The long and dwindling road to an incomplete banking union

It did not take just the past couple of years to create a European banking union, but at least 48. And it is still far from the fully-fledged European banking union that is now announced with great fanfare – running the risk of later disillusions. Taking a longer-term view on its emergence helps qualify the real nature of the Eurozone’s newest development.

In spite of the merits of the European banking union (EBU), the current excitement about its creation largely obscures both its origins and its limits. Media coverage nurtures the idea of a sudden interest in banking regulation and supervision that would have sprung among Eurozone policymakers in the past few years, due to the weaknesses of several European banking institutions. This presentation is not just a simplification; it also misrepresents the very nature and limits of the European banking union that is now coming into being.

The last details of the agreement about the European banking union are now clearly emerging. Its main rationale is to preserve the Eurozone’s financial stability: “The ‘banking union’ will be designed to fully address the structural shortcomings in the institutional framework for financial stability,” claimed President of the Commission José Manuel Durão Barroso at the European Parliament last June. But discussions about the creation of a banking union in Europe – that is, about the regulation and supervision of the Eurozone’s banks – are not really new. Media coverage is somehow giving the impression that all started in recent years (“The project was launched in June 2012 at the height of Spain’s crisis” explains The Economist’s Charlemagne column); while in fact, European policymakers have been tackling similar issues for the past sixty years – with, to be sure, tiny concrete results.

Back in the mid-1960s, the European Commission of the European Economic Community (EEC), the EU’s forerunner, started exploring ways of “harmonising” – that was the parlance of the time – banking legislations. Brussels was aiming at creating a common market in banking, and hence aspiring to remove the disparities that existed between the different supervisory and regulatory frameworks in which banks operated. The long-term goal of monetary union provided another important motivation. The reasoning was straightforward: an integrated capital market with a single currency needed, in order to function properly, a harmonised financial regulatory and supervisory context. If the Commission never ambitioned creating a supranational supervisor, it did tackle far-reaching features, such as prudential ratios, credit information exchange and deposit insurance.

In 1973 the European Commission changed its tactics however, mostly for two reasons: the difficulty of finding an agreement between the then six members of the EEC; and the accession of Britain. The original six EEC member states were having difficulties to find a consensus, given the highly different banking systems of the time. And Britain’s eventual entry to the EEC posed a challenge to the Commission’s plans: London was both the leading international financial centre, and one that had no tradition of the formal, written regulation and supervision of the sort Brussels was aiming at; and certainly no willingness to conform to it.

At the beginning of the 1970s, the Commission thus adopted a considerably more modest approach, mostly limited to removing obstacles to the freedom of establishment. The original aim at having one single all-encompassing directive had been ditched. Most importantly, global discussions, held in the framework of the Basle Committee on Banking Supervision (BCBS) at the Bank for International Settlements (BIS) in Basle that was created in 1975, quickly superseded EEC-centred debates. Banking activities – and crises – were increasingly global, and their spread did not necessarily coincide with that of the EEC jurisdiction. The 2008 US subprime mortgage crisis offered the most recent illustration of this, as it affected European banks, and in the end the financial stability of the Eurozone as such.

Realising that current discussions have roots in the 1960s and 1970s hence highlights continuities in the European story. But these continuities crucially uncover the limits of the European banking union that is now coming into being.

Take the case of the banks that are being supervised. A significant flaw of the EBU announced this week is that it is not covering German savings banks. Any wonder? Not really, as this has been the constant bargaining position of the German government ever since the 1960s. It was already an issue in the discussions of the 1960s and 1970s about the harmonisation of banking regulation and supervision. The Bundesbank’s opposition to developing some financial regulatory/supervisory framework at the time of the Maastricht Treaty’s negotiations is another case in point. This is highly problematic, since German Sparkassen have invested considerable amounts of money in US toxic assets and that these banks’ management and political acquaintances have often raised many questions. And their size is not insignificant: according to the Financial Times, German savings bank have more assets than the largest bank of the Eurozone (Deutsche Bank), and a little less than 40% of German bank lending and deposits. In other words, the new banking union is only covering a bit more than half of the banks of the Eurozone’s leading economy. The stability of the single currency is thus still vulnerable to a crisis that could erupt amidst German savings banks’ unwise investments.

The EBU that is now progressively entering into force should therefore be viewed in a longer-term perspective. Some key perennial features clearly emerge from this longer view: the role of London as a leading international financial centre; the supervision of German savings banks; the reluctance of many European governments to give up national supervisory/regulatory powers to an EU supranational institution. This reading grid helps understand that the search for financial stability in the Eurozone has still much to accomplish. The banking union clearly leaves substantial issues of the Eurozone’s financial stability unresolved, and by selling it as the panacea to the Eurozone’s multifaceted problems, EU policymakers run the risk of nurturing future disillusions in public opinion. This is a significant risk, at a time when the credibility of the Eurozone’s governance is often called into question.


Picture: photo of the Bundesbank in Frankfurt (c) E. Mourlon-Druol

Leave a Reply

Your email address will not be published. Required fields are marked *