The idea behind bringing banking rules to a European level was born out of a defensive response to the 2012 eurozone sovereign debt crisis.
As a number of euro area countries teetered on the brink of default, policymakers started thinking that the best way to limit contagion across the whole of the monetary union might be to develop a more integrated policy framework for European banks.
The bloc acted quickly to put up two out the three pillars of what has become known as the Banking Union, establishing common supervision and common rules for resolution within the bloc.
But some six years after the chaos of the eurozone debt crisis, the final pillar of having a common insurance scheme for European bank deposits is still sorely missing.
In a speech in Lisbon in June, Elisa Ferreira, vice governor of the Bank of Portugal, said Europe was at a crossroads and there was a “mismatch between European oversight and national liability”, which could pose a serious threat to the health of the European project.
“Decisive political will to move forward with the completion of the Banking Union is required, accompanied by a proper evaluation of the underlying implications for banks’ business models,” said Ferreira.
But policymakers have become mired in a debate about how far the overall level of risk in the European banking system might have to be reduced before member states can begin sharing in any of those dangers.
So there has been little to see in terms of establishing the European Deposit Insurance Scheme (EDIS) — the Banking Union’s third pillar.
Nothing of substance was agreed on EDIS at a summit of European heads of state at the end of June.
Even in the “Meseberg Declaration” made shortly beforehand, which was supposed to be a new founding document for the EU penned by Emmanuel Macron and Angela Merkel — the leaders of France and Germany — talk about completing the Banking Union was still hung up on having “risk reduction and risk sharing in the appropriate sequence”.
“It is disappointing and difficult to understand why we can’t get EDIS done,” says Matthieu Loriferne, executive vice president and credit analyst at Pimco in London.
A little less risk reduction,
a little more action please
A lot of the frustration stems from the fact that a large amount of risk reduction has already taken place.
A report in June on progress in achieving risk reduction measures showed that European banks had already zoomed past requirements in terms of capital, leverage, liquidity, and net stable funding and were even in advance of some of the tougher standards being discussed as part of a series of new banking policies.
The report, the second of its kind prepared by the European Commission, the Single Supervisory Mechanism and the Single Resolution Board, made note of the sustained trend towards a cleaner and safer European banking system and recommended engaging in “more concrete and committed discussions” on risk sharing.
“If you tell people that more risk reduction is still needed, some of them may have a hard time accepting that,” says Charles-Antoine Dozin, head of capital structuring at Morgan Stanley in London.
“Banks have considerably strengthened their overall quantum and quality of capital, are now subject to harmonised supervision, have got on with MREL [the minimum requirement for own funds and eligible liabilities], have restructured their operations and are shedding non-performing loans.
“A number of key milestones have been reached in recent years.”
But member states have yet to come to any consensus on what should be considered a sufficient level of risk reduction to enable the completion of the Banking Union.
Politicians in a number of southern European countries have increasingly been saying that it is high time that the rest of the bloc held up its end of the bargain and started engaging in risk sharing, while a group of member states including Germany is still asking that peripheral banks look a little steadier before stumping up money to cover their depositors.
The reporting that has so far been carried out by the Commission, the SSM and the SRB has helped to frame the discussion around six different indictors for showing whether risks have been reduced: capital ratios, leverage, liquidity, stable funding, non-performing loans and MREL.
Marie Donnay, head of unit resolution and crisis management at the European Commission, explains that discussions around risk reduction must nonetheless remain political in nature, because getting drawn into setting thresholds for these indicators would not offer the best route forward for completing the Banking Union.
“We believe that automatic triggers for assessing risk reduction should be avoided and we prefer informing political decisions with the help of a comprehensive assessment of legislative measures as well as quantitative indicators,” she says.
“A considerable number of legislative measures that are in force will take time to bear fruit, including the process of building MREL. Other impacts of legislation will be behavioural and difficult to quantify.”
Coming up with a plan to put up the third pillar of the Banking Union has become urgent business.
Roadmap to nowhere?
The EU is trying to reach an agreement through Trilogue meetings on a package of new risk reduction measures, which could help to clear a path towards greater risk sharing.
But a difference of opinion between the European Council and the European Parliament over the level of subordination required to meet MREL seems as though it could prove to be one of a number of potential blockages preventing the new measures from passing swiftly into law.
“We hope for a timely agreement on the legislative texts in the Trilogue discussions, but it won’t be a walk in the park,” says the Commission’s Donnay. “There are not very many contentious issues on the table, but the ones we have to deal with are very sensitive.”
Throw in the fact that elections to the European Parliament in late May 2019 will disrupt the EU’s legislative agenda, and the work that is taking place in the coming months begins to look particularly frantic.
“Whatever we don’t manage to deliver by the end of the year risks being postponed by at least six months, if not more,” Donnay says. “All minds are focused and we are continuing with the technical work.”
EU lawmakers will be looking to push forward the debate on all aspects of the European Council’s roadmap for
Though the timeline for completing EDIS remains painfully slow, there was a breakthrough at the euro summit in June for the second main element of risk sharing that was put forward in the 2016 roadmap — the creation of a backstop to the Single Resolution Fund (SRF).
There is widespread recognition that a fully operational SRF, with €55bn of contributions from banks by 2024, would fall far short of being able to provide financing for the resolution of a large bank.
Member states were able to agree in June that a backstop could take the shape of a credit line from the European Stability Mechanism to the SRF, reaching €55bn in size by 2024 and therefore effectively doubling the support available to failing banks.
“By December we need to agree on the design of the backstop and to think about what elements of risk reduction need to be in place before unlocking an early introduction of the backstop,” Donnay says.
Sharing is caring
It is difficult to overstate how tall an order it will be in getting member states to consent to further risk sharing in the short term.
But those involved in the discussions are still very clear on why it is worth pursuing the Banking Union with such fervour.
“We must reflect on the fact that risk sharing is also risk reduction when member states are so economically integrated and particularly when they share a common currency,” says the Commission’s Donnay.
“While risk reduction remains primarily the responsibility of the member states with significant risks, not delivering any mutualisation of risks could potentially mean being stuck in an imperfect solution in terms of financial stability.”
And though the Banking Union project was conceived as a defensive measure following the trauma of the sovereign debt crisis, market participants have also come to appreciate that the project could help European banks to go on the offensive.
“It can inform where banks want to go in the medium to long term and it may throw up opportunities for growth and acquisitions, fostering cross-border consolidation,” says Morgan Stanley’s Dozin.
Cross border consolidation has been a holy grail in recent years. It is coveted because of the perceived benefits that a larger scale might bring to a European bank’s cost base, to its efficiency in meeting regulatory requirements and to its ability to compete with the US giants.
Though firms including Commerzbank, Société Générale and UniCredit have all been put through the rumour
And each swell of speculation has prompted sober reflection on why a more level playing field is needed in Europe to promote cross-border activity.
Completion of the Banking Union could achieve just that. Deposits would be equally protected throughout Europe and banks would be adhering to a much more unified rulebook, whether they are operating in France, Germany, Italy or any other country within the bloc.
“There is not the free flow of capital and liquidity yet, which you would need for Europe to be a true Banking Union,” says James Macdonald, financials analyst at BlueBay Asset Management in London.
“Until you get that, banks looking at M&A would have to incur the costs associated with the having capital and liquidity in multiple jurisdictions.”
In her speech in Lisbon in July, the Bank of Portugal’s Ferreira considered what would have to happen if it turned out that there was insufficient political will to see through the creation of the Banking Union.
She said member states would simply have to “structurally revisit the project” or risk “fragmenting the single market and realising that we missed this opportunity when the next crisis hits”.
With the time for seizing that opportunity at risk of slipping away, those involved in crafting the Banking Union are going to have to push very hard to advance talks to the next stage in the coming months.
The future for the growth and stability of European banks may well depend on their success.