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EU Bank Union Should Embrace East, Development Bank Says

European Union proposals for a banking union risk disadvantaging lenders in emerging Europe, the world’s most-dependent region on foreign funding, according to the European Bank for Reconstruction and Development.

The plan to create a single supervisor and use rescue funds to recapitalize troubled banks ignores the needs of countries in the trading bloc’s east by limiting full membership and access to the funds to institutions in euro nations, the London-based EBRD said today in its annual Transition Report.

“The playing field would be distorted by the preferential access to the European Stability Mechanism,” Erik Berglof, the EBRD’s chief economist, told a news conference today in London. “It’s in the interests of the emerging European economies to have this incompleteness fixed. We’ll hopefully see developments there.”

Foreign lenders including and Erste Group Bank AG have helped fuel economic growth in nations such as Poland, Hungary and Croatia, where they control about three-quarters of banking assets. Euro-area governments have urged their banks to lend more at home at the expense of subsidiaries elsewhere in Europe, causing capital and liquidity to be hoarded and leading to credit shortages across emerging Europe.

Vienna Initiative

The EBRD will present the report to the European Commission this week and plans to push its recommendations through the Vienna Initiative, the group of banks, regulators and policy makers which helped prevent an east European financial collapse in 2008 and 2009, Berglof said. The group is currently chaired by Polish central bank Governor Marek Belka.

Under EU plans, the European Central Bank will become the main regulator for the biggest banks in the 17-nation euro region as early as Jan. 1, the first step toward a banking union. Next, the euro area will consider allowing direct bank bailouts from the 500 billion-euro ($648 billion) ESM. A full union will gradually come into effect, covering all 6,000 euro-area banks by Jan. 1, 2014.

While it would be mandatory for euro-area nations to place their banks under ECB supervision, EU states outside the bloc may voluntarily sign up to the plan. Still, with non-euro nations ineligible for support from the ESM, few would join the single supervisory mechanism, the EBRD said.

‘Significant Gaps’

“The proposed plans leave significant gaps and have raised concerns among emerging European countries,” Berglof said in the report. Among the fears “is that the banking union would tilt the competitive balance inside the EU against banks headquartered outside the banking union, as the latter would not be covered by the fiscal safety net provided to banking union members.”

The development bank proposes that countries outside the euro region should become eligible for ESM aid if they accept oversight from the single supervisor. National governments should retain responsibility for an initial amount of financial assistance to avoid “moral hazard,” it recommended.

An extension of the banking union to European countries that either were unable or didn’t want to become full members, for instance in the form of “associate membership,” may also be considered, under the EBRD’s suggestions. This may allow nations outside the euro region to benefit from liquidity support from the ECB with conditions and wouldn’t extend to fiscal support, it said.

Concern that the proposed supervisor may not pay enough attention to local problems in smaller countries may be addressed by giving individual nations more sway in oversight, according to the report.

The EBRD, owned by 63 countries and two intergovernmental institutions, was created in 1991 to invest in former communist countries and help them transform their economies. It’s expanding its scope to nurturing market economies and democracies in the southern Eastern Mediterranean region.

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