Monday, October 29, 2012

The first step in Europe’s banking union is achievable, but it won’t be easy

by Nicolas Véron


October 29, 2012

Eurozone leaders are firmly committed to a banking union, at least on paper. But do Member States agree on the current proposals? And what do these proposals leave out? This column argues that a dangerous combination of disagreements between Member States over contentious issues and pitfalls in the design of new institutions may well ensnare the Eurozone along its faltering path towards recovery.

The leaders of Eurozone countries issued an unprecedented commitment on 29 June; the statement began, “[w]e affirm that it is imperative to break the vicious circle between banks and sovereigns” (Euro Area Leaders 2012). This statement officially acknowledged leaders’ intention to break the ‘doom loop’ of the mutually-reinforcing deterioration of credit conditions afflicting weaker member states such as Spain and the banks headquartered in them. Severing this feedback loop will require a transfer of vast parts of banking supervision and policy apparatus from national- to European-level in the form of a new banking union. This transfer is probably a prerequisite for maintaining the integrity of Europe’s monetary union in any crisis-resolution strategy. Of equal importance is that leaders’ failure to deliver on their pledge would severely impair investors’ already-damaged confidence in the ability of Eurozone governments to act collectively.

The action plan outlined in the June statement defines a sequence of two explicit steps.
  • The ECB should first be endowed with broad supervisory powers and thus become the anchor of a ‘single supervisory mechanism’ for participating Member States.
  • Once the single supervisory mechanism is deemed effective, the European Stability Mechanism (ESM) - the Eurozone’s newly-established intervention fund - would be able to recapitalise banks directly. Corresponding instruments are yet to be clarified, but would probably include common equity.

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