euro zone ...Bank Reform

ECB's Draghi Calls for Bank Reform

 May 31, 2012 

By MARGIT FEHER

BRUSSELS—European Central Bank President Mario Draghi called on European politicians to come up with a vision for the euro zone for the years ahead to better tackle the region's debt crisis and to restore confidence, suggesting that a centralization of financial-sector regulation should be the first step.

"The sooner the vision is clarified the better for the European Union," Mr. Draghi said Thursday at a hearing in front of the European Parliament's Committee of Monetary and Financial Affairs.

Coming forward with a vision for the euro would restore confidence in the euro zone and be the best means to boost sagging economic growth, Mr. Draghi said.

As the first possible step for a more unified euro zone, Mr. Draghi called for "a banking union," entailing a euro-zone level fund for resolving failed banks, a euro-zone level deposit insurance guarantee scheme, and banking-sector supervision that is more centralized on a European level.

The banking resolution fund shouldn't use taxpayer money to bail out banks, Mr. Draghi said. Most EU countries already have deposit-insurance schemes that are funded by their respective banking systems, and some policy makers have suggested that an EU deposit-insurance scheme would only need to coordinate such national ones, rather than ask for extra funds.

Mr. Draghi said bailouts for Bankia in Spain, and before that Dexia in Belgium, showed that national regulators were reluctant to admit the extent of troubles at home. That only has the effect of raising the end costs of rescuing the banks and undermining trust and transparency, he said.

"What Dexia shows — and Bankia shows as well — is that whenever we are confronted with the dramatic need to recapitalize, if you look back, the reaction of the national supervisors... is to underestimate the problem, then come out with a first assessment, a second, a third, fourth," he said.

"That is the worst possible way of doing things, because everybody ends up doing the right thing but at the highest possible cost and price."

ECB Vice President Vitor Constancio recently said that the euro zone could also look at the U.S. as an example for how bank insolvencies are tackled there when establishing a banking resolution body.

Mr. Draghi also argued that the euro-zone's permanent rescue fund, the European Stability Mechanism, could be used to recapitalize banks, on the basis of a "memorandum of understanding".

Under its charter, the ESM is only allowed to lend to governments. That makes it impossible for many governments to recapitalize their countries' banks without putting unbearable stress on their own public finances.

Against such a backdrop, Mr. Draghi noted that governments tend to underestimate recapitalization needs and hinted that they were also reluctant to come clean about them, noting that transparency about recapitalization is crucial.

The issue is particularly acute in Spain, where the government earlier this month was forced to come to the aid of BankiaSA, BKIA.MC +0.48% the country's third largest lender by assets, which faces much bigger recapitalization needs than previously thought.

Pressure has been mounting for a change in the ESM treaty that would allow it to inject capital directly into banks, breaking the direct link with sovereign finances. But so far, the conditions that would need to be attached to such assistance haven't been spelled out, and Mr. Draghi also avoided that subject Thursday.

Mr. Draghi was speaking in his capacity as chairman of the European Systemic Risk Board, rather than as ECB President. He noted, however, that the ECB has carried out numerous steps in a very short time to tackle the crisis and now the ball is in the governments' court. He repeated his familiar message that the ECB can't compensate for the absence of fiscal discipline or the political will for necessary structural reform.

As for ECB action, "the ECB will continue lending to solvent banks and we will keep the liquidity lines active and alive with solvent banks," Mr. Draghi said.

The four Greek banks that were cut off from access to ECB operations recently have been recapitalized and have now regained access to the central bank's monetary policy operations, he said.

In his opening remarks, Mr. Draghi warned again about the emergence of new risks in the financial system as certain lending activities migrate away from banks to other, less regulated parts of the system, although he noted that "such developments can, in principle, be of benefit to the system."

He also warned about the increasing tendency for banks to rely on secured funding in short-term markets, as opposed to unsecured funding, which he said might dangerously reduce the flexibility of banks' operations.

"If taken too far, insufficient amounts of unencumbered bank assets in the future could reduce the stability of funding within the system and, in a self-fulfilling manner, reinforce the lack of access to private unsecured markets today," Mr. Draghi said.