Blog Post

Europe rightly pursues the road to a single resolution mechanism

European leaders continue to negotiate the most desirable structure of a single resolution mechanism. Making significant progress on that front is of central importance, as we have argued in a recent piece to the informal ECOFIN (link). The single most important reason why it is important relates to the reshaping of Europe's financial system.

By: Date: January 8, 2014 Topic: Macroeconomic policy

European leaders continue to negotiate the most desirable structure of a single resolution mechanism. Making significant progress on that front is of central importance, as we have argued in a recent piece to the informal ECOFIN. The single most important reason why it is important relates to the reshaping of Europe’s financial system.

Since the onset of the crisis, much of the pre-crisis financial integration was undone. This led to serious divergence of financing conditions, combined with a grave slump in economic activity in the countries most affected by prohibitive financing conditions.

The decision to move ahead with a banking union together with the ECB’ OMT programme have since greatly stabilised the situation, and funding has been coming back to a number of euro area countries.

The ideal next step forward would be to create a strong centralised resolution authority with a common fiscal backstop. Yet, this solution is proving to be difficult to achieve in a short enough time span to be operational next year, when the ECB’s asset quality review will likely trigger a number of important decisions on bank recapitalisation, resolution, as well as bank mergers.

Suppose it may not be possible to agree on such an ideal solution quickly. Should the best approach be to drop the attempt to organise a somewhat centralised resolution or would it rather be advisable to completely give up on the idea for now and move instead to purely national resolution. I am deeply convinced that even a less than perfect solution would be preferable to no agreement at all. There are three central reasons for this assessment.

  1. A complete failure and no agreement on any form of common bank resolution would be seen by citizens and markets as a clear failure, and as a signal that Europe is not ready to proceed any further on integration. The consequences would be radical. Markets would re-fragment along national borders. Banks would retreat behind national borders, and funding costs would start to diverge dramatically again. With an increasingly fragmented financial system, the fear of a break-up of the euro area would resurface, as markets would rightly see an inconsistency between purely national finance and monetary integration. This would undermine the little investment and growth prospects that returned this year. A deep recession would result.
  2. Bank resolution without any outside involvement is unlikely to be meaningful. One of the central reasons why bank resolution has been slow and regulatory forbearance prevalent was the fact that national political systems and banks are closely intertwined making hard bail-in decisions difficult. The result was considerably more bank bailout programmes in the euro area, than for example in the US. There is no reason to believe that national authorities that have not been addressing banking problems for several years will be likely to do so once they know that no resolution mechanism is in sight. Bank resolution in other countries will not likely impress a previously passive regulatory system.
  3. The ECB will find it much more difficult to act decisively as a supervisor if there is no agreement on any kind on resolution mechanism. This may have negative credibility effects on its monetary policy operations.

Europe should therefore move forward, as agreed by the European Council, with a next step towards banking union. A perfect solution may eventually require a Treaty change. But already in the current treaties much can be achieved. A sense of direction is of central importance for growth and stability in Europe. The alternative road towards decentralization could be hugely destabilising.


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