Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
IMF Survey: Options for Faster Financial Integration
March 19, 2007
- Europe's financial markets are transformed and successfully competing
- How should countries share fiscal burden of cross-border bank insolvencies?
- Current political climate not conducive to addressing problems at their roots
The IMF and the Brussels-based think tank Bruegel took stock of progress toward a more integrated European financial system and explored policy options to accelerate financial integration at a joint two-day conference in February.
European Central Bank (ECB) building in Frankfurt, Germany: conference heard opposing views on supervision role for ECB (Photo: Sean Gallup/Getty Images)
European Union
The event included more than 100 policymakers, academics, financial professionals, and key IMF officials.
Participants in the Brussels conference, "Putting Europe's Money to Work: Financial Integration, Financial Development and Growth in the European Union," agreed that financial integration was important for Europe's growth performance. They had a generally positive assessment of what financial integration policies had already achieved: the European Union's Financial Services Action Plan has put in place the basic elements of an integrated EU market, its implementation is well advanced, and its benefits will build significantly over time. Europe's financial markets have been transformed and are successfully competing with those elsewhere in the world, with London at the forefront.
Nonetheless, there was also a consensus that more work lies ahead. Among the main themes that emerged from the discussion was the need to adapt Europe's crisis prevention, management, and resolution framework to its integrating market and the changing risks that integration entails.
The discussion focused in particular on the question of how countries should share the fiscal burden of cross-border bank insolvencies (that is, the cost to taxpayers of dealing with a failing bank that operates in several countries) and how addressing this burden-sharing question relates to other reforms of the financial stability framework.
No appetite for reforms
Several participants noted, however, that they thought that the current political climate was not conducive to addressing these problems at their roots, because there is no appetite for the far-reaching reforms that would be required. Much discussion also focused on whether and how much Europe's financial sector is responsible for the low number of garage-to-multinational-in-one-generation companies, those that start penniless, with little more than an idea, and evolve into large firms, such as Apple Computer in the United States.
Participating in the February 21-22 conference, which was split into off-the-record and public sessions, were the IMF's First Deputy Managing Director, John Lipsky; Jaime Caruana, Director of its Monetary and Capital Markets Department; and Michael Deppler, Director of the European Department.
In his keynote speech, European Commissioner for Economic and Financial Affairs Joaquín Almunia observed that national authorities were not keeping up with developments on the ground. In particular, he said, reform of the supervisory framework was lagging: financial institutions operate increasingly across borders, but the incentive structures of supervisory authorities remain oriented toward the national level.
Almunia called for an open discussion of the costs and benefits of financial integration and argued that cost estimates were often exaggerated by vested interests, who feel threatened by the greater efficiency and competition an integrated market would bring. He also called for a debate on the risks related to hedge funds.
Dangerous cocktail
Participants on the policy panel on financial stability were in general agreement that there is a need for further centralization of supervision, although none advocated a single supervisor at this point. They also agreed that the burden- sharing question was important. Nonetheless, there were differing views on solutions.
Baron Alexandre Lamfalussy, the former president of the European Monetary Institute (the predecessor of the European Central Bank (ECB)), argued that the current environment is a dangerous cocktail of moral hazard (resulting, in part, from successful past episodes of crisis prevention), ample liquidity, and financial innovation. In this demanding environment, European institutions that manage and prevent crises are, "to put it mildly, suboptimal," and reform is proceeding too slowly, he said.
"The EU has the opportunity and the policy tools to take a leading role in designing a regional financial stability framework"
Caruana pointed out that the EU has the opportunity and the policy tools to take a leading role in designing a regional financial stability framework and that the current favorable conditions provide a window of opportunity for doing so. A new framework would require more centralization and the inclusion of an EU dimension in supervisors' hitherto national mandates. Although he agreed that the burden-sharing question was important, he saw it as being set apart by its political nature and solvable only in the context of broader reforms. The main scope for progress, he said, was in the areas of deposit insurance and crisis prevention and management.
Andrea Moneta of Unicredit pointed out that organizing a financial institution's activities across borders rapidly becomes very complex, pushing forward the need for more identical supervisory arrangements across countries. He said it is important to keep in mind that large financial groups in the EU typically also have large activities outside the EU and off their balance sheets. In this context, Moneta saw the Basel II approach of relying on banks' own risk management as sensible and thought that it would not be desirable for banks to be able to shop around for their supervisor of choice.
Fears of regulation
Sir Nigel Wicks, Chairman of Euroclear, observed that financial business in the EU was running ahead of the supervisory framework and the political situation. He saw the uncertainties related to crisis management and resolution (and to taxpayer responsibility for losses) as key issues. Nonetheless, financial markets were doing too well for a comprehensive, "big bang" reform, which would also raise fears of heavy-handed regulation.
"Central banks, as lenders of last resort, bear responsibility for ensuring financial stability"
Panel members agreed that reform efforts should focus in the first instance on the largest EU financial institutions, but held different views on the potential role of the ECB in prudential supervision. Lamfalussy and Caruana made a case for central bank involvement. Lamfalussy pointed out that central banks, as lenders of last resort, bear responsibility for ensuring financial stability. Wicks responded, however, that ECB involvement in supervision might fit uncomfortably with its status as a highly independent supranational institution.
The policy panel on financial integration and economic growth touched on a variety of issues. Former European Commissioner and Bruegel President Mario Monti argued that a major struggle was ongoing between those who envision an integrated financial market in the EU and those businesses that resist it. Lipsky called on Europe to focus on integrating its capital markets to allow banks and markets to develop symbiotically and said that this would require action by governments.
Countercyclical policies
Harvard Professor Philippe Aghion pointed out that firms that are intensely oriented toward research and development (R&D) need more equity capital than other firms and that such equity capital is more readily available in the United States than in Europe, where venture capital and capital markets in general are less developed. A well developed market for corporate control is also essential, because it would ensure the exit of underperforming firms and managers. Countercyclical macroeconomic policies could also support R&D.
Sofinnova Chairman Jean-Bernard Schmidt complained that innovation in Europe was being impeded by the difficult market for initial public offerings and said that the underlying problem is that financial markets focus too much on the short run. Several people in the audience disagreed, saying that more venture capital is available than ever and long-term investors need a mix of long- and short-term investment options. Lipsky added that the growth of hedge funds was less dramatic than often portrayed, and private equity could be expected to contribute to the rebalancing of asset prices by bidding up the stock prices of undervalued companies.