EU Races for Bank-Failure Deal Deadline to Avert Quagmire

In their campaign to bring the financial industry under control, European Union policy makers have a deadline problem.

The EU, which took three decades to clear such milestones as defining chocolate and setting up a common patent, has just months to create a system to handle failing lenders. It’s the biggest step toward building a banking union that its leaders say is essential to preventing a rerun of the euro debt crisis.

Without a deal before European Parliament elections in May, the politicians and bureaucrats who have been working on the project since it was announced in June 2012 risk leaving the European Central Bank lacking a critical tool when it starts supervising euro-area lenders next year.

“There is a tight deadline and anything that gets us out of order could kill the project,” said Charles Wyplosz, a professor of economics at the Graduate Institute of International and Development Studies in Geneva. “I still think we are very much in the danger zone.”

The 28 EU states have set a year-end deadline to reach a common position on a proposal by Michel Barnier, the bloc’s financial-services chief, for a Single Resolution Mechanism. It would centralize the handling of euro-area banks in financial trouble. Germany, Europe’s largest economy, has led the attack on Barnier’s plan, challenging its legal basis and warning it could weaken governments’ control over their budgets.

New Commission

At the same time, the European Parliament has begun its own deliberations on the proposal. When the government leaders and the parliament have each completed their respective drafts, they’ll then hammer out a compromise.

If this doesn’t happen before the elections scheduled in the bloc between May 22 and May 25, the decision-making machinery will go into hiatus. The parliament will divvy up committee slots, make internal appointments and hold hearings on candidates to join the commission, the EU’s executive arm. The next commission, almost certainly without Barnier, is scheduled to take office in November 2014.

“It is absolutely essential to get this out of the way and finished in this parliamentary session,” Elisa Ferreira, the lawmaker who’ll be shepherding the proposal through the EU assembly, said in an interview. “It is this parliament that has the memory of the crisis and the response to it. It doesn’t make sense to leave it to the next parliament, which may not have this memory or the same priorities.”

Supervisory Powers

The EU’s response to the financial crisis has been swift by the bloc’s standards even if it has repeatedly veered off its own timelines. The implementation of international bank-capital rules was delayed by a year. A law that gives the ECB supervisory powers over euro-area banks, which was supposed to be adopted by the end of last year, will probably hit the statute books at the end of this month.

German Finance Minister Wolfgang Schaeuble, who rejects Barnier’s proposal and says it doesn’t have majority support among EU member states, nevertheless shares Ferreira’s urgency.

“We’ll have to see if we can agree on a common legal ground,” Schaeuble said at a meeting of EU finance chiefs in Luxembourg this week. “We have to adhere to the rules of the European treaties. They are tight, which is why we support, in a second step, a defined treaty change, but until then we’ll have to find solutions within the current treaties. I hope that everyone is prepared to reach a solution as soon as possible.”

Budget Sovereignty

The legal service of the Council of the European Union, an EU institution representing national governments, has also raised concerns about budget sovereignty and the powers of a proposed central board.

The European Commission’s existing role as the EU’s top competition authority, which includes policing state aid, means the institution has already become “de facto a central crisis management and resolution authority,” Joaquin Almunia, the EU’s antitrust chief, said in a speech yesterday.

“Overall, and on top of the analysis of the national schemes to support their respective systems, we have worked on the restructuring or the resolution of almost 70 entities, an equivalent to around one quarter of Europe’s banking sector in terms of assets” since 2008, Almunia said in Brussels.

The banking union “is a complex and critical work, both to restart the adequate lending flows to the real economy and to complete the architecture of the Economic and Monetary Union,” he said.

ECB Duties

The ECB is scheduled to begin oversight of euro-area lenders as soon as November 2014, after it conducts an assessment of banks’ balance sheets. Barnier proposed that the Single Resolution Mechanism, become operational on Jan. 1, 2015.

“What we have said very clearly is that any supervisor, and we as the European supervisor, wants to have a resolution mechanism available,” ECB Executive Board Member Vitor Constancio said last month. While the ECB has said that the single system doesn’t need to be in place when it assumes oversight, it has urged the EU not to delay.

The Frankfurt-based central bank is seeking to avoid the bureaucratic morass that would ensue from resolving cross-border banks. The process “proved to be more difficult” during the financial crisis, Constancio said. “So we do want a European resolution mechanism to be put in place to accompany the first leg of the banking union.”

Dexia Breakup

Barnier has pointed to the breakup of Franco-Belgian lender Dexia SA to show why. After protracted talks among regulators, the lender was dismembered along national lines. Last December, Almunia described Dexia, which then had more than 300 billion euros ($410 billion) of assets, as “the largest bad bank in the EU.”

“The single resolution mechanism is very important. The ECB has stressed its importance,” Jordi Gual, chief economist of Spain’s La Caixa financial group, said in a telephone interview.

“The recovery in the euro area is very fragile and if they don’t do the SRM and the AQR well then we could get into new trouble,” Gual said, in reference to bank tests to be carried out next year by the ECB.

“There will be an interim SRM, that is for sure. It may not be the ideal SRM, but something will be needed while discussions continue about possible treaty changes. It will be there, I believe,” he said.

The banking-union project was first announced as a summit of EU leaders 16 months ago as the leaders tried to head off a sovereign bailout of Spain and to persuade the ECB they were serious about fixing the structural flaws that exacerbated the financial crisis that erupted in Greece in 2009.

Emergency Loans

So far, 496 billion euros of emergency loans have been pledged by the euro area and the International Monetary Fund; Greece orchestrated the biggest debt restructuring ever; Cypriot savings accounts were raided, and austerity demanded in exchange for the rescues have deepened the longest recession in the single-currency era.

Euro leaders said the project would break a “vicious circle” in which support provided by governments to crisis-hit banks weakens their public finances, in turn damaging banks whose holdings of sovereign debt mean their financial well-being is tied to that of the state.

The key elements of the planned banking union include common supervision, centralized bank crisis management and common rules for national systems to protect depositors.

‘Too Optimistic’

“Part of the problem about proposals for EU banking union is that they have been far too optimistic with regards to the timetable,” Richard Reid, a research fellow for finance and regulation at the University of Dundee in Scotland, said by e-mail. “As the financial crisis and euro-area crisis memories recede, the priorities of national authorities are reasserting themselves and this is slowing the process toward banking union.”

Wolf Klinz, a German member of the parliament’s Committee on Economic and Monetary Affairs, said “any roadblock” in talks on the proposal would jeopardize the bill’s passage by the current parliament.

“I’m not saying that it can’t be done before the elections,” Klinz said. “It can be done if everybody is serious and committed. It’s going to be tough. It is an extremely ambitious timetable,” he said.

“If we can’t finish it by round the end of March to mid-April then the thing is gone, and we lose half a year,” Klinz said.

‘Risk of Paralysis’

After the elections, the parliament may be a very different place, with nationalists on the rise in polls in France and other countries. Anti-European lawmakers could undermine attempts to strengthen central control of banks.

“The European Parliament could be composed in large part of anti-Europeans next May,” French President Francois Hollande said in an interview published in the Belgian newspaper Le Soir. “This would be a step back and would create the risk of paralysis.”

In her report on Barnier’s plan, Ferreira backed its main tenets. As the parliament’s so-called rapporteur, she’s responsible for suggesting ideas for amendments. Other committee members then put forward their own suggested changes, after which Ferreira will hold talks with the assembly’s different political groups to seek a compromise.

Once the parliament and national governments have both agreed on their negotiating positions, then talks can begin on the final version of the plan.

“Delays are not welcome in these circumstances because there is a global coherence” between “the different elements of the banking-union project,” Ferreira said. “If some of the elements are lacking, then the whole system is put in jeopardy.”

Before it's here, it's on the Bloomberg Terminal.