In a speech to the Frankfurt Finance Summit, Ms Lagarde said that progress has been made in transforming the financial landscape since the crisis erupted in 2008.
“But it is mostly in the wiring and the plumbing — essential elements of a solid structure, but under the surface. Balance sheet repair needs to be tackled at the same time as regulatoryreform, in a mutually reinforcing manner. Finishing the business in both areas is necessary to reap the fruits of hard-won gains in regulatory reform and to restore the full functioning of the financial sector so that it can do its job of intermediating funds to borrowers and support growth.”
Ms Lagarde argued that funding conditions for banks across the eurozone remained fragmented because of the high level of impaired assets. The only effective solution for this problem is to clean up the balance sheets of the banks and use the ESM as a common backstop for systemic cases.
“Enhanced disclosure and credible asset quality reviews will help restore confidence and banks should be urged to deleverage by raising equity and cutting business lines that are no longer viable.”
Ms Lagarde acknowledged the recent progress that has been made towards an EU banking union. This included the set up of the single supervisory mechanism; proposals by the Commission to harmonise regulations on capital adequacy for banks, moves towards resolution regimes and national deposit insurance schemes and an agreement to draw on the ESM to recapitalise banks.
However, what is needed is more “follow-through” on these initiatives. “Other priorities include endowing the single supervisor with requisite resources and authority; implementing the common resolution and safety nets with a coherent; credible backstop; and setting up the resolution authority and insurance fund with access to common backstops.”
She said it was unacceptable that some financial institutions were still considered too big to fail. There is implicit government guarantee for banks in this category, which is worth roughly $64bn annually in lower borrowing costs.
She noted very little progress has been made on regulating the shadow banking sector, which continues to attract robust flows of funds. “I am an optimist, drawing inspiration from Martin Luther, who said ‘Everything that is done in the world is done by hope.’ But I am also a realist. Immanuel Kant, one of the greatest German philosophers, said that ‘using reason without applying it to experience only leads to theoretical illusions.’ The free exercise of reason by the individual was a theme of the Enlightenment. Hopefully, we are moving toward an “Enlightened” era in global finance and regulation, one based on experience and reason.”