Ever since concerns were first voiced in Germany about the Bundesbank’s exposure to the Eurosystem’s payment and settlement system known as TARGET2, the Bundesbank itself has sought to assuage such concerns. In its March 2011 Monthly Report , the Bundesbank accepted that TARGET exposures constitute risks, but sought to play them down as “risks associated with the Eurosystem’s liquidity supply”. The Report reassured the reader that even if a Eurozone central bank were to default, an actual loss would only arise if the collateral such bank had posted failed to cover the exposure, and even if there was such a shortfall, the “cost of such loss would be shared among the national [central] banks”. The Bundesbank’s view on this subject obviously carries weight. With a net claim of 919 billion euros as at end April 2020, it is the largest creditor of TARGET2.
Financial and Banking Newsletter
ECB President Lagarde announced a keenly awaited new policy statement on April 30th. There was to be no increase to the Euros 750 billion Pandemic Emergency Purchase Programme (PEPP), but the economic deterioration of member states would be closely watched and, if necessary, the size of the programme would be adjusted in the future. She further endorsed the proposed new euros 1 trillion Recovery Fund which is supposed to take the pressure off the ECB in supporting member states’ efforts to rebuild virus hit economies. Media reported that the ECB was ‘keeping its powder dry’.
COVID-19 Responses Attempt to Pull Political Leaders Across Debt Mutualisation Red Lines
In the past month, two new large liquidity injections have been announced. Firstly, a euros 750 billion Pandemic Emergency Purchase Programme (PEPP) was launched to “expand the range of eligible assets under the corporate sector purchase programme (CSPP) and to ease the collateral standards.” And secondly, on 9 April the euros 530 billion SURE funding package (Supporting Unemployment Risks in Emergency) was agreed.
A substantial and growing amount of press attention has been devoted to the subject of Central Bank Digital Currencies (CBDCs) since last year’s announcement of Libra which spooked regulators at central banks who are petrified of losing control of the mint. Central banks have a mixed track record in understanding and predicting trends in alternative payment technologies, and prior to Libra were relaxed that bitcoin was unlikely to attain mass adoption. Jerome Powell, head of the Federal Reserve gave congressional testimony shortly after the Libra announcement denigrating it on several counts. Nonetheless, Libra doubtless turbocharged central banks’ research.
In the ten years since the first iteration of the European Stability Mechanism (ESM) emerged, its status has changed markedly. Initially, it was just a clever example of financial engineering deployed by the ECB to enable certain EU member states to be bailed out without imposing the costs directly on the better off countries of Europe.
Sir Donald Brydon, former Chairman of the London Stock Exchange, published just before Christmas his wide-ranging review of the UK audit industry. This is likely to have significant ramifications for bank financial reporting throughout Europe because (with only a few national opt outs) accounting and auditing rules set in London form the basis of the relevant European Union (EU) directives.
In November, Germany’s Finance Minister Olaf Scholz wrote an article in the Financial Times claiming that he had devised a common European Deposit Insurance Scheme (EDIS)[[EDIS has since 2015 been envisaged as a Eurozone-wide scheme which would cover the costs of repaying deposits of up to euro 100,000 lost in future bank failures.]] that could be acceptable to both sides of the hitherto gridlocked debate. Mr Scholz also circulated a document which he believed provided a clever solution to the stand-off between the heavily indebted European member states (‘debtor countries’) and the rest of the Eurozone. In particular, since the 2010 outbreak of the first Greek sovereign-debt default crisis, a number of countries led by Germany resisted debt mutualisation and the sharing of the costs of other countries’ bank failures. In fact, the financially stronger countries demanded new banking rules, which would ensure that any common bank insurance scheme would apply only to banks demonstrably solvent at the scheme’s inception. The stand-off has endured for over two years because the weaker countries, and Italy in particular, continue strongly to resist any reform of the rules which would overtly expose any of their major banks as insolvent.
As the momentum has built behind calls for policy responses towards climate change, the ECB and the Bank of England have not been the quickest central banks to act. Back in 2011, the Banco do Brasil announced that banks must incorporate ‘Environmental and Social Risk’ in their reporting and risk management strategies. In 2012, the Reserve Bank of India invoked its 1949 Priority Sector Lending legislation to encourage Indian banks to allocate credit to green projects: renewable energy infrastructures such as biomass fuel production, wind farms and solar. Last but not least, the governor of the French central bank recently suggested that the world authorities (i.e. taxpayers) should devote no less than $ 900 bn per year to address the climate problem and that the Bank will be ready to support the policymakers’ actions in this area. As a matter of fact, one of the earliest central banks to actively intervene on climate change was the People’s Bank of China. In 2007, working with other institutions like the Ministry of Environmental Protection and the China Development Bank, it acted to restrict financing from companies that failed to comply with environmental rules such as emissions targets. This might seem at odds with China’s huge programme of coal fired power station construction which is producing one new one each week.
New entrants into every aspect of banking were encouraged by two recent regulatory developments: the Open Banking initiative and the ‘sandboxing’ exemptions from regulations. Open Banking, part of the Payment Services Directive enacted October 2015, encourages customers to allow their data to be shared with licensed FinTech startups. We provided some detail previously. Sandboxing is relatively new, and identifies the remarkable regulatory practice of waiving the rules to help companies creating new financial technologies (FinTechs) get a foothold. In particular, the concept of a sandbox is that the development of new useful innovative tech will be held back if the full range of regulations need to be complied with immediately. In banking, one obvious costly impediment to startups is the required minimum level of regulatory capital. Of course, there are reasons why these minima exist, so the decision to license a startup to ‘play about in the sandbox’ rather than comply is based on matters such as the number of customers exposed to the new tech, and perceived risks to the financial system. Obviously, at the inception of any new challenger bank these risks are small. But at what point is a tech startup adjudged to be mature enough that it should leave the sandbox and play with the grown-ups? And when instructed so to do by regulators, how will these new challengers cope?
A cynical English expression popular in sporting circles is “All the Gear and No Idea”. This is expressed, sotto voce, at the club bar when mocking a typically well-off amateur sportsman who has shown up at the ski slope, the golf course or the clay pigeon shoot with the most expensive equipment and trendiest clothes, appearing confident. Sadly, he then falls flat on his face (literally in the skiing case), or fails to drive the golf ball past the ladies’ tee, or misses every clay. We suspect that outgoing President Draghi felt somewhat embarrassed along these lines as he delivered his penultimate press conference on September 12th, because everybody keenly awaiting his announcement knew that he and his crack team are aware that his 8-year tenure has been disappointing. The ECB has broadly two functions. In one it is paralysed – the quest for a “deeper” European Monetary Union (EMU), and in the other it is going around in circles – price stabilisation.