By Mojmír Hampl and Vladimír Tomšík (Financial Times 19.7.2011, p. 8)
The European Union’s stress tests are designed to restore investor confidence in a battered banking sector, but they are not without a flaw. They assess the resilience of European banking groups to adverse shocks on a consolidated, cross-border basis and shed little light on the health of individual members, treating a group as a single bank. The catch is that there is no such thing as a pan-European purse to foot the bill for a bank failure. Several EU nations learned their lesson hard during the financial turmoil that it falls on an individual nation’s taxpayer to provide the money to keep a bank afloat if need be. Our concerns go beyond the current stress tests.
George Soros once drew a parallel between a large bank and an oil tanker. If the tankers are not divided into smaller tanks inside, eventually the crude oil will cause the tanker to capsize in a storm. By analogy, if liquidity, assets and liabilities flow freely within a large bank or group of banks, they can capsize it when financial turmoil strikes. Some of the most recent EU directive proposals on bank recovery and resolution involve intra-group financial support within cross-border groups. We believe they may unintentionally put a large cross-border EU group at risk of sinking when the next financial storm hits. Let’s imagine a large cross-border financial group as a tanker divided into smaller tanks. If group members conduct transactions only under standard market conditions and behave independently, the “financial tanker” will perform as if it is split into isolated boxes. But if assets and liquidity can flow with absolute freedom within the group, the separation between its parts ceases to exist. In reality, relations between group members will probably be somewhere between these extremes. The point is, though, that intra-group support weakens the isolation of the “boxes” into which the financial tanker is divided. Provisions allowing for larger spills between the “boxes” when the storm hits will make the group only more interconnected, and thus vulnerable.
We believe intra-group support should be treated as an exception and, above all, that responsibility should not be separated from decision-making. Under the EU proposals, the European Banking Authority, which conducted the stress tests, would serve as a mediator and potential decision-maker to break a stalemate between national supervisors. That is plainly wrong, and we are certain our concerns are shared by supervisors in other EU countries that host subsidiaries of multinational banking groups. No mediator – be it the EBA or some other supranational agency – should have the last word in a disagreement between national supervisors. It is the national supervisor, not a supranational mediator, who would be held responsible for the losses.
In a nutshell, treating banks in the EU as pan-European entities rather than a sum of national parts risks amplifying the too-big-to-fail problem and creating more systemically important financial institutions and even greater moral hazard in the EU than before. We are playing with fire, since it is (and should remain) the national taxpayer who picks up the bill when something goes wrong.
Is this a little far-fetched? Not a bit. Many will remember the Icesave case, where savers in the UK and the Netherlands deposited their money in a branch of an Icelandic bank under the rules of the single market. Few of them seem to have suspected that payment of their insured deposits in the event of a crisis was guaranteed by Iceland, not by their home countries. When it turned out that Iceland could not, or would not, pay up, the home countries paid their savers for political reasons only, outside European rules.
Free movement of assets and liquidity among members of a financial group without the consent of the host supervisor could end in tears. Savers in one country may find out in bad times that their deposits are not covered by worthwhile assets and liquidity, as these have already been used to help the parent bank or other members of a pan-European financial conglomerate. This increases the risk of contagion between financial systems in the EU and accelerates that contagion. Moreover, we are creating a risk of multiple repetitions of cases such as Icesave, with national taxpayers bailing out their nation’s savers outside the agreed rules. This is hardly a basis for a safer, more robust and more resilient financial universe in years to come.