23rd Oct 2016


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.

Dear EUobserver reader

Subscribe now for unrestricted access to EUobserver.

Sign up for 30 days' free trial, no obligation. Full subscription only 15 € / month or 150 € / year.

  1. Unlimited access on desktop and mobile
  2. All premium articles, analysis, commentary and investigations
  3. EUobserver archives

EUobserver is the only independent news media covering EU affairs in Brussels and all 28 member states.

♡ We value your support.

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.


Europe ready to tackle Greek debt relief

The Greek government has built and broadened alliances in EU institutions and member-states that acknowledge the need to restructure the debt and deliver another economic model for the eurozone.

News in Brief

  1. Canada and Wallonia end talks without Ceta deal
  2. Juncker hopes for Canada accord in 'next few days'
  3. Romania drops opposition to Ceta
  4. Difficulties remain on Ceta deal, says Walloon leader
  5. Brexit could lead to 'some civil unrest' in Northern Ireland
  6. ECB holds rates and continues quantitive easing programme
  7. Support for Danish People's Party drops, poll
  8. Spain's highest court overturns Catalan ban on bullfighting

Stakeholders' Highlights

  1. EFADraft Bill for a 2nd Scottish Independence Referendum
  2. UNICEFCalls on European Council to Address Plight of Refugee and Migrant Children
  3. ECTAJoin us on 9-10 November in Brussels and Discover the new EU Digital Landscape
  4. Access NowCan you Hear me now? Verizon’s Opportunity to Stand for Global Users
  5. Belgrade Security ForumMeaningful Dialogue Missing Not Only in the Balkans, but Throughout Europe
  6. EASPDJoin the Trip! 20 Years on the Road. Conference & Photo Exhibition on 19-21 October
  7. EuropecheEU Fishing Sector Celebrates Sustainably Sourced Seafood in EU Parliament
  8. World VisionWomen and Girls Urge EU Leadership to Help end Gender-based Violence
  9. Dialogue PlatformIs Jihadism Blind Spot of Western Intellectuals ? Wednesday 26 October
  10. Belgrade Security ForumGet the Latest News and Updates on the Belgrade Security Forum @BelSecForum
  11. Crowdsourcing Week EuropeMaster Crowdsourcing, Crowdfunding and Innovation! Conference 21 November - 10% Discount Code CSWEU16
  12. EJCEU Parliament's Roadmap for Relations with Iran a Massive Missed Opportunity

Stakeholders' Highlights

  1. Nordic Council of MinistersFish Skin on Bare Skin: Turning Fish Waste into Sustainable Fashion
  2. CEDECOpportunities From the Creation of Synergies at Local Level in the Energy Transition
  3. ACCAFinTech Boom Needs Strong Guidance to Navigate Regulatory Hurdles
  4. Counter BalanceWhy the Investment Plan for Europe Does not Drive the Sustainable Energy Transition
  5. Nordic Council of MinistersThe Nordic Region Seeks to Make Its Voice Heard in the World
  6. Taipei EU OfficeCountries Voice Support for Taiwan's Participation in ICAO
  7. GoogleDid You Know Europe's Largest Dinosaur Gallery Is in Brussels? Check It Out Now
  8. IPHRHuman Rights in Uzbekistan After Karimov - Joint Statement
  9. CISPECloud Infrastructure Providers Unveil Data Protection Code of Conduct
  10. EFAMessages of Hope From the Basque Country and Galicia
  11. Access NowDigital Rights Heroes & Villains. Who Protects Your Rights, Who Wants to Take Them Away