Nicolas Véron

French Presidential Election: What Comes Next

In this interview by Steve Weisman, I explore some of the implications of the first round of the French presidential election, and challenges especially from a European perspective. 

French Presidential Election: 1st Round Results

On Monday the Peterson Institute published this back-of-the-envelope calculation I made just after the first round of the French presidential election. It suggests that, if (as I believe is relevant) the comparison is made with 2002 rather than 2007, the main feature is stability, to an almost disturbing degree. 

Europe Needs to Drop its Resistance to Non-Bank Credit

This column was published earlier this month by Bruegel and PIIE, as well as the Globe and Mail (Canada), Caixin (China), El Economista (Spain), Les Echos (France), Il Sole 24 Ore (Italy), Dziennik Gazeta Prawna (Poland), Publico (Portugal), and RBC Daily (Russia). 

The financial systems in the United States and Europe have long differed on an important aspect. In Europe, most of the credit flows through the banks. In the US the bank channel is less dominant, and borrowers gain access to capital directly by issuing bonds or through “non-bank” intermediaries that do not take deposits and are not regulated as banks. An oft-quoted measure is that in Europe banks represent more than two-thirds of total credit, whereas in the US the proportion is less than one-third.  In the past few years of crisis, this difference has mattered decisively.  

To begin with, the securitization of residential mortgages in the US went wild in the mid-2000s and was the initial trigger of market turmoil in the summer of 2007. Many continental Europeans have concluded that their bank-based system was less risky or more virtuous. But the subprime securitization debacle, severe as it was, has been one part of a more complex story. Many European banks have made risk-management mistakes just as massive as the reviled originators of US securitization deals. Spanish or Irish banks anticipating a never-ending property boom, or failures such as Dexia in France and Belgium, Hypo Real Estate or WestLB in Germany, or RBS in the UK, are sad reminders that Europeans have no grounds to feel complacent about their own system.

Another less visible point is at least as important. Systemic banking crises are almost inevitably followed by a scaling-back of many credit activities by most banks, a process known as bank deleveraging. In the US, this process has not been traumatic largely thanks to the flexibility and versatility of the system: while banks reduced their exposure, other channels of credit stayed active or expanded, and the credit squeeze was mitigated. By contrast, in many European countries, when banks started applying more restrictive lending standards, there were few substitutes to help even to creditworthy borrowers. Thus, in much of Europe credit provision is impaired, and the situation is likely to worsen further in the near future.

To some extent, governments can intervene to provide incentives via targeted guarantee schemes or to extend credit with direct lending. The UK is creating a Business Finance Partnership to lend to medium-sized enterprises, and both leading French presidential candidates want to create new public banks. But this kind of intervention also entails big drawbacks. Not only are many sovereign balance sheets strained; past experiences of government-directed lending have generally been sobering, as the process tends to be prone to capture by politically-connected special interests, resulting in large misallocations of capital. Therefore, encouraging non-bank credit provided through the private sector should be a major public policy objective.

Unfortunately, in much of Europe and at the EU level, policymakers seem unaware of this need. Instead, the European Commission has frequently appeared to take a punitive approach to non-bank credit channels, particularly in its regulation of investment funds and its latest project to regulate credit rating agencies, which play an enabling role in corporate bond issuance. The Commission also wants to tighten the regulatory screws on “shadow banking,” which the Financial Stability Board has defined as “the system of credit intermediation that involves entities and activities outside the regular banking system.” Some aspects of shadow banking, including securitization but also other types of entities or transactions, can contribute to systemic risk. But that risk does not justify repressing shadow banking in general. Some segments need to be regulated through rules of business conduct rather than of capital or liquidity. Other segments simply need better transparency and monitoring.  In some cases, existing regulations should be dismantled: it makes no  sense, for example, for several EU countries to prohibit leasing services offered by non-banks.

Making the transition from a bank-dominated system to a more diverse one in which non-bank credit plays a bigger role is difficult. Issuing bonds or other fixed-income securities requires high standards of financial disclosure, which is resisted by the culture of many medium-sized companies or banks in a number of European countries. Legal and regulatory differences across borders inside the EU also do not help because they contribute to fragmentation of some financial market segments.

But such legacies must be overcome if the goal is to minimize the risk of credit crunches in large parts of Europe, particularly the struggling southern Eurozone periphery. Incumbent banks are skillful at opposing diversification of credit channels as unfair or dangerous, but their lobbying should be seen as merely self-serving. After all, the financial crisis has been primarily a banking problem, and private equity or hedge funds have been proven to pose less systemic risk than was feared before 2007. The majority of European policymakers who still see finance and financial regulation through the prism of traditional banks need to expand their horizon, so that non-bank credit channels stop being unduly repressed. This is not about financial doctrine, but about long-term growth and jobs. 

 

Banking Union or Financial Repression? Europe Has Not Chosen Yet

This post is also on the Bruegel Blog and on PIIE Real Time, and was later published by Vox. 

European policymakers, particularly on the continent, have long appeared to be in denial over the systemic banking fragility that is central to the region's problems. They have first denied the existence of a homegrown banking problem, by shifting all the blame to Anglo-Saxons in 2007-09; then by engaging in timid, less-than-credible stress tests while redirecting the blame at the Greek government and other lousy fiscal managers in the European South. The October 2011 “recapitalization plan” was in effect another episode of denial, for various reasons: it was based on an unreliable capital assessment; and it assumed full fair value on sovereign debt, in violation of any prudential principles. It also relied on overly volatile debt prices, a dubious basis for capital assessments even at amortized cost, given the huge uncertainties about the Eurozone’s future fiscal framework. The ECB then had little choice but to provide Europe’s entire banking system with an expanded lifeline of long-term liquidity, as it did in December to great effect with the three-year LTRO.

In this sorry context, it is good news that a more lively debate seems to have emergde these days over the need for a European Banking Union as a necessary complement to a Eurozone Fiscal Union, as the FT recently reported. My Peterson Institute colleague Jacob Kirkegaard has a highly optimistic take on this and sees the emergence of an integrated European banking policy in the making.

I believe this view is overly bullish. There is widespread agreement among economists, and European and international technocrats, that Europe’s single financial market and monetary union cannot survive long-term without a banking union. Many observers had defended this view since before the crisis started (me included), and the International Monetary Fund articulated it more specifically in a landmark contribution in April 2010, which the then Managing Director endorsed in a speech in Brussels. But the obstacles are political, not analytical, and they have not disappeared at all.

Put simply, Europe’s leaders are not ready to create a truly meaningful federal framework for banking policy because a critical mass of countries see banks as a core instrument of national policy. Financial repression is back from the history books, arguably even more so in the Eurozone than in other so-called advanced economies. The catch is that a true banking union – which I define as the creation of a federal framework for banking policy, including not only regulation but also deposit insurance, supervision and resolution at least for transnational banks – would deprive national governments of many of their levers for financial repression. Therefore the two propositions are to a large extent mutually exclusive – and this is without mentioning other political considerations, from strong local links between banking and political establishments (e.g. Germany or Spain) to economic nationalism (e.g. France), that create huge political resistances to the very notion of a banking union.

An additional obstacle, not to be underestimated, is the discrepancy between the Eurozone and the 27-member European Union. A Eurozone-only banking union would be very difficult to square with the vision of a single EU market for financial services. Meanwhile, the European Banking Authority, created in 2011, happens to be located in London. But the UK is not ready to federalize decisions on banking supervision and resolution, partly because its big banks’ international activities are outside Europe rather than on the continent (see Figure 5 of this). There is no easy answer to this challenge, particularly because nobody knows what direction the UK will take vis-à-vis the EU over the medium term. Even policymakers who forcefully advocate the vision of a banking union, as the ECB’s Benoit Coeuré did in a recent speech, stop short of specifying whether they have a Eurozone or EU27 framework in mind. Senior policymakers acknowledge in private that this is a huge practical obstacle to progress on the way to banking union, and it is not likely to be resolved any time soon.

Ultimately, monetary union cannot be sustainable without fiscal union and banking union, and these will not themselves be sustainable without a form of political union (I tried to analyze this interdependency in my testimony to the US Senate last September). But my hunch is that there is a sequence here: we had monetary union first, we’ll (possibly) have fiscal union next, and (if at all) banking union last. Contrary to many people’s intuitive perception, it is politically easier for a nation to renounce its own currency and even its fiscal sovereignty than its control on banks. The US history is not directly comparable but suggests the same sequence, as a truly integrated national banking market did not emerge there until the second half of the 20^th century. The apparent new emphasis on banking union in Europe’s policy debate must be welcomed, but we’re still a very, very long way from the endgame.