25 July 2017

Financial Times: Banking union will transform Europe’s politics

[...] real, profound change is proceeding relatively unnoticed except by technical experts. The European banking union, launched in 2012 for the eurozone but enjoying increasing interest by non-euro countries, is shaping up to be the most significant transformation brought about by the financial crisis — not just of Europe’s economic structure, but of its political economy.

Within weeks in June, unrelated failing banks in Spain and Italy were wound down. Together, they illustrate how much banking union has transformed Europe’s financial governance.

Banking union was agreed at a June 2012 summit, and combined two planks. The first was “bail-in” — the requirement that banks’ creditors accept losses on their investments to protect taxpayers against risks taken by bank managers. The second was to elevate regulatory powers from the national to the European level.

These centralised powers were on vivid display in the resolution of Spain’s Banco Popular and the winding down of two small banks in Italy’s Veneto region. In both cases, national authorities’ hands were forced by the European Central Bank’s decision that the banks were “failing or likely to fail”. Another supranational agency, the Single Resolution Board, ordered Spain to put Popular into resolution under European rules; but let the Veneto banks be wound down under Italy’s own insolvency law.

The upshot was that in the Spanish case, the problem bank was dealt with without a cent of taxpayer subsidy. In Italy, however, the government poured in billions of euros to cushion the loss, rewarding failure and holding the public finances hostage to the banking sector.

Spain offered a glimpse into the future of bank regulation, while Italy clung to the bad habits of the past. Why this discrepancy? In part, Italy’s greater ability to lobby for its case. But power is not all; it matters what one uses it for.

Spain has proved much more willing to embrace the cultural change that banking union entails. Under the constraint of a eurozone rescue loan, it decisively restructured its savings banks sector after 2012, while Rome kicked the can down the road.

Banking union was undertaken in the urgency to short-circuit a “doom loop” between banks and governments that fuelled the sovereign debt crisis. But the reform has far-reaching repercussions.

In time, more centralised authority and the requirement to bail in creditors will revolutionise European economic and political relations beyond imagination. If eurozone leaders had fully realised what they were signing up to, they would probably have lost their nerve.

Economically, bail-in creates de facto risk-sharing between countries. Making writedowns a regular practice when things go wrong puts in place a system of transfers from creditors to debtors. Over time, this is functionally equivalent to transfers from surplus to deficit countries, since the net savings of the former are typically lent to the latter through the banking system.

In other words, banking union mimics the fiscal risk-sharing that surplus economies of northern Europe resist and peripheral deficit economies demand. With banking union, there is no need for fiscal union.

The political implications are greater still. This is because bail-ins have very different consequences for bank ownership than bailouts. Where taxpayer-funded rescues have frequently served to maintain existing ownership and control networks, bail-in can transfer ownership and control from previous owners to creditors who face writedowns.

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