Banking union falls short of EU goal

Nearly 18 months ago, with Ireland in an international rescue because of a bank bailout it could not afford, and Spain on the verge of a similar collapse, EU leaders came up with an unexpected solution: make Europe's banks the responsibility of Europe, rather than individual countries.

The decision was as simple as it was surprising. By shifting the burden of paying for collapsed banks from national treasuries to an EU-wide rescue system, never again would otherwise healthy governments be brought low by irresponsible bankers. The EU would break the link between governments and the banks that do business in their country.

But as EU leaders congratulate themselves for nearly completing their so-called "banking union", many analysts and officials - including at the top of the European Central Bank, which is now responsible for supervising banks in the new system - worry that it has fallen far short of that goal.

Instead of setting up a new, pan-European system that will shoulder the financial burden through pooled public funds, most of the burden - especially for the next decade - will continue to be the responsibility of national governments or private investors, who are newly on the hook for a significant chunk of the costs of a bank collapse.

In other words, bank failures may no longer be shouldered mostly by taxpayers such as in Ireland's case. But they may look a lot more like Cyprus - where taxpayers and a large chunk of private creditors were all hit - something that may unnerve national treasuries and financial markets even more.

"The agreement means short- and medium-term costs will primarily be borne by the private sector and national budgets," said Mujtaba Rahman, head of European analysis at the Eurasia Group risk consultancy. "This is quite an achievement as banking union was supposed to break the interdependencies between weak banks and weak sovereigns, not reinforce them."

As with most deals in the EU, the idea of banking union started as a trade-off. At a secret gathering of finance ministers from the eurozone's four largest economies at Charles de Gaulle airport outside Paris in June 2012, Wolfgang Schauble, German finance minister, surprised his counterparts by agreeing to shared responsibility for rescuing European banks, but at a price: supervision of European banks should be taken out of the hands of national authorities.

One person in the meeting remembered that Mr Schauble so surprised his counterparts by the change of heart that Pierre Moscovici, French finance minister, wanted reassurance.

"It went so far, that Mr Moscovici even said, 'Excuse my question, but have you checked this with your chancellor?'" recalled the official.

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The German demand for EU supervision was agreed with relative speed and surprising clarity: the ECB will assume direct oversight of the eurozone's 130 largest banks late next year and will have ultimate responsibility for all 6,400 banks.

But the trade-off - shifting the financial burden for winding down or recapitalising failing banks - has proven far more fraught. Under the deal reached on Wednesday night, a new "single resolution fund" will not be "single" at all at the start. Instead, it will be separate pots of national money under an EU umbrella.

Over the course of 10 years, those national pots - which are funded through bank levies - will be gradually mutualised into a European fund, something many EU officials believed Germany would never agree to.

But that fund will total only €55bn when it is fully operational in 2026. The collapse that set off the Irish crisis, Anglo Irish Bank, alone cost more than €30bn, though it was under the EU's old rule book where senior creditors were not forced to accept losses.

The chance of the fund's money running out is very real, and Berlin has resisted the idea that any public money be used as a common EU safety net to that fund. As part of the new deal, that backstop will only be negotiated at a later time, something that has unnerved the ECB and other eurozone finance ministries.

Simon Gleeson, who works on banking regulation at Clifford Chance law firm, said the panic engendered by the eurozone crisis has led banks to "pull back behind national borders", arguing that Europe's financial system is now more national than it has been in more than a decade.

The new banking union deal, because it does not address the issues it was originally intended to tackle, will do nothing to fix that, he said.

"It is a classic European response," said Mr Gleeson. "They look at a problem, decide it is too difficult to solve, embark on something different and declare victory."

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