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The gap between what needs to happen and what ends up happening is where Europe
can usually be found. The euro crisis will enter its fifth year in 2014 and, in
stark contrast to America s lenders, questions over the state of the euro zone
s banking system still remain. In response policymakers will take the first
step towards a banking union: responsibility for supervision of the euro area s
biggest banks is due to move from national authorities to the European Central
Bank (ECB) in late 2014. But this will be progress of a familiar kind, raising
as many questions as it answers.
The idea of a banking union is to break the feedback loop between weak banks
and weak governments. Banks that get into trouble turn naturally to the state
for support. If the public finances are already wobbling, the additional burden
of a bank bail-out makes things worse. Investors in bank debt fear the safety
net will not be used, and require higher interest rates in order to lend.
Investors in government debt fear the safety net will be deployed, and charge
more too. In the euro area, national problems quickly become shared headaches.
Weak banks tipped Ireland and Cyprus into bail-out programmes; Spain has
already been given European money to recapitalise its banks; concerns over
Italian lenders have grown as its economy stutters.
In 2012, when the euro crisis was still running hot, Europe s leaders acted to
break the bank-sovereign loop. They agreed to bind national banking systems
together, so that debtor countries can call on the resources of strong ones if
banks falter, and creditor countries can exercise control over lenders before
they get into trouble. The first step was to establish a single supervisory
mechanism, or SSM (this is the EU, there s an acronym for everything). From
late 2014 the ECB will be directly in charge of about 130 large banks in the
euro area, taking over responsibility from national regulators. That will
consolidate enormous power in Frankfurt, catapulting it past the Bank of
England as the heftiest financial super-visor in the European Union.
It s just a matter of abbreviations
In preparation for its new role, the ECB is first assessing the state of the
banks it is about to regulate. The asset-quality review (you guessed it, AQR
for short) is a chance for Europe to put uncertainty about its banks to an end.
Previous stress tests of banks balance-sheets have not dispelled suspicions
that they have too little capital to cope with the effects of Europe s
protracted economic weakness. But those tests were largely in the hands of
national regulators. The hope is that the ECB will be a more credible arbiter
of how strong the banks are. If, in 2014, investors can be reassured that the
banks are fundamentally sound, it may be the year in which the euro crisis
becomes a drama.
But can the ECB really be honest in its assessment of Europe s lenders? If a
bank is reckoned to need more capital, then it can try to raise equity from
private investors. For some, the strongest of the weak, the AQR will prompt
more capital-raising of this sort during 2014. But for others, the weakest of
the weak, private investors will not stump up. That leaves the state as the
obvious source of fresh funds which brings up the same old problem as before.
Debtor governments may not be able to take on the burden of strengthening their
banks; creditor states are opposed to using the euro zone s bail-out funds to
recapitalise banks. Without a clear way of filling any capital shortfalls it
identifies, the ECB will be tempted to pull its punches.
The problem of money runs through Europe s new banking architecture. The second
step of banking union, the creation of a single resolution mechanism (SRM;
sorry) that would be responsible for restructuring and, if necessary, propping
up failing banks, is meant to be agreed upon in 2014. (The third and final
step, a joint deposit-guarantee scheme, seems to be off the agenda completely.)
That deadline will slip. The European Commission has proposed taking on the SRM
role itself. But creditor countries balk at the idea of a central agency that
could call on common funds to rescue banks elsewhere. And the transfer of power
raises legal questions. Germany thinks a resolution agency requires a treaty
change. Without an SRM, the banking union will be only half-built: the
supervisor will not be captured by national interests but it will still rely on
national budgets to resolve big problems. The euro zone will celebrate an
important step in 2014 but it will be an incomplete one.
Andrew Palmer: finance editor, The Economist
From The World In 2014 print edition