February 19, 2009
The following briefing note has been prepared by BUSINESSEUROPE on behalf of the Moderator for Session 4, Guy Johnson from CNBC, at the 2009 European Business Summit. The summit – titled Dare and Care – will be held on 26th and 27th March 2009.
Please feel free to comment before and after the session about the topic below.
• Fundamental issues that have provided the environment for the crisis
o Market failures (that exacerbate asymmetric information and moral hazard): excessive risk taking, inadequate incentives, agency problems; complex and opaque financial instruments; opaque balance sheets; distorted risk rating; regulatory arbitrage
o Regulatory failures: homeownership subsidies; Basel capital requirements (pro-cyclicality); lack of wide and consistent regulation; lack of transparency in originate-to-distribute model; poor supervision
o Policy failures (in some countries): overly accommodative monetary policy (Greenspan put) and fiscal policy; exchange rate pegs
? Problems in the US sub-prime mortgage sector were the spark to set off the turmoil which developed into the worst credit crisis since WW II
• Since the outbreak in August 2007, major banks in the US and Europe have been severely affected, causing among others
o the sale of Bear Stearns (March 2008),
o bankruptcy of Lehmann Brothers, purchase of Merril Lynch by Bank of America and demands of AIG to the Fed for bridge loans (13-14 September 2008),
o adoption of “Paulson Plan” specifying government bailouts for major US banks (3 October 2008),
o the end of the US “investment banks”,
o bank rescue packages and deposit guarantees agreed across Europe (12 October 2008).
• Bank failures in Europe and the US have amplified the erosion of confidence among financial institutions.
• Banks’ access to funding through ordinary market channels remains severely hampered. A broad-based credit crunch is not yet evident in Europe, but containing the current financial turmoil and restoring confidence is a matter of utmost importance
• Since the outbreak of the crisis in August 2007, stock markets have crashed. Spreads on the interbank money market have soared. The market for commercial paper and IPOs has come to a standstill.
• The financial crisis has caused a swing from excess complacency to excess risk aversion, having a severe impact on investment, innovation and company creations.
• The banking crisis has spilled over into the economy
o Investment and business activity is plummeting across Europe. Business confidence has dropped to historical low levels in all developed economies and some emerging markets. Companies face severe difficulties in accessing finance even for short-term liquidity needs.
o All EU member states are affected:
1. “deficit” countries (e.g. UK, Ireland, Spain) have suffered from sharp housing market corrections and debt related problems
2. “surplus” countries (e.g. Germany) have been hurt by falling demand in export markets and insufficient domestic demand
3. loss of competitiveness at the global level due to lacklustre productivity gains and high wage settlements (e.g. Italy)
o Exchange rates have been very volatile, and commodity as well as oil prices have fallen dramatically
• The combined deceleration of global growth and the fallout of intense financial market turbulences imply a high level of uncertainty and stress on financial and economic systems.
• The G-20 summit in Washington on 15 November recognized the gravity of the situation and the necessity for strong and decisive action. This summit represents a start in the world’s response to the unfolding turmoil and will have to reinforce the financial architecture.
• Governments across the globe have decided upon or are in the stage of preparing national fiscal stimulus packages. However, to be effective a high degree of coordination is necessary.
• The European Commission has published an economic recovery plan en November, which has been endorsed by the European Council on 11-12 December.
2. Main issues at European level
In general, the European response to the crisis has been constructive and timely. It has significantly influenced discussions and solutions at the international level. In particular, European leadership has been a strong motor for the G20 summit in Washington.
• 12 October 2008: Euro area summit in Paris
Leaders from Euro area member states gathered in Paris to agree on an EU bank rescue plan, involving state guarantees to unfreeze interbank money markets, commitments to re-capitalise financial institutions and to respond flexibly to market conditions with ECB liquidity interventions and other policy instruments.
• 15 November 2008
The EU played a major role in securing significant outcomes at the G20 summit held in Washington.
• 26 November 2008
The European Commission published a 200bn EUR EU Recovery Plan
• 11-12 December European Summit
The European Council endorsed the EU recovery package proposed by the Commission
• Creation of high level group on banking supervision under Jaques de La Rosière
• ECB interventions
o Since early October – a 50 basis point cut concerted among 5 major central banks – the ECB has cut interest rates further by 125 basis points to currently 2.5%
o The ECB has undertaken massive liquidity injections since the outbreak of the crisis in order to ensure an orderly functioning of money markets
3. Challenges in the short/medium and long term
• Improve banking supervision
• Strengthen the coordination between national bank supervisors / regulators
• Improve the regulation of rating agencies in order to avoid conflict of interests between rating- and consulting activities
• Review accounting standards (in cooperation with the IASB) in order to prevent that “fair value accounting”-rules will have substantive pro-cyclical effects in times of financial market crises.
• Work together with the IMF and the FSF on ways to create a more stable world financial architecture.
• Encourage banks to resume normal lending and business activities; SMEs may face disproportionate consequences when bank lending standards tighten. The EU’s overall resilience to the present turmoil critically hinges on its capacity to maintain and facilitate SMEs’ access to finance. In this regard, instruments of the European Investment Bank could provide significant support if sufficiently funded and accessible.
• Avoid hurried solutions to a rapidly evolving financial situation as they would be counterproductive, and merely lead to increased cost and reduced choice for issuers and investors
EU economic recovery
• community actions should be endorsed and the mobilisation of the corresponding EU resources be rapidly authorised. For business it is particularly important to step up infrastructure investments and improve their effective delivery through Public-Private-Partnerships.
• Member States should deliver sufficiently financed and coordinated economic stimulus packages targeted towards private and public investment
• safeguarding the financial viability of Member States facing balance of payment difficulties
• initiatives to restore companies’ access to finance at affordable conditions, increasing the effectiveness of bank rescue plans, promoting loan guarantees as well as risk-sharing schemes and providing incentives for commercial banks to resume normal lending and capital market activities.
• Use the current crisis as a catalyst for growth-enhancing structural reforms
• ECB’s steps to ease liquidity constraints and lower market interest rates were timely, and should help to support confidence and economic activity. In the present context, the ECB’s strong credibility has been a tremendous asset to limit the extent of the crisis in Europe.
(also see appendix for more detailed information)
4. Possible questions to be discussed during the session
(taking into consideration the speakers participating in each session)
• How can European bank supervision be strengthened effectively? “Merely” better coordination among national regulators or creation of a single European authority? What needs to be done at the international level? Should the IMF and the FSF take the lead?
• How can the pro-cyclicality of current regulation be addressed effectively? Need banks’ capital requirements / Basel II be revised? What modifications are necessary as regards accounting standards? How can we improve risk management? How can the work of rating agencies be supervised in a better way?
• What is the appropriate timing of necessary changes to regulative frameworks?
• What are the biggest problems impeding banks to resume “normal” commercial activities and to become again key intermediaries for the functioning of the economy? How can confidence be restored to interbank markets? Have government rescue schemes addressed the right issues / are they effective?
• Have banks together with public authorities already thought about adequate exit strategies? How can the impact on public finances / for the taxpayer be limited?
• Has the crisis really triggered a true rethinking of banks’ remuneration schemes? Will banks adapt their risk appetite to prevent future crises from happening? Are these fundamental trends or merely short-term changes?
• The second G20 summit will take place in London on 5 April. What are your anticipations? Have working groups and ministerial meetings lived up to the high expectations since the first summit on 15 November? What do commercial banks expect from the future financial architecture / what should be priority actions? What is the institutions’ assessment of the G20 process?
• Has the crisis changed the way banks grant loans? Has the crisis lead to a renaissance of “good” banking practices where companies have close relationships with their main banker? Or has the crisis merely lead to a drying up of credit?
5. Further reading
• BUSINESSEUROPE positions and statements (regularly check website)
• regularly check IMF website
• newspaper articles