Follow Philippe Legrain on Twitter Follow Philippe Legrain on YouTube Follow Philippe Legrain on Facebook Email me
By Philippe Legrain ADD COMMENTS

After a 16-hour marathon negotiating session ending on March 20, politicians, technocrats, and journalists were all keen to declare the deal on the final piece of Europe’s banking union a success. But appearances are deceptive. While the “banking union” may soon exist on paper, in practice the eurozone banking system is likely to remain fragmented along national lines and divided between a northern “core,” where governments continue to stand behind local banks, and a southern “periphery,” where governments have run out of money.

Think back to June 2012. Spain’s busted banks threatened to drag down the Spanish state, as Ireland’s had done to the Irish state 18 months earlier, while panic tore through the eurozone. European Union leaders resolved to break the link between weak banks and cash-strapped governments. A European banking union would move responsibility for dealing with bank failures to the eurozone level – akin to America, where distressed banks in, say, Florida are dealt with by federal authorities with the power to bail in bondholders, inject federal funds, and close down financial institutions.

But, a month later, the European Central Bank finally intervened to quell the panic. That saved the euro, but it also relieved the pressure on Germany to cede control of its oft-distressed banks. Since then, the German government has used its clout to eviscerate the proposed banking union; all that remains is a shell to keep up appearances.

For starters, it will not apply to the huge losses incurred during the current crisis. The ECB will directly supervise bigger eurozone banks starting in November (the first step of the banking union), and now it is assessing the strength of their balance sheets. If this exercise is conducted properly – a big if – undercapitalized banks that are viable would be forced to raise additional equity, from bondholders if necessary, while unviable ones would be wound down.

But EU rules on national bank resolution will not yet be in force, while the eurozone’s single resolution mechanism will be initiated only in 2015. So banks in northern Europe that are still backed by creditworthy governments would be treated differently than those in cash-strapped southern Europe: Germany can afford to bail out its banks; Italy cannot.

More likely, the ECB will fudge the exercise, owing to fear of reigniting the financial crisis and pressure from national governments. Small countries will be singled out to make the exercise look tough, while bigger problems will be swept under the carpet: German banks have already succeeded in excluding many of their assets from the assessment.

One argument for making the ECB the watchdog for eurozone banks was that it was less captured by the banks than national supervisors were. But its behavior throughout the crisis suggests otherwise. It has repeatedly prioritized the interests of banks in “core” countries and proved more pliable to political pressure from Berlin and Paris than from Madrid or Rome, let alone Dublin or Athens.

Even after the new banking union framework is fully in place, it will be full of holes. At Germany’s insistence, the ECB will supervise only the eurozone’s 130 or so biggest banks. That will leave the smaller Ländesbanks (state-owned regional banks), many of which made spectacularly bad lending decisions in the bubble years, and Sparkassen (smaller savings banks) in the hands of local politicians and Germany’s pliable financial supervisor.

The argument that smaller lenders are not a systemic threat is spurious: consider Spain’s cajas. In any case, there will not be a level playing field.

Above all, the single resolution mechanism is a mirage, because national governments retain a veto over closing down any bank. The mechanism is deliberately complex to the point of being unworkable; it is inconceivable that a bank could be wound down over a weekend to avert market panic. And the collective funds that eventually will be at its disposal are meager: a mere €55 billion ($76 billion).

In practice, then, rescuing banks will remain in the hands of national governments, all of which are captured by “their” banks but whose capacity to bail them out varies: French and German banks will be rescued; Cypriot banks will not. To increase their chances of a bailout, banks in the eurozone periphery will doubtless borrow as much as they can from politically connected banks and investors in the core countries. Thus, national taxpayers will remain on the hook for bankers’ losses.

The upshot is that the eurozone as a whole is likely to struggle with a zombie banking system, with only patchy efforts to restructure banks decisively and fairly. Worse, the north-south, core-periphery divide will harden, with taxpayer-backed banks on one side and banks that must fend for themselves on the other.

That is a bonus for struggling southern taxpayers, but it implies that even sound banks could have higher funding costs than dubious northern European banks for the foreseeable future. Southern businesses would then face higher borrowing costs than northern businesses, hindering growth. The bogus banking union is thus a recipe for entrenching economic and political division.

Posted 14 Apr 2014 in Published articles

Leave a reply