A chance to straighten things up Symposium on Financial Stability and the Role of Central Banks

ECB Executive Board member Sabine Lautenschläger believes that roughly six years into the financial crisis, banks in Europe are on the right track. "I would say that banks are safer now," Ms Lautenschläger explained on 28 February at the Bundesbank's two-day symposium on "Financial Stability and the Role of Central Banks" in Frankfurt. But regulators had not yet got to the bottom of the issue of how the supervisory regime needed to be designed. "The SSM is a major step forward for Europe, but many topics still need to be addressed," added Ms Lautenschläger, who is to be appointed Vice-Chair of the new Single Supervisory Mechanism when it begins operations in November 2014. Together with Jürgen Fitschen, Co-Chairman of the Management Board of Deutsche Bank, Martin Hellwig, head of the Max Planck Institute for Research on Collective Goods in Bonn, and Gerhard Schick, member of the German Parliament and fiscal policy spokesman of the Bündnis 90/Die Grünen parliamentary group, Sabine Lautenschläger took part in a panel debate chaired by Mark Schieritz from the German weekly newspaper Die Zeit to discuss how much safer banks had become in recent years.

For Mr Schick and Mr Hellwig, what had been achieved so far still fell short of the mark. "Banks still haven't put their houses in order," Martin Hellwig said. "Many of them still have skeletons in their cupboards, and there are still too many weak banks in the market." Sabine Lautenschläger explained that it was now a matter of configuring the Single Supervisory Mechanism so that things could be put straight. "I think it's hugely important for our stress test to be tough." 2014 was a crucial year, she continued. "We've got a chance to straighten things up this year."

Wrong incentives

An additional problem, in Martin Hellwig's eyes, was the fact that many banks across Europe invested in government bonds rather than businesses because sovereign debt was classified as risk-free. Sabine Lautenschläger agreed that this was an issue that needed to be tackled. "The incentive system should not make it more attractive to invest in sovereigns than in the real economy. Rules will need to be changed here." Martin Hellwig went on to say that the weak banks were also a channel through which policymakers could get hold of money from the printing press. It all now depended on how the SSM was designed, he added. "Are we talking about Europeanisation that will sever this nexus? Or an instrument that will allow policymakers to keep this nexus in place and make the ECB even more accountable?" the head of the Max Planck Institute enquired.

"Too big to fail" problem unresolved

The question whether banks today were adequately capitalised was another contentious topic for the panellists. Sabine Lautenschläger praised what had been achieved so far. German credit institutions, say, now had between eight and ten times more capital than before, she explained. But for Martin Hellwig and Gerhard Schick, that was far from sufficient. "Capital may not be a panacea but it does create liability, and that's an integral element," Mr Hellwig cautioned. Banks asked industrial enterprises to hold up to 30% in equity, but they often didn't even hold as much as 4% themselves, Gerhard Schick pointed out. The fact that it was precisely the large banks which were undercapitalised, and that the "too big to fail" issue had not yet been resolved were problematic issues. This, he added, was a major source of risk. "I don't believe that institutions with total assets of €2 trillion or more can be managed effectively," the member of the German Parliament concluded.

Jürgen Fitschen firmly rejected this criticism, stating that the progress which the financial sector had made in recent years simply hadn't been acknowledged. If Mr Schick had any doubts about a large bank's management, then he really ought to come to a board meeting, the Deutsche Bank co-CEO suggested. "I think you'd be amazed at all the things we discuss there." He said he was also annoyed by assertions that it was impossible to wind down large institutions, because banks had long since submitted living wills to the supervisory authorities. It was just that nobody read them.

Quick agreement on stress test unlikely

Federal Finance Minister Wolfgang Schäuble likewise emphasised the importance of the forthcoming stress test in his subsequent keynote speech. It was crucial to agree on a procedure for resolving banks that failed the stress test, he said. However, Mr Schäuble put a damper on expectations that the European Parliament, the Commission and the finance ministers would quickly agree on a regime for resolving ailing banks. "That would fly in the face of experience," Mr Schäuble said.

He also praised the progress which the euro area had made so far. "Trust in the euro has been restored. Europe is no longer the world's biggest headache," he added. Now the euro area needed to embark on a sustainable economic growth path and not rely on central bank support. The issue now, Mr Schäuble said, was to establish more common rules and press ahead with the banking union.

Shadow banks undermonitored

Discussions in the symposium's afternoon session turned to the regulation of shadow banks such as hedge funds or money market funds. "Shadow banks can influence financial stability through their direct links to banks, say, and similarities in their business models," said Claudia Buch, President of the Halle Institute for Economic Research (IWH) and future Deputy President of the Deutsche Bundesbank. In her speech, Claudia Buch criticised the fact that data insufficiencies meant that there was no way of gauging whether these risks existed, how interconnected shadow banks were with other financial institutions, and how high their reserves were. Comprehensive monitoring was called for here. The extent to which these financial institutions' links to others needed to be contained or whether the system as a whole had to satisfy stricter capital requirements were also questions that needed to be tackled, she added.

Setting the right incentives

This demand was echoed in the subsequent panel discussion by Mark Carney (Bank of England), Andreas Dombret (Deutsche Bundesbank) and Elke König (BaFin). Regulation in the banking sector had shifted some business into the world of shadow banking, Mr Carney cautioned. "We need to be mindful of the incentives our regulation creates," he warned. In Andreas Dombret's opinion, that was why it was important to look beyond individual sectors – that is, the banking and shadow banking industries – and to observe the markets as a whole instead. All in all, it was a question of making measured adjustments to the rules. "Eliminating the shadow banking sector is not at issue here," Elke König explained. "It's a good system that needs boundaries." Regardless of whether or not the shadow banking system is monitored more closely in the future, some of the shadow banking reforms needed to be rolled out immediately, she concluded.

It's the implementation that counts

Policymakers and banking supervisors still had plenty on their plate before the next G20 Summit in Brisbane this autumn, Bundesbank Executive Board member Andreas Dombret said in his remarks wrapping up the two-day symposium. But he cautioned that regulation was only as good as its implementation. To drive his point home, he mentioned the Single Supervisory Mechanism in Europe and the need for a common resolution mechanism. "How can a European supervisory authority be credible if it can't wind down a bank?" Mr Dombret asked. That was why everyone now had to do their utmost to agree on a Single Resolution Mechanism ahead of the European elections in May, he concluded.