Friday

15th Dec 2017

Opinion

Banking union's major omission: debt mutualisation

  • Germany has opposed debt mutualisation and watered down the banking union (Photo: EnvironmentBlog)

Should we fear another banking crisis in Europe? European leaders would have you think that this is not possible anymore.

Indeed, after intensely caffeinated negotiations that ran late into the night, the leaders of the eurozone emerged with a deal in hand and smiles on their faces, proclaiming that the long awaited compromise on a banking union has been reached.

Thank you for reading EUobserver!

Subscribe now for a 30 day free trial.

  1. €150 per year
  2. or €15 per month
  3. Cancel anytime

EUobserver is an independent, not-for-profit news organization that publishes daily news reports, analysis, and investigations from Brussels and the EU member states. We are an indispensable news source for anyone who wants to know what is going on in the EU.

We are mainly funded by advertising and subscription revenues. As advertising revenues are falling fast, we depend on subscription revenues to support our journalism.

For group, corporate or student subscriptions, please contact us. See also our full Terms of Use.

If you already have an account click here to login.

Michel Barnier, the EU’s internal market commissioner quickly declared that the deal “will put an end to the era of massive bailouts”.

But will it?

The convoluted history behind Europe’s latest effort of achieving “an ever-closer union” can be traced back to the dark times of the financial crisis that rocked international markets half a decade ago. After the dust settled and some 110 banks caved under the weight of outstanding debts, the Union had already spent €1.6 trillion just to bail out its financial institutions.

With “never again” on their lips, Europe embarked on a grand project, conventionally called “the banking union”. In reality, it indicates a system of four major elements: a single rulebook for the financial market coupled a single supervisory and resolution mechanism, backed by an emergency fund.

The overarching idea was to preserve the European single market and break the noxious relationship between banks and its sovereigns.

Soon thereafter, tensions rose between major political stakeholders over how this new union should be achieved. Should it be a first step towards greater federalism or should it be simply a safety mechanism, controlled by national governments, meant only to address the single issue of banks’ solvency? On 20 March, the second option prevailed.

The compromise was clinched only after the German Finance Minister was woken up at 5am in order to sign off on key aspects. Under the deal, the Single Resolution Mechanism as it has been agreed will be responsible for supervising and/or shutting the 130 biggest eurozone banks as well as 200 cross-border banks and 6000 eurozone lenders.

The ECB, alongside a specialised agency, will undertake the regulatory supervision and will come to the rescue of troubled institutions by drawing from a €55 billion fund. Banks themselves will fill the funds’ coffers, through annual levies imposed by national governments. Under this deal, eurozone governments no longer have the final say whether a bank is too big to fail. It is up to the ECB to decide if funds are to be released.

Every country for itself

Fact: Italian banks have an estimated €150 billion worth of shaky, non-performing loans, while Europe prides itself with almost €1trillion. These figures are enough to give the shakes to any bank wanting to expand its lending business.

Fortunately, the European countries coming together under the banking union scheme can now act decisively and prevent another collapse of the system, right? Well, not quite. And I’m not referring just to the roughly 100 eurocrats that have to cast a formal vote on the closure of a bank.

The major fault of the system stems from German reluctance to accept debt mutualisation across the continent. This means that each country has to shoulder its banks using its own taxpayer money in case of a financial shock that overpowers the rescue fund’s existing capacity. And since the fund only has a few billions at its disposal, if major bank failures were to happen, the burden would once again fall back on individual countries. It doesn’t sound like a true banking union, does it?

The banking union was meant to reverse one of the most resilient financial laws, the so-called “financial trilemma”. In a nutshell, this triple dilemma is defined by three impossibilities: achieving financial stability, integration while maintaining national financial policies in an integrated market. Since the financial system is a dense web made up of streams of capital flows going from one node to the other, a faulty circuit can affect the entire market, threatening financial stability.

The watered down variant of the Single Resolution Mechanism that emerged in the wee hours of the morning of 20 March has severely weakened its initial purpose.

Investors are unsure about the health of banks’ balance sheets, the rigour of supervision and the capacity of cash-strapped European countries to provide the safety net needed to challenge the financial trilemma.

Although this is clearly a political victory for the European Parliament, which managed to force Germany’s hand into accepting a compromise, it is still a far cry from what Europe truly needed to turn around its wobbly banking sector. Like most rules coming from Brussels, the banking union is simply a jack-of-all-trades-master-of-none deal.

Robert Merton, an American sociologist, would have found the banking union a worthy inspiration for his studies. To illustrate how a false understanding of a given situation becomes an integral part of it and affects its outcome – otherwise known as a “self-fulfilling prophecy” – Merton used the parable of a fictitious bank run.

In his example, The Last National Bank, a profitable and stable institution, is suddenly affected by a false rumour that it was on the verge of insolvency. Panicked, its customers immediately flocked to take out their savings, overrunning the bank and forcing its default. The originally false definition of the situation – that the bank was insolvent – had become true, transforming into a self-fulfilling prophecy.

Like in Merton’s case, the EU’s banking union is geared in such a way that it automatically assumes that banks, maybe even big banks, will fail in the future. Unfortunately, the intricate decision-making mechanism and the limited scope of the fund are simply insufficient to reassure the market. Therefore, this is not a mechanism meant to help the banks that are now starving for cash, but a paradoxical way of instilling the idea, in both consumers and bankers, that a future liquidity crisis will happen.

This is a dangerous notion, which has the potential to act as an accelerant for future defaults.

Let’s just hope this will not turn into a self-fulfilling prophecy.

The writer is a Geneva-based economist.

Who pays the bills in a banking union?

The European Commission published the most important and eagerly awaited piece of the banking union puzzle on Wednesday but the backlash was predictable.

EU parliament gives final nod to banking union

MEPs on Tuesday signed off on the creation of a new authority and fund for failing banks – a missing element to the so-called banking union aimed at minimising the public cost of future financial crises.

Iceland: further from EU membership than ever

With fewer pro-EU MPs in the Iceland parliament than ever before, any plans to resume 'candidate' membership of the bloc are likely to remain on ice, as the country prioritises national sovereignty and a more left-wing path.

News in Brief

  1. Juncker: May made 'big efforts' on Brexit
  2. Merkel took 'tough' line on Russia at EU summit
  3. EU leaders added line supporting 'two-state' solution
  4. EU leaders agree to 20 European Universities by 2024
  5. Belgian courts end legal proceedings against Puigdemont
  6. French central bank lifts 2017 growth forecast
  7. EU leaders set to move Brexit talks on to next stage
  8. EU leaders confirm support for two-state solution

Stakeholders' Highlights

  1. Dialogue PlatformThe Gülen Community: Who to Believe - Politicians or Actions?" by Thomas Michel
  2. Plastics Recyclers Europe65% plastics recycling rate attainable by 2025 new study shows
  3. European Heart NetworkCommissioner Andriukaitis' Address to EHN on the Occasion of Its 25th Anniversary
  4. ACCACFOs Risk Losing Relevance If They Do Not Embrace Technology
  5. UNICEFMake the Digital World Safer for Children & Increase Access for the Most Disadvantaged
  6. European Jewish CongressWelcomes Recognition of Jerusalem as the Capital of Israel and Calls on EU States to Follow Suit
  7. Mission of China to the EUChina and EU Boost Innovation Cooperation Under Horizon 2020
  8. European Gaming & Betting AssociationJuncker’s "Political" Commission Leaves Gambling Reforms to the Court
  9. AJC Transatlantic InstituteAJC Applauds U.S. Recognition of Jerusalem as Israel’s Capital City
  10. EU2017EEEU Telecom Ministers Reached an Agreement on the 5G Roadmap
  11. European Friends of ArmeniaEU-Armenia Relations in the CEPA Era: What's Next?
  12. Mission of China to the EU16+1 Cooperation Injects New Vigour Into China-EU Ties

Latest News

  1. Dutchman to lead powerful euro working group
  2. EU mulls post-Brexit balance of euro and non-eurozone states
  3. EU asylum debate reopens old wounds
  4. Estonia completes two out of three priority digital bills
  5. EU countries are not 'tax havens', parliament says
  6. Tech firms' delays mean EU needs rules for online terror
  7. Slovak PM: Human rights are not a travel pass to EU
  8. British PM limps to EU capital after Brexit defeat

Stakeholders' Highlights

  1. EPSUEU Blacklist of Tax Havens Is a Sham
  2. EU2017EERole of Culture in Building Cohesive Societies in Europe
  3. ILGA EuropeCongratulations to Austria - Court Overturns Barriers to Equal Marriage
  4. Centre Maurits CoppietersCelebrating Diversity, Citizenship and the European Project With Fundació Josep Irla
  5. European Healthy Lifestyle AllianceUnderstanding the Social Consequences of Obesity
  6. Union for the MediterraneanMediterranean Countries Commit to Strengthening Women's Role in Region
  7. Bio-Based IndustriesRegistration for BBI JU Stakeholder Forum about to close. Last chance to register!
  8. European Heart NetworkThe Time Is Ripe for Simplified Front-Of-Pack Nutrition Labelling
  9. Counter BalanceNew EU External Investment Plan Risks Sidelining Development Objectives
  10. EU2017EEEAS Calls for Eastern Partnership Countries to Enter EU Market Through Estonia
  11. Dialogue PlatformThe Turkey I No Longer Know
  12. World Vision7 Million Children at Risk in the DRC: Donor Meeting to Focus on Saving More Lives

Stakeholders' Highlights

  1. EPSU-Eurelectric-IndustriAllElectricity European Social Partners Stand up for Just Energy Transition
  2. European Friends of ArmeniaSignature of CEPA Marks a Fresh Start for EU-Armenia Relations
  3. Nordic Council of MinistersNordic Energy Ministers Pledge to Work More Closely at Nordic and EU Level
  4. European Friends of ArmeniaPresident Sargsyan Joined EuFoA Honorary Council Inaugural Meeting
  5. International Partnership for Human RightsEU Leaders Should Press Azerbaijan President to End the Detention of Critics
  6. CECEKey Stakeholders to Jointly Tackle the Skills Issue in the Construction Sector
  7. European Friends of ArmeniaLaunch of Honorary Council on the Occasion of the Eastern Partnership Summit and CEPA
  8. EPSUStudy Finds TUNED and Employers in Central Governments Most Representative
  9. Mission of China to the EUAmbassador Zhang Ming Received by Tusk; Bright Future for EU-China Relations
  10. EU2017EEEstonia, With the ECHAlliance, Introduces the Digital Health Society Declaration
  11. European Jewish CongressEJC to French President Macron: We Oppose All Contact With Far-Right & Far-Left
  12. ACCASmall and Medium Sized Practices Must 'Offer the Whole Package'