The Banking Union: A recipe to tackle future crises?

The PDU explains the banking union and asks an important question: Will it guarantee that the Eurozone can promptly and effectively counter future crises? By Emanuele Barbarossa.

As the deep economic crisis of the past few years mercilessly stroke an ever more fragile European financial system, the union’s taxpayers ended up paying the highest price by rescuing the Eurozone’s failing banks with their money. Most of the funds used between 2008 and 2012 to tackle the severe impact of the crisis were dug out from their pockets, while the private sector (bank shareholders in primis) proved incapable of reaction (or simply unwilling).

Arguably, the lack of EU-level control over the financial stability of the euro area can be considered as one of the primary causes of the huge disparities between Member States post-crisis economies. Surprisingly, despite the presence of open economies and interdependent financial markets in the EU, until the crisis hit no plan was ever made to reduce the financial fragmentation of the euro area, and to improve its cohesion and resilience. That is probably why, after US financial giant Lehman Brothers declared bankruptcy, national governments tried to stem the repercussions of a collapsing banking system mainly through own resources and inward-looking (if not “beggar-thy-neighbor”) policies, therefore exacerbating spill-over effects of troubled cross-border financial institutions.

The Euro sign sculpture in front of the ECB headquarters in Frankfurt, Germany.

The Euro sign sculpture in front of the ECB headquarters in Frankfurt, Germany.

The domino effect had to be stopped. With a view to addressing significant threats to financial stability in the Economic and Monetary Union (EMU) and, most of all, in order to break the vicious link between sovereign debt and bank debt, EU policy- and decision-makers finally decided to intervene. The Banking Union, interrupting twenty years of deregulation and lack of supervision in the European banking sector, has now been built.

In a nutshell, the system is composed of three main elements: a Single Supervisory Mechanism (SSM), for the direct control of the Eurozone’s major financial institutions and the oversight of other 6000 banks; a Single Resolution Mechanism (SRM), to resolve or wind up failing banks; and a Single Resolution Fund (SRF), financed by credit institutions themselves (therefore, intended to ultimately protect taxpayers money from banks’ mistakes). These elements are based on a comprehensive legal framework, known as the “single rulebook”, and have also been the subject of an intense tug of war between the European Parliament and the Council, which, after fierce negotiations finally reached what we could call a successful compromise.

The initially lengthy and overcomplicated resolution scheme was eventually simplified, resulting in a 24-hour procedure managed by a Single Resolution Board and backed by the Commission (the Council intervening only in specific cases, therefore diminishing the risk of political interference). The Bank Recovery and Resolution Directive (BRRD) was finalized, stating that shareholders and creditors bear losses first. At first it seemed that the Council would gain ground on the bail-in tool (SRF), which is still partly regulated by an intergovernmental agreement. However, the European Parliament was able to prevail over the Council in stating that the fund shall reach its €55bn target level in 8 years (instead of 10), and 40% of the national compartment setup is to be mutualized already in the first year (thus adding a piece of security to the banking system and boosting confidence also during the transitional phase).

Currently, an extensive assessment of European banks’ assets is being performed by the European Central Bank, in cooperation with other public and private organizations, in view to testing their soundness before October 2014. Subsequently, constant supervision at national and European level will be carried out. The provisions concerning the SRM regulation and its fund will instead come into force in the course of the next two years.

In the wake of all that has been agreed upon, a well-developed banking union is meant to ensure the overall stability and transparency of financial markets in the future, addressing risks derived from “shadow banking”, as well as preventing and punishing market abuse. Citizens’ purse shall be spared through the protection of private deposits, and a fully regulated bail-in mechanism (auto-financing of bank funds as a backstop) should avert any future costly bail-out using public money. While it is commonly acknowledged that no preventative instrument can ensure complete protection, a big question is left open: Will a full-fledged Banking Union guarantee the Eurozone can promptly and effectively counter future crises?

Image “Euro sign sculpture in front of the ECB headquarters” courtesy of MPD01606 via Flickr, released under creative commons 2.0 attribution.

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