16 February 2016

Bruegel: European Deposit Insurance - a response to Ludger Schuknecht

Last November, the European Commission published a proposal for a European Deposit Insurance Scheme (EDIS), which is currently being negotiated among EU member states.

Yesterday, this elicited a response from Ludger Schuknecht, the German Federal Finance Ministry’s respected chief economist. While his objections to EDIS are not new, they have rarely been articulated with such clarity, at least in the English-speaking debate, and deserve careful consideration.

As it happens, none of his arguments of policy substance is compelling. By contrast, the obstacles he highlights in terms of Germany’s politics and political economy are real enough, and will ultimately play a big part in determining the EDIS negotiation’s outcome.

There are two major oversights in Dr Schuknecht’s anti-EDIS outburst, respectively about deposit insurance and about banking union. Correcting these would radically shift the balance of his arguments, and reverse his conclusions.

First, deposit insurance. While it carries the same name, this policy does not raise the same moral hazard issues as, say, fire insurance or theft insurance. Trust in deposits is a fundamental layer of confidence that underpins economic activities in developed countries. When it is compromised, so is social cohesion more broadly. [...]

Second, banking union. [...] The SSM was reportedly first proposed by no other than German Finance Minister Wolfgang Schäuble. When Dr Schuknecht implies that the SSM will be unable to enforce sound capital discipline because “national supervisors will always remain important,” he underplays his Minister’s achievement in fostering a broadly robust and credible SSM that is now the licensing authority for all banks in the euro area, not only the larger ones. [...]

A resilient banking union needs an EDIS, as countless economists but also the International Monetary Fund and European Central Bank have insisted, together with the European Commission.

Without an EDIS, national budgets remain the backstop for national deposit insurance schemes that rely principally on the quality of European-level supervision – a potentially more damaging misalignment of incentives than the ones Dr Schuknecht denounces. Most basically, the continuation of national deposit insurance perpetuates the highly destabilizing bank-sovereign vicious circle in the euro area, as last year’s developments in Greece illustrated once again.

The broader political challenge is the willingness of the German public to accept further risk-sharing with euro-area neighbours. It is not a legal issue. Dr Schuknecht’s insistence that the EDIS proposals are legally unsound or would require “the approval of all countries [instead of qualified majority] and changes to the European treaties” contradicts Germany’s past approval of the SRM Regulation of 2014, which is based on the same legal framework of the Internal Market as the EDIS would be. [...]

Rather, the problem is, as Dr Schuknecht writes, “the political risks arising from the mutualisation of liability.” But in truth, this mutualisation is inherent in the German Chancellor’s oft-repeated insistence that the integrity of the euro area must absolutely be defended.

The real debate is not abstract, about mutualisation or no mutualisation in a single currency area, but practical, about how to minimize perverse incentives, moral hazard, and risks to financial stability. From that perspective, and even with awareness of the undeniable reticence of German local banks and of significant parts of the German public, the adoption of EDIS would be an important step forward.

Full article on Bruegel

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