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Thorsten BeckSupranational regulation how much and for whom?

Increase in cross-border banking over time

Source: Claessens and van Horen (2013)Percentage of foreign banks among all banks in 20093/20Source: Claessens and Van Horen (2013)

Merger activity becoming international

Source: Buch and de Long (2010)Desirable Cross-Border BankingA healthy amount of cross-border banking is likely to be beneficialDiversification benefits for domestic banksDiversification benefits for domestic borrowersBut: higher volatility of flowsBut: contagion costs

Desirable Cross-Border BankingHealthy balance of in- and outflows of countryProper diversification of in- and outflows=> Resilience to domestic and foreign shocksNeed for regulation!Shift benefit-cost balanceExternal costs of bank failure beyond national bordersWhy regulate cross-border banking?Failure of cross-border bank imposes costs on foreign stakeholders that are not taken into account by home country supervisorContagion effects through common asset exposures, fire sale externalities, informational contagion, interbank exposures etc.Within-in monetary union: additional externalitiesClose link between monetary and financial stabilityLack of exchange rate tool exacerbates impact of asymmetric shockCommon lender of last resort leads to tragedy of commons problemBiased supervisory incentives to intervene in cross-border banksBeck, Todorov and Wagner (2013)Supervisor maximizes benefits to domestic stakeholders (equity holders, depositors and borrowers) when deciding to intervene into weak bank or notCross-border activity introduces distortionsForeign equity: earlier interventionForeign assets and deposits: delayed interventionTotal effects depends on mix Supra-national supervisor can help ifInformation as good as on national levelNo higher costs of resolutionMatch between geographic perimeter of bank and supervisor

Biased supervisory incentives to intervene in cross-border banksCDS spreads of large (mostly cross-border) banks three days before intervention during 2008/9 crisis; Source: Beck, Todorov and Wagner (2013)

Externalities through financial integrationContagion effects through common asset exposures, fire sale externalities, informational contagion, interbank exposures etc.Does not depend on direct cross-border engagements by banks and on bank-level not even on direct exposures to international marketsMore prominently as banks move towards market financebut one size does not fit allDifferences in legal systemsDifferences in preferencesOn government interventionOn fiscal independenceOn return-risk trade-offInformational asymmetriesSmall host country with market-dominating foreign subsidiary (e.g., Uganda) vs. large home country for whom foreign subsidiary does not matter (e.g., UK)ExternalitiesHeterogeneityJoint regulatory and supervisory authorityStrong ex-ante agreements on resolution and burden-sharingAsymmetric home-host country interests: stand-alone subsidiariesSupervisory colleges, MoUsBroader cooperation among stakeholders; regulatory convergenceCloser cooperation, especially on G-SIFIs, regulatory convergence12Need for cross-border bank regulation varies across regions/country pairsLow externalities, high heterogeneity: Memorandum of Understanding, Colleges of SupervisorsIndia,. Low share of cross-border banking, closed financial systemsLow externalities, low heterogeneity: move towards extended versions of MoUs and collegesEast Africa: joint historic backgroundHigh externalities, high heterogeneityUS/Europe/Japan Europe/UKFocus on G-SIFIs, coordination on market supportHigh externalities, asymmetric interestsStand-alone subsidiariesLatin America, Sub-Saharan Africa vis-a-vis European/US banksHigh externalities, low heterogeneity move towards closer cooperation: extended versions of MoUs and colleges; ex-ante burden-sharing agreementsNordic-BalticBanking unionExternalitiesHeterogeneityJoint regulatory and supervisory authorityStrong ex-ante agreements on resolution and burden-sharingAsymmetric home-host country interests: stand-alone subsidiariesSupervisory colleges, MoUsBroader cooperation among stakeholders; regulatory convergenceCloser cooperation, especially on G-SIFIs, regulatory convergence14

Banking Union the new kid on the blockCrisis development can be followed via buzz wordsRemember fiscal compact, growth compact, big bazooka? LTRO, OMTBanking union the latest buzz wordBut what kind of banking union? For whom? Financed how? And managed by whom?15 short columns by 20 economistsSurprising consensus even if contrasts on detailsThe main messagesNo piecemeal approach! Centralizing supervision alone is not only unhelpful but might make things worse!A banking union is part of a larger reform package that has to address sovereign fragility and the entanglement of banks with sovereigns.Immediate crisis resolution vs. long-term reformsNo piecemeal approachCentralizing supervision alone, while leaving bank resolution and recapitalization at the national level, is not only unhelpful but might make things worseSupervision without consequencesWalking zombies that cannot be resolvedCannot solve vicious cycle between bank and sovereign fragilityBanking union for all financial institutions, not just large institutionsMonetary and financial stability linked through systemic channels, not just large institutions

Part of larger reform effortNeed to address sovereign fragility as wellEuropean Redemption Pact Need to cut link between bank and sovereign fragility that has caused downward economic spiral in several periphery countriesAdjustments in regulatory framework for sovereign debt holdingsAdjust capital charges and liquidity requirementsConcentration limitsSovereign insolvency regimeImmediate crisis resolution vs. long-term reformsStatus quo: short-term fixes with enormous pressure and burden on ECB and piece-meal approach to long-term reformBUT: Urgent need to address banking and sovereign fragility transitional solutionsSuggestion: European Recapitalization AuthorityBanking union takes longer time to build necessary institutional frameworkDont mix crisis resolution with long-term reformsIntroducing insurance after the accidentDistributional fightsPolitical sensitivity

How can a banking union help?Address macro-economic imbalances, exacerbated by national regulation and supervision of Europe-wide banking groupsRisk diversificationTackle bank fragility in several periphery countriesOvercome regulatory and political captureWill ECB be really a more stringent supervisor?Help address Eurozones Tragedy of Commons problemInterest of every member government with fragile banks to share the burden with the other members, be it through the ECBs liquidity support or the TARGET2 systemthe ECB and the Eurosystem are being used to apply short-term palliatives that deepen distributional problems and make the crisis resolution ultimately more difficult

Banking union for whomDegree of regulatory integration is a function of externalitiesCross-border flows coordinationCross-border SIFIs joint framework, CoS, MoUsCurrency union specific externalitiesLink of financial and monetary stabilityLender of last resortBurden-sharing tragedy of commonsWhat does mean for Europe:Full-fledged banking union for Eurozone, for all institutionsMore institution-focused coordination and cooperation for non-Euro countriesExample: Nordic-Baltic MOUAlternative options: associate members of Single Supervisory MechanismLooking west learning from U.S. historyUS history suggests large gains from buffering currency unions with a union-wide deposit insurance, and partial debt mutualisationBut it is a long process: 12 systemic banking crises over 200 years, lots of failed deposit insurance schemes and lots of institutional experimentation, even after introduction of FDICIts all about politicsEurozone crisis is a governance crisis! Different narratives about Eurocrisis according to creditor/debtor statusNo one to represent interest of EurozoneIncreasing lack of political legitimacy and sustainabilityA banking union can therefore only succeed with the necessary electoral support to not get further caught in a legitimacy vortex.

In a nutshellCurrency union without banking union not sustainableTwo-pronged approach to crisis resolution and building up banking unionThere are lots of advantages of a well-designed banking union, there are lots of risks in a poorly designed banking unionThorsten Beckwww.thorstenbeck.comThank you