Banking union: big bang or damp squib?
Eurozone needs package of interrelated measures to prevent project going backwards
The Bulgarian government, after assuming the rotating presidency of the Council of the European Union in January 2018, became the latest in a growing line to pledge it would prioritise completing the eurozone’s banking union.
Progress has been made: the single supervisory mechanism at the European Central Bank (ECB) and the Brussels-based single resolution board already exist. In theory, the third leg of the stool is a single European Deposit Insurance Scheme (Edis) and then the job is done.
In reality, banking union is a set of much more complex interactions between different European institutions and pieces of legislation, with the overarching aim of removing barriers to a single banking market. These obstacles are more widespread than they appear, including the need for a single, pan-European pool of high-quality collateral to replace the current dependence on home sovereign bonds, and the prudential treatment of eurozone banks’ subsidiaries in other eurozone countries.
This complexity has stalled the European Commission’s draft Edis legislation, originally published in November 2015. Several members, led by Germany, want meaningful risk-reduction measures in the banking sector before the mutualisation of risk implied by guaranteeing other countries’ depositors.
The risk-reduction plan includes tackling high non-performing loans (NPLs) in certain national banking sectors, ensuring bank debt can be bailed in instead of recapitalising banks with a government bailout, and breaking the doom loop created by high home sovereign-debt exposures on bank balance sheets.
The EU seems to be changing its own approach: instead of arguing over the exact sequence of events to finalise the banking union, it is pursuing everything at the same time
Efforts to break the doom loop received a setback in December 2017, when the Basel Committee failed to agree even to consult on reforms to the standardised approach for calculating credit risk capital to be held against banks’ sovereign exposures. The EU had left the project to Basel in the hope of overcoming internal rifts and avoiding any competitive implications if Europe moved on sovereign risk while the rest of the world stayed still.
So the EU seems to be changing its own approach: instead of arguing over the exact sequence of events to finalise the banking union, it is pursuing everything at the same time. The Bulgarian presidency has promised to move on with Edis this year. The ECB and European Commission have joined forces to accelerate the clean-up of NPLs on bank balance sheets. And the commission is set to unveil another proposal intended to reduce home sovereign exposure while also developing a pan-European safe asset – the sovereign bond-backed security.
Meanwhile, the European Parliament has begun advocating concentration charges on banks’ sovereign-credit risk exposures to help break the doom loop and incentivise the uptake of SBBS. There are also council discussions on upgrading the European Stability Mechanism to provide proper backstop funding with which to tackle major national or cross-border banking crises, which threaten to exhaust the single resolution fund.
If all of these measures are worked on simultaneously to form a single, big-bang package, it could break the deadlock to completing the banking union. But the drawn-out process of finalising Basel III last year suggests another possible outcome. The giant package of reforms was delayed by a year because its progress slowed to the pace of the most controversial item on the agenda.
Complex engineering
In the meantime, there are several risks that could throw the entire project off the track.
Former German finance minister Wolfgang Schäuble let fly a parting broadside at the SBBS project as he departed last October, warning: “We must be able to create real stability through reforms, not through complex and expensive financial engineering.” As coalition talks are still ongoing, Schäuble’s successor has not yet been appointed – if they hold a similarly negative view of SBBS, it could scupper the idea before it sets sail.
The credibility of the single resolution board is under fire in a lawsuit over the resolution of Spain’s Banco Popular. Any upward trend in NPL ratios for specific countries would further undermine the appetite for risk mutualisation. The European Banking Authority’s third-quarter 2017 Risk Dashboard report showed NPL ratios continuing to improve. The proportion of banks with NPL ratios lower than 3% is at 51.4%, compared with just 38.1% for the third quarter of 2015. But this improvement could be reversed as the ECB curbs its ultra-easy monetary policy and interest rates rise.
So, time is of the essence. While it is important for new rules and institutions to be carefully designed, the status quo is not necessarily stable and there are inherent risks in allowing the banking union to persist in its current, incomplete form. This year, the leaders of the eurozone are likely to have to choose between big bang and damp squib.
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Printing this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Copying this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
More on Our take
Hedge funds must race the clock to check their dealer-rule status
Working out whether a firm is caught by SEC registration requirement could take months
Filling gaps in market data with optimal transport
Julius Baer quant proposes novel way to generate accurate prices for illiquid maturities
Why Europe still awaits a private credit CLO
Tricky questions face managers that plan to launch the structure on the continent
The signs of tacit collusion in the dividend play trade
Game theory and real-world data point to a different understanding of how arbitrage in markets works
Decades of history says you can beat high inflation with quality
Factors such as momentum and value generally outperform the market irrespective of inflation, but new research suggests quality stocks are best when prices are rising rapidly
Esma faces tough task in implementing Emir 3.0
EU regulator must contend with tight timeframes and increasing workload without additional resources
Quants are using language models to map what causes what
GPT-4 does a surprisingly good job of separating causation from correlation
China stock sell-off will test securities firms’ risk managers
Regulatory measures to support stock market could add to risks facing securities sector
Most read
- Industry urges focus on initial margin instead of intraday VM
- For a growing number of banks, synthetics are the real deal
- Did Fed’s stress capital buffer blunt CCAR?