December 22, 2013 6:36 pm
An exercise in prolonging a banking credit crunch
The lousy agreement on banking union will produce the financial sector equivalent of austerity
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The agreement on a eurozone banking union is neither a glass half full, nor half empty. As many commentators are saying, last week’s deal is hideously complex, and a common resolution mechanism without a fiscal backstop for failed banks is pointless.
To answer the first question, it is worth looking at how the debate evolved. Ahead of the negotiations several finance ministers called for a common fiscal backstop that could provide a credit line to the resolution fund. It was a reasonable request. Yet that is precisely what they did not get.
All they got were some warm words from Germany that there would be further talks about a backstop within 10 years. Some of the finance ministers tried to put a brave face on this humiliating defeat, pretending that Wolfgang Schäuble, the German finance minister, had given ground on an important principle.
But that is not the case at all. The banking union that was agreed was the banking union Mr Schäuble always wanted. He does not want German taxpayers to pay for the restructuring of banks in other countries. And he does not want the European Commission, or anybody else, to close down a German bank. If ever there was a game, set, match victory in EU history, this was it.
So why did the others accept it? Recall the previous discussion on fiscal integration. These culminated in the fiscal compact, a vehicle to deliver permanent austerity by forcing countries to pay down their excessive debt for 20 years. The periphery countries accepted austerity but failed to secure Berlin’s commitment to debt mutualisation as a quid pro quo. Berlin got an all-for-nothing deal: more eurozone fiscal discipline, at no cost to Germany.
One explanation is that Mr Schäuble is a formidable lawyer and better prepared than his negotiating counterparts. The fundamental reason is that the periphery countries were never able or willing to form an effective coalition against Germany, let alone willing to make a credible threat that they would leave the eurozone without such guarantees. Perhaps they did not trust each other. I am convinced Germany would have budged on some of these issues if confronted with such an existential choice. But it never happened, and now probably never will.
When it became clear none of the periphery countries would risk such a confrontation, Germany’s position became unassailable. The periphery governments were happy to support whatever Berlin demanded as long as sovereign bond yields were not too high. Their crisis resolution policy consisted of keeping their heads down. And so they kept on voting in favour of successively lousy deals.
But that policy is very short-sighted, with severe economic consequences, which brings us to the second question. The fiscal compact and its predecessors brought austerity, which had a devastating and lasting impact on gross domestic product. This banking union will produce the financial sector equivalent of austerity – a secular credit crunch.
To see this, one needs to understand how banking union is going to work. The European Central Bank, in its role as supervisor, has started a comprehensive assessment of the banking sector. As part of this exercise, it assesses financial risks, takes an in-depth look at balance sheets, and subjects banks to stress tests. This exercise is going to end with a demand that some banks raise their capital.
But without a common fiscal backstop, it lacks credibility. The ECB will be in no position to demand that banks raise capital if there is no backstop. It would risk financial instability if it exposed a bank as undercapitalised that has no access to outside capital. The resolution fund will not be able to help because it will not be fully mutualised for a decade. At the start all risks will remain within the member states.
Unlike the Federal Deposit and Insurance Corporation of the US, the eurozone’s resolution fund will have no credit line.
The ECB thus has every incentive to fudge the exercise. This is possible because reviewing a bank balance sheet or a stress test is no exact science. The key variable is the assumption made about the future.
Unfortunately, a fudge does not change the dire economic reality. An exercise in ending the credit crunch in the banking sector will actually prolong it because the recapitalising banks in the periphery will be put on ice due to a lack of funds.
Economically, this is 1990s Japan all over again, probably worse given the periphery’s dire economic state. The banking system in the eurozone will not be able to supply the economy with sufficient credit, except in creditor countries. The economic consequences of what finance ministers hailed as a “historic” decision will be substantially negative.
The periphery finance ministers who accepted this deal know all this. They are not stupid. And still they are not acting in their best interest. If your policy consists of keeping your head down, then perhaps this is the banking union you deserve.
Copyright The Financial Times Limited 2013
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