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A half-hearted banking union raises more risks than it solves
Jun 8th 2013 |From the print edition
PENNY-PINCHING lovers can always turn to Las Vegas, where wedding-chapel
packages start at just a couple of hundred dollars (wedding music included,
rose bouquets extra) and annulments are fast and cheap. The architects of the
euro zone s banking union are planning something similarly cut-price.
Almost a year ago, as the euro crisis raged, Europe s leaders boldly pledged a
union to break the dangerous link between indebted governments and ailing
banking systems, where the troubles of one threatened to pull down the other.
Yet the agreement that seems likely to emerge from a summit later this month
will be one that does little to weaken this vicious link. If anything it may
increase risks to stability instead of reducing them.
Almost everyone involved agrees that in theory a banking union ought to have
three legs. The first is a single supervisor to write common rules and to
enforce them uniformly. Next are the powers to resolve failed banks, which is
a polite term for deciding who takes a hit; these powers also require a pot of
money (or at least a promise to pay) to clean up the mess left by bust lenders
and to inject capital into those that can get back on their feet. The third leg
is a credible euro-wide guarantee on deposits to reassure savers that a euro in
an Italian or Spanish bank is just as safe as one in a German or Dutch bank.
National insurance schemes offer scant reassurance to savers when sovereigns
are wobbly and insured deposits make up a big chunk of annual GDP (see chart).
Judged against these three requirements, Europe s new plan is a miserly one.
Its outlines emerged in a joint paper released on May 30th by France and
Germany. The minimalism of the paper suggests the summit will offer little more
than the establishment of single supervisor and a promise to set up a vaguely
defined resolution mechanism .
If a pot of money is pledged it will probably be a small fund raised through a
tax on banks and without the backing of governments. If Europe s bail-out fund,
the European Stability Mechanism (ESM), is referred to it is likely to be only
as a last resort to recapitalise lenders after ailing countries have already
bankrupted themselves standing behind their banks. A euro-wide deposit
insurance fund is so controversial it isn t polite to mention it.
The reasons for this paltry progress are partly political and partly legal.
Creditor countries such as Germany are understandably reluctant to have their
taxpayers cough up for the mistakes of bank supervisors abroad. The politics
are seen as especially toxic when it comes to deposit insurance because, in the
words of one official, it is close to people s pockets . He dryly notes that
Germany couldn t even force its own savings banks to join its national
deposit-insurance scheme.
The legal challenges are also enormous. Each country in the euro has its own
bankruptcy code. A change in the treaties governing the European Union would
probably be needed to give a new resolution authority the power to seize bank
assets and impose losses on creditors.
Events outside the negotiating room have also reshaped the scope of a banking
union. The bail-in of Cypriot banks earlier this year dipped into the savings
of uninsured depositors in order to recapitalise lenders. Repeating that tactic
would risk deposit flight from peripheral banks and a sharp increase in banks
funding costs. But rather than committing public funds to shore up banks
elsewhere, some politicians would doubtless prefer to hit uninsured depositors
again.
Given these legal and political constraints to banking union, it is tempting to
applaud any sort of progress. Putting the European Central Bank (ECB) in charge
of the region s biggest banks should end the cosy relationship between banks
and regulators that allowed Irish and Spanish banks to keep lending during
property bubbles and the likes of Deutsche Bank to run with so little capital.
If the ECB proves itself an effective supervisor, Europeans may become more
inclined to take further steps. Germany, for instance, has indicated that it
would in time be willing to allow the ESM to inject capital directly into
banks.
A strategy of incrementally moving towards a full banking union might have
worked in normal times. Doing so in the middle of a crisis is risky. Over the
coming year the ECB will have the unenviable task of assessing the health of
the banks it is about to supervise. Its root-and-branch examination may well
reveal gaping holes at a number of big banks. Yet without ready access to a pot
of money to fill these holes, the ECB could be reluctant to force banks to come
clean. It is madness to expose capital shortfalls if you don t know where new
capital is going to come from, says one bank supervisor.
Even if the ECB has the nerve to tell banks to raise capital, it may lack the
legal authority to push them into resolution if they refuse. Those subject to
its writ may have cause of their own to complain. If you wanted to challenge a
decision, where would you go to court? asks the head of a European bank
regulator.
A separation between the power to supervise banks and the responsibility for
paying for supervisory mistakes is also a worry. Taxpayers in a country whose
banks were allowed to take on too much risk would justifiably be irked that
they have no way of holding the supervisor accountable. The ECB is the last
credible institution in Europe, laments the same regulator. This could
destroy it.