Since mid-2012, the eurozone crisis has been in remission. The period of relative calm which has prevailed since then has not been the product of an upturn in economic fortunes: until the recent summer uptick, the eurozone had suff ered six consecutive quarters of declining activity and rising unemployment (a result in part of synchronised fi scal austerity across
the region as a whole). Instead, the period of peace has refl ected two factors: the increased willingness of the European Central Bank (ECB), under Mario Draghi’s presidency, to act as a lender of last resort to governments; and a belated recognition by European leaders that the eurozone suff ers from design fl aws that need correcting. Sadly, the success of the fi rst factor
appears to have had unfortunate consequences on the second.
A design fl aw that was not spotted by critics when the eurozone was launched, and that only
became apparent after the 2008 fi nancial crisis, was the instability of a fi scally decentralised
currency union backed by a limited mandate central bank. This confi guration, it turned out,
gave rise to stresses in the eurozone that did not arise in the US. The most destabilising of
these was the emergence of ‘doom loops’ in which fragile banks and fi scally weak sovereigns
undermined each other. Reducing memberstates’ vulnerability to these spirals required
the eurozone to establish a banking union. The trouble, however, is that the ECB’s success in
lowering government bond yields in countries like Spain and Italy appears to have reduced thesense of urgency felt by European leaders to build a banking union.
Constructing a banking union was never going to be an easy task, not least because it raises
the same underlying political sensitivities as Eurobonds (an idea that was abandoned by EU
leaders for being too far ahead of its time). The original blueprint for a banking union outlined
by Herman Van Rompuy, the president of the European Council, in June 2012 envisaged four
pillars: a common authority to supervise banks across the eurozone; a single resolution authority to restructure or wind up insolvent banks; a joint fiscal backstop to recapitalise banks; and a deposit protection scheme jointly funded by eurozone members. In eff ect, this blueprint recognised that key functions relating to the banking sector
needed to be ‘Europeanised’ if the eurozone was to be placed on a more stable footing.
It would be churlish to deny that some headway has been made since the Van Rompuy proposals were originally set out. Good progress, for example, has been made in establishing a joint eurozone banking supervisory authority – or ‘Single Supervisory Mechanism’ (SSM) in EU jargon. The debates in late 2012 about which banks should be supervised by the ECB have now been settled. The ECB will assume day-to-day responsibility for supervising the 150 largest banks in the eurozone, and “ultimate responsibility” for the remaining 6,000 or so small and mediumsized banks. Day-to-day supervision of the latter, however, will continue to be exercised by national authorities. Following a positive vote in the European Parliament on September 13th 2013, the SSM should be up and running in 2014.
Progress on the other pillars, however, has been
less impressive. A common eurozone deposit
protection scheme is not yet on the agenda, and
will not be any time soon. A joint fi scal backstop
to the banking system is also a long way off . True,
European leaders have agreed that the eurozone’s
bail-out fund, the European Stability Mechanism
(ESM), should be allowed to recapitalise banks
directly. But the funds allocated to that end have
been capped at €60 billion – a tiny sum given
the likely scale of bank losses that have yet to be
recognised. In addition, for every euro the ESM uses
to recapitalise a bank, it will have to post two as
collateral to preserve its credit rating. Since this will
reduce the ESM’s total lending capacity, it will be a
disincentive to use the ESM for recapitalising banks.
Finally, the Commission’s proposal to create a
Single Resolution Mechanism (SRM) has run
into strong opposition since it was tabled.
Several countries have contested the proposal’s legal base – a single market article that would
avoid the need for treaty change – and argued (probably rightly) against handing responsibility
for resolving banks to the European Commission. Germany, for example, has argued for a looser system located outside Brussels, focused only on the 150 or so largest banks, and based initially on co-operation between national authorities (not on the writ of a supranational body). Since EU business will be disrupted in 2014 by European elections and the end of the Commission’s term, agreement on the SRM could be delayed until 2015 if it is not concluded before the end of 2013.
The banking union is still a work in progress and it is probably premature to prejudge its fi nal shape. But what the eurozone seems to be inching towards is a structure in which banking
supervision is partially Europeanised, but the various fi scal backstops to the banking system
remain overwhelmingly national. To put it differently, the eurozone will continue to be a
currency union shared by seventeen national banking systems, rather than a currency union
with a shared banking system. Does it make sense to call such a decentralised structure a banking union? The answer is no. If the purpose of a banking union is to break the lethal interactions between fragile banks and weak sovereigns, it is doubtful whether a structure as decentralised as that which seems to be emerging will do so.
"he structure which is emerging may refl ect political realities in the eurozone, but it does not look like a particularly stable one.”
The eurozone already starts with a handicap relative to the US, because it does not have a
common debt instrument that serves as a riskfree asset for banks across the currency union.
Eurozone banks therefore remain highly exposed
to the sovereign debt of the state in which they
are incorporated – and the price of that debt
still varies widely across the currency union. The
emerging banking union will do little to alleviate
this weakness. Member-states that experience
banking crises will still be susceptible to sovereign
debt crises. The absence of a common deposit
protection scheme will make individual states
more vulnerable to bank runs. And if the task of
resolving non-systemic banks is left in national
hands, the ECB will fi nd it hard to force (or
encourage) the closure of insolvent institutions.
The eurozone, in short, is building an edifi ce which
looks like the exact reverse image of the US’s. The
US combines a highly fragmented structure for
banking supervision with a set of critical functions
that are carried out at federal level – from deposit
protection, to resolution, recapitalisation and debt
issuance. The eurozone, in contrast, is building
a structure that partially federalises banking
supervision, but leaves the remaining functions
mostly in the hands of the constituent states. The
structure which is emerging may be that which
best refl ects political realities in the eurozone, but it
does not look like a particularly stable one. Further
progress will have to be made if the eurozone is
to become a stable currency union with a single
banking system.
Philip Whyte
Chief economist, CER
sourche: http://www.cer.org.uk/sites/default/files/publications/attachments/pdf/2013/bulletin92_pw_article1-7872.pdf
the region as a whole). Instead, the period of peace has refl ected two factors: the increased willingness of the European Central Bank (ECB), under Mario Draghi’s presidency, to act as a lender of last resort to governments; and a belated recognition by European leaders that the eurozone suff ers from design fl aws that need correcting. Sadly, the success of the fi rst factor
appears to have had unfortunate consequences on the second.
A design fl aw that was not spotted by critics when the eurozone was launched, and that only
became apparent after the 2008 fi nancial crisis, was the instability of a fi scally decentralised
currency union backed by a limited mandate central bank. This confi guration, it turned out,
gave rise to stresses in the eurozone that did not arise in the US. The most destabilising of
these was the emergence of ‘doom loops’ in which fragile banks and fi scally weak sovereigns
undermined each other. Reducing memberstates’ vulnerability to these spirals required
the eurozone to establish a banking union. The trouble, however, is that the ECB’s success in
lowering government bond yields in countries like Spain and Italy appears to have reduced thesense of urgency felt by European leaders to build a banking union.
Constructing a banking union was never going to be an easy task, not least because it raises
the same underlying political sensitivities as Eurobonds (an idea that was abandoned by EU
leaders for being too far ahead of its time). The original blueprint for a banking union outlined
by Herman Van Rompuy, the president of the European Council, in June 2012 envisaged four
pillars: a common authority to supervise banks across the eurozone; a single resolution authority to restructure or wind up insolvent banks; a joint fiscal backstop to recapitalise banks; and a deposit protection scheme jointly funded by eurozone members. In eff ect, this blueprint recognised that key functions relating to the banking sector
needed to be ‘Europeanised’ if the eurozone was to be placed on a more stable footing.
It would be churlish to deny that some headway has been made since the Van Rompuy proposals were originally set out. Good progress, for example, has been made in establishing a joint eurozone banking supervisory authority – or ‘Single Supervisory Mechanism’ (SSM) in EU jargon. The debates in late 2012 about which banks should be supervised by the ECB have now been settled. The ECB will assume day-to-day responsibility for supervising the 150 largest banks in the eurozone, and “ultimate responsibility” for the remaining 6,000 or so small and mediumsized banks. Day-to-day supervision of the latter, however, will continue to be exercised by national authorities. Following a positive vote in the European Parliament on September 13th 2013, the SSM should be up and running in 2014.
Progress on the other pillars, however, has been
less impressive. A common eurozone deposit
protection scheme is not yet on the agenda, and
will not be any time soon. A joint fi scal backstop
to the banking system is also a long way off . True,
European leaders have agreed that the eurozone’s
bail-out fund, the European Stability Mechanism
(ESM), should be allowed to recapitalise banks
directly. But the funds allocated to that end have
been capped at €60 billion – a tiny sum given
the likely scale of bank losses that have yet to be
recognised. In addition, for every euro the ESM uses
to recapitalise a bank, it will have to post two as
collateral to preserve its credit rating. Since this will
reduce the ESM’s total lending capacity, it will be a
disincentive to use the ESM for recapitalising banks.
Finally, the Commission’s proposal to create a
Single Resolution Mechanism (SRM) has run
into strong opposition since it was tabled.
Several countries have contested the proposal’s legal base – a single market article that would
avoid the need for treaty change – and argued (probably rightly) against handing responsibility
for resolving banks to the European Commission. Germany, for example, has argued for a looser system located outside Brussels, focused only on the 150 or so largest banks, and based initially on co-operation between national authorities (not on the writ of a supranational body). Since EU business will be disrupted in 2014 by European elections and the end of the Commission’s term, agreement on the SRM could be delayed until 2015 if it is not concluded before the end of 2013.
The banking union is still a work in progress and it is probably premature to prejudge its fi nal shape. But what the eurozone seems to be inching towards is a structure in which banking
supervision is partially Europeanised, but the various fi scal backstops to the banking system
remain overwhelmingly national. To put it differently, the eurozone will continue to be a
currency union shared by seventeen national banking systems, rather than a currency union
with a shared banking system. Does it make sense to call such a decentralised structure a banking union? The answer is no. If the purpose of a banking union is to break the lethal interactions between fragile banks and weak sovereigns, it is doubtful whether a structure as decentralised as that which seems to be emerging will do so.
"he structure which is emerging may refl ect political realities in the eurozone, but it does not look like a particularly stable one.”
The eurozone already starts with a handicap relative to the US, because it does not have a
common debt instrument that serves as a riskfree asset for banks across the currency union.
Eurozone banks therefore remain highly exposed
to the sovereign debt of the state in which they
are incorporated – and the price of that debt
still varies widely across the currency union. The
emerging banking union will do little to alleviate
this weakness. Member-states that experience
banking crises will still be susceptible to sovereign
debt crises. The absence of a common deposit
protection scheme will make individual states
more vulnerable to bank runs. And if the task of
resolving non-systemic banks is left in national
hands, the ECB will fi nd it hard to force (or
encourage) the closure of insolvent institutions.
The eurozone, in short, is building an edifi ce which
looks like the exact reverse image of the US’s. The
US combines a highly fragmented structure for
banking supervision with a set of critical functions
that are carried out at federal level – from deposit
protection, to resolution, recapitalisation and debt
issuance. The eurozone, in contrast, is building
a structure that partially federalises banking
supervision, but leaves the remaining functions
mostly in the hands of the constituent states. The
structure which is emerging may be that which
best refl ects political realities in the eurozone, but it
does not look like a particularly stable one. Further
progress will have to be made if the eurozone is
to become a stable currency union with a single
banking system.
Philip Whyte
Chief economist, CER
sourche: http://www.cer.org.uk/sites/default/files/publications/attachments/pdf/2013/bulletin92_pw_article1-7872.pdf
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