Skip to main content

German Chancellor Angela Merkel attends a debate after delivering a statement on her government policies in the German lower house of parliament, the Bundestag, in Berlin on May 10.THOMAS PETER/Reuters

The European Council is taking a watered-down plan to remake Europe to a key EU summit that promises to be fractious given the battle lines that are already drawn.

Bank supervision in the European Union would be shifted to a European supervisor and government would seek approval from other countries to run budget deficits, according to a broad outline of the plan prepared by European Council president Herman Van Rompuy.

His seven-page report, titled Towards a Genuine Economic and Monetary Union, presents a new design that could prevent another crisis for the euro zone, the embattled 17-member monetary union. Economists, though, believe any progress toward a banking and fiscal union, with common oversight of finances, will be halting at best and certainly not fast enough to prevent the current troubles from potentially spiralling out of control.

"We consider that convergence remains insufficient to produce any 'silver bullet' response to the current sovereign crisis," said Deutsche Bank economist Gilles Moec.

The report was released Tuesday as Spanish and Italian sovereign funding costs continued to rise and as Italian Prime Minister Mario Monti was forced to deny an Italian newspaper report that he planned to resign over his failure to convince German Chancellor Angela Merkel to endorse euro bonds.

Mr. Monti's faltering effort to get support from Ms. Merkel for anything other than a promise to endorse a relatively small European growth pact has played into the hands of former prime minister Silvio Berlusconi, who is now calling for Italy to abandon the euro unless the European Central Bank moves to inflate the economy.

The Italian government also announced Tuesday that it would lend as much as €2-billion to the country's oldest and third-largest bank, Monte dei Paschi di Siena. Founded in 1472, the bank is suffering from capital shortfall that must be filled by June 30. The Bank of Italy estimated late last year that Monte dei Paschi would need between €1.3-billion and €1.7-billion to bring its tier 1 capital up to 9 per cent.

Mr. Van Rompuy's report is less ambitious and more vague than earlier drafts. His newest version makes no mention of short-term efforts that could be used to take the edge off the crisis, nor does it lay out a timetable for a banking and fiscal union.

It does, however, call for a single supervisor to oversee all banks within the European Union, not just the big, trans-border banks.

"Such a system would ensure that the supervision of banks in all EU member states is equally effective in reducing the probability of bank failures and preventing the need for intervention by joint deposit guarantees or resolution funds," the report said. "To this end, the European level would be given supervisory authority and pre-emptive intervention powers applicable to all banks."

The effort to bring all the banks under one supervisory umbrella is recognition that some of the regional savings banks in Spain, Italy and Germany are big enough to transmit pain throughout the European banking system should they get into trouble. In Spain, the regional savings banks are seeking as much as €100-billion in new capital from Europe's bailout funds. The country's big international banks, among them Santander, are not pursuing international assistance.

The paper proposes several initiatives that would be politically impossible to implement in the near term. They include euro bonds, which would pool the debt of the euro zone countries in an effort to bring down the funding costs of the weakest ones, and veto powers on national budgets.

"Steps towards the introduction of joint and several sovereign liabilities could be considered as long as a robust framework for budgetary discipline and competitiveness is in place to avoid moral hazard and foster responsibility and compliance," the report said.

German Chancellor Angela Merkel has rejected euro bonds and other common efforts, such as joint deposit insurance, for fear that they may not pass muster in the German constitutional court and because they may remove the incentive among governments and banks to clean up their financial acts.

Ms. Merkel reiterated her opposition to a euro bond Tuesday, Reuters reported, quoting sources, telling coalition partners in a closed-door meeting that "I don't see total debt liability as long as I live."

Still, some economists think the Brussels leaders' summit on Thursday and Friday will make some progress in creating a European federal banking supervision scheme, plus growth plans to offset the harsh, German-inspired austerity measures.

Greece, Spain, Italy and France have all called for a growth plan to complement austerity, which they blame for killing growth. The deepening recession in Italy is particularly worrisome because it is the euro zone's third-largest economy. Investors' fears that Italy's enormous debt load is becoming unsustainable is pushing up bond yields to near crisis levels.

There appears to be little agreement on which fiscal and banking union measures should come first, and over what time period, spelling trouble for the summit.

"Germany wants to seed deeper fiscal integration with firm controls on expenditure and taxes first," Societe Generale economists said in a Tuesday note. "France, Italy and Spain would like to see more risk sharing as a priority. Our vi ew remains that little tangible is likely to result from the European Council, leaving markets vulnerable over the summer."

Fading hopes for a breakthrough at the summit kept markets soggy on Tuesday. The FTSE 100 was down marginally, as was the euro. Investor sentiment sank when Spain struggled to sell three-month bills. Yields on the bills nearly tripled over a similar sale only a month ago. Yields on Spain's benchmark 10-year bonds rose almost a quarter of a percentage point, to 6.87 per cent, not far short of the 7 per cent crisis level that doomed Greece, Ireland and Portugal to bailouts.