The rise of populism in the EU: should banks run?

Rosalie Van der Weide, Yvonne Bouhuizen, Laurèl Borggreve

December 2017

They are angry, they are anti-EU and they are upcoming: the populist parties of the EU members. Over the last year the middle class of many EU countries felt abandoned by their politicians. At the same time many people feel threatened by increasing terrorism, large numbers of migrants from the Middle East and the perception of losing their national identity. The perfect ingredients for a toxic cocktail of division. A recent example of this unrest is Brexit. The pound fell dramatically after the vote to leave the EU and domestic inflation increased. It had a big influence on banks and other financial institutes. Overall, separating from the EU has left big marks on the economies of the EU as well as for the UK. On the 1st of October, under Carles Puigdemont’s wing, Catalonia made the same mistake, since 90 percent of the Catalonian people voted in favor for independence of Spain. We strongly believe Catalonia should not make this step. Separating from Spain could mean that Catalonia will no longer be part of the EU, which is undesirable. We discuss why everyone, and in particular Catalonia, should favor a banking union and we also argue why regionalism harms banks in the EU.

“You will not pass!”

Currently, banks established in Catalonia are allowed to operate anywhere in the EU, known as passporting rights. Banks in Catalonia will encounter difficulties around passporting if she separates from the EU. As we saw before during the Brexit, banks can only maintain passport rights with the following three options [4]: First, they could join the European Economic Area (EEA). Current members of the EEA are for example Iceland and Norway. In this case Catalonia must agree with free movement and ruling from the European Court of Justice. As a consequence, they must passively accept rules from the EU. Logically, this option must be undesirable for Catalonia, since one of her aims is to operate independently from unions. For example, Theresa May, the prime minister of the UK, was also strongly against this option. Second, they could use the concept of equivalence. Equivalence is a concept to recognize cross border standards and facilitates cross border trades between markets [3]. Basically, it protects customers when the standards between markets are similar enough. The advantage of this approach is that nations do not have to copy each other’s laws. However, problematically a market can easy revoke an equivalence declaration within 30 days. Therefore, equivalence is not a sound solution for Catalonian banks. Third, banks could establish branches and/or subsidiaries within the EU. The problem with this option is that banks must deal with increasing regulation in both the EU and the non-EU region resulting in higher costs and lower liquidity.

A regulation tsunami

Financial institutions in the EU follow the same laws and regulation. The three main pillars of the Banking Union (BU) are: the single supervisory mechanism (SSM), a single resolution mechanism for banks and a common system for deposit guarantees. The EU provides safety nets such as liquidity for banks that are member of the BU. These rules and safety nets help banks that are in need of financial support. When banks are financially stable, customers’ money is protected and bank runs are unlikely to happen [7]. A divided EU will add complexity to regulation and leads to higher costs for financial markets. For instance, banks in the UK claim that diverging from EU regulations becomes “a race to the bottom”. They state that by abandoning EU regulations and rules, banks are less protected against unexpected economic shocks [4]. These shocks can have a damaging impact on banks, especially banks that are high on debt. Outside the EU regulations, banks have to protect their liquidity themselves so this increases regulatory costs tremendously. Looking at the current situation in Catalonia, large banks are already moving from Catalonia to other parts of Spain. This is the result of the fear of increasing regulatory costs and the loss of the ECB liquidity window [6]. The results of these relocations hurts Catalonia’s economy since it scares away investors and businesses [8]. If large banks are already relocating, it is a matter of time for other banks to follow. Another concern is that managing a market with one regime is easier than a market with multiple regimes [8]. Multiple regimes lead to a lot of different set of rules, which increases risk and makes European banking supervision more difficult. Additionally, banks face higher costs to monitor both regulations of EU and non-EU regions and this will also lead to lower liquidity.

A shrinking job market: how many will get the sack?

A divided EU lowers the profitability of banks, because it brings uncertainty and volatility to financial markets [4]. Uncertainty causes lower growth and raises the possibility of a significant slowdown of financial markets. For example, the announcement of the Brexit happened in times when interest rates were low. The uncertainty together with a low interest rate environment resulted in falling prices. Also, the low interest rate environment probably persists longer, which is undesirable, because a too low interest rate causes underconfidence. People and business are reluctant to borrow, because they view too low interest rates as a sign of desperation. This results in a market slowdown. Taking the Brexit as an example, we saw that this effect does not only affect UK banks, but also other banks in Europe. In turn, to protect themselves from possible limitations caused by the Brexit, multiple firms (Transferwise for example) and banks (Swiss bank and HSBC for example) announced that they will relocate their business from the UK to another location in Europe (Paris, Amsterdam, etc.). In this manner, they will still be able to access the single market and will not be damaged by barriers or other limitations. Again, we already observe the same pattern in Catalonia with banks deciding to relocate their head-offices to Spain.

Looking back at the Brexit, business investments have also suffered, since companies are reluctant to invest in the UK due to the uncertainty that is tight to future trade arrangements of the UK with the rest of Europe. Firms are also afraid of customs barriers and tariffs leading to investments. Lower investments and more savings damages future productivity growth and lowers the demand for labor. This results in a lower need for employees and higher unemployment, which is unfavourable. What numbers of unemployment are we talking about? The chief executive of the London Stock Exchange mentioned in January that the Brexit could cost London (alone) already 230.000 jobs [2] . It is highly likely that the same will happen to Catalonia. We do not think that economists and government workers in Catalonia will be happy about these numbers.

Another impact of the Brexit was that on the night of the decision itself, the pound depreciated enormously against the dollar making the pound cheaper compared to the dollar. This happened because traders predicted that leaving the EU would result in a long-term and permanent economic cost on Britain. Although a cheaper pound is favourable for UK exporters, it goes along with the fact that import is more expensive. This led to domestic inflation while simultaneously the employers do not receive a higher loan [2]. Since it is more difficult for people to meet their living standards, they will lower their consumption leading to a lower wealth. And what is more important than the wealth and happiness of your folks?!

The banking union: a safe haven

It has become quite clear that a separation from the EU is not only bad for the banking business, but also for the economy and, most importantly, the wealth of the people. But one might wonder why we are pro the banking union then? The banking union provides a safe haven in times of market turmoil and stress [5]. And isn’t that what we desire? Safety? For example, we see that all the noise around Catalonia’s request to become an independent country leads to fear and uncertainty. In response, banks immediately decided to move to other parts of Spain, since this a safer operating environment. Spain has a more stable, economic climate due to membership of the EU and also benefits by avoiding all the difficulties caused by regionalism. A BU provides a safer and sounder financial system. The BU has two sides: it is both a game changer for the crisis and a jump forward for Europe. First of all, a BU provides supervision, so that cross-border allocation of capital and liquidity is purely driven by business considerations. In this way, banks do not have to compete with each other. This supervision comes along with a common resolution fund that decreases the too-big-to-fail problem and thus reduces moral hazard. Since all the banks offer the same insurance coverage, there is no need for depositors to shift their funds across the continent in search of a safe haven [1]. Isn’t that great?!

What does this mean for Catalonia?

Our opinion is that Catalonia should not decide to separate herself from Spain. The fact that Catalonia did not want to be part of Spain anymore caused lot of noise. It also led to the decision of multiple banks to move their business to Spain, because they want to stay part of the EU and are afraid of what will happen to the economy in Catalonia. Being part of the EU provides lot of advantages. As mentioned in previous sections, passporting is easy. Also, there is less complexity of regulations and laws. Another reason is that profitability of banks that are part of a banking union is higher. Finally, the banking union provides a safe haven for banks during times of stress and market turmoils. The reason why we strongly disagree with Catalonia’s request to become an independent country is that, if she manages to become a stand-alone basis, she will have to ask the EU members for permission to stay in the EU. The EU members, including Spain, will have to take an unanimous decision on this request and there is a high chance that they will vote against it. Losing the EU benefits would be an economic disaster for Catalonia. Therefore, we not only suggest Catalonia, but also other countries not to step out of the EU. A diverging EU is not only bad for the banking business, but also affects the economy and the wealth of the people, your wealth! Luckily for Catalonia, the populist Carles Puigdemont has been fired, along with his cabinet, and ran off to Belgium. Hopefully he stays there, so that Catalonia is safe.


Footnotes

[1] Cœuré, B. (2012). Why the euro needs a banking union. Retrieved from: https://www.ecb.europa.eu/press/key/date/2012/html/sp121008_1.en.html
[2] Cox, J., Chu, B., & Rodionova, Z. Cost of Brexit: The impact on business and the economy so far. Retrieved from: http://www.independent.co.uk/news/business/news/brexit-economy-sterling-currency-investment -cost-impact-business-financial-banks-insurance-retail-a7695486.htm l
[3] Ford, J. (2017). Financial future after Brexit: passporting vs equivalence: Pros and cons of models that would allow companies to continue to sell services in EU. Retrieved from: https://www.ft.com/content/61221dd4-d8c4-11e6-944b-e7eb37a6aa8e .
[4] Jackson, P. (2016). Brexit - what happens to banking? Retrieved from: http://voxeu.org/article/brexit-what-happens-banking .
[5] Khan, M. (2016). Brexit vote could turn UK into a safe haven triggering EU disintegration, says Barclay . Retrieved from: http://www.telegraph.co.uk/business/2016/02/11/brexit-vote-could-turn-uk-into-a-safe-haven-trig gering-eu-disint/
[6] Myanchenkova, Y. (2017) Catalonia and the Spanish banking system. Retrieved from: http://bruegel.org/2017/10/catalonia-and-the-spanish-banking-system/
[7] Nouy, D. (2017). Regulation and supervision in Europe - can many cooks make a good broth? European Central Bank; Banking Union Conference. Retrieved from: https://www.bankingsupervision.europa.eu/press/speeches/date/2017/html/ssm.sp170515.en.ht ml !
[8] Petroff, A., Liakos, C. (2017). Top bank moving HQ out of Catalonia over threat of split from Spain . Retrieved from: http://money.cnn.com/2017/10/05/investing/catalonia-banks-relocation-independence-spain/inde x.html

References


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