A recent report of the European Commission (2015), the Five Presidents’ report on “Completing Europe’s Economic and Monetary Union” by the year 2025, updates relevant plans that were proposed by an earlier European Council Report (2012), the Four Presidents’ report. The stated aim is to gradually achieve a “genuine economic and monetary union,” which would gradually evolve towards “Economic, Financial and Fiscal Union.” What is meant by a genuine union, and would that involve at least de facto, if not de jure, political integration?
The 2012 report proposed closer integration in four main areas: banking union, closer integration of budgetary policies, better coordination of economic policies other than fiscal policy, and a strengthening of democratic legitimating and accountability. Little has been achieved to date, with the exception of some moves towards the banking union objective. But even within the banking union driver not much emerged. The only changes in the latter respect were the agreement on a new structure for prudential supervision of banks under the ECB pinnacle of national central banks and a common approach to resolving failing banks (the single resolution mechanism).
The 2015 proposals contain two consecutive stages: the first stage (1 July 2015 – 30 June 2017), “would build on existing instruments and make the best possible use of the existing Treaties” (European Commission, 2015). In the second stage (mid-2017 to 2025), “concrete measures of a more far-reaching nature would be agreed to complete EMU’s economic and institutional architecture” (European Commission, 2015).
The banking union proposals could be seen as the part of both reports, which are proceeding and will have some impact. It contains two relevant components: a common deposit insurance scheme which, however, is not an all-encompassing supranational one—it would only provide top-down funding when the national scheme is in trouble. And it will be based on contributions from the banking sector, rather than on public money. The second component is what is called a “bridge financing mechanism,” which reinforces the “single resolution fund” already agreed at the end of 2013 to help banks in need.
The Five Presidents correctly assert that “in a Monetary Union, the financial system must be truly single or else the impulses from monetary policy decisions (e.g., changes in policy interest rates) will not be transmitted uniformly across its Member States.” This point was one of many made before the formation of the Economic and Monetary Union but ignored by the supporters of the euro project. This weakness was part of the “one size fits all” approach whereby the ECB set the interest rate in pursuit of the price stability objective. But more is needed than a single financial system, as the way in which a policy interest rate is transmitted depends not only on the banking system and the ways in which they set their loan and deposit interest rates, but also on how the change in interest rate influences inflation, level of demand, and asset prices. The Five Presidents continue by saying that the lack of uniformity “happened during the crisis, which in turn aggravated economic divergence,” though that was evident prior to the crisis when, for example, there was a lack of convergence of real interest rates as inflation differed between countries. They further point out that “a single banking system is a mirror image of single money. As the vast majority of money is bank deposits, money can only be truly single if confidence in the safety of bank deposits is the same irrespective of the Member State in which a bank operates. This requires a single bank supervision, single bank resolution and single deposit insurance.” It is to be regretted that it has taken a financial crisis and recession for this to be realised by the Five Presidents and to register astonishment that these issues were not addressed when the EMU was being formed.
The formation of a banking union comes in number of stages. These include the “full transposition into national law of the Bank Resolution and Recovery Directive by all Member States” which aids the protection taxpayers from the cost of bank rescues. Second, “an adequate bridge financing mechanism—a way of ensuring there is enough money if a bank needs to be unwound.” Third, “setting up a credible common backstop to the Single Resolution Fund and making progress towards a full level playing field for banks in all Member States should be a priority during the transition period to the creation of the Single Resolution Fund.” It is, though, further stated that “this backstop should be fiscally neutral over the medium term by ensuring that public assistance is recouped by means of ex post levies on the financial industry.” It is interesting to note that this form of taxation (levies) is to be after the event rather than through the build-up of prior funds. And perhaps more significantly it could be seen as a move in the direction of a Federal-level tax policy. Another element would be the launch of a European Deposit Insurance Scheme, “as the current set-up with national deposit guarantee schemes remains vulnerable to large local shocks … common deposit insurance would increase the resilience against future crises.” This again could be viewed as a shift in the direction of Federal scheme.
A well-functioning monetary union requires a banking union, and at last EMU is facing up to that reality. The construction of a banking union, common approach to banking regulation and to bank resolution and recovery face the challenges from the diversity of banking institutions and differences in national banking regulation. A banking union involves a further step in the direction of political union with the adoption of a common policy approach to banking and the development of Federal level levies (if not taxes).
European Commission (2015), Completing Europe’s Economic and Monetary Union, Report by J-C. Juncker, in Close Cooperation with D. Tusk, J.Dijsselbloem, M. Draghi and M. Schulz, Brussels, 22 June.
European Council (2012), Towards a Genuine Economic and Monetary Union, Report by H.V. Pompuy, in Close Collaboration with J.M. Barrosso, J-C. Juncker and M. Draghi, 05 December.