Banking Union Showdown
This post is the second in a five part series from Jakob Vestergaard exploring reforms to the EMU that the Commission is hoping that member states will commit to at the end of June. Read part one here.
At the EU summit in Sofia a few of weeks ago, Emmanuel Macron urged Germany to respond to the reform visions he has been championing intensely since elected French President last spring. “Since the second world war”, he said, “there has never been a moment of such historical importance”. The European project depends on the EU’s ability to act decisively at a conjuncture characterized by conflicts with “traditional allies”, a global order in turmoil, and challenges in terms of the EU’s “internal solidarity”. “It is now time for decisions”, Macron declared. His frustration with Germany’s hesitation and lack of clear response to his calls for Eurozone governance reforms was palpable.
Over the weekend, Angela Merkel finally responded. In a much-discussed interview in the Frankfurter Allgemeine, Merkel rejected nearly all of Macron’s reform agendas. There will be no Eurozone finance minister; there will be no significant steps taken towards a fiscal policy for the Eurozone; and while the European Stability Mechanism (EMS) may be transformed into a European Monetary Fund (EMF), it will remain an intergovernmental institution, rather than become a supranational, European institution, as the integrationists propose. So massive was Merkel’s rejection, that Politico speculated that Macron may well now be wishing that he had never pushed the eurozone reform agenda as hard as he did over the past year.
There was one notable exception, however, to Merkel’s overall reluctance to engage in further economic and monetary integration; she expressed continued support to the banking union. So maybe it will be possible, after all, and despite considerable disagreements amongst member states, to reach an agreement on completing the banking union at the European Council meeting by the end of June? In my view, it remains un likely that anything much of substance will be agreed in that regard. The banking union agenda is slowly but surely being co-opted by efforts to strengthen the institutional embedding of fiscal disciplining of member states, so strongly desired of Germany and other northern member states.
The banking union first became a key concern of European heads of state at the EU summit in June 2012. At that time, the European banking crisis had become a sovereign debt crisis, with particularly devastating effects on Ireland, Portugal, Greece and Spain. The phenomenon that a weak banking sector could cause considerable sovereign debt problems, whereas an indebted state could weaken the domestic banking sector, was soon to be referred to as ‘the doom loop’ in Brussels lingo. A key aspect of bank-sovereign doom loops is that expectations of potential debt trouble ahead can easily become self-fulfilling and self-reinforcing, such that a crisis may speedily develop and contagion to other countries may result.
When the European sovereign debt crisis reached Italy – the third largest Eurozone economy – the survival of the euro was at stake. Few doubted that if the cost of refinancing Italy’s sovereign debt remained as high as it had become, or was to rise further, it would be impossible for Italy to remain in the euro – and a wider unravelling of the euro, implicating other countries (possibly even France), was a real risk. The European Central Bank (ECB) made it clear that it would intervene, doing “whatever it takes” to save the euro, and sovereign debt markets stabilized. But not all member states where equally enthusiastic of the ECB’s rescue intervention, to put it mildly.
The uproar was particularly pronounced in Germany. But deep ambivalence prevailed in many other member states too. Many agreed that it was important that the key role of the ECB in tackling the European sovereign debt crisis was an exception to confirm the rule that the ECB would generally not engage in such interventions; going forward, other mechanisms would have to be in place to deal with potential future recurrences.
The banking union became the EU’s response this challenge. To dismantle the doom loop and make sure that the EU never again found itself in a situation where (fairly) ‘localised’ debt problems could threaten the survival of the euro, member states were to pool resources and responsibility in the form of a banking union. The core idea was that a crucial dynamic of doom loops could be short-circuited if Eurozone banking had joint Eurozone backing. If a bank came in trouble, it would not be only one member state (its home country) picking up the bill, but all banking union member states jointly. So deposit guarantees as well as bail-out packages would be financed not by the home country, but by the banking union member states collectively. Such arrangements would neutralize the otherwise self-reinforcing effect by which fears of a banking crisis escalates into something that could potentially undermine the euro. If such supranational risk sharing were in place, the euro would be much more stable and resilient, in other words.
The many meanings of ’banking union’
The two central pillars of the banking union relate to these two key aspects of risk-sharing: joint handling and financing of banks needing recapitalization (or resolution), and joint handing and financing of deposit guarantees for customers of banks headquartered in banking union member states. The EU bank recovery and resolution directive (BRRD) was adopted in 2014, and the plan is to gradually build financial firepower in the European Single Resolution Fund (SRF), such that its funding reaches one percent of covered deposits in European banks (roughly, EUR 55 billion) by 2024, based on contributions paid by European banks themselves.
A key point of criticism has been that eight years is a long wait for funds that will likely will be inadequate if several large European banks gets in trouble. While EUR 55 billion is indeed a modest amount to cover any and call bailout costs associated with a new European banking crisis, proponents argue that it may nevertheless be sufficient. Whether or not the limited funds of the SRF, or its operational difficulties, constitute serious problems or not, it is encouraging that the SRF is a genuinely European institution. In contrast, there has to date been little if any progress towards establishing a European Deposit Insurance Scheme (EDIS), although the Commission launched its first proposal on this several years ago, in 2015.
One of the factors accounting for the lack of momentum on completing the banking union is that political agreement across member states is considerably more difficult when taxpayers’ money are (or appear to be) at stake. This may also help explain why the so far most developed dimension of the banking union is joint banking supervision, under the auspices of the ECB. Surveying a sector is generally considerably cheaper than bailing it out, and this applies in no small measure to banking. Moreover, the argument that large European banks operating transnationally should be supervised by a transnational institution, has immediate intuitive appeal and hence is much easier to sell politically than, for instance, joint deposit guarantees.
Most observers realize that the banking union remains a rather incomplete construction, with several pillars somewhat shaky or even non-existing. It should come as no big surprise, therefore, that banking union proponents repeatedly call for completion of the project, as soon as possible. Just a few weeks ago, economists Isabel Schnabel and Nicolas Véron posed a potentially discomforting question for policymakers involved in the process. What exactly would it take to do this, to complete the banking union?
Schabel and Véron notes that the answer to their question depends on what one means by banking union – an obvious but non-trivial point. Does one have in mind a single market in banking – with no cross-border barriers or “distortions”? Or is banking union understood more narrowly as a political framework that ensures a breaking of the otherwise devastating bank-sovereign doom loop? Schnabel and Véron observes that banking union in the former sense is a project for the long-term. But even in its narrower sense, the steps needed to complete the banking union seems to have effectively dropped off the EU reform agenda. The reforms currently considered by EU heads of state in the context of talk about “completing the banking union” falls well short of what would be required to prevent bank-sovereign doom loops from endangering the survival of the euro in the future.
Signs that the risk sharing agenda of the banking union was in trouble first appeared in December, when the Commission released an updated road map for its EMU reform agenda. Daniel Gros noted that the roadmap suggested little bu cosmetic or superficial changes, while comprehensive reform had effectively been shelved. The only potentially important element, Gross argued, was the proposal to incorporate the European Stability Mechanism (ESM) in the Treaty and give it a new name; the European Monetary Fund (EMF). As for completing the banking union, it was “surprising”, Gros commented, “that the Commission had nothing new to propose”.
Banking union without risk reduction?
Less than two weeks ago, the Commission announced that the European Council had reached agreement on the banking package that has been the pivot of political deliberations on risk reduction. Valdis Dombrovskis, Commissioner of financial stability, expressed his delight that the European Council had “reached a general approach on this very important risk-reducing package” which lays “the basis for further progress on completing the banking union”. The significance of the banking package is easily oversold, however.
In large measure, what is involved in the banking package is (delayed) implementation of new international standards agreed to by the Basel committee almost ten years ago, in the aftermath of the global financial crisis. It is telling that the banking package include no agreement on two key aspects of the risk reduction agenda, such as a strategy for reducing non-performing loans or the introduction of limitations on bank holdings of home country government bonds.
When both the risk sharing and the risk reduction agenda of the EMU reforms appear to be falling substantively short of the expectations of key member states, it is difficult to remain optimistic about the EU summit later this month. It should be noted, however, that there is one aspect of the potential agreement to transform the ESM into an EMF, which may have significant implications for the banking union. If member states agree to establishing an EMF, with an important role as fiscal backstop for the Single Resolution Fund, it would considerably strengthen and enhance the credibility of the Single Resolution Mechanism.
It is also more than likely, however, that serious commitment to a European Monetary Fund from Germnay and other northern member states will materialize only if all member states can agree that disbursement of EMF funds will come with strict conditionality, not least with respect to government deficits and public debt.
In this way, the EMU reform process seems to be drifting, from crisis prevention through risk sharing towards enhanced fiscal disciplining of member states – and in the process, the banking union will likely be reduced to little but a shadow of what was originally envisaged.
A central part of the EMU reform discourse has been the idea that risk reduction could pave the way for risk sharing. Or, in crude terms, that the banking package would pave the way for the banking union. Now political realities seems at odds with such neat scheming. Much suggest that one key condition of possibility of comprehensive EMU reform is particular far off the immediate horizon now, namely a shared sense that southern European countries have substantially reduced the risks associated with their (allegedly) weak banks and indebted states. As long as that remains the case, it is difficult to see how northern member states would agree to genuine, cross-border risk sharing.
In consequence, the banking union agenda increasingly seem to have been co-opted. When the ESM becomes an EMF – and is linked up with the banking union, as its fiscal backstop – a new institutional embedding may potentially have been achieved for the monitoring and sanctioning the economic policies and public deficits of all EU member states. Where excessive public deficit procedures and the discipline of financial markets have failed, the EMF would then take over. And the banking union would no longer aim at establishing an institutional framework for cross-border financial risk sharing – such as is seen necessary by many in the context a monetary union without pan-european fiscal policy – but instead be, first and foremost, an instrument of fiscal disciplining of member states.
Endgame for the EMU reforms?
If there is to be any hope that genuine risk sharing can make a comeback on the EMU reform agenda, it will require compromise and reconcilialtion across the north-south divide in the EU. Unfortunately, there is little indication things could conceivably move in that direction in the immediate future. If anything, public debate in two of the core countries embroiled in these controversies – Germany and Italy – is moving in the opposite direction. A front page illustration of the German Der Spiegel earlier this week marks a significant case in point. The covers shows a fork with spaghetti, forming a suicide loop; “Goodbye my love!”, the accompanying text reads; “Italy destroys herself – and crushes Europe”. The phrasing of the editorial is even rougher. Under the headline, The moochers from Rome, (’Die Schnorrer von Rom’), Jan Fleischbauer writes with contempt about a country that lives the sweet life, at the expense of others (”ihr schönes Leben von anderen finanzieren zu lassen”). At least the beggar is grateful, Fleischbauer notes, contrary to the Italians.
Macron said in his remarks in Sofia in May, that this summer would be the “moment of truth” for the European project. Many places in Europe, summer has arrived early this year; much suggests this to be the case for the EMU reforms also, in the saddest possible way. With less than three weeks to the EU summit prospects look bleak, at best. The question is whether there will be anything left at all, of the Commssion’s original EMU reform agenda when June expires?
Image credit: Atanas Kumbarov via Flicker (CC BY-SA 2.0)