Completing the Banking Union? Reducing the link between banks and sovereigns

EuroYesterday the European Commission adopted a roadmap for a Eurozone-wide (re-)insurance scheme for bank deposits by 2024 and set out further measures to complete the Banking Union.

The creation of a Single Supervisory Mechanism (SSM) has already achieved a rather strong separation of banks from national control through pressure exerted by supervisors. In addition, the Single Resolution Board (SRB) has been set up to deal with possible resolution of a Eurozone cross-border operating bank. However, the link between banks and sovereigns will persist as long as deposit insurances remain national and thus confidence of depositors is dependent on confidence in national institutions.

The creation of a European deposit insurance scheme, under which all European deposits are equally safe and in which bank funding costs still differ according to a bank’s solvency position, not by location of its headquarters, is seen as an indispensable part of a complete Banking Union.

The creation of such a European deposit insurance scheme would send a firm message of the political determination to strengthen the single currency’s foundations after the tremors caused by a near “Grexit”. This was highlighted in the five presidents’ report on Completing Europe’s Economic and Monetary Union (EMU) adopted in June of this year.

Nevertheless, plans for further mutualisation of bank risks have been met by fierce criticism from Germany, which reasserted its position that the focus should be on minimising risks  rather than sharing them in the banking sector. This echoes the debate between creditor and debtor countries on the orientation of Eurozone integration, and in particular some of the red lines around risk-sharing between Eurozone governments.

The European Commission now proposes to develop a European Deposit Insurance Scheme (EDIS) over time and in three stages, namely supplementing national deposit guarantee schemes through re-insurance (2017-2019) and co-insurance (2020-2023) in case national funds are depleted before eventually replacing them with a European fund amounting to about €43 billion by 2024.

More importantly, a staged approach to EDIS could help to mitigate concerns about greater risk sharing as the European Commission announced interlinked initiatives making a full European deposit insurance scheme contingent on measures that would render bail-in more likely, reduce the exposure of banks to sovereigns and reduce the link between banks and sovereigns.

Concretely, the European Commission will seek to further promote convergence of supervisory practices by proposing regulatory measures to align the use of national options and discretions in the application of macro-prudential rules, identified by the SSM, as well as monitoring consistent application of bail-in rules under the Banking Recovery and Resolution Directive.

To avoid costs to the taxpayer and ensure that enough “bail-inable” liabilities are available, the European Commission will bring forward a legislative proposal to implement the final Financial Stability Board standard for a Total Loss-Absorbing Capacity (TLAC) at global level by globally systemic important banks (G-SIBs),which will need to be consistent with minimum requirement of own funds and eligible liabilities (MREL) for all EU banks required under the Bank Recovery and Resolution Directive (BRRD).  This seeks to reduce the risk of G-SIBs drawing on national or European deposit insurance and/or the European Resolution Fund, both of which do not have the resources to deal with the large-scale failure of banks.

Most interestingly, the European Commission will reconsider capital rules that allow banks to consider sovereign debt as risk free. However, any differentiation in sovereign debt risk will add to the call for greater financial risk-sharing across the Eurozone, as a possible scenario where Germany pays zero interest on sovereign debt but Greece substantially more is not politically palatable.

Therefore the faith of the EDIS, Banking Union and Economic Monetary Union are ultimately intertwined. Its outcome will determine the level of market integration and in particular whether bank risk, funding costs and performance are shaped by European rather than national policies.

Roeland Van der Stappen is Senior Director in FTI Consulting’s financial services team.

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