Banking Union and the Single Resolution Mechanism: the road to federalism

by George Hatjoullis

The Single Resolution Mechanism (SRM) for the evolving European Banking Union (EBU) will be discussed again at the ECOFIN council meeting on December 10. The SRM is planned to come into effect on January 1, 2015. However, all is not going to plan and Berlin is the obstacle. It is not difficult to see why.

The commission proposal for the SRM (http://bit.ly/1jb82g9) envisages a strong central resolution body that will apply resolution decisions consistently across participating member states (the eurozone plus any EU members that wish). This body will be able to intervene in the banking system of a sovereign state and force it to resolve a bank. This body will be able to force Germany to resolve a bank if it deems it necessary. Not a popular idea in Germany. The body will have access to a fund, ostensibly financed by the banking sector, with which to effect resolution. It will deploy funds as it sees fit. In a systemic crisis the accumulated fund might prove inadequate and the question of collective funding arises. The idea of a collective fund introduces the possibility of joint and several liability into the agreement and Berlin is not comfortable. It could end up financing a body that will determine its banking structure.

To understand how the Commission proposal goes beyond existing arrangements one should recall the nature of the crisis response. It was structured as a series of bilateral agreements. The commitment of each eurozone member state to the ESM is bilateral. It is limited. Assistance is by agreement with the sovereign state. The state is not obliged to ask for assistance. If assistance is requested it is conditional. If assistance is offered it is conditional. At each stage the fiction of national sovereignty is maintained. Contrast this with the commission proposal to have an independent body that can intervene in a sovereign banking system at will and having access to a collectively generated fund to do so. Sovereignty in banking is clearly compromised and there is no lip service to the illusion of sovereignty.

The banking union is revisiting the issue of ‘mutuality’ that Berlin went to such lengths to sidestep in the response to the fiscal crisis. The Berlin preference in bank resolution is that it is funded at the state level. Moreover, it seeks a resolution mechanism that is under the control of a council of ministers. Berlin obviously has a lot of influence in the ministerial councils of the EU. This approach seems to have just about worked at the fiscal level but is nonsensical and quite dangerous at the banking level. Moreover, it is inconsistent with the single market principle.

The eurozone has one central bank; the ECB. The central bank manages monetary policy via the banking system. Logically, the eurozone needs a single banking system, with a single resolution mechanism under the control of a body just as independent as the central bank. However, this would require new legislation. The ECB pursues a eurozone-wide monetary policy and not one necessarily sensitive to Berlin’s needs. The Single Resolution Board (SRB) should pursue a single resolution mechanism not necessarily sensitive to Berlin’s view. The SRB should be as independent as the ECB. Given that the supervisor is the ECB perhaps the connection should be even closer. A single market in banking services does rather imply such an arrangement but is complicated by the fact that not all EU states are eurozone states. A single market in eurozone banking services is however both feasible and essential to the stability of the eurozone.

Perhaps the real fear of Berlin is that the commissions logical proposal leads to federalism. One of the stated reasons for a banking union is to break the link between the banking sector and sovereign debt. The domestic banking sector of a sovereign will no longer be able to fund the debt issuance of its supervisory sovereign at will. Although the Maastricht Treaty prohibited deficit financing by the ECB, the zero risk weighting of debt in bank balance sheets meant that banks could fund their own government largely unhindered. Presumably this will no longer be possible under banking union. Indeed, Basle 3 is risk-weighting sovereign debt a little. However, eurozone banks will need some highly liquid risk free asset to hold.

The pressure to issue a Eurozone Bond could come from the needs of the banking system. This would be the joint liability of all eurozone states…