Speech Thomas Leysen IBEC – CEO conferentie Economisch en monetair beleid in Europa: naar een...

7/30/2019 Speech Thomas Leysen IBEC CEO conferentie Economisch en monetair beleid in Europa: naar een goede balans

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Speech IBEC CEO conference 2013

Economic and monetary governance in Europe: Getting it r ight

Dubl in, 28/02/2013

By Thomas Leysen, Chairman, KBC Group and Umicore (prepared with the assistance of

Edwin De Boeck and Siegfried Top)

Dear President Barosso,

Dear Taoiseach,

Ladies and gentlemen,

It is a real pleasure to share some thoughts today with such a distinguished group of businessleaders, and to do it here in Dublin, the capital of a country that has been both a remarkableexample of economic dynamism since joining the European Union, as well as a focal point of the

Eurozone crisis.Today, the macroeconomic and business environment remains challenging, but, to quote ECBpresident Mario Draghi, the darkest clouds over the euro area have subsided. In my dualcapacity, as an industrialist, and as Chairman of one of the Eurozones largest bank-insurancegroups, I share this view. I am among those who see the glass as half full, or more than half full.And the election results in Italy will not change that view.

Admittedley, the process that has been followed in adressing the eurozone crisis has not alwaysbeen a pretty spectacle to behold, but the progress that has been made in aggregate is quiteremarkable. The euro is here to stay - a fact which those who, only a year ago, confidentlypredicted its imminent demise now grudgingly admit.

The complicated election results in Italy do not change my view. Also, many countries arefurther ahead on the road to reform and fiscal consolidation than was thought possible, andmuch better institutional mechanisms are already in place.

Yet, it is equally clear that there are absolutely no grounds for complacency. Much needs to bedone to ensure a sustained stability of the Eurozone and a return to sustainable growth.

In adressing the topic to hand, let me start by looking at the roots of this crisis, before turning tothe steps that have already been initiated, and the further steps that need to be taken to improvethe eurozone governance.

I will argue that further building on the institutional framework is necessary, but must go hand inhand with pragmatic economic policies to foster growth in Europe.

1. The eurocrisis as an insti tutional crisis

The eurozone crisis has many faces. It occured when the epicenter of the global financial crisismoved from the US to Europe. At first sight it appears as a sovereign debt crisis. But at its corelies a balance of payments crisis, reflected by large current account deficits, excessive debtaccumulation by both the public and private sector and loss of competitiveness of some memberstates.


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Ultimately, however, it is clear that at its very root also lies an institutional crisis. Sometimes it issaid that the euro is a currency without a state. This is only partially true, as clear supra-national institutions are in place at the EU level. However, the shortcomings in the process ofpolitical integration allowed countries within the common currency to maintain unsound fiscalpositions, and impeded a faster correction of unsustainable growth models in some countries.

This led to a build-up of macroeconomic imbalances, often heavily depending on intra-eurozonelending, actually facilitated by a strong integration of the European financial markets.

The global financial crisis in 2008-2009 brought these major macroeconomic imbalancesdramatically to the fore and extreme risk aversion suddenly stopped financial flows between themember states. All of a sudden, the shortcomings of the monetary union became crystal-clear.Its institutional framework was not prepared to deal with this challenge. The outcome was anever escalating crisis, reinforcing itself through the disintegration of the European financialmarket. The monetary union itself came under severe stress, with growing fears of eurozonebreak-up. Many analyses were made at that time predicting that the monetary union would eitherfall apart, or would have to transform into a completely integrated political and economic union,similar to the United States. I think we can say now that this thinking was overly simplistic .

Clearly, the crisis demonstrated the incomplete character of the Economic and Monetary Union.The existing governance tools failed: the Stability and Growth Pact was ill-equipped, andinadequately enforced. No effective economic coordination or correction mechanism was inplace, so that the building up of imbalances was left unattended. The financial sector remainedunder national supervision.

And thus pressing questions arose: what are the minimum conditions to ensure the full viabilityof the eurozone over time? What does Europe really need?

What surely is crucial in a monetary union is the role of a stabilizing central bank. Capitalisingon the credibility of the ECB established under J ean-Claude Trichet, his successor initiated boldaction when needed. Its formal commitment late September to safeguard the financial stability of

the euro with its OMT-programme as well as the LTRO-support earlier in the year werenecessary, but no sufficient conditions for assuring the sustainability of the euro in the long run.By doing so, the ECB has built a bridge towards stability, providing a window of opportunity forgovernments to address the fundamental challenges and complete the eurozones institutionalarchitecture. This depends on three institutional pillars:

- A fiscal pillar with enforceable rules to restore fiscal capacity and debt sustainability- An economic pillar that fosters competitiveness, sustained growth and employment- A financial pillar with a single supervisor, re-unifying the banking system

The future prosperity of Europe, its firms and its citizens, hinges on the ability of the Europeanleaders to complement the monetary union with these new pillars. Much has already been

achieved, particularly in the last year, but still, much needs to be done. I nevertheless do expectfurther progress to happen in small, persistent steps towards a closer union (or better: a moreefficient union) that creates a solid base for financial stability and a thriving businessenvironment.

Let me briefly go into each of these points, summing up achievements and further necessaryenhancements of the eurozone.


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2. Completing EMU: a fiscal pil lar

On the fiscal front, important reforms were put in place both at the national and the Europeanlevel.

As of September last year, a permanent European Stability Mechanism (the ESM) isestablished. It provides a solid safety net and mutualizes fiscal capacity in support of member

states if needed, at least for smaller countries. The new tools of this ES were a prerequisite forthe ECBs support through the OMT-programme, which proved to be a game-changer in theeuro crisis.

As such, the ESM is a first step towards a (limited) mutualization of debt.

On the other hand, one should not forget that real solutions to foster economic growth in Europecannot come from ever more government debt. From that perspective, it is very encouraging thatover the last two years, countries have renewed their commitment to fiscal reforms. At the centerof this are the Fiscal Compact and new European legislation, such as the Six Pack and the TwoPack. The Fiscal Compact treaty became effective since the start of this year, applying new,more enforceable rules to strengthen oversight of government budgets, including a balancedbudget rule and an institutional debt brake. The Compact strengthens the sustainability andcredibility of fiscal policies.

Here, in Ireland, it was adopted after a referendum that showed the willingness of the Irishpeople to stay in the euro and adhere to the principles of this strengthened governance, sendinga strong positive signal to the rest of the eurozone, and the world. I see now that public financesare gradually improving, as is markets confidence in governments actions.

To further strengthen this confidence, fiscal consolidation not only needs to credibly containpublic debt ratios, but also avoid a major short-term contraction of real economic activity. Thiscalls for a differentiated approach to consolidation, that, on top of the general debt and deficitrules defined in the Compact, allows to take into account country-specific economic conditions.

If growth unexpectedly deteriorates or a country-specific shock occurs, it should be given extratime to correct its excessive deficit, in order to avoid the vicious spiral of negative growth anddeteriorating public finances. In that respect, the creation within the fiscal pillar of a newsupranational mechanism to absorb temporary, country-specific shocks, is an essential furtherstep. The introduction of reform contracts, as proposed by EU-President Van Rompuy as aconvergence and competitiveness instrument is a good idea, though not (yet) accepted by theEuropean Council. Such country-specific contracts are conditional and imply only temporaryfiscal support. By limiting the financial support in time it is avoided that the eurozone turns into apermanent transfer union.

Moreover, the contracts target structural reforms, and are thus growth enhancing.

3. Completing EMU: an economic pil lar

This brings me to my next point: the economic pillar. The crisis has indeed shown that not onlygovernment finances should be the focus of further integration, but also economic policy.Coordinated economic policies are essential to complement the monetary union. To this goal,the Commission started its Macroeconomic Imbalances Procedure, aiming to prevent the build-up of new, and enforce the correction of existing imbalances. These are, among others, thelarge current account deficits (and surpluses), excessive debt accumulation by the privatesector, housing bubbles and loss of competitiveness. Correcting these imbalances is a difficultand painful process, but is essential for future and sustainable economic growth. Let me focushere on one key policy concern, the restoration of competitiveness.


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Europes future prosperity requires member countries to be competitive, meaning that theirinstitutional and macroeconomic conditions should allow productive firms to thrive globally. Tothat, Ireland is a bright example of restoring competitiveness, with relative unit labour costshaving fallen by almost 20% since its pre-crisis peak. Prices, costs and wages are importantfactors for firms to develop, but there are also other considerations, specifically for advancedeconomies. Europes comparative advantages at a global level are its specialization in high-value products and innovative technologies. Since the start of the euro, exports in high-tech andresearch-intensive products have increased faster than in other, more traditional sectors.

Being competitive in a broad sense is also taking full advantage of a well-educated labour forceand innovation potential. A central challenge for policymakers is thus to set conditions that allowthe skills and capabilities of the labour force, especially the younger people, to be well-developed and valuably employed by competitive firms, or in the new enterprises that theseyoung people will establish and develop. A flourishing, business-friendly environment shouldsupport entrepreneurs in crucial phases of the business life-cycle. To this end, a lighterregulatory burden, the seizing of the opportunities of the digital age and the green economy,and, of course, adequate access to finance, are crucial. Supplementary to that, there is a vitalrole for the banking sector.

4. Completing EMU: a banking union

This brings me to the third pillar, the banking union, which should again integrate the Europeanfinancial system and restore sustainable lending to the real economy. The decision to createsuch a union was perhaps the most important response to the eurocrisis in 2012, and this fortwo reasons. First, the strong interconnectedness between banks and sovereigns in Europe, andsecond, the role of banks in financing the real economy, and especially the many SMEs inEurope. Let me be more precise on that.

The strong link between the eurozone banking system and its sovereigns, and their respectivemutual risks, has played in both directions. Banks facing problems during the global financialcrisis had to be supported by their government. At the same time, European banks balancesheets are loaded with sovereign debt. Since the start of the crisis, the strong integrationbetween banks and sovereigns has thus threatened to create a vicious spiral of deterioratingpublic finances and a financial sector balance sheet crisis. Combine this with the importantintermediary role of the financial sector in Europe, and the risk of a credit crunch pushing thereal economy into a severe recession became very real.

Much however has in the meantime been done by European banks to improve theirsolidity.Much more, actually, then many people are aware of. By increasing their CT-1 capital by25% (or already 190 bn) and reducing their RWAs by 2%, major banks have improved theirCT-1 from 8.9% end 2009 to 11.4% in Q3 2012. Most of this improvement comes from bankrecapitalizations following European-wide stress-tests. My own institution, KBC, raised its CT 1ratio from 9,2 % to 12,5 % in three years time, despite repaying 4.2 bn in state aid +interests

over the same period. It did this by a combination of a capital increase, retention of earnings,reducing risk weighted assets in investment banking and divestments of non-core assets.

In the same period, lending to private persons and companies in our core countries actuallygrew, defying conventional wisdom.

More generally, investors' confidence in European banks strengthened in recent months, aswitnessed by improved funding conditions and the recovery of banks' share prices. The firstresults of regained trust in the banking system have also become visible in lending rates to thereal economy, that started to re-align.


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Nevertheless, banks continue to operate in a challenging environment, as e.g. illustrated by highnonperforming loans and weak profitability at banks in Ireland. European banks' resilience willbe further enhanced by the current regulatory overhaul provided by new Basel solvency andliquidity rules. Against the background of weak and fragile economic growth I would argue thatbanks, like countries, should be given enough time by regulators to comply with the new rulesand targets. In that respect I welcome the recent easing of the new liquidity coverage ratio(LCR) by the Basel Committee.

On top of these regulatory measures, institutional reforms towards a European banking unionwere necessary to counter the unravelling of the single financial market, disentangle banks fromtheir sovereigns, restore monetary policy transmission and fix the credit channel to restartgrowth. Over the last six months, European leaders have decided on a single supervisor, and bydoing so showed their capability to reach agreements on deepening the eurozone. Also thisdecision contributed to the return of trust in the banking system. However, to establish a fully-fledged banking union, it is imperative to continue to match the integrated supervision with asingle resolution mechanism, a credible fiscal backstop and, eventually, a single depositguarantee scheme. This again involves a greater solidarity and sharing of sovereignty betweenthe member states. But is indispensible if we want to really establish a level playing fieldbetween eurozone banks and avoid the resurgence of the vicious cycle the next time a crisis

hits.

Conclusion

Let me now draw to a more political conclusion.

Over the past two years substantial steps have been taken by European politicians to addressthe institutional shortcomings that were at the heart of the eurocrisis, including a new fiscal andeconomic framework, a permanent stability mechanism, and an area-wide banking supervisor.

On the country level, budgetary and structural economic reforms have been implemented,leading to first successes. In Ireland, competitiveness has been restored, economic growth isimproving, the structural deficit has been lowered significantly and a full return to the financialmarkets is underway.

European banks have made significant progress in building strong capital buffers and furtherregained credibility through recent reforms. These steps, together with the ECBs commitment tosafeguard the euro, have stabilized the eurozone and reverted the looming disintegration. Allthis constitues a necessary precondition for the recovery of sustainable economic growth.

Essential to all this was the clear willingness of European leaders to continue the politicalproject, a willingness which has often been underestimated by commentators and financialmarkets. Today, new EU member states, such as Poland and Lithuania, again consider joiningthe euro in the near future. I have the personal belief that ultimately membership of theEurozone and membership of the European Union will have to converge. This obviously wouldrequire a fundamental choice in some countries, especially by our British friends. The British pro-market instincts have often in the past provided a very welcome counterweight in the EUagainst more statist tendencies. Therefore a continued British membership is highly desirable but this will require acceptance by the British people that the European Union is more than aEuropean Free Trade Association. Those in Britain who are tempted by the vision of becomesome sort of a European Singapore outside the EU, should in my mind be aware of the dangerof ending up instead as a greater Monte Carlo, but one surrounded not by the Cte dAzur butby an industrial wasteland.


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Whilst the agenda of European integration should not be driven by the internal politicalconstraints in the UK, I personally feel that the debate about the shape and efficiency of theEuropean Union is one that we should not avoid now. It is a healthy and useful debate- butshould not drag on for five years.

In this respect, it has often been repeated that the European Union lacks political legitimacy.This view seems to forget that there is actually a European parliament, which is very powerful in

a number of areas, including the approval of the budget and the nomination of commissioners.Therefore, it seems to me that the run-up to the European elections in 2014 should be anexcellent time for raising the awareness of thin democratic tool. It should be the moment for thepan-European parties to articulate their visions and submit them to the European people.

Whatever the outcome of these debates and elections, the European Union will not, in theforseeable future, become a federal state like the US. Instead, Europe will continue to grow amodel of its own, seeking a right balance between a certain mutualization of risks, increase ofresponsibility of individual member states and some further sharing of budgetary sovereignty, ontop of ensuring a strong single market.

To find this model, to achieve a stronger and better Europe is the urgent mandate of thisgeneration. The sustained prosperity and the continued relevance of Europe in the 21st centurydepend on it.

Thank You very much


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Disclaimer

This publication is prepared by KBC Group NV, or related KBC-group companies such as KBC Bank NV,KBC Asset Management NV, KBC Securities NV (hereafter together KBC).

The non-exhaustive information contained herein is based on short and long-term forecasts forexpected developments on the financial markets and the economy. KBC cannot guarantee that theseforecasts will materialize and cannot be held liable in any way for direct or consequential loss arising

from any use of, or reliance on, this document or its content.

This publication is provided for informational purposes only and is not intended to be an offer, or thesolicitation of any offer, to buy or sell the securities or other financial products/instruments referred toherein. The document is not intended as personalized investment advice and does not constitute arecommendation to buy, sell or hold investments described herein.

This publication contains KBC proprietary information. No part of this publication may be reproduced inany manner without the prior written consent of KBC.

The information, opinions, forecasts, and estimates herein have been obtained from, and are basedupon, sources believed reliable, but KBC does not guarantee that it is accurate or complete, and itshould not be relied upon as such. All opinions and estimates constitute a KBC judgment as of the dateof the report and are subject to change without notice.

This publication is provided solely for the information and use of professionals (such as journalists,economists, and professional investors) who are expected to make their own investment decisionswithout undue reliance on this publication. Professional investors must make their own determinationof the appropriateness of an investment based on the merits and risks involved, their own investmentstrategy and their legal, fiscal and financial position.

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