The unthinkable becomes a possibility

At least on paper, a form of banking union is in place. So are the eurozone’s defences now big enough to let banks fail?

Those leading negotiations between the European Parliament and the Council of Ministers announced last week (20 March) that they had reached an agreement on the last building block in their construction of a banking union.

From next year, a European bank resolution board will have the power to wind up the eurozone’s largest banks in the event of failure. It will eventually be assisted by a €55 billion resolution fund, which is to be built up gradually over eight years by contributions from the banking sector.

This bank resolution mechanism is supposed to complete banking union: a plan launched by EU leaders in 2012 to bring the eurozone’s banks and some non-eurozone banks under a single regulatory system.

Banking union sets out to address the problem that some banks had become so big that they could not be allowed to fail because failure threatened entire financial systems. The credit crunch of 2008 onwards had exposed that, despite cross-border consolidation, when questions of liquidity and bank bail-outs arose, they were asked of individual national authorities. Banks are still largely dependent on their home states, so bank bail-outs can exhaust national finances (as happened in Ireland), and poor national finances can impede banks’ ability to compete against EU rivals (as happens in Italy).

In the future, a single European bank supervisor is supposed to ensure that the eurozone’s banks are regulated more rigorously, breaking up the unhealthy relationship between national governments and their banks (and main sovereign debt purchasers).

The European Central Bank (ECB) will directly supervise around 130 of the eurozone’s biggest banks under rules agreed back in March 2013. It will be for the ECB to initiate the procedures for intervention, by referring a financial institution with inadequate assets to a bank resolution board.

The latter’s executive will then draw up a resolution plan for that bank. Both the European Commission and the Council of Ministers have the power to modify that plan, subject to certain conditions. In addition, if the plan involves the fund spending €5bn or more, the executive board of the bank resolution board must seek the approval of its own governing board. Referred to as the ‘plenary’, it comprises the executive plus national regulators. Voting in the plenary is weighted according to each member state’s financial contribution to the resolution fund, which gives a lot of power to Germany and France. An added complication is that if the fund has paid out more than a total of €5bn over the course of a year, the plenary gains additional power to control the work of the executive.

Banks will pay their contributions into national resolution funds, which by 2023 will have merged entirely into a single European fund, which will hold funds equal to 1% of total bank deposits (today this would be €55bn). In the meantime, national funds will be first in line to fund the resolution of national banks, though they will be able to draw on the single fund if they run out of money.

There have been three main sticking-points since December, when member states and MEPs agreed their respective positions on the Commission’s proposal.

Firstly, MEPs accused member states of politicising decision-making by expanding the role of the plenary, which they warned (with support from the Commission and the ECB) would undermine the speed and the neutrality of the process.

MEPs also criticised the slow pace set for the merger of national resolution funds into a European fund, warning that a bank collapse could quickly exhaust the money in a national fund.

The third point of dispute was the decision by member states to base the single resolution fund on an intergovernmental treaty, taking it outside the EU’s law-making. MEPs wanted the fund to be based on EU law, as proposed by the Commission.

Member states, taking their lead from Germany, proved largely inflexible on all these points. Wolfgang Schäuble, Germany’s finance minister, resisted making his banking sector liable to pay for problems that emerged in foreign banks as a result of loose national supervision. Nor was he prepared to relinquish member states’ involvement in deciding whether to resolve banks. He insisted on the intergovernmental treaty, arguing – against the legal advice of the EU institutions – that German law required it.

The upshot is that the process for intervening in banks that are on the brink of collapse will be more complex and considerably less predictable than was envisaged by the Commission and the Parliament. MEPs have, however, managed to limit the involvement of the supervisor’s plenary to situations where €5bn or more is being or has been spent. In practice this means, perversely, that decision-making will be slowed down just when the crisis and sense of urgency is greater.

A second concession won by MEPs is that the national funds will merge more quickly into the single fund, with 60% of their funds pooled after three years. The smaller member states will therefore have earlier access to larger supply of funds. But whether the fund will have enough money to handle large bail-outs is doubtful. Germany, Ireland and Spain have each spent more than €55bn recapitalising their banks since 2008, according to Commission data. The potential lack of firepower will not be helped by member states’ refusal to provide the resolution fund with a massive credit line from the eurozone bail-out fund.

The cheerleaders for banking union argue that the eurozone’s banking sector looks very different now from at the start of the crisis. Banks will be supervised by the ECB and are subject to stricter capital requirements. They must draw up their own resolution plans, while new laws will shift part of the burden of bailing out a bank to its investors, which should do something to discourage excessive risk-taking. In January, the Commission published a proposal that could potentially lead to the eurozone’s largest banks being broken up.

Taking all this together, Michel Barnier, the European commissioner for the internal market and services, boldly predicted last week (20 March) that in the future fewer than ten banking collapses would require public funds. Compared with the 440-odd cases of bank state aid that have come before the Commission since the start of the crisis, that would indeed be a dramatic improvement.

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