Monday, September 17, 2012
A five-step guide to European banking union
September 17, 2012
Eurozone leaders have decided to create a banking union to help break the vicious circle between banking fragility and state insolvency. This is a bold move and an adequate response to the growing financial fragmentation of the European currency area. Last week the European Commission tabled its proposals for a single supervisory mechanism. Discussions on concrete proposals will start soon. They are bound to be highly complex, technical and controversial, because mistrust prevails and because participant countries hold very different views. However, it is important they succeed, so here is our five-point guide for the negotiators.
1. Be comprehensive. A true banking union must involve supervision, as currently discussed, but also resolution – how to wind-down ailing institutions – and access to a common fiscal backstop. The three go together. Common supervision without any kind of fiscal backstop would ultimately mean that national taxpayers have to pay for the failures of the ECB supervisor. A common fiscal backstop without common resolution would also be recipe for conflict as national resolution authorities would have every incentive of shifting costs on the European taxpayer instead of “bailing in” the banks’ creditors. Having one element missing or poorly designed would undermine the whole. As for the space shuttle Challenger that exploded because of a tiny O-ring seal failure in the right rocket, banking union will be as effective as its weakest component. Indeed, getting even a small part wrong may undermine the effectiveness of an entire endeavour.
2. Don’t confuse legacy issues with permanent ones. Banking ailments are daunting, but banking union is not meant to be a hospital. It should be introduced for banks healthy enough to have passed a robust screening. The costs of bad bank debt should be left to those that have been primarily responsible for them, i.e. creditors and national supervisors. The only exception should be for cases where government solvency is endangered. In such cases, partner countries will likely be affected one way or another and it is advisable to proceed with direct recapitalisation by a European institution. Again, this would require having at least the beginnings of the respective European supervisory and resolution tools at hand.
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