Transcript:

It's good to be here, in Croatia. Thank you very much for the invitation to respond to Boris's very insightful and very interesting speech on the single supervisory mechanism and the banking union, which was very embracing and a very in depth outline of some of the issues being considered. This is an interesting and a very important development. Again, just to summarize, as a single supervisory mechanism with a single resolution mechanism, meaning that it is a way of handling all the banks in difficulty on a common basis, in conjunction with the harmonized deposit guarantee scheme. We are only introducing the first stage, which is the BSSM, in itself somewhat problematic because it is not a part of the package, yet we have all been asked to sign up for it. I noticed yesterday in the Financial Times that a thousand new people are being recruited to start the asset quality review next month and carry this all out in the course of the year so we are going to have a very big new bureaucracy built up from Frankfurt to take over what was traditionally done at home country level. I want to address some other aspects of this new introduction, this new concept, and although I can see very clear reasons why it might be something that we need to deal with, we need to introduce, there are also arguments against it, views that people are concerned about some aspects of it, especially in smaller countries on the periphery, away from the center and large countries. My purpose is to address Boris's speech by looking at some of these arguments and issues. Henry Ford once said, if two members of a board think the same, one is unnecessary so I may come across with some different views, but the view Boris has produced is very convincing. I will turn to the euro first because, to an extent, this whole mechanism is built on the concept that if the euro works, it will continue to be with us for a long time and work for all the countries in it, therefore we need this mechanism in order to coordinate ourselves within it. However, the fact of the matter is, the euro has not worked for all jurisdictions, certainly not Ireland in my view. There are still many difficulties with it. The one-shoe-fits-all concept of the euro has now been applied to one-shoe-fits-all for the SSM. What's good for Germany is good for Ireland, for Croatia, for everybody else, as was the euro, but it is clear that the one-shoe- fits-all euro did not fit all quite the same by any manner of means. The fact of the matter is that a lot of peripheral countries because of the euro, have overvalued currencies to quite a considerable extent and Germany very arguably has an undervalued currency. In fact, I have always made the case in discussions, in London and elsewhere, and even in Germany, where Germans get really annoyed having to give the money to Irish banks, having to bail out other jurisdictions, which is very true, and there is no point that that is the case, but sometimes the point is missed that, in my view, and that of many others, the real benefactors of the euro was Germany. They have ended up with a highly devalued Deutsche Mark. Most people agree that the large element of their growth of the last decade is because of that undervalued Deutsche Mark. They have made a great deal of it, built up a lot of foreign resources, foreign reserve as a result of it, they also brought in a very low interest rate, where them in Germany they did a lot with it. They built it into commerce and industry, into building their industries, and built a very strong industrial base at a very low interest cost and a very low exchange rate in terms of the industrial market. Countries like Ireland ended up with a very overvalued currency, as well as Spain and Portugal, and cheap money was used through the banking system to invest into what turned out to be a property bubble, which, when it collapsed, brought the economies down with it. So I don't always agree that Germany are paying a very high cost for bailing countries out when you take into account the benefits they have received by this whole euro mechanism. That's not just my view. It is the view expressed by many significant financial commentaries in the Financial Times and elsewhere, but it is sometimes not ... I don't think that I have often enough and forcibly enough expressed it in terms of where we are. The fact of the matter is that because of an overvalued euro, in jurisdictions such as Ireland etc., the only way that smaller countries can compete on international markets is through what is called internal devaluation, which means countries have to reduce employment levels and wages, they have to make their goods cheaper and domestically produced in order to compete on the international market. In fact, official numbers just released in Europe suggest that the rate of earnings growth in Europe has dropped from 1.8 % per quarter to 1.1 %, and in the last quarter, growth and wages fell for 0.6 % in Spain, 1 % in Portugal, 6 % in Cypress and 10 % in Greece, believe it or not. So real wages growth is declining significantly in all these jurisdictions in order to become competitive. Real wages growth has increased by 2 % in Germany over the last quarter, which is actually below recent levels. Many people in the European Union argue that this is a good thing. President Herman Van Rompuy has said that this is an indicative situation, that lower wage costs in euro shows that euro is on the mend so the fact that these people are taking major cuts in salaries, that people have been laid off, is a good thing for the euro. However, there is obviously another view, that these reduced labor costs and employment conditions put real stress on domestic economy, on governments to support the increased unemployment, on issues concerning a lack of domestic demand. A gentleman called László Andor, the EU's top employment official, said that this recent change in employment growth was going to cause severe difficulties within the eurozone and that eurozone itself could suffer some spiraling debt and other difficult conditions going forward if this is allowed to continue. So this internal devaluation principle, which we in the outer regions of Europe have to deal with, is a very difficult pill to swallow and a difficult one to take and you really have to ask the question, and so should many countries: Why are we doing this, why are we continuing with the currency in this situation? Another situation is that internal devaluation is particularly difficult for countries within eurozone with competitor countries that are not. This is particularly so in the tourism industry. If Croatia were in the euro, as a measure in tourism industry, and suddenly Turkey and Greece went out of it and their prices dropped by 30 %, and you are in euro, the only way you could compete would be to reduce labor costs, reduce unemployment, reduce what you charge for your product. It is a very difficult situation to be in, but it is something you have to except and something even the President of the European Council feels is a good thing, which wouldn't be my view of the matter, I have to say. Now I want to go back to the European Union and the banking union in that context. Again, the banking union would work for all states if it were logical and in the interest of all states and if, what happened in Germany in terms of regulations of how countries, how banks should be handled, in terms how they should lend their customers and assess their credit worthiness, the factors they should take into account, if it were the same in Ireand as it is in Germany. And is it right that a thousand new bureaucrats should make all those decisions rather than people on the ground, in these territories, who know the circumstances much more familiarly than they could ever possibly know. It has been said by a recent article in the Financial Times that a monetary policy can be conducted from an ivory tower; but bank supervisory from people only very knowledgeable of it is a context for it with immediate political consequences when a bank fails. But it is not just about numbers, analyses, statistics and figures. It is about dealing with situations and not economy. For instance in Ireland we have a situation which I have always argued, and my colleagues in Ireland have never quite understood it, but people are still trying to convince me that I am very wrong and they are right. If you buy a house in Dublin in one of these very nice grand streets where houses were sold for ten million five years ago and are now worth one or two, but even that is not the point. In London, if you want to buy a house in Chelsea and it is earning a thousand a week in rent, then it's value is a million roughly. It is 5 % per year, assuming it produces 5 % in income per year. You give a yield of five and you multiple the rent by twenty, and you get the value. It is the same in most international cities. In Dublin that doesn't work. In Dublin, for the houses that earn only thirty thousand a year in rent, which suggest that their value isn't more than five or six hundred, people are still looking for 1-1,5 million. Because the value of the property bears no relationship with any objective analysis of yield. That is probably wrong. My view is that it is wrong. Why should Dublin be different from the rest of the planet? People say that if you want to buy a house on that road, you have to pay that price. Well, you could say the same for Chelsea, for Manhattan… So, there is an issue there. When we bring in all these new rules, then Dublin, and how the market in Dublin is valued will be a very significant issue. Local intelligence is, in my view, really important in these matters, and throwing it out in this manner is, in my view, potentially throwing the baby out with the bathwater and should be more finely evaluated in this whole concept of SSM. Another thing in this monetary policy… and this is why the SSM is set up as a separate unit within the ECB and not the ECB itself. Monetary policy will gain insights from the fact that they know how they have been operating in various countries, but there are very definite and clear potential conflicts of interest. That monetary policy has been set for a union, yet the same organization is conducting individual checks of the banking system. Many people have identified why this could produce many conflicts that don't arise from it because the ECB has a very specific policy and the regulators have another. That also must be addressed as we go forward. Another thing about the banking union in that sense is that it is very disappointing. If we argue that if we are going to go down this road and hand everything down to Frankfurt so that they decide what the value of a house in Dublin is worth rather than the Dublin banking system itself, this will have severe ramifications. Also, we don't have a banking union, there is one and a half out of three pillars, we don't have the resolution mechanism, we don't have the guarantee system in place and the fact of the matter is, as many commentators have mentioned, that we have not yet set up a mechanism to deal with serious debt problems that exist in Europe, that the ECB have produced with ECF 60 billion, when the whole world knows that non-performing loans are ten times that at the minimum. And this mechanism was initially a very grand design. We are going to bring in a European banking union where we will have joint responsibility to support all the banks, and in return for that, we'll have all supervisory authority. But they have given us a bit and they have given us the real thing and as a result, they have not supported the real problem at all and therefore countries like Italy have severe difficulty trying to deal with this problem. DSF obviously has no use to it, trying to deal with the scale of its debt issues and its banking issues, yet the ECB are not able to help either. And as we recognized, there is very little domestic potential of investment in it. So how to solve this problem? Who is going to deal with this problem? It is just being ignored. Unfortunately, the grand idea originally, that a banking union followed by a fiscal union would underpin what is a true common currency, is not what we got. We heard none of that. We have ditched the fiscal union. We have one pillar out of three pillar banking union, and we have taken the control away from the local territories. If you give a whole lot, you can have a whole lot. But to give a little bit and take a lot, I think is dangerous. That is my own personal view in terms of overall policy. Can I turn to an issue I've been thinking a lot about recently? That is something that has been mentioned by Boris in his paper; accounting policy and non-performing loans because ultimately this is what this is all about. How do we get to the bottom of what size the non-performing loans are, how do we assess them, how do we deal with them? One thing that is of constant worry for me is the method by which banking profits are measured, the method by which major firms of accountancy sign off audit reports, and in fact, this is not just a problem between sovereigns and debts. It is a problem between sovereigns, debts and four major accounting firms, who seem to run the global financial world by auditing each of the banks. My view is that this is not given anywhere near the attention that it deserves. There is a serious breach of Company Law in many jurisdictions, concerning the reporting of bank profits, which seems to be happily ignored by most people who deal with it and also by a lot of shareholders who rely on these accounting statements. The whole accounting policy of profits is that banks simply do not have to mark the market. They don't have to write the loan if the loan is in any way performing or may well perform at any time in the future and there is no need to write the loan to markers so you don't have to recognize losses until the loss actually occurs, arises and is there. Also, you don't have to provide against the loss. You just recognize when it happens, which is contrary to any standard accounting policy, whereby you must be prudent in assessing any account in order to report to a group of shareholders. This whole method of reporting just started, it started in the US, where what happened was the following. Very complicated instruments were introduced, derivatives, etc. of all kinds of descriptions. Accountants did not know how to deal with them, they did not understand half of them. The people who invented them did not understand half of them, as we all know. Also, all the people who invented these mechanisms were getting paid based upon the profits that these products made, so they said: How are we going to account for these things? How do we know if we made a loss on the policy? They took a view if you have a financial instrument of any description, be it a loan, an instrument etc., and only recognize that if you sell it, you make a loss. If it’s still in your balance sheet, leave it there. No marked mark. Just recognize that when you sell it, you lose it. And no provisioning. And they introduced it as a US accounting standard. Of course, the International Accounting Standards Board in Europe were always battling with the US. There is a battle going on there, they compete with them as much as anyone else competes with them for business. So this made its way into accounting standards. This form of reporting for financial assets was adopted as a major accounting standard throughout the world, not just America. This means that many banks were reporting on that basis. As a result, losses were seriously underprovisioned. They still are. Seriously underprovisioned. On a very significant scale. Even in Ireland, we don't know the situation, no one really does, but the numbers do look a bit odd in terms of provisioning. If you look at the Bank of Ireland, last year it had a 108 billion in loans, with 5 % provision against them, whereas the Bank of Scotland had 33 % of provision against their 27.6 billion in loans. There is a significant variation in provisioning between banks that were within the Irish system and wanted to continue keeping their profits up and their assets intact and ones that didn't care anymore and just reported it as it was because they were branches of the UK bank. Of any standard, 5 % doesn't seem like a lot, but having said that, they aren't doing anything on toward because they are following the accounting standard. If you look at the accounting port for any Irish bank or British bank, they will say… This is the important bit. Because under Company Law in Europe, auditors are required to give a true and fair view of the results of the year. That is paramount. That is a matter of law and what they now say is we give a true and fair view, in accordance with international accounting standards, which they counteract with, which means they are not giving you a true and fair view, we are giving you a version of a true and fair view. This has been commented upon. The accounting standards body in England took opinions from major experts to get guidance, and guidance they didn't like. And the guidance was very much, you can't do this, you must show it as is, shareholders must be shown the true story. But they found the way to avoid it and have come up with a new formulation and it is going on to this day. Significant financial assets are underprovided for, opinions given by very senior professional lawyers in Britain, Ireland and elsewhere seem to be ignored and they can't figure out why any kind of firms and accountants would take that risk, but they appear to be able to do so. So that is something going forward and it brings me now to this new asset quality review process, which is about to happen now. It is interesting because the asset quality review process about to commence is going to try to harmonize the diverse definitions of non-performing loans and they are going to draw a new definition being prepared by the EU regulator, the European Banking Authority, which incidentally didn't cover itself in glory when they reported last time on the loans. This will be followed by stress tests. And at the end of this asset quality review process, they are going to prepare, as Boris has pointed out, a published list of all the banks, their financial health, compare it to the CAMELS system in the US, where each bank will have strength of capital, quality, asset management, management, earnings, liquidity, sensitivity to market risks etc. The big question is what rules they are going to use to do asset test, what principles they are going to use for non performing, what accounting rules they are going to adopt, are they going to continue the existing ones, what happens if they come up with a list of findings that quite a number of European banks are in serious difficulty? What do you do about it? It is interesting because Wolfgang Münchau, who writes for the Financial Times, is a very interesting chap to read and is very perceptive on many things. Two days ago he wrote about this whole process and said: The monetary and banking data are telling us that the economy will teeter on the brink of zero growth in the foreseeable future because the financial sector is not supplying the economy with sufficient funds. And he goes on to say: The banking union could help, but only if it were to break the relationship between banks and sovereigns and clean up the balance sheets, yet neither is going to happen. I believe Mario Draghi, President of the European Central Bank has serious determination to produce a clean and honest asset quality review, which will start next month. He certainly doesn't want to repeat the mistakes of the European Banking Authority which has lost all of its credibility with farcical stress tests. He goes on to say: But what can he do if governments fail to agree fiscal backstop for this exercise? Would it not be irresponsible to admit that banks need several hundred billion euro in euro capital when that money is simply not there? But without the clean bill of the banking sector I see no trend change in the monetary and banking indicators? There you have it. Probably true. If the EU do what they say they are going to do, if they come up with this, we are presented and created not a truly honest problem, but a major problem, and how are we going to deal with the results of such an asset review if a trillion dollars, or somewhere close to it, is needed and Germany is not prepared to put it up. They are the only people who have that kind of money, as we all know. But there is another issue. As you know, the ECB had already established in 2011 at the Forum that Irish banks were collectively solvent, despite the Irish banks showing that they were not in fact insolvent. It's very difficult and recently we've had Victor Costanzio saying that he believed European banks were in very good health and that the capital ratios were in average better in Europe than in America, which, given what we've seen today, and given what is common knowledge, is hardly the case. Anyway, those are my general comments. Can I just turn to another issue, and then I'll let you go, which is a hobby of mine, of course, again, but it is relevant. This will move to the center of Europe, away from peripheries, away from the smaller states, into the center, bringing in control. It is not just happening where we are now considering it, in stress tests and banking supervision. But if you look at taxation matters, it is also indicative of what is occurring. If you look at new rules of what corporation tax policy in European Union is, it is potentially very concerning. We have a situation… Look at Ireland, which has low corporate tax rate and attracts a lot of companies like Google etc., who operate in Ireland. That has been a main driving force for our economy for a long period of time. There have been difficulties with it that I am sure many of you are aware, it hasn't had the best publicity at times. Nonetheless, it has been a major contributor to the economy and lots of East European states are copying the low corporate tax, attracting multinationals to their jurisdiction because of low tax, they are getting them in there to look at it. The new common consolidated tax base that Europe now wants to implement is such that… Take a typical example. Google is based in Ireland, but not based in France, for instance. So the income, the advertising revenue goes to Ireland even though the revenue is created by French customers, but under current tax law because Google don't have a base in France, a physical presence there, they don't pay tax there. They only pay it in Ireland even though the revenue is generated there and this is the root cause of the problem. They want to introduce a new rule and what they are now seeking to pass through is that, in the future, all profits in European country companies and groups will be consolidated together and the profits will be shared out to various other countries based upon turnover in those countries and based upon assets in those countries. This obviously means we get nothing and Germany, because the turnover might be 30 % will get 30 % in profits and tax, and we'll obviously get 1 %. This means they are transferring profits from smaller jurisdictions to larger jurisdictions because obviously that's where the main customers are and that is how the portion profit is going forward. To this end the OCD are following up by other similar mechanisms. This is very damaging because one of the best selling points a smaller jurisdiction has is corporate tax. It is a means of attracting international business, especially American, and once you get them through the door, you can sell them everything else, but if you don't have that to sell them and if they have to pay the same tax in Germany as in Ireland, in Croatia or elsewhere, then basically that is where they will go. There will be differences in labor costs, but other efficiencies being in those larger jurisdictions will make a lot of more sense to them. That is moving through the European Union as we speak and it is possible that it will be implemented within the next three or four years. Again, it is moving to the center, away from peripheries and it is a disconcerting trend in my own view. Much more control is being harnessed in Central European countries. It has been a great pleasure to be here, I appreciate the opportunity. Thank you very much.

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