The collapses in rapid succession of Silicon Valley Bank (SVB) and Signature Bank in the United States, and of Credit Suisse in Switzerland, have reawakened debates on banking policy. In the United States, reports assessing what went wrong are expected from both the Federal Reserve and Federal Deposit Insurance Corporation (FDIC) on 1 May. In Switzerland, the unorthodox engineering of Credit Suisse’s takeover by UBS has generated lawsuits and investigations.
By contrast, in the European Union as in the United Kingdom, there have been no visible signs of banking-sector weakness. Since more than nine-tenths of EU banking assets are in the euro area and under European banking supervision led by the European Central Bank (ECB), that counts as a success for the single supervisory mechanism – the main finished piece of the EU banking union project, on which the EU embarked in 2012. As emphasised by ECB Supervisory Board Chair Andrea Enria, in a 21 March speech, European supervisors have been focused on both interest-rate risk and business-model risk in recent years, two areas at the core of the SVB and Credit Suisse disasters. This stands in sharp contrast to the pre-2012 period, when banking supervisors in the EU looked unable to get anything right.
Meanwhile, EU banking union remains incomplete – and it is likely that the absence of banking sector turmoil in the EU will mean that pre-existing political obstacles will continue to prevent its completion any time soon. The two key stumbling blocks are a European deposit insurance scheme (EDIS), for which the Commission’s ill-fated proposal of 2015 has been left unadopted despite protracted negotiations, and the regulatory treatment of banks’ sovereign exposures (RTSE), which has been negotiated in parallel, outside of public view and also without concrete results.
On 16 June 2022, an acrimonious meeting of euro-area finance ministers in the Eurogroup format acknowledged the impasse. Ministers decided to shelve the discussions on EDIS and RTSE and asked the European Commission to make proposals on a more limited reform agenda of crisis management and deposit insurance (CMDI). In doing so, they admitted that the EU framework for the handling of unviable banks, which they had enshrined in 2014 in the bank recovery and resolution directive (BRRD, 2014/59/EU), had not worked as intended.
Closer to the US?
This policy area is hard to grasp, and not only because of its unseemly proliferation of four-letter acronyms. In simplistic terms, the essence of the CMDI project is to move closer to the US system in which the FDIC is the single authority for both deposit insurance and the resolution of failing banks. In that system, all deposits, insured or not, have equal and preferred status to the failing bank’s other liabilities, a feature known as general depositor preference. This creates incentives for the FDIC to finance takeovers of failing banks by sounder peers, protecting all depositors from losses in most cases. A degree of market discipline is nevertheless preserved, since uninsured depositors have incurred losses in a minority of bank failures in recent decades.
The irony is that, by invoking a systemic risk exception and extending an unlimited guarantee to all depositors of SVB and Signature Bank, the US authorities may have departed permanently from this model, at precisely the time when the EU was considering adopting it. The European Commission had planned to publish its CMDI proposal on 8 March, then procrastinated and eventually published it on 18 April. In the meantime, the US systemic risk exception was triggered on 12 March.
Moving towards a US-inspired system with general depositor preference, as that proposal suggests, still makes sense for the EU. But this may be impossible without simultaneously completing the banking union, because the continued reliance on national deposit guarantee arrangements defeats the purpose of a single Europe-wide framework. In any case, time is short to wrap up CMDI before the end of the current EU legislative cycle in about spring 2024, especially as several EU countries appear unhappy with it. The CMDI proposal will likely end up being useful as a basis for public debate rather than actual legislation.
All is not deadlocked, however. Another rule, which transposes into EU law the international accord known as Basel III Endgame, was proposed in October 2021. Its adoption is expected before end-2023. The current, non-final version is not compliant with the Basel III template. However, the recent banking turmoil has given the Basel framework renewed legitimacy: SVB may not have failed so miserably if it had not been exempted from the Basel framework. As noted by Bundesbank President Joachim Nagel in a speech on 14 April, “it is now all the more important to implement the Basel III rules globally without any concessions”.
The EU should focus on achieving that outcome, even as it leaves its menagerie of other acronyms – EDIS, RTSE and CMDI – unfinished for the time being. By emphasising the importance of strong capital and liquidity positions, the US banking mess could usefully lead EU policymakers to adopt the Basel III Endgame in a compliant manner.