World Review | European scheme to protect taxpayers in future banking crisis

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European scheme to protect taxpayers in future banking crisis

European scheme to protect taxpayers in future banking crisis
Smaller savers get more protection (photo:dpa)

TAXPAYERS will no longer be asked to help bail out ailing commercial banks if a new European Union mechanism - the Single Resolution Mechanism (SRM) - is ratified, writes Professor Enrico Colombatto.

The SRM was created after prolonged debate. But it means that the EU can count on a new agency which will ensure that bad banks are no longer bailed out at taxpayers’ expense but by their stakeholders. Deposits under 100,000 euros are guaranteed by the EU rather than by national governments.

The mechanism has yet to be ratified by the European Parliament. European authorities are confident that the SRM will be approved before Easter 2014.

The Single Resolution Mechanism is actually the second pillar of the European Banking Authority (EBA).

The first - the Single Supervisory Mechanism (SSM) - was passed in October 2013 and gives the European Central Bank the power to supervise and regulate the European banking system. Within this context, the SRM details how the authorities should intervene when a bank is about to go bankrupt.

Bankruptcy should no longer be a political issue in the future, and investors, shareholders and depositors will be encouraged to keep an eye on bank managers and to think twice before they are lured by miraculous profits and/or before they authorise grand strategies with uncertain returns.

The upshot is that the introduction of the SRM could be interpreted as a further step to remove the world of banking from the sphere of political decision-making and assigning it, with minor constraints, to the world of Euro-technocrats.

Yet, this transfer is not accepted without reservation by all the parties involved and is likely to create tension over the next few months in the European Parliament in Strasbourg.

The political authorities can be accused of failing to offer appropriate responses to the banking crisis. They offered many words and confused signals, but no clear strategy, let alone action. The European Central Bank dictated the agenda in the end.

Large amounts of new money were injected into the system to strengthen the reserves of the banks and avert a run of depositors fearing for their savings. Lots of new money was also made available to bail out troubled governments. This strategy has paid off. Banks’ balance sheets have improved and profligate governments have not defaulted.

That has made people happy. Yet, public opinion is also aware that the quality of banking has remained modest, the industry is vulnerable, and that public indebtedness continues to be a serious problem. In other words, disasters have been averted, but the system’s structural failings have not been fixed.

Funding for the SRM - 55 billion euros - is inadequate and will come too late. By today’s standards, 55 billion euros are just one per cent of the insured deposits, whereas the amount of ammunition required to stop a systemic crisis detonating is about one hundred times that amount.

Second, those 55 billion euros would be gradually accumulated by the mid-2020s. What happens if some banks go belly up over the next five years?

Third, the complex structure of the SRM - and the many local operational elements it includes - show that although dealing with future banking crises will be centralised, implementation of the rescue plan will be carried out locally.

It looks as if the national authorities are willing to please the ECB and let it establish a new agency, but reluctant to delegate their powers to Frankfurt.

This is because banks have been playing a key role in financing public debt, and governments are understandably reluctant to accept a reduction in their power to influence banking strategies in the future.

At the same time, banks may be wary of becoming accountable to a rather heavy euro-bureaucracy, with which interaction might be slower and less effective and certainly more formal than with national authorities.

The SRM reflects the fundamental ambiguities that the EU has been unable to solve since the euro was introduced.

On the one hand, part of the union applies pressure in order to transform national debts into federal liabilities with guarantees and bailout rules coming from Brussels and Frankfurt. On the other, the German bloc insists on national liability and accountability, according to which the European authorities might contribute only discretionary and limited financial support.

We believe we will witness a debate over the coming months which will reflect this unresolved issue.

Professor Enrico Colombatto

ENRICO Colombatto is a professor of economics at the University of Turin, Italy. Professor Colombatto is also Director of Research, Institut de Recherches Economiques et Fiscales (IREF) in ...

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