Euro Area Banking Union

Philip Arestis and Malcolm Sawyer

The EU summit meeting, 28th/29th June 2012, took a number of relevant decisions in terms of a possible euro area banking union. However, this particular set of decisions was more about initial steps rather than steps for a significant move towards such a union. The relevant decisions are related to: banking supervision by the ECB; banking licence for the European Stability Mechanism (ESM); The ESM will provide financial assistance to members of the euro area when in financial difficulty. It was established on 27th September 2012, but will not come into full operation before 2014. It will function as a permanent firewall for the euro area with a maximum lending capacity of €500 billion. It will replace the two existing temporary EU funding programmes: European Financial Stability Facility (EFSF) and the European Financial Stabilisation Mechanism (EFSM). ESM member states would be able to apply for an ESM bailout when they are in financial difficulty or their financial sector is a threat to stability and in need of recapitalization. Another precondition for receiving an ESM bailout will be that the member state must have fully ratified the Fiscal Compact (see our blog of December 2011 for more details on the Fiscal Compact); when the ESM is introduced, it will have access to the ECB funding and this will greatly increase its firepower. Germany objected to the latter proposal on two grounds: the ECB should not be responsible for all 6000 euro area banks (including small banks such as Germany’s regional savings banks); and there should be a clear separation between ECB monetary policy and bank supervision. The relevant European Council statement (adopted on 18th October 2012) insists on such a separation, and yet no focused explanation is provided for such a need. We would argue that such separation is not acceptable. Central banks need to play a key role in supervising banks as the “great recession” has demonstrated. A good example is the case of the Bank of England, where the removal of banking supervision from this Bank in 1997 has now been reversed.

Christian Thimann argued recently that a “Banking union should ease Europe’s Target worries” (Financial Times, 11th January 2013). These worries relate to large balance sheet positions of the countries’ central banks, which are members of the euro area, known as ‘Target balances’ (Trans-European Automated Real-time Gross Settlement Express Transfer System). A net outflow from a country leads to the reserves held by the corresponding central bank declining, and correspondingly a net inflow to rise in reserves held by national central bank.  The movement of reserves depends on whether the central bank’s country has outflows (liabilities) or inflows (claims). Target2 is the large-value cross-border payments and settlement system for the euro area  The ‘Target worries’ with the drain of reserves from some central banks to others are a reflection of balance of payments imbalances between euro area member countries, and it is the latter which then needs to be resolved.

On 12th December 2012 the EU finance ministers reached a technical agreement to create a new single supervisor at the ECB. The ECB will supervise banks with assets worth more than 30bn euros or 20% of their country’s GDP (this amounts to around 200 out of 6000 euro area banks). National supervisors will run the day to day supervision of other banks, although the ECB has the right to supervise in an emergency and at the request of the ESM. The creation of the new supervisory body is to be set up by March 2013, although plans to use the ESM to recapitalise banks directly, cannot be in place before 2014. The plan has had political approval from the majority of the EU/EMU countries at their summit meetings of 13th/14th December 2012. The banking regulator for the 27 EU members is the European Banking Authority (EBA). National supervisors within EBA, but outside the euro area, will continue to function as before. Those within the euro area will come under the jurisdiction of the ECB and the umbrella of the Single Supervisory Mechanism (SSM). The EBA sets the rules under which all banks in the EU must work the ECB would be able to impose its will on the national banking regulators. It now needs to be approved by the EU and individual country parliaments. The UK, Sweden and the Czech Republic refused to join the single supervisory agreement; it is the case, though, that they remain members of the European Banking Authority that co-ordinates supervisors. Interestingly enough, proposals by the summit chair towards a euro area fiscal and political integration were delayed until next opportunity amid strong German resistance.

Furthermore, a ‘growth pact’ was proposed at the EU summit meeting on June 2012, which would involve issuing project bonds to finance infrastructure. Two long-term solutions are proposed: one is a move towards a banking union and a single euro area bank deposit guarantee scheme; another is the introduction of euro bonds and euro bills. Germany has resisted the latter two long-term solutions, arguing that it would only contemplate such action only under a full-blown fiscal union. Such a suggestion is pertinent not merely in terms of the introduction of the two solutions proposed but for the long-term survival of the euro area. In any case these are long-term solutions when they are desperately and immediately needed, especially the common deposit guarantee scheme. A further problem is the absence of bank resolution policies; namely a directive to provide the legal basis for future bank bailouts in the euro area, a necessary supplement to the single bank supervisory mechanism referred to above, or indeed letting them go bust. We may conclude that both a European Banking Supervision and a European Banking Resolution Authorities are needed: but for them to be successful they would have to come under a political integration arrangement, which would provide the necessary fiscal capacity desperately and urgently required at the euro-area level.

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