16 March 2014

Wolfgang Münchau: Europe should say no to a flawed Banking Union

There are two classes of compromise in political life. In the first, your ultimate aim is sweeping change, such as switching the side of the road on which your country drives; but, in the name of expediency, you sacrifice important principles and gradually try to phase in the new rules. This is deadly. The other involves settling for as much as you can get even when it is less than you want. This is not great either. But often it is good enough to leave everyone a little better off.

The art of the second kind of compromise has been the essence of political life in the EU. The proposed legislation on Banking Union, however, is not of that kind. I have been hesitating to make this call but I now believe that it would be best for the EU and the eurozone if this legislation were ditched altogether.

The matter is now in the hands of the European Parliament. A deadline for a compromise in the negotiations between finance ministers and parliamentary representatives is approaching fast. The parliamentarians should simply say no to the proposals and walk away.

At issue is new legislation that would give regulators the power to close down a bank or force it to seek new capital. In December finance ministers agreed this so-called single resolution mechanism. Parliament and the ministers have since been locked in negotiations, but have made little progress. European agreements always look impossible five minutes before a breakthrough. But this time, the distance between the two sides is especially large.

A bad Banking Union is worse than none. Some advocates miscalculated because they thought of it as a cheap alternative to a fiscal union. But cheap it is not. On my own calculations, the European banking sector needs to raise its capital by at least €1 trillion. I arrive at this number by looking at the total size of all banking sector assets, making a rough guess of the losses to expect in a large financial crisis, and knocking off the bit absorbed by existing capital. Of course, this is very rough but it gives you an order of magnitude.

A detailed study by financial economists Viral Acharya and Sascha Steffen came up with an estimate of €510 billion - €770 billion for the shortfall. But this range relates to only 109 banks out of the 128 that would be subject to ECB supervision. I doubt the ECB will come up with a number anywhere near this high. It would require lots of public money. The EU is not prepared for that.

What is the alternative? My suggestion is that the legislation should be dropped for now. Policy makers should start from scratch after the elections in May – possibly without Germany. This could be done under EU law, under a procedure called enhanced cooperation.

The Germans have adopted a take-it-or-leave-it stance in the negotiations. Banking Union, to put it mildly, is not a German priority. Berlin wants neither to pay for the closure of foreign banks nor to allow foreigners to close their banks themselves. If a smaller Banking Union can be made to work, Germany may join eventually.

That carries risks of its own. But it would at least be a start. It would be the second type of compromise, not great but good enough. Otherwise, we will end up letting the lorries drive on the wrong side of the road.

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