Banking Union Before Euro Adoption: Flak Jacket or Straitjacket?
IMF Blog, August 19, 2015
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- Authors: John Bluedorn, Anna Ilyina, Plamen Iossifov
- Published: August 19, 2015
Banking Union origins
- Rationale: The recent crisis led to the realization that a common currency area needed centralized bank supervision and resolution to overcome financial fragmentation and break the link between bank and sovereign stress.
- Elements:
- The two main arms of the Banking Union are the Single Supervisory Mechanism and the Single Resolution Mechanism.
- The Single Supervisory Mechanism (SSM) aims to raise the credibility and quality of bank supervision by removing the distinction between home and host supervisors.
- The Single Resolution Mechanism (SRM) aims to sever the links between bank and sovereign stress by unifying the bank resolution and restructuring frameworks across countries and providing a common, industry-funded backstop.
- The other two elements – a common fiscal backstop and common deposit insurance – are also essential to complete the Banking Union.
- Benefits:
- Raise the quality of supervision.
- Lower bank compliance costs.
- Remove existing barriers to cross-border banking activity.
- Lower resolution costs.
- Ultimately, lower bank funding costs.
Missing pieces
- With the SSM and SRM now operational, an effective common fiscal backstop is still needed to break the sovereign-bank links.
- The European Stability Mechanism (ESM) is currently acting as de facto common fiscal backstop for euro area banks, but its powers are limited and the threshold for access is high.
- The industry-financed Single Resolution Fund (SRF) will be fully funded and mutualized only by 2024.
- There is still no pan-European deposit guarantee scheme.
Different rules for non-euro area members
- Non-euro area members of the Banking Union would not be treated in the same way as the euro area members.
- Non-euro area countries are not members of the European Central Bank’s (ECB) Governing Council, which is charged with adopting decisions drafted by the SSM.
- Non-euro area opt-ins will not be eligible for direct bank recapitalization by the ESM.
- Non-euro area opt-ins would not have direct access to the ECB liquidity facilities.
Trade-offs when deciding to opt in before euro adoption
- Framework: The decision involves weighing LESS national policy flexibility against COMMON insurance.
- LESS national policy flexibility vs. COMMON insurance:
- Local supervisors currently have significant flexibility to impose macro- and micro-prudential requirements and use early intervention powers.
- Upon joining the Banking Union, some of this flexibility could be lost.
- Loss could be mitigated by access to common insurance—fiscal, industry-funded, and deposit insurance backstops—but some of these are not yet in place or not available to non-euro area BU members.
- LESS national control over cross-border flows vs. COMMON liquidity backstop:
- Membership would limit local authorities’ ability to ring-fence the euro area banks’ subsidiaries.
- This is important for the new EU member states, whose banking systems are dominated by the euro-area owned banks which are systemically important in the host countries but account for a small part of the parent bank balance sheets.
- Having less control over cross border flows in times of stress could be compensated by access to a common liquidity backstop; however, the latter is not available to the Banking Union opt-ins.
- LESS national control over bank resolution vs. COMMON resolution fund:
- Upon joining the Banking Union, decisions on whether or not to resolve a bank would be taken at the Banking Union level.
- Less control over resolution decisions could be compensated by access to a common backstop; however, until the SRF is fully mutualized, financing of the resolution process will remain largely a responsibility of individual countries.
Decisive factors for individual countries
- The cost-benefit analysis could lead to different conclusions for different countries, depending on their fundamentals.
- For some countries, an immediate boost to the quality and credibility of bank supervision and eventual access to larger backstops may outweigh other considerations.
- For others, the attractiveness of early opt-in will likely hinge on:
- The Banking Union’s ability to establish a fully equivalent treatment of euro area and non-euro area members.
- The Banking Union’s credibility and operational excellence.
John Bluedorn, Anna Ilyina, Plamen Iossifov; August 19, 2015.
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