The notion that the euro zone can have 17 different banking systems and one currency died late Wednesday night. The region finally has the outline of a banking union designed to spare, if not fully eliminate, losses to taxpayers when failing banks are rescued.
The banking union project, some 18 months in the making, marks the biggest loss of national sovereignty since the euro’s creation almost 15 years ago. It comes after close to €500-billion ($734-billion Canadian) in capital was pumped into European banks since the 2008 financial crisis, which destroyed Lehman Bros. and sent shock waves throughout the global banking systems that are still being felt today.
“This is the final building block of the whole banking union,” Dutch Finance Minister Jeroen Dijsselbloem said after the Brussels meeting. “We make the banking sector responsible for their own risks and their own losses.”
His comments should be viewed more as a goal than a reality, for if a euro zone bank were to fail in the next few years, taxpayers would still be on the hook. That’s because it will take many years to ramp up the industry-financed bank resolution fund that would restructure dud banks.
The banking union idea was enormously ambitious and the agreement reached in Brussels fulfills only part of the goal, though an important one.
When the project got under way in mid-2012, the idea was to create a single banking regulator for the euro zone banks, a resolution authority that would decide quickly which banks need to be rescued and how, a rescue fund and a deposit guarantee scheme.
The first part – a single banking regulator – was agreed well before this week’s negotiations. The European Central Bank, led by Mario Draghi, will become the top banking supervisor in 2014. The last part – the deposit guarantee – has pretty much gone nowhere, largely because of Germany’s objections to the idea of pooled insurance.
The other two – the resolution authority and the rescue fund – have now been created, at least in outline. The authority will be composed of a board of European Union authorities and national representatives. If the ECB were to decide that a bank is in danger of failing, the board would propose a rescue plan that would ultimately require approval from the European Commission, the EU’s executive arm.
While the approval procedure would be complicated, the point is that the board could override a national government’s objections to any rescue plan. The big question is whether a rescue plan could be agreed in, say 48 hours, given the complexities of the national and supranational voting procedures. When banks fail, they fail in hours or days, not weeks.
A resolution fund financed by a bank levy would pay for the rescue. The fund will be created over 10 years or so, eventually reaching €55-billion. But if a big lender were to go under before the fund reaches full strength, the fund would be inadequate, meaning national governments might have to stump up rescue funds.
Some countries, notably France and Italy, were lobbying hard for a common backstop that would pump money into banks not covered by the industry-finance resolution fund. The obvious source of this backstop would Europe’s permanent, €500-billion rescue fund, known as the European Stability Mechanism (ESM). A precedent already exists: The Spanish government last year tapped into the ESM so it could pump capital into its ailing banks.
While there was no agreement by Wednesday on a backstop, German finance minister Wolfgang Schaeuble, the most powerful voice in the entire bank resolution debate, assured that the ESM would not lie idle in emergency bank situations. “If member states aren’t able to meet their commitments, they can resort to the solidarity of member states in the ESM,” he said.
The bank resolution system and related fund will require legislative approval and won’t be up and running until 2016. Still, the outline of the bank rescue plan is clearly in place and comes on top of new EU rules that already insist that bank shareholders and creditors take losses before rescue funds are employed (the banking crisis in Cyprus early this year required depositors to take a “haircut” as well).
While the new bank resolution system is fundamentally undemocratic, because it can bypass national governments, the alternative is to demand that taxpayers take the full brunt of a bank rescue. There is no longer any appetite for that. “We have reached a historical agreement, almost at par with the historical agreement which established the monetary union,” Italian finance minister Fabrizio Saccomanni told the media after the Wednesday meeting.
As the resolution mechanism takes shape, the EU finance ministers are praying that the rescue of a big bank will not be needed soon. With the euro zone on its way to recovery, they may get lucky.