Fabio Panetta: Pursuing a successful path towards euro area accession

Honourable members of the Committee on Economic and Monetary Affairs at ECB,

Thank you for inviting me to discuss with you the state of convergence of the EU Member States that are committed to adopting the euro1 under the EU Treaties, as assessed in our latest ECB Convergence Report. This gives me the opportunity to update you about the important decisions taken last week with regard to Bulgaria and Croatia and what this may imply for the future of the euro area. Let me thank the European Commission and the Bulgarian and Croatian authorities for the very smooth cooperation in the run-up to these decisions.

As we announced last Friday, the Governing Council of the European Central Bank (ECB) has decided to enter into close supervisory cooperation with the central banks of Bulgaria and Croatia (Българска народна банка and Hrvatska narodna banka).2 With this step, the two countries fulfilled the last prior commitment that was required for the other major decision, namely the inclusion of the Bulgarian lev and Croatian kuna in the exchange rate mechanism (ERM II).3 This decision was taken last Friday and entered into effect today.

As Bulgaria and Croatia have now simultaneously entered both the banking union and ERM II, they may be able to adopt the euro by around 2023, provided that they comply with all Treaty-based convergence criteria.

As I have argued in the past4 it is in everyone’s interest that euro area accession countries meet the conditions for successful membership.

In my remarks today, I will explain the importance of the ERM II process, close cooperation and sustainable convergence in preparing to adopt the euro.

The role of ERM II in the euro area accession process

The euro represents a source of economic strength and a political commitment to grow closer together over time. All EU Member States are committed to adopting the euro once they fulfil the necessary conditions, except for Denmark, which has an opt-out.5

All countries must strive to fulfil all the convergence criteria. Their readiness to adopt the euro is assessed by the ECB and the European Commission6 and described in their convergence reports.

In line with the role given to the ECB by the Treaties, let me focus here on readiness and the role of ERM II in the euro area accession process.

ERM II was introduced in 1999 as one of the ways to assess a country’s convergence with the euro area. The mechanism not only enables exchange rates between the non-euro area Member State’s currencies and the euro to be managed,7it also, and most importantly, is a way to test the sustainability of convergence before and after euro adoption.


The ECB plays a central role in ERM II. It is the operational hub of the system. The ECB’s General Council, which includes the governors of euro area and non-euro area central banks, monitors the operation of ERM II and ensures that monetary and exchange rate policies are coordinated. The General Council also administers the intervention mechanisms together with the Member State’s central bank. The ECB is also one of the parties that decide whether a given currency can be admitted to join ERM II. To take this decision, it prepares annual reports on the functioning of the mechanism. And together with the European Commission it assesses whether a country’s participation in ERM II has been sustainable.

The last wave of countries joined ERM II in 2004-05 and subsequently joined the euro area.8 From that experience, we have gained a better understanding of the regime shift that ERM II entails for participating countries. It became clear that participating in ERM II alters the economic incentives of international and local investors as well as those of the authorities of the participating countries. Evidence suggests, in particular, that after a country joins ERM II, it may experience large and volatile short-term capital inflows. Especially if coupled with a weak institutional set-up, this may set the wrong incentives, leading to the postponement of necessary reforms and a deterioration in the country’s adjustment capacity.

We have learned lessons from the financial crisis related to sustainable convergence that have led to reforms in the architecture of Economic and Monetary Union, such as the establishment of the banking union.

These lessons were taken into account when designing the path of Bulgaria and Croatia towards ERM II.

Both countries made prior commitments that were designed to ensure that their participation in ERM II would be smooth. The fulfilment of these commitments was carefully monitored and assessed by both the ECB and the European Commission in their respective fields of competence.9

More specifically, both countries made country-specific commitments pertaining to structural policies10, strengthening the macroprudential toolkit and transposing the EU anti-money laundering directives into national legislation.

Close cooperation – the path to the banking union

Bulgaria and Croatia, as prospective ERM II members, also established close cooperation between ECB Banking Supervision and their national competent authorities (NCAs) under the legal framework of the Single Supervisory Mechanism (SSM).

They were asked to do so as any country that wishes to join the euro area not only has to ensure sustainable economic convergence, but should also be ready to participate in the banking union.

The idea behind a country participating in the banking union before adopting the euro is to promptly address potential weaknesses in its domestic banking sector. This, in turn, avoids these weaknesses weighing on the national economy and public finances in the future, with negative spillovers across the entire euro area.

From a procedural point of view, establishing close cooperation requires the prospective member country to adopt legislation that allows the ECB to carry out its supervisory tasks. Moreover, the banking sector has to undergo a comprehensive assessment by ECB Banking Supervision, very similar to the one conducted on euro area banks in 2014 before the SSM was set up.11 In addition, the ECB can request information from the national supervisory authority and provide it with technical support to facilitate its smooth transition to the SSM supervisory approach.

Once close cooperation is established, the Member State participates in the SSM – as well as the Single Resolution Mechanism – with the same rights and obligations as the other participating Member States, except for small differences.12

As regards close cooperation with the central banks of Bulgaria and Croatia, the decisions of the ECB’s Governing Council will apply 14 days after their publication in the Official Journal of the EU. Once the Bulgarian and Croatian significant banks have been formally identified, the ECB will begin supervising banks in these countries on 1 October 2020.

Ensuring a sustainable convergence path

The prior commitments taken by Bulgaria and Croatia in recent years spurred important reforms that will mitigate risks under ERM II. However, these reforms will not fix all the imbalances and vulnerabilities that the two countries are facing.

I therefore welcome the additional voluntary policy commitments taken by Bulgaria and Croatia when joining ERM II.13These post-entry commitments aim at ensuring sustainable economic convergence by the time the two countries adopt the euro. The ECB and the European Commission, in line with their respective roles, will carefully monitor the implementation of these commitments.

Let me conclude by broadening the perspective and providing some general observations on the state of convergence of the non-euro area Member States that are committed to adopting the euro.

The ECB 2020 Convergence Report finds that mixed progress has been made over the past two years.

While important steps have been taken to address fiscal imbalances – and, in most cases, other macroeconomic imbalances, too – more progress is needed with regard to the overall quality of institutions and governance. In none of the seven countries examined is the legal framework fully compatible with all the requirements for adopting the euro. Advancing on this front is key as sustainable convergence requires sound institutions.

It is also important not to underestimate the risk of increased divergence due to the coronavirus (COVID-19) crisis. Given the cut-off dates for the analysis contained in the report, it was not possible to carry out a full assessment of the impact of the COVID-19 pandemic on the convergence path.

We should not exit the crisis with more divergence than before, neither in the euro area nor in the EU as a whole.

The European Commission’s proposal for a revised Multiannual Financial Framework and the temporary recovery instrument – Next Generation EU – are crucial in this respect. It is in Europe’s common interest that a strong joint response is quickly deployed to counteract the fragmentation risk stemming from the crisis and potential divergence in the longer run. It is in this spirit that we all look forward to the upcoming meeting of European leaders.

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