Turmoil Frays Ties Across Continent

Amid Europe’s intensifying debt crisis, a spat between banking authorities in Germany and Italy shows how Europe’s carefully nourished financial ties are fraying.

The row kicked up last fall when German banking regulators ordered Italian bank UniCredit SpA UCG.MI +0.24% to stop borrowing billions of euros from its German subsidiary. They wanted to protect their banking system from being infected by the weaker one to the south. The move angered Italy’s central bankers and sent relations between financial authorities into a nose dive.

Such disputes have been flaring up across the continent, as European Union members worry that a relatively borderless financial system created in happier days now risks funneling problems from ailing countries to healthy ones.

Burned by the extended crises and distrustful of some of their peers, financial authorities in countries including Austria, the Netherlands, Spain and the U.K., in addition to Germany and Italy, are adopting fend-for-yourself approaches designed to insulate their own financial systems from problems elsewhere.

“It’s part of a bigger trend. We are taking steps backward in integration on many fronts.” said Andrea Beltratti, chairman of Italian bank Intesa Sanpaolo ISP.MI -0.79% SpA.

Jon Pain, a former head of bank supervision at the U.K.’s Financial Services Authority, said the regulatory nationalism “is testing the notion of a single market in Europe.”

As Europe scrambles to contain its intensifying financial crisis, officials are zeroing in on the bloc’s disjointed approach to dealing with struggling banks. On Wednesday, the EU’s executive arm floated a proposal to consolidate supervision of lenders by moving toward a “banking union” across Europe. The proposal from the European Commission included allowing its rescue fund to directly prop up vulnerable banks—an idea quickly rejected by Germany.

When Europe in 2003 adopted so-called passporting rights that let European banks operate anywhere in the EU, the move was rooted in a new era of trust among members’ financial authorities. They increasingly ceded supervision of foreign lenders operating within their borders to regulators back in the banks’ home countries.

While a bank’s foreign subsidiary would face supervision both by the bank’s home country and the country where the subsidiary operated, banks also were allowed to open “branches”—appendages not legally independent—overseen just by the country where the parent was based. As they agreed to increase cooperation, Europe’s financial authorities also pledged to keep each other in the loop if problems arose within their borders.

One aim of the integration rules was to benefit customers. Banks could raise funds where cheaper money was available and transmit the savings to borrowers. It would become easier for individuals and companies to borrow money and open bank accounts anywhere in Europe.

A small flurry of cross-border mergers further integrated European banking. The biggest was UniCredit’s 2005 takeover of German bank HVB for €15.4 billion (roughly $19 billion).

The deal was hailed as a symbol of Europe’s financial integration. UniCredit executives said they had created “the first truly European bank.”

The global financial crisis, however, led national regulators to begin retightening the screws.

The U.K.’s Financial Services Authority, or FSA, has tried in recent years to increase its ability to police large European banks operating in Britain.

It has pressed some banks with London investment-banking arms—such as France’s Société Générale SA, GLE.FR -1.03% Germany’s Deutsche Bank AG DB -2.76% and Switzerland’s UBS AG UBS -1.88% —to convert them into subsidiaries instead of branches so they face tougher FSA oversight, say people familiar with the matter. Most of the FSA’s efforts have failed because of resistance from the banks and their national regulators, the people say.

European bank executives say they have encountered similar pressure from supervisors in many EU countries since the debt crisis flared up in early 2010.

A new agency, the European Banking Authority, was created last year, in part to iron out differences in regulations and resolve regulatory spats. Its work has been complicated by wrangling among its representatives from the EU’s 27 countries. “There is still a long way to go to enhance consistency…and to achieve adequate levels of information exchange and cooperation,” the new agency’s chairman, Andrea Enria, said in a May 23 speech.

Last summer, as the debt crisis escalated to new levels, so did regulators’ concerns. Austria’s authorities became anxious that their banks could be exposed to problematic loans in Eastern European countries where they have operations, such as highly indebted Hungary. After discussing their concerns for several months with the banks’ executives, the Austrian regulators in November announced rules that, in essence, limited the ability of the banks to issue new loans in Eastern Europe.

The Austrian Financial Market Authority and Austria’s central bank didn’t consult with counterparts in other countries, according to people involved in the process. These people added that the unilateral move angered regulators in Eastern Europe, who feared it could cause a credit crunch and who complained to European policy makers.

Mr. Enria, chairman of the European Banking Authority, or EBA, phoned Austria’s central-bank governor to express concerns about possible retaliatory actions, according to the people involved in the talks. The EBA and other EU agencies sent officials to Vienna to try to get Austria to backtrack.

In March, Austria did so, issuing new guidelines that left implementation of loan rules up to a group of international regulators responsible for jointly overseeing cross-border banks.

Around the same time last year that Austrian financial authorities sought to crack down, those in Germany grew worried about UniCredit’s local operation.

Because it is a subsidiary, not a branch, it is subject to supervision both by the Bank of Italy and by Germany’s Federal Financial Supervisory Authority, known as BaFin.

The overlapping setup had long contained the potential for conflict—and conflict struck last summer. As the euro-zone crisis was threatening to engulf Italy, UniCredit, struggling to borrow from traditional sources, transferred billions of euros from Germany to the parent bank in Milan. By the end of last year, the German unit had moved €11.3 billion of funds to other parts of UniCredit, according to regulatory filings.

The transfers caught the attention of BaFin officials in Bonn. They fretted that banks from stressed European countries were exploiting Germany’s financial health for their own benefit, say people familiar with the matter.

They also worried that UniCredit was siphoning money in a way that could undercut the financial health of the German business. If UniCredit ran into financial problems, BaFin feared, German depositors might have trouble recouping their money. The Italian bank’s German arm is one of Germany’s largest domestic banks, with roughly €170 billion in deposits, 940 branches and more than 19,000 employees.

In an interview this month, BaFin bank-supervision chief Raimund Röseler, while noting he wasn’t referring specifically to UniCredit, said that “there were several instances of foreign banks that were gathering liquidity from their affiliate institutions and moving [it] to the home country.” It is “our duty to ask critical questions,” he said, and “monitor worst-case scenarios.”

BaFin officials wrote to UniCredit’s German bank urging it to limit transfers to its Italian parent company. Dieter Rampl, then chairman of the Italian bank, described BaFin’s letter to fellow directors at a September meeting of UniCredit’s board.

Members of the board bristled, according to a person present, and a few muttered that BaFin’s move, instead of being related to UniCredit’s health, might reflect Germany’s concerns about the then-government of Italy’s unfulfilled pledge to enact economic changes.

At Italy’s central bank, officials felt BaFin’s request violated an agreement by the two supervisory agencies not to act unilaterally, an accord dating to when UniCredit bought the German bank. “Unilateral responses…can penalize cross-border companies, hurt member states…and lead to a fragmentation to the market,” the Bank of Italy wrote in an internal memo earlier this year.

Problems involving cross-border banks “must be tackled jointly,” a Bank of Italy spokeswoman said this week. “Segmentation creates inefficiencies and may even cause risks where there are none. For good reason, Europe is meant to be a single market.”

UniCredit Chief Executive Federico Ghizzoni complained to Germany’s finance minister. Mr. Rampl, who is German, also tried to sway BaFin. Bank of Italy Governor Ignazio Visco personally got involved in the negotiations, an unusual move for such a senior official.

During one conversation, said a person familiar with the matter, a top UniCredit official told a BaFin regulator that the Italian bank might turn its German subsidiary into a branch to cut the German role in its regulation.

UniCredit also considered taking the dispute to the European Banking Authority, said people familiar with the matter.

The Italian bank ended up doing neither. One executive involved said UniCredit’s hands were tied because BaFin had the power to make life difficult for its German operation.

Meanwhile, the Bank of Italy decided to look more carefully into Germany’s Deutsche Bank, which runs a large Italian business.

The Bank of Italy requested detailed financial information about Deutsche Bank and pushed its executives to develop a plan to become financially self-sufficient in Italy and no longer lean on their Frankfurt parent, according to regulatory documents and people familiar with the situation. Deutsche Bank complied.

A Deutsche Bank spokeswoman said, “We are not aware of any tensions between our home and host regulators and maintain close and cooperative relationships with them both.”

In December, the European Central Bank decided to dish out an unlimited quantity of cheap, three-year loans to euro-zone banks. UniCredit borrowed €26 billion, an infusion that alleviated pressure on it to keep borrowing from its German business. UniCredit also sold €7.5 billion of new shares in January, helping ease BaFin’s concerns about its health.

In March, UniCredit told BaFin that its German unit would reduce its exposures to other parts of the company by roughly half. The Italian bank also promised to provide its German arm with collateral in exchange for any future loans, according to regulatory filings and people familiar with the matter. German regulators were satisfied.

Even so, relations between the Bank of Italy and BaFin have yet to be fully restored. The Bank of Italy is continuing to push BaFin for more detailed financial information about Deutsche Bank.

On April 27, a group of German regulators traveled to Rome at the invitation of Bank of Italy’s Mr. Visco. Over lunch at the Bank of Italy’s banknote printing press on the outskirts of Rome, the regulators tried to patch things up and discussed the need for more information sharing.

In a follow-up letter, the German regulators thanked Mr. Visco “for your outstanding hospitality last Friday.” The May 2 letter, reviewed by The Wall Street Journal, added that holding such meetings on a regular basis “will help prevent and resolve misunderstandings.…We are looking forward to an even better cooperation in the future.”

A version of this article appeared May 31, 2012, on page A1 in the U.S. edition of The Wall Street Journal, with the headline: Turmoil Frays Ties Across Continent.


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