Another small step on the long and winding road towards banking union

Last night, Eurozone finance ministers agreed on the guidelines for the ESM’s possible direct bank recapitalisation.


Ahead of the big European Summer summit, Eurozone finance ministers tried to pave the way for their bosses last night. Next week’s summit will mainly be about three issues: how to tackle (youth) unemployment in Europe, how to kick-start lending to SMEs and how to get the banking union going. Particularly the banking union remains clear work in progress.

Last night, Eurozone finance ministers agreed on an important connecting piece of the banking union building blocks: direct bank recapitalisation through the Eurozone’s bailout fund, the ESM. Of course, this direct aid will only come under certain conditions. The first part of any bank recapitalisation would have to come from private investors, shareholders and creditors. Then, the government of the country where the bank is based would have to step in, contributing 20% of the needed capital injection. For the time being, the ESM’s firepower to recapitalise banks will be limited to €60bn.

Retroactive application of this direct bank recapitalisation was not excluded but will be decided on a case-by-case basis. Most importantly, however, this direct bank recapitalisation will only become effective once the Single Supervisory Mechanism is up and running and an agreement on a bank resolution mechanism has been reached. This still seems to take time.

As it currently looks, the easiest part of the three-pillared banking union, the single supervisory mechanism takes longer to become effective than initially thought. Last year, Eurozone leaders agreed that the ECB should take over the role as single bank supervisor in the Eurozone. The ECB itself declared that it would need around 12 months after all relevant laws were passed before it could start with its new tasks. The ECB needs a real legal basis before it can start hiring staff and start all other necessary preparations. Initially, all legislation was supposed to be ready by March this year. However, a series of power struggles between all stakeholders involved (European Parliament, ECB, Council, national parliaments) has stretched and delayed the process. It now looks as if the finalization of the legal process could take until September, possibly postponing the start of the single supervisory mechanism to September/October 2014.

As regards the bank resolution mechanism, the second pillar, discussions are still ongoing. The bank resolution mechanism is supposed to lay down clear rules for unwinding troubled banks, keeping taxpayers’ involvement as limited as possible. In this context, the guidelines on how the Eurozone’s bailout fund, the ESM, could directly offer financial support to banks gives more than only a clear hint at future bank resolutions. It looks as if any bank resolution mechanism will consist of a clear sequencing of bail-ins, followed by national government financial support and a possible new fund financed by the financial sector. European taxpayers’ money will only be the very last resort. As Germany is still blocking the idea of a new bank resolution authority, the mechanism could start with a system of national authorities and the ESM or another financial source as a backstop. Last night’s decision has increased chances that eventually the ESM could become the financial backstop for a real bank resolution mechanism.

Ideally, the final and third pillar of the Eurozone’s banking union is a common deposit insurance scheme to prevent bank runs. For the time being, this issue seems to be off the political agenda. Particularly the German government is rejecting it, as it could be considered another form of financial burden sharing. In this context, it is noteworthy that only one out of the four parties that realistically will form the next German government (in whichever combination) actually explicitly mentions a common deposit guarantee scheme in its election manifesto.

All in all, last night was another small step towards the Eurozone’s banking union. It also showed the political commitment across all Eurozone countries for a banking union. Fears that some (big) Eurozone countries would actually oppose the banking union look unjustified. However, given the fact that these steps are not exactly taken at lightening speed, the banking union should be up and running just in time to prevent the next crisis but clearly too late to make a difference in the current crisis.