Banking Union (SRM and SSM)

Background

Banking Union is a political project lunched in summer 2012 to address the trends against financial fragmentation that started arising after sovereign crisis of 2011. The main aim is to address the “vicious circle between banks and sovereigns”, in which the solvency of banks and the individual sovereigns that stand behind them have become too interlinked. The project does so by mutualising risk among participating countries and by moving responsibility for bank supervision and crisis management to the European level.

The first component of the Banking Union is Single Supervision Mechanism allocated at European Central Bank that became operation after year long comprehensive assessment.

The comprehensive assessment was a financial health check of 130 banks in the euro area (including Lithuania), covering approximately 82% of total bank assets.  It was carried out by the ECB together with the national supervisors between November 2013 and October 2014.

The second component of banking union is the Single Resolution Mechanism of the Banking Union, the Single Resolution Mechanism (SRM), in March 2014 just before the end of the Parliamentary term. The SRM includes the Single Resolution Fund (SRF) and the Single Resolution Board (SRB), which will function according to the regulation establishing the SRM.

Actions of Finance Watch

Finance Watch welcomed the SRM agreement in a press release on 1 April but added that, to truly end the sovereign-bank feedback loop, the next Commission would also need to (1) tackle regulatory incentives that favour sovereign debt, and (2) the Parliament and Council should adopt the proposal for structural reform of bank activities to make bail-in and bank resolution credible.

As the stress tests and AQR approached, Finance Watch published a 14 page policy brief on 8 October, "Should precautionary recapitalisations make taxpayers nervous?", warning that if banks that fail the tests cannot raise funds in the market, authorities could in some circumstances recapitalise them with public money. This shows the need for bank structure reform to reduce fragility and interconnectedness in the European banking sector.

Two days before the stress test and AQR results were published we organized a webinar , “EU Banks stress tests - why taxpayers are at risk?”, to explain how the assessment is meant to work and what to look out for in the results.  On 29 October 2014, after studying the results, we issued a press release with a more detailed critique of the assessment and calling for a binding leverage cap.

In February 2015, we responded to the EBA consultation on MREL and to the FSB consultation on TLAC, both available in our website.

Key risks

On one hand, the logic of the Banking Union seems to be geographical: banks have grown too large for their sovereigns because of international operations; therefore the solution to move supervision and resolution to the European level is natural. On the other hand, there was also a change in the scale, complexity, and connectedness of banks’ activities over last decades, which create problems for resolution of the largest banks.

It goes back to the necessity of structural reform (see Dossier) that without it and without reforms to the activities of the largest banks recovery mechanisms will struggle to work and struggle to be credible as it will not have sufficient resources to back up resolution.

The danger of this situation is that Europe creates a paper tiger – an SRM that delays reform of the banks because it appears capable of handling bank failure, but which in fact cannot do it in the time of crisis.

The financial crisis had a devastating impact on public finances, due in part to interconnectedness of large too-big-to-fail banks. As the IMF reported in April 2014, "the expected probability that systemically important banks will be bailed out remains high in all regions."  If Banking Union is to work in the future, it has to succeed in lowering the political and economic risks of taxpayers having to pay for bank bail-outs. 

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