Olli Rehn 
Board Member of the Bank of Finland
Seminar: Capital Markets Union (CMU) – What are the priorities and means? 
Helsinki, 27 March 2017


Ladies and Gentlemen,

I am glad to have the opportunity to comment on Director-General Olivier Guersent's inspiring and important keynote speech. As a former cabinet colleague in the last millennium, I have learnt to know Olivier as a creative and trustworthy colleague, which are indeed the best qualities for a senior policy maker. He played a key role as head of cabinet of Michel Barnier in the EU's response to the crisis in financial regulation and supervision. And the work goes on, as we’ve heard today.

As a result of crisis management – often ad hoc, as the instruments of crisis management had to be created from the scratch – the Eurozone was able to weather the rock-bottoms of the debt crisis in 2010 – 12 and, with the ECB's "whatever it takes" pledge in July 2012, return to the path of recovery and growth. Since then, the Eurozone has experienced soon four years of continuous, even though mostly modest growth.

One key reason for the slow recovery and the double-dip recession of 2011 – 12 was the fact the financial repair in Europe was badly delayed compared to the US. Only after the decision to build a banking union in June 2012, to restructure the Spanish banking sector around the same time, to establish the permanent European Stability Mechanism in the fall 2012, and to conduct the Asset Quality Reviews in 2013 – 14, did the health and resilience of the Eurozone banking sector start to heal properly.

As Olivier Blanchard, one of the leading economists of our time, coined it after the crisis, “It has become a cliché to say that macroeconomic thinking understated the role of financial factors in economic fluctuations.”

Thus the health of the financial sector does indeed matter. Most importantly, it matters to the real economy, to our capacity to deliver sustained growth and create jobs. That is why we should be concerned if there are plans to roll back these reforms, or water them down.

Capital Markets Union to boost investment and bring resilience

The Capital Markets Union is designed to broaden the funding of EU businesses, especially SMEs, by increasing market-based finance across borders to companies that are providing jobs and growth. Another rationale for the CMU is that the more diverse the sources of funding are, the more resilient the financial system is to economic shocks.

While the goals of the CMU – better funding to support jobs and economic growth – are easy to agree upon, the means to it are more contentious. Among the many measures, there are some that touch on delicate issues, such as taxation and insolvency proceedings. 
Compromises are needed, but suboptimal outcomes in order to pursue quick wins should be avoided. The basic goal of the CMU – to diversify sources of finance to the real economy in order to support growth and jobs – should set the minimum requirements for any outcome.

Regulation, supervision and macro-prudential policy

The political will for enhanced global coordination in financial regulation seems to be in short supply today. I find it regrettable that only a decade after the financial crisis, many of its lessons seem already forgotten. 

This has happened despite the fact that it took seven years before the Eurozone GDP again reached the pre-crisis level, and the social and fiscal problems caused by the crisis are still very much felt.

The alternative to blind deregulation is continuous reform. The European Commission’s approach to do a built-in review of the financial legislation is much more sensible than one of a regulation–deregulation cycle.

The comprehensive review of the financial regulatory framework in the EU is in fact the first global case in point of such built-in review approach. It enables us to adjust the legislation once its effects have become known and apparent, and to do this in a gradual, piecemeal fashion, instead of repealing and replacing entire legal acts.
Moreover, such an approach enables us to take into account new developments like FinTech. Advances such as the distributed ledger technology hold great promise, but have also disruptive potential, which must be carefully monitored. For this, the Commission just launched a public consultation on FinTech to gain better understanding of how to develop policy approach towards technological innovation in financial services.

One lesson learnt from the financial crisis is the creation of the EU’s macro-prudential framework. The crisis taught us that even when individual financial actors in isolation are prudent, the financial system as a whole might be at risk. Developing the macro-prudential approach and some instruments for it are indeed very significant achievements.

But we need to review the current setup in the light of the experience gained in implementing some recent macro-prudential decisions.

For example in Finland, the macro-prudential authority, the board of the Finnish Financial Supervisory Authority, has decided to take measures to set a floor for risk weights for housing loans in the banks which are using internal risk (IRBA) models. This would increase the amount of capital these banks will have to hold against their housing loans.

The preferred legal instrument for this task is Article 458 of the CRR. However, actually using the Article 458 has proven to be a very burdensome process that is not suited for its purpose.

Finnish features: “branchification” and a level playing field

One particular feature of the Finnish banking system has recently been something called “branchification”, or increased dependence on foreign branches. Nordea transformed its Finnish subsidiary to a branch in January this year, and Danske has already started organizational restructuring to become a branch by the end of this year. Taken together, these two banks represent ca. 40% of the total deposit and lending volume in Finland, and the overall share of branches would be ca. 50%.

This poses major challenges to banking regulation and supervision, which have not been adequately taken into account in the current EU legislation. The review of EU legislation should provide a good opportunity to find ways and means to address this shortcoming.

Systemically important branches can play a central role in a country’s financial system and thus for its financial stability, especially if they cover close to 50% of the entire system. This implies that larger powers of the “host” country supervisor would support the financial stability of host and home countries alike, and reduce the room for regulatory arbitrage.

The progress made since 2012 in creating the banking union has meant big strides towards creating a level playing field for the banking and financial industry across the EU, especially in the Eurozone. In our view one should indeed have only a minimum scope for regulatory arbitrage within the EU and globally.

For our part, we are neutral to banks’ decisions concerning their home country. Any financial institution knows that in Finland we play by the European rules, which are well-known and transparent. However, it is also clear that we lose some of the benefits of banking union, if the bulk of banking services in Finland is provided by banks coming from countries that do not belong to the SSM.

Ladies and Gentlemen,

According to Aristotle, learning from experience was one of the main virtues. This applies to financial regulation, too. In other words, after what we have gone through in the last 10 years, there can be no factual ground to believe that looser supervision or weaker regulation of the financial and banking sector would lead to stronger growth. Opening up new space for asset bubbles again would not be supportive for sustainable growth.

Instead, ensuring financial stability in a preventive way, together with conducting sound monetary and fiscal policy, and carrying out structural reforms, is the best recipe for sustained growth and job creation. That is the recipe we should follow, both in Finland, in Europe and also globally.