13 September 2012

Douglas J Elliott: Banking union faces long road ahead

The European Commission's detailed proposal for a "banking union" also underscores just how much still needs to be done, and how many political disputes need to be fought before such a union can be implemented.

Banks in many nations would be in much better shape if they did not own so many of their home country's bonds. That has often created a vicious circle where weakness at the government level and weakness at the banks have reinforced each other. Breaking that link through a banking union will hopefully reduce some of the risks facing the eurozone.

The real key for the immediate crisis is creating a common deposit guarantee fund, so that depositors in troubled nations can be sure their money will be safe even if their own country is too weak to back up the guarantee credibly.

A severe enough bank run could lead to a sovereign default or even withdrawal from the euro. Bolstering depositor confidence is key to preventing such runs. For similar reasons, it would be very useful, and probably necessary, to have a common "resolution" authority to handle banks that become insolvent or are about to do so, similar to America's FDIC. Furthermore, moving the deposit guarantees to the European level, and adding the responsibility for at least temporary funding for bank resolutions, spreads financial risk across the participating nations.

The strong countries will not agree to this without ensuring that a sound set of rules will be followed by all countries, and that supervisors will effectively oversee the safety and soundness of the banks.

All of these are good things, if executed correctly. But they also represent a big set of changes for these countries and their taxpayers. Proposals will be gone over with a fine tooth comb and national interests will be resolutely defended, although the common need to contain the euro crisis will certainly help goad leaders into reaching an agreement.

The bottom line

The banking union will come and it will be helpful, but expect a lot of bumps along the way and an extended timeline, unless markets induce another wave of crisis that forces Europe's leaders to put aside the smaller fights in order to save the entire system.

Among the difficulties ahead, the part of the banking union structure that is most directly about money -- the deposit guarantees -- was not included in this proposal. But it will be offered up at some future point.

Full article

© CNN