Yes Virginia, There is a European Banking Union! But It May Not Make Your Wishes Come True

The paper discusses the prospects for European Banking Union as they appear in the summer of 2014. The first part gives an overview over the problems that gave rise to the Banking Union initiative, the second part discusses the legislative measures that have been taken towards this objective. The euro area is currently suffering from low growth, high indebtedness of private households and firms, banks, and governments, and the weakness of financial institutions. Weakness of financial institutions affects the economy not only in countries with outright banking crises and sovereign debt crises, but also in some of the core countries that so far have seemed more stable. ECB policies have so far stabilized the system without solving the underlying problems. At the national level, political will to solve the underlying problems is missing; most governments prefer procrastination over cleanups, some governments do not have the funds to recapitalize the banks of their countries, and some governments like their banks to borrow from the ECB and lend to them. The European Banking Union comes with a promise of reducing cross-border externalities in dealing with banks. However, the Single Supervisory Mechanism is hampered by the need to apply national laws that implement European directives; this makes for fragmentation even if the ECB is in charge. Moreover, procedures for the recovery and resolution of institutions in difficulties are problematic: If banks with systemically important operations in several countries enter into resolution, there is no way to prevent the breakdown of these operations and to limit the resulting systemic damage. Further, the legislation makes no provisions for the liquidity needed for maintaining systemically important operations at least temporarily. Finally, there is no fiscal backstop. Because of the deficiencies, the “too-big-to-fail” syndrome is still present. In view of the many legacy problems, this issue is critical. If the European Banking Union is to work, further reforms will be needed shortly.