Nicolas Véron

Financial Times Comment: Europe Must Avoid Two Extreme Doctrines on Bank Restructuring

The Financial Times today published my analysis of what the bank restructuring in Cyprus and of Eurogroup President Jeroen Dijsselbloem’s much-commented interview earlier this week. I suggest that the EU must now find a more stable path between too extreme, harmful policy stances – excessive moral hazard (which I call the “Sanio Doctrine” based on the seminal decision to bail-out IKB in late July 2007), and denial of systemic risk (the “Mellon doctrine” with reference to ill-fated US policy before the inauguration of Franklin D. Roosevelt). This is an important debate for Europe and not least for future discussions on the banking union framework.

Briefing Paper for the European Parliament

On October 4, I was invited to present a briefing paper at a meeting of the Economic and Monetary Affairs (ECON) committee of the European Parliament, in preparation of their hearing of European Central Bank President Mario Draghi the following week. the paper is about the European initiative to create a banking union and more specifically the European Commission's proposals for A Single Supervisory Mechanism and related reform of the European Banking Authority, published on September 12.

Bruegel later published a lightly edited version of the same paper in its Policy Contribution series, available here. The paper is also available on the European Parliament's website.

December 11 update: an updated and slightly expanded version was also published by the Peterson Institute (PDF version here)

 

The Political Redefinition of Europe

On June 8, I was invited by Sweden's Financial Markets Committee (FMK) to give opening remarks at a conference they organized in Stockholm about the role of the European Parliament. I used this occasion to collect some personal thoughts on the political and historical dimensions of the Eurozone crisis.

The text is available here as published by FMK, here as published by PIIE, and here as republished on the Bruegel Blog - or alternatively here in PDF format. 

US Senate Testimony - The Future of the Eurozone

Click here to download the PDF version of the statement I delivered today at the US Senate, Committee on Foreign Relations, Subcommittee on European Affairs chaired by Senator Jeanne Shaheen. 

A video of the hearing is available on the Senate's website, as well as the statements of the other two witnesses, Frances Burwell and Simon Johnson. 

The statement was also published by the Peterson Institute and by Bruegel. 

The EU's Bank Recapitalization Plan

In this piece published by Emerging Markets, the magazine distributed in major international economic gatherings (in this case the Cannes summit of the G20), I take a critical look at the bank recapitalization plan announced by EU leaders last week and suggest that the Eurozone cannot be sustainable without an explicitly federal framework for banking policy. 

US Senate Testimony: the European Debt and Financial Crisis

On 22 September, I was a witness at a hearing of the Subcommittee on Security and International Trade and Finance of the US Senate Committee on Banking, Housing, and Urban Affairs. My written statement is accessible here, and a webcast of the entire hearing including my oral testimony and questions is here. 

Click here for the publication in Bruegel's Policy Contribution series. 

Click here for the publication on the Peterson Institute's website. 

The Dodd-Frank Act, One Year On: e-book

In July, Vox published this e-book based on a conference in which I participated in Washington DC, at the initiative of the Pew Charitable Trusts and NYU Stern School of Business. I contributed the (short) last chapter on financial reform outside of the US and global financial authorities, and how they connect with the reforms undertaken in the US. 

Click here to download the PDF version directly. 

Eurozone Crisis Resolution Requires a Single Banking Market

The Financial Times on 15 July published this column, in which I emphasize the importance of EU-wide integration of the banking system for both short-term crisis resolution and long-term sustainability of the Eurozone. 

It is also accessible on the websites of Bruegel and PIIE. 

The next Managing Director of the IMF

This post co-authored with Arvind Subramanian was published by the Peterson Institute for International Economics yesterday.

Update: on May 19th we published a follow-up post which is also pasted below.

A Quick Guide to the Upcoming Contest for the Next MD of the IMF

by Arvind Subramanian and Nicolas Véron | May 17th, 2011 | 04:24 pm

This note provides a quick guide—in the form of a table—to the likely candidates to succeed Dominique Strauss-Kahn as next Managing Director (MD) of the IMF, assuming that he resigns shortly. It also highlights some key points that must guide the process of selecting the next MD.

Need for urgent action. The IMF is at a critical juncture with lots of problems to solve, not least in Europe. A leadership vacuum and uncertainty must be avoided, which requires urgent initiatives by the larger players—the United States, Europe, China, Brazil, India, South Africa and others.

Europe can no longer claim the job of MD: Europe no longer has the divine right to this job, irrespective of the circumstances of the European incumbent’s (assumed) departure. The world has changed, and antiquated if unstated arrangements dating from 1945, in which a European heads the IMF and an American heads the World Bank, must keep pace with reality. The next MD must be selected on the basis of merit, which is not to be found only in Europe.

The thoughtful Wolfgang Münchau of the Financial Times made the case yesterday that the successor to Dominique Strauss-Kahn should be another European. "The eurozone’s contagious financial crisis constitutes the biggest threat to global financial stability today," he wrote. "The IMF is a partner in the multilateral loan programme for Greece, and a structural partner in the eurozone’s financial rescue mechanism. The size of these programmes dwarfs whatever else the IMF is doing at the moment."

We disagree. For a start, it elicits the obvious question: During the Asian financial crisis, would Mr. Munchau have extended his logic and asked for an Asian to be head of the IMF? And for most of the history of the IMF, given the identity of the borrowers, should the head have come from the developing world?

Dominique Strauss-Kahn has played a key role during the Euro crises, especially last year, in persuading eurozone leaders to partner with the IMF in addressing the Greek crisis. But the next challenges will be of a different nature. Last year, the IMF leadership’s sensitivity to European politics was key to ensuring acceptance in Europe of IMF-led conditionality for the countries receiving aid. Now, if and when Greece comes back for its second tranche of borrowing, the MD will have to play a different role: to convince Europe, in what promises to be a heated discussion, that Greece has a solvency problem and requires debt restructuring; or, if the IMF concludes that Greece merits international support and all other options are worse, to convince the rest of the world to extend further financial commitments. Either way, there is less need for a European and more for an objective outsider.

Key US role: The leadership of the IMF and World Bank are linked. So, a corollary to Europe forgoing its monopoly rights to the IMF leadership is that the US right to leadership of the World Bank (and for that matter, to the Number Two position at the IMF) is no longer a given either. Although the United States supported a weak G20 commitment in 2009 to a merit-based selection procedure for both institution, it has been more recently sitting on the fence on this issue. But its leadership is needed to avoid weakening the Bretton Woods institutions in a 21st-century world that arguably needs them more than ever. The United States has always argued that American leadership at the World Bank helps persuade Congress to put up the money for development assistance. But that argument has been rendered obsolete by the realities of modern global politics and economics. President Obama or Treasury Secretary Timothy Geithner should say clearly that Washington commits to the principle of fair, transparent, and merit-based selection for the leadership of both institutions.

Strong emerging market candidates: As the attached table shows, the list of potential contenders from emerging market countries is very strong. There is absolutely no excuse therefore for not casting the selection net wide to focus on these contenders. The attached table also shows what the possible doubts about some of these candidates might be. Given the importance of the process and the break from the past that it would represent, the search should not be confined to those who are well-known in IMF and World Bank circles. In other words, even among those on this list, there are "insiders" and "usual suspects" and the process should not be biased towards them.

On the other hand, since Asia is at present the location of the world’s strongest-growing economies, and the countries of Asia are clamoring for more of a role in all international institutions, the IMF would do well to look carefully at candidates from that continent. In that spirit, serious consideration should be given to the Finance Minister of Singapore, Tharman Shanmugaratnam, who ticks many of the key boxes: he is an Asian who might be acceptable to other Asians; he has the right senior policy experience, both as central banker and as finance minister; and most important, he is highly regarded intellectually and has a track record of strong and thoughtful leadership. As many commentators have already noted, Kemal Dervis of Turkey, a former director of the United Nations Development Program, is also strong in the list, as a highly respected emerging-market figure who is also culturally and politically very close to Europe. Trevor Manuel, the finance minister of South Africa, has no obvious disqualifications. Perhaps less predictably, we also suggest considering a senior IMF career staffer, Ajai Chopra, who has distinguished himself during the European crisis in his handling of the Irish IMF program, even if he lacks political heft and connections compared with others in the list.

This is certainly not to say that there is no matching talent in Europe, or the United States for that matter. Christine Lagarde, finance minister of France, is highly respected internationally, and a first-ever female MD would be welcome. But our point is that there are more credible candidates from emerging countries this time than arguably ever before.

Pitfalls to avoid: There are two major dangers. One is that jockeying between Europe and the United States will lead to protracted uncertainty, creating a rush to make a quick perpetuation of the status quo as a means out of the IMF’s leadership instability. This underscores the need for the United States to be clear about selection procedures for both Bretton Woods institutions. A similar possibility arises if emerging market countries squabble among themselves and cannot agree on a common candidate. Unlike EU member states, these countries do not have strong institutional mechanisms to coordinate their positions, but they too should resolve their differences and get their act together.

In short, after years of talk about change, the time is ripe for genuine reform in the governance of international institutions to reflect the changing economic realities. The list of emerging market candidates for the IMF job is very strong. The United States should not cast itself as a defender of an antiquated status quo; and the decision should be made quickly. Letting this key negotiation drift would threaten the legitimacy and effectiveness of what are vital structures of international cooperation.

	A Guide to the Potential Non-European, Non-American Successors to Dominique Strauss-Kahn
	Name	Current Position	Nationality	Qualifications	Questions
	Montek Singh Ahluwalia	Head, Planning Commission	India	Previous IMF experience; associated with successful Indian economic reforms	Will China agree to an Indian head of the IMF?
	Agustin Carstens	Governor, Central Bank	Mexico	Extensive IMF experience	Is Mexico seen as too close to the US?
	Ajai Chopra	Senior Staffer, IMF	India	Career IMF staffer; extensive Europe experience; handled recent Irish crisis	Is he viewed as having political heft?
	Kemal Dervis	Vice-President, Brookings Institution	Turkey	Close to US and European policy-making; implemented a successful adjustment program in Turkey as Finance Minister; has headed an international organization (UNDP)	Will he command the support of his own country?
	Mohamed El-Erian	Co-head PIMCO	Egypt	Combines IMF and private sector experience
	Arminio Fraga	Senior Position, Gavea/J.P. Morgan	Brazil	Successful stint as head of the Brazilian central bank	Are public sector credentials seen as strong compared to his private sector background?
	Trevor Manuel	Head, Planning Commission	South Africa	Successful national experience as Finance Minister during time of transition away from Apartheid; Led task force on reform of IMF governance
	Il Sakong	President, Korea International Trade Association	Korea	Varied experience, including as Korea chaired last year’s G-20 summit	Will some be concerned about close ties to the US? Can two Koreans head major international organizations (IMF and UN) at the same time?
	Tharman Shanmugarathnam	Minister of Finance	Singapore	Singapore seen as bridge within Asia	Is he as prominently known internationally as other candidates?
	Zhou Xiaochuan	Governor, Central bank	China	Would represent rising power	Will other Asians agree and will China accept this level of international responsibility?
	A Truly International Monetary Fund or a Continuing North-Atlantic Monetary Fund? by Arvind Subramanian and Nicolas Véron | May 19th, 2011 | 02:53 pm This post follows up on, updates, and responds to a number of comments we received on, our previous post on the succession to Dominique Strauss-Kahn as Managing Director of the IMF. Why not a meritorious European this time? Some have argued that the key principle to introduce is merit not nationality. And if that results in a European candidate—for example Christine Lagarde—that should be fine. We agree. But this time is special. The process must be, and must be believed to be, merit-based. If the process throws up a European candidate, doubts will linger: was the candidate truly meritorious or will the presumption be that the result was a stitch-up—once again—between the Europeans and Americans. Signaling a decisive change from the past requires an outcome that is different. This principle would apply also to the next change at the World Bank to which the United States must commit, difficult as it might be for the US administration to convince Congress that a non-American should head this institution. Once the process acquires legitimacy, one can move to a truly nationality-blind process that can then throw up Europeans to lead the IMF and Americans to head the World Bank. We think it highly desirable to have women as heads of international institutions. But at this stage, discrimination on the basis of nationality is an even bigger threat to the legitimacy of the Bretton Woods institutions than that based on gender, which of course must also be addressed. What are the most important selection criteria? Imagination and leadership, then experience and political heft. The world economy faces unprecedented challenges: the euro crisis of course, but also global imbalances and the US fiscal situation. Also, the risk of instability in emerging markets has not disappeared. These challenges call for a spirit of policy innovation, absence of doctrinal or cultural prejudices, and an ability to create consensus on new solutions. It is difficult to find this combination of talents, so it is crucial to enlarge the potential pool of candidates. Shouldn’t Europeans get the job just because the IMF has so much exposure in Europe? As our colleague Ted Truman has noted, the Fund has only about half its exposure in Europe at this point, and who knows what will happen in the emerging world over the next five years. In any case, why should the debtors be in charge of the bank? This is certainly not an argument we heard from Europe during the Asian Crisis in the late 1990s. From a European viewpoint, isn’t it in the European interest to have a European MD even if it is not in the global interest? Things are less clear-cut in practice. A year ago, the key challenge for the IMF was to convince the Europeans that the Fund’s involvement in the euro crisis was in their own interest. This is now done and accepted, not least thanks to Dominique Strauss-Kahn’s past leadership. The next challenges will be different: especially, if the Fund decides that further assistance is needed for Greece, the most difficult part will be to convince reluctant stakeholders in the rest of the world, especially Asians and the US Congress, to keep going along the Europeans on this path. All things equal, a European MD would find this task more difficult than a non-European. If this is the right way to look at it, then one could even argue that the special interest of Europe calls for a non-European MD. How can Europe be expected to voluntarily renounce a top position? Europeans head the World Trade Organization (Pascal Lamy), the Financial Stability Board (Mario Draghi), the Bank for International Settlements (Jaime Caruana), the Basel Committee on Banking Supervision (Nout Wellinck), the International Accounting Standards Board (Hans Hoogervorst), and many other international organizations with economic policy relevance. In a changing world, they simply cannot keep all these. Can a non-European understand and manage the intricacies of European politics? Certainly as much as a European could understand the intricacies of Asia in the late 1990s. There is a long track record of non-Europeans who have been very adept at managing the complexities of Europe. The European Department of the IMF itself is an example, with a string of officials, from Michael Deppler to today’s Ajai Chopra, who have commanded widespread respect in the Europe. Can the emerging countries defend a common candidate? This is probably the biggest reason why it remains likely that the next MD will be a European. For all their customary squabbling, the Europeans have a powerful coordination mechanism with the machinery of EU institutions and meetings. This does not exist in the emerging world, where the rhetoric can be common but common positions on substantial matters are not frequently achieved. If the BRICS were able to field a joint candidate, it would be a game-changer. But this remains less than likely.

The European Union should start a debate on too-big-to-fail

This column co-authored with Morris Goldstein was published online by Vox, and also in Dutch by NRC Handelsblad.

The existence of too-big-to-fail financial institutions represents a three-fold policy challenge.

• First, such institutions exacerbate systemic risk by blunting incentives to manage risks prudently and by creating a massive contingent liability for governments that, in extreme cases, can threaten the latter’s own debt sustainability; Iceland in 2008-2009 and Ireland in 2010-2011 serve as dramatic, recent cases in point.
• Second, too-big-to-fail financial institutions distort competition. The 50 largest banks in 2009 benefitted from an average three-notch advantage in their credit ratings (BIS 2010) -- an advantage presumably related in part to the higher likelihood of official support at times of crisis.
• And third, the favoured treatment of too-big-to-fail institutions – often summarised as “socialisation of losses and privatisation of gains” – lowers public trust in the fairness of the system (Johnson 2009).

It is no wonder then that the too-big-to-fail issue is at the forefront of the debate on financial regulatory reform --as least as seen from Washington DC, London, and Zurich. Federal Reserve Chairman Ben Bernanke testified in September 2010 that “if the crisis has a single lesson, it is that the too big to fail problem must be solved” (Bernanke 2010). US Treasury Secretary Tim Geithner underscored that “the final area of reform (…) is perhaps the most important, establishing new rules to constrain risk-taking by – and leverage in – the largest global financial institutions (Geithner 2010). The Dodd-Frank Act of 2010 contains a host of provisions targeted at the regulation and supervision of systemically-important financial institutions, including enhanced risk-based capital, leverage, and liquidity standards and the requirement to prepare and maintain extensive rapid and orderly dissolution plans. In the UK, Bank of England Governor Mervyn King emphasised in a recent interview that “the concept of being too important to fail should have no place in a market economy” (King 2011). And later this month, the Vickers Commission is slated to give its recommendations on the banking industry, including its verdict on the merits of separating functions within the largest banks. Meanwhile, in the strongest approach to date to deal with the too-big-to-fail problem, a committee of experts appointed by the Swiss Federal Council (and including a representative from the Swiss National Bank) recommended that the total capital requirement for Switzerland’s two largest banks (UBS and Credit Suisse) be set at 19% of their risk-weighted assets, and that at least 10% of those assets must be held in the form of common equity (Committee of Experts 2010). If adopted, these capital requirements would be substantially more rigorous than the minimums recently agreed under Basel III (Goldstein 2011).

It is all the more remarkable then that the too-big-to-fail problem is barely present in substantial financial policy debates and initiatives in most Continental European countries and at EU level, including the European Commission. These jurisdictions have tended to favour the application of uniform regulations to financial institutions irrespective of size and systemic importance, and have been generally reported as arguing against specific policies targeted at systemically-important financial institutions in international bodies such as the Basel Committee on Banking Supervision and the Financial Stability Board.

In a working paper that specifically analyses the transatlantic and intra-European variations of the too-big-to-fail debate (or absence thereof); we identify four broad reasons for this contrast (Goldstein and Véron 2011):

• First and foremost, the much higher degree of concentration of banking markets makes the too-big-to-fail problem more acute but also intrinsically more intractable in virtually all EU countries than it is in the US, which may explain a strong reluctance to consider financial reform through the too-big-to-fail prism in the first place; see Figure 1.

Figure 1. Aggregate assets to GDP of top three banks in selected countries (%)

Source: Bank for International Settlements

The higher assets-to-GDP ratios observed in Europe are mainly due to high banking sector concentration, significant international expansion of some major banks, and business models that lead banks to retain many assets on their balance sheet. Differences in accounting standards also play a role, but only to a much smaller extent.

Of course, a large part of this transatlantic difference would disappear if the systemic importance of Europe’s largest banks could be assessed against the size of the entire European economy, rather than national GDP. Indeed, the ratios of consolidated assets to European GDP for Europe’s largest banks are similar to the ones that can be observed in the US, or actually smaller when corrected for differences in accounting standards. Unfortunately, this is not the correct scale of analysis as long as no EU-wide policy framework exists for bank crisis management and resolution. Such a framework has been advocated and discussed by the IMF and others (see Cihak and Decressin 2007; Fonteyne and al 2010; Véron 2007; Wall et al. 2011) but has not achieved political consensus in the EU so far. Policy proposals are expected from the European Commission this year, but they are unlikely to result in more than incremental progress from this perspective (European Commission 2011).

• Second, most European countries have displayed a general reluctance to let banks fail irrespective of their size, so that the moral hazard problem is not confined to the largest institutions. An example of this (early in the recent crisis) was the German government’s rescue of IKB and of other small-to-medium-sized institutions at a significant cost to the taxpayer. By contrast, scores of US banks were allowed to fail since the start of the crisis, most of them (including the very large case of Washington Mutual) through the Federal Deposit Insurance Corporation’s receivership procedure that has no direct equivalent in many European countries. This difference can partly be traced back to long-term historical legacies and attitudes to risk and failure.
• Third, the interdependence between banking and political systems tends to be high in Continental Europe, though difficult to assess quantitatively in comparative perspective. Significant segments of Europe’s banking industry are constituted of non-commercial banks such as savings banks and mutual’s whose governance often directly involves elected officials, as in Spain or Germany, as well as directly state-controlled institutions such as Poland’s PKO BP or Germany’s Landesbanken. France’s tightly knit financial establishment, which brings together both senior regulators and senior bank executives, is another example of such interdependence. While the features vary markedly from one country, there is ample scope for capture of the policy debate and process by the industry’s dominant players.
• Fourth, nationalism continues to play a significant role in shaping Europe’s financial policy choices which tend to differentially protect and favour domestic “banking champions”, in spite of the non-discriminatory principles enshrined in EU treaties and their increasingly assertive enforcement by the European Commission. One result has been a near-generalised preference for intra-country bank mergers rather than cross-border ones, especially in larger Western European countries. This has tended to exacerbate the too-big-to-fail problem, both before the crisis and since its start.

The discussion on possible remedies to the too-big-to-fail problem is not a simple one, and no silver bullet is at hand. There are different dimensions to the problem, each of which is associated with different policy options: absolute bank size (which may be addressed with size caps or capital surcharges), market concentration (which calls for competition policy or limits to market share), conglomeration (Glass-Steagall-like separations, or the more recent Volcker rule), internationalisation (requirements for local funding and/or capitalisation), and complexity (central clearing of transactions, living wills). Depending on the context, definitions of systemically-important financial institutions generally rely on a mix of these criteria. But many gaps remain in our analytical understanding of the too-big-to-fail problem. Furthermore, much of the available research tends to be focused on the US case, whose features may not be easily extrapolated to non-US contexts (Demirgüç-Kunt and Huizinga 2011).

However, these analytical gaps should not be taken as an excuse to avoid an in-depth debate on the too-big-to-fail problem in Europe; on the contrary. Moreover, given the potential risks to systemic stability, there is a case for policy action even in the absence of analytical certainty. The very large too-big-to-fail problem faced by most European countries should motivate a broad policy discussion on how to reform banking structures in Europe to mitigate it. The sooner the better.

References

• Bernanke, Ben (2010), Testimony to the US Financial Crisis Inquiry Commission, September
• BIS - Bank for International Settlements (2010), 80th Annual Report, June
• Cihak, Martin, and Jörg Decressin (2007), “The Case for a European Banking Charter”, IMF Working Paper WP/07/73
• Committee of Experts (2010), “Final Report of Committee of Experts for Limiting the Risks Posed by Large Companies”, Swiss Financial Market Supervisory Authority and Swiss National Bank, October
• Demirgüç-Kunt, Asli, and Harry Huizinga (2011), “Do we need big banks?”, VoxEU.org, 18 March.
• European Commission (2011), “Technical Details of a Possible EU Framework for Bank Recovery and Resolution”, DG MARKT working document, January
• Fonteyne, Wim, Wouter Bossu, Luis Cortavarria-Checkley, Alessandro Giustiniani, Alessandro Gullo, Daniel Hardy, and Sean Kerr (2010), “Crisis Management and Resolution for a European Banking System”, IMF Working Paper WP/10/70, March
• Geithner, Timothy (2010), “Rebuilding the American Financial System”, speech at NYU Stern School of Business, August
• Goldstein, Morris (2011), “Integrating Reform of Financial Regulation with Reform of the International Monetary System”, Peterson Institute for International Economics Working Paper 11-5, February
• Goldstein, Morris, and Nicolas Véron (2011), “Too Big To Fail: The Transatlantic Debate”, Peterson Institute for International Economics Working Paper 11-2, January
• Johnson, Simon (2009), “The Quiet Coup”, The Atlantic, May
• King, Mervyn (2011), Interview in The Telegraph, March
• Véron, Nicolas (2007), “Is Europe Ready For a Major Banking Crisis?”, Bruegel Policy Brief 2007/03, August
• Wall, Larry, Maria Nieto, and David Mayes (2011), “Creating an EU-Level Supervisor for Cross-Border Banking Groups: Issues Raised by the U.S. Experience with Dual Banking”, Federal Reserve Bank of Atlanta Working Paper 2011-06, March