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  • 2018/07/03
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Banking union: try not converted

Reforming the eurozone and finalising the banking union were on the agenda at the latest European Union summit on 28 and 29 June. The eagerly awaited conclusions included little in the way of concrete progress. Agreement on a European deposit guarantee scheme is now unlikely to be reached before the European elections in 2019.

In spite of an ambitious agenda, expectations of real progress on economic and financial integration were reasonably modest. The migration question substantially dominated other issues. Furthermore, the persistent fault line between Northern and Southern European countries limited the meeting’s scope . Besides, the recent Franco-German agreement in Meseberg  had confirmed Angela Merkel’s lack of enthusiasm for mutualising banking risks.

However, there was consensus on one measure: the creation of a European safety net to finance the Single Resolution Fund (SRF) in case of need. The SRF – part of the second pillar of the banking union – is funded by banks and aims to achieve total funding of €60 billion by 2024. In the meantime, it is underfunded, and this is undermining its credibility.

The string of bank failures last summer ended up convincing even the most reluctant parties of the urgent need to allow the SRF to access European funding as a last resort – even though, in that particular instance, every effort had been made not to call on the Fund’s resources. After burden sharing  was implemented, it was the Italian government that came to the rescue of Monte Paschi and paid for the liquidation of Popolare di Vicenza and Veneto Banca, while the burden of the resolution of Banco Popular was borne by Santander.

The role of lender of last resort will fall to the European Stability Mechanism (ESM), replacing the never used and overly restrictive direct recapitalisation instrument. While this new tool is welcome, its implementation will be constrained in a number of respects:
-    Financial support will take the form of a renewable credit line whose size may not exceed that of the SRF. This means the total firepower (SRF + ESM) will be capped at around €120 billion.
-    The European Council is proposing that it be implemented by 2024, which is still quite a long way off, and even then only if sufficient progress has been made on reducing banking risk.
-    Lastly, the decision process is ambiguous: it stipulates that the ESM will be in the driving seat while still meeting “national constitutional requirements”.  This has raised fears that a veto or a vote in the Bundestag could call into question decisions made by the ESM.

Clarification will be required, particularly as regards the timeline and governance. Implementation of a safety net forms part of broader plans to reform the ESM. All of the proposals will be discussed at the next summit in December.
The real issue was the third pillar of the banking union, namely the European Deposit Insurance Scheme (EDIS), which has remained in deadlock since the project was kicked off in 2012. The debate is not so much around the pillar itself – at bottom, there is consensus among States on the end goal – but rather the best way of getting there.

While stopping short of burying the project, Northern European countries (Germany and the Netherlands) have succeeded in deferring any form of commitment. The roadmap put forward by the European Commission in 2016 will continue to serve as the framework for EDIS. This calls for the gradual mutualisation of deposit guarantee at the European level, provided there is a parallel reduction in banking risk. This conditionality has now been strengthened: an assessment of progress made in implementing risk reduction measures will be undertaken prior to any political negotiations.

Six monitoring indicators have been proposed: the solvency ratio, the leverage ratio, liquidity ratios (LCR and NSFR), the non-performing loan ratio and the ratio of bail-inable liabilities (MREL). However, no target has been set. Moreover, this list could evolve further. The question of whether banks’ exposure to their own countries’ sovereign debt should be included has been substantially debated and constitutes the main roadblock between Northern and Southern European countries.

The date for clarifying these points has been set for December. However, with the European elections only six months away, that will be too late to enter into new commitments. With eurosceptic parties in the ascendancy, it is anyone’s guess what the next legislature will look like.

Anna Sienkiewicz, Group Economic Research

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