Deposit Guarantee Schemes

A European Perspective

F. Arnaboldi

• Publisher: Palgrave Pivot
• Year: 2015
• Print ISBN: 9781349482771, 9781137390868
• eBook ISBN: 9781137390875
• Topic: Business
• Subtopic: Financial Services
• Index: Business

Arnaboldi highlights the importance of one of the three pillars of the Banking Union, the common mechanism for insuring deposits. She claims that integrated financial markets require a European solution with regard to deposit insurance and that the establishment of a pan-European scheme could address the problems for large cross-border banks.

1

The European Financial Framework

Abstract: This chapter covers the progress in European banking integration over the past 20 years. Since the signing of the Treaty establishing the European Economic Community in Rome in 1957, the European Union has grown to comprise 28 member states and a population of nearly half-a-billion citizens. The financial sector has played a key role in the process of European Union economic integration. This role is illustrated by reviewing the major legislative changes that have contributed towards European banking integration, which set the background for the establishment of a banking union.

Arnaboldi, Francesca. Deposit Guarantee Schemes: A European Perspective. Basingstoke: Palgrave Macmillan, 2014. DOI: 10.1057/9781137390875.0009.

1.1Introduction

Despite the positive achievements in the integration of European financial markets and economies, the financial crisis that started in 2007 (hereinafter ‘the financial crisis’) confirms that closer coordination of prudential policies and safety nets is now required. Against this background, this chapter covers the key initiatives towards European banking integration over the past 20 years. Since the signing of the Treaty establishing the European Economic Community in Rome in 1957 (11957E/TXT), the EU has grown to comprise 28 member states and a population of nearly half-a-billion citizens. Nowadays, the EU is the largest integrated economic area in the world, accounting for more than 20 per cent of the world’s GDP. The financial sector has played a key role in the process of EU economic growth. Since the introduction of the First Banking Directive in 1977 (Council Directive 77/780/EEC), the deregulation of financial services, the establishment of the Economic and Monetary Union and the introduction of the euro have helped create the single market for financial services. European authorities consider financial integration to be one of the key issues in making Europe more efficient and competitive (European Central Bank, 2005). The next four sections present a review of the major legislative changes that have contributed to European banking integration.

EU financial integration has brought with it a range of benefits, from increased income generation, to improvements in technology and risk management, risk diversification and deepening of financial markets (Arnaboldi & Casu, 2012). Despite the positive achievements, it is unclear whether the single market can ever operate properly across an area which is so heterogeneous. It is argued that the single market for financial services was in a sense too successful, as it allowed the creation of banks that are too large relative to individual member states and an excessive accumulation of debt in many countries, thus highlighting the need for an integrated framework for cross-border crisis management and resolution, surpassing a supervisory framework based predominantly on domestic supervision (European Commission, 2009b; Fonteyne et al., 2010). Regulators have also begun to question the suitability of financial institutions’ supervisory systems (European Commission, 2010a).

A review of the period of advanced integration and of the structure of the European banking system helps develop greater understanding of why deposit guarantee schemes are still fragmented in the EU, why they are so important and the policy issues raised by pan-European schemes, all of which are discussed in the following chapters.

1.2The establishment of the common market

Deposit guarantee schemes are extremely important from a financial stability perspective, because they protect depositors in case of bank failure. This promise prevents sudden withdrawal of deposits, thereby reducing the potential for severe economic consequences. In the new European framework, deposit guarantee schemes play a central role, being one of the three pillars of the banking union, together with the single supervisory and the single resolution mechanism. Thus, deposit guarantee schemes in Europe cannot be investigated without some preliminary consideration of the key legislative changes that led to the banking union, which is then discussed in Chapter 2. The process of creating a unique economic area in Europe, which dates back to the Treaty establishing the European Economic Community in 1957, can be broadly summarized in relation to five periods, described below.

Period one: from 1957 to 1973

The European Commission and the Council of Ministers worked to deregulate entry into domestic markets. The goal of the Treaty of Rome was the transformation of highly segmented national markets into a unique common market and this was achieved through the recognition of the right of establishment and the coordination of legislation. In particular, the Council Directive 73/183/EEC of June 1973 and the Council Directive 73/240/EEC of July 1973 required the member states to implement the principle of non-discriminatory treatment and abolish the restrictions on freedom of establishment. However, the goal of the Treaty of Rome was far from achieved in the banking sector. It is difficult to secure international competition and the supply of cross-border services because of regulations on capital flows. Furthermore, banking supervision was still fragmented. Banks operating in different countries could be subject to different regulatory frameworks, thus lowering bank profitability in cross-border operations.

Period two: from 1973 to 1983

Various attempts towards the harmonization of regulations were made, for instance with the adoption of the First Banking Directive in 1977 (First Council Directive 77/780/EEC), which set common conditions with which banks should comply to be granted authorization by member states’ competent authorities. Nevertheless obstacles to the creation of a single European banking market were still in place. Host country authorization was needed when a bank started operations in another member state by opening branches. However, according to article 4.2, authorization could not be refused to a branch of a bank ‘on the sole ground that it is established in another member state in a legal form which is not allowed in the case of a credit institution carrying out similar activities in the host country’.

Period three: from 1983 to 1991

The completion of the internal market was made possible thanks to a new approach towards European integration prompted by the European Commission and consisting of home country control with minimal harmonization of national regulation (Dermine, 2006). In 1985, the European Commission published a White Paper on the completion of the internal market which established the free circulation of persons, goods and capital in the EU (Commission of the European Communities, 1985). The Second Banking Directive (Second Council Directive 89/646/EEC) applied free circulation to the banking sector, establishing the principle of home country control.¹ The supervision of banks operating in two or more member states was gradually transferred to the home country authority of the parent bank. A single banking license, home country control and mutual recognition were established. A bank authorized in an EU country could open foreign branches or provide cross-border services without further authorization. The universal banking model, which permits banks to undertake a wide range of activities including investment banking, was adopted. The minimal harmonization of national regulation was also attained through Commission Recommendation 87/62/EEC (Commission of the European Communities, 1987), which set limits on large exposures of credit institutions, and through Directive 89/299/EEC on credit institutions’ own funds, which defined the concept of ‘own funds’ on the basis of the Basle Capital Accord of 1988.² The capital of a bank can serve to absorb losses which are not matched by a sufficient volume of profits and also act as an important measure for competent authorities, in particular for the assessment of the solvency of credit institutions and for other prudential purposes. Capital also ensures the continuity of credit institutions and protects savings. The harmonization of the rules concerning the definition and calculation of capital promoted the supervision of credit institutions and contributed to further integration in the banking sector. The directive was part of a wider effort to reconcile minimum prudential standards for financial institutions in the EU with the dual aim of safeguarding the safety and soundness of the financial system and establishing a level playing field for financial institutions competing in the single market.

In addition, free movement of capital was finally achieved. A first step was Directive 86/566/EEC, which modified the previous framework, extending liberalization to long-term lending for commercial transactions and purchases of securities not dealt in on the stock exchange (Usher, 2007). Council Directive 88/361/EEC cancelled all remaining restrictions on capital movements between residents of the member states as of 1 July 1990. As a result, liberalization was extended to monetary or quasi-monetary transactions, which were likely to have the greatest impact on national monetary policies, such as loans, foreign currency deposits and security transactions.³

In 1989, the Delors Report (Committee for the Study of Economic and Monetary Union, 1989) set out a plan in three stages over 10 years leading to European Monetary Unification (EMU), which is summarized in Table A.1 in the Appendix.

Period four: from 1992 to 2005

The Treaty on European Union (11997M), signed in Maastricht on 7 February 1992, confirmed the White Paper programme on the creation of a single market. In addition, Directive 94/19/EC first provided for mandatory insurance for all EU banks, even if, as discussed in Chapter 3, deposit guarantee schemes are still highly fragmented across member states. The European System of Central Banks (ESCB) was established to maintain price stability and national central banks retained regulatory and supervisory powers according to the principle of decentralization. The European Central Bank (ECB) was allowed to regulate and supervise financial institutions only under very special circumstances and with unanimity in the European Council. Thus the euro, which was created in 1999, was not backed up by a common supervisory framework.⁴

In the same period, the Financial Services Action Plan (FSAP) was launched (European Commission, 1999) with the goal of accomplishing the full integration of banking and capital markets by the year 2005 through the creation of a single EU wholesale, retail banking and insurance market and the development of state-of-the-art prudential rules and supervision. Fiscal rules to implement a single financial market in an effective manner were included in the plan. The FSAP comprises more than 20 Directives, which fall into two categories:

level 1 Directives or Lamfalussy Directives, which set out the framework principles;

level 2 Directives, which set out the implementation measures that allow these principles to be put into practice.

There are four level 1 Directives, specifically the Directive on Markets in Financial Instruments (Directive 2004/39/EC), the Market Abuse Directive (Directive 2003/6/EC), the Prospectus Directive (Directive 2003/71/EC) and the Transparency Directive (Directive 2004/109/EC). All four directives are crucial pieces of legislation to accomplish the full integration of banking and capital markets in the EU and to maintain investor confidence. The Directive on Markets in Financial Instruments, for example, effectively creates a ‘single passport’ that allows investment firms to operate across the EU. The Market Abuse Directive aims to prevent insider dealing and market manipulation, which is essential if investor confidence is to be maintained. The Prospectus Directive provides issuers (including small and medium enterprises) with a ‘single passport’, which allows them to raise investment capital on a pan-European basis and to seek out the cheapest capital available to them. The Transparency Directive sets out uniform rules for the disclosure of accurate, comprehensive and timely information by issuers throughout the EU.⁵

The level 2 Directives include, among others, the Capital Requirements Directives, which represent the common framework for the implementation of the Basel II Capital Accord (Directive 2006/48/EC and Directive 2006/49/EC), the Directive on the Reorganization and Winding-Up of Credit Institutions (Directive 2001/24/EC), Regulation (EC) 1606/2002 on the application of international accounting standards, Regulation (EC) 2157/2001 on the Statute for a European company, supplemented by Directive 2001/86/EC, and Council Directive 2003/48/EC on the taxation of savings income in the form of interest payments. All directives have been transposed in the national framework and their general economic impact has been assessed (Box 1.1). Table A.2 in the Appendix summarizes the action taken, the relevant directive number and the transposition deadline.

BOX 1.1 Assessments of the impact of the FSAP

In the framework of the economic evaluation of the Financial Services Action Plan, the European Commission launched two studies: a study to assess the general economic impact of the FSAP and a survey to estimate the cost of compliance with the FSAP measures. Work on both studies started in December 2007 and was completed in 2009.

The aim of the first study was to provide an economic assessment of the specific impact of the FSAP on the EU financial services sector (Malcolm et al., 2009). The ...

Table of contents

• Cover
• Title
• Introduction
• 1  The European Financial Framework
• 2  The European Banking Union
• 3  Deposit Guarantee Schemes
• 4  Empirical Investigation on Deposit Guarantee Schemes
• Conclusion
• Appendix
• References
• Index