In 2012, EU political leaders agreed to set up a Banking Union to reduce the risk of another financial crisis that would pose an existential threat to the EU. Many had believed that when it really matters, member states can work together even if this means giving up some of their sovereignty. Seven years on and the Banking Union is still only work in progress.
The latest attempt to rescue the Banking Union from becoming another failed grand project comes from the German finance minister Olaf Scholz who wants the eurozone banking system to thrive on steroids rather than on vitamins. He made a sobering statement when he said that Europe’s global role would be undermined if it failed to complete the integration of the eurozone’s financial sector.
In an opinion article published in the Financial Times, Scholz stated the obvious: “The need to deepen and complete European banking union is undeniable. After years of discussion, the deadlock has to end.” Has Germany indeed had a change of heart about removing obstacles to a real banking union?
The most contentious element of the Banking Union as originally conceived was the setting up of European Deposit Insurance Scheme. While national deposit insurance schemes that guarantee that bank depositors are repaid up to €100,000 of their capital, it was consistently argued that at a time of a banking crisis in a particular member state, bank depositors needed a pan-European guarantee to put their minds at rest.
The sad reality is that Europe is already de facto a two-speed Union. Northern states that are usually more orthodox and conservative in the management of their public finances are unlikely ever to accept to guarantee the deposits of Southern European banks that are perceived to be weaker and often mismanaged.
So was Scholz signalling a change of heart on the part of Germany? The German minister linked his surprising proposal with some conditions. The first condition is that national insurance schemes will remain the first line of defence in case of bank failure. If this were not to be enough, a European deposit insurance would provide additional compensation to depositors. Finally, if still more liquidity would be needed, the relevant member state would step in.
Many exploit the benefits of a common currency but are not prepared to yield any sovereign powers
Scholz cautiously pointed out that the European Deposit Insurance Scheme would only come in force when the missing elements of the Banking Union were completed. One missing element is a Single Resolution Mechanism that, although already in place, is hindered by diverse insolvency resolution procedures for banks.
The failure of some smaller banks in Italy in 2016 proves how ineffective the Single Resolution Mechanism is. National interests ensure that the winding down of banks is made as painless as possible. Italy made sure of protecting its national interests by concocting creative resolutions financed by taxpayers’ money to save its failing banks. All this was done with the blessing of the ECB and the European Commission.
Scholz’s other condition is that eurozone banks, especially those in the south, should make greater efforts to reduce their non-performing loans. He added that the vicious links between sovereigns and banks should be severed.
Banks’ holdings of sovereign debt are at present considered risk-free. Scholz wants to consider sovereign debt exposures as containing an element of risk and therefore needing more capital overage. Italy and France, amongst other member states, will undoubtedly resist this change as its implementation would increase the risk of financial instability in the short term.
Perhaps the most controversial element of Scholz’s roadmap to a robust Banking Union is the reform of tax law. Scholz restated the familiar German mantra: “Tax law still distorts completion within the EU. This is why Germany, together with France, is calling for the adoption of a common corporate tax base and a minimum effective tax. Progress with banking union must not lead to competition-distorting tax arrangements.”
Scholz’s proposals have not been well received in some member states. The financial media also cautioned against accepting Scholz’s proposal at face value. Italy will continue to be the main obstacle to the completion of the Banking Union project. With about 500 banks, Italy is the best example of Europe’s fragmented banking system that lags behind the US in profitability.
Euro bashers will continue to argue that the infrastructural reforms that the common currency needs are unlikely ever to be approved by the member states. Many exploit the benefits of a common currency but are not prepared to yield any sovereign powers.