Balancing Act


3 May 2011


European banks will generally become more resilient, thanks to the new regulatory framework put in place at global level. Guido Ravoet, chief executive of the European Banking Federation (EBF), however, writes that policy makers must strike the right balance between stability and economic recovery, and the banking sector has a key role to play.


Banks have started implementing the various measures designed to create a new regulatory framework, the aim of which is eventually to induce greater resilience in the banking sector and prevent future crises. This all-encompassing approach requires the global playing field to be level if it is to be efficient. All jurisdictions, including developing countries, should implement the new regulation at the same time and in equivalent scope.


Among these regulatory measures, the most crucial ones, with a global impact, are those proposed by the Basel Committee for Banking Supervision, which revise the Basel II rules. The importance of this is such that they may have an impact on the economy as a whole, and not just in Europe.


The European Banking Federation considers it vital that no one country is at an advantage when implementing Basel III. The challenges the Basel III obligations present for many banks are significant; before raising the requirements in Europe or in individual countries, whether in capital or liquidity, the focus should be put on raising all European banks to the proposed common minimum.

We believe that is a prerequisite for stress tests and analyses to show valid results, and to ensure an optimal level for stability going forward. We should not forget that the strength of the weakest bank determines the stability of the system, and for that reason stress testing is a valuable tool for supervisors as part of their ongoing supervision of a bank. Such tests should use harmonised rules that are already agreed upon and in force to assess the strength of an individual institution on a dynamic and ongoing basis.


The new regulatory regime will also require successful and effective cooperation between national supervisory authorities and the new European ones - the European Systemic Risk Board and the European Banking Authority. National measures and divergence in implementation of new regulations should not be allowed if we are to maintain a fair, competitive environment, both within Europe and globally. Attention and effort should focus on improving supervision, particularly at European level. The European banking sector has high expectations of the new supervisory bodies; they should pave the way to a sounder, consistent supervision across the EU.


From the point of view of crisis prevention and management, the European Banking Federation generally endorses the objectives put forward by the European Commission. It is understood that there is no full insurance against any future crises because they generally stem from a series of interlinked events and causes. But we believe that it is possible to minimise their probability and reduce their impact. Here again, only a level playing field will ensure harmonious management of future alerts and a synchronised answer to problems.

Systemic risk

Taxpayers should not be forced to carry the burden of banking crises or bail out failing financial institutions. We live in a market economy and as market operators, banks must be able to fail. In fact, no bank should be too big to fail, which is why with an effective crisis management framework, competition and efficiency-harming suggestions - such as special rules around systemically important financial institutions - will become less meaningful and most likely unnecessary.


Every market participant, large or small, bank or non-bank, contributes to systemic risk, which is dynamic in nature. Too great a focus on enhancing loss-absorbing capital and creating lists of systemically important financial institutions may result in insufficient attention being paid to other sources of risk. Furthermore, the methodology used to determine the systemic importance of a financial institution could be used to differentiate their treatment without reverting to fixed lists. A much sounder approach would be to enable an economically integrated Europe to agree on cross-border recovery and resolution issues.


Systemic risk should therefore be dealt with through initiatives to improve the functioning of the financial markets, to reinforce micro and macro-supervision, and to implement robust crisis prevention.


A blanket increase in capital requirements for banks deemed systemically important is not the solution. Numerous initiatives to improve the resilience of the banking system already exist, such as tier I capital, contingent capital, bail-in debt instruments, and recovery and resolution regimes. We should be able to substitute these in place of a blanket increase. Furthermore, it is crucial to time their introduction accurately in order to avoid constraints on banks' ability to lend.

Impactful measures

European banks have expressed concern that the impact of the whole range of measures - adopted and proposed - could have adverse consequences on financing in European economies; this can be explained because of their multiplicity, their cumulative overall effect and, more generally, market expectations.


With this in mind, we would like to cooperate with the authorities on a collective approach, particularly during the observation periods provided in Basel III, so that measures can be adapted where necessary. This would likely be the most productive way to ensure that the interaction between the different pieces of legislation in progress is understood, that coordination is achieved, duplication prevented and that the impact on the economies is minimised.


When implementing the new global standards, several key principles have to be observed in addition to the aforementioned level playing field: the preservation of banks' lending capacity in the EU; the necessary consistency in the regulations (towards a single rulebook); the maintenance of the competitive edge of the banking sector, notably the ability to raise new capital; and the possibility of generating attractive dividends for investors.

Basel III proposals on liquidity

The final Basel III package, published in December 2010, has taken on board some of the concerns of the industry, but important pending issues remain. Among these, the Basel III proposals on liquidity are of particular concern. The European Banking Federation firmly believes that further work is still needed and that an appropriate regulatory framework has not yet been created. For one thing, the definition of liquid assets is far too narrow: covered bonds should be recognised as highly liquid assets, for example, but in the US they are out of the Basel III scope.


There are also a number of uncertainties about the consequences of the changes, and because of them, the observation period outlined in the liquidity proposal should not be used merely to examine if individual banks are resilient to liquidity risk; it should also be used to find out how the new requirements are influencing the financing of the economy. It is crucial for the authorities to be able to pause and review the rules during the process, and amend the proposed metrics should experience gained from standardised reporting during the observation period show it to be necessary.


European banks have recapitalised substantially during the past two years in their search for further robustness, partly as a reaction to market requirements. Capital requirements were meant to add stability to the banking sector, and they generally have. But the requirements, as well as overall measures, should not hamper the development of traditional banking business and the economic recovery.

Trade finance

Another cause for concern that has already been widely acknowledged by experts is the potential negative impact of the overall proposals for trade and export finance, and therefore for employment and the world economy. The new capital standards, as finalised in the December 2010 documents of the Bank for International Settlement, put at risk the availability of short-term trade finance, as well as medium-term and long-term export credit. This would threaten international trade, as well as the economies of emerging markets, which rely heavily on trade finance as an alternative to revolving bank loans, running counter to the G20 goals for economic recovery.


Medium-term and long-term export credit provides borrowers with a stable source of funding; this is important at times of market turbulence, because it is backed in large part by an export credit agency. Moreover, export credits covered by such agencies are often the only feasible way of conducting business in emerging and developing countries, since private sector companies do not provide finance in these regions.


The European Banking Federation - the members of which are active as lenders, financial intermediaries and advisers - can offer an assessment of conditions in the market for medium-term and long-term export credit. Policy makers should adapt the relevant Basel Committee proposals on the basis of three key recommendations:

  • to fully evaluate the effects of the leverage ratio on the availability of trade and export finance
  • to recognise the normal liquidity profile of export credits (cash inflows/repayments and undrawn portion)
  • to achieve a global level playing field in the implementation of Basel III, by harmonising provisions that allow export credits to be eligible at the refinancing windows of central banks.

The European banking sector is facing a time when the right balance needs to be struck between stability and measured risk, between regulation and free market. It is also a time when we can help to devise the framework in which we will be working in the future. They are no minor challenges, and we need to meet them together, as an industry, but also in cooperation with policy makers.