Blog Post

Continued financial fragmentation will put ECB on the hook

Failure to agree on a strong banking union will push more responsibilities onto the ECB. The introduction of tough bail-in rules, higher capital levels and a common insurance fund backed by an ESM credit line within a shorter time period would make the job of the ECB easier and could save tax payers’ money. It would also facilitate the recovery in Europe’s South. The ECOFIN should be bold.

By: Date: January 8, 2014 Topic: European Macroeconomics & Governance

Europe is coming closer to a deal on banking union. The creation of the single resolution mechanism and the single resolution fund is its most important element and the hope is to conclude discussion next week. Well designed, it would end financial fragmentation and lead to a desirable and needed convergence in funding conditions throughout the single currency area. An insufficient agreement next week at the ECOFIN and the European Council would put the ECB in an awkward situation and may force the ECB to engage in non-standard monetary policy measures to fulfil its mandate.

The ECOFIN next week intends to finalise the work on the single resolution mechanism and the fiscal back-stop. Some of the elements of the deal that have leaked from the ECOFIN meeting this week are encouraging. The bail-in instrument will be advanced to 2016 helping to reduce the bill for tax payers. Yet, depending on the final agreement, the deal could be insufficient to end financial fragmentation and fix Europe’s banking problems. For a very long period, national bank insurance funds will have to shoulder the largest part of the costs. With only a few large banks per country, national funds will be insufficient in case of one of them facing a problem. Indeed, an insurance requires many banks to participate. Put differently, if a large national bank was to face trouble, the national insurance fund would be insufficient and national tax payers would have to foot the bill. A common insurance fund paid by bank levies from the banks supervised by the ECB would make sense for the German tax payer also, as the risk would be spread over a larger geographic area.

But the basic elements of the deal also suggest that banks will face different funding conditions for an extended period. Banks in countries with weaker public finances will have to pay a risk premium because of their location. Banks in countries with larger banking systems compared to GDP will be put at a structural disadvantage. Banks in Germany will benefit from the value of the best state guarantee that the German state provides. As a result, interest rates on credit will be different for a long time. A good company in Europe’s South will not be able to access affordable credit. Yet, without credit, the recovery will not come and the downward dynamics observed in Europe’s South will continue.

Confronted with this situation, the ECB will be faced with increasing pressure to act and the case for more action is actually compelling. Inflation rates have been falling throughout the euro area also because the ECB’s monetary policy signals do not reach the households and corporations in Europe’s South. The different levels of state guarantees and the unfinished cleaning-up of balance sheets is impairing the monetary transmission channel. The best way to fix it would have been to clean the balance sheets and afterwards put in place a common backstop. Now the ECB may have to rely on non-standard policies or changes in the collateral framework.

Having to work with different levels of government guarantees for banks can also lead to conflicts of interest for the ECB. What if, in 5 years, a major bank faces massive capital shortfalls but the national fund and the government behind it would not have the resources to stem the problem? Should the ECB really risk another crisis and an ESM financial assistance programme or rather keep the bank alive with liquidity?

Failure to agree on a strong banking union will push more responsibilities onto the ECB. The introduction of tough bail-in rules, higher capital levels and a common insurance fund backed by an ESM credit line within a shorter time period would make the job of the ECB easier and could save tax payers’ money. It would also facilitate the recovery in Europe’s South. The ECOFIN should be bold.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More on this topic More by this author
 

Podcast

Podcast

REOPENING EUROPE - Reopening Common Good?

What should be the ground rules to support more sustainable business in a post-pandemic world?

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: August 12, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

REOPENING EUROPE - Reopening Tourism?

In this episode we unpack some reflections about tourism we have collected during the Reopening Europe journey.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: August 5, 2020
Read about event
 

Upcoming Event

Sep
1-3
09:00

Bruegel Annual Meetings 2020

The Annual Meetings are Bruegel's flagship event which gathers high-level speakers to discuss the economic topics that affect Europe and the world.

Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author
 

Podcast

Podcast

REOPENING EUROPE - Reopening Borders?

In June 2020, as Europe reopened after lockdown, we crossed ten national borders. We listened to diverse citizens, from passers-by to politicians, business people to artists, recording, documenting, and publishing stories.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: July 29, 2020
Read article
 

Blog Post

Is the EU Council agreement aligned with the Green Deal ambitions?

On 21 July, EU leaders agreed on a €1.8 trillion package that should boost the recovery after the COVID-19 crisis, but also contribute to the advancement of key EU societal objectives, starting with the climate transition. In this blog post we assess the green ambitions of the package and evaluate its consistency with the European Green Deal.

By: Grégory Claeys and Simone Tagliapietra Topic: Energy & Climate, European Macroeconomics & Governance Date: July 23, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

REOPENING EUROPE - Reopening Governance?

This is a summer feature of the Sound of Economics in cooperation with the Reopening Europe project.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: July 23, 2020
Read article More on this topic More by this author
 

Blog Post

Having the cake, but slicing it differently: how is the grand EU recovery fund allocated?

The European Commission’s original allocation mechanism really favoured lower-income countries and to a large extent was based on pre-COVID economic data. The modification adopted by the European Council gives more consideration to the country size and the adverse economic impact of COVID-19. As a consequence, by using the Commission’s May 2020 economic forecasts, I estimate that only Germany and France will get more grants from the EU’s recovery fund compared to the Commission’s original proposal, while other countries will get less.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: July 23, 2020
Read article More by this author
 

Opinion

The EU’s Opportunity to Turn Its Markets Toward the Future

Meeting the fiscal demands of COVID-19 will require the European Union to borrow on capital markets more than ever, and for European pension funds and households to look more widely for ways to build their nest eggs safely. The EU should take the challenges of the pandemic and Brexit as a chance to get its financial infrastructure house in order.

By: Rebecca Christie Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: July 16, 2020
Read article More by this author
 

Podcast

Podcast

The benefits of the single market - the case of last enlargement

As the Brexit negotiations are entering their final straight line, the question of trade agreements is heating up. Economists talk about the “cost of non Europe”. How much each country has gained from belonging to the EU’s single market? How much would it have missed out on if it didn’t belong to the single market? […]

By: The Sound of Economics Topic: European Macroeconomics & Governance, Global Economics & Governance Date: July 15, 2020
Read article More on this topic
 

Blog Post

Ukraine: trade reorientation from Russia to the EU

Over the past five years conflict has led to a deterioration of Russo-Ukrainian economic relations while ties with the EU have been deepened. This shift is evident in trade flows: the European Union has become Ukraine’s biggest trading partner, while China is poised to overtake Russia as its second. Natural gas imports from Russia, Ukraine’s prior Achilles heel, have been partially replaced by reverse deliveries from the EU and reduced as result of reform of the gas sector.

By: Marek Dabrowski, Marta Domínguez-Jiménez and Georg Zachmann Topic: European Macroeconomics & Governance Date: July 13, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

Apps without borders? How COVID-19 apps show the limits of the EU digital single market

In their toolkit against a pandemic that knows no borders, several EU countries have bet on new technology from our era of globalisation: digital contact tracing COVID-19 apps. But the way they've been rolled out illustrate troublesome limits to the EU digital single market.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: July 9, 2020
Read about event More on this topic
 

Past Event

Past Event

An EU budget for Europe's future with Johannes Hahn

How do we make the EU fit for future?

Speakers: Zsolt Darvas, Johannes Hahn and Mehreen Khan Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 7, 2020
Load more posts