IMF Assessment of Financial Stability in Europe: Much Achieved to Address the Crisis but Vulnerabilities Remain and Intensified Efforts Needed
In its first-ever overall assessment of the soundness and stability of the European Union’s financial sector, under its Financial Sector Assessment Program (FSAP), International Monetary Fund (IMF) says that much has been achieved to address financial crisis in Europe but vulnerabilities remain and intensified efforts are needed across a wide front:
- Bank balance sheet repair. Progress toward strong capital buffers needs to be secured and disclosures enhanced. To reinforce the process, selective asset quality reviews should be conducted by national authorities, coordinated at the EU level.
- Fast and sustained progress toward making the Single Supervisory Mechanism (SSM) effective as a stage towards banking union (BU). Such progress is essential to anchor financial stability and ongoing crisis management in the euro area. A single resolution mechanism needs to become operational as the SSM becomes effective. Agreement on the modalities for the European Stability Mechanism to take up its role to directly recapitalize banks needs to be reached quickly.
- Further strengthening of the European Union’s financial oversight framework. Prompt passage and implementation of various EU directives are needed, as well as enhancing coordination across the various supranational agencies so as to achieve policy consistency, including at a national level. Further progress towards a full embrace of a Union-wide approach to financial stability—crisis management, deposit insurance, supervision and resolution, with a common backstop for the banking system, especially for the monetary union is needed to strengthen the ability of the system to avert and withstand shocks
Much has been done to address the recent financial crisis in Europe. Banks have boosted their capital adequacy ratios, although partly through deleveraging. Unconventional monetary operations have enhanced liquidity and firewalls have been put in place. Bank supervision has been improved. Agreement was reached last December to establish an SSM for the euro area, open also to non euro area members. New tools for addressing financial stability, including coordinated stress tests have come into play. The newly-established European Supervisory Authorities (ESAs) are making their marks.
Nevertheless, financial stability remains fragile. Recent Financial Sector Assessment Program (FSAP) assessments of individual EU member states have noted remaining vulnerabilities: stresses and dislocations in wholesale funding markets; a loss of market confidence in sovereign debt; further downward movements in asset prices; and downward shocks to growth. These vulnerabilities are exacerbated by the high degree of concentration in the banking sector; regulatory and policy uncertainty; and the major gaps in the policy framework that still need to be filled.
In the near term more forceful action is warranted to cement recent gains in market confidence and end the crisis. The priorities are bank balance sheet repair, including addressing impaired assets; fast and sustained progress toward the SSM and the BU; and essential steps toward a stronger EU financial oversight framework. Governance arrangements of existing pan-EU institutions must be adapted to have a EU (or BU)-wide perspective and also evolve to meet the diverse needs of members of the euro area, SSM members not part of the euro area, and other members of the EU.
The ESAs and the European Systemic Risk Board (ESRB) need further strengthening. The ESRB, as the EU systemic risk watchdog, should develop the macroprudential toolkit, analyze macroprudential effects on the cyclical downside and not just the upside, and ensure consistent application of macroprudential policies across the various parts of the financial sector and across the EU. Governance arrangements need to be adapted to avoid potential national biases.
Proposals by the European Commission to harmonize capital requirements, resolution, DGS, and insurance supervision frameworks should be implemented promptly. While ensuring that the Fourth Capital Requirements Directive and Capital Requirements Regulation are in full compliance with Basel III, their swift adoption, as well as that of the directives on resolution, DGS and insurance supervision, are necessary. The resolution directive needs to be enhanced to provide for automatic intervention in the event that a bank’s solvency position falls below a certain trigger level, as well as to provide flexibility for intervention in the event of liquidity or other problems. In addition, more effective supervision and resolution arrangements need to be worked out for financial institutions crossing the borders between the SSM and the rest of the EU and beyond.