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Although more progress has been achieved than most observers could have imagined 12 years ago, the European Banking Union still has important gaps and deficiencies. The authors argue that policymakers should at a minimum aim for reform involving (i) a ‘super’ Single Resolution Board that both fully integrates national resolution bodies and national deposit insurance schemes, possibly in a two-tier design; and (ii) concentration limits for sovereign bond holdings by banks, thereby discouraging government bailout of banks and weakening the bank-state nexus.
Banking Union is based on three major pieces of legislation: the Single Supervisory Mechanism (SSM) Regulation (2013), the Bank Recovery and Resolution Directive (BRRD) (2014), and the Single Resolution Mechanism Regulation (SRMR) that established the Single Resolution Board (SRB) in 2015. The institutions and policy changes were supposed to make banking fragility less likely, permit national bailouts only in exceptional circumstances, and ensure that failed banks could be resolved without fiscal support and without creating a financial disaster. In turn, this was expected to prevent contagion from banks to sovereigns and from sovereigns to banks and facilitate the development of a pan-European banking market and the formation of pan-European banks, thus avoiding the concentration of country-specific risk on the balance sheet of national banks. It was also meant to facilitate bank exit in overbanked economies.
By and large, these aims have not been realised. There have been few bank exits. The euro area banking system remains fragmented along national borders, with very few cross-border mergers and very limited cross-border competition. Banks remain disproportionately exposed to their national sovereigns, and the solutions to banking problems stays predominantly national. In most recorded cases of ailing or failing banks, the SRB-led resolution option has been circumvented, and national practices of dealing with banking crises have continued to diverge significantly.
There are four proximate causes. First, significant crisis management competencies remain at the national level. Common supervision and resolution primarily apply to the largest 100-plus banks in the euro area, while national authorities remain responsible for most supervisory tasks in relation to ‘less significant institutions’ (LSIs). Deposit insurance remains national. So is the option to liquidate an ailing bank under normal (national) insolvency procedures, which vary significantly across member states, and allow generous injections of public funds.
Second, supranational decision-making remains fragmented. For example, resolution decisions taken by the SRB may need the consent of other authorities, including DG COMP, the Council, and, at the implementation stage, the input from national resolution authorities (NRAs). This effectively creates numerous veto players and renders efficient decision making difficult, as special interests and their political backers have many places to turn to in their lobbying efforts.
Third, supranational decision makers (the SRB and the European Commission) have both the option and strong incentives to shy away from implementing EU-level resolution. SRB can deny a public interest in resolving a failing bank at the EU level if it determines that resolution objectives can be achieved under normal insolvency proceedings. One incentive to do so is the harsh creditor bail-in regime envisaged by the BRRD, which creates incentives to avoid EU-level resolution in order to allow national bailouts. Another is legal risk: the ‘no creditor worse off’ (NCWO) principle, enshrined in SRMR and BRRD, requires resolution authorities to pick resolution schemes and actions that do not impose greater losses on bailed-in creditors than these would have incurred in national insolvency proceedings.
Fourth, attempts to enact regulation that would limit the exposures of banks to the domestic sovereign, such as concentration limits, have not been successful....
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