20 May 2012

Simon Nixon: Europe needs a genuine financial union

According to Nixon in his WSJ column, restoring confidence in the banking system is the most urgent priority facing eurozone leaders. The answer must be a genuine European banking union.

The European Union has already taken steps down this path... Now it needs urgently to complete the process with a pan-European bailout fund and a pan-European regulator with the power to identify and resolve failing banks. The first step should be to give the European Stabilisation Mechanism, due to come into existence on July 1, the ability to take equity stakes in banks without having to channel funds via governments.

True, this isn't a simple step. A eurozone bank bailout fund would be a form of fiscal transfer, so far taboo in the crisis. Several countries including Germany have yet to ratify the ESM treaty; giving it new powers at this stage might complicate parliamentary approval. Governments are sure to resist yielding national control of banking supervision. 

As the recent battles over the new Basel III rules showed, every national banking system has unique characteristics, making governments wary of one-size-fits-all solutions. Many institutions are controlled by local politicians who have used them to push their agendas.

There are other thorny issues to consider, notes Guntram Wolff, deputy director of the think-tank Breugel. Would the banking union apply to the whole EU or just the 17 eurozone Member States? Should the banking union include only large banks, all banks, or the entire financial system? Where would the new regulatory and supervisory powers reside? The EBA is weak and under-resourced; the ECB has credibility but would governments feel comfortable handing it more power? How would the bailout fund itself be funded? Would it be backed up by a European deposit-guarantee fund? There are also questions of fairness: if the ESM is used to bailout Spanish banks, shouldn't it acquire other government bank stakes? Irish citizens have had to bear a very heavy burden to protect the rest of the European financial system through the bail out of its banks.

Finding answers to these questions will take time—time the eurozone doesn't have. For now, policy-makers should settle on an interim solution to address the immediate crisis. That means allowing the ESM to recapitalise Spanish banks based on a severe stress test. In return, Madrid would lose sovereignty over its banking system. The Spanish government would accept such a solution, according to people familiar with its thinking. After all, without this contingent liability, government bond yields might fall, giving Madrid space to tackle its deficit, while a recapitalised banking system free of concerns over its exposure to the sovereign might be able to start funding itself in markets again. That would offer hope to Spain—and the entire eurozone. The alternative doesn't bear thinking about.

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