The Challenges facing European Banking

Manuel Romera. Professor. IE Business School

14 June 2013

The creation of a common regulatory framework for Europe’s banking sector is one of the key challenges facing the continent.

Regulation of the banking business is attracting increasing attention amid the current economic difficulties in Europe. Hence, ECOFIN is trying to homogenize different aspects of European banking in order to be able to establish the much-needed banking union. First, it is trying to set up a system designed to save or manage banks that go bankrupt which would work the same way as for all financial entities, whatever their country of origin.  It is also considering increasing the so-called “regulatory capital” – the level of solvency measured using a bank capital ratio.

In addition to the attempt at creating a banking union, there is growing concern about the different ways that banks are being bailed out, given that the injection of public money into banks with problems is, at the very least, disputed by banks that haven’t received any help. In fact, many senior executives of banks without problems are demanding that those that have got themselves into trouble should have to sort out their own mess. Perhaps the most difficult part is to measure just how likely the risk of contagion is if a bank is just left to go bankrupt in a disorderly fashion. In order to do this, first we have to see if what we most value is the fact that banks generate money and provide the economy with a vehicle for payment, and as such are highly regulated, or if we need them to compete, and are willing to let the market reward and punish them. Not only is there no alignment in the way banks are examined among different European countries, but also within our own country, where the losses of shareholders and the unfortunate holders of the doomed “preferential” accounts have been treated differently depending on the bank in question.

Another issue that is currently under debate is if the European Deposit Guarantee Fund should exist, run along the lines of the guarantees offered in most countries, Spain included, where each account holder is guaranteed his or her first €100,000 if the bank goes bust. I think this is a wonderful idea, given the DGF of individual countries will not have enough cash available to cope with the bankruptcy of a medium-sized bank. Hence, the bigger the guarantee fund, the more feeling of union it gives the creditor or account holder. And with the reluctance and fear fuelled by negative growth rates of the first quarter of 2013 in Europe, this measure would have a positive effect on levels of confidence in the financial system. Germany’s reluctance to apply this idea demonstrates the difficulties involved in generating a feeling of unity through shared bank regulations, as well as Germany’s general resistance to reviewing the state of its savings banks, which also have their own black holes, while telling the other countries to do their homework where solvency and liquidity are concerned.

Banks have been punished in the form of shareholder profits at record lows, with drops of more than 20% in profit margins, and greater demands of capital, multiplying “core capital” by four in two years. Now is the time to reactivate credit to fuel growth, and thereby lend support to the weakened European economy.

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