A conversation with ESM Chief Economist and Management Board Member, Mr Rolf Strauch

This conversation was conducted by our Research Associate, Leopoldo Pérez Obregón, and recorded on 27 June 2024 at the EUI premises in Florence, Italy.

Banking supervision and crisis resolution are key areas of cooperation to enhance the resilience of the European Banking Union (EBU). The European Stability Mechanism (ESM) is one of the key pieces of that system. Its core purpose is to support member countries that are ‘experiencing, or are threatened by, severe financing problems, if indispensable to safeguard the stability of the euro area as a whole and of its Member States’i. The process to expand the ESM’s mandate is ongoing. Its new functions would include providing a backstop to the Single Resolution Fund (SRF), and enhanced monitoring capacities for crisis-prevention in collaboration with the EU Commission. 

But what implications would this new mandate have on the cooperation between the ESM and other institutions of the Banking Union, such as the Single Resolution Board (SRB) and the Single Supervisory Mechanism (SSM)? To discuss this issue, I sat down with Mr Rolf Strauch, Chief Economist and Management Board Member at the ESM. 

Mr Strauch began our conversation by reminding the intensity of the crisis that gave birth and purpose to his institution. ‘I think we can rightfully claim that without the ESM, today the euro area would not be the same as it is because some parts may have broken off. So, the integrity [of the euro area], that is our core mandate.’ 

At this point, it is worth recapping the history of this institution and its ongoing reform process. 

The ESM was established in 2012, following a series of emergency measures taken during the European sovereign debt crisis. Prior to that event, there was no instrument in place to support countries facing public debt and bond market difficulties within the euro area. This intrinsic vulnerability in the design of the European Monetary Union (EMU) exacerbated the crisis initially triggered in the USii. Several legal hurdles prevented an easy fix to this weak spot in the EU framework. A solution was eventually worked out through a limited amendment of the TFEU and the creation of the ESM as an intergovernmental organisation under international law rather than EU lawiii. It is the treaty governing the ESM that is currently undergoing reform, but prior to entering into force, it must be ratified by the parliaments of all euro area countries. All countries but Italy have completed the ratification process. 

According to Mr Strauch, the main components of the reform are threefold. First, there is the formalisation of the ESM as a common backstop to the SRF. ‘That is core to preserve the stability of Banking Union. It is the financial backbone of Banking Union because we would step in if the SRF runs out of money’, he explained.   

‘The second important element of the treaty change is that ESM is meant to have a broader mandate in designing policy conditionality in future programs’, he continues. This means that when a country seeks financial assistance, the ESM, jointly with the EU Commission, will design the economic policies that countries should enact to regain market access and guarantee the sustainability of their financial commitments. Mr Strauch emphasises that preparedness is crucial for this purpose. Successful interventions cannot be designed ‘without having a chance to monitor countries to identify the sources of financial instability that emerge there. So that is why we need a stronger monitoring mandate’, he asserts. 

The final element of this treaty change is the strengthening of the preventive character of interventions. ‘We have precautionary credit lines, and one of the lessons that we have drawn from the past crises experience is that it is better to prevent than to cure. It is easier and more efficient to extinguish a small fire rather than a big one’, Mr Strauch says, highlighting the specific features of the monitoring carried out by the ESM: Mainly, that is linked to their role as a crisis resolution mechanism, differentiating the ESM from other European institutions, including the SSM.

“We look at where financial stability risks emerge in the economy, in the household sector, firms, financial institutions, the public sector, how those risks may migrate from one balance sheet, if you wish, from one sector to another, and how that creates ruptures and financial stability risks. That is our task. And then to assess how we potentially may be called in. I think it’s this specific monitoring perspective that makes our work valuable” 

When discussing the specific risks that the ESM plans to monitor under its new mandate, Mr Strauch underscored the continuous efforts to improve the institution’s monitoring capacity. ´We have developed a very sophisticated toolbox for that, and there are also new elements that come to the monitoring framework.’ Most notably, he mentions the integration of climate change-related risks. 

These innovations are also implemented as part of a collaborative effort. Jointly with the SRB and in close consultation with the ECB and the EU Commission, the ESM has developed a renewed methodology to assess the repayment capacity of the banking sector. ‘We are a lender, and for us to give an upfront loan to the SRF, we need to confirm to our shareholders, and to the [EU] institutions, that we consider the banking sector able to repay that loan without being overburdened.’ If that crisis mechanism becomes active, interactions with other institutions from the Banking Union would be crucial. Nevertheless, ‘in that framework, our direct interlocutors, our counterpart, are the colleagues from the Single Resolution Board.’ 

Another aspect to clarify about this reform is how the monitoring functions will be carried out in practice. Most specifically, whether they would be conducted through public reports or via direct communication lines with the SSM. I asked this question to Mr Strauch: 

‘In our role as a backstop, as I said, our main counterpart is the SRB, and our interaction with the system would be rather via the colleagues from the SRB. So, there is no direct reporting in that regard to the SSM. Having said that, there is close interaction in “normal times” with the colleagues from the SSM. We talk to them, with a view to certain countries that we monitor and that had programmes with us. And they will also engage with us in the development of the repayment capacity methodology. So, there is interaction with colleagues [from the SSM], but when we deploy our instrument, then the connecting point is rather the SRB’. 

As a member of a transparent and accountable institution, Mr Strauch is well aware of the importance of communicating to the public, ‘for example, through a blog series where we address certain topics to clarify where we see financial stability risks, how we work, what we do, what our instruments do. […] But when it comes to crisis, for other institutions and for us, it’s also very important that things that need to remain confidential [are safeguarded] in order not to broaden the crisis. When we deploy our instrument, our interaction with the single resolution fund will be done in full confidentiality to preserve the financial stability in that specific situation. So, there will be no public reporting on this when we deploy the instrument.’