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Eurozone banks “an ever closer union” 

More than three years after it began, political momentum to solve the crisis has moved forward with the announcement of the intended banking union. EU leaders are arguing for decisive progress towards a European ‘banking union’, as part of a package to try to stabilize the eurozone and stem the risk of eurozone contagion.

The rationale

There is a clear logic to a European banking union (EBU), not only as part of the solution to the crisis but also as the next step in a long-term project: first towards a single currency, next to EBU, later to tax harmonization and common economic policy-making and ultimately to political union.

In June 2012, Michel Barnier, European Commissioner for Internal Market and Services, said “We urgently need to adopt a vision for a fully-developed economic and monetary union.  The moment of truth has arrived…In acting on our vision we will no doubt have to make a quantum leap to a banking union.”1

In the same month, German Foreign Minister Guido Westerwelle echoed those sentiments and made the explicit link with eventual political union: “The grand idea of Europe is in danger. But the truth is that we need more Europe, not less. Europe must stand up for itself, for the idea of cultural unity. Steps towards a genuine political union would make a tangible contribution to ending the crisis.”2

So the key issues in considering the implications of an EBU are not only what would it entail – and will it happen – but also, what would be the broader impacts on the euro and on the European Union?

What would it entail?

The core objective of an EBU would be  to enhance the stability of banks in the eurozone by creating a single supervisory  and regulatory structure, a common deposit insurance framework and an appropriately- funded system for recovery and resolution. An EBU would provide:

  • implicit support from stronger economies to help weaker economies adjust
  • more pooling of resources, whether through common Eurobonds or some other mechanism
  • a shared backstop for the banking system to strengthen banks and protect depositors
  • as a consequence, much closer collective oversight of fiscal and financial policy.

José Manuel Barroso, the current  President of the European Commission, has suggested that the core supervisory powers and responsibilities underpinning the union should be rapidly created and transferred to the European Central Bank (ECB). There would be obvious advantages to focusing supervision in the ECB, rather than creating a new institution. But there would also be a potential conflict of interest in combining banking supervision and monetary policy responsibilities.

There is also continuing debate over the desirable scope of a banking union: should it cover all banks in the eurozone? All banks in the EU as a whole? Or just systemically important institutions and regional savings banks? It is already clear that it is not just the big banks that will be in scope.

UK government policy was made clear by UK Chancellor of the Exchequer, George Osborne, in his Mansion House speech in June 2012: “So we are clear that Britain will not take part in this banking union. British taxpayers will not stand behind eurozone banks, and British voters want the British authorities to be in charge of supervising our own banks, especially in a  crisis.” But if the UK and other member states outside of the Eurozone did not join the banking union, would it be fatally weakened?

Will it happen?

Political leaders, especially those in the eurozone, face great pressure to take decisive action in order to avert the collapse of the euro. Such  an outcome could have a profound impact on the EU as a whole. But the challenges of an EBU are fearsome. It is an endeavor that has been described as “in some respects no less ambitious and complex than the creation of  a monetary union itself.”3 That powerful European leaders are talking of achieving this in a matter of months is a sign of their aspiration and of the fear of the alternative. There is also opposition from some member states that have questioned how the new body will work. A particular concern is how non-eurozone countries that want to join the scheme will fit into the eurozone-focused infrastructure.

"We want to have, as soon as possible, a single supervisor for the eurozone."

José Manuel Barroso

Despite the challenges, the overall political conclusion is likely to be that the alternative to an EBU is worse and that some form of an EBU has to be achieved. European Commission Vice-President and Commissioner for Economic and Monetary Affairs and the Euro Olli Rehn dismissed arguments at the recent Capital Markets for Growth – 2012 ECMI Annual Conference that the plan is not workable. He reiterated his commitment to EU negotiators concluding negotiations on a single eurozone banking supervisor by the end of 2012, insisting that Europe is still pushing ahead: “We are indeed pursuing this banking union and, as the first step, the euro area banking supervisor.”4

At the time of writing, agreement has been reached on a single supervisory mechanism for all 6,000 eurozone banks, with concessions over the ECB’s influence over smaller banks. Formal adoption of ECB supervision is expected in December 2012, with the single deposit scheme and common resolution fund still to be worked on early next year. The difficulty will be in quickly setting up the package to tight timescales and coordinating with national authorities – pulling together the right technology and people to implement it effectively. The logistical challenge of picking up the relevant workstreams is significant.

Impact on the banks

In terms of the consequences for European banks themselves, harmonization of banking and supervision is not the only important development. Multiple banking regulatory reforms are taking place in tandem. The banking union plans will shape developments in this area, but other plans that would fundamentally shake up the European banking system are already on the table, such as the European bank ring-fencing proposals in the liikanen review currently under consultation by the European Commission. Combined  with measures that constrain banks’ capital and liquidity, Europe’s banks have a lot to think  about and many changes on the way for which they must be adequately prepared.

Broader impacts

A banking union would greatly strengthen the collective European resources – financial and political – available to resolve banking crises within the eurozone and stabilize the currency system. It would also provide a framework in which the European Stability Mechanism (ESM) could be used to strengthen struggling banks directly.

The ESM, formally launched in October, is the eurozone’s €500-billion permanent bailout fund for struggling member economies and banks, aimed at addressing “severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro.”5 Uncertainties remain, however, over whether the ESM has enough firepower to cope with the worst-case scenario – that is, if Spain and Italy need full sovereign bailouts. Collectively, these countries require around €670 billion of government financing in 2013 and 2014.6

By itself, the EBU would only represent a partial solution to the current eurozone problems. A banking union should help prevent the next crisis, but will not address the roots  of the current crisis. This requires restoring the competitiveness of peripheral countries, placing sovereign finances on a stable basis and recapitalizing the banking sector. The logic of a common regulatory framework for eurozone finance is that it requires a common approach to fiscal and economic policy – and this must lead, ultimately, to some form of political union or supranational government.  But it is unclear whether a single-policy framework can be successfully imposed on the diversity of economies within the eurozone –  or at what cost.

The vision of the creators of the euro, like that of the founders of the EU itself, extended beyond financial and economic issues to the creation of a new foundation for political stability. But if the promoters of the EBU are to create a stable context for an enduring union, they will need to persuade the citizens of Europe that the surrender of national sovereignty is acceptable as the ultimate price of peaceful co-existence, or find ways of building popular consent and democratic accountability into the framework of a deeper European Union.

By Giles Williams, KPMG in the UK


1Financial Times, 18 June 2012

2Passauer Neue Presse, 21 June 2012.

3What Kind of European Banking Union? Jean Pisani-Ferry, Andre Sapir, Nicolas Veron, Guntram B Wolff, Bruegel Institute June 2012

4Capital Markets for Growth, ECMI Annual Conference, Brussels, 18 October 2012

5Mario Draghi, European Central Bank President, 6 September 2012

6IMF World Economic Outlook, April 2012

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