Wednesday, December 25, 2024

EU capital markets and banking unions will gather pace post-elections, say experts

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European banks may breathe a sigh of relief as the upcoming European elections are unlikely to lead to more capital requirements, but focus on the EU capital markets and banking unions, according to analysts and bankers. 

If the last 10 years have seen a strong focus on prudential regulation following the global financial crisis, the focus now seems to have shifted to the competitiveness of the banking industry as a way to achieve policy goals such as the green transition, explains Nicolas Charnay, managing director at S&P Global Ratings.

As it took years for EU legislators to reach a political agreement on the Basel III implementation, experts anticipate that instead of looking to increase capital requirements, the next EU legislative and executive bodies that will be formed after the parliamentary elections on June 6-9 will be busy looking at long-standing dossiers such as the capital markets union and the banking union.

The current capital markets fragmentation means that the European market is less developed than the US’s. Between 2016 and 2022, the equity capital market capitalisation as a share of gross domestic product increased from 48 per cent to 66 per cent in the EU, and from 104 per cent to 157 per cent in the US, according to a May report by consultancy Oliver Wyman. This highlights that, despite its recent growth, Europe capital pools are still small relative to the size of the bloc’s economy. 

The EU risks losing its competitiveness as a more developed market could create bigger capital pools for investments, according to the report.

The CMU and banking unions, if completed, have the potential to indirectly tackle European banks’ long-standing profitability issue, says the report. In particular, banks might be able to expand and diversify their revenue by expanding asset management activities if the capital markets were more integrated, it states. 

Stumbling blocks

Both dossiers have also come up against barriers as a result of differences in national interest. The proposal to centralise capital market supervision, and discussions on potential — though minimal — harmonisation of corporate tax and insolvency law, part of the attempt to re-launch the CMU, became stuck in the European Council recently, where national governments expressed differing views, says Lucia Quaglia, professor at the University of Bologna.

A significant increase in the number of MEPs less supportive of European integration would slow down the introduction of a digital euro or any move towards the completion of a banking union and CMU, she explains.

“A considerable amount of political will, and political capital, is needed for these dossiers to move forward,” adds Quaglia.

It would really need massive commitment to really push [the CMU] forward to make serious progress

Giles Edwards, managing director, S&P Global Ratings

In the last few months, the moment has been building for the CMU, a project first envisioned in 2014. In April, French finance minister Bruno Le Maire proposed that only the bloc’s interested countries could proceed with the project.

“The CMU is incredibly complex. It would really need massive commitment to really push that forward to make serious progress,” says Giles Edwards, managing director at S&P Global Ratings.

But some parts of the broader project seem more likely to be implemented than others.

In particular, securitisation is at the top of everyone’s mind and the political momentum is there, according to a representative at a large European bank. “On other pillars of the CMU, such as a single supervision of capital markets, there’s more division across member states,” he adds.

European banks are readying themselves for regulatory changes that will allow the revitalisation of the securitisation market — and more capital relief for the sector — under renewed efforts to revitalise the CMU.

Over the last decade, increasing capital requirements have pushed banks to reduce the size of their balance sheets, while securitisation is a way to increase lending, argue proponents.

Ben Pott, international head of public policy and government affairs at BNY Mellon, agrees that securitisation is going to be one of the main features of the CMU relaunch. Still, “there are other interesting ideas that are being considered, such as a European savings product, auto-enrolment into some kind of a pan-European saving or pension product, and insolvency law harmonisation. 

“Some of these are technical details that might not grab the headlines, but will probably make the harmonised European capital market a lot more likely,” he explains.

Meanwhile Michael Peters, researcher at NGO Finanzwende, believes the securitisation narrative is mainly a “lobby initiative by big banks that want to hold as little capital as possible and do as much investment banking as possible”.

The banking union was conceived following the global financial crisis to weaken the bank-sovereign nexus and ensure taxpayers’ money was not further used to rescue failing banks.

‘A maze of rules’

A decade on, the banking union is not yet complete. 

It is based on three pillars: Europe-wide banking supervision (which has been in place since 2014), a common framework to handle failing banks (currently under reform), and a European Deposit Insurance Scheme (not yet in place).

Giovanni Sabatini, general manager of the Italian Banking Association, welcomes the advances on the crisis management and deposit insurance proposal, which initially saw resolution extended to a larger number of banks. “There are still doubts on the package such as the role of all the different authorities in a crisis,” he adds. 

According to Peters, the effectiveness of the CMDI framework isn’t very plausible in practice. “If a bank fails in the European Union, no one knows exactly what happens, as there is a maze of rules at both national and European level. In the March 2023 banking crisis, the US authorities were able to act quickly as they had significant power and financial backing,” he explains. 

If a bank fails in the European Union, no one knows exactly what happens

Michael Peters, researcher, Finanzwende

Last year, the European Commission put forward a legislative package to establish a framework for a digital euro.

Banks’ concern was that households will prefer to hold risk-free central bank digital currencies over keeping their funds as deposits at banks.

According to Sabatini, the banking sector is now confident a digital euro will mostly be used as a means of payment rather than a store of value, which would have resulted in an outflow of deposits from banks. “It remains to be seen how a digital euro will add value. If it will replicate payments systems that already exist, one should ask if it is worth it,” he adds.

Banks are also trying to figure out how open banking will impact them.

According to Sabatini, the revised Payment Services Directive has created an uneven playing field between banks and fintech start-ups after the latter were granted access to banks’ customer data but not vice versa. Now the Financial Data Access, or FIDA, framework is letting Big Tech companies into the game as well, but still without a reverse flow of the data to banks, says Sabatini.

More in general, according to Finanzwande, European banks claim to be behind on digitalisation issues because of regulation, but they are simply “late to the game”.

With the outgoing European Commission there has been a lot of activity on ESG files. “There is now greater focus on making sure that the sustainable finance framework takes greater account of transition activities,” Pott predicts.

“We now have a green taxonomy but the real problem is not financing green projects but financing transition projects,” agrees Sabatini.

Addressing risk

The European Commission, whose political leadership is set to change to fit the changing balance of power arising from the EU parliamentary elections, is increasingly looking at the systemic risks posed by non-bank financial institutions and their interconnectedness with banks.

On May 22, the European Commission ran a workshop where it launched a consultation on macroprudential policies for NBFIs. Lenders are worried that increased attention on the issue might result in more requirements for them.

“This is one area everyone is looking at at the moment. If you regulate these entities through banks only, you will not address the full issue because they are also linked with other parts of the financial system,” explains the European bank representative.

In Europe the Basel rules have already been decided, but in the US the final rules are likely to be less onerous than the initial proposal, which has received a lot of industry pushback.

“This is likely to create an uneven playing field with the US, which will also implement the final Basel rules six months later than the EU. The European Commission is monitoring implementation across different jurisdictions,” the bank representative says, suggesting European authorities might still be pushed to do some fine-tuning to preserve the banking sector’s competitiveness.

According to a representative at another bank, authorities are quite “proud” of the Basel compromise that has been struck. “The general view is that to reopen that compromise, even if it’s only to change implementation timelines, is a very bad idea,” he concludes.

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