Europe’s banking union remains incomplete and the prospect of significant progress toward closer integration, particularly with respect to a common deposit insurance scheme, remains unlikely, as creditor countries are unwilling to indirectly backstop debtor countries’ sovereigns. The euro area sovereign and financial crisis which started almost exactly fifteen years ago led European policymakers to the realization that Europe’s fragmented banking supervision regime, largely under the purview of national authorities, required significant strengthening. Economic and Monetary Union (EMU) had been intentionally designed in such a way as to force members to take responsibility for their own financial stability by prohibiting individual members from assuming the financial liabilities of others. In the face of the financial crisis late noughties, however, the absence of an overarching financial architecture capable of pre-empting a systemic financial crisis due to the so-called sovereign-bank nexus. In some instances, sovereign distress and default caused banking sector instability (Greece, Italy, Portugal). In others banking sector weakness led to sovereign financial distress (Cyprus, Ireland, Spain). Without the ability to intervene and backstop sovereigns and national banking sectors, this nexus risked turning into a self-reinforcing financial doom loop. In response to the Greek financial crisis, the euro area created financial instruments and a financial architecture to deal with financial instability by providing distressed countries with financial support in the form of loans issued to government. In the face of the Spanish banking crisis, Europeans then proceeded to consider the public, joint and direct recapitalisation of banks through the European Stability Mechanism, which originally was meant to provide loans to governments only. With a fiscal union not on the agenda due to creditor country opposition and a desire to sever the sovereign-bank nexus, banking sector union represented a second-best solution. The reform of the euro financial architecture, including the move towards banking union, allowed ECB President Mario Draghi to give his “whatever it takes pledge” in the summer of 2012, which effectively saved the euro area from a financial meltdown and potential breakup.
> Pre-crisis, there existed only limited harmonisation of banking regulation, but only in the form of directives rather than regulations, such as the Banking Directive (2000) and the Capital Requirements Directive (2006). National authorities remained in charge of supervision. The EU also created a Committee of European Banking Supervisors (CEBS) in 2004.
> The Maastricht Treaty contains an enabling clause that allowed the ECB to take on prudential supervision of credit institutions and other financial institution, subject to Council approval and EU Parliament assent. This article formed the legal for the euro area members to establish a banking union and delegate supervision to the ECB.
> In 2012, the Van Rompuy proposed the establishment of a banking union, a fiscal union, an economic union and a political union to strengthen EMU and the EU. Banking union presented the path of least political resistance.
Banking union, as originally envisioned, was to consist of three pillars – supervision, resolution and common bank deposit insurance – but euro area governments only succeeded in establishing the first two. Rather than a politically impossible to achieve fiscal union to sever the bank-sovereign nexus, euro area governments agreed to move towards a banking union by establishing euro area level banking supervision and a resolution authority (including a resolution fund) to reduce the risk of destabilizing financial spill-overs by preventing bank failures from triggering sovereign distress and preventing sovereign distress from destabilizing the national and European banking sectors. The Single Supervisory Mechanism (SSM) entered into force in 2014 and transferred the supervision of larger euro area banks from the national supervisory authorities to the European Central Bank. Smaller and mid-sized remained under the supervision of the national authorities, but the ECB was given authority to intervene in them in case of a risk to systemic financial stability. The Single Resolution Mechanism (SRM), consisting of a Single Resolution Board (SRB) and Single Resolution Fund (SRF), transferred the authority to intervene in and, if necessary, resolve in an orderly fashion euro area banks to the body. But euro area governments failed to create a common European deposit insurance regime and a common backstop supporting the SRF. Instead, they issued a political declaration that a common backstop would be created to strengthen SRF within the next ten years. Meanwhile, member states would ensure that national deposit insurance schemes would accumulate sufficient funds to cover 1% of their deposits by end-2023, which would then be fully mutualized to support the SRF.
> All twenty euro area members are members of the SSM. Non-euro area members have the option to participate in the regime.
> The SRF is financed by contributions from banks. A reform was meant to create a common public, if limited financial backstop to the SRF in the guise of a ESM revolving credit line of nearly EUR 70 billion in case SRF resources are insufficient to finance a resolution. This reform has been stalled due to Rome’s unwillingness to ratify ESM treaty change.
> The SRF is not meant to be used to absorb financial losses incurred by a distressed bank or to recapitalize it. Under certain circumstances, the SRF can provide substantial support to a bank under resolution, but only if at least 8% of the bank’s total liabilities have been bailed in and contribution must not exceed 5% of the bank’s total liabilities.
Efforts to establish a common European Deposit Insurance Scheme (EDIS) to guarantee euro banking sector deposits has not made any substantial progress, largely due to opposition from creditor countries like Germany, while the creation of common ESM-backed backstop to SRF has been blocked by the Italian government. As it stands, the SFR has only limited funds to deal with a systemic banking crisis. But creditor countries not willing to make a pledge to guarantee banking sector deposits in the guise of EDIS for fear of indirectly underwriting debtor countries banking sectors and sovereigns. Instead, Germany has pushed for higher capital charges on bank holdings of sovereign debt to reflect their inherent risk. Such concentration charges would reduce the risks to (debtor) countries’ banking sectors. This however is unacceptable to debtor countries, as they rely on their banking sector to provide financing, particularly during a crisis, and if necessary through moral suasion. The so-called regulatory treatment of sovereign exposures (RTSE) is a non-starter for debtor countries, while it is the starting point for creditor countries if they are ever to agree EDIS. Without progress on RTSE, creditor countries are not going to back a European deposit insurance regime, as they are concerned about indirectly risk insuring other countries’ sovereign risk. Meanwhile, the establishment of a (limited) common backstop to the SRF failed due to Italy’s failure to ratify the necessary ESM treaty change. Making further strides toward a more complete banking union will require euro area governments to find a compromise on how to deal with sovereign exposures and how to share the financial risks related to EDIS. The present relative stability of euro area banking sectors, which have managed to make it through the global monetary tightening relatively unscathed compared to some of its American peers, sharply limits the incentives to reach an agreement. It will require another major crisis for substantial progress to occur.
> The SRF common backstop was meant to replace the so-called (unwieldly) Direct Bank Recapitalization Instrument. Italy continues to block changes to the ESM and has prevented the common backstop from entering into force. We need to send somebody to Rome to find out why the government opposes ratification. The we did not like the way we were treated a decade ago explanation does not strike one as a plausible explanation.
> The von der Leyen EU Commission failed to establish, or make progress toward a European deposit insurance scheme and create a common backstop to the SRF, despite its pledge to do so when it came to office in 2019. This shows just far apart creditors and debtors are on the issue of completing banking union.