Guest Commentary: Thomas Wieser

(The guest commentary appeared in SAFE Newsletter Q3 2014)

How will the Banking Union change economic policy making?

Thomas Wieser is President of the Economic and Financial Committee of the European Union. He held the keynote address at the SAFE Policy Center Summer Academy 2014.


The Banking Union is going to change the structure and organization of banking and financial markets in Europe. It will also bring about noticeable changes in the interaction of these sectors with other parts of our economies, and thus their functioning. Most recent commentary has focussed on the direct, immediate impact of a new Single Supervisor setting up business. Whilst important, the long-run structural effects may in fact be more significant than so far realised.

In the Banking Union, the cost of bank resolution will, over time, be brought down. More importantly, the distribution of losses will be shifted significantly. What are the main drivers of change?

The Single Supervisor will be quicker to identify risks to the viability of individual banks, and the Single Resolution Mechanism will be more decisive in resolving failing banks than national authorities were. Thus, the Single Supervisory Mechanism spells the end of an industrial policy approach to supervision in the countries concerned. This constitutes a clearly positive economic effect, already in the short run.

Replacing bailouts with bail-ins will shift the cost away from sovereigns, and consequently away from future taxpayers to current investors, and possibly unsecured depositors. The inter-temporal distribution effects will thus change decisively. Also, the impact on banks, business and households will be much more direct. Wealth effects will be non-negligible. In a truly integrated financial market, the effects of this shift should ultimately be beneficial for the economy as a whole, not only for governments' budgets. The transition to this new equilibrium will be successfully completed over the average maturity of a bank's portfolio. In the meantime, however, the sign of the economic effects is less clear, and short run effects may be different than medium-term effects.

In the medium term, bank finance will thus be considered relatively riskier. Therefore, the cost of funding will go up, and the structure of financing bank balance sheets will become more conservative. Consequently, banks will have to re-evaluate their lending policies. As the loan-to-deposit ratio comes down, the costs of financing the economy will be pushed upwards, with slightly mitigating effects from positive selection bias for less risky projects and loans. The corporate sector may thus be encouraged to diversify its funding strategy and look for other sources of funding. For large corporates this is, even in Europe, not a new situation as they routinely finance themselves via capital markets. The challenge will be greater for midsize firms and particularly small and medium enterprises (SMEs). Especially in the present, low growth environment, governments will need to address this issue by developing the necessary framework conditions for the development of capital markets and for SME financing.

A gradually shrinking banking sector will inevitably become less of a growth driver than it has been in the more recent past. Policy makers will have to consider the impact of changing costs and risks of individual instruments on savings and investment decisions.

Sources of instability will not go away in the Banking Union, but dealing with them will require more careful analysis at the national level and subsequent policy action at the national level, or at the Banking Union level – and sometimes jointly. We will therefore need to develop (or improve) our analytical apparatus for detecting emerging imbalances, and stand ready to take action.

As national regulatory and supervisory discretion fade away over time, other drivers of competition will emerge, especially as regards cross-border competition. Differentials in tax treatment will start to play a vital role in shaping the relative position of bank groups. In the medium term, it should not come as a surprise that bank groups will start relocating headquarters to the most tax friendly jurisdiction in the Banking Union. The associated loss of "national identity" will not harm financial stability – but how it affects overall tax revenues is quite open.

National and European authorities have to consider how best to adapt to this new environment, also in the way they interact with each other. The impact of policy decisions and events taking place beyond national borders – also on macro-financial stability in individual countries – will increase. Not all actors have yet thought this through.