The experience of the Eurozone crisis marked a turning point in the European integration process for many different reasons. On the one hand, the sovereign debt crisis contributed to deepening the divide between creditor and debtor countries, which in turn still poses a substantial threat to European integration. On the other hand, by highlighting the structural strains within the European Monetary Union (EMU), the Eurozone crisis served as a stimulus for pursuing further European integration, in order to lessen the burden of these strains. The European banking union is an important result of this latter process, and arguably one of the most important steps towards further European integration taken as a result of the Eurozone crisis.
The European banking union is indeed a direct attempt to address the important frictions that lay behind the presence of an integrated market for financial services without the presence of an integrated regulatory framework. The most important objective was to break—as ECB President Mario Draghi put it—“the vicious feedback loops between sovereigns and banks”, due to Eurozone banks holding large amounts of debt of their own national governments and sovereign bond markets being subject to high pressures. This combination generated a vicious circle: the financial situation of the banking sector was bound to deteriorate following the increase in government bond yields, and at the same time sovereigns were subject to even higher market pressure following the bailout of fragile banks.
The first proposal for a European banking union was put forward by European Commission President Herman van Rompuy in June 2012, in the very midst of the Eurozone crisis. The banking union envisaged by van Rompuy was to be based on three pillars: integrated supervision, a European resolution scheme and a European deposit insurance scheme. From that moment on, the progress on the first two pillars has been quite steady: in two years a single rulebook for all financial actors in the 28 EU countries, the Single Supervisory Mechanism and the Single Resolution Mechanism for all the EMU member states have been put into place. Indeed, starting from the end of 2014 the ECB directly supervises the 126 “significant financial institutions”—namely, the biggest banks—of the EMU, holding almost 82% of banking assets in the euro area. In parallel, an EU-level resolution authority— the Single Resolution Mechanism—is in charge of ensuring an orderly resolution of failing banks under the European supervision. Significantly, the SRM is provided with a Single Resolution Fund to of about €55bn, which is fully mutualized among EMU member states.
While the implementation of the first two pillars appeared to be somewhat smooth (though not totally straightforward), this has not been the case for the third pillar, the European deposit insurance scheme. Indeed, despite a Commission proposal in November 2015 and much academic debate around it, no substantial mutualization of deposit guarantee schemes has taken place yet, and the current regulatory framework is limited to the harmonization of the system of national deposit guarantee schemes, ensuring that all deposits up to €100,000 are protected through national schemes all over the EU.
POLITICAL FAULT LINES
The rather smooth process leading to the implementation of the banking union should not be seen as devoid of harsh intergovernmental and supranational conflict. Indeed, the path towards the creation of the European banking union has been tortuous and has directly involved many different actors taking oftentimes opposite stances.
First, the Single Supervisory Mechanism implied the transfer of wide-ranging powers from national to supranational institutions, as the role of banking supervision of major financial companies passed from national central banks to the ECB. Notwithstanding German interest in having a centralized monitoring for financial institutions in countries subject to financial distress, the dominant German stance—most notably represented by finance minister Wolfgang Schäuble together with the Bundesbank—was initially that of pushing for a treaty revision to shore up the legal basis of the banking union. Envisaging the great difficulties of treaty change in the midst of the crisis, the Commission kept on calling for speeding up the reform of the banking industry, and distanced itself from Germany’s insistence that European Union treaty change was necessary first. The transfer of supervision powers to the ECB was eventually made possible without any treaty change on the basis of Article 127 of the Treaty of Lisbon. This required the consensus of the EU Council of Ministers, which appears to have been attained mostly due to the fact that the final design of the SSM met German demands to leave the smaller Ländesbanks (state-owned regional banks) and Sparkassen (smaller savings banks)—the greatest opponents to a banking union plan—in the hands of local politicians and Germany’s financial supervisor.
Even more contentious has been the implementation of the Single Resolution Mechanism. The supervisory role of the ECB would lose much of its substance without a body to deal with troubled banks: this is the rationale behind the implementation of a single regulatory framework also for bank resolution. France, Spain and the Netherlands backed the Commission’s proposal that the EU resolution bank fund, which would have the power to rescue as well as to wind-up stricken EU banks, should be able to recapitalize banks directly. Again, Germany started from a tough stance, refusing to help banks directly without making their home governments responsible for repaying the aid. Disagreement also spurred as to whether the Commission or the finance ministers should have the last say on whether the fund should resolve crisis-hit banks. Worth noting is the eventual turn-about of Wolfgang Schäuble on both issues, as the agreement reached in March 2014 went substantially towards the direction indicated by the Commission, with the set up of a new supranational institution—the Single Resolution Board—and a mutualized fund of €55bn paid for by the banks—the Single Resolution Fund. An important role for this achievement was played by the ECB itself, with Mario Draghi repeatedly stressing the need for “a strong and credible resolution mechanism” in order to properly address issues of financial stability.
A similar dynamic of intergovernmental convergence under the auspices of supranational institutions has not taken place for the European Deposit Insurance Scheme (EDIS), the last pillar of the European banking union. While the implementation of the EDIS was set as a major priority by the Five Presidents’ Report in June 2015 and in Jean-Claude Juncker’s 2015 state of the Union address, German opposition to greater mutualization of risk has remained consistent over time and has de facto hindered any substantial advancement on the matter. In particular, following Juncker’s statement, a paper Germany submitted to a meeting of EU finance ministers in September 2015 made it clear that “to start a discussion on further mutualisation of bank risks through a common deposit insurance or a European deposit reinsurance scheme is unacceptable”. In the subsequent months, Italian finance minister Pier Carlo Padoan has tried to draw further attention on the issue, by defining the EDIS as a top priority to relaunch a strategy of European growth and stability. Yet, the success of this initiative so far has been very limited.
Despite the fact the European banking union has been one of the most important achievements for European integration after the beginning of the Eurozone crisis, it is fair to say that the expectations linked to this project have not been entirely fulfilled. First, the recent Italian banking crisis shows that European financial policy decision-making—among both member states and supranational institutions—is bound to remain a controversial issue in the upcoming months and years. An example is given by the conflict between the Italian government and the ECB over the management of Monte dei Paschi di Siena’s financial hardship: Pier-Carlo Padoan has accused the ECB of being “rigid” and “opaque” in its calculation of the capital shortfall at Monte dei Paschi di Siena, exposing tensions over the rescue of Italy’s third-largest bank.
Second, the Italian government’s decision to offer state aid to rescue the Monte dei Paschi underscores that structural strains in the European financial system, including the doom loop between sovereigns and banks, are far from being resolved by the implementation of a single regulatory framework, as long as the degree of financial risk differs widely across EMU member states. Indeed, the different levels of risk across the EMU remain the greatest obstacle to the completion of the banking union. Recent developments in the EU Council of Ministers show that the fragility of the banking sector in Italy and other Southern European countries has made Berlin even less keen to agree on plans to share risks by means of a European common deposit insurance scheme. Thus, it seems unlikely that an agreement on EDIS will be reached before southern European banks will get rid of the large amount of bad loans by which they are currently burdened.
Photo Credits CC hpgruesen
Also published on Medium.