The Eurozone crisis has gone through its fair share of buzz words — fiscal compact, growth compact, Big Bazooka. The latest kid on the block is the banking union. Although it has been discussed by economists since even before the 2007 crisis, it has moved up to the top of the Eurozone agenda. But what kind of banking union? For whom? Financed how? And managed by whom?
A new collection of short essays by leading economists on both sides of the Atlantic — including Josh Aizenman, Franklin Allen, Viral Acharya, Luis Garicano, and Charles Goodhart — takes a closer look at the concept of a banking union for Europe, including the macroeconomic perspective in the context of the current crisis, institutional details, and political economy. The authors do not necessarily agree and point to lots of tradeoffs. However, several consistent messages come out of this collection:
- No piecemeal approach. Centralizing supervision alone at the supra-national level, while leaving bank resolution and recapitalization at the national level, is not only unhelpful but might make things worse.
- A banking union is part of a larger reform package that has to address sovereign fragility and the entanglement of banks with sovereigns.
- Immediate crisis resolution vs. long-term reforms. There is an urgent need to address banking and sovereign fragility to resolve the Eurozone crisis. Transitional solutions that deal with legacy problems, both at the bank and at the sovereign level, are urgently needed and can buy sufficient time to implement the many long-term institutional reforms that cannot be introduced immediately.
The push for a banking union stems from the realization that the financial safety net for the Eurozone is incomplete. Although the original Eurozone structure did not foresee it, the European Central Bank (ECB) is effectively the lender of last resort, but — as argued by Charles Wyplosz — it is ill-equipped to act as such. First, it has limited information about banks and no authority to intervene. Second, national authorities with the responsibility to intervene, restructure, and recapitalize banks procrastinate as long as possible, putting additional pressure on the ECB to intervene, but only when it is too late. Several authors criticize the sequential introduction of supervision and bank resolution, which might lead to less, rather than more, stability, as conflicts between the ECB and the national resolution authorities are bound to arise.
Several contributors point out that one should distinguish between solutions to the current crisis and institutional solutions to make the Eurozone a long-term sustainable currency union by constructing a banking union. Using a Eurozone-wide deposit insurance and supervision mechanism to solve legacy problems would be like introducing insurance after the insurance case has occurred; it would also entangle important changes in the European architecture with distributional conflicts related to crisis resolution. One suggestion is to establish a crisis resolution mechanism (European Resolution Authority), using the European Financial Stability Facility and the European Stability Mechanism as backstop funding sources, while at the same time establishing the necessary structures for a banking union.
The resolution of the banking crisis and the creation of a banking union have to go hand in hand with the resolution of the sovereign debt crisis, as stressed by Viral Acharya. In terms of regulatory reform, this requires adjustments in capital charges for sovereign bonds, and government bonds eligible for liquidity holdings must be in the highest quality bucket and possibly diversified across sovereigns.
A properly working banking union would also help address the existing macroeconomic imbalances within the Eurozone. Daniel Gros starts from the observation that the desire to protect the home turf in Northern Europe has bottled up large amounts of savings there, thus contributing to the severity of the Eurozone crisis. Providing the ECB with supervisory authority could have an important macroeconomic impact because the ECB would not penalize cross-border lending in the way national supervisors do today. Such a move would thus allow the Single European Market in Banking to function again, including intra-bank capital markets, i.e., flows between parent banks and subsidiaries, a critical condition not only for making the credit channel of monetary policy work again, but also for restarting growth especially in peripheral countries, and thus dampening the multiplier effect of fiscal policy.
Banking union for whom?
One critical question is whether the banking union should be “just” for the Eurozone or for the whole European Union. In my contribution, I argue that the need for a banking union is stronger within a currency union, as it is here where the close link between monetary and financial stability plays out strongest. It is also where the link between government and banking fragility is exacerbated because national governments lack the policy tools that countries with an independent monetary policy have available. By contrast, Jeromin Zettelmeyer, Erik Berglöf, and Ralph de Haas, from the European Bank for Reconstruction and Development, argue that non-Eurozone countries should be allowed to opt into the banking union but, if they do so, they must be given a say in its governance and access to euro liquidity through swap lines with the ECB. Apart from full membership, intermediate options could be considered that would extend some but not all the benefits and obligations of membership to all financially integrated European countries — including countries outside the European Union.
The institutional details
Should the responsibilities for running the banking union be concentrated in the ECB? There is certainly a strong argument for centralizing responsibility on the supra-national level. There are clear arguments to separate bank resolution and deposit insurance in an institution outside the ECB, to avoid conflicts between monetary and micro-stability goals and introduce additional monitoring (Dirk Schoenmaker). One argument for a supra-national supervisor is that it would help reduce the political capture of regulators that has been observed across Europe over the past years and became obvious during the current crisis. This lesson can also be learned from Spain, as Luis Garicano points out: “the supervisor must be able and willing to stand up to politicians.” In addition, there is a supervisory tendency to be too lenient toward national champions, while bailing them out is too costly, explains Charles Goodhart. Franklin Allen, Elena Carletti, and Andrew Gimber argue, however, that the ECB might not necessarily be a tougher supervisor than national supervisors. It might actually be more lenient, because it is concerned about contagion across the Eurozone and it has more resources available. Tying its hands by rules might therefore be necessary.
Looking west across the Atlantic
This time is not different. Studying history can be insightful, for both economists and policymakers. Accordingly, several observers have looked for comparisons in economic history for clues on how to solve the Eurozone crisis. Joshua Aizenman argues that the history of the United States suggests large gains from buffering currency unions with union-wide deposit insurance and partial debt mutualization. It is important to note, however, that it took the United States a long time to get to where it is now, and quite a lot of institutional experimentation and several national banking crises. And, as is currently being discussed in Europe, the United States had to address both banking fragility and state over-indebtedness. Fiscal and banking unions go hand in hand.
It’s the politics, stupid!
In addition to a banking, sovereign, macroeconomic, and currency crisis, the Eurozone faces a governance crisis. Diverse interests have hampered the efficient and prompt resolution of the crisis. And as financial support for several peripheral Eurozone countries has involved political conflicts both between and within Eurozone countries, so the discussion on the banking union has an important political economy aspect, Geoffrey Underhill points out. More importantly, there is an increasing lack of political legitimacy and sustainability of the Eurozone and for the move toward closer fiscal and banking integration. “Citizens in both creditor and debtor countries increasingly perceive rightly or wrongly that the common currency and perhaps European integration tout court have intensified economic risks.” A banking union can therefore only succeed with the necessary electoral support.
The essays in this collection lay out an impressive agenda for policymakers in the Eurozone. Over the past years, the crisis has been exacerbated by half-baked approaches and unsustainable policies. Political inaction has put greater responsibility and stress on the ECB, expanding its realm far beyond monetary stability and its democratically assigned responsibilities, and forcing it to go for second or third-best solutions. It is high time for Eurozone governments to take bold steps not only to address the current crisis, but also to put the euro on a long-term sustainable basis.
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