Banking Union

Europe's Sham Banking Union

Note: This is a longer version of what appeared as an opinion piece in the Wall Street Journal on the 1st of Feb 2013

After a year in which European Union policy makers spent much time obsessing about banking union, it is time to take stock of the discussion. The question today is not about the intellectual case for a more unified approach to bank regulation and supervision within a single-currency area such as the euro zone. That case is still strong. Rather, it is about if what is being pedalled as a ‘banking union’ will deliver the goods—whether it will help tackle the economic crisis that still looms large over Europe or not. Evidence is now stacking up that it will not.

The EU's banking union was sold as a means to break the "vicious circle" connecting weak banks and weak sovereigns—and to do so quickly. As a way to mitigate the risks that troubled banks pose and weak sovereigns pose to each other, however, the plan is looking more ineffectual by the day. Although the European Stability Mechanism (ESM) can inject capital into struggling banks, a number of caveats apply.

EU banking, whither now?

Large uncertainties haunt the banking sector in the EU. A lack of clarity about the scope and timing of several pieces of financial sector legislation that are in the pipeline, the macroeconomic headwinds from the unresolved problems of the Eurocrisis and the prospect of a risky transition to a smaller, safer and better-regulated banking system are weighing on investor interest in the sector. Without a renewal of interest from investors in recapitalizing and funding banks, the sector will remain in limbo. In this piece, first published in the Quantum Magazine of the Qatar Financial Centre, Sony Kapoor highlights the key aspects of reforms underway.

The European Union’s initial legislative response to the global financial crisis was much slower than that of the United States, which moved rapidly to introduce the Dodd-Frank bill on financial reform. But, as the economic crisis in the EU deepens, new legislation on the functioning of the financial system continues apace and the Eurozone is now pressing ahead with plans to create a banking union.

The reforms which are in the pipeline will result in a radical transformation of the banking sector. There will be changes in the structure of banks, their capital and liquidity requirements and even a single supervisory authority. However, the speed at which these reforms are to be introduced is much less clear. The new structure will have to be approved by EU governments, balance the needs of Eurozone and non-Eurozone states and take into account the views of the banking sector, which itself remains divided on some of these reforms.

The Eurogroup provides a reality check

The last sentence of the European Council Communique from the June meeting simply states “We task the Eurogroup to implement these decisions by 9 July 2012.” This was always going to be a stretch and as expected the marathon 10 hour meeting of the 9th of July has failed to do any such thing as is clear from the Eurogroup communique.

As we discussed in detail in our report following the European Council, there were four important decisions taken that day. Some of these, such as the decision to set up a Eurozone-wide bank supervisor, the decision to allow Eurozone crisis funds to directly inject equity capital into troubled banks in member states got a lot of people excited. However, as we discuss in this commentary, the Eurogroup meeting provided a good reality check for those who may have got carried away after the better than expected (only because expectations were managed so low) results from the European Council meeting in June.

Oui Nein & Non Ja - Franco-German fault lines & Eurocrisis

Whenever the future of the European Union was considered in the past, at least in the last couple of decades or so, a crucial fault line that always limited progress towards an 'ever closer union' was the critical differences between the French and German approaches to the European Project.

Germany favoured a stronger institutional structure with more co-ordination and a centralized decision-making structure, France a more decentralized construction where groups of national leaders were the ultimate decision-making authority and the transfer of sovereignty to the centre was rather limited. This same fault line is now once at the heart of the discussions surrounding the Eurocrisis and the ability of the two countries to bridge this will determine the shape of Europe, in particular the Eurozone!