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Banking Union: update on supervisory issues - Resilience of the EU financial sector in the global context

The new EU framework for financial stability: where do we stand?

By Signorini Luigi Federico - Deputy Governor and Member of the Governing Board, Banca d'Italia

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Substantial progress has been made in addressing the sovereign-bank nexus. The EU fiscal and economic governance is now stronger, with a better coordination of policies. A sound long-term outlook for public finances is a prerequisite for stability. A sovereign crisis management system has been established. Euro area banks are subject to the Single Supervisory Mechanism, backed by a common supervisory framework informed by best practices. The Single Resolution Mechanism and the new European rules on bank recovery and resolution are now fully in place. Uniform rules, a single resolution authority and common resources to fund resolution should contribute to avoid fragmentation and decouple a bank’s assessment from the strength of its sovereign.

However, evidence from the markets seems to suggest that the sovereign-banks link has not completely come to an end. In this regard, the credibility of resolution arrangements and a complete Banking Union are key ingredients to promote full financial integration in the euro area. To this end, further steps are needed.

First, to convince investors on the adequacy of the resolution arrangements in the Eurozone and to complement the Single Resolution Fund, a common European backstop needs to be rapidly designed and implemented. This could be done through a credit line from the European Stability Mechanism to the SRF, as indicated by the Five Presidents Report.

Second, a common deposit guarantee scheme is needed to preserve confidence in the banking sector, reduce the risks of runs and further support level playing field, thus increasing the resilience of the whole euro area. The Commission’s proposal on a European Deposit Insurance System is a welcome step in this direction.

The credibility of resolution arrangements and a complete Banking Union are key.

Third, we need to reflect on the capability of the new resolution framework to ensure that banks can fail without adverse consequences on financial stability in any circumstances. A review of the European bail-in approach to ensure consistency with the TLAC framework for G-SIBs should be considered to make the tool more credible and feasible. By June 2018 the Commission is expected to present a legislative proposal to review the BRRD; it would be appropriate to take advantage of this opportunity, building on the experience of application of the directive. Furthermore, the EU framework does not provide for effective tools to safeguard financial stability when the application of the resolution rules would exacerbate rather than alleviate systemic risk; a balance should be found between the need to minimise moral hazard and protect the taxpayer on the one hand, and the need to avoid instability in the banking sector on the other.

Finally, in order to break the vicious circle between sovereign and bank risk once and for all, the stabilising potential of the ESM’s direct bank recapitalisation instrument should be fully exploited; a review of the conditions for its use should be considered.