Bailing In while Bailing Out
European finance ministers have finally agreed to a set of rules that should govern future bank resolutions, i.e. clarify who will pay for shutting down failing institutions. If the aim of the deal, reached in the early morning hours of June 27th, was to be at the same time both clear and fuzzy, it succeeded beyond expectations. By spelling out strict Europe wide bail-in rules while preserving some discretion for member countries, the deal is deeply contradictory. It is a great example of European diplomacy and the member states’ willingness to find common ground, at almost any cost.
Whether the new rules—if and once approved by the EU parliament—will contribute to a stronger European banking sector is a different matter entirely. Indeed, the first reaction I received from an economist in Washington was, “flexible but rigid? What is this, an ad for a mattress?”
Well, yes, sort of. A first look at the deal does create the impression that there will be a clear Europe-wide pecking order in future instances of banks needing to be wound up. Yet a closer examination reveals the rules allow for a very different reality.
While it is true that equity holders and different classes of creditors will be asked to bleed before member state resolution funds and the European Stability Mechanism (ESM) come to the rescue, under certain conditions, EU member countries can still choose who pays for what and when. This national flexibility fosters uncertainty and will likely confuse investors. These investors will probably continue to treat banks from individual countries differently. The new rules will neither succeed in reversing financial fragmentation within the euro zone, nor sever the vicious link between banks and their sovereigns.
Then there is the issue of timing. Contrary to earlier attempts made by the European Central Bank to accelerate the implementation of the new regime to 2015 (ECB board member Joerg Asmussen asked for it at the Eurogroup meeting in Dublin in April 2013), under the current deal the bank resolution mechanism would only come into force in 2018. The vulnerable EU banking sector would be left in a no man’s land for five long years. In the meantime, the single supervisor, i.e. the ECB, would be forced to think carefully before exposing weak banks to public scrutiny, as there will be no functioning cross border resolution mechanism to deal with a failing bank for quite some time—apart from the possibility to use 60 billion euros from the European Stability Mechanism (ESM) for direct recapitalizations of banks.
The clean up of banks remains largely in the hands of national authorities and the institutions themselves. Under current plans, the template for bank rescues between now and 2018 would remain a combination of what happened in Cyprus and Spain with a mixture of bail-ins and bailouts. Such a mechanism would depend on how systemically important one’s banking sector is and where the member country ranks in the European pecking order.
Indeed, the deal struck in Brussels on June 27th reflects the current state of Franco-German affairs. France had pushed Germany to accept a full banking union for a year, yet it backpedaled when the government in Berlin finally agreed to potentially sweeping changes. Paris ended up choosing the highest possible degree of national independence over true integration. Chancellor Angela Merkel got what she wanted all along, namely the responsibility by member states to address so-called “legacy” challenges largely on their own. The deal exposes Franco- German bluffs and counter bluffs.
Paris expects almost unlimited German financial solidarity but is not willing to give up its own sovereignty. Germany’s chancellor is only willing to offer more solidarity, and therefore accept further transfer of powers to supranational authorities, if member states do their homework first. In her mind, integration is a reward, not a solution. Only when all current problems are solved, i.e, by 2018, could Europeans finally move into a new banking paradise, where financial institutions are solid and do not fail. In the event that they do fail, taxpayers can be shielded from losses.
But 2018 is a long way away, and many European countries are too weakened by the crisis to clean up their own banking sector without any significant outside help. As long as France and Germany don’t agree to speed up the process of real financial integration, the uncertainty about the future shape of Europe’s banking sector will continue to be a drag on the real economy and make the European journey a very rough one.