In our excitement over what is new, we often miss what is important. The election of Emmanuel Macron has triggered expectations of a Franco-German entente on further fiscal integration in the euro zone. Brexit has given new momentum to proposals for a multi-speed Europe.
But behind these speculative possibilities real, profound change is proceeding relatively unnoticed except by technical experts. The European banking union, launched in 2012 for the euro zone but enjoying increasing interest by non-euro countries, is shaping up to be the most significant transformation brought about by the financial crisis – not just of Europe’s economic structure, but of its political economy.
Within weeks in June, unrelated failing banks in Spain and Italy were wound down. Together, they illustrate how much banking union has transformed Europe’s financial governance.
Banking union was agreed at a June 2012 summit, and combined two planks. The first was “bail-in” – the requirement that banks’ creditors accept losses on their investments to protect taxpayers against risks taken by bank managers. The second was to elevate regulatory powers from the national to the European level.
These centralised powers were on vivid display in the resolution of Spain’s Banco Popular and the winding down of two small banks in Italy’s Veneto region. In both cases, national authorities’ hands were forced by the European Central Bank’s decision that the banks were “failing or likely to fail”.
Another supranational agency, the Single Resolution Board, ordered Spain to put Banco Popular into resolution under European rules; but let the Veneto banks be wound down under Italy’s own insolvency law.
The upshot was that in the Spanish case, the problem bank was dealt with without a cent of taxpayer subsidy. In Italy, however, the government poured in billions of euros to cushion the loss, rewarding failure and holding the public finances hostage to the banking sector.
Spain offered a glimpse into the future of bank regulation, while Italy clung to the bad habits of the past. Why this discrepancy? In part, Italy’s greater ability to lobby for its case. But power is not all; it matters what one uses it for.
Spain has proved much more willing to embrace the cultural change that banking union entails. Under the constraint of a euro zone rescue loan, it decisively restructured its savings banks sector after 2012, while Rome kicked the can down the road.
Banking union was undertaken in the urgency to short-circuit a “doom loop” between banks and governments that fuelled the sovereign debt crisis. But the reform has far-reaching repercussions.
In time, more centralised authority and the requirement to bail in creditors will revolutionise European economic and political relations beyond imagination. If euro zone leaders had fully realised what they were signing up to, they would probably have lost their nerve.
Economically, bail-in creates de facto risk-sharing between countries. Making write-downs a regular practice when things go wrong puts in place a system of transfers from creditors to debtors. Over time, this is functionally equivalent to transfers from surplus to deficit countries, since the net savings of the former are typically lent to the latter through the banking system.
In other words, banking union mimics the fiscal risk-sharing that surplus economies of northern Europe resist and peripheral deficit economies demand. With banking union, there is no need for fiscal union.
The political implications are greater still. This is because bail-ins have very different consequences for bank ownership than bail-outs.
Where taxpayer-funded rescues have frequently served to maintain existing ownership and control networks, bail-in can transfer ownership and control from previous owners to creditors who face writedowns.
Given the cross-border lending from surplus to deficit economies carried out by Europe’s banking system, this will over time make ownership and control more pan-European and more dominated by surplus country investors.
This will gradually dissolve the tight bonds between national political and banking elites, intermingled everywhere in Europe and especially the eurozone.
That is so whether banks are formally owned or controlled by state entities (as many banks are in Germany and used to be in Spain), run by politically embedded foundations (as in Italy) or are formally private businesses (as they used to be in Ireland before becoming wards of the state).
In all cases, incestuous relations between state and banks have had the same effect: deep confusion between the national interest and that of the banking sector; hidden subsidies from taxpayers to banks, protecting both their managers and their investors; and gross inefficiencies in an allocation of capital driven more by political and personal priorities than economic logic.
This phenomenon – call it the bank-state complex – shoulders much of the blame for economic waste in the boom and for the weakness of the recovery. By dissolving it, banking union promises a much healthier political economy in Europe and its nation-states.
The bank-state complex is most resistant to reform precisely where it causes the greatest harm. Italy is a prime example of both things. Its leaders may resent the impositions banking union brings. Its citizens should greet them with open arms.
– Copyright The Financial Times Limited 2017