Cause and Effect in European Politics and Law

Draghi: An Unclear Agreement with UK Could Have Systemic Consequences

Adelina Marini, February 16, 2016

Three main subjects dominated the regular hearing of European Central Bank President Mario Draghi in the European Parliament's economic committee -  the negotiations with Great Britain, the latest offensive of Italian Prime Minister Matteo Renzi aiming at eliciting more concessions from the fiscal rules, and the turmoil in the international financial markets. The question most often asked by MEPs, however, was about the deal with Great Britain, which is expected to gain final shape during the EU summit this Thursday and Friday. The leaked drafts of the agreement caused criticism, for they hide a risk of setting a dangerous precedent - tailoring the Union for anyone not feeling comfortable in it.

A common market, but not at the expense of integration in the euro area

Most of the MEPs, interested in the effect of the negotiations with Great Britain on the banking union, were worried by some wording in the latest draft, which was leaked last week. It allows for implementing different regulations from the common rules of the banking union, which concern financial oversight and recovery measures for banks in the countries, which are not part of the banking union. At the same time, it is said that more uniform rules should be enforced regarding the prudence requirements for credit institutions or other measures, taken in an attempt to protect financial stability, including with countries, which are not part of the banking union.

Mario Draghi explained that even though the ECB was not a party in the negotiations it is important that the agreement with Great Britain is as clear as possible, for otherwise it hides a threat of creating consequences of a systemic character. He did not go into detail of exactly what problems he envisages, but stressed that if there were any ambiguities in the text it would not have a positive effect on the euro area. To him the most important thing about the agreement with the United Kingdom must be the protection of the common market and the euro area. "And it's pretty clear that further integration of our monetary union is essential", he said. Further on, answering other similar questions Mr Draghi added one more word to his previous statements -  "right". It is important to protect the euro area's right to go towards deeper integration.

He feels the opportunity that the British question opens up should be used to deepen integration in the euro area. This is yet another integration voice lately, after the past week marked a peak in integrationist rhetoric, as euinside reported. The ECB boss emphatically denied the possibility that the British question be in any way linked to the long term vision on the euro area's development, as it is presented in the five presidents' report. No connection should be made between the two, he said. 

In the draft document for the summit on Thursday and Friday, the text, concerning the relationship with the euro area, the so called "basket A", is considerably altered, obviously  aiming at preventing an avalanche effect of discount requests. It is expressly noted that more integration is necessary in order to fulfil the aim, set in the Treaties, for the creation of an economic and monetary union, whose currency is the euro. It is underlined that the future measures in this direction will be voluntary to the ones, which are not in the euro area, but it is reminded that this does not free the states, which do not have the necessary exemptions from the obligation to work on fulfilling the criteria for adopting the common currency.

There is enough flexibility built in the rules

Italian PM Matteo Renzi opened up a new resistance front in the EU, but received a cold shower from Brussels and Berlin. Another cold shower came from Frankfurt on Monday. Mario Draghi, an Italian, answered the many questions, mainly coming from Italian MEPs, linked to the additional fiscal concessions requested by Rome because of the greater expenses for dealing with the refugee crisis, in Italian, stating that the current rules contain enough flexibility and the EC is doing great in implementing it. He explained that fiscal policy can be used in difficult situations only when there is fiscal space. If there is not any, however, then rules must be followed. Italy cannot boast with a large fiscal space, being the state with the largest public debt at the moment (excluding Greece) 132.4% of GDP for this year, according to the EC's winter economic forecast.

It is expected in the forecast that the structural balance will worsen by around three quarters of a percentage point of GDP. Budget deficit will deteriorate this year to 2.5% of GDP, which does not leave much space to manoeuvre. Mario Draghi reminded that most budgets of euro area states are not shrinking at the moment, quite the opposite. There is talk of budget expansion in the economic forecast for Italy as well.

It is no longer 2012

The situation in the banking sector in the euro area is much different than the one in 2012, he said, picking up the moods of the Eurogroup, after presenting his analysis on the situation on financial markets. At the moment, banks in the currency club have significantly increased their capital positions over the past years, most of all due to the assets appraisal of 2014. Currently, they are much more resilient to shocks. He forecasted that if the current situation held, there would be no need for further increases of the capital requirements. There are troubles in some parts of the banking sector, including some linked to the accumulation of non-performing loans. Draghi ensured, however, that there are good opportunities at the moment for a sustainable decrease of non-performing loans over the next few years.

He also confirmed his already made promise that if the situation demanded it, the ECB will take all necessary measures during the next meeting of the governing council in March. Driving factors for change will be the oil prices and financial turbulences. At the moment, ECB policies are the only relief actions, said Draghi and once again reminded that it is important that the bank is supported by structural reforms in member states and fiscal responsibility. "Compliance with the rules of the Stability and Growth Pact remains essential to maintain confidence in the fiscal framework", he said.

The governor of the ECB also spoke at length about the implemented since January 1 of this year new rules on recovery of banks in trouble, introduced with the Bank Restructuring and Recovery Directive (BRRD). According to him, this directive will introduce considerable change for the better, but for it to succeed it is important that banks have sufficient loss absorption capacity.  This, in his words, is a key prerequisite. He backed the opinion of the boss of the permanent bailout fund of the euro area Klaus Regling that the new bail-in rules are not the main reason for markets' nervousness, but admitted they might have some impact. He reminded though that many countries already have such rules, so the EU is not an exception in this sense.

Mario Draghi also stressed that, having in mind the experience with Italy and Portugal, it is important that the bail-in rules are implemented in an identical manner, for this will bring security to investors that they will be treated equally.

Translated by Stanimir Stoev