2013-06-12 11:32:17
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.