vol. 11 no. 1 march 2011 -...

Vol. 11 No. 1March 2011

RomanianJournalof European AffairsVol. 11, No. 1, March 2011

EUROPEAN INSTITUTE OF ROMANIA

Founding DirectorNiculae Idu

DirectorGabriela Drăgan

Editor-in-ChiefOana Mocanu

Associate EditorsMădălina Paula MagnussonMihai SebeGilda Truică

Editorial BoardFarhad Analoui – Professor in International Development and Human Resource Management, the Center for International Development, University of Bradford, UKDaniel Dăianu – Professor, National School of Political Studies and Public Administration, Bucharest, former MEP, former Minister of FinanceEugen Dijmărescu – Deposit Guarantee Fund RomaniaGabriela Drăgan – Director General of the European Institute of Romania, Professor, Academy of Economic Studies, BucharestAndras Inotai – Professor, Director of the Institute for World Economics, Budapest Mugur Isărescu – Governor of the National Bank of RomaniaAlan Mayhew – Jean Monnet Professor, Sussex European InstituteCostea Munteanu – Professor, Academy of Economic Studies, BucharestJacques Pelkmans – Jan Tinbergen Chair, Director of the Department of European Economic Studies, College of Europe - Bruges Andrei Pleşu – Rector of New Europe College, Bucharest, former Minister of Foreign Affairs, former Minister of CultureCristian Popa – Vice Governor of the National Bank of RomaniaTudorel Postolache – Member of the Romanian AcademyHelen Wallace – Professor, European University Institute, Florence

Romanian Journal of European Affairs is published by the European Institute of Romania7-9, Regina Elisabeta Blvd., Bucharest, Code 030016, RomaniaTel: (+4021) 314 26 96, 314 26 97, Fax: (+4021) 314 26 66E-mail: [email protected], http: www.ier.ro/rjea

ISSN 1582-8271DTP: Monica DumitrescuCover design: Gabriela ComoliPrint: Alpha Media Print, www.amprint.ro

[email protected]/rjeawww.amprint.ro

Contents

EU ECONOMIC GOVERNANCE REFORM: ARE WE AT A TURNING POINT?Daniel Dăianu 5

DEPOSIT GUARANTEE SCHEMES JOIN FINANCIAL SAFETY-NET Eugen Dijmărescu 24

ECONOMIC INTEGRATION AND STATIST REACH - TOWARDS A HOLISTIC ASSESSMENTClara Volintiru 31

ROMANIA AND INTEGRATION INTO THE EUROPEAN MODEL OF E-INCLUSION: FROM ACCESS TO THE USE OF ADVANCED COMMUNICATION SERVICESThe Social Dimension of Internet Diffusion in Romania: Examining the Connection between Internet Uses and FrequenciesGeomina Ţurlea, Esteve Ollé Sanz, Constantin Ciupagea 43

AN EXTENDED APPROACH TO E-INCLUSION AND ITS IMPLICATIONS FOR ROMANIAViorel Niţă 63

THE BOLOGNA PROCESS: THE REFORM OF THE EUROPEAN HIGHER EDUCATION SYSTEMSÉva Szolár 81

ESTABLISHMENT OF THE INTERNATIONAL CRIMINAL TRIBUNAL IN THE FORMER YUGOSLAVIA (ICTY): DEALING WITH THE “WAR RAGING AT THE HEART OF EUROPE”Galina Nelaeva 100

Book Review: Jack D. Eller, From Culture, to Ethnicity, to Conflict: An Anthropological Perspective on International Ethnic Conflicts Patty Zakaria 109

5

ROMANIAN JOURNAL OF EUROPEAN AFFAIRS Vol. 11, No. 1, 2011

EU ECONOMIC GOVERNANCE REFORM: ARE WE AT A TURNING POINT?

Daniel Dăianu*

Abstract**: The sovereign debt crisis is creating enormous anguish in the EMU. Not surprisingly, emergency measures continue to be used at a time when a sort of economic recovery seems to be underway. Against this background the European Council summit of last October considered a Task Force report with a telling name: “Strengthening economic governance in the EU”. This document is to be examined in conjunction with the governance reform proposals issued by the European Commission at the end of September and related documents. For the depth of this financial crisis and the “Great Recession” have forced EU governments and EU institutions to take a hard look at the governance structure of the Union. But it would be wrong to say that this demarche is an attempt to explore a terra incognita. From the very beginning of the European Monetary Union (EMU) there was some discomfort with its institutional underpinnings and there were misgivings regarding its optimality as a currency area. This explains why a train of thought underlines a political rationale, too, for the creation of the EMU. Likewise, criticism regarding the way regulation and supervision have been established in the Union is not of recent vintage. And insufficiencies of the Stability and Growth Pact (SGP), with almost all member states flouting its rules at various points in time, have been repeatedly pointed out. This said, however, the flaws of financial intermediation have been less tackled by policy-makers and central bankers for reasons which, partially, are to be found in a paradigm which has dominated economic thinking in recent decades. This paper focuses on roots of the huge strain in the EU (EMU) and main policy issues ensuing from the current crisis. It also looks at the stake NMSs have in a reformed EU economic governance structure. The challenges for EU economic governance reform are to be seen from a broad perspective: the crisis of the financial intermediation system; the sub-optimal character of the EMU; institutional and policy underpinnings of the EU (EMU) including the regulation and supervision of financial markets; the capacity of the EU to deal with global imbalances, etc. Nota bene: there is a “political reality” which constrains decisions in the EU; the latter is not a federal state and what appears to be rational when defined strictly economically may clash with implications of the political configuration of the Union.

Keywords: EMU, economic governance, fiscal policy, financial markets, economic crisis

*Daniel Dăianu is Professor of Economics at the National School of Political and Administrative Studies (SNSPA) in Bucharest, former Finance Minister of Romania and former MEP. His latest book is “Which way goes capitalism”, Budapest/New York, CEU Press. E-mail: [email protected]** This report is part of RCEP’s project Romania as an active actor in EU debates II and was financed by the Soros Foundation Romania under the Foreign Affairs Initiative programme. The paper was firstly issued as Policy Memo no 17, December 2010, within the Romanian Center for European Policies (RCEP).

mailto:daiandan%40b.astral.ro?subject=

6

DANIEL DĂIANU

1. Roots of the strain in the EU and policy issues

1.1 A flawed financial intermediation system

Financial stability has staged a formidable comeback on the policy-making agenda in advanced economies. Episodes of financial crises did occur in emerging economies during the past century recurrently. But they were thought about as a specific phenomenon of poorly developed financial systems and fragile institutions. Once the crisis engulfed almost the whole industrialized world1 a watershed chain of events has taken place. The current crisis has shown that something is structurally wrong with financial markets. The financial crisis cannot be explained only by years of cheap money and growing imbalances in the world economy. Mistakes in macro-economic policy were accompanied by gross abuses of securitization, excessive leverage, abnormally skewed incentives and a loss of moral compass, inadequate risk-assessment models and failures to check for systemic risks, a breakdown of due diligence and an almost blind belief in the self-regulating virtues of markets. Structure is key in understanding the current crisis. For, on one hand, it can derail even brilliantly conceived policies; on the other hand, for it can shape policies wrongly. For instance, complacency vis-à-vis the expansion of financial entities overexposes economy to major risks (like it happened with Iceland, Ireland, UK, etc). Or take a premature opening of the capital account, as it happened

in numerous emerging economies, and the policy approach which propounded total deregulation of financial markets as a means to foster economic growth.

Financial intermediation, as it has evolved during the past decades proves that not all financial innovation is good, that inadequate risk and business models have been used by banks and other financial institutions. Quite a while ago warnings were sent regarding the growing opaqueness of markets due to securitization and off balance sheet activity. Lamfalussy noted that financial integration made “crisis prevention and handling it more difficult” (p.73). Moreover, the financial industry has become oversized in not a few economies. The paradigm shift which is, currently, underway is rediscovering systemic risks: the complexity and inter-connectedness of financial markets, contagion effects, “Minsky moments”2. But there is need to make here a distinction between two opposed cognitive approaches: one that believes that nothing can be done about the evolution of markets, whatever the way financial innovation goes; and another approach, which does not take the complexion of markets as God given and has misgivings about a range of financial innovations. Networks do not mushroom accidentally only; they are also shaped by policies. As Haldane, the director of research at the Bank of England remarked: “Deregulation swept aside banking segregation and, with it, decomposability of the financial network. The upshot was a predictable lack of network robustness…”(p.31).

1 Local financial crises did happen in western economies in recent decades: in Scandinavian economies in the early 90s, in the US (the Savings &Loan Associations crisis) in the 80s, etc. Canada has been much less hit by the current crisis owing to its better regulated and supervised banking system.2 These are moments at which, according to Minsky, financiers lay waste to the economy

7


1.2 The EMU: sub-optimality and institutional and policy weaknesses

Nowhere is more glaring the impact of structure than in the European Union, in the EMU in particular. For, in this area massive cross border operations take place while national prerogatives in regulation and supervision, in tax policies stay, basically, in national hands. In addition, the EMU is still far away from an optimal currency area3.

The current crisis has highlighted the inadequacy of existing institutional and policy arrangements and a stark fact: that not all problems have a fiscal origin (though they may end up, ultimately, as public debt). These arrangements have favoured the accumulation of internal imbalances against the background of one-sided, inadequate policy tools. The “one size fits all” monetary policy of the European Central Bank (ECB) could not prevent excessive capital, frequently of a speculative nature, flowing into less

developed areas of the EMU, in the EU as a whole. Resource misallocation and bubbles were stimulated in this way. Likewise, an increasing entanglement of mutual exposure among financial entities4 has happened while burden-sharing arrangements in case of a failed entity were missing. Ironically, the ECB has been forced to turn into a de facto lender of last resort to various governments which have tried to prop up financial institutions, be it indirectly (by accepting a wide range of bank collaterals). Contagion effects have reinforced the sentiment that institutional and policy arrangements are precarious in the EU. Systemic risks, which have been engendered by “too big to fail” cases, are compounded by effects of a “too big to be saved”5 syndrome. This crisis is also one of deep financial integration, which the intensity of the sovereign debt crisis mirrors quite glaringly6. Thence arises the need for deep reforms of the EU governance structure.

3 The optimum currency area (OCA) theory says that the adoption of a single currency pays off when a single monetary area is highly integrated economically and has the capacity to adjust quickly to asymmetrical shocks. There are five core OCA properties namely: wage and price flexibility, trade integration, cyclical convergence, factor mobility, and fiscal federalism, which are used to assess an OCA area. On these accounts, the euro area still seems to have way to go for an efficient functioning. In the EU wage setting continues to be done, predominantly, at the national level, and quite often at the sectorial level. Within the euro-area real wages have tended to be downwardly rigid with a relatively high level of indexation. Although nominal interest rates have largely converged, there is a wide discrepancy among real interest rates of the euro zone members. Although business cycles synchronization appear to have increased within the eurozone countries, much of it has to do with the fall in the amplitude of global business fluctuations during the past decade, which benefited from low interest rates, high economic growth and low inflation. Considerable structural differences remain at the euro-zone country member level. European labor mobility remains fairly limited, despite persistent differences in regional unemployment. Given an independent EU monetary authority, the ECB, the argument for a EU Fiscal Authority appears to be compelling. This would create more room for maneuver for the fiscal mechanisms of purchasing power transfers in the face of idiosyncratic shocks. It would also place less pressure on the ECB when dealing with regional divergences. But the EU budget is little more than 1% of the EU GDP, providing limited scope for stabilizing cross-state transfers. Moreover, a large part of that budget is allocated towards spending on the Common Agricultural Policy and Structural Funds, which are weakly related to cyclical fluctuations in the individual member states.4 Banks outside of Greece, Ireland, Portugal and Spain hold 2 trillion euro in debt instruments from these countries, which underscores the systemic risk to the financial system if one or more borrower countries fails (data researched by by Jacques Cailloux, cited by Kanter)5 The overexpansion of some financial entities has dwarfed the capacity of home states to intervene in order to deal with systemic risks (Gros and Micossi). 6 Reinhart and Rogoff’s observation that deep financial crises are followed by sovereign debt crises is quite meaningful in the case of a highly integrated monetary union

8

DANIEL DĂIANU

In Europe, integration, with its financial component, was seen as a principal way to achieve catching up. And this economic philosophy brought about benefits. But it has also entailed vulnerabilities, which, therefore, are not to be linked exclusively, with weak policies. For even countries which were quite prudent budget policy-wise and limited their external disequilibria (ex: the Czech Republic, Poland, etc) were caught into the crisis maelstrom. Big bubbles and much investment in non-tradable goods sectors occurred in several NMSs7 following the opening of the capital account. Inadequate regulatory and supervisory arrangements operate in their case, too, in view of the size of cross-border financial flows and the domination of local markets by foreign banks. Outside Europe and learning from previous crises, emerging economies tried to forestall shocks by the accumulation of foreign exchange reserves as a buffer (a high premium was attached to them); uphill financial flows were seen as a cost for the build up of a wherewithal capacity in the advent of unanticipated shocks. Industrial policy aims, too, played a role in this respect.

Regulation and supervision of financial markets in the EU

Late in 2008 European leaders continued to be mired in the illusion of a relative robustness of EU economies; they seemed not realize the extent of EU headquartered big banks’ involvement in the origination and distribution of toxic financial products, the interconnectedness of financial markets,

the presence of a shadow banking sector in Europe as well. In addition, the distribution of responsibilities between home and host country and the inexistence of detailed burden-sharing arrangements in the event of a crisis has been a major handicap for the single market under conditions of deep financial integration.8 Under current arrangements, responsibility for the stability of financial institutions belongs to the supervisor of the country where they are headquartered whereas responsibility for the stability of financial systems belongs to the supervisor of the host country. This crisis reinforces the idea that a common rulebook, more integrated supervision, and a common framework for crisis resolution are all needed to match the degree of financial integration. On the other hand, the burden-sharing issue prompts national governments and supervisors to think more along national lines, in view of their accountability toward national tax-payers. How this contradiction will be addressed is essential for the future of European integration.

1.3 Redistribution of power in the world economy

The Lisbon Agenda was enacted in 2000, as an EU response to Asia’s growing assertiveness in the world economy. In a global space in which competition is taking place, frequently, via zero-sum games, there was evidence that the EU, as a whole, is losing ground. Europe 2020 is a resuscitation of the Lisbon Agenda, which was hardly a success. But one of the lessons of the past decade

7 A Bruegel publication highlights this type of capital flow into the Baltic economies, Romania, Bulgaria (Becker et al., “Whither economic growth in Central and Eastern Europe…”, especially chapter 2).8 As the de Larosiere report says, ‘The absence of a sound framework for crisis management and resolution (with sufficiently clear principles on burden sharing, customers’ protection, assets transferability and winding up) complicates the introduction of an effective and efficient supervisory system to avoid financial crises in the first place’ (p. 76).

9


is that national policies make a difference. The results of Scandinavian countries, of Germany in undertaking reforms with a view of improving competitiveness are a proof in this regard.

1.4 Global imbalances

Global imbalances enhance crises, which produce contagion effects. Can the EU push for a reform of the IFIs and of global arrangements which should limit dangerous global imbalances? The EU would gain in persuasion and bargaining power in the G20 to the extent it can deal with its own problems effectively. Yet, conflicting views and interests among EU member states reduce its internal cohesion and harm its power projection externally.

There are lessons which policy-makers

need to learn from this crisis: • price stability is not sufficient for securing

financial stability• fiscal prudence is not sufficient for

securing economic stability; • unless financial markets are properly

regulated and supervised they pose enormous systemic risks; this is particularly valid in a deeply integrated area such as the EU;

• private sector over indebtedness creates systemic risks when it involves “too big to fail” financial entities;

• ways have to be found so that private investors bear the risks they assume (for the rescue programs have increased moral hazard); banks (their share-holders, bond-holders) should not take for granted that whatever they do tax-payers’ money stays behind them;

• deep financial integration demands stronger regulation and supervision at the EU level;

• because of deep integration contagion effects hardly leave one immune to the effects of a crisis;

• the incompleteness of the policy regime in the EU (EMU);

• deep financial integration collides with the reality of national tax prerogatives;

• policy coordination needs to take into account EU-wide interests;

• trustworthiness among member states is essential for the sale of preserving the common public goods;

• national policies do matter for improving competitiveness, even when the room of manoeuvre is quite limited;

We are living in an increasing uncertain world, which diminishes policy effectiveness and asks for “policy space” (like fiscal space) in order to cope with “tail events” and non-liniarities (Taleb).

2. The EU policy response

The EU policy response to the current crisis has two components. One is a crisis management endeavour, which has tried to curb the economic downturn and avert financial meltdown. The ECB has taken an active role in this, which has gone much beyond its usual mandate. The other component aims at reforming the economic governance structure of the EU. This second component (which relies on policy recommendations of the Task Force of the European Council and the EU economic governance package of the European Commission9, the de Larosière group report, the Monti report, etc) is manifold. Some

9 This was made public on September 29th 2010. The European Parliament is expected to make amendments to this package

10

DANIEL DĂIANU

measures aim at improving the regulation and supervision of financial markets – from a global perspective too. Other measures focus on weaknesses of the EMU as a currency area and revealed flaws of the SGP in tandem with a prise de conscience regarding “internal imbalances” in the EU. The overall goal is to achieve: greater fiscal discipline; a broadening of and more effective economic surveillance (which refers to macroeconomic imbalances and vulnerabilities); deeper and wider policy coordination (“the economic semester”); a scheme for crisis management; and stronger institutions for effective economic governance.

2.1 Dealing with macroeconomic imbalances in the EU

2.1.1 Towards greater fiscal discipline

The sovereign debt crisis (ensuing from the financial and economic crisis) has heightened the fiscal sustainability policy concern at a maximum. Governments’ responses during this crisis and in other crisis episodes show that, in the end, trying to avoid a systemic collapse burdens the public debt. Consequently, strengthened fiscal discipline, as a primary element of the new policy framework, should be seen in conjunction with policies addressing macroeconomic imbalances in the EU. A stronger Stability and Growth Pact (SGP) is to be buttressed by better surveillance and better quality of the data gathered from EU member states. The new system would rely on a much stronger compliance regime via “financial and reputational sanctions”.

The preventive arm of the SGP considers the sustainability of overall public debt, while the corrective arm targets a budget deficit path which should bring down the debt to GDP ratio over time, in a consistent manner. The preventive component of SGP is to be added an “expenditure rule” aiming at limiting its annual growth in accordance with “a prudent medium term growth rate of GDP”, unless the excess expenditure is offset by measures on the revenue side. But “deterministic governance does not work in a stochastic world (Jean Pisani Ferry, p.2). If we accept this assumption the task of judging medium term dynamics for an economy gets more complicated and, thence, what are a prudent budget policy and an effective approach in dealing with overall imbalances.10 And if this is the case a political haggling between member states and the Commission officials may be unavoidable. Could the Council solve it via the procedure of “reverse majority voting” (which says that a policy recommendation/sanction would be given to a state unless a majority of member states opposes it). This debate would clearly be linked with the introduction of sanctions for countries which are in breach of their budget policy obligations.

The corrective component is to be modified by making the debt criterion no less important than the deficit criterion (according to a Commission proposal). Thus, public debt over 60% of GDP would force a country to bring it down at a pace of one twentieth of the excess over the previous three years. But making this modified rule work is not uncontroversial. For instance,

10 In the EMU, in particular, the room of manoeuvre of policy-makers is quite limited and adjustments have to occur, principally, via wages and product and service prices.complicates the introduction of an effective and efficient supervisory system to avoid financial crises in the first place’ (p. 76).

11


asking a country to bring down its debt during a recession period may be self-defeating –owing to the pro-cyclical nature of debt to GDP ratios. Nonetheless, as the current crisis has shown a grace period may be allowed to the extent a higher budget deficit is caused by automatic stabilizers while a government mounts a serious effort at reforming budget expenditure.

The criterion of public debt is to be better reflected in the budgetary surveillance mechanism with a focus on “fiscal sustainability”. This is because of the rise in public debts following bank rescue programs, apart from the impact of population aging and other factors. There will also be more attention given to the interplay between debt and deficit. Quite likely, the TF and the Commission experts had in mind Ireland and Spain when thinking of this aspect. For both these two countries, as members of the EMU, did not show budget profligacy before the crisis.

Except Hungary, NMSs do not have large public debts. But budget deficits have gone up dramatically in the wake of this crisis. In several NMSs problems in the private economy were transmitted to the public sector through reduction in the level of output (and thence, diminished budget revenues) and in the form of increased off balance-sheet public obligations and, especially, of increased deficits as a result of the deleveraging process in the private economy. As a Bruegel publication underlines, fiscal consolidation has to consider the risk of adding public deleveraging to the ongoing private deleveraging, for this could harm economic recovery11.

But there is also a risk of basing budgetary strategy on overly optimistic assumptions and of endangering the sustainability of public finances. Because a dramatic rise in budget deficits, in the wake of the current crisis, may not be a temporary affair. Particularly where there has been resource misallocation for years and structural budget deficits were hidden by bubbles, non-sustainable economic growth (this is, arguably, the case of Baltic countries, Bulgaria, Romania). Consequently, fiscal consolidation programs are necessary where there is a permanent loss of output and economic growth prospects have been impaired. Moreover, substantially increased borrowing interest rates (not least owing to worsened international credit markets and crowding out effects exerted by big economies’ borrowing needs) bring the spectre of a debt service snowball effect to the fore12. For instance, a positive differential between the GDP growth rate and the interest rate should be a sufficient condition for stabilizing the size of public debt provided this differential is superior to the budget primary deficit as a share of GDP. But, if there is a jump in the interest rate this differential can become inferior to the primary deficit, or even turn negative, and if this reversal persists the debt service turns into a destabilizing element in public debt dynamics. This is why, in most NMSs EU structural and cohesion funds get an additional strategic dimension --as a means of combating the influence of expenditure reduction (out of own resources) on aggregate economic activity and of bolstering public investment in a period of distress, of fiscal consolidation. These resources would

11 If growth remains depressed owing not only to low private but also public demand, these countries may face problems similar to those that Latin American countries went through in the 1990s. Then, interest rates shot up and growth remained depressed for years as governments ran high primary surpluses in order to repay their accumulated debt obligations (Becker et al., “Whither economic growth in Central and Eastern Europe”, p.131)12 Countries can default in spite of not having excessively large public debts (Sturzenegger and Zettelmeyer)

12

DANIEL DĂIANU

help prevent fiscal consolidation becoming pro-cyclical during a deep recession13; they could also raise the growth potential of economy, which was lowered by the deep crisis. The IFIs and EU supported adjustment programs in NMSs have, arguably, not paid sufficient attention to the strategic role of EU structural and cohesion funds in this new context. Likewise, how contributions made to private pensions schemes (which is part of the pension system reform) is accounted for in the measurement of structural budget deficits matters a lot.

The SGP should take into account the specific macroeconomic conditions of the countries in the region and, where necessary, conditional lending and measures to raise the absorption of EU funds should balance the need for fiscal consolidation in a period of private-sector deleveraging. The EU should support the adoption of national budgetary frameworks that promote sustainability and are conducive to counter-cyclical policies.

The automaticity of sanctions is a tremendously contentious issue14. The Council Summit of October 2010 ended up with a compromise formula that dented the initial suggestion to have full automaticity of sanctions, which, reportedly, was supported by the European Central Bank. On the other hand, the compromise seems to reflect Germany’s insistence that a debt resolution scheme involve the private sector in eventual

losses. As some point out, the “no bail out” clause (no co-responsibility for public debts) of the EMU arrangements is not synonymous with a no assistance provision. As a matter of fact, were assistance to be given on the basis of a strong program of reforms/adjustment – with proper conditionality attached—it would make full sense. Moreover, the EMU has likely reached a threshold from where solitary exits are pretty costly for the Union as a whole--because of deep financial integration, in particular.

A legitimate question is the suitability of an adjustment program. For there could be conflicting views in this respect, especially at a time when financial markets behave quite nervously and an economy can easily get into a spiral of vicious circles. Just think about CDS quotations during 2010, which are highly indicative of how a debt service (in EMU southern economies, mainly) can get out of control, in spite of attempts at fiscal consolidation.

The timing of the new governance framework implementation differentiates between euro zone and non-euro zone member states. One can say that a faster introduction in the EMU is justified by the deeper economic integration. On the other hand, intense contagion effects would ask for a stern EU wide surveillance system and policy coordination.

13 Romania is a particular case, in this respect, owing to its pretty low level of budget revenues (cca 30% of GDP while in almost all other NMSs this share is above 37-38%). It shows a significant jump in its public debt –from cca 22% at the end of 2008 to 30.1% in 2009 and an estimated 35% of GDP in 2010. Its debt service also went up considerably: from 0.8% of GDP in 2008 to 1.2% in 2009 and an estimated 1.6% in 2010, while the primary budget deficit rose to -7.1% in 2009 from -4.6% in 2008. The rise in the share of short term debt is also to be taken into account. 14 In the preventive part of the SGP sanctions would be consist of early warnings and, subsequently, interest-bearing deposits on the infringing EU state; in the corrective part and unless the State has not taken effective action to correct the excessive deficit “a fine will be imposed”, including a variable component related to the deficit level.

13


2.1.2 Broadening economic surveillance and dealing with macroeconomic imbalances

Broadening the scope of monitored macroeconomic imbalances and asking for related policy corrections is directly linked to the acknowledgement that competitiveness gaps strain the EMU15. Procedure-wise EU officials can use the logic of excessive budget deficit warning. As a matter of fact the Commission proposes that an “Excessive Imbalance Procedure” (EIP) be available, which should be backed by financial sanctions for EMU member countries. But as an analytic endeavour and making it operational, this is a highly demanding new exercise for EU institutions, for the Commission in particular. The latter has to come up with a scoreboard of indicators16 to be monitored constantly and prepare early warning recommendations for the Council. As some point out there is substantial vagueness in this regard (Giavazzi and Spaventa, Wiplosz).

Another issue is how would threatening “internal imbalances” be defined? For the scoreboard needs to get criteria on the basis of which judgments are to be made. Would markets discriminate among EMU member states in relation to their current account imbalances? Could a surplus economy be seen as being in violation of EMU stability when the latter is seen as a “public good”. Who would coordinate adjustment of imbalances in the EMU? How would

Germany be judged in view of its heavy export orientation, outside the EU borders? How would non-euro zone member states be examined through the lenses of surveillance, for these economies are supposed to be net capital importers? Would the rules for dealing with “internal imbalances” apply to them as well17? And a bottom line: wouldn’t measures to limit “internal imbalances” contradict the free capital flow as a rule of the game in the EU?18

There would be major implications for national policies which are asked to undertake corrective measures. Governments could become more involved in the management of the economy, in mediating between social partners for the sake of achieving competitiveness targets. How realistic is it? It may be that the experience of Scandinavian countries, of Germany in undertaking reforms and making markets more flexible (while not undermining the social fabric of society) indicates the road ahead. But as competitive devaluation can be damaging the same could happen with wage controls, etc throughout the EU. Can EU policy guidelines help in this respect? Is Germany supposed to provide a benchmark for competitive policies in the EU? Answers are still to be given. It is noteworthy that Germany has introduced a balanced budget rule and France is contemplating one as well. This measure could put pressure on other EMU economies to do the same. Will they oblige?

15 Duillien argues in favour an additional “stability pact”, which should limit the size of current account imbalances inside the euro-area16 Among these indicators one would range: current account balances, net foreign assets, real effective exchange rates, real estate prices, government debt ratio, private sector credit and its dynamics as a share of GDP, etc (see Buti and Larch, p.4)17 A dangerous current account imbalance could be deemed as such when its financing is, principally, done via borrowing and, or speculative inflows.18 This is question raised by Dabrowski too ( p.2)

14

DANIEL DĂIANU

2.1.3 Policy coordination: The economic semester

High hopes are pinned on “the economic semester”19 for improving policy coordination and internalizing EU priorities in national budgets. In order to ensure that macro-financial stability issues are considered alongside macro-economic, fiscal and structural policies, the relevant communications from the European Systemic Risk Board (such as warnings and recommendations) are to be taken into account. National budget frameworks will have to be constructed by addressing certain requirements: higher transparency and predictability; more reliable forecasting and effective multi-annual programming; the use of numerical rules in accordance with the SGP provisions; the functioning of independent bodies (fiscal councils) capable of providing thorough and honest assessment of government policies20.

Peer pressure and Commission and EU Council recommendations are supposed to help structure national budgets better, discipline national policy making. Nonetheless, it is questionable whether national priorities can be set by Brussels. Guidelines and constraints can be put forward, but how much would they count when it comes to deciding on

the composition of public investment, of overall budget expenditure, is an open question. At the end of the day, national parliaments are sovereign. The heated debate on the size of the EU budget for 2011 would indicate what is in the offing in this respect. Therefore, a key aspect herein is how to increase national ownership of Commission and Council recommendations and bring national politicians (members of national parliaments) more in tune with the thinking in EU institutions.21 Unless this is done an additional facet of the “democratic deficit” will arise, which is liable to cause new friction. To paraphrase “no taxation without representation: “no policy without representation” can endure.

For countries which are notorious for inadequate fiscal frameworks and weak local institutions, exogenous pushes would be helpful and should be welcome. Domestic fiscal rules and independent bodies (like fiscal councils) for checking how national policies are devised and implemented are also badly needed. These independent bodies need to be staffed with capable people (which implies that pay has to be adequate) and be given a status commensurate with their role. How would their independence and competence be secured depends also on by whom and how their senior management people are nominated.

19 This ex-ante coordination device was adopted by ECOFIN (The EU Council of finance ministers) on September 7 2010; it will cover policies to ensure fiscal discipline, macroeconomic stability, and to foster growth, in line with the Europe 2020 Strategy. “Existing processes – e.g. under the SGP and the Broad Economic Policy Guidelines – will be aligned in terms of timing while remaining legally separate. Stability and Convergence Programmes and National Reform Programmes will be submitted by Member States at the same time in the spring and assessed simultaneously by the European Commission” (The Task Force report, 2010)20 See also Council of the European Union (a)21 In order to enhance national ownership of the recommendations issued under the “European semester”, governments, when submitting the draft budget to the national parliament are expected to include policy recommendations by the Council and / or the Commission accompanied by an explanation of how these have been incorporated

15


2.2 Regulation and supervision of financial markets

2.2.1 The reform of the regulation and supervision

European policy-makers are pushing for an overhaul of the regulatory and supervisory structures of financial systems, including the parallel banking sector and rating agencies. Harmonization of rules is not a sufficient response to the crisis, since the very content of regulations and supervision needs radical change. This is what comes out prominently from the de Larosiere report and the Turner report (in the UK), from documents of the European Parliament and directives of the European Commission. A reformed regulatory and supervisory framework would observe certain basic principles: • all financial entities (including hedge

funds and private equity funds) should be regulated and leverage be constrained;

• derivative markets should be regulated (products be standardized/simplified and clearing houses be used);

• remuneration be tied to long-term performance and be constrained;

• banks be better capitalized (both the

amount and quality of capital, primarily of tier 1) and capital adequacy ratios set in light of systemic risks22;

• pro-cyclicality be avoided in macro-economic policymaking and the way banks modify their capital adequacy ratios;

• banks asked to hold equity shares of securitized loans;

• accounting rules should not fuel pro-cyclicality and be standardized globally;

• dealing with the “too big to fail” and “systemically important” entities: the splitting of big groups23 and a return to a sort of Glass-Steagall24 legislation are sensible options;

• regulatory arbitrage (including tax havens) be avoided;

• use of capital controls, where possible;• imiting volatility in exchange rates and

commodity markets (buffer stocks, curbing naked short-selling)25;

• the protection of consumers of financial services;

• transaction taxes as a means to help downsize an over-expanded financial sector, diminish negative externalities, and create fiscal revenues26.

22 The new form of Basel Accord (Basel III) would raise the tier 1 capital ratio to at least 7%. 23 Market power (concentration) leads to market abuse and, in banking, as this crisis has glaringly proved, to heightened systemic risks by the formation of conglomerates which have engaged in the manufacturing of synthetic products, used high leverage and very risky investment strategies. Ironically, “the oligopolistic banking system that has emerged from this crisis is riskier than the one that went into it” (Wolf p. 9). Those who claim that size does not matter use a self-serving argument. The British authorities have already taken steps in this field by asking several banks to divest from some of their business components.24 However complicated such an undertaking would be it does make sense. ‘Casino-type” banking has to be curtailed as much as possible and “proprietary trading” operations of banks be severely restrained. 25 Measures have been initiated by EU commissioners Michel Barnier and Dacian Ciolos in order to restrict naked short-selling.26 There are two basic issues here: a/ systemic risk, which cannot be divorced from size and b/ allocation of resources and distribution of profits. The intake from such a tax would help the IFIs cope with effects of crises in emerging economies, poor economies in general. Proceeds from such a tax could help the EU set up a stabilization scheme for dealing with crises and could help fund the EU budget (commissioner Janusz Lewandowski has alluded to such a use)

16

DANIEL DĂIANU

In the EU there is need to strengthen the regulation and supervision of major financial groups, which operate cross-border. Hopefully, the ESRB (European Systemic Risk Board) and the new three authorities27 (which will start to function from January 2011) will bring a decisive plus in this regard. The ESRB should intervene whenever credit expansion is threatening the stability of one or several of the EU member economies28. The G20 plans to regulate, more strictly, big banks, which have global operations, is a move in the right direction.

2.2.2 Financial stability in NMSs29

There are several means to enhance access to liquidity and mitigate solvency threats at a supra-national level; many of remedies have been implemented during the crisis: rules on convergence of deposit guarantees, which should prevent beggar your neighbour policies; medium-term financial facilities; IFIs credit lines and investments. Two avenues to improve the EU’s support to NMSs deserve discussion: swap lines between the ECB and central banks of non-euro area countries; a broadening of ECB range of accepted collaterals to national currency denominated bonds issues by non-euro NMSs countries. These two measures, which would have helped to ward off euro liquidity shortages, were considered but not implemented at the height of the crisis. They should if conditions require them again.

Preventing credit booms will be an issue again in NMSs, sooner or later. Instruments that can be used are: counter-cyclical capital and reserve requirements; dynamic provisioning against expected losses; limits on leverage and maturity mismatches; discretionary macro-prudential measures under the guidance of newly created macro-prudential supervision bodies such as the European ESRB. The difficulty for the NMSs is that this toolbox mostly applies to countries where credit is in the hands of national banks or autonomous local subsidiaries of foreign banks. It is not likely to be effective in countries where credit is mostly in the hands of foreign bank branches or lending can be outsourced to foreign entities of the banking group (i.e. the parent bank or a subsidiary in another country). Coordination among supervisors can be a response and should continue being developed but calling for coordination is no solution when institutions participating in it have different, possibly conflicting mandates and incentives. This is where the role of the ESRB comes prominently into the picture. NMSs cannot rely on capital controls as the single market prohibits such measures. Therefore, the risk of destabilizing capital inflows leading to credit bubbles has to be addressed through other means, which may include action on the demand for credit. Regulatory and tax instruments can for example be used to tame mortgage credit when deemed excessive from a macro-prudential point of view.

27 The current EU Committees of supervisors (The Committee of European Securities Regulators (CESR), Committee of European Banking Supervisors (CEBS) and Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) would turn into European Supervisory Authorities (ESAs): a European Banking Authority (EBA), a European Insurance and Occupational Pensions Authority (EIOPA), and a European Securities and Markets Authority (ESMA). National supervisors should remain responsible for day-to-day supervision of individual firms. A steering committee of the ESAs should be set up to reinforce mutual understanding, cooperation and consistent supervisory approaches, in particular in relation to financial conglomerates, and to coordinate the necessary information sharing between the ESAs and the ESRB.28 This could involve applying differential minimum reserve requirements or by imposing anti-cyclical capital ratios (de Grauwe, a, p.5)29 This section draws on “Whither growth in central and eastern Europe” (2010)

17


Since non-euro zone EU members states’ financial markets are dominated by foreign groups, the home-country authorities have to work very closely with host-country authorities should a case of bank distress appear. It would be important for governors of the central banks (representing the main regulatory/supervisory bodies) in the region to keep in close contact and coordinate their measures.

2.2.3 Euro adoption

The crisis in the euro area shows that removing the option of adjusting a nominal exchange rate may be very costly in terms of fiscal adjustment if it is not accompanied by efforts to limit excessive demand in the private sector, even if fiscal policy is broadly in order. However, limiting excess demand in the private sector is not easy to achieve for national governments that have surrendered their power over monetary policy in an environment with free capital mobility. It is noteworthy that housing and credit booms in Ireland and Spain, and in several NMS have been quite similar, suggesting that the fall in real interest rates as the result of financial integration and economic catching-up matters both inside and outside the euro area. Euro outsiders should therefore be careful before fixing the exchange rate and should allow as much flexibility as possible on the way to euro adoption; they, in any case, should introduce measures preventing the emergence of unsustainable credit booms. But host country authorities may not be effective in this effort because of deep financial integration.

The crisis in the euro zone, in particular, the competitiveness problems of Spain, Portugal and Italy and the inability of these countries to adjust their competitiveness

inside the euro area highlights a big policy issue: Should the criteria for the optimal currency area (OCA) be fulfilled ex ante, i.e. before a country enters the euro area, or is it sufficient to expect that they will be fulfilled ex post, i.e. euro admission will create structural changes in the economy that will make the country suitable to the monetary union, even if it had not been before? The inability of southern EMU countries to adjust to competitiveness pressures inside the euro zone suggests that it would be better for euro newcomers if OCA criteria are satisfied ex ante and there are policy instruments to guide the eventual need to adjust real exchange rate divergences ex post. The NMSs form a multi-coloured cluster; some of them are better integrated in EU industrial networks and show balanced trade accounts, while others (including Romania) have skewed trade imbalances and much of capital inflows went into non-tradable sectors. Therefore, their chances of joining EMU are not similar.

A stumbling block for euro accession are the Maastricht criteria – which look more difficult to fulfil in view of the evolving European economic context (not to mention the Balassa-Samuelson effect in the case of catching-up economies). The EU could, in theory, adopt a more permissive approach towards NMS countries willing to adopt the Euro by relaxing/adapting the Maastricht criteria requirements. But allowing economies with a rather more “fragile” position to join the euro zone would weaken the Euro. Nevertheless, several NMSs are more liable to be fiscally sound, inside the Euro area, then some older EMU member states. And if this is the case the menace of a weakening euro, because of an eastern enlargement of its area, loses some of its punch.

18

DANIEL DĂIANU

2.2.4 A mechanism for crisis resolution The sovereign debt crisis in the euro

area shows that the EMU policy framework is incomplete. EMU did not have policy tools to manage and resolve the crisis. After much delay the European Union agreed on assistance for Greece and created the European Financial Stability Facility (EFSF) for a three years period (until 2013). The ECB has called for the creation of a crisis management fund for the euro area, which would come into play if the strengthening of the rules-based framework does not suffice to prevent future debt crises. Such a fund should provide ‘last-resort financing’ at penalty rates to governments facing difficulties in accessing private credit markets. The European Council of 28-29 October 2010 stated that ‘Heads of State or Government agree on the need for Member States to establish a permanent crisis mechanism to safeguard the financial stability of the euro area’30.

A recent report says that “The absence of any rules guiding market expectations about how governments and the Commission would respond to the crisis contributed to the volatility of financial markets during the crisis and this, in turn, contributed to the sense of urgency policymakers felt about the need to act”(Gianviti et.al,). The authors suggest the creation of a European Crisis Resolution Mechanism (ECRM) consisting of two pillars: A procedure to initiate and conduct negotiations between a sovereign debtor

with unsustainable debt and its creditors leading to restructuring of its obligations in order to re-establish the sustainability of its public finances. And rules for the provision of financial assistance to euro-area countries as an element in resolving the crisis. Should a euro-area country be found insolvent, the provision of financial aid should be conditional on the achievement of an agreement between the debtor and the creditors re-establishing solvency.

However, making the above mentioned proposal operational is not going to be easy. For instance, how to deal with the classic “free rider” problem that is the creditors who do not wish to participate in an orderly debt restructuring that implies “haircuts”. Are “collective action clauses” a sufficient instrument in this respect? There is also a view which says that the proposed sovereign debt default mechanism will make the EMU more prone to crises since it will introduce speculative dynamics into it, and an analogy is made with the Exchange Rate Mechanism (ERM) that preceded the start of the euro zone (de Grauwe, b, p.3). Because of such problems some see a European version of the IMF, as suggested by Gros and Mayer, as an alternative to a post-ESFF institution (Nielsen). There is even a train of thought which says that there is no need for a formal mechanism, that traditional tools, such as an exchange bond offer, would be sufficient (Roubini). But, high mutual exposure among financial entities in the

30 A French-German agreement on 18 October talks about setting up a ‘permanent and robust framework to ensure orderly crisis management in the future’. German authorities are reported to be preparing a proposal for coordinating the demands of bond holders in a sovereign debt crisis and imposing ‘haircuts’ on the face value of the debt of a government in financial distress. The German position is revealed by finance minister Wolfgang Schauble’s words: “it is worth remembering that monetary union was not intended to be a panacea for eurozone members, or for that matter a get-rich scheme for financial speculators. Nor was it meant to be a system of redistribution from richer to poorer countries via cheaper borrowing for governments by means of common Eurobonds or outright fiscal transfers. European Monetary Union won’t succeed if some countries persistently run deficits and weaken their competitiveness at the expense of the euro’s stability”(p.60). What this position underestimates, in my view, are implications of EMU’s sub-optimality and the need to use more effective tools in order to foster real convergence in this area.

19


EMU and powerful contagion effects would make individually triggered sovereign debt restructuring highly risky for both the country involved and the euro area. Moreover, as the experience with Greece and Ireland shows a country would hardly swallow its pride and declare, of its own volition, a moratorium on debt payments and ask for a restructuring. Another big problem can be that an inconsistent combination of “no bail out, no exit, no default” (as in the current EMU arrangements) would turn into another inconsistency, namely: the possibility of default, persistent imbalances and lack of proper fiscal arrangements (Munchau). This brings us back to square one, namely, the possibility of having a monetary union without a solid fiscal (budget) underpinning. Added to this is the need for real economic convergence in the EMU. Can Europe 2020 provide an effective tool to this end?

In the meantime, one wonders whether the fiscal adjustment programs, which are undertaken in several EMU countries, are all realistic; it appears that, in some cases a sovereign debt restructuring is unavoidable, in the end. This is more necessary since these programs are taking place in a pretty hostile external environment. Could EU policies play a role in bolstering the chances for these programs to be successful?

2.3 Dealing with global imbalances

The current crisis has reinforced one of Keynes’ intellectual legacies, which was enshrined in the Bretton Woods arrangements —namely, that highly volatile capital flows are inimical to trade and growth and that financial markets are inherently unstable31.

As a matter of fact restraining financial flows is a way to solve the the impossible trinity, which says that an autonomous monetary policy, stable exchange rate and free capital flows cannot be achieved concomitantly32. Therefore, if free trade and relative stability of exchange rates are to support durable economic growth capital flows need to be managed. The French government signalled its intention to enlist G20 in an effort to rethink and overhaul the architecture of the international financial system – which goes beyond redistribution of voting rights in the IFIs. The increasing number of emerging economies which resort to capital controls (in order to stem speculative flows) is quite telling about actual dynamics in the world economy. The IMF’s policy turnaround in this respect is also noteworthy.

3. Issues to ponder on

Disentangling private from public debt has become a huge, overwhelming issue in the EU in view of its deep financial integration. It is likely that the rescue program for Greece and Ireland were not least motivated, by the big exposure French, German and other European banks have to Greek and Irish sovereign debt. Private sector (bank) debts are making up enormous contingent liabilities on public debts when bankruptcies are not tolerated (not to mention the moral hazard problem). This is one of the big revelations entailed by the current crisis. And the inability to disentangle the myriad of intertwined debts will impact, negatively, on fiscal policies for years to come. Even now this feature of deep financial integration seems to be under-estimated by some. What

31 For John Maynard Keynes’ contribution to the debate on the Bretton Woods arrangements see also Eichengreen. Skidelsky argues that it is high time to undertake a reform of the international monetary system and use some of Keynes’ ideas. 32 This is shown, analytically, by the Mundell-Fleming model.

20

DANIEL DĂIANU

is worrisome is that bank consolidation would preserve the hostage relationship governments budgets are held into. Ways must be found to make sure that a golden rule of market economy operates, namely, that investors bear the risks they assume and losses are not socialized.

The current crisis has refocused attention on public budgets owing to big jumps in their size, which were registered in countries where large financial entities were threatened by collapse and state intervention (rescues) occurred. But fiscal deficits are no less important in economies where the economic downturn has been significant and a permanent fall of potential output has, quite likely, ensued –where the crisis blew up bubbles and revealed years of resource misallocation. A country may have a relatively low public debt, but if its structural deficit is pretty high its debt service can skyrocket. Unless fiscal consolidation is put into motion a solvency crisis looms at the horizon. Related to this issue is the relevance of economic indicators. Fiscal deficits may be low for a while, until they explode when “hidden” imbalances come into the open. In the EMU, current account imbalances among member states were not paid attention until this crisis hit. Some use an analogy with the US which, arguably, is hardly relevant in view of very different fiscal arrangements.

Fiscal rules, surveillance and peer pressure may not be enough for strengthening the cohesion of the EMU, of the EU in general. A handicap in the EU is linked with the political reality that tax-payers are, ultimately, national citizens. Can “common goods” (including the euro) be protected unless “common resources” (the EU budget?) are more substantial? Can resolution schemes and orderly restructuring schemes of sovereign debts be devised so that they compensate the smallness of the EU

budget and complexity of the EU decision making process? Can the EU policy-makers use additional instruments in order to foster more real convergence in the EMU, in the EU as a whole? Is there room for strengthening policies at EU level?

Would a deflationary bias in the conduct of monetary policy appear in view of the willingness to prick bubbles in their infancy? On the other hand, would’ n’ it, by fostering less instability, support long-term growth? This is also an issue which demands more thorough answers. In a way, answering this question is analogous to deciding on a proper speed of implementing Basel III: for a too fast implementation could stifle recovery; on the other hand, a too slow implementation would create prerequisites for a new crisis.

Debt deflation is a policy risk, though less in the EU than in the US. If this occurs in several major economies a relapse into a financial crisis would ensue, with staggering effects. A “Japanization” of these economies, namely a long period of stagnation induced by liquidity trap and low consumption, would take place. Financial stability would be once more at the top of public agenda in view of the steadily worsening bank balance-sheets. Public debts would be additionally burdened provided an exit via deliberate creation of inflation is considered not an option. And intense contagion effects would also be at work.

Does size matter for judging fiscal risk? It appears it does. Large economies are, seemingly, considered to have a bigger capacity to resists shocks; they are, potentially, more resilient. Resilience (ability to withstand external and internal shocks) will increasingly be a principal policy aim in the years to come.

What would be the impact of new technology for circumventing rules (ex: high-frequency trading)? Regulators and supervisors need to take it into account as

21


well, when thinking about financial stability. The latter can be linked also with the capacity of economy to withstand effects of natural disasters, with social strain. Demographics, too, plays in a role when it perturbs inter-generational balance and, consequently, fiscal equilibrium.

The years to come will quite likely be accompanied by an increasingly uncertain environment; complexity will also be on the rise. These circumstances advocate a simpler, resilient financial intermediation system, for the sake of its own stability. If this does not happen and global imbalances persist, more fragmentation is to be expected, with societies turning, probably, more inward-looking. This will have profound implications for the global system. It may be that, in view of the lessons of financial crises and of the need to lend to economies more resilience, there is an optimal size of openness (trade and finance-wise). This implies that firms need to think globally and operate selectively as a means for mitigating risks. It may also be the case that we will end up with a three blocs-based financial system as a means to maintain a relatively open global system (Dăianu, 2009, 2010).

Final remarks

This paper puts emphasis on structure and networks in understanding the roots of the current crisis and the tension in the EU (EMU). Such a perspective reinforces the rationale for a reform of the EU economic governance. As this crisis indicates it is

not only fiscal rules and their compliance with that a proper functioning of the EMU hinges on. Flaws of financial intermediation, growing imbalances stemming from the dynamics of private sector saving and investment flows, inadequate regulation and supervision of financial markets, have played a major role in triggering the sovereign debt crisis in the EMU. The overexpansion of financial institutions and their investment behaviour are to be highlighted as well. Consequently, a reform of the EU economic governance has to deal with fiscal rules and compliance, macroeconomic disequilibria and competitiveness gaps, the regulation and supervision of financial markets. The need to tackle global imbalances and overhaul international arrangements is to be mentioned in this context. Fostering real economic convergence remains a major issue in the EMU. Therefore, the EU institutions need to address this issue more thoroughly. A threat for the EMU is a growing cleavage between its northern tier and its southern tier, with the latter becoming, possibly, mired into vicious circles, incapable of overcoming the impact of fiscal consolidation in a hostile external environment. Another chasm could be deepened between older EU member states and several NMSs. Can Europe 2020 provide a light in this regard? NMSs have a deep stake in EU governance reform since they cannot escape the impact of EU wide externalities and the functioning of their economies depends on the rules of the Union.

22

DANIEL DĂIANU

REFERENCES

• Becker Torbjorn and Daniel Dăianu, Zsolt Darvas, Vladimir Gligorov, Michael Landesmann, Pavle Petrovic, Jean Pisani-Ferry, Dariusz Rosati, Andre Sapir, Beatrice Weder Di Mauro, (2010), “Whither Growth in Central and Eastern Europe? Policy Lessons for an Integrated World”, Bruegel Bluprint Series;

• Buti, Marco and Martin Larch (2010), “The Commission propsals for stronger EU economic governance”, VoxEU, 14 October;

• Dabrowski, Marek (2010), “Macroeconomic surveillance within the EU”, CASE network E-briefs, No 13, November;

• Daianu, Daniel (2009), “Limits of Openness”, in European Ideas Community, Europesworld, 17 August

• Daianu, Daniel (2010), “The Economic Monetary Union: Entering an Age of Diminished Expectations and Growing Uncertainties”, in “The Euro in 2019”, Revue d”Economie Financiere, no. 96, January, pp.135-150;

• Dullien Sebastian (2010), “Towards a sustainable growth model for Europe”, Berlin, 1/IPG, pp.36-44

• Eichengreen, Barry, (1996), “Globalizing capital. A history of the international monetary system”, New Jersey, Princeton University Press;

• Grauwe, Paul de (2010, a), “What kind of governance for the eurozone?”, CEPS Policy Brief, no.214/September 2010;

• Grauwe, Paul de (2010,b), “A mechanism of self-destruction of the eurozone”, CEPS Commentary, 9 November;

• Gianviti, Francois, Anne A. Krueger, Jean Pisani-Ferry, Andre Sapir, Jurgen von Hagen, (2010), “A European Mechanism for Sovereign Debt Crisis Resolution: A Proposal”, Brussels, Bruegel, 9 November;

• Giavazzi, Francesco and Luigi Spaventa, (2010), “The European Commission’s proposals: empty and useless”, VoxEU, 14 October;

• Gros, Daniel and T. Mayer, (2010), „Towards a Euro(pean) Monetary Fund”, CEPS Policy Brief, no.202, February;

• Gros, Daniel and Stefano Micossi (2008), „The beginning of the end game”, VoxEU, 20 September

• Haldane, Andrew (2009), “Rethinking The Financial Network”, Speech at the Financial Student Association in Amsterdam, April,

• http://www.bankofengland.co.uk/publications/speeches/2009/speech386.pdf.• Kanter, James (2010), “Bondholders and EU square off over Ireland”, International

Herald Tribune, 12 November;• Lamfalussy, Alexander (2000), “Financial Crises in Emerging Economies’”, New

Haven, Yale University Press;• Minsky, Hyman (1986), “Stabilizing an Unstable Economy” (first edition), New

York, McGraw-Hill, 2008;• Monti, Mario (2010), “A new strategy for the single market”, report to the President

of the European Commission, 9 May;

http://www.bankofengland.co.uk/publications/speeches/2009/speech386.pdf

23


• Munchau, Wolfgang, (2010), “Fiscal union is crucial for the euro’s survival”, Financial Times, 15 November;

• Nielsen Erik, (2010), “Eurozone must fashion its bond haircuts in an appealing style”, Financial Times, 10 November;

• European Commission (2010), “A new EU economic governance –a comprehensive Commission package of proposals”, 29 September;

• European Council (2010, a), “National fiscal frameworks: report on the exchange of best practice”, Brussels, 7 October;

• European Council (2010), “Strengthening Economic Governance in the EU. Report of the Task Force to the European Council”, Brussels, 21 October;

• EFC (2009), “Lessons from the financial crisis for European financial stability arrangements”, EFC High-Level Working Group on Cross-Border Financial Stability Arrangements, 18 June;

• Pisani-Ferry, Jean, (2010), “Euro-area Governance: What Went Wrong? How to repair it?”, Bruegel Policy Contribution, June;

• Roubini, Nouriel (2010), “Irish woes should speed Europe’s default plan”, Financial Times, 16 November;

• Reinhart, Carmen M. and Kenneth S. Rogoff (2009), “This Time is Different. Eight Centuries of Financuial Folly”, Princeton, Princeton University Press;

• Schauble, Wolfgang (2010), „A Plan to tackle Europe’s debt mountain”, Europesworld, Automn;

• Skidelsky, Robert (2010), “A golden opportunity for monetary reform”, Financial Times, 10 November

• Sturzenegger, Federrico and Jeromin Zettelmeyer (2006), „Debt Defaults and Lessons from a Decade of Crises”, Cambridge (MA), MIT Press;

• Taleb, Nassim N, (2004), “Fooled by Randomness. The Hidden Role of Chance in Life and in the Markets”, London, Penguin Books;

• The High Level Group on Financial Supervision in the EU, chaired by Jacques de Larosière (2009), “Report”, Brussels, 25 February;

• The Turner Review. A regulatory response to the global banking crisis (2009), FSA, London;

• Wiplosz, Charles (2010), “Eurozone reform: not yet fiscal discippline, but a good start”, VoxEU, 4 October;

• Wolf, Martin (2009), “The Challenges of Managing our Post-crisis World”, Financial Times, 30 December.

24

DEPOSIT GUARANTEE SCHEMES JOIN FINANCIAL SAFETY-NET

Eugen Dijmărescu*

Abstract: Deposit Guarantee Schemes (DGS) become more visible under the current conditions of the world financial markets. If those have played in the past a rather discreet role for social stability through the function of pay box following a bank failure, the recent crisis put them in a new light, once the guarantee ceiling for eligible deposits grew in order to make for the accumulation of wealth worldwide and the increased risk incurred by the leverage of banking operations. Consequently, the resources accumulated by the DGS from the member banks and their proper management make possible their involvement in pre-emptive actions aimed to avoid bankruptcies via special administration and purchase of assets and assumption of liabilities. These new attributes give DGS a role in the mechanism of financial safety-net, along the supervisors of the market. Hence, an increased preoccupation for applied corporate governance has developed and Core Principles for Effective Deposit Insurance Systems have been adopted by the Basel Committee on Banking Supervision together with International Association of Deposit Insurers. Concurrently, the EU Commission has put forward a process for reviewing the Directives 94/39 and 09/14 EC, in order to make the European DGS more prepared to deal with above mentioned issues and bestow increased confidence upon depositors.

Keywords: deposit guarantee scheme, deposits, banking system, surveillance, risks

Recent developments in the World financial market, touched deeply by the first outburst of the globalization crisis, have brought upfront the search for reassessing the role of the deposit guarantee schemes (DGS) within the broader task of achieving a new monetary order sought by G20 for the past two years. Indeed, the DGS, especially in Europe, have primarily assumed up to now the role of compensating the loss incurred to customers by the insolvency of banks. Hence, their prime task was to back up the social stability, as their competence was to

provide liquidity mainly to natural persons and, to a more restricted scale, to corporate.

The huge amount of money raised mainly out of taxpayers revenues and spent since 2008 by those policies seeking to put a brake to the derailment of the international banking system, have unveiled the capabilities of DGS, especially in those countries where by their powers and organization the DGS are the alternative or the complement to scarce resources of public treasuries. Almost all political and scientific forums have highlighted the support of the

* Eugen Dijmărescu, PhD, is currently the CEO of the Bank Deposit Guarantee Fund (FGDB) in Romania, the sole such organization in the local banking market since 1996. Before joining the FGDB he served as Deputy Governor to the National Bank of Romania, responsible, a.o for financial stability and open market operations. He has also been a member of the Board of the Central Bank. He is an associate professor to the Romanian-American University of Bucharest and an associate fellow to the National Institute for Economic Research of Romania. Opinions expressed herein belong to author and they do not bear any responsibility of the Romanian Bank Deposit Guarantee Fund. E-mail: [email protected]

ROMANIAN JOURNAL OF EUROPEAN AFFAIRS Vol. 11, No. 1, 2011

mailto:eugen.dijmarescu%40fgdb.ro?subject=

25


head of states and government of G20, of the institutionalized watchdogs for financial stability (IMF, BIS, ECB), or even prominent economists for the “market solution”, i.e. for a search for mechanisms and instruments to intervene, if needed, within the mechanics of the market. This is a normal choice for preserving the system that brought prosperity to all and has endorsed the competition. In this context the legitimate question is: are the DGS ready for assuming a role towards the future? Are they ready to assume new responsibilities to the traditional task of being a “pay box”?

Within the European Union the DGS are organized according to national regulation and with the support of the common guide represented by the Directive 94/19 EC and its subsequent amendments (Directive 09/14 EC). The organization of the European DGS goes from entities located within the central banks to independent bodies, either public or private, one or more for the same banking market, with resources derived from ex-ante or ex-post contributions of the member banks. Until now the EU has not succeeded to give DGS the feeling of cohesion from the functional point of view (even the term “scheme” generalizes the variety). Moreover, the different chain of their command has not entitled the DGS to the position of a partner to EU bodies and even their professional association, the EFDI (European Forum of Deposit Insurers) is only consulted by the EU divisions, if deemed necessarily. This is an outdated behavior compared to the BCSB/IADI approach recognizing that “a deposit insurance system clarifies the authority’s obligations to depositors, limits the scope

for discretionary decisions, can promote public confidence, helps to contain the costs of resolving failed banks and can provide countries with orderly process for dealing with bank failures and a mechanism for banks to fund the cost of failures”.1

Nevertheless, a noted realignment of politicians from the trenches of claiming new public debt to cope with bank insolvency increases the attraction for DGS involvement. This is due to the insurer capability of DGS which, by collecting annual premiums from the banks, gather resources from the banking system which spares thus public treasuries and the taxpayers from new constraints.2 From this point another discussion may be opened about the availability or scarcity of DGS resources, the timing for their collection and the related costs to the banks of the insurance extended to their customers by another entity.

The debate on the new role of DGS was initially, not to say properly, supposed to end with a revised and updated text of the Directive 94/19 EC before the end of year 2009. At least that was the spirit of Pittsburgh and London of G20 Summit. But another year has elapsed without much progress. On the contrary, an icy analysis of the changes brought to the proposed text of the EU Commission by the member states in the second half of 2010 enlightens the setback from the pan European view of comprehensive approach to a mere national behavior that will further deprive Europe of the power to pair with other major players in dealing with the issues of the globalized financial market. Examples that may be quoted are: EU regulators and

1 Basel Committee on Banking Supervision/International Association of Deposit Insurers - Core Principles for Effective Deposit Insurance System, June 2009.2 “Taxpayer money should not be used again to cover bank losses” - Ana Maria Tarantola, Strengthening Financial Stability: The Contribution of Deposit Insurance, IADI/EFDI Annual Conference, Rome 2010. See also Pittsburgh G-20 meeting, September 2009.

26

EUGEN DIJMĂRESCU

supervisors have authorized banks to offer their customers the freedom of choice between currencies for their deposits and banking operations, but when it comes to whatever form or repayment, derived from insolvency of a bank, the limitation to national currency is preferred; another example is the reduction to “non-prevented” possibility of borrowing/lending among EU DGS which is a straighter indication of refraining from further rise of money in the domestic market via floating treasury bonds or other securities sold to taxpayers. The inconsistence stemming from the setback from the idea of fostering similar regulation of DGS throughout EU will unavoidable affect the dynamics of European solidarity while confronted with common threats that may occur also in the framework of cross border banking activity. The debate about which of the approaches bear a higher risk should be moderated by the forward looking attitude required for better mastering of financial market developments in the aftermath of the recent drop offs.

However, related to the proposed amendments one issue needs to be mentioned: the more ambitious, deepen shift of the DGS from its current “pay box” statute into a responsible component of financial stability, by the endowment of DGS with the P&A function (Purchase and Assumption, in which all deposits – liabilities - are assumed, via intermediation of the DGS, by an open bank, which also purchases some or all of the failed bank’s loans - assets). At least, with reference to this issue, it should be remarked the European vision addressed by the Commission to national regulatory authorities, with the prospect for a better cohesion of DGS, thus making them partners to the monetary single market of Europe and to free capital movement.

The EU Commission project may be considered as up to the day minimum

consensus possible. Nevertheless since the European road toward finalizing any document is so much lengthened and as the prospect for viewing the phenomena which raised the initial interest repeated seems to be fading away, the chance for getting a final text so much different from the original is no longer a surprise. This might be another proof that Europe is so much keen to commit public authorities even if solution is deemed to be more expensive than of freeing the market more.

With respect to deposit insurance, the main issues are: (a) a unified guarantee ceiling of € 100,000 shall be applied by all member states, which establishes equal opportunities to customers in choosing their bank, as well as to local and foreign branches of banks from other EU members. Worth mentioning is the provision that this ceiling shall be applied by all credit institutions present in a market, so that branches are either affiliated to a DGS outside the host country applying at least the same ceiling, or they shall join the DGS from the host country which endorses the EU ceiling; (b) shortening of payout deadline to 20 workable days for the guaranteed amount of the restitution, so that social tension and possible contagion that may occur shall be contained at an earlier stage; (c) introduction of an automated system of payout for the restitution amount by the insurer, thus sparing the customer from queuing for getting his right; (d) introduction of a non-discriminatory and equal treatment to all natural and legal persons, meaning that all corporate enjoy the same benefit as the natural persons; (e) the assumption by the DGS from a host country of the function of proxy to depositors at branches set up by credit institutions from other member states, on behalf of the scheme from their home state.

According to data available for Q III 2010, the impact of the raising of the guaranteed

27


ceiling from € 50,000 (valid during 2010) to € 100,000 (valid since January 2011) for the deposits to credit institutions member of the Romanian Bank Deposit Guarantee Fund, increases the value of insured deposits by 8.3 p.c., which might be assimilated to a similar growth of confidence. These data cover currently eligible deposits, according to local regulations, without measuring the potential impact of enlarged, under discussion, area of deposits to be covered under the revised Directive.

As it seems to be no dispute among the EU Commission and the member states with regard to the level of the guaranteed ceiling, in other areas the harmonization has fewer supporters. If the reason for DGS is primarily of being transparent and able to respond to customers need with less delay versus their emergencies, the authorities are called upon to forget bureaucratic arguments and replace them by commitment. This should be more obvious since the savings of the customers are the perennial and healthy source for economic growth and financing public debt.

The second set of proposals which are deemed to increase transparency and confidence in the insurance mechanism and to support the DGS power to intervene when needed concerns the way resources of DGS are built and their size. The long term target for each EU member is to reach resources at a level of 1.5 p.c. of the overall covered deposits of the member banks, collected through an ex-ante contribution policy, with the supplementary possibility of getting an additional ex-post contribution equal to another 0.5 p.c., if needed. Before venturing into the debate about the sufficient level, the possibility for a big bank failure

should be reassessed together with the alternatives for increased financing of DGS.3 The general prevailing view is that resources gathered by DGS are considered reliable to cope with a medium banking crisis and they shall be sufficient in order to prevent it, but those are not supposed to be high enough to resist a systemic outburst. As EU proposal for revision of the Directive 94/19 EC speaks out, “the share of irrevocable payment commitments...shall not exceed 30 p.c. of the total available financial means”.

It is fair to say that for Romania the proposed target has reached (for the deposits selected as eligible by current rule) the level of 1.25 p.c. in 2010. Hence, noting that contribution level for 2011 has been set at 0.3 p.c. of eligible deposits4 and the net revenue from the proper management of resources is added to the overall available fund, it is foreseeable that the target shall be achieved sooner compared to those countries where the financing applied till now has been only ex-post.

Europe is a land of diversity when speaking about DGS resource building: from ex-ante contributions from the banks (which equals to deposit insurance) to ex-post (drawing when needed) there are approaches which are impregnated with national content. Confronted with the dangers highlighted by the crisis, the EU Commission favors the idea of ex-ante contributions, at least once a year (but not preventing additional financing from other sources), coupled, if deposits become unavailable, with extraordinary contributions not exceeding 0.5 p.c. of the eligible deposits per calendar year (ex-post). The coherence of the proposals is sometimes weak: while the December 2010 revised text

3 The debate around „Too big to fail” rose along the strengthening of the crisis retreat signals, but solutions for another governance of banking practice, a priority claimed by G20, has not been envisaged yet, thus „best practices” remaining less regulated.4 Romania – Letter of Intent and Technical Memorandum of Understanding, IMF, September 2010.

28

EUGEN DIJMĂRESCU

of the changes to be brought to the Directive invite member states to ensure that DGS have in place adequate alternative funding arrangements to enable them to obtain funding on short notice where necessary, the Stand-by arrangement of Romania with the IMF/EU speaks unilaterally about compulsory drop-off of any stand-by credit lines opened to the DGS by banks, although this instrument may have been the answer to the EU concern.

Moreover, exactly because wrongdoing has characterized most endeavors to deal with banking resolution, the proposal of letting the DGS to use part of their financial means in order to avoid a bank failure is central to the new role to be entrusted to DGS as partner for financial stability. This is an indication marking the appreciation for the FDIC experience and a closer approach of dealing with the banking sector on the two shores of the Atlantic. Purchases of assets and assumption of liabilities provides for both social benefits and financial stability inputs, as savings compared to compensation payout and a bank failure. However, the involvement of a DGS in P&A operation shall comply with the need of maintaining its available financial means above 1 p.c. of eligible deposits, after such a measure, without other restrictions to financing the transfer of deposits to other credit institution.

When it comes to risk based contributions the suggested model is a discussion around the combination of non-risk and risk-based elements. The non-risk based element of the contribution should be based on the amount of the covered deposits, while the risk based element of the contribution involves a number of indicators reflecting at least the

capital adequacy, the asset quality, liquidity and profitability. Everybody understands that globalization has developed within the banking entities a lot of financial instruments bearing different risk. When it comes the time of charging insurance premium for the deposits taken based on the degree of risk exposure of individual member banks one should not favor any room for speculative rumors instead of transparency. Even if the issue requires further analysis, proper information would enhance the trust of depositors into the DGS exposure versus the banks, but also into the offer of the banks themselves.

As the BCBS/IADI Core Principles for Effective Deposit Insurance Systems claims, the reform of deposit insurance systems requires them to become part of a well-constructed financial system safety net, including prudential regulation and supervision, a lender of last resort and deposit insurance5. The Core Principles require the approval of IMF board in order to make them the linchpin for future FSAP reviews. Even if the Core Principles are a non-compulsory framework for DGS conduct, they testify of the will to establish best practices by national authoriti

vol. 11 no. 1 march 2011 -...

Documents