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Preventing a European Banking Crisis

Germany Fights Back

Written by Joseph Cafariello
Posted July 11, 2013 at 1:52PM

Commissioned by the European Union a year ago, E.U. financial regulation commissioner Michel Barnier this week unveiled a plan to create a single agency that will oversee the rescue of failing European banks.

The proposed Single Resolution Mechanism gives the E.U.’s European Commission the power to decide whether a troubled bank will be dissolved or bailed out and whether public funds should be used.

europe banking
Source: AFP/Getty Images

France, Italy, and several other countries quickly showed their support for the plan, which would distribute the pain of bank bailouts across all E.U. member states, an idea that financially troubled France and Italy would understandably favour.

But other governments, such as Germany, the Netherlands, Finland, Slovakia, and Estonia, are not very keen on the idea of a body not elected by their citizens dictating how their tax dollars should be used.

With five E.U. economies already brought to their knees by failing banking systems, and the continuing weakness of the euro, the pressure to cooperate with a plan is on. Will Europe ever be able to agree on a Union-wide banking safety-net? Will investing in Europe ever be safe again?

The Proposed Plan

Since 2009, state-wide banking failures in Europe have brought several nations to the brink of insolvency – if not to outright bankruptcy – especially the smaller nations of Ireland, Iceland, Portugal, Greece, and Cyprus. More recently, even larger countries such as Spain, Italy, and France, to a limited degree, have taken hits to their economies.

Destabilizing the Eurozone all the more are the punitively high borrowing costs imposed on failing countries, which prolong recovery and stifle trade, ultimately affecting even those countries whose banking systems were sound. And the financial flu spreads.

“We have seen how the collapse of a major cross-border bank can lead to a complex and confusing situation,” Barnier qualified before reporters, as cited by Reuters. “We need a system which can deliver decisions quickly and efficiently, avoiding doubts on the impact on public finances, and with rules that create certainty in the market.”

To ensure such quick and decisive action, the Single Resolution Mechanism would create a single authority under the supervision of the European Central Bank, with powers to bail out, restructure, or close any Eurozone bank in danger of failing.

The single agency would be comprised of representatives of the European Central Bank, the European Commission, and member states of the European Union where the bank’s branches are located, which could include several countries in the case of a multi-national bank.

Any recommendation by the agency to shut down or restructure banks, reappropriate assets, or impose writedowns would override the banking authorities of any single member state but would still be subject to final approval by the European Commission, the E.U.’s regulatory branch.

It sounds like a great safety net, which would go a long way to strengthening confidence in Europe’s banking systems, not to mention preventing contagion across the continent.

But those who oppose the plan cite the one issue that has been a sticking point since the financial crisis first began: who pays for it all.

Funding and Sovereignty Objections

At its outset, the agency would be given €55 billion collected from bank levies, which would be used to support any failing banks. Over time, these levies would be scaled according to the riskiness of each bank’s activities.

Yet before these funds are used in a bank’s rescue, the plan’s guidelines require a failing bank’s shareholders and junior creditors to take losses first. There is even a guideline which we 99%-ers can delight in: the salaries and bonuses paid by a rescued bank must be reasonably capped.

Only after such measures are executed would the agency’s funds be used. European states and their taxpayers would be called upon to pay into a bailout only as a last resort.

Opponents, however, fear that the new agency would be given powers over another sovereign nation’s finances and taxpayer money, not to mention the restructuring or closing of its banks.

As Alexandria Carr, lawyer with London firm Mayer Brown, underscores to the New York Times:

“Giving the commission the power to close banks ‘is arguably the greatest transfer of sovereignty in the history of the E.U. and points toward a fiscal, as well as economic and monetary, union’”.

But not all in the E.U. want such a cozy union. How much authority will this centralized agency have over the finances of member states? And what recourses will there be for disputing the body’s decisions?

“We have to stick to the legal basis we have. Otherwise, we will fail and we will create new uncertainty in markets,” German finance minister Wolfgang Schäuble advised other European finance ministers, as transcribed by the New York Times.

As the German government has repeatedly pointed out, the current framework of treaties linking European states into a union does not allow for any single member state’s finances to be allocated or used without that state’s consent. As such, the Single Resolution Mechanism would have no legal foundation upon which to administer the authority proposed for it.

Addressing Germany’s concern, Barnier insisted to Bloomberg that “the text states explicitly that the resolution board would not, in any scenario, be allowed to commit a member state’s public money without its agreement ... The German legal point is linked in particular to the question of fiscal sovereignty, and we are going to solve it,” he reassured.

Investment Uncertainties

For a plan whose purpose is to stabilize Europe’s economies, take the turbulence out of its investment climate, and instil confidence in its banking systems, the Single Resolution Mechanism has managed to stir up more division than there ever was.

And that division extends clear across to the other end of the spectrum, too. While Germany and others want the plan to be less imposing, Italy insists it should be more.

Governing Council member and governor of the Bank of Italy, Ignazio Visco, expressed his concern to Bloomberg that the plan as is “won’t break the vicious circle between the conditions of sovereign debtors and those of the banks and eliminate the national fragmentation of financial markets.” In essence, it won’t stop the bickering unless it is firmer and has more bite.

Visco is right about one thing at least, there is no end to the bickering, which the Single Resolution Mechanisms has excited all the more.

Europe is going through a major shift. It used to be so much simpler for the continent when all it had was the simpler European Economic Community, just a larger version of the U.S.-Mexico-Canada free-trade agreement.

But when its hand shakes were replaced by embraces as the EEC evolved into the E.U., the ensemble grew cosier and more intimate. Now they are bordering on crossing into another frontier – that of fiscal union. And what will comes after that? Political union, akin to America’s federation of states?

Despite the growing pains and turbulence as the governments of Europe continually tweak and improve their union, there are still solid companies and industries to invest in. As long as investors are aware of the increased risks.

Europe’s banking systems need to be evaluated on a case by case basis; not all are strong, yet not all are weak. Bond investing in Europe must also be considered on a country-basis, as yields will range from 2 or 3% in Germany to the low teens in Greece. And regions must similarly be scrutinized for their investment climate one by one.

Europe’s investments as much as its politics make for an uneven landscape that should be traversed carefully.

Joseph Cafariello


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