Blog post

A five-step guide to European banking union

Publishing date
09 November 2012

Eurozone leaders have decided to create a banking union to help break the vicious circle between banking fragility and state insolvency. This is a bold move and an adequate response to the growing financial fragmentation of the European currency area. Last week the European Commission tabled its proposals for a single supervisory mechanism. Discussions on concrete proposals will start soon. They are bound to be highly complex, technical and controversial, because mistrust prevails and because participant countries hold very different views. However, it is important they succeed, so here is our five-point guide for the negotiators.

1. Be comprehensive. A true banking union must involve supervision, as currently discussed, but also resolution – how to wind-down ailing institutions – and access to a common fiscal backstop. The three go together. Common supervision without any kind of fiscal backstop would ultimately mean that national taxpayers have to pay for the failures of the ECB supervisor. A common fiscal backstop without common resolution would also be recipe for conflict as national resolution authorities would have every incentive of shifting costs on the European taxpayer instead of “bailing in” the banks’ creditors. Having one element missing or poorly designed would undermine the whole. As for the space shuttle Challenger that exploded because of a tiny O-ring seal failure in the right rocket, banking union will be as effective as its weakest component. Indeed, getting even a small part wrong may undermine the effectiveness of an entire endeavour.

2. Don’t confuse legacy issues with permanent ones. Banking ailments are daunting, but banking union is not meant to be a hospital. It should be introduced for banks healthy enough to have passed a robust screening. The costs of bad bank debt should be left to those that have been primarily responsible for them, i.e. creditors and national supervisors. The only exception should be for cases where government solvency is endangered. In such cases, partner countries will likely be affected one way or another and it is advisable to proceed with direct recapitalisation by a European institution. Again, this would require having at least the beginnings of the respective European supervisory and resolution tools at hand.

3. Don’t get distracted. Banking systems in Europe are heterogeneous. France has basically only systemic banks whereas the German system includes Deutsche Bank, a world-class institution, and a myriad of small local saving banks. Germany has six deposit insurance schemes. An attempt to merge deposit guarantee schemes is bound to consume considerable time and political capital, for very limited benefits.

4. Plan for the worst. Good resolution policy aims at minimising costs to tax payers while at the same time preserving economic and financial stability. Measured bail-in of creditors and bank closure are crucial in this regard. Yet, historical evidence shows that major banking crises involve substantial fiscal costs: in one-third of all crises in advanced economies, the direct cost to the budget exceeded 10 per cent of GDP. Leaving such fiscal costs exclusively to the national taxpayers would risk undermining sovereign solvency. The currently observed financial and real economic disintegration is the consequence. To complete the banking union, it is therefore indispensable to agree on fiscal burden-sharing.

5. Get the incentives right. The organisation of a common fiscal backstop raises important questions about potential distributional biases, moral hazard and contributions to the insurance pool. The design of the system should ensure that incentives are set right. This means that national taxpayers should be always involved but it also means that burden sharing arrangements need to be made before the cost occurs. Relying on constructive ambiguity would be the wrong approach as it would not be credible in case of a crisis. The fiscal backstop thus needs to be designed with a strong institutional set-up that is robust to withstand major crises. Different options for a fiscal backstop can be envisaged. A European Resolution Fund financed by contributions from the financial industry would have major advantages but would unlikely have sufficient funds for the next 10 years. The ESM could also serve as a fiscal backstop. While insufficient in case of a dramatic banking crisis, it has the advantage of a strong governance structure. In the long-run, contingent European taxation power with appropriate democratic legitimacy should be envisaged.

Banking union is an essential piece of Europe’s plan to ward off the fragmentation of the Eurozone. It can be built step by step but cannot be left unfinished.

This post draws on the authors’ recent report, The Fiscal Implications of a Banking Union, Bruegel Policy Brief No 2012/02.

A version of this column was published in the FT-A list

About the authors

  • Jean Pisani-Ferry

    Jean Pisani-Ferry is a Senior Fellow at Bruegel, the European think tank, and a Non-Resident Senior Fellow at the Peterson Institute (Washington DC). He is also a professor of economics with Sciences Po (Paris).

    He sits on the supervisory board of the French Caisse des Dépôts and serves as non-executive chair of I4CE, the French institute for climate economics.

    Pisani-Ferry served from 2013 to 2016 as Commissioner-General of France Stratégie, the ideas lab of the French government. In 2017, he contributed to Emmanuel Macron’s presidential bid as the Director of programme and ideas of his campaign. He was from 2005 to 2013 the Founding Director of Bruegel, the Brussels-based economic think tank that he had contributed to create. Beforehand, he was Executive President of the French PM’s Council of Economic Analysis (2001-2002), Senior Economic Adviser to the French Minister of Finance (1997-2000), and Director of CEPII, the French institute for international economics (1992-1997).

    Pisani-Ferry has taught at University Paris-Dauphine, École Polytechnique, École Centrale and the Free University of Brussels. His publications include numerous books and articles on economic policy and European policy issues. He has also been an active contributor to public debates with regular columns in Le Monde and for Project Syndicate.

  • Guntram B. Wolff

    Guntram Wolff is a Senior fellow at Bruegel. He is also a Professor of Public Policy and Economics at the Willy Brandt School of Public Policy. From 2022-2024, he was the Director and CEO of the German Council on Foreign Relations (DGAP) and from 2013-22 the director of Bruegel. Over his career, he has contributed to research on European political economy, climate policy, geoeconomics, macroeconomics and foreign affairs. His work was published in academic journals such as Nature, Science, Research Policy, Energy Policy, Climate Policy, Journal of European Public Policy, Journal of Banking and Finance. His co-authored book “The macroeconomics of decarbonization” is published in Cambridge University Press.

    An experienced public adviser, he has been testifying twice a year since 2013 to the informal European finance ministers’ and central bank governors’ ECOFIN Council meeting on a large variety of topics. He also regularly testifies to the European Parliament, the Bundestag and speaks to corporate boards. In 2020, Business Insider ranked him one of the 28 most influential “power players” in Europe. From 2012-16, he was a member of the French prime minister’s Conseil d’Analyse Economique. In 2018, then IMF managing director Christine Lagarde appointed him to the external advisory group on surveillance to review the Fund’s priorities. In 2021, he was appointed member and co-director to the G20 High level independent panel on pandemic prevention, preparedness and response under the co-chairs Tharman Shanmugaratnam, Lawrence H. Summers and Ngozi Okonjo-Iweala. From 2013-22, he was an advisor to the Mastercard Centre for Inclusive Growth. He is a member of the Bulgarian Council of Economic Analysis, the European Council on Foreign Affairs and  advisory board of Elcano.

    Guntram joined Bruegel from the European Commission, where he worked on the macroeconomics of the euro area and the reform of euro area governance. Prior to joining the Commission, he worked in the research department at the Bundesbank, which he joined after completing his PhD in economics at the University of Bonn. He also worked as an external adviser to the International Monetary Fund. He is fluent in German, English, and French. His work is regularly published and cited in leading media. 

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