EURO TURMOIL Grand Illusion Behind Europe’s Banking Union

The euro zone’s too-big-to-fail problem is too-big-to-fix under the current system, writes finance professor Christian Kröger.
Owners of debt in the nationalized Hypo Alpe-Adria bank face steep losses, said Austria's finance minister this week.

If the euro zone wants to survive as a currency union, it will have to be more deeply integrated – and a stable banking union is indispensable.

One huge problem now is the tenuous link between the financial sector and national governments.

In crises, governments save their banks from bankruptcy and incur debts. Then they borrow by issuing government bonds – largely through the same banks they saved. That connection is why the national supervisory practice has completely failed up to now. It has no chance of bailing out big banks without throwing financial markets and the economy into turmoil.

Europe needs a sustainable solution for a banking union. It could follow the U.S. model – the Federal Deposit Insurance Corp. – which has long been responsible for watching over banks in financial trouble. Unlike in Europe, if a bank closes in the United States, the FDIC takes over and "switches off the lights."

But what would a strong banking union in the euro zone look like?

The institutional evolution in the U.S. has led to a stable banking union system. Bringing that to the euro zone would go a long way to solving the problem.

In November 2014, the European Central Bank took over supervision of 130 “system-relevant” banks with a total balance of €22 billion, or about $24.7 billion. The new supervisory mechanism is designed to break the vicious circle between national budgets and banks.

The agreed upon single resolution mechanism, which includes a common fund for ailing banks, was publicly celebrated at the time as a “revolutionary change” by Michel Barnier, the European Union’s commissioner for financial affairs.

But to really solve the too-big-to-fail-problem, system-relevant banks would have to be bailed out against the will of national governments. Only then would the procedure be credible. But that is not the case. The resolution program for system-relevant banks can only be launched if the European Union Commission and finance ministers do not object.

And that means any proposed solution for supervision could be eliminated for political reasons.

An independent authority is needed to solve that problem. In bailing out too-big-to-fail banks, financial markets must be reassured on the next business day that all is well.

If there is no independent authority to give that assurance, investors would rush in to take out billions in deposits, and markets would go haywire. In that case, the resolution fund would not be enough to provide ailing banks with urgently needed billions fast enough.

In theory, bailing out a struggling bank is possible under the single resolution mechanism – but not in practice. System-relevant banks support the economic system and are not limited to a single E.U. country. They also balance complex risk assets that even financial experts can barely understand.

So under current conditions, zombie banks cannot be bailed out without massive harm to the markets. Unless there are clear and feasible rules, all political promises end up being empty ones.

Under the current system, national governments or the European Central Bank will carry on intervening with possible bailouts and save ailing banks with taxpayer money. But that cannot be the goal of a stable and independent banking union. So there really is no reason to celebrate yet.

The institutional evolution in the United States has led to a stable banking union system. Bringing that to the euro zone would surely go a long way to solving the problem.


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