Regulation and Competitiveness
Sharon Donnery unpicks the relationship between economic competitiveness and the banking sector
Sharper definition
Competitiveness is the EU buzzword of the moment. With the EU economy lagging against peers, and the geopolitical situation ever more challenging, boosting competitiveness and growth has become a central objective for European policymakers. But while everyone seems to agree on the need to improve Europe’s competitiveness, there is often a degree of vagueness about what exactly the concept means. What is competitiveness? And what are the right policies to promote it?
On 25 June Sharon Donnery offered some answers in an interesting speech to the ECB’s SSM Senior Forum in Königstein, just outside Frankfurt. In particular Donnery discussed the relationship between competitiveness and regulation, further developing the ECB’s case against loosening regulatory (and supervisory) requirements for banks in the name of promoting economic growth.
Disentangling banks
Donnery began by separating the competitivness of the European economy as a whole from that of its banking sector. Too often, she argued, these are conflated in public debate (not least by the banking industry itself). But, drawing on a recent policy paper by Nicolas Véron and Juan Mejino-López of the Bruegel think tank, Donnery insisted that they were not the same, and should be considered separately.
Competitive economy
At the macro level, Donnery argued, competitiveness means the ability of an economy to generate high levels of employment and income while competing in an international market. This, she said, was mainly a function of productivity. As Mario Draghi’s report on European competitiveness last year showed, European GDP has lagged behind that of the US in recent decades primarily because of slower growth in European productivity (the amount of value created for each hour worked).
Europe’s poor productivity performance, Donnery argued, was largely the result of European firms’ slower adoption of digital technology than their US competitors. This was due to several factors, including the fragmentation of the European market, where different national regulations create significant barriers to businesses scaling up to trade continent-wide. Completing the single market - as recommended by Draghi and his fellow former Italian Prime Minister Enrico Letta - is therefore the “clearest path to unlocking [Europe’s] economic potential.”
Competitive banks
Turning to the banking sector, Donnery again focused on European banks’ competitiveness relative to their US rivals. She considered why European banks’ profitability has lagged that of their American counterparts over recent decades.
One reason is different market structures. The US banking sector is more concentrated, with the largest banks enjoying a bigger share. Crucially, they operate across the US, whereas European banks remain more bound within national borders. At the same time, the more developed capital markets in the US afford American banks both greater opportunities to shift loans (especially mortgages) off their balance sheets via securitisation and more scope to profit from higher-margin investment banking activities.
But this, Donnery said, was not all. Again channeling Véron and Mejino-López, she argued that differences in the US and European response to the global financial crisis had had a major effect. US authorities recapitalised and cleaned up troubled banks faster and more thoroughly than their European counterparts. This, Donnery said, allowed American banks to bounce back and return to profitability quicker - and to use their lead to seize market share from EU rivals. US banks’ greater capital strength thus enabled their profitability. As Véron and Mejino-López wrote , the experience of the crisis “reaffirmed … that, while bankers always call for lower capital requirements, these are not in the sector’s collective interest.” Or as Donnery put it, European banks’ “problem was not too much resilience - but too little.”
No deregulation
Donnery thus refuted the argument that deregulation, including perhaps lower capital requirements, is the right way to promote competitiveness. (Indeed, in her description of this as a “convenient narrative” that “tends to resurface” when “memories of previous crises begin to fade”, she implied this was largely a cynical one put forward by the industry.)
Instead of looser regulation, Donnery concluded, what Europe needs to become competitive is more progress on deepening the EU Single Market. For banks that means first completing the Banking Union, by finally enacting a European Deposit Insurance Scheme, and harmonising remaining national rules to allow for the pooling of liquidity and capital across borders within the EU. Meanwhile Europe should press ahead with building an integrated EU capital market by establishing uniform regulations and aligning securities law, insolvency practices and accounting standards. (Once again Donnery did not include tax in her list.)
Different argument, same conclusion
Donnery thus arrived at the same answer to the competitiveness question as ECB leaders have been repeating since at least last September. No deregulation; more banking and capital market integration; and more progress on the Single Market more generally.
Underpinned by Véron and Mejino-López’s work, Donnery’s argument was perhaps more sophisticated than previous ECB interventions in the competitiveness debate. And while it is possible to pick some holes in it - for example, to question how far restricted access to capital accounts for European firms’ slow adoption of modern IT - overall, she presented a convincing case. I will watch with interest how far her arguments influence the wider EU policy debate.
PS. Not so simple
Donnery also had some interesting comments on work to improve the efficiency and effectiveness of banking regulation and supervision. (Don’t call it simplification.) I’ll cover these in a bonus post - look out for this in the coming days.