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Financing of the EU economy - Fragmentation risks in the EU and potential impacts

Coping with the challenge of fragmentation

By Wieser Thomas - Chairman of the Eurogroup Working Group and the Economic and Financial Committee, Council of the European Union

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Europe has been facing the urgency of adapting to a constantly changing environment for quite some time. In the past few years, new policy frameworks and institutions in the economic and financial area have been set up with unprecedented speed. On the other hand, the recent agreement on the so-called new settlement for the United Kingdom in the EU has openly acknowledged the obvious: even in the long run, not all EU members will join the Economic and Monetary Union (EMU), while they will remain active and indispensable members of the Single Market. Furthermore, continued integration in the euro area should not undermine the Single Market, and non-euro area countries should not impede a deeper EMU.

Are these objectives contradictory? Not necessarily – the key is to find the right balance: the degree of diversity that still allows us to reap the benefits of the Single Market and the single currency. Take the banking union, for example. The EU-28 share the same rules on capital requirements for financial institutions, their recovery and resolution, and deposit guarantees – the single rulebook. The implementation of these rules is in the hands of the relevant national authorities. For the 19 euro area countries bank supervision and resolution is centralised, whereby the Single Supervisory Mechanism and the Single Resolution Board cooperate with the relevant national authorities. Other EU countries can join the banking union without having to give up their national currency. Here we come to the question of ensuring a level playing field across all member states: all financial institutions, regardless of where they are located, should be treated in the same way. It is clearly a challenge shared by the EU-28 rather than an issue between euro “ins” and “outs”.

And there is still a lot of work to be done. On capital requirements alone, there are well over hundred national options and discretions. About a quarter of these were granted to member states, the rest to supervisory authorities. Some of them are transitional and will be phased out in years to come; others are being analysed to see whether and how a higher degree of convergence can be achieved. Naturally, these options and discretions have been granted for a reason. There are still a lot of specificities in individual countries regarding the structure and functioning of their financial systems. Harmonisation for harmonisation’s sake cannot be the objective; we are trying to strike the right balance between respecting national specificities and ensuring a well-functioning, resilient and integrated banking sector across the EU. It is a work in progress and cannot be achieved in one day, but it is clearly a priority.

The right balance: the degree of diversity that still allows us to reap the benefits of the Single Market and the single currency.

The formulation and adoption of the current framework has been marked by the urgency stemming from an acute financial crisis. Although the framework was underpinned by impact assessments, its actual effect on the banks and the economy is not static and must be continuously monitored and analysed, especially in areas where there is a lack of historic data. While this is an ongoing process, the intention is not to overturn the framework so recently adopted, nor to constantly add more rules, but rather to establish whether any unintentional long-term negative effects have arisen and to correct them if necessary. The authorities must continue to implement the existing regulatory framework rigorously and consistently. Banks, on the other hand, will have to adapt their business models to the changed legal and institutional landscape and complete the process of cleaning up their balance sheets by reducing their (generally still excessive) levels of non-performing loans.

The experience of recent years can also teach us a lesson: cross-border flows flourish in good times, but in a crisis there is a tendency to turn inwards. For the first decade after the euro was introduced, cross-country capital flows in the EMU steadily increased. During the global financial crisis and the euro area sovereign debt crisis this gradual process of integration was substantially reversed, and the pricing of risk became much more dependent on the country of origin. Cross-border activities have started picking up again only since 2012, albeit at varying speeds in individual market segments and countries. Thus, the risk of fragmentation will remain unless we ensure a stable macroeconomic environment, and that is only possible with the right mix of sustainable, growth-enhancing fiscal policies, structural reforms and investment.