The European banking union: breakthrough or missed opportunity?
By Filip Abraham, Professor of international economics at Vlerick Business School
These are decisive days for the European banking sector. All eyes are focused on the recent developments in the creation of a European Banking Union. During the last European summit meetings a preliminary agreement was reached on the dismantling and restructuring of distressed banks. It gradually becomes clear how ailing banks will be recapitalised or liquidated and who is supposed to pays for this. This regulation forms a second pillar of the common monitoring mechanism at European level. Earlier it was already decided that the European Central Bank (ECB) would be responsible for the supervision of the larger and "systemic" European banks .
Just as in many other policy areas of European decision-making, the subsidiarity principle is central to understanding banking supervision. To put it simply, subsidiarity states that cross-border matters are best decided at the European level while national matters are best determined at the national level. The experience of the financial crisis has clearly shown that developments in the banking sector transcend national borders and that national Governments have to delve (too) deep in their wallets when they have to absorb the problems of their banks. For that reason, the single supervisory mechanism places the supervision of banks with more than a national footprint at the ECB. Smaller and more local banks are supervised by the national supervisors.
Furthermore, the architecture of the banking union puts an end to the situation where the taxpayer of a Member State is de facto responsible for the cost of the liquidation or recapitalization of the private banks. In the proposed "bail-in" procedure shareholders, bondholders and even savings deposits will be asked to contribute to bearing the costs of a bank rescue. Moreover, in each Member State an emergency fund will be set up that will be financed by the banking sector. Starting from 2016 those national funds will then be transformed into a single European Fund of € 55 billion that will be jointly managed. This makes it possible that German money is used to save used Italian banks. In other words, the principle of solidarity between EU Member States is introduced progressive and tacitly.
Transfer of national decision-making powers, subsidiarity and solidarity between Member States… It is no wonder that the proponents of the process of European integration are lauding the recent agreements as a historic breakthrough. By contrast, critics argue with equal conviction that the whole set-up is a missed opportunity: "too little, too late" and too complex to be feasible.
A breakthrough or a missed opportunity? I believe that neither trumpets nor laments are called for. Recent decisions are potentially an important step forward. But the construction of the banking union is far from being completed.
A first challenge is to spell out clearly the remaining future path towards a banking union. The criticism of "too little, too late" comes from a comparison of the European blueprint with the American reality. Five years after the bankruptcy of Lehman Brothers, a reformed and consistent supervisory framework at the federal level is operating in the US. The contrast is striking with the European approach. In Europe, the reforms are spread over the long term. For example, the agreements on the "bail-in" only take effect in 2016. Such a long transition period creates uncertainty. For the time being a counterpart to the US common deposit guarantee scheme is missing in the plans for the European banking union. Every EU member state remains responsible for the protection of its savers. If the experience of the recent past is a reliable guide, it is doubtful whether some Member States will be able to finance the guaranteed protection of savings on the moment a new banking crisis erupts.
A second challenge is the concrete implementation of the subsidiarity principle in the regulation and supervision of the banks. A successful policy model assumes a good cooperation between national and European authorities with transparent policies and clearly defined powers. This cannot be taken for granted because sensitivities between the national and the EU policy level persist. From their side, banks are worried that the banking union will become a bureaucratic maze due to the accumulation of national and European obligations. This does not only lead to ever-increasing administrative costs of compliance for the banks and their customers. The danger is also real that banks will be treated differently according to their size or the national market in which they are operating. If one does not take care, the risk exists that national financial markets start to fragment . It would be very costly if Europe were to lose the benefits of an integrated financial market.
A third issue relates to the effectiveness of the system in times of tension on the financial markets. On paper a common resolution fund looks fine but will the size of the fund provide enough fire power to act decisively in times of crisis? The proposed procedure of liquidation and recapitalisation of banks in difficulty looks cumbersome and slow because a multiple of policy organs of the EU, the euro area and the Member States that are involved in the decision process. Will this decision-making model function when the need for intervention is high and time is short? Suppose one has only a weekend to decide about the dismantling of an ailing bank. Is this feasible when according to some sources, more than 100 people will have to be consulted?