Mayra RodrÃguez Valladares is managing principal at MRV Associates, a New York-based capital markets and financial regulatory consulting and training firm. She is also a faculty member at Financial Markets World.
It is often challenging enough to appreciate the political horse-trading surrounding the creation of United States bank regulations. We could certainly be forgiven for not understanding the political nuances of how the 28 member states of the European Union are creating new banking regulatory bodies.
Yet a last-minute compromise last week to create a so-called Single Resolution Mechanism, a central authority to resolve a bank failure in Europe, will have lasting consequences not only for European taxpayers, but also for Americans.
According to the Bank for International Settlements, globally systemically important banks in the United States have billions of dollars in exposures to European banks. Moreover, a significant portion of American banks’ derivatives portfolios are often booked in Europe for hedging, tax or regulatory capital purposes. Not captured in the data is that the majority of the foreign subsidiaries and branches of those American banks are in Europe. Given the interconnectedness of American and European banks, Europe’s ability to create a credible Single Resolution Mechanism that can resolve a bank failure in an orderly manner is an important step in strengthening the global banking sector.
José Manuel Barroso, president of the European Commission, was pleased with the agreement, because having that resolution system is an important pillar in constructing Europe’s nascent banking union, which as of this fall will also include centralized supervision of 130 European banks, about 85 percent of banking assets, by the European Central Bank.
If the European Commission’s proposal for the Single Resolution Mechanism is adopted jointly by the European Parliament and the member states in the European Council in April, the system would begin on Jan. 1, 2015. In speaking about the political agreement, the Internal Market and Services commissioner, Michel Barnier, stated that “the Single Resolution Mechanism might not be a perfect construction, but it will allow for the timely and effective resolution of a cross-border bank in the euro zone thus meeting its principal objective.â€
Unfortunately, the mechanism is in its infancy, and like any infant, there are bound to be many stumbles before it can walk, not to mention run on its own. Not only does the system not begin until next year, a centralized banking union is a relatively new idea in Europe, compared with the United States. Europe has a new equivalent to the United States Federal Deposit Insurance Corporation, the European Banking Authority. Moreover, the mechanism is insufficiently funded at 55 billion euros. And it remains unclear how resolution powers might be split among the European Central Bank, the Single Resolution Mechanism, the European Commission and the governments of the individual European countries.
One of the greatest challenges in resolving an ailing American banking giant lies not in the United States, but across the Atlantic, where federal bankruptcy laws and bank resolution expertise do not apply. Despite working closely with European regulators, there are limits to what the F.D.I.C. can influence overseas.
Until the Single Resolution Mechanism is functional and well funded, the responsibility to resolve or bail out a failing European bank still lies with the national authority where the bank has its headquarters. Given the lingering effects of the global and euro-zone financial crises, most sovereign states in Europe, especially those in the periphery like Spain and Greece, would struggle to be able to rescue any of their banks. Because European banks have subsidiaries and branches in the United States, the F.D.I.C. would be saddled with resolving those entities here.
Also, if any American banks failed, their legal entities in Europe would be resolved according to European bankruptcy laws, not American ones. If an American bank were to fail, it is unclear how the European Central Bank and the individual member states would work with the F.D.I.C. The last thing we want is for European regulators to fence off the assets of our entities abroad, which might impede liquidity coming to our shores or worsen a financial panic.
Along with waiting for Europeans to resolve their political challenges in creating a banking union, it behooves United States banks and regulators to be aware that Europe’s public and private sectors remain heavily indebted, especially in the periphery countries, which slows down the anemic European recovery. European banks are exposed to overly indebted companies and households. Additionally, the unfolding sanctions against Russian individuals and companies will adversely affect many European companies and banks. And European banks continue to have high exposure to sovereign bonds in their own countries.
Later this year, both the European Central Bank and European Banking Authority will conduct stress tests of European banks before unified supervision begins in the fall. The purpose of those stress tests is to analyze whether banks are sufficiently capitalized to sustain unexpected losses during economic or market shocks. The framework for those stress tests will be released in March and April. Given banks’ enormous data collection and aggregation challenges and the fact that the stress tests are likely to rely on a risk-weighted asset framework where banks get to pick a lot of the risk drivers for the models, no one should hold their breath about the validity of those stress tests.
Unfortunately, what happens in Europe does not stay in Europe. Anyone interested in the health of the global economy should be wishing Europeans the best of luck. Just as Henry Kissinger is once said to have asked, “Who do I call if I want to call Europe?,†the F.D.I.C. would like to know whom to dial should it have to call Europe.
