The creation of the European Stability Mechanism (ESM) and the banking union were instrumental in stemming the euro-area sovereign crisis. However, both remain incomplete. While the ESM reduces the risk of sovereign debt crises, it still lacks an instrument to deal in an orderly way with insolvency crises. This makes the no-bailout clause of the Maastricht Treaty toothless. Two of the banking union’s pillars – common European supervision by the European Central Bank and common European resolution by the Single Resolution Fund – are up and running. But the third, common European deposit insurance, is still missing. Furthermore, the governance of the ESM is wanting. Decisions to provide financial assistance are taken by unanimity, preventing swift crisis response when it is needed.
The re-election of Chancellor Merkel and the election of President Macron create a new momentum for strengthening the euro area’s crisis framework. There is agreement to turn the ESM into a European Monetary Fund (EMF). We propose to design this EMF as part of a broader risk-sharing and market-discipline agenda. Risk sharing would come from the increased capacity of the EMF to intervene early in a sovereign or banking crisis and to act as a fiscal backstop to a complete banking union that includes European deposit insurance. Market discipline of sovereigns would come from the reduced exposure of banks to their home sovereigns and from a newly-established debt restructuring mechanism. The proposed transformation of the ESM into an EMF should be viewed as part of a wider institutional reform of the fiscal dimension of the euro area.