30 January 2019

Financial Times: Europe should be wary of the lure of bigger banks

Supplying kindling to the gathering flame, the regulator for banks in the eurozone — the European Central Bank — appears to be positively encouraging combinations. Danièle Nouy, the just-retired chair of the ECB’s Supervisory Board, has gone on record saying that the “European banking union sets the scene for banks to merge across borders”. And in the perennial joust between managements, who typically want to do deals, and shareholders, who tend to be sceptical, having the referee on your side clearly makes the desired result more likely.

But is it safe to have larger banks? Consider perhaps the most important lesson of the financial crisis from Mervyn King, then governor of the Bank of England: “Global banks are international in life, but national in death.” Put in practical terms, the 2008 rescue of the globally active Icelandic banks fell mainly on the narrow shoulders of Icelandic taxpayers. Crucially, this lesson is as relevant today as it was then.

But doesn’t the “banking union” Ms Nouy cited spread the burden of rescuing banks across all Europe’s taxpayers, not just a single country? Unfortunately not, since a Europe-wide deposit guarantee scheme — arguably the most important part of that union — remains out of reach.

Today, as in 2008, it will be down to taxpayers in the home country to rescue their own banks, something the chair of the eurozone’s Single Resolution Board, Elke König, admitted in a recent Financial Times interview.

But surely, at least, banks have shrunk enough today such that they are no longer too big to fail? Again, no. [...]

Finally, don’t new rules today mean that the cost of rescuing a bank falls on providers of bank capital and debt, not taxpayers? To an extent, yes; new rules provide some protection. But, in practice, it is clear that a large bank facing imminent collapse would not simply be allowed to fail once other providers of capital were fully wiped out. In the real world, taxpayers would again be required to step in, especially if failure to do so risked a systemic crisis. That is what happened in 2017 with the rescue of some small Italian banks. In reality we are a long way from ending “too big to fail”.

For European banks, getting bigger may feel like an attractive escape route after a painful decade. Unfortunately, it is rarely the right response for shareholders. But it would also be a worrying development for Europe’s citizens who still have to deal with the consequences of banks that become too big to bail.

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