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Resolution mechanism, a major step but not the end of the story

March 30, 2014

Published in ‘New Europe’ Print and Digital Editions

Resolution mechanism“Today’s political agreement on the single resolution mechanism completes our banking union,” declared the European Commission’s President, José Manuel Barroso. So, is the banking union complete? Not quite, but a step has been taken—even though, it took lengthy negotiations among the main European member states, and finally a political compromise to reach an agreement.

But let’s take things from the start. The so-called “banking union” is an idea that was born out of the euro-zone crisis in 2012, and aimed at creating a centralized system for supervising EU’s too-big-to-fail banks. Its ultimate purpose is to prevent soverign debt crises from evolving into banking crises and vice versa. This system has three key components: a monitoring mechanism, a resolution mechanism, and a bank deposits guarantee scheme.After intense debate, the monitoring was assigned to the European Central Bank (ECB), but—at Germany’s insistence—only for “systemic” banks, thus excluding all the Landesbanken, which Germans wouldn’t want to see audited by an external authority. Under this arrangement, smaller banks, that aren’t a threat to the euro system, will continue to be supervised by the local central banks of the member states. Finally, the Single Supervisory Mechanism or SSM (in pure bureaucratic language) was created.

The second component is the the resolution authority, or Single Resolution Mechanism (SRM). The idea behind a Europe-wide authority is to avoid situations such the one that prevailed in Spain, where the local central bank long covered the banking system’s bad debts in order to avoid taking resolution decisions. Here again, Germany started by being opposed to the idea, claiming that a single authority would be impossible under current EU treaties, and proposed the creation of national resolution funds, each using its own funds for bank resolution and restructuring instead. Another thorny issue was that of decision-taking inside the authority; how would a member state be protected from an external decision to spend money from its budget in order to restructure one of its banks? A pure veto option, supported by several member states, would have undermined the very concept of the single resolution authority. Other solutions, such as giving the affected state’s vote more weight, or exercising some form of control on the authority’s board, were deemed unsatisfactory. Finally, a compromise was reached whereby ‘recommendations’ on whether to close down a bankrupt bank and how to share costs of such closing will be presented by a single resolution board, while the European Commission will have the final saying. In some limited cases, the member state concerned will be able to oppose the decision.

The resolution authority will be backed by a common fund of 55 billion euro that will be built up over eight years. The common fund will replace the national resolution funds, which will ultimately merge. This fund will have permission to tap the markets, but (at Germany’s request) will not get any government guarantees, neither will it be authorized to seek financing from the European Stability Mechanism (ESM)—another emergency fund set up to finance euro-zone governments in distress.

All in all, the adoption of the single resolution mechanism is a positive step towards common banking supervision. However, being a multilateral compromise, this system has several limitations that might render it inoperative. The scope of the mechanism is only limited to ‘systemic’ and ‘cross-border’ banks and does not apply to all banks operating within the EU, as the Commission and the Parliament had initially planned. The common resolution fund is too small to face a major bank restructuring (remember, Dexia cost around double the fund’s assets), and the time frame for its creation is too long—eight years, although European Commission negociators consider this a success against the initially planned ten year period). Finally, the decision mechanisms are too complicated, and full of tightrope walking; nobody can tell if all this is going to work in practice, or if it’ll end in deadlocks.

Apart from the supervision and resolutiom mechanisms, there is a third key component for the banking union to be complete: the common deposit guarantee scheme. Without such an EU-wide deposits insurance program, the whole supervision project cannot work. Let’s not forget, the ambitions are quite high—to avoid new bank bailouts with the taxpayers’ money. We’re not quite there yet.

http://www.neurope.eu/article/resolution-mechanism-major-step-not-end-story

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