Speech by Minister for Finance, Paschal Donohoe to the Sixth ECB Forum on Banking Supervision - Shaping Financial Regulation in an Era of Distrust

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Good morning,

Let me begin by expressing my gratitude to the organisers of the Sixth ECB Forum on Banking Supervision – it is a pleasure to be present in Frankfurt to speak here today.

The theme of this year’s conference “resilience in times of disruption” is very apt, and I am delighted to have the opportunity to contribute to this discourse.

Our system of central banking and financial regulation in Europe has many origins and has been drawn from many schools of thought. In those early days of the ECB and its precursor, the EMU, the work of Walter Eucken was foundational.

Central to his work was the understanding that a stable and well-functioning market economy needs to be underpinned by a strong legal and institutional framework. As he astutely summarised: “Freedom in the economic sphere is only possible if it is bound by order”.

We are now living in a world of increasing disorder defined by geopolitical tensions and economic fragmentation, which creates challenges for our established rules-based international order.

However, we must be cognisant that disruption to the status quo presents opportunities as well as challenges. The key is to balance the trade-offs between the risks and opportunities that disruption brings.

Therefore, today’s Forum provides a valuable opportunity to reflect upon how the various changes, ongoing in the economic and geopolitical landscape, are shaping the future of the banking sector, and how this requires us to adapt and innovate while at the same time maintaining our focus on resilience.

When we look back, we should be very proud of what we have achieved to date. As the first pillar of Banking Union, the establishment of ECB Banking Supervision and the creation of the Single Supervisory Mechanism were landmark and defining moments in the institutional transformation of the euro area.

Indeed, the SSM is now firmly embedded as a symbol of euro area integration, and I note that in the Eurogroup our engagements with the regulators represent a critical aspect of our discussion on the banking sector.

Just this week, it was a pleasure to welcome Claudia, as Chair of the SSM and the head of SRB, to the Eurogroup meeting in Brussels as part of our bi-annual reporting on Banking Union.

While at the time the establishment of ECB banking supervision was a very difficult decision, we know now that it was the correct response to strengthen our banking and financial system in the wake of the financial crisis and linked sovereign debt crisis.

Our resilience has been our strength, and it is important that we continue to build upon this.

When we talk about our supervisory practices today, it is good to remind ourselves of the need for banking sector regulation, and to revisit the past events that have shaped its current form.

In particular, we can recall the global financial crisis, which, as one of the mostly costly economic events in recent history, exposed the fragilities of the prevailing approach of deregulation. During this time our banks were under-capitalised and under regulated.

We can also recall the aftermath, characterised by public bailout of the banks, a spiral in unemployment levels, and a surge in debt to GDP ratios, which ultimately led to a sovereign debt crisis in a number of countries, including Ireland.

Today, we can still see the scars of the following period of prolonged economic weakness, which was defined by reduced investment levels and lower productivity in Europe.

The aftermath of the financial crisis, of course, also led to an erosion of trust in our institutions; a trust that we have worked very hard to reclaim.

Global cooperation was central to rebuilding this trust through the reshaping of banking supervision, notably driven by the Basel Committee on Banking Supervision (BCBS) and the Financial Stability Board (FSB).

At EU level, this reinforced the need for the creation of a Banking Union. Although we have a lot more to do, the steps we have since taken to establish a Banking Union and to introduce banking supervision have been instrumental to promoting financial stability, protecting the taxpayer and more broadly in strengthening our Single Market in banking.

As we are all aware, one of the key objectives of our efforts was to break the negative feedback loop between the banks and the sovereign – in my view this was the cornerstone of rebuilding trust.

It would also be remiss of me not to mention the strong performance of our banks under the supervision of the SSM, with the resilience of our banks improving considerably in the past decade.

We have indeed come a long way since the global financial crisis and rigorous stress tests have shown that our banks are now in a position that they can weather severe economic shocks.

As I mentioned already, global cooperation has been instrumental to creating the regulatory environment we know today. Perhaps it is even the key ingredient to effective regulation as financial stability is a global public good.

If we want to live in a world order with an open global financial system, then safeguarding financial stability requires a set of minimum global standards.

Otherwise we risk regulatory fragmentation, regulatory arbitrage and an unlevel playing field, which can ultimately pivot to a broader race to the bottom, together with the associated list of negative externalities, including increased systemic risk, financial instability, reduced consumer and investor protection and lower quality of services.

I would also stress that the independence of the regulator has been fundamental to the maintenance of financial stability.

As is recognised in the Basel Core Principles of Effective Banking Supervision, it is essential to preserve the independence of the regulators in order to maintain the financial stability prerogative and to prevent the relaxation of supervisory policies due to short term incentives.

Just as the independence of the ECB and all central banks in setting monetary policy is a foundational principle, similarly, the independence of the supervisory role of the ECB and SSM is fundamental.

We are living in a world where disorder is increasingly woven into the status quo, where regulation is increasingly being questioned against a backdrop of economic fragmentation.

‘Globalism’ has become a catchword for populists seeking to attribute local decline to integrated international markets.

This impedes international cooperation and collaboration, which is the backbone of a strong international financial system. While perhaps more mainstream in other regions, these voices are also becoming more prominent in Europe.

Concerningly, this threatens to erode the hard-won progress we have achieved. I believe our response should be rather greater cooperation and collaboration. I believe this response should be based on three core elements;

• Firstly, transparency of message is crucial. Economic actors, governments, politicians, and, above all, our citizens must understand the steps we are taking and why;
• Secondly, we need to preserve the independence of our regulators, which in turn will protect resilience;
• And finally, we must show that banks and the private sector are part of any response to crisis.

If we do this, instead of a crisis feedback loop, we can develop the semblance of a virtuous circle. This response would give us the best prospect of maintaining a stable regulatory system and the orderly functioning of markets.

As I have laid out, I firmly believe that resilience is the foundation to a sound and stable banking sector. However, this does not mean that we should not also be focussing our attention on ensuring that our banking sector is globally competitive and is fully unleashing its growth potential.

We need to consider if the EU banking system is meeting the needs of our economies in the simplest and most competitive way possible, in a manner that ensures continued financial stability and resilience.

In a world of disruption, with instability in the geopolitical and economic landscape, I would argue that this creates a greater impetus on the necessity for our banking sector to adapt, to innovate and to contribute to the financing of the real economy to the best of its ability.

Getting this balance right is key, especially in light of the many challenges we are facing, not least in relation to the external geopolitical environment. Challenges also include the urgency to tackle structural issues in relation to digitalisation, demography and the green transition, while also financing defence expenditure.

This does not translate to an argument for deregulation or a call for the EU to join “a race to the bottom” when it comes to financial regulation, but what we should do is examine what can be improved, streamlined and simplified.

The goal should be efficient regulation and supervision, underpinning a stable and resilient banking sector. We need to strike the right balance between effective regulation and supervision without stifling innovation, otherwise we risk falling further behind our global partners in terms of competitiveness and productivity.

Achieving deep and liquid capital markets, together with a well-functioning Banking Union are key ingredients to this prerogative. This provides a greater impetus for us to drive forward with swift and timely implementation of the Savings and Investment Union initiatives, and, of course, completing the Banking Union.

In a similar vein, we also need to act with urgency on the recommendations as laid out in the reports of Enrico Letta and Mario Draghi if we are to secure Europe’s longer-term prosperity and competitiveness.

By doing so, we will strengthen European integration and our sovereignty, while also deepening the foundation of the euro.

I will conclude by reiterating my earlier point that the stability, and reliability, of the euro area is one of our primary attributes in an uncertain world, and that the work of the Single Supervisory Mechanism in the sphere of financial regulation plays a very important role in maintaining this stability.

However, just as the financial crisis and sovereign debt crisis over a decade ago provided crucial impetus and political will to deliver major structural changes to the Euro area regulatory system, the current uncertain geopolitical environment should also serve as a driver to finish what we have started.

This hard-fought financial stability that we have come to know in recent years was not achieved by standing still, therefore we must be bold again and make bold decisions.

Let me be clear that I believe these bold actions must be:

• Accelerating progress on the delivery of deeper and more competitive capital markets;
• The implementation of the Savings and Investment Union initiatives; and
• Finally completing the Banking Union.

In this increasingly uncertain world, I believe Europe does not need more or less regulation: we must ensure that we have better regulation.

We know that for the EU to remain competitive we must act to boost innovation and simplify regulations, and I would ask the regulators to think about how they can contribute to the delivery of these goals.

In relation to completing the Banking Union, we should be unequivocal about this.

Member States and the EU at large need to be braver in taking decisions on making progress on the outstanding elements of the Banking Union if we are to truly achieve cross-border banking and deliver upon the promise of a single banking system.

In my role as the Irish Minister for Finance, I can appreciate the stark challenges in taking difficult decisions to both secure the financial future and address the financial failures of the past.

Under my tenure, I have fully supported the return of the Irish banking sector to private ownership following government intervention in the aftermath of the global financial crisis.

This has been a long and arduous road for the Government, and the Irish people, with many difficult decisions along the way.

Such difficult decisions are, however, needed if we are to commit ourselves to finalising the Banking Union, enhancing EU competitiveness and financing the future of Europe and its citizens.

President John F Kennedy was fond of quoting Irish author Frank O’Connor’s story that as an adventurous boy when he and his friends would come across a wall that appeared altogether too high, they would throw their hats over the wall, so they had no option but to find a way over.

We must throw our hats over that wall and commit to delivery. As political leaders and as key actors in the EU’s institutional framework, we have a responsibility to act without complacency.

Ends