongside other proposals such as CRD4 and DGS it is crucial in achieving the single rule book for the banks so dearly needed. I would by the way at this point, once again, just like to highlight the risk I see currently by throwing too many proposals of different kinds up in the air at the same time. Getting those we now have on the table must be an absolute priority before we dig into further dossiers.
Having said this on my overall starting point for the dossier, I would like to turn to some of the areas where I in my draft report have sought to further improve the Commission’s proposal.
First of all I would like to touch upon the subject which has been my predominant concern: the fundamental difference between a single bank in a crisis and a banking crisis.
We will never be able to predict what shape or form the next crisis will take; therefore, I think the best thing we can do is to make sure we are as well prepared as possible. This includes drafting regulation on many different matters of the financial industry, but also being humble enough to say that we are not in a position to fully gauge the consequences of our new rules; even, perhaps, to admit that some of the rules we made in the past contributed to increasing risk rather than reducing it and that this might happen again.
Hence, we will not know what the next crisis will be like and for that reason we will have to resort to what is the second-best solution which is to be as flexible and adaptive as possible and I sought to bring about this preparedness by further expanding the tool-box available in the resolution phase – which is arguably the most important part of the proposal.
I have, in my draft report, introduced what I call “Government financial stabilization tools”, including the opportunity for the individual Member State to take, if so deemed necessary as a final resort, the institution fully or partly under temporary public ownership or issuing a guarantee of the liabilities of one or more institutions.
I do not do this because I think the government should be running banks. You may accuse me of many things but not for being a supporter of state run enterprises.
I rather do it because I think it is unrealistic to assume all future crises will be resolved without a single cent of tax-payers’ money involved. And if we anyhow go along with that assumption, reality will prove us wrong and we will see situations where Member States will have to resort to various forms of public intervention the day the systemic crisis occurs anyway.
I see it better then to ex-ante clearly define when and how the government may intervene. Not only to provide for this option, but equally so in order to make sure there will be some order for how this is done, legal certainty if you like. If we refrain from including this in the directive today, we certainly run the risk of seeing Member States taking uncoordinated action in the next crisis if nothing else can prevent a further deterioration. That would increase uncertainty about what will actually be the management of the next crisis.
This would, to my mind, be a worse outcome.
Apart from this, although certainly very related, I have tried to make a clearer distinction between the powers and measures in the recovery, early intervention and resolution phases, e.g. by moving the Special Manager to the resolution phase as this is where a my mind tool with so far-reaching powers naturally should be.
I have moreover tried to make it clearer that owners shall still be the ones to carry full responsibility of the institution as long as it has not fallen into resolution, when authorities shall take over in full. A blurred line would serve to increase uncertainty and raise the expectations of public intervention at various points in time: quite the opposite to what we seek to achieve.
On the bail-in tool, I have extended the exemption of short-term liabilities to 6 months in order to make sure short-term funding is not adversely affected by what should be a tool for governance of the institution in the medium to longer term.
Finally, I have tried to introduce a slightly new concept of the way to think about resolution funds, very much based on the current Swedish framework. I acknowledge this is a very difficult topic where much work will have to be done.
My view is that resolution should be funded by the industry ex-ante, since ex-post solutions probably will not be feasible when all banks are hit by a systemic crisis Also, it would imply that the still viable banks, i.e. those who have proven to be the most properly managed, will have to make up for the mistakes of others. This would be wrong for two reasons; first, it is a form of collective punishment otherwise not accepted in our societies; and two, it would indeed pose a significant moral hazard risk if others are to mop up the mess one self’s excessive risks have created.
An ex-ante scheme does not, however, imply that there must be a resolution fund in the true meaning of the word. Considering the investment strategy problem arising from the fact that this fund in many Member States would be very big, even if the Commission’s proposal of one per cent of eligible deposits was to be kept, an alternative could be to pay down public debt instead of piling the contributions into a fund then investing in specific assets
The logic would then be that of an insurance scheme whereby the industry makes annual contributions and that the State provides the funds needed for resolution when so warranted. Since these funds would only be available for banks in resolution, i.e. as gone concerns where shareholders and creditors take the first hit, eventual moral hazard risks should be mitigated. A specific target level would then be irrelevant.
What would pose a moral hazard risk, on the other hand, is an automatic right to borrow from other Member State’s resolution funds. Whilst burden-sharing will be needed for cross-border institutions, I have clarified that for standard resolution, i.e. not a cross-border institution, there should be no obligation for one Member State to lend to another, but rather an opportunity to do so if the former Member State so concurs.