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About this book

Since the last financial crisis, much work has been undertaken to strengthen the ability to respond to distress in the EU financial system. However, reforms enacted since the Single Resolution Mechanism was created in July 2014 as part of the Banking Union initiated in 2012 mainly focused on non-performing loans, and the third pillar of the Banking Union, namely a European Deposit Insurance Scheme, has not been completed.

Against this backdrop, this book focuses on the reasons why the EU banking system continues to remain fragile. In particular, high stocks of non-performing loans in some countries, the Level 3 assets evaluation and high exposure of many banks to the debts of their own governments are among the major concerns. Secondly, the book discusses the completion of the public safety net for banks, including deposit insurance, which remains primarily at the national level. This creates scope for contagion from banking sector fragility to national sovereign debt distress. Of interest to banking researchers, academics and students, this book combines rigorous analysis of the regulatory framework and empirical investigation on EU banking system data to prove that market discipline and risk sharing should be viewed as complementary pillars of the Euro-area financial architecture rather than as substitutes, requiring a reformed institutional framework.

Table of Contents

Frontmatter

Chapter 1. The Euro Area Banking System: Where Do We Stand?

Abstract
Banks across Europe have been through a significant restructuring process in response to weak profitability and to meet the new laws and regulations that have been approved in the wake of the financial crisis. Euro area banks have spent the last decade recovering from the global financial crisis. While the performance of European banks has improved since 2008, the average return on capital is still low. This average covers large geographic differences: banks in some European markets have completed this restructuring process, while other markets continue to struggle. This chapter in principle analyses the process of restructuring that euro area banks have been facing. Then it investigates the European banking system, presenting structural developments in the euro area, providing a broad set of structural information.
Francesca Arnaboldi

Chapter 2. The Main Challenges Facing the Euro Area Banking System

Abstract
This chapter presents the first of the main issues that are still undermining euro area banking system soundness, that is, the large amount of non-performing loans on banks’ balance sheet. For a number of European banks, the main focus of the restructuring work has been on cleaning up their balance sheets by selling off or winding down large non-performing loan portfolios. This chapter provides insights into changing regulations and introduces the role of the European Central Bank in the field of non-performing loans management by banks. A comparison of the European Council Action Plan on non-performing loans presented by the European Commission with the last addendum of the European Central Bank on the same topic is provided.
Francesca Arnaboldi

Chapter 3. Non-performing Loans in the Euro Area

Abstract
Since the progress that banks have made in restructuring has varied among countries, this chapter investigates cross-country heterogeneity in the non-performing loans restructuring process focusing on those countries with the highest non-performing loan ratios. Non-performing loans created by local real estate bubbles have proven easier to deal with than those from corporates or small- and medium-sized enterprises in economies struggling for competitiveness. Restructuring loans for corporates and small and medium-sized enterprises is typically more difficult as these counterparties are often financed by multiple banks, and creditor coordination therefore becomes more complex. Banks in countries with high non-performing loan ratios are expected to continue the process of restructuring, writing off and selling off in the next few years to significantly reduce their risk exposure.
Francesca Arnaboldi

Chapter 4. Level 3 Assets and Sovereign Exposure

Abstract
This chapter first revises the state of the art on Level 3 assets, one of the drivers of fragility for the euro area banking system. European authorities have mainly focused on fragility from credit risks, but the global financial crisis highlighted the importance of correctly pricing highly complex and opaque instruments. In this respect, the crisis started a trend towards simplification and transparency, entailing a radical change in banks’ business models. Then the chapter focuses on the linkage between sovereign debt and bank balance sheets. This chapter investigates two proposed options to address this issue: applying non-zero risk weights to sovereign exposures and putting limits on exposures to sovereigns, similar to those in place for other exposures.
Francesca Arnaboldi

Chapter 5. Progress on the First Two Pillars of the Banking Union

Abstract
It has long been understood that deeper financial integration would lead to a better functioning of Economic and Monetary Union. Single European supervision and resolution frameworks have overall proved beneficial to the banking industry. Risk assessments have become more harmonised and systematic, whereas, in the past, broad discretion in applying European Union rules led to significant national differences in key prudential aspects, such as the definition of funds, or capital and liquidity requirements. In this context, this chapter focuses on the progress achieved and rules to be completed on the first and second pillar of the Banking Union.
Francesca Arnaboldi

Chapter 6. The Third Pillar of the Banking Union: The European Deposit Insurance Scheme

Abstract
This chapter addresses the legislative proposal made by the European Commission in November 2015 for introducing a European Deposit Insurance Scheme. The chapter describes the Commission’s proposal, which builds on national deposit insurance schemes and would be accessible only on the condition that commonly agreed rules have been fully implemented. Following the European Commission proposal, a number of different recommendations have arisen in this area, but none of these options has met sufficient consensus among euro area countries, producing a deadlock in the policy discussion, with no apparent progress in the legislative discussion of the 2015 proposal itself. This chapter investigates the evolution of the third pillar of the Banking Union after the approval of Directive 2014/49/EU.
Francesca Arnaboldi

Chapter 7. The European Deposit Insurance Scheme

Abstract
This chapter empirically investigates the level of contribution banks must provide to a single deposit insurance scheme according to their level of risk. European Banking Authority (EBA) guidelines on methods for calculating contributions are applied to a sample of global systemically important banks in two different points in time: in 2014, before the Commission’s proposal on a European Deposit Insurance Scheme, and in 2018, the last year with available accounting data on EBA website. For the banks under scrutiny, core and additional indicators, as defined by EBA, are computed. The aim of this empirical investigation is to contribute to the regulatory debate by assessing which countries—if any—are better off after the full implementation of common monitoring system of bank riskiness.
Francesca Arnaboldi

Correction to: Risk and Regulation in Euro Area Banks

Francesca Arnaboldi

Backmatter

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