EU leaders leave critical issues on banking union unanswered

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Published October 19, 2012

| Reuters

EU leaders have agreed to allow the European Central Bank to supervise banks from next year, but questions remain about how the process will work, which lenders will be involved and whether those in trouble can be helped.

The European Commission has proposed making the ECB responsible for supervision as a step towards a banking union in which euro zone countries and any others that want to join would together resolve problem banks and protect savers' deposits.

But at a meeting of EU leaders that ended on Friday, issues such as what method will be used to accommodate non-euro nations that join the scheme, how many banks the ECB will directly supervise and whether that can lead to countries sharing the cost of resolving problems, were left undecided.

German Chancellor Angela Merkel acknowledged that the details needed to be worked out, including how the new supervision will fit with existing regulatory structures.

Poland, a non-euro-member country that is interested in joining the banking union scheme, underscored the complexity of the negotiations that lie ahead if the new supervision is to become a reality in the course of next year.

"Forecasts around the table on when it would start working last night were very different - some thought it would take 2-3 years," Prime Minister Donald Tusk told journalists.

Investors are following the negotiations closely in part because they expect cross-border supervision to allow the euro zone rescue fund, the European Stability Mechanism (ESM), to inject capital directly into struggling lenders.

This pledge, first made in June, helped drive down borrowing costs for countries such as Ireland and Spain.

Merkel signalled, however, that a further element of a banking union would first need to be in place before that can happen, namely the establishment of a resolution fund, and cautioned that direct aid would not cover existing problems.

"The critical question is whether the recapitalisation by the ESM of bad banks or problems of the past is possible," said Graham Bishop, an adviser to banks on European financial policy. "That has not been answered."

There are many hurdles to a banking union, each with the potential to delay or even derail the plan, which requires the approval of all 27 countries in the European Union.

The European Commission has proposed that the ECB should over time take charge of the roughly 6,000 euro zone banks. Merkel signalled that while some would be under direct ECB oversight, others would be under the watch of national supervisors.

Germany wants to keep oversight of its cooperative and savings banks but if it succeeds, other countries may demand the same.

The structure of the new supervisor and how it can be separated from the monetary policy arm of the ECB is also open.

"The German view is that interest-rate decisions should not be influenced by supervisory policy," said Guntram Wolff, an economist with Brussels think tank Bruegel. "In other words, the ECB should not cut interest rates to avoid closing a bank."

The thorny issue of including non-euro zone banks could also hamper negotiations. Countries that do not use the euro may find it difficult to join a banking union because legally, they would not be allowed to fully participate in supervisory decisions taken by the ECB.

Ultimately, a banking union is expected to establish financial backstops or central funds, paid into or guaranteed by banks or governments, to back problem lenders and shield savers. But such steps are a long way off.

Establishing a unified deposit-guarantee scheme would be a major stumbling block, with Germany regarding a single guarantee as akin to the mutualisation of euro zone debt - something it firmly opposes. The idea appears to have been dropped for now.

Setting up a scheme for the resolution or winding up of troubled banks could be similarly problematic.

David Mackie, an economist with JP Morgan, said even a simple banking union combined with other support measures would be sufficient to calm investors: "You don't have to have the federalist dream of full debt mutualisation or the euro bond."

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