The Eurozone crisis, following hot on the heels of major banking failures across the globe, triggered the revolutionary quest for European banking union. From mid-2012, the economic troubles of the European Union provided a catalyst in seeking a long term solution to the problems besetting banking and the euro, writes Roger Davies
By this time, the bailing out of faltering banks had become a threat to national economies and using the tax payer as the lender of last resort was always unsustainable. Politicians have been mindful to avoid redrafting European treaties and have instigated a less contentious three-pronged strategy to deliver banking union.
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The Pillar One measures, announced in late 2012, focused on the Single Supervisory Mechanism awarding new powers to the European Central Bank (ECB). Much more recently, with the European elections looming, MEPs resolved their differences approving both MIFID-2 and the Pillar Two banking union legislation introducing a Single Resolution Mechanism (or SRM). Pillar Three, in due course, will be a re-hashed deposit guarantee scheme.
The SRM should ensure that bank failures are managed efficiently and at minimal cost to taxpayers and the economy. It is undoubtedly a key development although last minute political compromises never result in optimal regulation. That being said, after a long and tortuous gestation period, the 18 Eurozone countries will be pleased to have taken steps to combat the ‘too big to fail’ issue. The legal process is not yet complete and the 28 individual EU member states will have two years to transform this latest bill into their state law. Experience says not all will meet this deadline.
The SRM creates a ‘Single Resolution Board’ (SRB) and a ‘Single Resolution Fund’ (SRF). The former has responsibility for all cross-border and major banks whilst the 18 NRAs (National Resolution Authorities) will look after the smaller banks. Any decisions taken are essentially European but will involve the NRA ‘in view of the significance of bank resolution for national economies’. The decision that a bank is failing or likely to fail will normally be made by the ECB and the SRB will then assess if a systemic threat and if no alternative private solution.
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By GlobalDataIf so, it will adopt the resolution scheme including any demands on the SRF and submit details to the European Commission for their approval. This is required within 24 hours. The European Council can object but only on technical grounds. In March 2014, the press release on the SRM proudly stated "the system cannot become a hostage to political power games and can deliver swift and credible decisions." To others it is, at best, a fudge.
A 55bn SRF (£45bn) is being raised incrementally. These monies can be injected in an emergency into a failing bank although strict rules will apply. The fund will be financed from Eurozone domestic bank levies paid into ‘national compartments’ for an eight year transitional period. The fund will also be able to borrow on the financial markets, if required. If MEPs hope to avoid a repeat of the public bail outs of Greece and Ireland this rescue pot does appear paltry. However, the creation of this fund is also symbolic as with banking union in place it clears the way for a truly federal Europe for the Eurozone countries and a two speed EU.
In future, should a bank fail in the Eurozone, monies will first be recovered from creditors and shareholders. Although UK banking regulation will not be impacted by European banking union, this principal is also being established with the Co-operative Bank and the proposed ‘bail-in’ of existing bond holders. All 18 Eurozone countries have agreed to participate in the SRM and countries waiting to join the Euro can sign up too.
From November 2014, under Pillar One, the ECB will start directly supervising the Eurozone’s 130 biggest banks and in extremis it will have the powers to overrule national authorities. Under a revamped harmonised deposit guarantee scheme, EU customers remain protected up to 100,000 in any ordinary account in the event of a bank failure but there is no common backstop. The ECB is currently conducting stress tests to ensure that all Eurozone banks are correctly capitalised with the results due in October. The ECB’s findings may yet spook the markets.
The Eurozone is not out of the woods. Many impartial observers are yet to be convinced that the measures announced are sufficient to protect the public with banks complex entities and contagion a global risk. Internationally, we need uniform structural reform but see only a mosaic of new regulation and arbitrage. The ‘too big to fail’ conundrum has not been solved. In April 2014, the IMF had arrangements with 7 European countries and commitments totalling 82bn highlighting the alarming inadequacy of the SRF.
The devil will always be in the detail but the ECB’s role and the SRM procedures appear clumsy. The IMF, a long time supporter of banking union, is calling for accelerated implementation. However, it is the common national interpretation of the final rules that will be key to the success of banking union. Is this possible? The Financial Transaction Tax and the Liikanen reforms are also waiting in the wings but progress in these areas is dependent on the results of the forthcoming European elections. Michel Barnier sees banking union at the centre of a new EU but, amidst a fractious organisation, there can be no certainty.
Roger Davies is the Principal Consultant at EA Consulting Group
