A European Banking Union

Wolfgang Münchau, writer for the Financial Times, has written a very clear article about the possibility of a European banking union.  What is most interesting in the piece is his reflection on what a banking union might mean for he eurozone.

The basic point is that given the banking problems that now exist in each country of the eurozone and in the whole of Europe, almost everyone is moving to the conclusion that a banking union of some form is needed.  Even German chancellor Angela Merkel has seemed to move in this direction in recent days.  Some, like ECB President Mario Draghi, are getting rather aggressive about such a move.

The need is certainly there, highlighted by yesterday’s announcement that Portugal  will inject €6.6 into three of the country’s largest banks. The Portuguese government claimed that the need came about due to the very severe new capital requirements of the European Banking Authority.  

Let’s concentrate on a few of the points that Münchau makes in his article.  First, almost all banks within the eurozone should be a member of the banking union…and, this includes Spain’s Bankia and the Landesbanken of Germany.  That is, the bar for membership, Münchau argues, should be very low.  The banks themselves would become members of the banking union and not of the individual states making up the banking union.

After this, the banking union needs a treasure chest… Münchau suggests a total of €1 trillion…to help banks recapitalize.  The suggestion here is that part of the funds would initially come from member governments but eventually the full €1 trillion would be raised by a eurozone bond or something similar.  This fund would make the banks solvent, although a large number of the banks would, in essence, be nationalized.

A second fund would need to provide deposit insurance.  The essence of this idea would be to stem bank runs or the possibility of bank runs.  The deposit insurance would be based upon bank membership in the banking union and not upon whether or not the country remains within the eurozone. 

The basic model of the deposit insurance fund is that of the United States and the Federal Deposit Insurance Corporation, the FDIC.  This would mean that where ever the deposit insurance fund is located it must have the power and backing to be able to close banks down, much in the way that the FDIC does.

This means, however, that the deposit insurance fund would have a supervisory function, one that would have the ability to examine banks on a regular basis and one that would have the ability to limit bank functions and operations as is needed.  No more “mickey mouse” stress tests, but real examinations that had a sting to them and that would be enforced.

Where to locate this regulatory authority of examination and closure is a problem.  It would not have to be “independent” as is the FDIC in the United States but could be connected in some way to the ECB.    

But, Münchau continues, this starts to widen the circle.  The author states very clearly that to give the deposit insurance fund the power and the authority to close a bank, regardless of what country the bank claims as its home, means that the political union of the member states must be sufficiently strong to back up the banking agency in its efforts.  National interests cannot interfere with the deposit insurance fund because this would immediately destroy the credibility of the banking union. 

“Without a commitment to further political union, deposit insurance is either ineffective or ruinous.”

People in the eurozone have begun to talk about the possibility of bank runs and systemic bank failures.  Here I refer you to a recent article in the Economist magazine, “The Fear Factor: Preventing a Big European Bank Run”.

There has been a change in attitude with respect to European banking problems...focus has shifted from the bank problems being one of illiquidity to being one of solvency.  “Unlike six months ago, officials now realize there is no alternative to a banking union.” (This from Münchau.)

Notice, that the solvency question has arisen due to the concern for the banking system…not in terms of sovereign debt.  So, the thought process has still not moved as far as it needs to go!

However, a “proper” banking union is going to require a political union.  And, the political union is going to require a fiscal union. 

If Europe moves on down the road in creating a European banking union, then, this argument goes, Europe will move on down the road in creating a central European fiscal and governing union. 

The question is, therefore, will European officials move on the creation of the European banking union?

To do this, some Europeans are going to have to step up and become leaders.  Up to this point, the lack of leadership has been the most deficient resource on the European continent. Will someone please step up!