Draghi: A bridge from Brussels to Berlin

Past the German elections, the President of the European Central Bank, Mario Draghi, must have left free to take some steps forward in his quest for the accomplishment of the European Banking Union, and promote the defragmentation of Eurozone’s financial markets. Speaking yesterday in a hearing at the Committee on Economic and Monetary Affairs of the European Parliament, he made a conciliatory proposal over the funding of the Single Resolution Authority (Mechanism). Then he assured the Parliament that the ECB will not let short-term interest rates rise and impede the fragile growth prospects of Eurozone. Let’s take one thing at a time. Bank resolution While reading his introductory statement Draghi said “A key priority of the agenda for the last quarter of 2013 is to complement it (the Single Supervisory Mechanism) by a Single Resolution Authority and a Single Resolution Fund as proposed by the European Commission”. At this point it must be reminded that the European Commission has proposed to enact under its own roof the Single Resolution Authority, dealing centrally with failing banks in the entire Eurozone. It remained though to be clarified how this task will be financed. To this end, the Commission also proposed the creation of a Single Resolution Fund, which will be financed by a levy imposed on all Eurozone banks. However what if one or more cases of failing banks that appear before this Fund is adequately financed? Again the Commission says that in the mean-time the Resolution authority should be able to borrow from the European Stability Mechanism (ESM), currently endowed with €500 billion, and return the money later. In this way though the ESM may be weakened and become unable to perform the task it was created for, that is to support Eurozone countries in distress. There is another argument against this prospect. By borrowing from the ESM to resolve failing banks, the Commission will diffuse, for example the liabilities of a failing Greek or Spanish bank to the entire Eurozone, because its member states will be obliged to recapitalise the ESM if it is weakened. It’s not only that. Given that systemic banks in various member states are tightly connected with sovereign and local business risks, a centrally managed and financed by the ESM bank resolution mechanism, will pass those particular national risks to all Eurozone taxpayers, through the ESM. In view of all that, Germany insists that the creation of a centrally financed single bank resolution authority constitutes such a giant step towards a de facto mutualisation of national risks, not foreseen by the Treaty of the European Union. So Berlin says that if the bank resolution task is to be bestowed to the Commission, there must first be a change of the EU Treaty. Since a change of the Treaty however will take years to accomplish, and Eurozone needs a bank resolution mechanism within months, Berlin proposes a decentralised option and bestow the real task to 17 national authorities. In this way the liabilities to be left for coverage after a resolution of a bank, will be confined at national level. In the long run the nationalisation of liabilities in bank resolutions will act as a incentive for banks and sovereigns to cut off the umbilical cord between them. There are also objections over the imposition of the levy to finance the Bank Resolution Fund. Draghi’s bridge In view of this antithesis between the Commission and Berlin, Mario Draghi took the initiative to make a bridging proposal. He chose to do this from the most prestigious tribune of the European Parliament. It was mentioned above that while reading his introductory statement he said that he supports the creation of a Single Resolution Authority and a Single Resolution Fund, as proposed by the European Commission. Later on however, when asked by the legislators about the means to finance bank resolutions, according to the relevant Press release issued by the Parliament, he replied like this “until the resolution fund is fully financed, it should be able to borrow from other sources, including national ones, to ensure that properly-funded resolution is an option from the start”. In this way Draghi retains the central character of bank resolutions under the Commission, to secure a standard procedure applied to all. In the financing part of the task however he turns to national sources, obviously including the national governments and probably the existing or the future bank deposit guarantee schemes or other national tools. In conclusion Draghi says that, if the Banking Union is to go ahead timely as planned, the bank resolution tool has to be agreed during this year. Only in this way the bank stress tests to be conducted early in 2014 will have utmost credibility. The idea is that if the resolution option is available, bank stress tests can become unbending and severe. Understandably Draghi has very good reasons to press the two sides, Commission and Berlin, to agree on the structure of the bank resolution mechanism/authority, because as he said “the single resolution mechanism should be in place by the time the forthcoming bank balance sheet checks are completed, thereby ensuring the credibility both of the tests and the EU bank supervision system”. Those checks are to be conducted early next year and as the President of ECB said “Private reviewers will help to carry out the bank balance sheet health checks and potential conflicts of interest will be addressed at all stages of the process, all of which should help to build credibility”. In reality the ECB tells everybody that this is the only way to go ahead. Bonanza of loans The other breaking news that Draghi released yesterday, while addressing the Parliament, was his firm stance to keep interest rates down in order to support the fragile growth rate Eurozone attained during the second quarter of this year. He started by observing that the trillions the banks took from the ECB at near zero interest cost “have not yet fed through into higher credit provision. We will maintain the degree of monetary accommodation warranted by the outlook for price stability and aim at promoting stable money market conditions”. This is a direct reassurance that the ECB will do whatever it takes to keep interest rates at their present or lower levels, by feeding the economy with cheap and abundant money. Inflation is not a problem not even in the long run. The President of ECB however knows that in order the SMEs in all member states to have access to the same financial options for the same business risks, he said that “To ensure an adequate transmission of monetary policy to the financing conditions in the broader economy, it is essential that effective measures be taken to further reduce fragmentation of euro area credit markets and to strengthen the resilience of banks where needed”. Draghi described the way to achieve this as it follows, “By giving (to banks) unlimited access to central bank refinancing against adequate collateral, our non-standard measures have been pivotal in relieving bank funding stress. The collateral framework has been adjusted as necessary to ensure continued adequate risk protection for the ECB’s balance sheet”. In this quote Draghi rushes to repel probable criticism from Germany, that he waters down the credibility of collaterals. To repel that he is reassuring everybody that ECB’s balance sheet is always adequately protected against risks. All in all Draghi drew new lines towards the prompt achievement of the European Banking Union, while addressing the legislators yesterday. He also reassured them that the ECB will do what ever it takes to secure adequate finance to the real economy businesses, but he warned that the ECB “can only address impairments in transmission (of its monetary policy of cheap and abundant money) insofar as they are not related to more structural barriers”. By that he asks the governments to do their bid and remove the structural impediments to growth.