As market observers will no doubt concur, nothing in Europe is ever straightforward. The European finance ministers finally reached an agreement on 13 December regarding the European banking supervisor. While this is welcome progress, questions remain unanswered, and some governments and their banks still have some difficult decisions to make.
Although there was general consensus that something needed to be done (and that it needed to be done quickly), questions are still being raised by the European Commission’s push for a Single Supervisory Mechanism (SSM) as a first step towards the banking union. European finance ministers reached a deal on rules for supervising the eurozone banks, a key step towards closer integration that was unthinkable just months ago, which also paves the way for the EU’s main rescue fund to come to the direct aid of struggling banks.
In terms of which banks this would cover, initially up to 200 of the biggest banks (arguably those deemed to be of systemic importance) would come under the direct oversight of the European Central Bank (ECB) via the new eurozone banking supervisor; these 200 banks would be joined by banks receiving support from the European Stability Mechanism (ESM). The fact that only 200 of the 6,000 banks in the eurozone would be covered is proof of remaining political resistance to closer European integration across the EU.
After much discussion on the decision-making mechanism of the SSM, it appears that the commission’s proposal can be put into place without having to change EU treaties and that it satisfies the concerns for a separation of supervisory and monetary policy functions of the ECB. Non-eurozone Member States can opt in and would have full and equal voting rights in the new ECB supervisory board. The board’s decisions will be deemed adopted unless rejected by the ECB governing council (which governs the eurozone). Opt-out Member States (the U.K. , and possibly Sweden and the Czech Republic) will be protected by proposed changes to the governance of the European Banking Authority (EBA).
Although the SSM is a great achievement, a joint deposit guarantee scheme (DGS) and a single resolution mechanism for winding up banks are also necessary to ensure implementation of SSM decisions and to break the link between EU banks and their governments (the source of many rating downgrades). These three phases cannot be viewed or addressed in isolation, and valid concerns are being raised that call this approach and the overall timetable into question. Despite there being political will to make this happen, there is the risk that this initiative will start to lose momentum as objections are raised when next steps and additional hurdles are identified. In particular, a joint DGS replacing the patchwork of national DGSs (with different rules and that are sometimes undercapitalized) would provide the greatest support to ailing banks in indebted eurozone countries such as Greece and Spain. But mutualization of bank debt is an anathema to some Member States such as Germany, at least in this form (intervention via the ESM is a preferred alternative). A single resolution mechanism is also controversial as it would impose painful and costly decisions on individual governments without a common DGS.
So much is yet to be agreed upon, and as always, “the devil is in the details”. How should this supervisor be staffed — with physical representation from each national regulator, or should existing mutual co-operation relationships be allowed to pertain? How is resolution going to be dealt with? How will the DGS work? What governance framework and fiscal backing is needed? Can a European banking union have credibility and proper functionality for European citizens and investors if the largest financial market remains outside the scope? More poignantly, can a financial system actually be separated from the underlying real economies? No one said building a federated Europe was going to be easy, just as no one said rebuilding trust in the financial system was going to be easy.
Our recently published Global Market Sentiment Survey sought out investors’ views on market sentiment, performance, and as market integrity issues for 2013. The survey illustrates that advanced economies are especially optimistic on global economic expansion next year, despite the continued worldwide impact of the European debt crisis. Even so, it’s important to remember that we are not out of the woods yet!