STOCK MARKET WATCH -- Friday, 15 June 2012

[Demeter]

16. Banking union in the Eurozone and the EU

http://www.voxeu.org/index.php?q=node/8093

The opportunities for institutional advancement in the EU created by the dismal management of the Eurozone crisis may well include the establishment of a banking union, a theme that could be placed on the agenda of the forthcoming European Council at the end of June. The debate on this topic, however, seems mired in confusion, notably as regards the features and tasks of deposit insurance at the Eurozone or EU level in combating contagion and restoring financial stability. It also seems at times to overlook the fact that many constituent elements of banking union are already present in the legislation in force or tabled for approval and, more importantly, that much of what is needed may be feasible with ordinary legislative procedures.

There is a need, to start with, to distinguish clearly what is needed to address a ‘systemic’ confidence crisis hitting the banking system – which is mainly or solely a Eurozone problem – and ‘fair weather’ arrangements to prevent individual bank crises and, when they occur, to manage them in an orderly fashion so as to minimise systemic spillovers and the cost to taxpayers, which is of concern for the entire EU. Much of the on-going debate on deposit insurance and banking resolution funds mainly refers to the latter issue; deposit insurance or resolution arrangements can be instrumental in confidence-building over the medium term but couldn’t ever have sufficient resources to meet a spreading run on deposits. More important, “using extended insurance coverage to stabilise financial systems in the absence of appropriate institutional, political, and fiscal conditions to address existing problems” would entail moral hazard (IADI 2012). Financial stabilisation in the short term is the proper task of lending of last resort by the central bank.

Taking up the ‘fair weather’ system first, we have always known that a stable and well-functioning internal market in banking requires EU-wide deposit insurance, crisis resolution procedures, and supervision. While the desire to preserve national prerogatives in these domains has slowed down the progress in this direction, the crisis is now accelerating progress on all three fronts. As to deposit insurance, Directive 94/19/EC, as amended by Directive 2009/14/EC, and a new directive under consideration by Council and Parliament, based on a Commission proposal of July 2010,1 have already harmonised the level of depositor protection (€100,000) and will require all national systems to be funded ex-ante with a significant risk-based component of fees paid by participating banks. The European Commission has further proposed that each national scheme should target a level of funding of 1.5% of total insured deposits, to be reached within 10 years (which Parliament has lengthened to 15). The target level is supported by the European Parliament, but the member states in the Council would like to lower it to 0.5%. A recent survey prepared by the Financial Stability Board shows that most EU members are already compliant with the principles of the Commission proposal (with ex-post-funded deposit insurance still present in Italy, the Netherlands, and the UK); however, the size of insurance funds is very small, well below even the lower target acceptable to the member states (see FSB, 7:52).

There is also a provision whereby national guarantee funds may, under certain circumstances, lend funds to each other on a voluntary basis to meet unexpected shortages; the commission wanted this to be a legal obligation but the parliament and council did not accept it. This provision is insufficient to meet the funding needs that may arise from substantial losses at a large cross-border bank. An adequate solution may only come from an EU-wide deposit insurance scheme covering all cross-border banks, as proposed by Carmassi et al. (2010).