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"A single monetary policy requires integrated financial markets"

"A single monetary policy requires integrated financial markets"

Bundesbank President Jens Weidmann has called for the greater integration of European financial markets. Speaking at Eurobörsentag 2015 in Frankfurt, he said that "a single monetary policy requires integrated financial markets" and emphasised the importance of enhancing individual aspects in order to make the financial system as a whole more resilient to crises.

No free insurance

With regard to the banking system, Mr Weidmann called for higher levels of capital cover in order to prevent systemically important financial institutions from failing. He stressed that there could be no question of governments providing free insurance, adding that systemically important banks, in particular, needed to make their own contribution to protecting themselves against default by increasing their equity capital. This contribution, he said, would need to be oriented to the size of the given institution. "Therefore, in my opinion, a capital regime that is also geared to total assets is absolutely necessary," said Mr Weidmann, with regard to the mandatory introduction of a leverage ratio set to take place in 2018.

Balancing act for central banks

Mr Weidmann acknowledged that even these stricter capital requirements could not entirely prevent individual banks from collapsing. However, this was okay, he said, as the possibility of failure is essential in a market economy. In this context, Mr Weidmann referred to the situation that would arise if abundant injections of central bank money were used not only to bridge temporary liquidity shortfalls but also to keep insolvent banks on life support. "The more the central bank safeguards banks against risks and promises them central bank funding even in dubious situations, the more incentive they will have to take on excessive risks, of course," he explained. This decision, he said, represents a balancing act for central banks. Although being too restrictive in granting liquidity could cause a spark to turn into a fire, granting liquidity too liberally and propping up institutions without sustainable business models could also mean that the water used to extinguish the fire might end up causing more damage than the fire itself.

A functioning resolution regime is therefore crucial for the reform of the financial system in Europe, Mr Weidmann stressed. With the introduction of the banking union and the adoption of European recovery and resolution legislation, important steps had already been taken in the right direction, he said. However, in his view, one critical step was still missing: the establishment of standards for loss-absorbing liabilities in the case of a bail-in. These are rules that set out how debt capital from creditors can be bailed in for the purposes of restructuring or resolving a bank. While draft legislation exists on this matter, more still needed to be done, he said.

Good fiscal policy is not rewarded

In his speech, Mr Weidmann also recommended that central banks steer clear of taking lending to sovereigns. "Whenever monetary policymakers have signalled a benign willingness to rescue a country from insolvency, this has put them at risk of neglecting their price control mandate," said the Bundesbank's President. Restoring confidence once it had dissolved was both difficult and expensive, he added. Furthermore, where a central bank took on the task of lending to governments it neutralised the disciplining effect of the capital markets. "Bad fiscal policy is not penalised while good fiscal policy is not rewarded through lower financing costs," Mr Weidmann told the audience. This posed a particular problem in a currency union, as the price of unsound budgetary policies could to some extent be passed on to all the other member states. In addition, the Eurosystem lacked the legitimacy to redistribute fiscal risks between member states. "This should remain within the remit of parliaments and governments in the various euro-area countries," he said.

He emphasised that the euro-area countries already had a lender of last resort to which they could turn - the European Stability Mechanism (ESM). This should not involve absolving existing creditors from their liability, said Mr Weidmann, referring to a proposal by the Bundesbank to automatically extend the maturity of all bonds by three years as soon as a government applied for an ESM programme. If a sovereign still found itself locked out of the capital markets after this time, bonds should be restructured so as to restore its solvency. "The key factor here is that any resultant losses can also be borne by the bondholders without causing the financial system to collapse," he explained. Given that, in the Eurosystem, these bondholders were frequently banks, the current preferential regulatory treatment of sovereign bonds should be ended "at the earliest possible opportunity," he added.

A pillar safeguarding financial stability

The Bundesbank's President also called for greater integration in the equity markets, saying that it could help to improve the absorption of economic shocks, thereby also helping to improve risk sharing in Europe. "That is why the capital markets union is so important for monetary policy, too," said Mr Weidmann. He saw plenty of opportunities for pushing ahead with capital market integration, including the market for high-quality securitisation, crowdfunding or, in the longer term, the creation of a European level playing field in insolvency law.

According to Mr Weidmann, the  preferential tax treatment afforded to debt over equity capital was hampering growth in the equity capital markets. At the moment, interest payments could be deducted from taxable income whilst equity costs could not. "Eliminating this distortion would encourage businesses to bolster their equity base," he said. This could, for example, also have a positive impact on banks, making them more resilient to crises. "Putting an end to the debt bias in the corporate taxation regime could therefore also prove to be a major pillar safeguarding financial stability - one that could potentially provide lasting relief for the public sector," said the Bundesbank's President.  

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