A Copernican turn in Banking Union urgently needed. CEPS Policy Brief No. 297, July 2013 [is another Brief with no. 297]

Despite broad agreement among central bankers, policy-makers and economists that creation of a ‘Banking Union’ is essential for the survival of the euro, progress in building this union has been painfully slow. This is largely due to the protracted fights over which government will be the payer of last resort when banks fail because of bad loans made in the past. Taking a cue from Copernicus, Thomas Mayer suggests in this new CEPS Policy Brief that the impasse may be broken by turning the whole process on its head. So, instead of trying to move from common bank supervision, over to bank resolution and then on to deposit insurance, he proposes reversing the process by starting with deposit insurance, moving from there to resolution and ending with supervision.

Time to Set Banking Regulation Right. CEPS Paperbacks. March 2012

Excessive leverage and risk-taking by large international banks were the main causes of the 2008-09 financial crisis and the ensuing sharp drop in economic activity and employment. World leaders and central bankers promised that it would not happen again and, to this end, undertook to overhaul banking regulation, first and foremost by rectifying Basel prudential rules. This study argues that the new Basel III Accord and the ensuing EU Capital Requirements Directive IV fail to correct the two main shortcomings of international prudential rules: 1) reliance on banks’ risk management models for the calculation of capital requirements and 2) the lack of accountability by supervisors. Accordingly, the authors propose the calculation of capital requirements without risk adjustment and creation of a system of mandated action by supervisors modelled on the US framework of Prompt Corrective Action (PCA). They also recommend that banks should be required to issue large amounts of debentures that are convertible into equity in order to strengthen market discipline on management and shareholders.

Discussions in Europe on Variable Compensation in the Financial Sector. EU Centre Singapore Working Paper no. 20, February 2014

Bonuses – which are often used to mitigate principal-agent problems and to encourage employees to work harder – have increased tremendously in the financial sector during the last decade, and have often been seen as a contributing factor to the financial crisis of 2008. The recent European Union (EU) action to adopt a policy that restricts bonuses paid to bankers may seem promising at first, but this does not address the real issues behind variable rewards. Compensation policies should be changed to encourage responsible risk-taking and decision-making through the implementation of broader performance metrics, forfeitable holdbacks and hybrid bonds. Furthermore, a change in organisational culture is needed to improve ethical behaviour leading to a re-balancing of stakeholders’ interests in the financial sector.

Fine-tuning the use of bail-in to promote a stronger EU financial system. CEPS Special Report No. 136/April 2016

This paper discusses the application of the new European rules for burden-sharing and bail-in in the banking sector, in view of their ability to accommodate broader policy goals of aggregate financial stability. It finds that the Treaty principles and the new discipline of state aid and the restructuring of banks provide a solid framework for combating moral hazard and removing incentives that encourage excessive risk-taking by bankers. However, the application of the new rules may have become excessively attentive to the case-by-case evaluation of individual institutions, while perhaps losing sight of the aggregate policy needs of the banking system. Indeed, in this first phase of the banking union, while large segments of the EU banking sector still require a substantial restructuring and recapitalisation, the market may not be able to provide all the needed resources in the current environment of depressed profitability and low growth. Thus, a systemic market failure may be making the problem impossible to fix without resorting to temporary public support. But the risk of large write-offs of capital instruments due to burden-sharing and bail-in may represent an insurmountable obstacle to such public support as it may set in motion an investors’ flight. The paper concludes by showing that existing rules do contain the flexibility required to accommodate aggregate policy requirements in the general interest, and outlines a public support scheme for the precautionary recapitalisation of solvent banks that would be compliant with EU law.