The European Commission backs it. The ECB backs it. The leaders of France, Italy, Spain, and (possibly) Germany back it. A ‘banking union’ may save Europe’s banks, but does it also spell the end for the single market in financial services? POLSIS PhD researcher Samuel McPhilemy examines the implications of the latest plan to resolve the financial turmoil in Europe.
With each passing week, the sovereign debt and banking crisis in the Eurozone appears somehow to become exponentially worse than it was the week before. Last weekend, Spain became the fourth Eurozone country to receive an international bailout, when it was offered a 100 billion euro credit line to help recapitalise its banks. On Monday, global stock markets rallied for about four hours before it became clear that Spain itself, not merely its banking sector, will soon need to be rescued. By Thursday, the yield on 10-year Spanish government bonds had climbed above 7%, a Euro-era high. This weekend, Greek voters will head to the ballot boxes, with the radical SYRIZA coalition neck-and-neck with establishment parties in the opinion polls. Could a SYRIZA victory spark a run on Greek banks? Would it spread to Spain? Italy? France? Scenarios of impending doom abound.
Amid the all the fear and uncertainty, a plan to help resolve the crisis by pooling the cost of future bank bailouts is gathering a head of steam in the run up to yet another crucial summit of European leaders later this month. As the Commission has explained, the so-called ‘banking union’ is not some new legal instrument to be drafted. Rather, it is a political vision for more financial integration within the EU. The banking union would involve three key elements: the creation of pan-European deposit insurance scheme; the establishment of a common fund that could be used to bail-out or resolve failing banks; and the transfer of responsibility for conducting day-to-day banking supervision from national authorities to a new pan-European supervisory agency, possibly housed at the European Central Bank.
The banking union has already generated opposition from German banking associations and the German Bundesbank. Nevertheless, the plan has the backing of key European power-brokers including the President of the European Council Herman van Rumpuy, European Commission President Jose Manuel Barroso, and European Central Bank President Mario Draghi. Unsurprisingly, the political leaders of France, Italy, and Spain are also firmly behind the plan. German Chancellor Angela Merkel is broadly supportive, although she has insisted that Germany expects more progress on establishing a political union before it will commit to further pooling of financial liabilities. This has placed Germany at odds with the Mediterranean countries, which are clamouring for more money upfront. However, the substantial transfer of sovereignty implied by the idea of common banking supervision suggests that the differences between these countries are not insurmountable.
Could such a scheme end the crisis?
The key idea behind the plan is to sever the pernicious link between teetering banks and heavily indebted recession-struck governments, which is a key aggravating factor driving up interest rates on Southern European countries’ sovereign debt. Implicitly or explicitly, countries such as Spain, Italy and Ireland are committed to rescuing their moribund banking sectors. The example set by the collapse of Lehman Brothers in 2008 has demonstrated that allowing the disorderly failure of even a medium-sized bank invites generalised financial panic, with contagion throughout the financial sector and eventually massive damage to the real economy.
Until now, the burden of recapitalising or resolving a failing bank has rested squarely with the government of the jurisdiction in which the bank is based. This was made explicit in 2008, when Merkel and Germany’s then-finance minister Peer Steinbrück rejected French proposals for a pan-European rescue fund for ailing banks. Unfortunately, the countries that today are home to the most troubled financial institutions are also those with the least capability to intervene in their financial markets. Deep recessions in these countries have caused their governments’ budget deficits to balloon. Add to this the potential liabilities from their financial sectors, and it’s easy to see why their borrowing costs have soared. In the jargon of the financial crisis, banks in these countries are both ‘too-big–to-fail’ and ‘too-big-to-save’. Worse still, it is the realisation of these very facts that is driving investors for the exits, making bank failures, sovereign defaults and the eventual collapse of the Euro into a nightmarish self-fulfilling prophesy.
The logic behind the banking union is sound. If a country such as Spain lacks the resources to rescue its domestic banks, why not supra-nationalise the public guarantee that lies behind its banking system? By convincing depositors and wholesale funding markets that their investments are ultimately guaranteed by an almost inexhaustible supply of European funds, confidence can be restored and the self-fulfilling prophecy can be halted. Right?
Well, possibly. Ending the mutually destructive interdependence between zombie banks and bankrupt countries is certainly a step in the right direction. However, it doesn’t address the root cause of Europe’s current predicament, which is the macroeconomic imbalance between northern creditor countries and Southern debtor countries. In the long-term, restoring confidence in ‘Club Med’ sovereign debt requires ending the deep recessions that have placed such severe strains on these countries’ budgets – something that is unlikely to happen via crippling efforts to achieve ‘internal devaluation’.
UK unhinged
The plan to integrate Europe’s banking systems has also created massive uncertainty regarding the future of the single market. Barroso has claimed that he wishes the banking union to apply to all 27 countries of the EU. However, the implications for countries outside the Eurozone are unknown at present. Most significantly, the UK government has explicitly ruled-out any UK participation, whilst simultaneously urging Eurozone countries to get on with deeper integration amongst themselves. This represents a reversal of decades of UK policy towards European financial services regulation, which has always involved robust negotiation from ‘inside the tent’.
At present, the size of the UK financial sector and clout of its Financial Services Authority allow the UK to punch above its weight in negotiations over European regulations that affect the City, even if those rules are subject to qualified majority voting. Were the Eurozone to establish a single supervisory body, the UK’s position in the single market for financial services would be critically diminished. Not only would it find itself frequently outvoted by a 17-country Eurozone bloc; crucially the ability of its supervisors to win arguments and exert ‘soft power’ would be massively undermined by the presence of a far larger Eurozone supervisory agency.
Under such circumstances, it is unclear whether case for remaining within the the single market would continue to trump Eurosceptic demands for the UK to exit the EU altogether. Then again, London as an ‘offshore’ financial centre would hardly fare much better. The key danger under either scenario is that London-based international financial services firms wishing to do business inside the Eurozone would find themselves subject to rules that UK authorities had little or no hand in creating.
Europe’s leaders will discuss the banking union when they meet on June 28th. In a re-run of the UK’s position in a similar meeting last December, its government appears to be gambling that it can secure a series of safeguards for the UK financial services sector, including a commitment that the European Banking Authority will remain in London and changes to the voting procedures concerning future negotiations. Last December, this approach ended up with David Cameron wielding his now infamous 3am ‘non-veto’, where Britain blocked a treaty change but other European countries effectively carried on regardless. Such an acrimonious outcome is perhaps unlikely to be repeated. Nevertheless, given the UK’s self-destructive negotiating position ahead of the meeting, and the pressure on Eurozone leaders to produce concrete proposals to make the banking union a reality, a favorable outcome for London is difficult to envisage.
Samuel McPhilemy is a PhD researcher at the Department of Political Science and International Studies at the University of Birmingham (Email SPM072@bham.ac.uk).