The European Banking Union is celebrated by advocates as a revolutionary way to create a more stable institutional architecture for the euro zone. Opponents say the planis indirectly creating a Europe-wide liability for all eurozone taxpayers and customers of indebted banks.
Euro skeptics such as Markus Ferber, the chairman of the Christian Social Union’s fraction in the European Parliament, wants to take the issue to the Federal Constitutional Court of Germany. In reality, the critics are exaggerating.
Consider the key elements and the facts of the banking union.
In the future, the European Central Bank will oversee banks in the euro zone. Before that scrutiny begins, the ECB is screening the balance sheets of the largest banks so that hidden losses can be revealed. All banks will be required to maintain more equity. The results of these “stress tests” will be announced in October.
If the banks still have financial problems, they will be restructured or liquidated according to a uniform, regulated process spelled out in the banking union’s agreement. In the case of losses, bank equity owners and creditors will be liable first and foremost. Small investors will be protected through a deposit protection fund.
“The European Banking Union is celebrated by advocates as a revolutionary way to create a more stable institutional architecture for the euro zone. Opponents say a Europe-wide liability is being introduced through the back door for all eurozone taxpayers and customers of indebted banks. ”
The second line of defense is in the form of a rescue fund financed by banks in the euro zone.
The fund can be tapped only after a bank’s owners and creditors have absorbed losses of at least 8 percent of its balance sheet total. When tapped, the fund can make available funds to a troubled bank representing a maximum of 5 percent of its balance sheet.
Taxpayer money will come into play only when the bank rescue fund is tapped out. Then, a direct recapitalization of the bank can be applied for at the European Stability Mechanism (ESM). This recapitalization, however, should as a rule involve a financial participation — a contribution — of the country in which the bank is headquartered. The aid from the mechanism is limited to €60 billion ($80.45 billion).
So the banking union by no means will lead to an unlimited liability by euro zone taxpayers for all savings account holders in the 18-country bloc. Rather, the union is essentially a form of limited insurance with deductibles.
Some regulations need to be improved, such as more being done to prevent already incurred losses being mutualized.
It must also be made clear that the liability of private financiers is not limited to just 8 percent of the balance sheet of a troubled institution. In principle, the financiers should be liable for 100 percent of their capital as in every other private business undertaking or provide cost security at their own expense.
Eight percent is therefore only the lowest amount that bank creditors and owners would have to contribute to a rescue.
It must also be guaranteed that private liability is possible without the financial sector becoming destabilized.
The simplest way to implement that would be if the banks were required to maintain equity of at least 8 percent. The planned 3 percent guideline is decidedly too little. Since not only owners but also creditors, such as holders of bank bonds, are to be held liable, it should be ensured that they can absorb losses without threatening stability.
According to the regulations of the banking union, the banking supervisory authority is supposed to make sure all banks have sufficient risk capital — but how much is “sufficient” has yet to be made clear. Moreover, it is unacceptable that government bonds will continue to be considered as investments without default risks.
Instead of preventing the banking union, we should concentrate on improving it — with the goal of increasing the stability of the financial system and the monetary union.
Opponents of the banking union often give the impression that by abandoning a union, the liability risk for euro zone taxpayers and domestic banks and their account holders will be eliminated. That is an illusion. Without the banking union, it would hardly be possible to induce all member countries in the monetary union to demand better capital resources at their banks and provisions for the liability of private investors.
There is the possible danger that banks in the next crisis once again will be saved by their national governments, and the affected countries then receive aid from the ESM or the ECB to buy their government bonds. That would also be a mutualization of risk — but one in which only the liability community would have influence the process.
Instead of preventing the banking union, we should concentrate on improving it — with the goal of increasing the stability of the euro zone financial system and the monetary union.
Clemens Fuest is president of the Centre for European Economic Research. He can be reached at firstname.lastname@example.org