Repairing the EU Banking System and the Role of Securitization

Abstract

This article is a summary of a presentation the authors made at the Global ABS Conference in Barcelona on June 12, 2014. The first part of the presentation provides a macro-picture of the current state of the European Union (EU) banking system. Significant challenges within the EU banking sector continue because of the heavy debt overhang in the public and private sectors, persistent asset quality deterioration, a likely rising level of provisions, squeezed net interest margins, and profitability concerns. A dislocation between financial markets and the real economy continues to be observed, and risks to the EU growth outlook still weigh more heavily on the downside. Financial fragmentation persists, although it is receding, and retrenchment to home markets is still a concern. The distress in emerging markets may raise risk aversion and affect capital flows. The second part of the presentation provides an in-depth analysis of the historical performance, regulatory initiatives, and concerns surrounding securitization and discusses the important role securitization can play for banks and the economy as a whole. The securitization market in the EU continues to be impaired, banks are currently reluctant to use securitization as a funding tool, and investors are reluctant to invest in securitization products. Nonetheless, the European Banking Authority sees a number of compelling reasons justifying the development of a “high quality” securitization (HQS) market. Securitization, if used in a prudential way, can play an important role in helping the EU banking sector to become more robust and mature and to facilitate banks in the funding of the real economy. The securitization industry, via the establishment of the Prime Collateralised Securities (PCS) association and label, has shown regulators that it is capable of imposing some level of self-control in the development of the securitization market. If the securitization technique is used inappropriately, however, it can cause massive and long-lasting shocks to the whole financial system.