We look at the two main components of the new banking regulations in the euro zone. On the one hand, the implementation of new regulatory ratios (capital, liquidity, stable funding); on the other hand, with the banking union, the replacement of bailout (of banks by governments) with bail-in (if a bank defaults, the shareholders, the bondholders and the depositors holding more than the insured amount of deposits have to share in the losses).
The new regulatory ratios are reducing euro-zone banks’ capacity to lend and, what is an accepted consequence, are leading to a partial disintermediation of corporate financing, as companies will have to raise financing more in equity and bond markets and less by bank credit. The criticism levelled against these regulatory changes is that retail savers do not want to hold risky financial assets. As soon as uncertainties appear, they sell risky assets and switch to risk-free assets, which leads to a “shutdown” of equity and bond markets and make it impossible for companies to use them to raise financing, a development we can see already now.
The shift to bail-in aims to reduce the incentive for euro-zone banks to take risks by eliminating the guarantee of a government bail-out. But it makes the securities issued by banks (shares, junior and senior bonds and even covered bonds) riskier, leading to, in the event of uncertainty, a slowdown in growth, a sharp rise in risk premia on these securities, and therefore a sharp rise in banks’ funding costs.
The shift from bail-out to bail-in has therefore made bank financing very pro-cyclical, as banks will have financing problems due to the cost of their funding as soon as the economic situation deteriorates, which we are witnessing now. The new European banking regulations (ratios, bail-in) have therefore led to an extremely pro-cyclical behaviour (reinforcing the real economy cycles) both in terms of financial markets and banks, which the critics of these new regulations pointed out from the beginning
