What's wrong with Europe's banks? CEPS Commentary, 12 July 2013

In offering his diagnosis of Europe’s ailing banking sector, Daniel Gros finds that it is undercapitalised, too large and populated by too many players without a viable long-term business model. In his view, it is the combination of the last two factors that is the most worrying and he warns that any major problem could overburden public budgets, making the sector, with total liabilities over 250% of GDP, possibly “too big to be saved”.

Saving for Retirement and Investing for Growth. Report of the CEPS-RCMI Task Force on Long-term Investing and Retirement Savings. CEPS Task Force Report, September 2013

Europe is facing a double challenge: a significant need for long-term investments – crucial levers for economic growth – and a growing pension gap, both of which call for resolute action. Crucially, at a time when low interest rates and revised prudential standards strain the ability of life insurers and pension funds to offer guaranteed returns, Europe lacks a framework ensuring the quality and accessibility of long-term investment solutions for small retail investors and defined contribution pension plans. This report considers the potential to steer household financial wealth – accounting for over 60% of total financial wealth in Europe – towards long-term investing, which would achieve two goals at once: higher growth and higher pensions. It follows a holistic approach that considers both solution design – how to gear product structuring towards long-term investing – and market structure – how to engineer a competitive market setting that is able to deliver high-quality and cost-efficient solutions. The report also considers prudential rules for insurers and pension funds and the potential to build a single market for less-liquid funds, occupational and personal pensions, with improved investor protection. It urges policy-makers to act aggressively to deliver more inclusive, efficient and resilient retail investment markets that are better equipped and more committed to deliver value over the long-term for beneficiaries.

Fiscal policy, banks and the financial crisis. National Bank of Belgium Working Paper No. 234, October 2012

This paper studies the effectiveness of Euro Area (EA) fiscal policy, during the recent financial crisis, using an estimated New Keynesian model with a bank. A key dimension of policy in the crisis was massive government support for banks—that dimension has so far received little attention in the macroeconomics literature. We use the estimated model to analyze the effects of bank asset losses, of government support for banks, and other fiscal stimulus measures, in the EA. Our results suggest that support for banks had a stabilizing effect on EA output, consumption and investment. Increased government purchases helped to stabilize output, but crowded out consumption. Higher transfers to households had a positive impact on private consumption, but a negligible effect on output and investment. Banking shocks and increased government spending explain half of the rise in the public debt/GDP ratio since the onset of the crisis.

Who decides? Resolving failed banks in a European framework. Bruegel Policy Contribution 2013/16, 29 November 2013

As the basis for a European regime for resolving failing and failed banks, the European Commission has proposed the Bank Resolution and Recovery Directive (BRRD) and a regulation establishing a European Single Resolution Mechanism (SRM) and a Single Bank Resolution Fund (SBRF). There is a debate about which parts of the proposed SRM-SBRF to add to the BRRD. The BRRD sets out a resolution toolkit that can be used by national resolution authorities. The SRM would involve European institutions more at the expense of national resolution authorities. This change could affect resolution outcomes. Domestic resolution authorities might be more generous than supranational authorities in providing assistance to banks. A supranational approach might be more effective in minimising costs for taxpayers. But regardless of the final design, more attention is needed to ensure that resolution authorities are politically independent from governments. When public support is provided to failed institutions it should come from a bankfunded resolution fund. This would reduce taxpayers’ direct costs, and would make banks less likely to take risks and advocate for bailouts.

Strong governments, weak banks. CEPS Policy Brief No. 305, 25 November 2013

Banks in the northern eurozone have capital ratios that are, on average, less than half of the capital ratios of banks in the eurozone’s periphery. The authors explain this by the fact that northern eurozone banks profit from the financial solidity of their governments and follow business strategies aimed at issuing too much subsidised debt. In doing so, they weaken their balance sheets and become more fragile – less able to withstand future shocks. Paradoxically, financially strong governments breed fragile banks. The opposite occurs in countries with financially weak governments. In these countries banks are forced to strengthen themselves because they are unable to rely on their governments. As a result they have significantly more capital and reserves than banks in the northern eurozone. Recommendations More than in the south, the governments of northern Europe should stand up and force the banks to issue more equity. This should go much further than what is foreseen in the Basel III accord. If the experience of the southern eurozone countries is any guide, banks in the north of the eurozone should at least double the capital and the reserves as a percentage of their balance sheets. Failure to do so risks destroying the financial solidity of the northern European governments when, in the future, negative shocks force these governments to come to the rescue of their undercapitalised banks. The new responsibilities entrusted to the European Central Bank as the single supervisor in the eurozone create a unique opportunity for that institution to change the regulatory and supervisory culture in the eurozone – one that has allowed the large banks to continue living dangerously, with insufficient capital.

The SRM and the dream to resolve banks without public money. CEPS Commentary, 19 December 2013

In his assessment of the compromise agreement reached on the Single Resolution Mechanisn (SRM), Daniel Gros finds that the popular perception that the periphery has the most to gain from the establishment of a unified resolution regime might have gotten it backwards. In reality, he finds that Germany and other surplus countries have a bigger interest in tying the hands of their national resolution authorities, which have a tendency to be too generous.

The Asset Quality Review and Capital Needs: Why re-capitalise banks with public money? CEPS Policy Brief No. 311, 19 December 2013

It is generally assumed that any capital needs discovered by the Asset Quality Review the ECB is scheduled to finish by the end of 2014 should be filled by public funding (= fiscal backstop). This assumption is wrong, however. Banks that do not have enough capital should be asked to obtain it from the market; or be restructured using the procedures and rules recently agreed. The Directorate-General for Competition at the European Commission should be particularly vigilant to ensure that no further state aid flows to an already oversized European banking system. The case for a public backstop was strong when the entire euro area banking system was under stress, but this is no longer the case. Banks with a viable business model can find capital; those without should be closed because any public-sector re-capitalisation would likely mean throwing good money after bad.

Regulation of European Banks and Business Models: Towards a new paradigm? CEPS Paperbacks. June 2012

Amidst talks of establishing an EU-wide banking union, the recent changes in the regulatory framework and the rethinking of the future of European banking structure, the future of EU bank regulation is inextricably linked to banks’ business models. Using a sample of over 70 banks, which overlaps with those subjected to the EBA’s 2011 stress tests, this report emphasizes the key regulatory gaps that emerge from a comprehensive analysis of the soundness and performance of bank business models and provides policy-makers with guidance to reinforce the evolving regulatory framework in European banking.

The Crowding-out Effect of Mandatory Labour Market Pension Schemes on Private Savings. Evidence from renters in Denmark. CEPS Working Document No. 389, February 2014

This paper aims to estimate the crowding-out effect of the Danish mandatory labour market pension reforms begun in 1993 on the level of total household savings for renters. The effect is identified via a large panel of individual administrative records utilising the differences in speed, timing and sectoral coverage of the implementation of the reform in the period 1997 to 2005. Little substitutability was found between current mandatory labour market pension savings and private voluntary savings. Each euro paid into mandatory labour market pension accounts results in a reduction in private savings of approximately 0 to 30 cents, depending on age. This low rate of substitution is only, to a minor extent, explained by liquidity constraints. The results point to mandatory pension savings having a large effect on total household savings. Thus, pension reforms that introduce mandatory savings have macroeconomic implications.