Developments in the banking landscape
The European banking sector grew strongly in the years leading up to the crisis. In many countries, banks' balance sheet volume by far exceeded national income.Banks in several countries tookconsiderable risks. If a country's government is compelled to support banks on a large scale in a situation of crisis, this may have major consequences for its financial position.That risk materialised in a forceful way during the crisis. Problems at banks led to rapidly increasing public debt, for example in Ireland and Spain. In addition, governments' funding costs are at the heart of the funding costs in the economy and consequently those of banks. For that reason, banks are vulnerable to the credit rating of their country's government. This was the case in Greece and Portugal. The interaction between banks and governments caused a downward spiral and worsened the problems in these countries. Banks from other Member States also run risks, given that they have exposures to the countries and banks in question.
Proposals for a banking union
The creation of a European banking union as proposed at the Euro summit of 29 June 2012 serves to break these dynamics and strengthen the financial sector in the monetary union. The banking union will also contribute strongly to the functioning of the internal market.A banking union aims to bring supervision,resolution mechanisms and, possibly at a later stage, deposit guarantees up to a European level, with a view to preventing problems at banks or governments from causing a vicious cycle in individual Member States. Breaking the negative interaction will also improve the transmission of the monetary policy stance throughout the monetary union. In addition, as the funding costs of banks in a banking union will have less bearing on those of governments, lending rates between countries will vary less. To arrest the current downward spiral in some Member States, one of the agreements reached at the Euro summit was to recapitalise banks directly from the ESM. A banking union is a way to strengthen the European Monetary Union, as presented by President Van Rompuy in his vision for the future.
European supervision at the ECB
A key element of the banking union is to put an independent supranational authority in charge of European supervision. Agreement was reached on this point at the most recent Euro summit. European supervision will reduce the inclination of national supervisory authorities and governments to put off painful measures for their national banking sector or to paint too rosy a picture of the situation. It will also promote a level playing field for banks, ensure consistent regulatory requirements and prevent regulatory arbitrage. That way, supervision will be more in keeping with the current situation, in which many European banks operate across borders.The ECB will be responsible for European supervision, starting withsupervising banks that have received or applied for public financial support. In the period up to 1 March 2014, supervision will be expanded to cover significant banks in the euro area, i.e. banks with a balance sheet total exceeding either EUR 30 billion or 20% of their country's national income.The national supervisory authority, which together with the ECB forms part of the single supervisory mechanism, will remain responsible for the other, smaller, banks. The ECB may nevertheless decide at any time to take control of a given bank, thereby assuming ultimate responsibility for the entire banking supervision in the euro area. The most important prudential supervisory duties and powers will be transferred to the ECB, including the imposition of regulatory requirements relating to capital and liquidity as well as early intervention measures.The national supervisory authority will have a significant role in the preparation and implementationof the ECB's supervisory duties and decisions, in view of its knowledge, experience andresources. An effective start to European supervision will require an assessment of the banks' financial situation to prevent the European safety net from assuming hidden losses. With a view to differentiating from the monetary policy duties, a new Supervisory Board will be set up for the new supervisory duties within the ECB.
Resolution and funding
The second building block of the banking union is the development of a European resolution mechanism comprising a European resolution authority and a single fund. After all, even European supervision cannot rule out entirely the possibility of a bank collapsing. The resolution authority should be able to settle a bank failure in an orderly fashion and seek to find solutions in which shareholders and, where necessary, creditors are the first to sustain the losses. Temporary funding may be provided from the resolution fund, which will be financed ex ante by European banks. A resolution fund at European level will limit the financial risks for European governments as, in principle, banks are liquidated without national public funding. European governments will jointly provide a safety net only as a last resort, for example by means of the ESM. The third building block of the banking union, a European deposit guarantee scheme, may be added as the final element at a later stage to further break the negative interaction. To that end, harmonising national guarantee schemes with pre-funded schemes is a major step forward.
Correlation between the building blocks
It is important that supervision and the resolution mechanism, including funding, are set up simultaneously to the extent possible. This was also emphasised in the conclusions of the European government leaders, who seek to implement the resolution mechanism before June 2014. A situation in which only supervision is brought up to the European standard but in which the resolution mechanism remains national for the time being could give rise to conflicts of interest. For example, supervisory decisions to liquidate a bank would be taken at a central level whereas the bill of such decisions would have to be footed at a national level. "He who calls the tune must pay the piper" should be the guiding principle in this respect. Moreover, a simultaneous set-up reduces the risks for taxpayers because the European resolution authority will be able to prevent the costs from being passed on via European financing mechanisms by intervening at an early stage.