Europe has hit yet another stumbling block on the path to banking union, just as central banks are being urged to look for an exit from QE. Without a solid financial system, including a resolution framework which gives the public confidence that bank failures can be handled, growth will continue to be constrained.
European banking union was always an ambitious project. The
idea of centralising the regulation of over 8,000 banks, with myriad business models,
across 27 EU member states, smacks of the “whatever it takes” desperation that
has come to characterise the eurozone debt crisis.
But when you think about it,
it’s not much more insane than the idea of 17 different countries sharing the same
currency, so it shouldn’t come as too much of a surprise. Saving the euro was
always going to be an all-in bet.
Over the weekend, talks between European finance ministers
over bail-in — one of the key building blocks of banking union — hit more
obstacles. This is not what Europe needs, especially after Ben Bernanke’s justifiable insistence on considering
a potential data-driven exit from quantitative easing has riled markets.
EU commissioner Michel Barnier eloquently summed up the crux
of the disagreements between Eurogroup ministers: Europe is not a federal
system, and therefore a level of national discretion is necessary when the
authorities are deciding how to rescue failing banks or resolve ones that are
already past saving. But that flexibility must not compromise the integrity of
the single market.
Black and white
But the whole idea of a pan-European resolution and recovery
regime is that it specifies the exact process that must occur when a bank is
judged to have reached the point of non-viability. The stability of any
financial system is compromised when consumers are unsure about what is going
Given the lack of basic education about banking, a certain
degree of misunderstanding in these situations is inevitable. But it is
exacerbated if we do not have an established framework for dealing with the
Take the example of the UK’s Co-op Bank. It took over a
month for the bank to work out how it was going to fill its £1.5bn capital
hole. That is a long time in financial markets, and if Co-op were a more
systemically important institution, the shockwaves from the resulting uncertainty
would have been far bigger.
In the end, Co-op Bank’s subordinated bondholders are set to
suffer losses. It is a bail-in of sorts, but not quite. It is being conducted
via a debt for equity swap. It panders to the political desire for bondholders
to take the pain, rather than taxpayers, but uses coercive liability management
as the mechanism to apply that pain. It’s messy and hardly the straight up
haircut that bail-in is supposed to be.
The arguments for national discretion over bail-in are
strong. Yes, different banks have different business models and funding
structures. Yes, bailing in one banks’ investors could impact access to
funding markets for other banks within that jurisdiction.
But it’s not enough to claim that every situation is an
isolated case, meriting a different regulatory response. You can take that
view, but if you do, you have to relinquish banking union.
Consumer and investor confidence is the bedrock of a
thriving financial system. Confidence will only prevail if people have a good
idea of what is going to happen if banks fail. Europe’s financial system is too
deeply entwined by now for national regulators to pick and choose who shares
the burden when banks fail. Such a policy is anti-confidence, and therefore
Set the rules. Enshrine the rules in regulation. Respect the
rules. Do all of that, or you’re stuck with a bunch of idiosyncratic rules for
idiosyncratic situations in idiosyncratic jurisdictions. If that is the case,
we’re back to square one. And in that case, doing “whatever it takes” to save
the euro might as well mean the ultimate act of self-sacrifice — letting it go