2014-01-07 09:34:59
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