Banking union: the disadvantages of opportunism

Abstract

The EU’s approach to what it describes as “banking union” is not what one would design with a clean slate. It reflects the political constraints and the path of history. This paper compares the institutional and operational structure of “banking union” that has been decided upon with a complete structure. It focuses on the distortions caused by a system based on the euro area, which excludes Europe’s most important financial market. It considers the difficulties posed for the Single Resolution arrangements and the European Deposit Insurance System by the continuing problem of the relation between weak banks and over-indebted sovereigns.

Keywords:

• banking union
• Bail-in
• deposit insurance
• single supervisory mechanism
• Volcker rule

JEL Classifications:

• F36
• G21
• G38

Notes

1. This includes the “Single Rulebook” and related harmonisation measures by the European Banking Authority (EBA) which seek to set common standards across the whole of the EU/EEA and not just minimum standards as tended to be the case previously.

2. Regulation (EU) No 806/2014 of the European Parliament and of the Council establishing uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of a Single Resolution Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/2010, available at http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014R0806&from=EN (last accessed 12 November 2015), labelled SRR hereafter.

3. It was felt necessary to buttress the SRF by adding an intergovernmental agreement to the SRR (Council of the European Union, Agreement on the transfer and mutualisation of contributions to the Single Resolution Fund, 8457/14, available at http://register.consilium.europa.eu/doc/srv?l=EN&f=ST%208457%202014%20INIT .

4. Howarth and Quaglia (2016) provide a helpful exposition of the process of agreement and how the views of the different protagonists were taken into account in the compromise.

5. The European Commission (2015b) and the Five Presidents’ Report (Juncker et al. 2015) suggest ways forward.

6. European Commission (2014).

7. See HLEG (2012) for the report.

8. Stuchlik (2016) gives a clear exposition of what is intended (European Commission, 2015a) and its progress through the European Parliament.

9. The ECB acts as Lender of Last Resort in the traditional sense of providing emergency liquidity to all solvent banks when markets dry up and has done this extensively since 2008; see chapter 1 in Castañeda, Mayes, and Wood (2016). Emergency Liquidity Assistance to individual banks is provided by the national central banks, with the ECB’s approval in the case of the euro area. The lacuna is where a small national central bank cannot provide adequate support for a large cross-border institution, as was the case in Iceland. Lending to enable recapitalisation and restructuring via the European Stability Mechanism (ESM) only helps if the loan can be repaid, as in the case of Spain in 2013. Traditionally, such loans are either paid back from the insolvency if the bank fails or from the profits or refinancing if the bank recovers successfully. The ECB only offers euro financing, so some recoveries may require actions outside its immediate control.

10. There has been no shortage of direct advice for EU decision-makers on the appropriate form for “banking union” and the various short contributions to Beck (2012) offered a wide range of thoughtful advice. See also Elliott (2012).

11. There is an immediate problem in this ideal picture as, in the main, banking in the EU/EEA has strong divisions along national lines. Even where banks operate in more than one member state, these operations are separate. Thus, even though you may be a long-standing customer of Nordea in Finland, to have access to full banking facilities in Norway with the same bank, you have to open a new account and go through the normal “know your customer” requirements as if your Finnish account did not exist. (Although Nordea ATMs in Norway will automatically give instructions in Finnish if you insert a Finnish Nordea card.).

12. Goodhart (2012) emphasised the importance of taking the two parts together, and Schoenmaker (2012) went even further in arguing that banking union should be constructed from the opposite direction, starting with the resolution mechanism and then working out what that implied for the structure of supervision and regulation. The argument for starting with the SSM is that unless one can agree how adequate supervision across the EU is to be established then no one will be willing to discuss a resolution system where one country may in effect be bailing out another.

13. As the EDIS proposal mentioned below illustrates, it is possible to run an agency with different component schemes as is illustrated by most insurance companies. The possibility of setting up an EDIC was suggested by Wall, Nieto, and Mayes (2011) simply because the US template existed and could be followed.

14. See http://www.efdi.eu/efdi.

15. The phrase in the SSM Regulation (art 7) is “in close cooperation” (European Council 2013).

16. There is of course considerable doubt over whether that will happen given the UK government’s present stance (May 2017), but many think that in the longer term the UK’s position in the single market for financial services will effectively be maintained (Leigh 2017).

17. Indeed, this is something which may happen if ESMA becomes the centre of “capital markets union”.

18. The main circumstance where deposit insurers are likely to have to contribute to the resolution is when creditors of the same priority are bailed in and hence they become liable, along with uninsured depositors, for the (proportionate) amount that depositors would have had to contribute to the resolution had they not been insured (Directive 2014/59/EU art 109). This is an application of the pari passu principle.

19. In simulations of who would have been bailed in had the BRRD been applied to the failure of banks in the EU in 2008–10, Conlon and Cotter (2016) find that in almost all cases it would not have been necessary to bail-in senior creditors. In a similar exercise looking at the 26 largest banks in the euro area, Hüser et al. (2017) find that, for the largest shock they consider, 7 of the 26 banks would require some degree of bail-in of deposits to return to being well capitalised.

20. There has been an extensive debate about whether the SRF is large enough to handle all eventualities. Clearly, there can be circumstances that could require recourse to back up funding, but outside major crises this is unlikely if the calculations of De Groen and Gros (2015) are to be believed.

21. In the Nordic crises, the insurance funds became depleted and required replenishing or replacing by the state (Mayes 2017).

22. § 619 (12 U.S.C. § 1851) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

23. Independent Commission on Banking (2013).

24. Gesetz zur Abschirmung von Risiken und zur Planung der Sanierung und Abwicklung von Keditinstituten und Finanz Gruppen, 7 August 2013,Bundesgesetzblatt Part I, p. 3090.

25. Loi no. 2013–672 du 26 juillet 2013 de separation et de regulation des activités bancaires, Journal Officiel de la Républic Française no. 0173 du 27 juillet 2013, p. 12,530.

26. HLEG (2012).

27. European Commission (2014).

28. See Binder (2014) inter alia for a review of the arguments.

29. With single point of entry, the home country resolves the problems for the entire cross-border banking group by ensuring that the parent company becomes adequately capitalised again and hence that all of the subsidiaries in host countries that might be thought systemically important can also continue.

30. https://www.nordea.com/en/press-and-news/news-and-press-releases/press-releases/2017/09-06-16h50-the-nordea-bank-ab-publ-board-of-directors-initiates-a-re-domiciliation-of-the-parent-company-to-finland.html