Removing the Regulatory Barriers to Cross-Border Banking

The establishment of the Banking Union and the introduction of the European Single Rulebook seek to pave the way for a single banking market and to break the nexus between banks and sovereigns. Ideally, banks should be subject to a common set of rules and do business across the Banking Union without having to comply with different supervisory practices and methodologies. However, there are still loopholes and discrepancies in the legislative framework that cause regulatory fragmentation, among others, by allowing national authorities to take restrictive measures to protect national interests against the common interest. The present paper analyzes the current obstacles to the free flow of funds within cross-border banking groups operating in the Banking Union, namely the obligation for subsidiaries to meet prudential requirements (capital, liquidity and internal MREL) at individual level and the restrictions to intragroup exposures. To that end, this paper proposes some amendments to the Union regulatory framework aiming to achieve a dual objective; to strengthen banks’ profitability and overall financial position and to promote financial integration and consolidation of the banking sector, preferably through cross-border mergers and acquisitions (M&As). The proposed changes have become more significant today amidst the COVID-19 crisis and its impact on the European banking sector and the European economy. The European Central Bank (ECB) and the Single Resolution Board (SRB) have granted (temporary) relief measures to banks to withstand the effects of the pandemic and continue lending to the economy. Nonetheless, in light of the ECB’s pressure on banks to address effectively and timely the financial impact from the COVID-19 crisis, it is necessary to establish a framework to relieve banking groups from the unnecessary capital and liquidity burden placed on them. The aim of the proposed framework is to improve the banks’ ability to generate sustainable profits and, hence, to enhance their capacity to absorb the impact from the COVID-19 crisis and any future external shock as well. The proposed regulatory reform is governed by three (3) principles. Firstly, the introduction of a default approach for the application of reduced prudential requirements (capital, liquidity and internal MREL) to subsidiaries accompanied by the lifting of restrictions to intragroup exposures. Secondly, particular emphasis is placed on the Supervisory Review and Evaluation Process (SREP) and the resolvability assessment carried out by the ECB and the SRB respectively whose outcome may result in an increase of the prudential requirements. Thirdly, the establishment of a credible escalation mechanism to ensure that parent entities will remain committed to providing capital and/or liquidity support to subsidiaries should their financial situation deteriorate. The proposed mechanism serves as a safety net to prevent the failure of subsidiaries and, if that happens, to minimize the negative implications for domestic financial stability and fiscal sovereignty of host Member States. Under the proposed escalation mechanism, banking groups wishing to take advantage of the proposed capital and liquidity relief measures should sign intragroup financial support agreements on a mandatory basis. Furthermore, the group recovery plan should cover all the subsidiaries enjoying the proposed preferential treatment, irrespective of their materiality for the banking group and/or the host Member State. Once a recovery trigger relevant to a subsidiary is triggered, recovery action should be taken to restore the subsidiary’s financial position. If the parent entity is reluctant to respond appropriately to the worsening of the financial situation of the subsidiary, the ECB and the SRB should take early intervention measures, which could be extended to the parent entity. As a last resort measure, if a material subsidiary comes into a “failing or likely to fail” situation, the SRB may decide the write-down and/or conversion of internal MREL-eligible instruments into equity either independently or in combination with resolution action. The proposed regulatory measures could promote both financial integration and financial stability in various ways, particularly if were accompanied by the completion of some institutional reforms (e.g. establishment of the European Deposit Insurance Scheme).