The financial crisis has showed that national governments in Europe were unable to provide timely or cost-efficient solutions to problems affecting their banks, and this created knock-on effects, amplifying troubles across the eurozone, the IMF said in documents published on Wednesday about the single currency area’s planned banking union.
Banks were unwilling and often unable to send funds across borders to eurozone countries where funding was tight, lending and deposit rates vary widely across Europe, while borrowing costs for the private sector rise together with governments’ borrowing costs.
“A banking union can reverse this fragmentation of European financial markets and break the adverse spiral of private and sovereign borrowing costs witnessed across the monetary union,” Mahmood Pradhan, deputy director in the IMF’s European Department, said in a statement on the IMF’s website.
All the elements of a banking union – a single supervisory mechanism (SSM), single resolution mechanism with common backstops and a common safety net – are needed for the banking union to be successful, and ideally progress would be made on each of them, the IMF experts noted.
But they acknowledged that, given the need to resolve outstanding differences of views on the details, it may not be possible for progress to be made on all these elements.
Instead, they suggest a well-defined timetable for progress on the most important issues, which would remove uncertainty and boost confidence that the eurozone would finally get out of the crisis.
Adoption of a single rule book – on capital requirements, recovery and resolution and deposit insurance – “needs to proceed urgently,” the IMF expects said.
“Agreed drafts of these EU legislations should be submitted to the EU Parliament as soon as possible, with approval during the first half of 2013 and adoption in national legislations in the course of 2013,” they said in documents published online.
COMMON SUPERVISION THIS YEAR
The SSM should become “effective” for troubled systemic banks over the course of the year, with the aid of a phased rollout, according to the IMF.
“The emphasis should be on establishing a strong SSM in which the ECB has formal powers, the decision-making processes, and the capability to perform essential supervisory tasks in an intrusive delegated monitoring model,” the paper said. It said that once “essential capacity” is in place, the European Central Bank could start, maybe by the middle of this year, to actively supervise banks that receive state aid, “with an appropriate degree of delegation to national authorities but with the key decisions taken at the center.”
Reaching an agreement on direct recapitalization of banks by the eurozone’s permanent bailout fund, the European Stability Mechanism (ESM), would allow for direct recapitalization – which would break the toxic link between banks and sovereigns – to occur soon thereafter, it also said.
Further down the line, “it is essential that the European Council commit to a firm timeline for implementing a single resolution mechanism, including burden-sharing arrangements,” the paper said, noting that the EC will present a proposal on this during the year.
Meanwhile, resolutions would be handled by the national authorities under strengthened regimes and, as needed, with support from the country with borrowing from the ESM.
“Single supervision should reduce national distortions, bring a uniformly high standard of oversight, and mitigate the buildup of concentrated risk that compromises stability for all,” said Rishi Goyal, one of the authors of the study.
“And moving responsibility for potential financial support to the supranational level would de-couple banks’ prospects from that of sovereigns with weak finances, protect individual sovereigns from banking sector weaknesses, and thus enhance confidence.”
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