Eurozone crisis: Calls grow louder for European banking union
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Eurozone crisis: Calls grow louder for European banking union

Hype builds around new solution; But how to get the German taxpayer to agree?

As European policymakers struggle to find a way out of the seemingly unending crisis that has bound together banks and sovereigns like two struggling swimmers trying to hold each other above the waves but only dragging each other under, a new solution has suddenly grabbed the headlines: a banking union.

Speaking at the Institute of International Finance meeting in Copenhagen in June, Michel Barnier, European commissioner for the internal market and services, and the driving force behind adoption of new regulatory initiatives into law, offered a breathless update on recent calls for even more integration of the eurozone banking sector.

Michel Barnier, European commissioner for the internal market and services
Michel Barnier, European commissioner for the internal market and services, points out that key elements of a banking union are already in place

"Ideas will be presented to the European Council by president [of the European Commission José] Barroso and president [of the EC Herman] Van Rompuy at the end of this month," he says. "This is very important and we are working on it in that sense." There were many in his audience eager for the urgent adoption of the three key building blocks for such a banking union: a supervisory body for banks, a new resolution frameworkfor troubled institutions and a deposit-guarantee scheme.

Euro survival

Wolfgang Münchau, co-founder and president of Eurointelligence, even went so far as to declare: "If we don’t get at the very least the contours of a banking union in the coming weeks, then I fear the euro will not survive. We will be going back to our national currencies."

It is not just the most immediate storm around how to fund the needed equity injection into Spanish savings banks that is prompting such calls. Bankers attending the IIF meeting report that the single market in financial services in the EU is disintegrating before their eyes.

One says: "You have episodes of the relationship between home and host-country regulators breaking down, with some national regulators pressing to ringfence assets in the country, while discouraging banks from lending to other countries within Europe."

The IIF’s chairman, Douglas Flint, chairman of HSBC Holdings, says: "Earlier reactions to the financial crisis, now reinforced by acute uncertainty over the eurozone, are leading to risk-management and regulatory actions that lead to home bias and concerted reductions in cross-border financing. To some extent, banking systems are becoming more national, less global. The result is rising fragmentation and balkanization of the financial system."

Banks also want to get on with establishing a cross-border resolution framework, rationalizing that if taxpayers are therefore protected from assuming the contingent liability for banks, regulators should ease up on their capital demands, even though the cost of bank funding will rise if bondholders know they can be bailed in.

Yet the notion that a true European banking union can suddenly be summoned into existence in a matter of weeks at the height of the crisis strikes many in the markets as utterly fanciful.

"It’s a nice-sounding idea, but it’s just a concept," says Stefan Ingves, governor of the Riksbank, member of the European Central Bank general council and chairman of the Basle Committee on Banking Supervision. And many share his view.

German intransigence

Philip Suttle, deputy managing director and chief economist of the IIF, notes on the question of a banking union: "If you think it is a stretch to ask German taxpayers to stand behind the liabilities of non-German governments, how would you rate the chances of them standing behind non-German banks?"

In Spain, small local banks have, often with little supervision and at the prompting of local politicians, channelled funds to local projects with local benefits that have brought them low.

"Banking union may come five years from now or 10, but right now it is not the answer to the immediate and pressing problems," says one banker. "Let’s not mix up what needs to be done right now with the long-term vision for what might be nice to have if the single currency survives."

Yet it’s possible that such understandable cynicism about another grandiose European concept might miss the mark and that, in the midst of the crisis, a banking union might be the back door to fiscal union.

Barnier points out that two of the three key building blocks are in place. A supervisory body of sorts exists in the European Banking Authority. For now, it lacks the credibility of the ECB, but it has conducted stress tests and overseen the recapitalization process demanded by heads of government in October.

Just last month, the European Commission proposed its new framework for bank resolution.

Barnier adds: "The Commission made a proposal for more integration between national deposit guarantee schemes two years ago. All these measures are fundamental cornerstones of a banking union. Some of them are in place. Others should be adopted shortly."

And support around the official sector is growing. Benoît Cœuré, member of the executive board of the ECB and a former deputy director general of the French treasury, told a Morgan Stanley global investment seminar last month: "The adverse feedback loop between banks and sovereigns, in which doubts about the solvency of the sovereigns feed doubts about the solvency of the banks and vice versa will be broken more readily by the establishment of a true banking union." He adds: "This should include the creation of a pan-euro area deposit insurance fund and a pan-euro area bank resolution framework, supported by a single supervisory system with centralized decision-making."

It sounds very much as if Cœuré is pitching the ECB to take this role, while also pressing governments to do more. He says: "If the European Stability Mechanism could inject capital directly into banks, with strong conditionality and control, this would also help to break the bank-sovereign loop." That was still being debated at the end of the month, as Euromoney went to press.

Cœuré concedes that such a banking union would result in additional sharing of fiscal risk among eurozone countries, but says: "These mechanisms should come with the appropriate parliamentary controls. There should be no sharing of fiscal risks without democratic decision-making and accountability."

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