[...] The basic idea is just that in the case of a bank failure anywhere in the EU, depositors would be protected by an insurance scheme funded by all European banks. This would reduce the chance of pro-cyclical runs on weak banks, or on banks in fiscally weak countries.
To a hardline partisan of risk reduction, this is risk sharing at its worst: it puts the Northerners on the hook for southern mismanagement and removes market incentives. This misses a key point, though. A truly European and therefore fully credible deposit insurance scheme would make market discipline easier to enforce. If a bank’s bondholders are close to being bailed in or wiped out, reliable deposit insurance could stop the depositor run that would make the situation worse, and reduce the incentive for the national government to intervene. It would allow banks to go into supervised resolution with less risk of causing a political crisis.
The risk-reducers, and Germany in particular, have long insisted that any form of risk sharing can only take place when risk reduction is complete — with completeness vaguely defined. They have much to gain by changing their view, and the political moment is ripe. Both the German and French finance ministers prioritise banking reform, aiming for an agreement by this summer. Eurogroup president Mário Centeno and European Council president Donald Tusk are supportive, too.
The coalition agreement among the German political parties expresses willingness to support EU countries that are willing to undertake serious supply-side reforms. There is consensus among professional economists behind the idea, too. An agreement will not be easy to reach. The risk sharers, Italy in particular, will have to commit to further reforms for their banks before the Germans come on board. But an agreement on deposit insurance could be a meaningful step forward for countries on both sides of the European divide.
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