A Fragile Euro System Still Needs a Genuine Banking Union

Sept. 24 (Bloomberg) -- As recently as a couple of weeks ago, it seemed that Europe’s governments had reached agreement on the need for a banking union. This consensus, if it ever existed, is unraveling, and that’s dangerous.

When Mario Draghi, president of the European Central Bank, announced his plan for a big, new euro-zone bond-buying program this month, he rightly linked it to progress in building new European institutions. Banking union belongs at the top of the list.

The logic is simple. The euro area has a deeply integrated financial system. It lacks a single bank regulator, a common resolution agency for distressed banks and a deposit insurance system that spans the currency zone. That’s what “banking union” means.

At least, that’s what we thought it meant. Recently the European Commission, the European Union’s executive arm, published its bank-regulation plan. It would give the ECB new supervisory powers over the euro area’s 6,000 banks, which is good. The other two elements of a banking union -- a single system of bank resolution and an area-wide deposit insurance system -- have apparently been set aside. Not so good.

Weak Compromise

Even the plan for a single supervisor looks like a weak compromise. Under the commission’s plan, the ECB would work with existing national supervisors, rather than absorb them into a new supervisory unit under its control. That’s probably good news for the regulators concerned -- more of them will keep their jobs and status -- and also for the banks that have invested much time and effort in getting friendly with those regulators. It isn’t such good news if effective supervision is the goal.

At first the hope was to win agreement on how a banking union would operate by the end of this year and then put it in place by the end of 2014. This now looks unlikely. Germany and others say the plans are being rushed. Further complications arise almost daily. Wolfgang Schaeuble, Germany’s finance minister, has called for new stress tests to be conducted on banks across the euro area before supervisory powers are reorganized. Supervision for EU countries that don’t use the euro, such as Poland, Sweden and the U.K. is another bone of contention.

More important, though, is the evaporation of plans for a single system of resolution and deposit insurance. German officials have objected to these proposals out of concern that they would expose German taxpayers to new demands on their pocketbooks. That fear, of course, is fully justified, although the burden placed on German taxpayers wouldn’t necessarily be disproportionate.

Banks in Germany are still fragile and undercapitalized, just as in many other countries. And Germany has a lot to lose if a bank run in Spain, for instance, jeopardizes the euro system and spreads financial panic throughout the euro area.

Resolution and deposit insurance could involve fiscal outlays, though experience has shown that prompt and well-conducted interventions would cost taxpayers nothing -- and could even return a profit. Granted, euro-area countries need to negotiate the terms of any such cooperation, a complex matter in its own right. There are different ways of carrying out such a plan, some more risky for taxpayers than others.

In the end, though, it comes down to this: If Europe can’t accept the limited degree of fiscal union that includes a single bank-resolution authority and a deposit-guarantee system, all its talk of creating a true banking union is so much hot air.

Failure to act would be a grave error. A European banking union is essential to break the connection between distressed banks and sovereign insolvency. After all, that is the motor driving Europe’s financial crisis. The pressure of events has seemed to abate since Draghi announced his bond-buying plan. The ECB has bought Europe some time. Governments should resolve to use it, not waste it.

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