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Questions raised over ‘slowly emerging’ eurozone banking union

The system’s complex and hybrid nature raises questions about its effectiveness and the ramifications for national supervisory systems and, indeed, sovereignty – warns Paweł Tokarski

With deficiencies in the eurozone’s banking sector a constant source of trouble for the common currency, the European Central Bank is beginning a comprehensive assessment of financial institutions within the single currency bloc. This is an important practical step towards a banking union but is extremely challenging due to the scale and complexity of the undertaking. After completion of the review, an even more difficult task may be the costly and complicated resolutions actions against some banks.

Eurozone members are still struggling to create a supervisory system capable of handling their largest banks. The first component of this banking union, the Single Supervisory Mechanism, has finally been approved. In a year’s time, the ECB will therefore take responsibility for supervising the largest eurozone banks. In the interim the ECB, in cooperation with the European Banking Authority, national supervisory authorities and private firms specialising in audit – and asset evaluations – will review the financial health of the 128 largest banking groups.

Previously – the EBA quickly lost much of its credibility after performing a stress test, which was later undermined by events. And yet, governments and the financial-sector lobby will still be tempted to water down the review. The probability of leaks is certainly lower at the ECB than the European Commission. However, interested parties can nevertheless count on a steady flow of information. Even if they do not use this information to interfere with the review, any speculation about capital shortages may cause instability on the markets. Several questions still remain unanswered. One relates to how the exposure of banks to sovereign debt will be valued. Single currency governments have been buoyed by demand for bonds from private banks and have an incentive to portray them as safe.

Even more important, though, is what happens after the assessment: the supervisory system should have the capacity to resolve failing financial institutions so that the markets know it is capable of dealing with any fall-out from the review. Yet, the European Union still lacks credible national and supranational-level safety nets. Finance ministers held last minute talks on a Single Resolution Mechanism for restructuring or winding down failing banks and creating a resolution fund at the Brussels summit on December 18-19.

A separate inter-governmental treaty on the cross-border use of national funds has emerged as a precondition for the creation of a central fund. The European Council and the European Parliament managed, on December 11, to achieve a compromise on a Bank Restructuring and Resolution Directive – or the so-called ‘bail-in rules’. Under the terms of the directive, from 2016 the private sector will itself have to cover losses of up to 8 per cent of bank liabilities before national or eurozone assistance applies. This system should certainly save some taxpayer money although question marks still remain and there are potential loopholes in the system. In short, the banking union is slowly emerging. And yet the system’s complex and hybrid nature raises questions about its effectiveness under such time pressures.

A banking union poses an important dilemma for Poland and other non-eurozone countries. On the one hand, efforts to reduce instability and fragmentation in the single currency area’s financial sector, not to mention supervisory costs, are in everyone’s interests. Poland and other Central and East European states support for stronger EU supervision cannot be unconditional. Bank ownership in the CEE is dominated by large eurozone banking groups and there is some fear that the EU’s new supervisory system will give more weight to the interests of big eurozone banking groups than to their subsidiaries in Central Europe. What is more, the country’s deposit-guarantee system is better than in many eurozone states and the country’s financial supervisory commission enjoys respect.

Therefore the new bail-in rules should not deteriorate these national systems, which proved to be effective during the global financial meltdown. The Polish banking sector, the largest in the region, has come through the crisis without any major problems and its foreign-owned banks are therefore at risk principally from instability in their mother countries.

Warsaw must clearly push for the design of the banking union to be more inclusive towards the future euro area members and provide a level playing field between ‘ins’ and ‘pre-ins’, concerning not only participation in the decision-making process and access to information but also the bank recapitalisation tools. The extension of the EU balance-of-payments mechanism tasks for the recapitalisation of non-eurozone banks is so far difficult for Berlin and London to swallow.

Paweł Tokarski is a senior analyst at the Polish Institute of International Affairs think-tank

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