Transcript:

Thanks a lot, Gerry. Only you can make such an introduction. I don't know who you were talking about while you were looking at me, but he must be a great chap. I'm so happy to be here and be a speaker at the Ante Čičin-Šain Lecture for the first time. It has become a tradition to remember our first governor. I had a talk yesterday. It is very unusual for a governor to have back to back talks. Yesterday I spoke about the fiscal and monetary policy and today I decided to talk about something quite different. That's banks and banking in Europe. The title is Banking in Europe: What went wrong and how to fix it. I'll talk more about what went wrong than how to fix it, but later on I'll talk about the banking union, which is on our menu at the moment and we haven't been talking about it much in Croatia so far. I think it's time to start talking about it because we'll be asked by the EU what we think about it. I'll give you the first idea of where we are in our ideas about the banking union today. So, this is what I'll talk about today. A little overview of what is going on in the European banking sector. On the lending capital, deleveraging, the famous connection between the banks and the sovereigns as well as the government intervention in the banking sector, which we have seen a lot over the last few years. And then I'll talk about the idea of how to solve some problems that we have in the banking system in Europe through the creation of the banking union, what in our view are the benefits, and what the potential problems for a country that has an opt-in clause, like Croatia as well as what are the reasons to join the banking union or not to join it? That's the plan. First, on the credit activity of the EU area. What we have seen since the beginning of the crises is that the loans to the private sector in the EU area have stagnated. There has been a 0.8 % increase since the beginning of the crisis, which means an effective decrease. But if you look at different countries, you see huge differences. Some countries have seen an increase in the stock of loans while others have seen a huge decrease. Basically, a serious credit crunch. Here you see the data for different countries. Ireland comes here, of course, because of the big crisis of the banking sector, but you see that there are countries like Finland, which has seen the cumulative credit growth of 30 %, and you also see other countries, which have seen the cumulative decrease of the credit growth from 10 to 20 %. There are huge differences, but on average, there is stagnating growth in the EU area. Here is Croatia, which saw some increase in credit growth in comparison to the beginning of the crisis, like September 2008, but not much, and most of which being to the government sector, to the state, rather than to the private sector. There was some increase in the outstanding amount of the credit to the corporate sector. There has been a deleveraging in the household sector, but the only real growth of credit extended by the banks during the crisis was to the government. That leads us to something else we have seen during the crisis and it is not confined only to this crisis. If you look at the history of the economic crises, what has been a fil rouge of all of them is that in the crisis, there is an increasing orientation of the banks towards their own sovereigns. The home country bias increases and the exposure of banks toward their own governments increases too. This is something we have seen once again during this crisis. The banking market has actually become increasingly fragmented in the sense that there was an increase in the home bias, which means withdrawal of banks from other markets and focus on the domestic market. All banks in your area increase shares of domestic bond holding with the bulk of them going to government bonds, which in a sense seems like a logical response to the crisis because it supports the capital adequacy ratio of banks as the government bonds are still zero risk. In that sense, it is logical. Also, if the risk increases, it's logical to expect the banks to again turn towards government bonds, which have a zero risk waiting, at least on paper. Also, at the same time, you have a low private sector demand, so you would expect something like that to happen, but you always think whether there was the invisible hand of the government, extended over the banks, as is usually the case in the crisis. There is asking for more money and banks being happy to provide. We have seen this kind of development in history and it always seems like the same process all over again. If you look at the home bias of the bank towards the domestic market versus the external one, you can see that the exposure of the banks towards the domestic market in Europe, when it comes to the bond market, is extremely high. You have a group of countries where almost a hundred percent of bond holdings are home country bonds. From this already, you can see that there is not really an integration of the banking market, at least when it comes to the holdings of bonds by banks in Europe. You have a group of countries which has a smaller home bias in terms of bond holdings, but in all countries except for Finland you actually have an increase of the home bias from 2008 to 2013, including also Croatia, where domestic bond holdings are on the increase. If you look at the government securities as a share of government securities to loans to private sector growth, you can see the same development. In each and every country, you have an increase in banks' exposure toward the domestic government sector. So banks are ever more funding their own government's debt, again, including Croatia. This leads us to the question we are going to talk about more later, which is the exposure of the banks towards the sovereigns or the negative feedback loop between the weak sovereigns and weak banks, and the attempt to break that negative feedback loop with the creation of the banking union. Meanwhile, what is happening with asset quality? Of course, we are talking about the time of crisis, and in a crisis, asset quality deteriorates, non-performing loans increase, making the value adjustment costs decrease very unlikely. There is a clear difference here between the eurozone and the US. In Eurozone, we have a continued increase in non- performing loans while in the United States, you have a tendency of a decrease there. In East-Central Europe, there is a much greater increase in non-performing loans, Croatia being among the countries with the highest level of non-performing loans, after, as we know, basically five years of recession or stagnation in this country. We have still not recovered from recession. If you look at non-performing loans coverage, you can see a startling difference between the US banks and eurozone banks, with the US banks having a much higher coverage ratio than eurozone banks. Here, Croatia is again underperforming compared to the peer group of Central and Eastern European countries. As we explained earlier this year, this was one of the main reasons why we decided on the introduction of the new provisioning rules for domestic banks with the view of increasing provisioning. If we look at the bank performance… I will skip that and go to the slide containing the graphs which compare the same group of countries. We can see that Croatian banks have been doing relatively well despite the crisis in terms of the bank return and not the assets, keeping the relatively high bank return on assets compared to other countries or the group of countries through the crisis, but lately, because of prolonged recession, the worsening of economic conditions has also been draining on the profitability of banks and as the new data on bank profitability gets published, we will see that the economic situation has finally dented into the results of banks, where the fall has been very significant. Again, if you compare the eurozone with the US, we see that bank performance in eurozone remains subdued, while the performance of the US banks has recovered relatively well since 2009. Now, if you look at the bank return on assets, including value adjustment costs, Croatian banks are again looking quite well compared to other banks, and eurozone banks again underperforming compared to the US banks. Capital adequacy ratio is relatively high in Europe if you look at it, but the leverage in Europe is much higher than in the US. One of the problems we are talking about these days is that we are not seeing the leverage in Europe declining in crisis while the leverage in the US banks has declined significantly since the beginning of the crises. Many people are asking themselves when and how the banks in Europe will decrease their leverage. In Croatia, we are doing well in this regard, having the highest capital adequacy ratio in Europe, which, as we know, is a consequence of very tight countercyclical regulatory policies we were running before the crisis, and is in particular due to the capital inflow tax that we had before the crises when we were taxing the borrowing of the banks, or deposit taking of the banks and not taxing the equity, so the banks were to a large extent financing their credit growth from the increase of equity. That has led to the banking sector being highly capitalized once the crisis struck and makes it very resilient to the prolonged recession that we are observing. Leverage in Croatia is again much lower than in the eurozone, Central European countries or even the US banks, but the problem again is really how to lower the leverage of European banks. A few words now on the cost of financial aid by the European Union from 2008 to 2011, for which we have the latest data. As it turns out, this crisis has actually been quite costly. According to the European Commission data, 27 EU members approved around 4.6 trillion euro of financial aid with 1.7 trillion approximately spent until the end of 2011. The UK, Germany, Denmark approved more than 500 billion euro while there was only a handful of countries which didn't provide any help to their banks. Bulgaria, Malta, the Check Republic, Estonia, Romania and Croatia, as the 28th member of the EU. Relative to the 2011 GDP, the highest bank support was provided by Ireland, 328 %, and Denmark, 258 %. It's interesting how Ireland became a very big case. Everybody has been talking about Ireland, and Denmark somehow went under the radar. Unnoticed, nobody is talking about the large banking crisis Denmark has experienced, but it probably has to do with the fact that Denmark did it on its own, without publicizing it and telling the rest of the world what they are doing. However, the cost was really very high. There was a serious banking crisis. Belgium and the Netherlands also had a serious banking crisis, committing more than 50 % of GDP as well. If you look at the structure of the support, it was mostly in the form of guarantees, 27.3 %, and recapitalization, buying trouble assets, liquidity measures amounted to 5, 3.6 and 1.7 % of GDP. So, not negligible, but not high either. This is a graph that depicts the amount of state aid as a yearly average of 2011 GDP. Here we have Belgium, Denmark, Ireland, the Netherlands, Sweden, significant amount, and the UK as well. Here is the brake down according to the types of aid, mostly in the form of guarantees, but also quite a lot of recapitalization. Lithuania and the Baltic states also, banks acquiring trouble assets. Significant risks still remain. The banking crisis is not over. A lot of focus is now centered on the asset quality review of European banks, which will happen next year. What we are seeing is that we have a further continuous increase in non-performing loans across Europe so that trend has pretty much not been stopped yet. The worsening of banks' portfolio dents into any kind of buffers they might still have. The risks which arise from the worsening of the bank asset quality are fiscal risks which might arise from the resolution of NPLs or, in other words, from the potential need for the recapitalization of European banks after the asset quality review, and also from the dampening of the potential growth of banks in the following years. In Croatia, we are on much safer ground with the very high buffers of capital adequacy in the banks. Basically, we will be watching what happens in the countries from which our main eurozone banks are coming into the Croatian market more than being worried about what's happening on the Croatian market itself. This is an interesting graph which shows how capital ratios that are reported at the moment are sensitive to non-performing loans coverage. Here you can see the blue bars which show capital ratios in 2012. The red squares show what capital ratios look like when you deduct uncovered non-performing loans. Here you see that we shouldn't be too worried because Croatia looks relatively healthy, together with the US, Slovakia, Estonia. There is also a number of countries which have capital ratios below five per cent or even close to zero per cent. One wonders, once the asset quality review is completed, how many banks will have to be recapitalized and the main risk lies between the moment that the asset quality review is completed, reports are issued and banks can actually recapitalize. If they are listed banks on the equity market, a lot can happen in between. Another fact is that European banks are still to a large extent reliant on wholesale funding. This is also something everyone expected would change more quickly, than it actually did. If you look at the loan to deposit ratio, you can see it is still much higher in eurozone banks than either in the group of Central and Eastern European banks or the US. You can also see that in the US, the already low loan to deposit ratio has been declining from the beginning of the crisis, while this has not happened in eurozone. Also, if you look at the change of equity to assets, you can see that in eurozone banks, not much has changed. They were unable to increase the ratio of the equity to assets so they remain very much reliant on the whole sale funding, and they increasingly became reliant on the funding with the Central European Bank. That can obviously go on for some time and the ECB can provide funding for the banks. If necessary, unlimited, for a prolonged period of time, but it can't go on forever. At some point, banks should move from to being so exposed towards whole sale funding and the central bank to the market. However, it is not looking like it is going to happen any time soon. Unlike the eurozone, in Central-Eastern Europe, if you break it down, you can see a more logical development of the situation where banks which had a high loan to deposit ratios, in the first place the Baltic banks, adjusted very quickly as the crises started. Loan to deposit ratios came down whereas in the rest of Central and Eastern Europe loan to deposit ratios were not that high, but were adjusted, both in Southeast Europe and Croatia while on the eurozone periphery, if you take them as a subgroup, nothing has actually changed since the beginning of the crisis. They have not been able to reduce loan to deposit ratios. The change in the banks external debt between March 2013 and the beginning of the crisis, the so called leveraging, has also been the function of the initial state of the problem that the banks saw so, basically, the countries that had a higher loan to deposit ratios were those that had to deleverage faster. Croatia, although it has seen a significant deleveraging in the second half of 2012, actually saw an increase in the leverage compared to the beginning of the crisis, if you look at the whole period as such. Every crisis usually leads to some change and as Paul Romer used to say, every crisis is a terrible thing to waste, so Europe has decided to make a bold move towards a banking union. The idea we discussed in Europe a long time ago was to think about the harmonization of the supervision in Europe. We were always aware that the regulatory rules across Europe were different, that even the data we look at in many instances are not comparable and we talked about how to harmonize that. When the crisis struck, we saw that we had to make two or three bold steps, make a whole banking union and forget about harmonizing only supervisory rules. Europe kind of decided to create a banking union, a system which will consist of a supervising mechanism, a single supervisor, which will be the Central European Bank, a single resolution mechanism and a harmonize deposit guarantee scheme, the three pillars based on a common set of rules, the so called single handbook. The reason why Europe has to decidedly move in that direction is that there is a need to break the negative feedback loop between the sovereigns and the banks and this drawing shows the negative feedback loop between the sovereigns and the banks. I am not going to spend too much time on it, but basically, the banks get too exposed toward sovereigns and the sovereign gets downgraded. If a sovereign has a problem that feeds into the problems of banks’ balance sheets, it increases the problems about the solvency of the banks and increases their funding costs, which puts leveraging pressure on them and can then feed into the higher bale out probability for the government. If that happens, the government gets downgraded even more and is considered even more risky, which feeds back again into the bank's problem. The question, now that we have this increased home bias and the exposure of the banks towards the sovereigns and both week sovereigns and weak banks, how to break the negative feedback loop between the two? The banking union is an obvious answer. If not a full one, then a crucial part of the answer to this problem. I don't want to go into too much detail in everything. What is the main advantage of creating the banking union? One reason to create it is to improve the regulatory framework. The idea is to have more effective supervision, which means that if you have a banking union, then you will have an impartial supernational supervisor and it is less likely that the supervisor will be captured either by the interests of the politicians or the industry itself, less likely to turn a blind eye on the problems, less likely to use the forbearance, practices which are generally acceptable and therefore you have a supervisor who will intervene in a more timely fashion than was the case so far with a national supervisor. And that makes sense. It definitely increases the likelihood that you will have an impartial supervisor and a level playing field on the banking market in Europe. The second thing is that you will have a common safety net and the backstops, which is crucial for breaking the negative feedback loop between the sovereigns and the banks because then you will have a supernational fund again to take care of the resolution of the bank once they get into trouble. This is the way to break negative feedback. Thirdly, when you put together more timely supervision and the common backstops at the European level, it will reduce the overall costs of the banking crisis, once it happens in Europe. This sounds very well. One thing that happens in the process is something we discussed even much before and that's the harmonization of the banking regulation and supervisory practices, which should improve the assessment of the true state of the banks’ balance sheets and make the data of the banks that we often use and that you have seen in my presentation more comparable than they are even in this presentation. Once we are able to provide a common set of rules, out of the single rulebook, only then will we be able to put in the same graph the data of banks belonging to different countries, and know that we are comparing apples and apples and not apples and pears, which is unfortunately still the case. So the data you see here should be taken with a grain of salt, knowing that in Europe we are still not applying a common set of rules in banking supervision. That would also lead to less need for cross border cooperation, reduce compliance costs for the banks, which is nice for banks and is something that has become very popular in the last few years, the so called macroprudential policies. The creation of the banking union should ensure that macroprudential policies are consistent and that there is no conflict of interest between different countries applying different sets of macroprudential policies in order to reinforce their own national markets, which is also a worry. The dust around macroprudential policies, which will be at the disposal of national regulators has still not been settled, but we are intensively talking about the type of macroprudential policies that we will be able to use or not use. What are the advantages for non-euro countries like Croatia, countries that are EU member states but are not a member eurozone, countries which have an opt-in possibility, so we can join the euro countries from the beginning or wait and join later? The one that is usually emphasized is fostering financial integration. Whenever I talk to the Commission, they say, they should get in because that fosters financial integration in Europe. I say OK, but what other content can we see there? The second is providing better information across cross-border banks and improving their supervision. Similar to something we have now, i.e. the supervisory colleges. At the moment, we coordinate supervision between home and host supervisors through supervisory colleges, but we as a host are now dealing with a number of national home supervisors. Once there is a banking union, there will be us as the host supervisor and one supervisor pretty much for all eurozone banks, only one home supervisor, which is the Central Bank. We don't know what that will look like. On the one hand, you can hypothesize that dealing with one supervisor is easier than dealing with five, but this one will be different than the five in many aspects, so the costs and benefits, I must honestly say, are at this moment not clear. Of course, there will be great consistency in the supervisory practices, which would avoid the distortions on the single market, but even if we don’t get into the banking union, for us as a non-eurozone country, we would see great consistency in the supervisory practices because we would all be applying a common set of rules created by the EBA. What are the challenges for being a part of the banking union? One is participation in the decision making process. That has been an issue from the start and we have made great progress in that respect. The participation of non-euro states in decision making has improved to such a level that we can say that we are content with the options for non-euro member states. There are all kinds of guarantees for non-euro member states, they can't be outvoted by eurozone member countries, etc. But there are still some restrictions and it is not a completely level playing field. The greatest problem is that the final form of the banking union is still not known. At the moment, we have almost one and a half of the three pillars agreed on the paper, a number of decisions made on what it is going to look like, but we don't actually know what it will look like in the end. To make a decision right now is for us a big leap into the unknown. In particular, we don't know what the future and the revolution of cross border banks will look like, which is a very important issue. There is an agreement now that there is a possibility after opting in to opt out of the banking union, but I would not be happy if you ever had to make such a decision. It is better to make sure before opting in that you know what things are going to look like than to have to make a choice of opting out once you have been in the banking union. That should be avoided at all costs. One thing we are constantly worried about is even connected to the way the banking union is designed as a concept. We still don't have it on paper, we don't have decisions made, but it would tilt the level playing field one way or another. We would be much happier as a non-euro member country if the coverage of the banking union were for all banks, and not just the big banks or the systemic banks. It is clear why. Because even if you have a complete banking union, you would have the majority, in terms of the number of your banks, staying out of the banking union, which is not good. It is not difficult to argue that it is better to have full coverage than to have an uneven playing field for different types of banks, which is determined by their size, nothing else. Other issues include the problem of conveying the message domestically, that there is someone else supervising your banks, you are bearing the cost of the resolution of the banks without having much say about that and you can't use the common backstop nor can you tap the common liquidating facility for the banks. This is a very difficult thing to square in for a non- eurozone member country. Also, if you are in the single supervisory mechanism, that too might reduce the degrees of freedom for your independent use of macroprudential policies and you know how important macroprudential policies have been in this country. We were basically doing most things through macro prudential policies because the usual channels for the transmission of monetary policy, the exchange rate channel and the interest rate channel, don't work here. They are impaired. They don't work to the extent that you need them as a policy maker. That is why we have to rely on macroprudential policies. They serve this very well. Another worry everybody keeps mentioning these days is the lack of supervisory experience so you ask yourself the following. In Croatia, we have a very good supervision of banks and these days everyone is telling us that we did our job perfectly well so why would we surrender our supervision to someone who doesn't have any track record on supervision? You might want to wait and see how that works and then decide whether it works well enough? Some people mention Cyprus, etc., but of course, ECB supervision will be made of experienced supervisors from different countries. Us, as central bankers know what it means to build on central institutions. You can't just bring people. You have to build a whole institution. Even if you have very good people, it takes time for it to start functioning well. Also, there is a possibility of subsidiaries operating so that small states get under the radar of supervision somewhere up there and these subsidiaries are very systemic for our domestic market, so we assume that we would pay much more attention to subsidiaries then a single supervisor tomorrow might. It might not be the case, but this is one of the issues you are thinking about. Having a parent in the banking union might get you some benefits you would have if you were in the banking union, so you don't need to really be in it. This is a timeline and again I am not going to go into too much detail. The real stuff starts at the beginning of 2014 with the asset quality review and EB and ECB stress tests. In a way, for us, it is almost a luxury to be out and wait for that to pass to see how things are going to develop, but of course, we are also very much focused on how that is going to work out, particularly with those 80 % of assets in Croatia being owned by eurozone banks. So we are definitely not indifferent. Except for the single supervisory mechanism resolution scheme, there has been a draft of the recovery resolution directive, which has recently been presented. This removes some of the uncertainty that we have, but even this draft now leaves member states with much discretion, which may lead to competitive distortions the way we look at it. We know that a single supervisor cannot work without a proper resolution scheme. This is probably the most interesting development we will see over the next year or so, where will the single resolution mechanism agreement between the states lead us to. In theory, everyone knows what needs to be done. But as Juncker said before his departure, we all know what to do, but we don't know how to go back home after that and get reelected. That's why we have been dealing with the single resolution scheme for so long. And the deposit guarantee scheme is an even more complicated issue. It is also complicated for technical reasons. You have very different legal practices, very different set ups of deposit schemes in Europe and to put it all together will definitely require much more time. It is possible. You can think of the ways in which this is technically doable, but it is definitely not something that is very easy. There has already been an attempt of harmonization of deposit insurance schemes, but that has been put on hold until the adoption of the EU bank resolution arrangements through new directives, so it is going to be a step at the time. Here is the map showing which countries have an ex-post and an ex-ante deposit insurance schemes in Europe, but in reality, as we know, most of the deposit insurance schemes are ex-post because if you have a real banking crisis like we had in a number of countries over the last four years, then the funds in a deposit insurance company might not be enough to cover all the expenses and ex-ante then turns into ex-post deposit insurance scheme. Here is a comparison of different countries of eligible deposits to GDP. Cover deposits is the blue section of the bars and the deposit guarantee fund compared to GDP. And this is the right hand side, the multiples of GDP and the percentage of GDP so you can see how much is covered with the existing funds. Relatively speaking, Croatia looks well with eligible deposits to GDP 0.86 and cover deposits 0.44 and DGS fund size with 1.21 % of GDP. Compared to other European countries, you see that we have a solid deposit insurance base, but, again, if we are talking about a systemic banking crisis, we are talking about something else. To conclude, setting up the banking union is half way through. It will take much more time for us to see what the end result will look like and in Croatia we definitely support the creation of the banking union, but the stage it is in now, the process of the creation of the banking union is such that it actually increases the status in which you are waiting rather than making a decision. Postponing the decision does not entail high costs while making the decision right now is still a leap into the unknown for which we don't see justified reasons at the moment. Things might change in a few months. I am talking about where we are at the moment thinking about that. What would make the SSM membership more attractive for a non-eurozone member country? Access, of course, access to some kind of resolution funds, where we are also talking about the possibility of BOP assistance to be used in such a way. That is definitely attractive. Or also liquidity assistance that would be available to domestic banks and, of course, once we get to deposit insurance level playing field in the deposit insurance systems. Overall, I usually say, the more complete the banking union is, the more encompassing it is, the more attractive it is for us. The less complete it is, the less attractive it is for the opt-in. That is the conclusion I want to end up with. Thank you.

↑ Na vrh ↑