Well, it’s [1] official (pending approval [2]). The ‘second pillar’ [3] of the EU’s banking union — a 55 billion euro bail-out fund and a bunch of new rules — appears to be in place following recent negotiations. It was an all night compromise bender! [4] Yes, lots of compromises were made, but the core principles that have emerged during the EU’s multi-year-long quest [5] for a banking union are still intact. Those principles being, of course:
1. Bail-ins by depositors and creditors should be expected for bank failures before the bail-out fund is tapped. In other words, it’s the ‘Cyprus Solution’ of bail-ins [6] for the entire EU so it’s potentially fairer to smaller nations in that respect.
2. The banking union can’t be too forgiving. Nations with ailing banks should have the minimal help needed to avoid a complete catastrophe. The joint bank bail-out fund shouldn’t be large enough to actually solve a large banking crisis. Smaller nations should still remain disproportionately vulnerable because the bailout fund, itself, will be so small that any serious crises will quickly overwhelm the fund and leave the remaining liabilities on the individual nation. At that point, it’s troika-time! [7]
3. The eurozone member nations, which are presumably more inclined to a mutual pooling of liabilities given the shared currency, will not actually share those liabilities in the event that the bail-out fund is spent even though that was a central tenet of the original banking union idea.
4. Banks shouldn’t be allowed to treat their national debt as ‘risk-free’, a move intended to minimize the ‘bank-sovereign nexus’ where domestic banks load up on domestic government debt because it’s given favored ‘risk-free’ status. It’s been a proposal championed by Bundesbank chief Jens Weidmann [8]. As Greece demonstrated, sovereign bonds in the EU aren’t necessarily ‘risk free’ because bondholders just might be forced to take a trip to the bond-barborshop [9]. In theory, preventing risk-free sovereign bonds should prevent the concentration of a nation’s debt in its own banking system. In reality, it might accomplish that goal, but it will probably also exacerbate any existing “sovereign debt bank nexus” problems if implemented poorly and generally goes against the spirit of a real “union” [10] by emphasizing a “each member is on its own” attitude.
5. The minimally helpful plans should be hailed as a triumph of compromise, practicality, and fairness.
Yes, the second pillar in the EU’s banking union is a triumph of compromise, practicality, and fairness [11]:
Europe strikes deal to complete banking union
Thu Mar 20, 2014 8:33pm GMT
(Reuters) — Europe took the final step to complete a banking union on Thursday with an agency to shut failing euro zone banks, but there will be no joint government back-up to pay the costs of closures.
The breakthrough ends an impasse with the European Parliament, which persuaded euro zone countries to strengthen the scheme. It completes the second pillar of banking union, which starts at the end of the year when the European Central Bank takes over as watchdog.
The accord means that the ECB has the means to shut banks it decides are too weak to survive, reinforcing its role as supervisor as it prepares to run health checks on the still fragile sector.
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Michel Barnier, the European commissioner in charge of regulation, said the scheme would help to bring “an end to the era of massive bailouts”.
“The second pillar of banking union will allow bank crises to be managed more effectively,” he said.
Thursday’s agreement makes it harder for EU countries to challenge the ECB if the central bank triggers bank closures, and establishes a common 55 billion euro back-up fund over eight years — quicker than planned but far longer than the ECB’s watchdog had hoped.
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Notice that the compromises include establishing the 55 billion euro bail out fund in eight years, which is sooner than expected but far longer than the ECB’s new watchdog [12] had hoped. It raises the question of the time frame the ECB’s Watchdog would have preferred for the full funding of the too-small fund? 5 years? 3 years? Now?
Continuing...
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But the new system, which Barnier conceded was not ‘perfect’, has shortcomings.For one, the ‘resolution’ fund is small and would, in the view of the ECB watchdog, be quickly spent. To remedy that the fund will be able to borrow to replenish spent money.
Euro zone governments will not, however, club together to make it cheaper and easier for it to do so.
The 18 euro zone countries do not intend to cover jointly the cost of dealing with individual bank failures, a central tenet of the original plan for banking union.
Germany resisted pressure from Spain and France to make such a concession. Its finance minister Wolfgang Schaeuble welcomed new rules forcing bank creditors to take losses and that “the mutualised liability ... remained ruled out” — a reference to sharing the burden of a bank collapse.
Neither will there be any joint protection of deposits.
DEADLY EMBRACE
Almost seven years since German small business lender IKB became Europe’s first victim of the global financial crisis, the region is still struggling to lift its economy out of the doldrums and banks are taking much of the blame for not lending.
The banking union, and the clean-up of banks’ books that will accompany it, is intended to restore their confidence in one another. It is also supposed to stop indebted states from shielding the banks that buy their bonds, treated in law as ‘risk-free’ despite Greece’s default in all but name.
Under the deal reached, a fund made up by levies on banks will be built up over eight years, rather than 10 as originally foreseen. Forty percent of the fund will be shared among countries from the start and 60 percent after two years.
It also envisages giving the European Central Bank the primary role in triggering the closure of a bank, limiting the scope for country ministers to challenge such a move.
Mark Wall, Deutsche Bank’s chief euro zone economist, said new rules to impose losses on the bondholders of troubled banks would reduce the burden on the fund but warned that its size was too modest. “A cross-European fund of the size of 55 billion raises some eyebrows in terms of scale,” he said.
The fund will be able to borrow against future bank levies but will not be able to rely on the euro zone bailout fund to raise credit. Critics say this means primary responsibility for problem lenders remained with their home countries and that the banking union will never live up to its name.
“The key to the banking union is an authority with financial clout. They don’t have it so we don’t have a banking union,” said Paul De Grauwe of the London School of Economics.
“The whole idea was to cut the deadly embrace between bank and sovereign. But if a banking crisis were to erupt again, it would be back to how it was in 2008 with every country on its own.”
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Let’s review some of the details being proposed:
— A 55 billion euro bailout fund is being created from levies on banks. The CEB Watchdog say this is much too small and could be spent quickly.
- It will take 8 years for the fund to be fully financed, less than the planned 10 years but much longer than the ECB watchdog was hoping for.
- The 55 billion euro fund can borrow against future blank levy’s but it can’t rely on the eurozone bailout fund (which makes sense since this banking union includes eurozone and non-eurozone members).
- And, due primarily to German opposition, the 18 eurozone members states are not going to be jointly funding for the bailouts, even though joint funding was one of the original central tenets of the banking union. There will also be no joint protection of deposits (it’s the third pillar of the banking union, so some scheme involving). So the smaller nations or those with weaker economies should probably be expecting some sort of troika following any future major financial crises.
- Once the 55 billion euro fund is exhuasted, “it would be back to how it was in 2008 with every country on its own”.
The More Things Change, the More They Stay the Same In the Banking Union. Via Veto Power
If the above plan doesn’t sound very likely to succeed keep in mind that there’s nothing preventing corrective changes to the banking union in the future. Except for the veto-power of individual member states. Yes, because this was an inter-governmental agreement, individual members need to agree to future changes and hold an implied veto power. So while the banking union may be here to stay, it doesn’t have to stay the same. But it easily could [13]:
Financial Times
A highly imperfect banking union
Eurozone banks and sovereigns remain tightly embraced
March 23, 2014 5:01 pm
EditorialTwenty months ago, at the height of the sovereign debt crisis, EU leaders vowed to shore up the eurozone’s financial system by building a “banking union”. The aim was to end the deadly embrace between governments and banks that had proven catastrophic for countries such as Spain and Ireland. Never again would a single member state have to deal with a banking crisis alone, as its partners would help by sharing some of the burden.
Last week the journey towards the EU’s most ambitious integration project since the creation of the euro came to an end [14]. After a 16-hour negotiation, the European parliament and member states agreed to create a unified system for handling banking crises. The so-called “single resolution mechanism” is one of the building blocks of a banking union. The other cornerstone – removing from national regulators the powers to supervise the eurozone’s largest banks and attributing them to the European Central Bank – had already been laid last year.
Constructing a banking union was always going to involve uneasy compromises between states. Early in the negotiations it became clear that Germany was opposed to the idea of building a common guarantee scheme that would protect small depositors in case of a bank failure. But while this part of the plan was abandoned, the hope was that the other elements of the banking union would not be watered down. Alas, the opposite has happened.
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Most importantly, the promise that eurozone members would share the burden of rescuing or resolving a bank has been forgotten. True, the extensive use of “bail-in” rules means that bondholders will finally face the true cost of the risks they take. But after that the financial responsibility for saving a bank will largely fall on the shoulders of an individual government. As for banks that need to be shut down, at just €55bn the common resolution fund is tiny and, anyway, will take eight years to build.
One would worry less about these imperfections if it were clear that the agreement would be improved at a later stage. But this will be difficult. For example, since the single resolution fund was included in an inter-governmental agreement, member states will retain veto powers over subsequent changes. Germany, which is terrified of anything that involves a mutualisation of liabilities, is unlikely to give much ground.
The eurozone risks being stuck with a flawed banking union until the next crisis. This places a greater onus on the ECB. The central bank is undertaking a forensic audit of the balance sheets of the institutions it will supervise to ensure they hold enough capital. This assessment must be credible and put the largest banks in position to withstand the next shock. After this week’s deficient agreement on banking union, any mistake risks being extremely costly.
Yes, “since the single resolution fund was included in an inter-governmental agreement, member states will retain veto powers over subsequent changes. Germany, which is terrified of anything that involves a mutualisation of liabilities, is unlikely to give much ground.”. And if Germany isn’t giving much ground, ground probably isn’t going to be given at all. That just how things work. It’s the implied sixth principle of the banking union:
6. He who has the gold makes the rules.
So does this implied veto right by member nations mean that a clearly questionable banking union is now the law of the land? Indefinitely? Well, perhaps, but that doesn’t mean there aren’t other possible positive changes coming as a result of the new union. For instance, one of the unambiguous positives to the new ‘bad bank’ resolution scheme is that it takes us one step closer to resolving the the previous ‘bad bank’ resolution schemes. As Berlin recently made clear, those previous really bad [15] ‘bad bank’ resolution schemes that bankrupted entire countries and mandated troikas aren’t going to get resolved until the entire banking union is set up. So, as bad as many the new banking union seems with the announcement of these new proposals, at least it gets us closer to undoing the last horrible banking scheme [16]:
Irish Times
Germany dampens hopes of Irish bank recapitalisation from ESM
Schäuble rules out mutual liability of EU member statesSuzanne Lynch, Derek Scally
Fri, Mar 21, 2014, 01:00
Germany has dampened expectations of imminent bank recapitalisations for Irish banks from the European Stability Mechanism bailout fund after yesterday’s agreement on a further pillar of the European banking union.
After 16 hours of talks through the night, European Union member states and the European Parliament agreed final details of a single resolution mechanism (SRM) to wind up failing banks.
Taoiseach Enda Kenny welcomed yesterday’s agreement as another “essential” stage in the euro area’s post-crisis path towards a banking union.
“This means that we’re moving towards the endgame in terms of having the structure put in place by which matters of recapitalisation can be considered,” he said, speaking on his way into a summit of EU leaders in Brussels. “And, as I’ve always said, that will apply on a case-by-case basis by the end of the year.”
German finance minister Wolfgang Schäuble agreed that yesterday’s deal marked a “great step forward for Europe” on the banking union, which he described as the “greatest European projection since the introduction of the euro”.
Mutual liability ruled out
While the political deal represented a sensible compromise, with Berlin giving ground on key points, Mr Schäuble insisted that it “still rules out mutual liability of participating member states”. Berlin officials were circumspect about the time it would take to complete the banking union’s final lap. For now, they said, Berlin’s priority was “pouring the SRM deal into a concrete structure”.“Only then can we look further,” said a finance ministry spokesman.
After agreement in December 2012 on a single supervisory mechanism for banks, the SRM is the second of three pillars of Europe’s banking union with talks still outstanding on a third: a common deposit insurance fund. Until all three are in place, and the banking union is operational, Berlin declines to entertain even discussion of recapitalisations. The idea of establishing a common European banking deposit insurance fund is highly unpopular both with German banks and German savers and is likely to trigger a prolonged political debate there.
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Note that the German Constitutional Court very recently ruled that a direct recapitalision of Ireland banks would indeed be constitutional [17], removing a major hurdle to this needed step. But don’t expect any recapilisations any time soon since, as mentioned above, Berlin is declining to entertain even discussion of bank recapitalizations until all three pillars are in place for the new banking union. And the third pillar — deposit insurance — has yet to even be addressed and is likely to trigger a prolonged debate. So the Ireland, the ‘good student’ that has been holding out for recapitalisation for years, is going to have to keep waiting [18].
Continuing...
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Late-night haggling
Yesterday’s agreement between member states and the European Parliament under the co-decision process follows agreement among member states in December. The centralised resolution body and accompanying €55 billion fund will be responsible for winding-up struggling banks.After late-night haggling, including a reported 5.30am phone call to Mr Schäuble, euro-group president Jeroen Dijsselbloem emerged with a deal at 7am.
It has been seen as favouring smaller countries such as Ireland because it accelerates the pace at which the €55 billion fund will be fully mutualised. (The first SRM draft proposals envisaged a 30 per cent mutualisation in the first three years, with full mutualisation only after a decade.)
This was one crucial concession European Parliament negotiators wrung from Germany; another was reducing from 10 to eight years the transition period during which a pool of national funds would shift towards a shared fund.
Mutualisation
The revised package also brings forward mutualisation: 40 per cent in the first year; 20 per cent in the second year; and the rest equally over a further six years.According to Dutch MEP Corienn Wortmann-Kool the resulting resolution process will treat banks equally regardless of their home country.
“We want bail-in of creditors and investors to be applied in the same way to all banks irrespective of the member states these banks are located in,” she said, using the example of Ireland as compared with larger states such as Germany and France.
The plan agreed by member states in December would have seen, for example, French or German banks backed by a large fund allowing moderate bail-ins. An Irish bank with a smaller national fund would, under draft proposals, have been forced into a deeper bail-in, leading to higher funding costs, she said.
“This would definitely not be what we want to achieve in terms of breaking the link between sovereign and banking debt,” she said.
The agreement also envisages that the European Commission, rather than member states, will approve decisions made by the SRM’s board on resolving banks. MEPs were anxious to limit political interference from member states, though finance ministers will still have power to intervene in certain cases.
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So it’s bad, but not all bad, right? At least it wasn’t “definitely not be what we want to achieve in terms of breaking the link between sovereign and banking debt” like the proposed plan in December was [19] where the larger members would have larger bail-out funds. Instead, everyone shares in the too-small-too-succeed bailout fund.
The EU’s ‘Mutual’ Fund Has ‘Eye-Opening’ Non-Mutual Benefits
Additionally, notice how the ‘compromise’ is being spun as “favouring smaller countries such as Ireland because it accelerates the pace at which the €55 billion fund will be fully mutualised.” As the article points out:
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The plan agreed by member states in December would have seen, for example, French or German banks backed by a large fund allowing moderate bail-ins. An Irish bank with a smaller national fund would, under draft proposals, have been forced into a deeper bail-in, leading to higher funding costs
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What does this mean? Well, basically, the 55 billion euro bailout fund isn’t fully funded or fully “mutualised” for 8 years. There’s a transitionary phase of 8 years when the fund builds up. During this phase the funds are separated between “national” funds and “European funds” and money in each nation’s “national” compartment is only available for bailing out that nation’s bank. In other words each member is sort of on their own when it comes to dealing with a banking crisis during this transition period. But the degree to which a country is on its own will go down each year as the fund grows in size and become increasingly “mutualized”. But, again, it’s going to take 8 years for this process to be completed and 8 years can last a LONG time when you’re in the midst of some sort of socioeconomic experiment gone horribly awry [20].
So the recent changes made in the compromise agreement really would reduce the risk assumed by the smaller states because that’s what mutualisation does. By speeding up the overall time frame from 10 to 8 years and by speeding up the mutualisation schedule from the 10 year schedule proposed in December it really does reduce systemic risk (otherwise insurance wouldn’t really work). So this is quite an accomplishment, right?
Well, as we already saw above [13], mutualisation is indeed helpful but that helpfulness is dramatically limited by the fact that the bailout fund is limited to 55 billion euros.
Sure, 55 billion euros sounds like a lot of money, but keep in mind the Ireland, alone, spent 85 billion euros bailing out its private banks [21] and this basically bankrupted the country (require an additional bailout and endless austerity...and the ongoing need for recapitalisations). Portugal need 78 billion euros [22]. Once that 55 billion euro bailout fund is expended the liabilities fall back on the member nations. So bailouts are mutualised, but only to an extent that would have been inadequate for dealing with virtually ALL of the crises we’ve seen thus far.
Still, we can be a bit relieved that the newly proposed bailout fund scheme is an improvement over the proposal in December. By pushing up the funding schedule from 10 to 8 years and increasing the mutualisation rates the new scheme is probably fairer overall. At least, it’s hopefully a fairer arrangement between the larger nations (like Germany and France) and the smaller states like Ireland.
As the following article points out, however, there’s still a question of fairness between the larger states. Yes, in what turned out to be quite an “eye opener” last week, it looks like France, and not Germany, will be paying more into the bailout fund than anyone else and “mutualisation” will dramatically bring down Germany’s overall share for the 55 billion euro fund. Given the intense opposition by German negotiators to the very idea of mutualisation, this wasn’t the expected outcome [23]:
Financial Times
March 17, 2014 4:41 pm
France and Germany squabble over who pays for EU banking unionBy Alex Barker in Brussels
France and Germany are squabbling over who should foot the bill for Europe’s banking union, with Paris fearing its banks will pay the biggest share towards a €55bn rescue fund.
As the EU enters a potentially decisive week in talks on a central system for handling bank crises, France is fighting plans to make its sector of big universal banks the leading contributors to the common insurance plan.
It is one of several highly political issues that remain unresolved with days left before a Wednesday deadline to agree legislation with the European parliament, so that it has time to pass before the European elections.
Although it is highly technical, the dispute over the bank levy cuts across some fraught EU issues: whether the rescue system is genuinely European or actually partly national; whose banking system is most risky; and therefore whose lenders should pay more for insurance. France, Spain and Portugal have all submitted papers on the topic.
One senior diplomat said the breakdown of contributions was an “eye opener”, given that Germany, the EU’s biggest economy, is leading resistance to increasing the heft of the rescue fund or accelerating its mutualisation.
“Everyone put up with [Germany’s] antics because they thought it was the German banks that pay by far the most, but that isn’t quite true. It is the French banks that will fund this party,” the official said.
Some MEPs think it right that complex, “too big to fail” banks pay more. Sven Giegold, a German Green in the parliament negotiating team, said he was “appalled” by member states’ attempting to rig the calculation, to “give a subsidy to risky banks”.
A French informal position paper, circulated on Friday, lays out rough estimates showing the variance in national contributions depending on the method used. One big factor is whether the funding target – expected to be around 1 per cent of covered deposits – is set at European level or national level.
Under a European target France’s highly concentrated banking sector, including BNP Paribas and Société Générale, is on the hook for 21 per cent of the fund, slightly more than Germany’s more deposit funded sector.
By contrast, if the target is set at national level, the contributions of German banks would rise to 35 per cent, while France’s remain at 21 per cent. Berlin fought hard to limit the contributions of its big savings bank sector to the central fund.
France argues that given the fund is established with national compartments that are gradually broken down over 10 years, the European target level should also be phased in. This would leave French banks paying 21 per cent, or around €11bn, while German lenders would pay 28 per cent, around €15bn.
“Using a reference to national target level during the transitional period is consistent with the existence of national compartments,” the French paper argues, pointing out that a failing bank’s access to rescue funds varies according to its home state.
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That might have seemed like a lot of jargon. Here’s the critical part:
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Under a European target France’s highly concentrated banking sector, including BNP Paribas and Société Générale, is on the hook for 21 per cent of the fund, slightly more than Germany’s more deposit funded sector.By contrast, if the target is set at national level, the contributions of German banks would rise to 35 per cent, while France’s remain at 21 per cent. Berlin fought hard to limit the contributions of its big savings bank sector to the central fund.
France argues that given the fund is established with national compartments that are gradually broken down over 10 years, the European target level should also be phased in. This would leave French banks paying 21 per cent, or around €11bn, while German lenders would pay 28 per cent, around €15bn.
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Keep in mind that the above article was written days before the latest deal, so the earlier bailout fund schedule was still on the table (10 years for financing the fund and slower mutualization) but the overall dynamic described hasn’t changed with the new deal. Now notice the point made by the French negotiators at the time: The bailout fund is established with national compartments that are broken down and merged into the “European” compartment as the fund gets mutualised. If the contributions where set at the “national target level”, Germany’s banking sector would be on the hook for 35% of the 55 billion euro fund. But at the “European level” the German banks are only liable for 20% of the fund. The French banks, on the other hand, appear to be on the hook for 21% either way. So, somehow, the formula used for the “mutualisation” of liabilities seems to dramatically slash the German liabilities without impacting the French banking sector at all. Banks can have different structures and risks, so this isn’t entirely surprising that the formulas chosen can have different impacts on different banking sector. But, again, the opposition to debt mutualisation has been the strongest in Germany and yet, in the end, debt mutualisation appears cut the German liabilities by 42%! It helps explain why this scheme was such an ‘eye opener’.
You Say Mutualise, I Say Mutualize. Let’s Call the Whole Thing Off All Create A Limited Liability Company
Still, our eyes shouldn’t be too wide with surprise by the new EU banking New Deal and its quirky funding formulas because it wasn’t simply “mutualisation” of the bail-out fund that Germany has been opposing this entire time. It’s the “mutualisation” of ALL potential liabilities that Berlin has been fearing.
Sure, the “mutualisation” of the 55 billion euro fund appears to reduced Germany’s bailout liabilities for the 55 billion euro fund, but that’s not where the major saving for Germany are accrued. The major reduction in German liabilities (and the liabilities of any leading European economies in the future) come from the fact that the “mutualisation” of liabilities is capped at 55 billion euros. That’s the major ‘eye-opener’ in this plan because once that 55 billion euro bailout fund gets used up nothing else gets mutualized and the relevance of the banking union effectively ends. The EU, at the end of the day, is a limited liability company for nation states. That’s the unifying principle underlying the banking union. My Brother’s Keeper, LLC.
And why kind if banking union “crisis resolution” power will a nation state LLC have? One that appears to intentionally create of a scheme that is unable to handle anything other than a small, single-nation banking crisis coupled with a very serious threat of “Troika Time! [24]” for any member states that that find themselves in need of national bailout. In other words, it’s a preventative approach. The EU’s new plan for dealing with a crisis is to have a bank crisis resolution scheme that is so completely inadequate that member nations will preemptively curtail excesses in their banking systems simply to avoid the possibility of needing a national bailout (and more Troika [25] timeouts [26]). It’s the ‘all stick, no carrot’ approach [27] to creating a union.
But will it work? Can it work? After all, we’re talking about a banking union within a European union. Can unions rooted in conflicts of interest, a lack of trust, and a deep aversion to burden-sharing actually survive in the long run? If so, is a limited liability company really the kind of long-term relationship the EU wants to be [28]?
Wouldn’t the E-“U‑and-Me” be better?