25th Oct 2016

Who pays the bills in a banking union?

  • Who pays when a bank goes bust? RBS received a ₤45.5 billion taxpayer bailout (Photo: Fergus Ray Murray)

The European Commission published the most important and eagerly awaited piece of the banking union puzzle on Wednesday (10 July) but the backlash, particularly from Germany, was predictable.

Despite a delay of several weeks, internal market commissioner Michel Barnier's big idea - to set up a Commission agency responsible for deciding whether and when to wind up an ailing bank - came as no surprise.

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Neither was the German government's swift and curt dismissal of the text as being in breach of the EU treaty. Stephen Goetzl, head of the GVB, the Bavarian association of co-operative banks, then buffoonishly compared Barnier's proposal to Hitler's enabling act.

It is hardly surprising that the rules on resolution and recovery are the most politically controversial part of banking union. The question of what to do when a bank gets into such severe difficulties that it must get emergency funding, be wound down, or be restructured, is at the heart of preventing a repeat of the 2008-9 banking crisis. Five years after the collapse of Lehman Brothers, there are still no common EU rules that would allow individual institutions to fail while safeguarding the overall stability of the banking sector.

Nobody should underestimate the important transfer of national sovereignty that a genuine banking union represents. Sharon Bowles, chairperson of the European Parliament's influential economic affairs committee, has described it as a "greater pooling of sovereignty than signing up to the euro."

But while it is clear that the main pitched battle will be on who is given the authority to decide on whether to take a bank into resolution, the second big idea in the proposal has got surprisingly little coverage - a bank resolution fund for the eurozone.

The eurozone already has a €500 billion bailout fund, the European Stability Mechanism (ESM), of which up to €60 billion will be available to recapitalize banks from late 2014. Now the commission is proposing a common bank resolution fund for the eurozone which, it estimates, could be worth about €55 billion.

Unlike the other funds which are, ultimately, taxpayer backed, the idea is that the resolution fund would be financed by bank levies totalling 1 percent of insured deposits. Of course, they would not be worth €55 billion overnight, the commission plan is that the pot would be accumulated over a ten year period.

The question of resolution funds to cover the costs caused by taking a bank into resolution is nothing new. Moreover, the principle underpinning them - namely, that banks not taxpayers should pay for any future crisis - is sound.

But there are competing views on how they could be structured.

The UK has had a bank levy worth around ₤2.5 billion (€3 billion) per year since 2010, while Brussels policy wonks have been churning out research papers on the subject for more than a year. One of the better papers, by Daniel Gros and Dirk Schoenmaker for the Duisenberg School of Finance, talks of creating a new institution, a single European Deposit Insurance and Resolution Authority, to be responsible for crisis resolution and depositor protection.

The draft bank recovery and resolution directive (BRRD), on which the Commission's Single Resolution Mechanism is based, also includes provisions for countries to set up national resolution funds.

A single eurozone fund is particularly attractive to the eurozone's smaller member states and it is not hard to see why.

They have no control over the ECB's monetary policy and no central bank to print money or provide emergency liquidity. These handicaps have been brought into sharper focus by the Cypriot bailout fiasco, where €7 billion of the €17 billion package had to be found from bailing in creditors of its two largest banks, one of which is now being liquidated.

Most countries are aware that, like Cyprus, the failure of one or two domestic banks would wipe out their national resolution funding, but would be small change to a eurozone fund. The eurozone periphery countries need all the help they can get.

It is certainly an indication of the European banking sector's fragility that lawmakers are still set on creating more multi-billion euro piggy-banks to be raided if there is another expensive banking crisis.

But it would be a mistake to imagine that a eurozone resolution fund would have the muscle to cope with a systemic banking crisis of the kind witnessed in 2008-9. A €55 billion fund would be able to cover most of the 6,000 banks that will be fall under the ECB's new supervision regime next summer, but could never cover the costs of a Deutsche bank or Credit Agricole collapse.

There is also opposition to both national and eurozone funds. The UK is anxious to avoid setting up a national resolution fund, arguing that the handful of mega-banks that dominate its high-street banking are simply too big. For example, the taxpayer bailouts for Royal Bank of Scotland and Lloyd's totalled ₤65.5 billion (€76 billion), more than ten times the size of a national resolution fund.

Meanwhile the German government is resistant to agreeing on a eurozone fund, fearing that it could become another bailout fund and knowing that, as the bloc's largest country, it would pay in the most.

There are other philosophical and practical concerns. For one thing, they undermine the point of legislation on resolution and recovery which should, primarily, be about preventing a banking collapse rather than emergency tools to pay for it. MEPs and ministers are also divided over whether countries should be allowed to merge the funding for resolution and for deposit guarantees, or whether member states should have to set up two identical pots of money.

At the heart of the political roadblock on banking union is a fundamental disagreement on what banking union should look like.

On one side, the EU institutions and a France-led group of member states, envisage shiny new authorities in Brussels and Frankfurt with extensive powers to supervise and intervene in the banking sector. On the other side, a German-led group is anxious to avoid a large transfer of power over supervision and the creation of a common resolution fund that looks suspiciously like a bail-out tool.

Bank supervision was always going to be the easy part. Resolution and recovery is about following the money. The Cyprus crisis reminded people that banking failure brings tangible financial costs. But politicians are still a long way from agreeing on who should be responsible for paying the bill.


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