European Banking Union

The crisis in the euro area revealed points of weakness in the architecture of the Monetary Union. It appeared that the common monetary policy also required a common system of banking supervision. Ultimately, this resulted in banking crises and bailouts at the taxpayers’ expense. In addition to weaknesses in national financial supervision, legal resolution options for banks in precarious situations are also lacking. This, along with a lack of capital requirements for government bonds meant that a shared risk was generated by the states and banks in the eurozone whereby sovereign debt crises and banking crises mutually reinforced each other. A banking union therefore seems necessary as a long-term framework for the completion of the European Monetary Union.

This report summarises the current proposals and decisions regarding the Banking Union and evaluates the Banking Union’s three pillars – banking supervision, bank resolution and common standards for deposit guarantees – from a regulatory economic perspective. Particular emphasis is placed on the proposed design of the resolution mechanism and coordination of national deposit guarantee systems and their consequences for Germany’s banking system. The consequences for private institutional guarantee systems are also analysed. The planned exemption provisions for creditor involvement are also discussed critically, as is the European Commission’s proposed right of last decision for cases of bank resolution and the lack of capital requirements for European government bonds.

Burden-sharing in bank resolution is also a point of contention. The European Commission favoured a common European Resolution Fund, while Germany instead preferred a network of national resolution funds. Both variants are contrasted with an alternative proposal by the Cologne Institute for Economic Research. This model avoids the situation automatically resulting in the pooling of costs and losses. The ministers of finance in the EU have agreed to a similar model. Under this plan, a network of national funds will gradually be transferred to a European fund.

The implementation of the Banking Union is discussed against the backdrop of still existing legacy liabilities in the bank balance sheets. To that end, the Cologne Institute for Economic Research proposes an alternative timetable for the implementation of the three pillars that would prevent excessive demands being placed on the Banking Union from legacy liabilities in the bank balance sheets. This proposal provides for a quarantine period for banks that do not qualify for the Banking Union under the audit. According to the proposal, they will be placed under special supervision by the European Central Bank (ECB) during this time and will be required to submit detailed restructuring plans. If the ECB does not approve these plans or if the restructuring objectives are not met, the Cologne Institute’s proposal stipulates resolution for the banks in question.

This report recommends further improvements on the previous plan for the Banking Union. In the process, reliable creditor involvement should be confirmed for bank resolutions as early as 2014. Furthermore, the Banking Union will be accompanied by risk-based capital requirements for government bonds. Through better risk provisions, banks, including their owners and creditors, must be robust enough to ensure that in the case of future banking crises, a burden on the taxpayer can be avoided as much as possible.