On Tuesday, Commissioner Michel Barnier touted the trilogue
agreement on creation of a
single supervisory mechanism for the eurozone as a
first fundamental step towards a real banking union which must
restore confidence in the eurozone's banks and ensure the
solidity and reliability of the banking sector.
Barnier insists: This will contribute to strengthening
the single market and to guaranteeing financial
But no one in the markets was paying much attention to this
grand talk, with all eyes on Cyprus, where the
botched bailout reveals the glaring absence of a properly
deposit guarantee fund. This would be the true mark of a
real banking union. But that now looks like a dream that will
never come true.
The market tremors from the much-maligned attempts to bail
out Cyprus an economy that represents just 0.2% of
the EUs GDP will reverberate for years to
come. The proposal to impose a tax on insured retail depositors
in Cyprus violates creditor-hierarchy norms.
Although consensus opinion decrees there is no imminent risk of
depositor flight in neighbouring eurozone countries, a
cloud of uncertainty now hovers over banks funding and
capital structures at a time of economic and political
distress. After all, the proposal undermines the sanctity of
insured deposits, touted as the preferred funding source for
banks over more flighty wholesale debt.
| Protesters in Cyprus. Source:
How flighty will retail and corporate deposits be in future,
now that its clear that depositors are just another class
of creditors to banks that face losses when there are no
bondholders to haircut? Meanwhile, speculation mounts that the
senior bondholders could also be on the cards sooner than
expected in similar instances of bank problems.
But thats not the biggest consequence of the tentative
Cyprus bailout plan, which unravelled on Tuesday amid domestic
opposition. At its core, it highlights the fundamental flaws in
the EUs plan to improve the eurozones economic
architecture, which has been touted by some as the crisis
circuit-breaker, in conjunction with ECB support.
Put simply, the lesson from Cyprus: the prospective EU banking
union is unlikely to be backed up by an EU-wide deposit
insurance scheme even as fears grow over the stability of bank
deposits. (The other lesson: Germanys desire to ensure
losses are not socialized across EU borders is particularly
apparent in an election year.)
As Euromoney has reported, the
idea appears to have been quietly dropped amid German
resistance, even as the IMF continues to argue a common
deposit scheme is a pre-requisite, or at least an essential
component, of a viable banking union.
Zsolt Darvas, researcher at European think-tank Bruegel, tells
Euromoney: I now dont see any prospect of a
eurozone guarantee scheme. Policymakers have clearly taken the
view that a functioning banking union can take place without
it, citing the asymmetric cost-sharing between north and
south Europe for the financing of any deposit guarantee scheme
at the EU level, as the Cyprus saga lays bare.
The Bank Recovery and Resolution (BRR) directive was
proposed by the Commission in June 2012 and policymakers insist
it will be adopted this summer, to be followed by the Single
Resolution Mechanism the second major plank of the
banking union project which would transfer all
responsibilities and powers for the authorization and
prudential supervision of the large banks in the euro area to
In the words of the IMF: Moving responsibility for
potential financial support and bank supervision to a shared
level can reduce fragmentation of financial markets, stem
deposit flight, and weaken the vicious loop of rising sovereign
and bank borrowing costs.
One of the aims of the BRR directive is ostensibly to
protect depositors by boosting confidence in the integrity of
the banking system. Even after the troika-backed Cyprus bailout
proposal implicitly conceded that a euro in a peripheral bank
account has potentially less value than a euro in a bank
account in northern Europe, policymakers are banking that faith
in eurozone bank-recovery and resolution can be achieved in the
forthcoming directive without the existence of a common deposit
Crucially, Darvas says this hole in the heart of the
institutional architecture will remain in the long-term,
rejecting suggestions the absence of this backstop also
reflects a desire to separate fiscal and bank-recapitalization
demands in the short-term from the longer-term need to reshape
the EUs fiscal design.
While the final outcome of the Cyprus bailout remains
uncertain as the original deal is renegotiated, the fact the
ECB, IMF and eurozone finance ministers took the decision to
tax insured depositors exposing the worthlessness of a
deposit guarantee from a bankrupt sovereign means a
taboo has been irrevocably broken.
As a result, even if the EU wanted to beef up depositor
insurance confidence, it might now be too late. The US
created its deposit insurance scheme in the 1930s to restore
confidence at a time that deposits looked seriously at
risk, Nomura analysts say. "The euro area might have lost
the opportunity to create such a guarantee scheme at the
regional level for a long time."