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    ECB Report Notes Pandemic Did Not Impair Financial Integration

    April 06, 2022

    The European Central Bank (ECB) published a report on financial integration and structure in the euro area, noting that the financial fragmentation that occurred at the start of the coronavirus pandemic was reversed relatively quickly.

    The report discusses issues relevant to financial-sector policies related to the European Banking Union and Capital Markets Union. The report highlights that due to decisive set of policy measures, the financing of firms and households in the euro area held up during the pandemic crisis, with a significant increase in public debt. In addition to fiscal support and guarantees, another factor that helped nonfinancial corporations to stabilize was a fast change in their financing mix toward bank credit lines and corporate debt issuance, which was also facilitated by monetary policy measures. The rise in non-bank financial intermediation continued, with especially strong growth in investment funds, most notably in equity funds. The findings of the report suggest that completing the Banking Union and making material progress with the Capital Markets Union are key to enhancing the integration and resilience of the financial sector and helping post-COVID recovery of Europe. The areas that need enhanced policy efforts include equity markets, debt issuance procedures, and bank consolidation.

    In report, ECB states that consolidation must remain a market-driven process and be conditional on safeguards on the business plan, business model sustainability, governance, and risk management. To this end, ECB has published a guide on the prudential treatment of mergers and acquisitions to provide transparency on its assessment approach to merger transactions. However, the report notes that several regulatory obstacles may hamper cross-border consolidation. These include the limited cross-border fungibility of capital and liquidity within a single banking group. ECB has made several suggestions as to how to facilitate the use of intragroup liquidity waivers within the current regulatory framework. However, a lack of harmonization of tax and insolvency regimes, customer protection, and labor laws may still pose obstacles to the cross-border provision of services, in particular in the retail market. The planned Basel Committee revision of the implications of developments related to the European Banking Union for the global systemically important bank (G-SIB) methodology, which will include a targeted review of the treatment of cross-border exposures within the Banking Union, represents an opportunity to assess issues related to effective integration.

    Another way to pursue cross-border integration would be for banks to review their cross-border organizational structures. Relying more extensively on branches and providing services directly across borders, instead of through subsidiaries, could be a way to develop pan-European business within the Banking Union and the Single Market. The digitalization of the banking market may offer new possibilities here, especially for cross-border provision of banking services. The ECB Banking Supervision has made some suggestions for improving the regulatory framework to facilitate the use of branches as a means of cross-border banking. Debt issuance procedures also need to be further integrated and harmonized to reduce costs and allow investors to better diversify across European Union countries. As domestic and cross-border bank consolidation could help address structurally low profitability and fragmentation in retail credit markets, removing remaining regulatory obstacles should be considered.

     

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    Keywords: Europe, EU, Banking, Basel, Lending, Covid-19, Financial Integration, Capital Markets Union, Banking Union, Financial Fragmentation, Cross-Border Activities, ECB

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