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May 11, 2018

While speaking at the European University Institute in Florence, the ECB President Mario Draghi emphasized the creation of a more stable financial sector by completing the banking union and the capital markets union. He added that capital markets have differing rules and market practices for financial products across countries, along with a wide variance in insolvency and judicial systems. For banks also, the Single Market is fragmented along national lines and the incomplete framework for bank resolution deters the cross-border integration.

Mr. Draghi said that the Bank Recovery and Resolution Directive (BRRD) already places depositors at the top of the creditor hierarchy in resolution. Furthermore, the new minimum requirements for own funds and eligible liabilities should ensure that there is a sufficient buffer of loss-absorbing capacity to make depositor bail-in extremely unlikely. However, a backstop for the Single Resolution Fund is still missing. Resolution needs financing and the Resolution Fund, which is funded by banks, will ensure that it is paid for by the private sector. In a deep crisis, the resources of such funds can be depleted, which is why in all the other large jurisdictions, such as the US, the UK, and Japan, resolution funds are backstopped by the fiscal authority. The aim of such backstops is to create confidence that bank resolution can always be enacted efficiently, which has a stabilizing effect in a crisis and prevents more banks from being dragged into difficulties.

He highlighted that a good example of this is FDIC in the United States, which is also the resolution authority and is backstopped by a credit line with the U.S. Treasury. During the crisis, nearly 500 banks were resolved in the United States without triggering financial instability. In contrast, one estimate puts the total number of banks resolved in the euro area in that period at about 50.An orderly resolution of this magnitude was possible in the United States because of confidence in a well-functioning resolution framework, with the presence of the Treasury backstop being fundamental in creating this confidence. Although FDIC did not have to draw on its credit line, it was clearly reassuring to markets and to depositors that it had that option as a last resort. FDIC has only borrowed from the Treasury once, during the savings and loans crisis in the early 1990s and it repaid in full a few years later. Mr Draghi said: "This example underlines that the dichotomy between risk-reduction and risk-sharing that characterizes the debate today is, in many ways, artificial. With the right policy framework, these two goals are mutually reinforcing."

Public risk-sharing through backstops helps reduce risks across the system by containing market panics when a crisis hits. In addition, a strong resolution framework ensures that, when bank failures do happen, very little public risk-sharing is needed, as the costs are fully borne by the private sector. Therefore, completion of the resolution framework in all its dimensions is important. Creating a properly designed European deposit insurance scheme would be an additional element that could further reduce the risk of bank runs. "All in all, a consistent framework of regulations, laws, judicial enforcement, and resolution is essential for deep and resilient financial integration. Completing the banking union and the capital markets union is, therefore, a necessary condition for the expansion of private risk-sharing in the euro area, " said Mr. Draghi.


Related Link: Speech

Keywords: Europe, EU, Banking, Banking Union, Capital Markets Union, Resolution Framework, ECB

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