There is growing financial protectionism. This is happening even within the Eurozone – in violation of the Treaty. For instance, the Italian central bank (Banca d’Italia) has just created a Collateralised Interbank Market, where the Banca d’Italia will serve as the universal counterparty, guaranteeing settlement in case of default. The arrangement is, however, only open to Italian banks (one per group). In the current turmoil, the Banca d’Italia may be able to get away with an arrangement that clearly violates the Eurosystem’s principle of “equal treatment of institutions across the euro area”, but the ECB will want to get rid asp of anything that hints at balkanisation of the eurosystem and preferential treatment offered by NCBs to their national counterparties. The ECB asserts indeed that the general eligibility criteria for counterparties to national central banks “are uniform throughout the euro area”.
This finanancial protectionism is to a large extent the unavoidable consequence of the rediscovery, during the current financial crisis, that although banks and other financial institutions have become global, regulation and the fiscal capacity to bail out banks and other tottering financial institutions have remained national. Consequently, we have seen two forms of re-nationalisation of banking and finance.
The first form of nationalisation has been the taking into partial or complete public ownership of banks and other financial institutions deemed too systemically important (too big, to interconnected or too politically connected) to fail. This has happened virtually everywhere the financial crisis has struck – in the US, the UK, the Netherlands, Denmark and Belgium among them. More examples will follow.
The second form of re-nationalisation of banking and finance is the restriction of access to the fiscal and financial resources of the nation state just to those banks and other financial entities that have a significant presence in that nation state. The foreign subsidiaries of bank groups or bank holding companies registered and headquartered in the UK will not be able to count on the fiscal support or on other financial support of the British sovereign. These foreign subsidiaries will sink or swim on their own or take the begging bowl to the fiscal authority of their host country. The same will hold for the foreign subsidiaries of bank groups or bank holding companies registered in the US, Switzerland, the Netherlands, France, Germany or any other country with large cross-border banks headquartered in its jurisdiction.
Branches create a bit of a problem, since they tend to be the regulatory/supervisory responsibility of the home country authority. As a result there may be pressure on the home country authority from the parent bank (or from the host country government, as the case of the Icesave depositors in the UK illustrates) to make fiscal resources available to support the commitments entered into by the branches.
As a result of the current crisis, I expect that cross-border bank branches will become a thing of the past, and that the only cross-border subsidiaries we will continue to see will be independently and fully capitalised entities, regulated and supervised by the host country regulator and with recourse to the resources of the host country central bank and fiscal authority on the same terms as ‘domestic’ banks in the host country, that is, host-country banks that are not wholly owned by some foreign bank.
The Eurozone is in a bit of a pickle here, because although it has a central bank with supposed uniform access to its resources for all Eurozone banks, regulation and supervision remain national and fiscal bail-outs (recapitalisation by the state, guarantees, insurance, loans or whatever provided by the sovereign) definitely remain national. When the central bank acts as market maker of last resort, as the Banca d’Italia is now doing in the Italian interbank market, it takes on significant credit risk which requires a fiscal back-up – the Italian Treasury. But that undermines the principle of equal treatment of banking institutions across the Eurozone, and makes a mockery of the claim that general eligibility criteria for counterparties to national central banks “are uniform throughout the euro area”.
So there we are. If we are to avoid the balkanisation of the Eurosystem, and its degeneration into 16 national sub-systems, with different conditions of access to central bank resources, we will need some form of common European fiscal authority.
One solution would be a supranational fiscal authority with its own tax and borrowing powers, accountable to the European Parliament (as the lower house) and the Council (as the upper house). It may be a while before we get there.
A second solution would be a pan-Eurozone fund, fully pre-funded and containing, say, 2 or 3 trillion euro to begin with. This Eurofund could be managed by the European Commission, subject to parliamentary oversight and control by the European Parliament and the Council. The fund could be drawn upon to provide financial assistance to systemically important troubled banks in the Eurozone, according to guidelines agreed by the EC, the EP, the Council and the ECB. An interesting way to combine the creation of such a fund with beneficial financial innovation would be for the fund to raise its resources through the issuance of bonds that would be guaranteed jointly and severally by all Eurozone member states.
There are undoubted potential benefits from cross-bording banking. But these benefits can only be realised fully if all the countries involved in the cross-border banking arrangement have a common regulator and a common fiscal backup for these banks. I believe it requires a common currency as well. The Eurozone has one out of three. Not bad – and better than the UK, the US and Switzerland – but still no cigar. Unless we move towards a common regulator and a common fiscal back-up, the re-nationalisation of cross-border banking will continue, even within the Eurozone.