15 December 2013

Simon Nixon: Shadow of noose speeds up Banking Union

This deal will include a legally binding set of arrangements for the winding up of failed banks—the so-called Single Resolution Mechanism—to be headed by a Single Resolution Board with access to a Single Resolution Fund to help pay for the cost of clearing up bank failures...

The ECB fears the resolution process is inefficient and could make it hard to wind up a failed bank over a weekend. But officials in Brussels and Berlin believe they have found an elegant and workable compromise: the European Commission is satisfied that it will be represented on the SRB and so will have a say in resolution discussions; while Berlin believes that Brussels would never refer a decision to the European Council given the institutional rivalry, so the SRB will be effectively independent...

Perhaps the strongest criticism is that 10 years is too long to wait for the resolution funds to be fully merged, and that there is still no common taxpayer-funded backstop should the SRF be insufficient.

Many argue that a true Banking Union is impossible without common deposit guarantees. Progress here seems very unlikely given the strength of German resistance. But other eurozone countries will continue to push Berlin to allow the European Stability Mechanism to lend to the SRF where necessary.

But while these concerns are relevant to the long-term success of the Banking Union, they are less important to the near-term success of the project. The new rules will not take effect until 2016 and only become fully active 10 years later. Before then, the eurozone needs to restore confidence in the safety and soundness of bank balance sheets using existing rules. This is the goal of the ECB's Comprehensive Assessment and stress tests of the 130 largest eurozone banks to be completed in 2014.

This remains very much a work in process. The ECB has started collecting information and has met with the chiefs of the relevant banks. But all the key questions that most concern investors remain unanswered: What level of provisions will the ECB require against non-performing loans? How will it stress test banks' exposure to sovereign debt? How will it stress test the safety and soundness of bank funding structures, including continued reliance on ECB facilities and the recent sharp rise in ultra short-term market funding?

What is becoming clear is that the Comprehensive Assessment may not be as comprehensive as some had hoped. The ECB will be bound by existing national rules relating to provisions and quality of capital. Indeed, some officials fear the ECB is being burdened with excessively high ambitions: It is unrealistic to expect the Comprehensive Assessment to lead to a miraculous transformation in the eurozone's financial landscape.

Yet without a transformation in the financial landscape, the ECB is likely to come under further pressure to adopt radical measures to ease borrowing costs in the periphery. It is not just eurozone governments that face the prospect of being hanged in the morning.

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