16 January 2014

Nicolas Véron: One giant leap for Europe, but the democratic deficit remains

Translated from the French

On 18 December, the European finance ministers announced an agreement on the establishment of a Single Resolution Mechanism (SRM) to facilitate dealing with banking crises. Some commentators see this agreement as the completion of Banking Union, others as an unworkable compromise. This apparent contradiction is indicative of the nature of the Banking Union concept: it’s radical and yet long-term. The SRM is not the completion of Banking Union, but it illustrates the progress made since the initial decision in June 2012.

What is Banking Union? In its simplest definition, the term refers to the transfer at European level of policy instruments related to the banking sector, in particular supervision, crisis resolution and deposit insurance.

The motivation is to break the vicious circle between public finances and banking system, identified in 2011-2012 as a key factor in the crisis of the euro area. Relating to the first point, a Single Supervisory Mechanism (SSM) has already been decided and provides for a transfer of authority from the national to the European Central Bank (ECB).

The relationship between banks and government is at the heart of the historical development of European economies. The transfer to the supranational level is a far-reaching structural change and raises the question of political, fiscal and budgetary powers at European level. President of the European Council, Herman Van Rompuy, is right to suggest a "quadruple union": banking, fiscal, economic and political, in order to resolve the crisis.

But the debate on fiscal and political union is hindered by the reluctance of political leaders, the lack of trust between Member States and the difficulty of changing the EU treaties. As long as this is the case, the Banking Union may remain an incomplete construction. However, even if incomplete, this construction is a major achievement. Monetary union is made ​ stronger even by a partial Banking Union.

The Single Supervisory Mechanism (SSM) alone is a huge step forward for European financial stability. In comparison, the SRM whose powers are inferior of those of SSM, appears much less convincing, with its hybrid procedures between Member States and the European Union, its Byzantine complexity and conditional application, and coming into effect between 2015 and 2025. Political discourse focused on the resolution of banking crises "at zero budgetary cost" by paying creditors and banks themselves.

In reality, a levy imposed on banks like corporate tax is indeed a tax, even if it is not directly levied on households. It means creating a partial and disguised fiscal and budgetary union, hence the understandable distrust of certain governments. As to involve creditors, the intention is welcome, but its implementation will be difficult.

Since the beginning of the crisis, European governments have been too generous with bank creditors who benefitted from an excessive attachment to the maintenance of national banking champions. In some scenarios of acute crisis, government intervention is justified to stop the panic. The goal now, however, is to find a better balance in imposing discipline based on more sound incentives  - but this balance will be defined by the practice of years rather than the legislation under discussion at the moment.

The United States have better market discipline on this point and have closed hundreds of banks since 2007 by imposing significant losses on creditors. But the system itself is far from perfect, and it took decades to get there. The European delay on this point will not be made up for in one step. In the short term, the key to this lies elsewhere.

Implementation of the SSM requires a review of banks' balance sheets which pass under the authority of the ECB. Some of those will be identified as under-capitalised should be restructured by national public authorities well before the operational implementation of the SRM. And it’s at this point where the future of the Banking Union will be decided.  

If the review of balance sheets fails to restore confidence, there is nothing to expect from the SRM and the euro area will probably relapse into crisis. But if the exercise is successfully completed in late 2014, the legacy of past failures will no longer weigh as heavily on European negotiations as today. In this new political context, it is not impossible to imagine that the substantive issues of accountability and representation, in other words political union, can be addressed a renewed way.

The agreement of 18 December is only one step, and not the most important, on the long road to a Banking Union in Europe. The central issue, however, remains the democratic deficit of the Union. Without a democratic mandate, the European institutions, the Council included, remain seized by their lack of executive capacity. Without this ability, the Banking Union is doomed to remain unfinished .

Original article (French) © Le Monde

Video Véron evaluates the agreement on the proposal for a Single Resolution Mechanism, 22.1.14  © Bruegel

© Le Monde.fr