European Banking Union Explained

The much talked about European Banking Union proposals has been making news on and off. For a complex set up such as the European Union which is comprised of various sovereign countries, in this article we explain the basics of the European Banking Union, the purpose of setting up the banking union and its far reaching implications on the Eurozone member countries. If one has to summarize the EU Banking Union proposal, it can be said that the idea is to break the vicious circle between the banking systems and their respective governments in order to create buffers of financial ‘safety nets’ to avoid a repeat of the financial crisis.

European Banking Union – Brief History & Context

The idea of establishing a common banking union across the Eurozone was highlighted after the Eurozone financial crisis, which crippled countries such as Ireland, Portugal, Spain and Greece, followed by the brief shocks from Cyprus. In late 2012, the European Commission proposed a common banking union with the intention of giving the European Central Bank (ECB) supervisory powers to oversee the regions central banks. The idea has been floating around since 2007 and soon moved to the top of the agenda during and after the European financial crisis.

The proposal aims to make the ECB as a central supervisory authority and gives its powers such as issuing licenses for credit and financial institutions, ensuring that the Eurozone banks comply with the regions banking policies and last but not the least, gives power to the ECB to close down banks if required.

The intention of the EU banking union is to create a direct link between the ECB and the Eurozone member nation’s Central bank so as to avoid national budgets. By bringing the regional central banks under the ECB supervision, the EU banking union hopes that funds are allocated at the EU level, especially for troubled banks so that it may relieve pressure on the sovereign governments.

If one can recollect how the Greece and Spain’s banking systems failed or even Ireland for that matter, it is easy to see how the banking systems are closely tied to their respective governments. While Spain for example saw a failing banking system, in Greece it was the opposite, where the banks had to bear the brunt of the soverign default on the debts. Further more, the Cyprus crisis highlighted even more critical risks as at one point the EU proposed taxing the average citizen’s savings deposits (but thankfully retracted their statements).

The banking union deals with three main aspects:

  • to create a single banking supervisory body (given to the ECB)
  • to create a common bank crisis management and resolution system
  • to create a uniform system for protecting savings deposits

Why call for a Banking Union?

At the most fundamental level, the push for the banking union comes out of the fact that there is no financial safety net for the Eurozone. While the ECB in effect is the lender of last resort, as we have seen many a times, the institution is inadequate in discharging its responsibilities. This is partly because the ECB has limited information about the regional banks and secondly it has no authority to directly intervene. Combine this with the fact that the sovereign governments of the Eurozone, whose job it is to intervene when required tend to look the other way until things get critical.

The ECB therefore makes a case for having more direct involvement in the Eurozone banks.

Banking Union – The Debates & Obstacles

There have been been voices, loud and clear from both sides of the table. While some welcome the move, there are an equal number who oppose the move. Critics of the Banking Union state that the banking union should be set up on a long term basis and cites the fact that addressing just the banking system would not solve the issue at hand, but also the sovereign sector needs to be reigned in, which implies that due diligence and controls should be in place for the bond/debt markets. Some even call for a creation of diversified bond holdings of banks and creation of synthetic Eurozone bonds.

Another point raised by the critics is that the ECB’s supervisory powers might seem lenient as it would effectively be concerned with preventing a contagion as compared to the sovereign governments dealing with the crisis which aims to resolve the root cause of the problem. Secondly, by creating a tight banking system, the effects of contagion are more easily spread, some analysts argue.

Besides the critics another factor that is proving to be an obstacle is the regional governance itself. Because financial aid to help banks and credit systems in crisis is primarily funded by the tax payer, there have been growing objections, as we have seen during the Greece crisis where initially Germany (followed by the Troika) had to impose strict haircuts in order for the country to receive the bailout aid.

The bottom line to the EU banking union is that despite policy makers trying to push for an ambitious timetable, there are still many issues that are yet to be addressed; such as the political legitimacy, sustainability of the single currency; interdependence with other countries and losing certain aspects of autonomy for the sovereign governments.

About the author: Editorial Team

ForexPromos Editorial Team is comprised of a selection of hand picked editors that bring you the latest breaking news from the financial markets. We also provide forex educative articles as well as comprehensive fx broker reviews.

Related Posts