Yet another “break- or-make” summit

European leaders met for yet another “break-or-make” summit. My sense is that we have gotten a relatively good deal but more summits will follow.  So the glass is half-full but governance by brinkmanship will continue. Here are some initial observations on the banking part of the deal.

1)      Leaders have now fully endorsed the view that the negative sovereign-banking loop needs to be stopped.  The statement is really strong on this.

2)      It is a major step forward to grant supervisory authority to the ECB or an institution at the ECB. As we have argued in a recent paper on the banking union, this is basically the necessary first step to introduce a common insurance.

3)      It is also a major step that the ESM will be given the possibility to directly capitalize banks in need once the ECB has the supervisory powers.

4)      The document says very little on bank resolution, except that capital injections into banks “… would rely on appropriate conditionality, including compliance with state aid rules, which should be institution specific, sector-specific or economy-wide and would be formalised in a Memorandum of Understanding.”

• There will have to be much more work done on who is actually going to do bank resolution and how. The statement suggests that the Commission will play somewhat of a role but this will need to be defined clearly. Most importantly, a strong governance will have to be put in place to allow the euro area to effectively take a decision to intervene in case of problems.

5)      It appears that the Euro Summit opens the scope for a re-negotiation of the Irish deal. Equal treatment certainly played a role and the Irish must have insisted that should Spain’s banking problems be Europeanized it would be unfair to keep the Irish banking problems for the Irish taxpayer.

• More important is, in my view, however the consideration that the euro leaders want to create a success story and make it possible that Ireland returns to the market next year. The Irish basically fulfilled their programme. To be able to regain market access, some debt relief may eventually become necessary.

6)      On Spain, it appears that we stay with the current model for the time being. However, seniority is removed. Only once ECB supervision is in place, the ESM will be able to directly inject capital. So instead of a 100bn increase in the debt level, perhaps only half of it will be on the books of the Spanish government.

7)      The removal of the preferred creditor status (PCS) will likely prove controversial. In Slovakia, PCS played a major role to get the ESM pass the ratification process. This is now somewhat being circumvented by agreeing that the EFSF would provide credits without preferred creditor status and then migrating these credits under the same conditions to the ESM.

• I am not sure, how the Bundestag will react on the matter in the ratification process of the ESM. See FAZ on the matter.
• It is unclear what PCS as enshrined in the ESM treaty means when the ESM gets to do equity injections into banks.