Opinion

Getting eurozone deposit insurance right promises benefits

EU-wide security of savings must be considered in order to take banking union seriously. Banks' holdings of government bonds must be limited.

By: and Date: January 5, 2016 Topic: Finance & Financial Regulation

This op-ed was also published in The Banker, Caixin, Die Zeit,  Finance, El Economista, and Dziennik Gazeta Prawna.

the bankerDie_Zeit-Logo-Bremen.svgcaixinFinance (slovenia) logo

el economista logo

Dziennik-Gazeta-Prawna-2011_ok_CMYK_bez_cienia-300x65

The European Commission presented its proposals for European deposit insurance last November. Officials hope to stabilise the banking system and decouple banks’ financing costs from the solvency of their host states. This would achieve the original aim of Banking Union: to break the link between states and their banking systems.

But the proposals are met with fierce resistance as the popular assessment is often that tax payers in the North of Europe would have to pay for “rotten” banks in the South of the European Union. German critics in particular have called the proposal an “attack on German savings” and point to high levels of public debt on the books of banks in Southern Europe but they also worry about high levels of non-performing loans.

But a sensible banking union necessarily requires common deposit insurance. Achieving it requires not only attention to details but especially a clear risk sharing and risk reduction strategy. There are various potential models for a European deposit insurance scheme. The most fundamental differences regard the size of the national and European components.

On the one hand, deposit insurance can be a purely national matter. In fact, some EU countries have not yet implemented the minimum level of legally required national deposit insurances – a step that needs to be fulfilled before any further steps with cross-country schemes can be designed. The credibility of national insurance depends on the size of the fund, the health of the national banking sector and state finances, since deposit insurance schemes generally call on the state as a backstop guarantor. But the financial crisis showed that this final aspect can be problematic when states have insufficient resources. This creates major tensions in the banking system, which in turn place burdens on the European Central Bank that push it to the limit of its mandate.

On the other hand is a deposit insurance scheme entirely at the European level. The quality of deposit insurance would thus be totally independent of the individual countries’ policies. However this would create a problem with incentives, where truly shared liability tempts policymakers to dump costs on others. States with less rigorous rules might feel only weak pressure to improve the regulatory framework of their financial system. This would be the case, for instance, with minimum loan-to-value ratios for mortgages or the treatment of foreign currency loans. Through such rules, states influence banks’ risks. Even more relevant, though, is the large exposure of banks to sovereign debt.

The European Commission has now proposed a middle-way: a European deposit re-insurance scheme with a certain national component and a re-insurance with a European pool if national funds are insufficient. Such a system would indeed reduce the risk of “moral hazard” in the sense that the first loss is with the national systems. But the ties binding the banking sector to national fiscal and economic risks would only be weakened, not fully severed. In particular, any national banking crisis would lead to significant disadvantages for all banks located in that country as they would be faced with a higher premium for their deposit insurance. Therefore, in the long run, this cannot be seen as a satisfactory endpoint for Banking Union.

One of the main problems with the current situation is that a single common banking supervisor is pitted against strong national responsibilities. Because national differences remain, governments would understandably want to get involved in the supervision of banks as well. On the other hand, national governments would have a strong case that liabilities for problems that were not discovered in good time by the common supervisor are not theirs.

A coherent solution would be to create a European deposit insurance and resolution authority. Much like the USA’s Federal Deposit Insurance Corporation (FDIC) this authority would take total responsibility for the insurance of deposits. It could fall back on reinsurance from the European taxpayer when even hard bail-in rules are not sufficient to pass on losses to private creditors. However, such a system requires that banks become fundamentally “European”, and, in particular, that they hold fewer government bonds on their books.

A common upper limit on the proportion of government bonds on banks’ balance sheets is thus a vital prerequisite for European deposit insurance. Since this upper limit would be applied in all countries, banks would be incentivized to diversify their government bond portfolio to bonds from governments other than the one in which they are located. The link between banking sectors and states lies not only in implicit and explicit liability; it lies primarily in the huge quantities of domestic government bonds that banks buy. The diversification would reduce that link.

Germany, which is strongly opposing a true Europeanisation of deposit insurance, also has much to gain if Europe’s banking system can finally achieve stability. It can only be won over, though, if this risk sharing is complemented with risk reduction. For once, the ECB would no longer have to assume indirect liability. The German and European banking systems would also become more efficient, since loans would be approved according to economic rather than political criteria.

 

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read about event More on this topic
 

Upcoming Event

Mar
25
14:00

The state of the policy debate on the EU crisis management and deposit insurance framework

This members-only event welcomes Elke Koenig, Chair of the Single Resolution Board for an conversation with an invited audience.

Speakers: Elke König and Nicolas Véron Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author
 

Blog Post

Can the gap in the Europe’s internal market for banking services be bridged?

The European Union has made significant progress to a more unified banking market but frictions remain between euro and non-euro countries. Without a coordinated approach to remaining issues in completing banking union, the gap could widen.

By: Thomas Wieser Topic: Finance & Financial Regulation Date: December 7, 2020
Read article More on this topic
 

Blog Post

The impact of the crisis on smaller companies and new mechanisms for non-performing loans

The ongoing recession will result in a fresh surge in non-performing loans (NPLs) once payment holidays and moratoria end later this year. NPL investors played a valuable role in tackling the stock of problem loans from the last crisis, but in the aftermath of the current recession more complex financial restructuring will be needed. Governments should facilitate the refinancing of distressed but viable companies, possibly through a special regime for SMEs.

By: Alexander Lehmann and Bruegel Topic: Finance & Financial Regulation Date: July 22, 2020
Read about event More on this topic
 

Past Event

Past Event

Tackling too-big-to-fail banks: have the reforms been effective?

Evaluation of the global reforms implemented to deal with "too-big-to-fail banks".

Speakers: Alexandre Birry, Claudia M. Buch and Nicolas Véron Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 9, 2020
Read article More on this topic More by this author
 

Blog Post

Banks in pandemic turmoil

The banking system is critical to society and requires attention and support. In doing so, however, tough love is preferable to complacency.

By: Nicolas Véron Topic: Finance & Financial Regulation Date: March 24, 2020
Read article More on this topic
 

Blog Post

A European anti-money laundering supervisor: From vision to legislation

In fighting anti-money laundering, the European Commission should act fast toward creating a central supervisory authority.

By: Joshua Kirschenbaum, Nicolas Véron and Bruegel Topic: European Macroeconomics & Governance Date: January 24, 2020
Read article More on this topic
 

Blog Post

Non-performing loans’ legacy versus secondary markets

Eleven years since the start of Europe’s financial crisis, and the legacy of non-performing loans in the EU, though much smaller, is still a live issue for some member states.

By: Joanna Surala and Bruegel Topic: Finance & Financial Regulation Date: December 10, 2019
Read article
 

Blog Post

Bank regulation in the European Union neighbourhood: limits of the ‘Brussels effect’

The EU model of financial market regulation is increasingly copied by third countries. In this context, the EU’s efforts to promote its model beyond its borders should take into account the underdevelopment of financial markets in many partner countries, and the often insufficient capacity of regulators and supervisors.

By: Alexander Lehmann and Bruegel Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: November 20, 2019
Read article Download PDF
 

Policy Contribution

Crisis management for euro-area banks in central Europe

Euro-area bank integration has decreased as post-financial crisis national rules require banks to hold more capital at home. It might be undermined further by bank resolution planning. Either a Single Resolution Board takes the lead for the entire banking group or independent local intervention schemes need to be developed for crisis resolution.

By: Alexander Lehmann and Bruegel Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: November 19, 2019
Read article More on this topic
 

Opinion

Upbeat outlook from Chinese banks' profits masks growing problems for small banks

The performance of Chinese banks has been resilient so far, despite decelerating growth. While the performance of large banks remained steady, the rebound came from small banks. Why have small banks rebounded and is the rebound sustainable?

By: Alicia García-Herrero, Gary Ng and Bruegel Topic: Global Economics & Governance Date: November 12, 2019
Read article More on this topic
 

Opinion

China's dual banking system: consolidation as the final solution for weak small banks

There are fundamental solvency and liquidity issues for some small Chinese banks, widely influencing both the bond market as well as the broader financial sector. Given the difficulties in creating a level playing field between small and large banks, there is an expectation that small banks will continue to under-perform.

By: Alicia García-Herrero, Gary Ng and Bruegel Topic: Finance & Financial Regulation Date: September 16, 2019
Read article More on this topic
 

Podcast

Podcast

Backstage at BAM19: How much further reform is needed for the new financial sector?

Backstage at the Bruegel Annual Meetings, Rebecca Christie talks with Nicolas Véron on the new financial sector.

By: The Sound of Economics and Bruegel Topic: Finance & Financial Regulation Date: September 5, 2019
Load more posts