International finance institutions

• A new European Investment Bank (EIB) report, the CESEE Bank Lending Survey, provides insights into banking group activities and business expectations in Central, Eastern and Southeastern Europe (CESEE).
• The report is part of regular reporting from the EIB, IMF, EBRD and World Bank for the European bank coordination Vienna Initiative, a framework for safeguarding the financial stability of emerging Europe.
• The EIB survey for the new edition of the report was conducted as the COVID-19 pandemic unfolded.
• About the EIB CESEE Bank Lending Survey

  The EIB CESEE Bank Lending Survey is a unique, bi-annual survey of some 90 local banks, banking groups and financial institutions in Central, Eastern and Southeastern Europe.

• In this capacity, he was a member of the Executive Board, collectively responsible for conducting the daily operations of the IMF.
• Dr. Obiora replaces Dr. Joseph Nnanna, who following three years of distinguished service to the Corporation, retires from AFCs Board of Directors.
• Alongside Dr. Obiora, AFC also announces the following board appointments:
  Ms. Soula Proxenos joins the Corporation as an Independent Non-Executive Director.
• To date, the Corporation has invested over US$6.6 billion in projects within 30 countries across Africa.

• Prepared by Sander Tordoir, Jacopo Carmassi, Sebastian Hauptmeier and Malte Jahning[1] This article provides an overview of progress with various aspects of the deepening of Economic and Monetary Union (EMU).
• A banking union was established, with shared supervision of Europes largest banks at supranational level and a common framework for addressing and resolving ailing banks.
• The European Stability Mechanism (ESM) was put in place to support euro area countries facing deep economic crises.
• And a number of adjustments were made to the shared rules governing national fiscal and economic policies.
• However, there is no room for complacency: EMU needs to become even more resilient to adverse economic shocks.
• Against that backdrop, this article provides an overview of various different elements of the deepening agenda for EMU and identifies a number of outstanding issues.

1 Introduction

• [2] Responsibility for reforming the architecture of EMU is shared by all EU institutions and Member States.
• Ultimately, political decisions on EMU are taken at Euro Summits, which bring together the heads of state or government of euro area countries.
• The ECB participates in these EU and euro area fora and acts as an adviser on EMU reforms.
• Thus, reforms to EMU are a product of the interplay between these various actors and their competences in the legislative process.
• The EUs last two legislative periods saw significant progress on the architecture of EMU (as outlined in Figure 1).
• The introduction of the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) delivered two of the three pillars of the banking union, with the third pillar a European Deposit Insurance Scheme (EDIS) left incomplete.
• Private and public risk sharing are still more limited in the euro area than they are in other monetary unions (such as the United States).
• The banking union remains incomplete without the EDIS, and further progress is needed on the establishment of a genuine CMU.
• On the fiscal side, the euro area continues to lack a central fiscal capacity for the purposes of macroeconomic stabilisation.
• At the same time, mechanisms aimed at ensuring resilient policies at national level could be strengthened further.
• [4] The deepening of EMU is just one of a number of challenges facing the Commission, the Council and the European Parliament.
• [9] Further decisions and follow-up work on a number of different aspects of the deepening of EMU are scheduled for the near future.

2 State of play as regards the various elements of EMU architecture

• The structure and approach advocated by the Four and Five Presidents Reports in 2012 and 2015 respectively provide a useful framework for analysing the current state of play.
• Both reports structured their architectural proposals around four unions (financial, fiscal, economic and political) and argued that there was important interplay between those unions.
• [11] At the same time, private and public risk sharing were not just seen as substitutes; they were regarded as complementary.
• Finally, those reports proposed an approach to the deepening of EMU, linking risk sharing and risk reduction in a comprehensive roadmap with a timeline and clear milestones.

2.1 Banking union

• The Five Presidents Report, which was published in June 2015, reiterated the key messages of the Four Presidents Report as regards the banking union, but also included a new and more detailed proposal for an EDIS.
• The banking union is underpinned by a single rulebook, which builds on key contributions by the various European supervisory authorities (ESAs), with the European Banking Authority (EBA) having specific responsibility for the banking sector.
• Establishing the third pillar of the banking union is crucial to ensure uniform deposit protection across the euro area, regardless of a banks location.
• Thus, all three pillars of the banking union will be complementary and mutually reinforcing.
• It is therefore of the essence that the third pillar is established, completing the architecture of the banking union.
• Outside observers such as the IMF have also called for the banking union to be completed in a comprehensive manner.
• [13] Table 1 State of play as regards the banking union
• Despite the progress made so far, the banking union remains incomplete. Outstanding issues include regulatory fragmentation, gaps in the crisis management framework (e.g. the lack of a harmonised insolvency regime), the absence of a common deposit insurance scheme, and the lack of a common framework for the provision of liquidity in resolution. A number of these elements are linked, and in June 2019 the High-Level Working Group on a European Deposit Insurance Scheme (which consists of members of the Eurogroup Working Group) was tasked with carrying out further technical work and identifying a transitional path with a view to addressing unresolved issues and moving towards a steady state banking union (see Table 1 for an overview of the various elements). At the Eurogroup meeting on 4 December 2019, the Chair of the High-Level Working Group put forward several proposals:[16]
  • An EDIS should be established, initially covering only liquidity needs, but eventually encompassing also loss coverage in line with progress on risk reduction. In the initial phase, a hybrid approach could be adopted, providing liquidity support within certain limits and relying on existing national deposit guarantee schemes, with a central fund gradually being established. In a subsequent phase, the EDIS could also increasingly cover losses.
  • The regulatory treatment of sovereign exposures (RTSE) should be reformed gradually. Initially, supervisory (Pillar 2) and transparency (Pillar 3) requirements could be strengthened further. Following further analysis and an impact assessment, risk-based contributions to the EDIS could also take account of sovereign exposures, and that regulatory treatment could also include the gradual phasing-in of concentration charges for sovereign exposures. That gradual phasing-in of measures would take due account of the possible impact on national debt markets and financial stability. Further analysis of a “European safe portfolio” (i.e. safe assets and the role they play in the banking sector) should also be conducted.
  • Proposals were also made in respect of the crisis management framework and cross-border integration. These involved, among other things, harmonising elements of insolvency law, formalising support arrangements within EU banking groups (i.e. establishing a formal mechanism for subsidiaries’ support by their parents), phasing out options and national discretions that had ceased to be justified, reviewing the governance of the SRB and facilitating cross‑border banking. These measures should ensure that bank failures can be tackled effectively and without bailouts, preserving a level playing field and ensuring financial stability. It was also suggested that financial integration should be strengthened by rolling back prudential and non-prudential obstacles to cross-border banking between Member States.
  • The establishment of the second pillar of the banking union was also rapid and represents a key milestone in the process of strengthening Europes bank resolution framework.
  • The SRM, with the Single Resolution Board (SRB) at its heart and the Single Resolution Fund (SRF) providing resolution financing, has been operational since 2016.
  • The SRF pools contributions received from credit institutions in the banking union and has a target capacity of at least 1% of the total covered deposits of all authorised credit institutions in participating Member States, which must be reached by the end of 2023.
  • senior unsecured bonds) which are deemed able to absorb losses and contribute to recapitalisation needs in the event of resolution.
  • When failing banks go into resolution, viable parts can be resolved and restructured, re-entering the marketplace either as a standalone entity or as part of a larger banking group.
  • Although they vary in terms of their precise design, these systems generally rely on central bank liquidity, underpinned by fiscal guarantees.
  • Moreover, national solutions risk fuelling the bank-sovereign nexus, as fiscal authorities may have to backstop banks liquidity needs using national fiscal guarantees.Work is under way with a view to finding an adequate solution to this issue within the banking union, and various different options are on the table.
  • The Council and the European Parliament are expected to continue working on legislative initiatives relating to the banking union and banking regulation more broadly.

2.2 Capital markets union

• The idea here is that well-functioning capital markets can strengthen cross-border risk sharing through deeper integration of bond and equity markets.
• An increase in private risk sharing and greater integration of markets can also provide a buffer against systemic shocks in the financial sector.
• The goals of the CMU project, as defined in the Commissions 2015 action plan,[18]are manifold, with the overarching aim being to create stronger capital markets in the EU.
• The CMU project originally stemmed, in essence, from the observation that, relative to other monetary unions, the euro area had less well developed and less integrated capital markets, which were preventing it from enjoying a number of economic benefits.
• A fully fledged CMU (which, in combination with the banking union, could lay the foundations for a financial union) would help mobilise capital in Europe and channel it to all companies, as well as deepen financial integration through more cross-border risk sharing, more liquid markets and diversified sources of funding.
• [19] In its response to the Commissions 2015 green paper,[20] the Eurosystem noted that CMU has the potential to complement the banking union, strengthen Economic and Monetary Union (EMU) and deepen the Single Market.
• Strengthening the EUs capital markets will become even more important after Brexit.
• The persistence of such dynamics, and the emergence of a clearly multi-centric euro area financial system, could pose a number of challenges.
• In particular, without further progress on the CMU, a more fragmented financial structure could eventually jeopardise private risk sharing.
• Where services can continue to be provided out of London on the basis of third-country access regimes, regulatory and supervisory consistency is needed.
• Measures aimed at developing capital markets would help to strengthen the EUs domestic capacity in areas where reliance on London is more pronounced.
• Thus, in a post-Brexit world, initiatives fostering the development of genuine capital markets will be even more important.
• These included recommendations aimed at generating long-term savings opportunities, developing equity markets, enhancing cross-border financial flows, and developing debt, credit and forex financing tools.

2.3 Fiscal instruments for the euro area

• In the realm of fiscal union, the Five Presidents Report called for the establishment of a euro area-wide fiscal stabilisation function for severe crisis situations.
• In such circumstances, national fiscal buffers may not be able to provide the degree of economic stabilisation that would be optimal from an aggregate euro area perspective.
• For an overview of concluded and ongoing work streams in this area, see Table 3.
• Table 3 Fiscal and economic union: state of play as regards EU and euro area fiscal instruments
• If designed appropriately, a common macroeconomic stabilisation function would increase the economic resilience of both individual participating Member States and the euro area as a whole, thereby also supporting the single monetary policy, particularly in the presence of deep euro area-wide recessions.
• [26] Those proposals have been discussed in EU fora, which are continuing to work on them, but only at a technical level.
• Meanwhile, Commission President Ursula von der Leyen has indicated that she intends to propose a European unemployment benefit reinsurance scheme.
• At this stage, however, there is no concrete information on the possible design of such a scheme.
• (In other words, Member States can never receive less than 70% of the funds that they have paid in.)
• Given that it is currently expected to be fairly limited in terms of capacity, the BICC will probably not have a material impact on the convergence, competitiveness or stabilisation of the euro area.
• At the same time, over the last few years, a number of budgetary instruments aimed at supporting investment have been developed and scaled up at EU28 rather than euro area level.
• The establishment of a central fiscal capacity could involve the issuance of some form of safe asset at euro area level.
• [32] At present, however, no specific proposals on euro area safe assets are being discussed in EU fora at political level.

2.4 Governance of national fiscal and economic policies

• In the realm of fiscal and economic union, the Five Presidents Report called for stronger coordination of national policies under both the Stability and Growth Pact and the MIP.
• On the subject of fiscal policies, that report emphasised the need for responsible budgetary policies at Member State level.
• As regards economic policies, the Five Presidents Report emphasised the need for further economic convergence in order to achieve consistently resilient economic structures throughout the euro area.
• An effective coordination system for national economic policies is essential for the smooth functioning of EMU.
• The fiscal and economic governance framework in EMU has been reformed over the years, drawing on lessons learned both before and during the crisis.
• Table 4 Fiscal and economic union: state of play as regards the governance of national policies
• Overall, the debt and deficit levels of the euro area as a whole are below those seen in other major advanced economies.
• There are no ongoing excessive deficit procedures (EDPs) at present, and many euro area countries have now reached their medium-term budgetary objectives (MTOs).
• [38] At the same time, some countries have made insufficient progress in terms of reducing government debt and deficits.
• [39] There are currently limited fiscal buffers available to support growth if downside risks to the current economic outlook materialise, particularly in high-debt countries.
• [40] As regards structural policies, continued weak implementation of countryspecific recommendations (CSRs) by Member States including those with excessive imbalances remains a challenge for the European Semester.
• [41] Indeed, in February 2019 the Commission concluded that none of the 2018 CSRs for euro area countries had been fully implemented.
• A number of possible ways of rectifying the EUs fiscal governance framework have been put forward by stakeholders.
• In 2017, for instance, the Commission proposed amending the Treaty on Stability, Coordination and Governance (the fiscal compact) and integrating it into the EUs legal framework.

2.5 Crisis management

• In response to the euro area sovereign debt crisis, euro area countries established the European Financial Stability Facility (EFSF) in 2010.
• This was followed in 2012 by the establishment of the ESM as a permanent euro area crisis management body outside the EUs legal framework.
• Over the last two years, euro area countries have been negotiating a reform of the ESM in order to increase its operational capacity.
• In December 2019, the Eurogroup agreed in principle on four broad reforms, which will be reflected in a revised ESM Treaty.
• The revised ESM Treaty should be signed in the coming months, once all remaining legal issues have been resolved.

2.6 Other institutional issues (“political union”)

• Specifically, greater responsibility at EU and euro area level needs to go hand in hand with greater democratic accountability, legitimacy and institutional strengthening.
• [53] As regards these broader institutional reforms, a number of initiatives proposed in the Five Presidents Report have yet to materialise (see Table 5 for an overview).
• These institutional reforms could potentially become more relevant when it comes to the institutional arrangements for any future fiscal capacity.
• Table 5 State of play as regards other institutional issues
• Treaty change could potentially take place under this Commission, opening up avenues for broader institutional reforms.
• The Commission envisages a Conference on the Future of Europe, starting in 2020 and running for two years, which could result in the revision of EU Treaties.
• [55] In response to the Commissions tabling of this suggestion, France and Germany published a joint paper on 25 November 2019 outlining their views on the remit and process for such an intergovernmental conference.

3 Conclusions

• The first priority is the need to complete the banking union. An unfinished banking union will prevent the euro area and its citizens from reaping the full benefits when it comes to market integration and the uniform protection of depositors. There is, however, some momentum in this regard, which should be seized upon in order to pursue a package of measures in parallel:
  • Establish a European Deposit Insurance Scheme: The establishment of a fully fledged EDIS should be the key priority, as it is the main element that is missing in terms of completing the banking union. In the short to medium term, a common deposit insurance scheme could be set up on the basis of a hybrid model, relying on existing national schemes and a central fund, with loss coverage gradually increasing over the next five years. However, the end goal should be an EDIS with full loss and liquidity coverage, in order to ensure uniform protection of covered deposits.
  • Harmonise national bank insolvency procedures at European level: Bank insolvency frameworks continue to vary across countries, potentially giving rise to very significant differences in terms of outcomes. Taking the US Federal Deposit Insurance Corporation (FDIC) as a model, a harmonised liquidation framework should be established, and the Single Resolution Board should be given the tools needed to oversee the orderly liquidation of banks (especially in the case of small and medium-sized banks which are not subject to resolution).
  • Remove impediments to the free flow of capital and liquidity: In order to protect domestic bank balance sheets against adverse shocks, capital and liquidity should be allowed to flow freely within EMU (including within cross‑border banking groups). Striking a balance between the interests of financial integration and financial stability will be crucial in order to remove those impediments within the euro area.
  • Recognise that the regulatory treatment of sovereign exposures and the development of a common euro area safe asset can be two additional mutually supportive aspects of the deepening of EMU: Work on a sound and prudent design for each concept should continue independently. The introduction of RTSE needs to take into account financial stability considerations and reinforces the case for ensuring ‎sufficient availability of safe assets for the liquidity and risk management of financial institutions. At the same time, the creation of a common euro area safe asset, if so decided by Member States, should be pursued in a way that does not undermine incentives for sound national fiscal policies. That common safe asset will also be conducive to the smooth conduct of monetary policy. Together with RTSE, it will also contribute to the safety and soundness of banks, as well as contributing indirectly to the strengthening of the international role of the euro.
  • Close the gap in terms of the provision of liquidity to banks in resolution: A European-level guarantee promising access to Eurosystem liquidity for banks in resolution would bring the euro area into line with other major jurisdictions such as the United Kingdom and the United States.
  • Improve Europe’s anti-money laundering (AML) framework: The existing AML Directive should be turned into a regulation, establishing an effective European toolkit combating money laundering. An EU body outside the ECB should be given responsibility for AML tasks and could be equipped with direct supervisory powers.
• A second priority is the development of a European capital market, which is vital in order to improve private risk sharing and is an area that remains underdeveloped. The European Commission and its High-Level Forum looking at the CMU are expected to make proposals on this issue in early 2020. Those proposals will need to show renewed ambition in order to drive the CMU project forward, particularly as regards the following:
  • Fostering supervisory convergence: A genuine CMU will need to have a single capital market supervisor at European level, with a level playing field not only in terms of regulation, but also as regards supervisory practices and their application across the EU.
  • Harmonising products and standards: Capital market products and standards should be harmonised, with a Pan-European Pension Product and common standards for securitisation, fintech and green bonds, for example.
  • Convergence of framework conditions: In order to create a landscape conducive to vibrant capital markets, the EU requires greater convergence of framework conditions with a bearing on the CMU, such as tax and insolvency frameworks.
• A third priority is the need to improve the euro area’s fiscal architecture, which has not entirely delivered as intended. The current fiscal rules do not do enough to ensure the achievement of sound and sustainable fiscal positions in economic good times. The resulting lack of fiscal space in bad times may then entail a need for procyclical fiscal tightening, which may render the macroeconomic policy mix inappropriate at the euro area level. Going forward, there is therefore a need for the following:
  • Reforms to fiscal rules to make them simpler, more effective and less procyclical: There is a fairly broadly based consensus in both academia and policy institutions that it would be beneficial to move towards a framework with a single indicator (e.g. an expenditure rule) with links to a debt anchor. The ongoing review of the two-pack and the six-pack represents an opportunity to reassess the effectiveness of the SGP framework.
  • Creation of a central fiscal capacity for the euro area for the purposes of macroeconomic stabilisation: The existing rules are not conducive to the establishment of a euro area-wide fiscal policy stance that could complement monetary policy, particularly at the effective lower bound. A central budgetary function of this kind would help to increase the euro area’s resilience when facing severe economic crises.
• A fourth priority is the need to improve the resilience of national economic structures. The implementation of structural reforms to increase the resilience of labour and product markets, as well as institutions, has waned in recent years. Two different avenues can be leveraged in order to address this:
  • Use the macroeconomic imbalance procedure more effectively: Existing means of coordinating economic policy – including the excessive imbalance procedure – should be applied more effectively.
  • Deepen the Single Market: Europe is increasingly shifting from the production of goods to the provision of services – an area where the Single Market is not as well developed (partly as a result of shortcomings in terms of the implementation of the Services Directive). Consequently, there are still many national regulations governing the delivery of different types of service in the various Member States. With that in mind, the Commission should place renewed emphasis on initiatives aimed at deepening the Single Market, reaping the benefits of its proven track record of boosting economic growth. In parallel, it could explore the possibility of broadening the scope of the Single Market in areas where reform efforts have lost momentum (e.g. as regards conditions for doing business).

INTERVIEW

Capital markets union: the role of equity markets and sustainable finance

Contribution by Luis de Guindos, Vice-President of the ECB, on the occasion of the publication of the ECB report on “Financial integration and structure in the euro area”, Frankfurt

• Without progress towards a fully-fledged CMU, we will face significant difficulties in effectively addressing the global challenges facing the EU.
• Further developing and integrating EU capital markets takes on even more urgency in light of the challenges posed by the United Kingdoms departure from the EU.
• Last, but certainly not least, there are strong synergies between the completion of the CMU and the finalisation of banking union.
• For one, badly functioning financial systems have the potential to harm all of us as the experiences of 2008 and beyond have shown.

Significant advances were made in the first phase of the CMU, but more can be achieved

• Following its launch in 2015, the CMU agenda led to some important accomplishments.
• These policies are expected to have very positive effects on the development and integration of EU capital markets, even though initial ambitions had to be scaled back in some cases in order to reach agreement among the co-legislators.
• While it will take time for the full impact of these measures to unfold, we need to go further to unlock the potential of the Single Market important building blocks are still missing.

Relaunching CMU should be a priority for the years ahead

• First, the EU needs to address the consequences of the United Kingdoms departure from the EU.
• Given uncertainties regarding regulatory divergence, we should not take it for granted that the EU and UK financial systems will retain their current degree of interconnectedness.
• Future actions on sustainable finance will be crucial, also in increasing public support in Europe for further policy measures.
• Third, relaunching the CMU agenda goes hand-in-hand with enhancing the international role of the euro, which has become more important in the present global context.
• Achieving a fully-fledged CMU will require progress across a wide range of issues.

CMU and private equity markets in Europe

• Private equity investment, particularly in risk capital markets, is a pressing area for improvement in the context of the CMU.
• By risk capital markets I mean private equity and venture capital markets that fund young innovative companies whose projects face higher uncertainty, but also have higher economic value in terms of technological growth.
• Deep private equity markets are associated with well-documented economic benefits.
• Similar to, but more forcefully than equity shares traded on stock markets, more private equity investment leads to higher rates of patented innovation.
• What can the CMU do to stimulate the development of risk capital markets in Europe?
• [10] However, European private equity markets are comparatively less dynamic in the sense that they fail to provide young and innovative firms with sufficient funding or adequate help in expanding.

CMU and the sustainable finance agenda

• The CMU and sustainable finance are two mutually reinforcing initiatives and we could benefit from considerable synergies by making progress on both fronts.
• On the one hand, the development of the CMU could support the EUs drive towards a greener and more sustainable economy.
• ECB research shows, for instance, that equity finance seems to be more effective than debt finance in reallocating investment towards relatively greener sectors.
• But the positive feedback between CMU and sustainable finance works both ways.
• This, in turn, could support financial integration in the EU and strengthen Europes role as a global hub for sustainable finance.

Conclusion