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Even getting to base camp—the bare minimum level of due diligence that all agree is needed to underpin the credibility of the new single supervisory mechanism—is hardly straightforward. That requires a robust common European definition of how to measure bad debts, which can be used in the asset-quality review to uncover hidden losses.
Currently, most countries require banks to register a bad debt when a loan has been in default for 90 days, but beyond this, national rules differ widely, allowing plenty of scope for banks to hide problems.
The European Banking Authority expects to announce a new harmonised definition this month. But the new rules require the consent of the European Commission and are unlikely to become binding until the end of 2014. Will national supervisors allow the ECB to conduct its asset quality review on the basis of rules that don't yet have legal force and could disadvantage domestic banks—not to mention expose their own failures? Despite pushback, the ECB hopes it can win this battle, given the stakes and degree of public scrutiny.
Meanwhile, the ECB seems likely to duck tackling the most glaring weakness in the eurozone banking system: the continued reliance of many banks on cheap central bank funding. This funding was provided to give banks time to adjust their business models, raise capital and dispose of bad assets. But the fear is that some banks have become addicted to what is effectively a subsidy that allows them to keep bad assets on their balance sheet, absorbing capital that can't then be used to support new lending.
Pushing ahead with the Banking Union while some banks remain so weak isn't without risks. If banks are too feeble to extend credit, economies will struggle to grow, adding to pressure on sovereign debt dynamics. The system will remain vulnerable to shocks. And encouraging the creation of new cross-border institutions will create new political and institutional challenges should one of them fail.