The European Central Bank’s long-awaited charm offensive aimed at German public opinion has started – and the Germans are reciprocating in kind. In the first act in an elaborate series of manoeuvres aimed at papering over cracks between the ECB and German politics, Olaf Scholz, German finance minister, has held out an olive branch to debtor states by calling for action to complete Europe’s banking union through a common deposit insurance scheme.
Scholz’s move was coupled with a well-scripted conciliatory gesture by Christine Lagarde. In her first official speech the new ECB president in Berlin heaped lavish praise on Wolfgang Schäuble, her former colleague as German finance minister, who has played a big part in stiffening German opposition to further-reaching European integration efforts over money and finance. Lagarde did not mention monetary policies, but lauded Schäuble in an award ceremony and called for European ‘strength’ to overcome the continent’s challenges.
A deposit guarantee scheme, long requested by states such as Italy held to have more fragile banking systems, has met considerable German resistance on the grounds that creditor nations would be bankrolling weaker members of the euro bloc and regarding ‘profligate’ behaviour. Scholz, Schäuble’s successor, has shifted the argument on to more positive territory, putting forward a nuanced form of deposit reinsurance system designed to overcome some of the criticism by the public sector savings banks and co-operative banking groups that make up the lion’s share of Germany’s overall deposit base.
Scholz – battling to become leader of the electorally pressed Social Democratic Party, junior partner in Chancellor Angela Merkel’s coalition – coupled his plea with a new bid to bring in capital risk weightings for banks’ holdings of sovereign bonds. This request – aimed in particular at Italy – forms part of a traditional German panoply of conditions for more risk-sharing throughout the euro area. As in the field of deposit insurance, Scholz has subtly adjusted the customary German view by calling for a sophisticated mechanism to prevent sovereign risk weightings adding substantially to banks’ capital burdens in normal circumstances.
The role play involving Schäuble and Scholz represents a big effort to forge European harmony over the balance of fiscal and monetary policy in the euro area. Latest ECB credit easing orchestrated by Mario Draghi, ECB president for eight years until end-October, has met stiff opposition from Germany. Schäuble himself has led the charge in recent years, claiming that Draghi’s ultra-accommodative policies, by lowering returns for German savers and allegedly propping up weaker states, has helped drive the surge of Alternative for Germany, the anti-euro, anti-immigrant far right party, particularly in eastern Germany.
The finance ministry under Scholz has been trying to withstand the impression that it is anti-Italian. In a first reaction from Italy, officials say they respect the ‘opening’ from Berlin, although they add that the hotly contested sovereign risk weighting plan cannot be accepted as a precondition for further steps towards banking union, including an improved resolution regime for failing or failed banks.
Writing in the Financial Times, Scholz recommended a European deposit reinsurance scheme to ‘significantly enhance the resilience of national deposit insurance. However, such a scheme would be subject to certain conditions, one of which is that national responsibility must continue to be a central element.’
On the contentious sovereign debt capital weighting issue, Scholz wrote: ‘Sovereign bonds are not a risk-free investment and should not be treated as such. Banks should have to make provision for risks arising from sovereign debt within an appropriate transition period. We should introduce capital requirements reflecting credit and concentration risks from sovereign exposures on banks’ balance sheets in a careful, gradual manner without threatening financial stability.’
A longer separate position paper released by the finance ministry gave more details: ‘During a crisis, this sovereign-bank nexus presents a large risk to financial stability in the monetary union. The introduction of risk-based concentration charges would create incentives to reduce home bias and spread risks with regard to sovereign bonds. In this case, banks would also have to make provisions for risks arising from sovereign debt.’
The ministry called for ‘base risk weighting for different qualities of loans, measured using ratings, for example. This would include a certain allowance for sovereign debt, which would be exempt of the capital requirements irrespective of the rating (e.g. up to a concentration of 33% of the Tier 1 capital of the individual bank).’
‘The lower the quality of the loan and the higher the concentration of the liabilities from individual countries or borrower units on the bank’s balance sheets, the higher the applicable risk-based concentration charge.’
This type of model could be calibrated to avoid ‘excessively large additional capital requirements.’ There would be an incentive for banks to diversify their sovereign bonds portfolios and ‘hence function better as a buffer in crisis situations.’ In addition, challenges resulting from the transition could be mitigated with a five to seven-year phase-in period.
David Marsh is Chairman of OMFIF.