European banking union risks sinking once again

David Chance

Optimism: Both Paschal Donohoe and his predecessor Jeroen Dijsselbloem have supported the banking union project. Photos: Douglas O'Connor and Luke MacGregor/Bloomberg

April 01 2021 02:30 AM

Earlier this month, Paschal Donohoe told eurozone finance ministers he would press on with plans for a European banking union, a measure that has been mooted for a decade and which aims to break the doom loop between banks and indebted governments.

At the same time back home, Mr Donohoe is presiding over the opposite as State-owned AIB and Permanent TSB move to carve up Ulster Bank between them.

Proposals for a banking union – and its sister capital markets union – are pieces of a jigsaw that would make financial crises less damaging and create a single market for finance, a measure that could cut hefty mortgage costs in Ireland.

As president of the Eurogroup, Minister Donohoe has little choice but to express optimism over the stalled project. His predecessor Jeroen Dijsselbloem promised the same, and if you can’t express your full support for a eurozone project in Brussels, where else can you do it?

The pandemic should have accelerated the process as a feared wave of unemployment and company bankruptcies could risk toppling weaker banks, especially in southern Europe.

Instead, it is mired in the biggest problem at the heart of the euro project – the lack of trust when it comes to transferring power from individual state bodies to higher level European Union institutions.

And right on cue last week – as if to prove that point – in stepped the German Constitutional Court in Karlsruhe (yet again) to bring the €750bn European recovery fund to a screeching halt by preventing the German president from signing it.

In a year, we have gone from Europe’s ‘Hamilton moment’ in agreeing to collective fiscal action with the creation of the recovery fund to an abrupt stop, if perhaps only a temporary one.

Banking is even more fragmented than it ever was and capital flows are stalled.

The Commission’s inept handling of the bloc’s vaccine rollout has also undermined trust in centralised European institutions.

Of the two parts of the banking union that have been implemented, only one actually works – the Single Supervisory Mechanism – while the Single Resolution Mechanism to clean up bad banks has been ignored as governments prefer to wash their dirty linen at home.

The Germans did this with NordLB, as did the Italians with Veneto Bank.

As a result of the failure to create an effective framework for banking – one that ensures that deposits across the bloc are covered – the market is now even more fragmented than it was when the reform proposals were launched in the wake of the financial crisis.

Cross-border capital has dried up and national authorities ensure their own banks have the capital and liquidity they need to operate at home.

At the same time as Mr Donohoe was urging ‘more Europe’, he was presiding over a very national fix at home to ensure that the departure of NatWest from the Irish market did not choke funding for local companies or stymie the mortgage market.

Ulster Bank looks set to be divvied up between AIB and PTSB, both of which are majority owned by the State.

At best, the banking union proposals could see agreement on a halfway house on deposit insurance in which national schemes back each other up. That is far short of the creation of a ‘safe asset’ and the pan-eurozone scheme that is really needed and may lumber the bloc with a sub-optimal outcome forever.

With eurozone governments piling up an extra €1.5trn in debt as a result of the pandemic, there is also a pressing need to stop banks loading up on their own government debt and risking another sovereign debt to banks crisis.

Still, there’s always the default option of leaving it all to the European Central Bank to keep on suppressing bond yields and spreads.