This week, the Eurogroup (Ministers of Finance of all Eurozone countries) agreed on some reforms for the banking union and Eurozone governance. As always, it is two steps forward and one step back. There has been an important step towards creating a backstop for the Single Resolution Fund (in the form of a revolving credit line from the ESM), which will strengthen the resolution component of the banking union. Having access to the necessary funding (even if only for transitional needs) provides supervisory and resolution authorities more options and stronger incentives to intervene in time. Moving towards a Eurozone-level deposit insurance, on the other hand, has been referred to yet another High-level Working Group, which is supposed to report back by June 2019 – typical can kicking. While one might see backstop and Eurozone deposit insurance as substitutes, creating a common backstop specifically for depositors in the form of a Eurozone deposit insurance can help create stronger confidence in the banking system in some periphery countries where the national backstop to the deposit insurance is not trusted and might also help to move the Eurozone towards a Single Market in banking.
Beyond the rather slow progress towards a complete banking union, one major gap is the refusal to address the stock problems in the Eurozone, most notably the large share of NPLs in Italy and other countries. I know I sound like a broken record (here, here and here), but the refusal to address these stock problems will also prevent further progress towards a full-fledged banking union that allows for full risk-sharing and is the regulatory fundament for a Single Banking market in the Eurozone. As long as creditor countries in the North of Europe are afraid of having to foot an open bill for legacy problems in the South, they will be reluctant to move to complete risk sharing. Simply waiting for these problems to disappear (also known as flow solution) or national governments to address them (after they have dragged their feet for the past ten years), however, seems somewhat disingenuous.
This constraint is also reflected in the discussion on sovereign restructuring mechanisms and the role of the ESM, given the sovereign fragility of Italy. The idea of allowing for a restructuring mechanism for sovereign debt (similar to the bail-in regime for banks) has not been adopted and the aim is now to rather introduce single limb collective action clauses (allowing for one resolution decision to cover all bonds) by 2022 and enable the ESM to facilitate a dialogue between debtholders and Eurozone governments in times of crises. In addition, precautionary credit lines from ESM for countries are planned, with conditionality imposed and monitored by the European Commission. While this might strengthen market discipline to a certain extent, the introduction of risk sharing mechanisms in the form of common fiscal policy has been left for future discussions.
As always, the question is whether the glass is half full or half empty. Maybe a different question is whether the glass will break with the next earthquake – will the necessary reforms only be undertaken when there is an acute need or will the Eurozone and its banking system enter the next crisis better prepared?
On a somewhat different, but related note, the appointment of Jakob of Weizsaecker as chief economist in the German Ministry of Finance is an incredibly good and important signal that the German government might finally move away from an exclusive focus on market discipline to a more holistic view on the Eurozone governance structure. Jakob has actively participated on the discussion on Eurozone reforms over the past ten years, with innovative proposals, so we might see a shift in the role of the German government in these discussions (where his appointment already signals a possible shift in thinking).
6. Dec, 2018