Eurozone plans for single bank resolution authority in disarray

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Efforts to create a single European resolution mechanism to bail out or wind down troubled eurozone banks are bogged down in uncertainty and political wrangling, throwing the banking union project into doubt, according to experts.

EU banking union, which aims to prevent future eurozone banking crises, is made up of three pillars: a regulator or single supervisory mechanism (SSM) – headed by the European Central Bank (ECB); deposit insurance; and a single resolution mechanism (SRM), consisting of a resolution authority and a resolution fund.

At its heart, banking union aims to sever the connection between banks and sovereign debt through centralized supervision and a common financial backstop to support banks in difficulty. It’s hoped this in turn will take pressure off member states and enable them to borrow at lower rates.

The resolution mechanism – which will ultimately form the cornerstone of banking union – needs the backing of member states to become law. However, with Germany still forming its new government after September elections, a hoped-for agreement by the end of the year is looking unlikely – and with the current European Parliament’s term ending in March, any deal could be pushed back further.

Implementation of the first stage of banking union, under which the ECB will supervise the eurozone’s largest 130 lenders directly and be responsible for overall supervision of the other 5,900, has already been delayed to the end of 2014.

However, before the ECB assumes its new powers, it plans to conduct stress tests on least 124 of these banks next autumn and needs to have a financial backstop in place in the event it uncovers lenders that need to be recapitalized or restructured.

“Even if the SRM is passed, I don’t think it’ll be fully operational before 2015,” says Raoul Ruparel, head of economic research at Open Europe. “There are plenty of forces at work trying to delay it even now and if banks get into trouble again you could see a bigger push to delay it.

“A common resolution system is of key importance. Yes, there be could banking union in name without it, but I don’t think it would achieve the goals the EC has laid out for itself.”

He adds: “It would fall short of promoting resumption of cross-border financing again and there’d still be a lot of fragmentation in the markets, and the situation would remain disjointed across the eurozone.

“As long as risk remains national, the question of whether banks can be funded by individual states is still going to be there.”

However, Ruparel has reservations. “The resolution mechanism as it stands will have a very small fund built up over a number of years, so we don’t think it’ll be sufficient given the size of the banking sector,” he says. “It’s not yet at the stage where it’s good enough in terms of size or usability to fill the gap that needs to be filled.”

The proposed single bank resolution fund will be €55 billion – to be contributed by banks over a 10-year period – to backstop the eurozone’s €33 trillion banking sector. The assets of the banking sector amount to more than 340% of eurozone GDP.

Open Europe estimates the fund would need to be between €500 billion and €600 billion to provide an effective backstop.

Banks, already worried about the impact of new bail-in rules on their balance sheets, are balking with the European Banking Federation, which is pushing for the resolution fund’s build-up period to be extended to 15 years.

The ECB’s recent announcement that its stress tests will be looking for a higher-than-expected 8% capital requirement caused banking shares to drop sharply on fears the tests will fluster banks into tightening up lending.

However, ECB president Mario Draghi has been stressing that, if necessary, the fund should be able to borrow money during the period it’s gradually being built up by bank contributions.

However, these are the least of the SRM’s problems. There are serious political and constitutional obstacles to Germany’s participation. These include its usual fear that it might end up bailing out other eurozone members, the sharing of resolution funds and the legality of what it says involves unparalleled transfers of national decision-making powers to the EU-level.

Chief among these is the resolution authority’s board having power to allocate funds and close banks with no veto by member states.

German politicians are also constrained by the knowledge they are democratically accountable for decisions involving, or potentially involving, taxpayers’ money.

The Germans are said to be particularly concerned about the potential moral hazard implicit in providing financial guarantees knowing that someone else will bear the cost because it could encourage banks and governments to act irresponsibly.

Consequently, it wants supervision, and any clean-ups necessary, before any eurozone-backstop is provided – the reverse of the sequence the EC and ECB are trying to push through.

German finance minister Wolfgang Schäuble has hinted he would take the matter to the European Court of Justice if the EC pushes ahead with a proposal opposed in Germany.

The EC’s overriding rationale is that the SRM is single-market driven because it aims to right an imbalance whereby eurozone states are disadvantaged by virtue of their inability to print – or borrow – their own currency to backstop their financial systems.

Germany and France have proposed an alternative that would use national funds and authorities in the form of a resolution board, supplemented by the bail-in rules adopted this summer and the European Stability Mechanism – the eurozone bailout fund – and could seek to circumvent the EC by pursuing this option inter-governmentally.

While the SRM enshrines bail-in to bear the brunt of resolution, with the mutualization process road-blocked the Germans and French might get their way by default as new rules on state aid make bail-in a reality on the ground.

EC changes to bank state-aid rules mean any bank receiving aid would have to present a restructuring plan in advance with shareholders and creditors, including some bondholders, bailed-in.

“The SRM is caught up in the whole idea of banking union,” says Richard Comotto, senior visiting fellow at Reading University. “There’s certainly opposition to extending it too far, too fast, and this is an essential component.

“It all depends on politics and getting an agreement on burden sharing. A banking union with just a single supervisory mechanism is seen as imbalanced. So you’ve got the European integrationist pressure to complete bits of the union coming up against national interest.”

He adds: “Failure would mean the European project is torpedoed in its latest remedy and there’s concern whether banking union makes any sense without the SRM and deposit insurance.

“If you’re the supervisor – the ECB – but don’t have any tools to organize recovery and resolution, you’re a very strange supervisor. Having determined a bank needs to be resolved, it would then have to rely on national resolution recovery and resolution regimes, which would all react differently and have different ways of doing things.”

Comotto concludes: “It makes it dysfunctional, with responsibilities and resources being mismatched. Come a crisis, how much confidence would you have that this would work?”