House of Lords - European Banking Union: Key issues and challenges

European Banking Union: Key issues and challenges - European Union Committee Contents

European Banking Union: Key issues and challenges

Chapter 1: Introduction

1. The continuing euro area crisis, and the strain that it has placed on the EU banking sector, has given rise to calls for reform of the way the banking sector operates and is regulated. The June 2012 report of the President of the European Council, Herman Van Rompuy, Towards a Genuine Economic and Monetary Union,[1] proposed an integrated financial framework elevating responsibility for bank supervision to the European level, and providing common mechanisms to resolve banks and guarantee customer deposits. These proposals were envisaged as the three core elements of a so-called European "banking union".

2. In light of this, we decided to launch this inquiry into European Banking Union: Key issues and challenges. At the time of writing this report, only the Single Supervisory Mechanism proposals had been published. Our report analyses these proposals, the significant strengthening in the powers of the European Central Bank (ECB) that they would entail, and the implications for EU-27 organisations such as the European Banking Authority (EBA) and the European Systemic Risk Board (ESRB). The report also considers the further steps towards banking union that may follow in due course.

3. Although the Government have made clear that the UK will not participate in a banking union, the implications, both for the UK and the single market, will be profound. It is important in this context to distinguish between the operation of a harmonised regulatory framework for the single market in financial services across the EU-27 and the introduction of a banking union whose primary aim is to secure the position of the euro area. The Government argue that the Single Supervisory Mechanism, and the UK's decision not to participate, should not and need not adversely affect London's position as the leading financial centre in Europe, nor undermine the single market. The strength of this argument may soon be tested.

4. In the course of this inquiry we received evidence from 34 witnesses, and heard oral evidence in London and in Brussels from academics, MEPs, banking sector representatives, thinktanks, leading officials, and key figures including the Chairman of the EBA, Andrea Enria; the Vice-President of the ECB, Vitor Constâncio; the German Ambassador to the UK, Georg Boomgaarden; the European Commissioner for Internal Market and Services, Michel Barnier; and the Financial Secretary to the Treasury, Rt Hon Greg Clark MP. In addition, the President of the European Council, Herman Van Rompuy, helpfully met the Committee to discuss the proposals.[2] We are grateful to all of our witnesses for their assistance. We are also grateful to Professor Eilís Ferran, Professor of Company and Securities Law, University of Cambridge, who acted as Specialist Adviser for this inquiry.

5. We have produced our report in time for the important discussions scheduled for the December 2012 European Council. Those discussions will not mark the end of the debate, neither can the proposals be expected to solve all of the problems in the euro area. Yet banking union will have fundamental implications for the future shape of the euro area and of the EU as a whole. We will continue our analysis of the banking union proposals as they develop during 2013. In the meantime, we make this report to the House for debate.

The inquiry in context

6. "Europe is once again going through a period of heightened tensions. The crisis surrounding sovereign debt and the weakness of the financial sector, together with persistent low growth and macroeconomic imbalances, are slowing down economic recovery and creating risks for the stability of Economic and Monetary Union (EMU)."[3] Thus stated the Conclusions of the June 2012 European Council.

7. That month Spanish ten-year bond yields had hit a euro-era high, and recapitalisation of its seriously indebted banking sector seemed inevitable. As we reflected in our February 2012 report on The euro area crisis, the fundamental problem for Spain (and for the euro area as a whole) was the systemic link between its struggling banks and an indebted sovereign state.[4] The plight of the fourth largest economy in the euro area threatened to overwhelm the resources of its rescue funds, the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM), placing the future of the currency union itself at risk. In the words of the conclusions of the June 2012 Summit of euro area Member States (held in parallel with the European Council), it was now imperative to break the vicious cycle between banks and sovereign states.[5]

8. The euro area Summit envisaged that, once an effective Single Supervisory Mechanism was established involving the ECB for banks in the euro area, it could be possible for the ESM to recapitalise banks directly.[6] Following this, the 'Four Presidents'[7] were invited by the Council to develop by the end of 2012 "a specific and time-bound road map for the achievement of a genuine Economic and Monetary Union".[8]

9. The banking union agenda has developed rapidly (see Box 1 below). Before examining the proposals in detail, three central questions need to be addressed:

· Is a banking union necessary?

· What constitutes an effective banking union?

· Who will be the members of a banking union?

BOX 1

Timeline of developments

June 2012: Publication of the Recovery and Resolution Directive proposals.

June 2012: Publication of the Van Rompuy report Towards a Genuine Economic and Monetary Union.

June 2012: Meeting of the European Council and euro area Member States. Four Presidents asked to develop "a specific and time-bound road map for the achievement of a Genuine Economic and Monetary Union".

September 2012: Publication of the Single Supervisory Mechanism legislative proposals, including a proposed ECB Regulation, a proposed EBA Amending Regulation, and the Commission Communication A roadmap towards a Banking Union.

September 2012: Publication of the Van Rompuy Issues Paper on Completing the Economic and Monetary Union.

October 2012: Publication of the Van Rompuy Towards a Genuine Economic and Monetary Union: Interim Report.

October 2012: Meeting of the European Council. It was proposed to produce a legislative framework for the proposals on a Single Supervisory Mechanism by the end of 2012, with implementation to follow in 2013.

December 2012: Target deadline for agreement of the legislative framework of the Single Supervisory Mechanism and the Recovery and Resolution Directive, as well as the two existing proposed elements of the "single rulebook", the Capital Requirements Directive and Regulation (CRD IV) and the recast Deposit Guarantee Schemes Directive.

December 2012: Publication of the Van Rompuy Towards a Genuine Economic and Monetary Union: Final Report.

December 2012: Meeting of the European Council.

2013: Proposed date for implementation of the Single Supervisory Mechanism. Prospective date for publication of further steps towards banking union, including a common resolution scheme, and, possibly, a single deposit insurance scheme.

Date to be confirmed: Possibility of the ESM engaging in direct recapitalisation of euro area banks.

Is a banking union necessary?

10. Jean Pisani-Ferry, Director of Bruegel, described the June 2012 Council Summit as a watershed when the focus shifted from crisis management and fiscal discipline to a recognition of the need to tackle the vicious cycle between banks and sovereign states.[9] Mr Enria said that the choice was a stark one: either sever this "dangerous interconnection" or risk the break-up of the currency union.[10]

11. Representatives of the banking sector acknowledged the systemic weaknesses of EMU that the financial crisis had revealed. Barclays highlighted the over-exposure of some banks to commercial real estate and to sovereign debt.[11] HSBC argued that the existing economic imbalances between Member States had deepened as some became dependent on their domestic banks to absorb new debt issuance.[12]

12. In our report on The future of economic governance in the EU, published in March 2011, we concluded that the interconnection of the sovereign debt and banking sectors was one of the principal causes of the euro area crisis. We highlighted the risk of a vicious cycle between sovereign debt and a weakened banking sector.[13] The escalation of the crisis since that report was published has reinforced these conclusions.

13. We regret that it has taken so long for European leaders to bring forward concrete proposals to deal with the systemic deficiencies in the design of EMU. We welcome the necessary and long-overdue steps that have now been taken towards the introduction of a banking union. The June 2012 European Council was a watershed in acknowledging the imperative need to break the vicious cycle between banks and sovereign states. Yet the path to banking union will be far from straightforward.

What constitutes an effective banking union?

14. The Towards a Genuine Economic and Monetary Union report proposed that a European banking union should have three legs, as set out in Box 2 below:

· A Single Supervisory Mechanism (SSM);

· A European resolution scheme;

· A European deposit insurance scheme.[14]

BOX 2

The proposals of the June 2012 report Towards a Genuine Economic and Monetary Union[15]

(i) "Integrated supervision is essential to ensure the effective application of prudential rules, risk control and crisis prevention throughout the EU. The current architecture should evolve as soon as possible towards a single European banking supervision system with a European and a national level. The European level would have ultimate responsibility. Such a system would ensure that the supervision of banks in all EU Member States is equally effective in reducing the probability of bank failures and preventing the need for intervention by joint deposit guarantees or resolution funds. To this end, the European level would be given supervisory authority and pre-emptive intervention powers applicable to all banks."

(ii) "A European resolution scheme[16] to be primarily funded by contributions of banks could provide assistance in the application of resolution measures to banks overseen by the European supervision" with the aim of providing for an orderly winding-down of non-viable institutions, thereby protecting taxpayer funds.

(iii) "A European deposit insurance scheme[17] could introduce a European dimension to national deposit guarantee schemes for banks overseen by the European supervision. It would strengthen the credibility of the existing arrangements and serve as an important assurance that eligible deposits of all credit institutions are sufficiently insured."

The deposit insurance scheme and the resolution fund could be set up under the control of a common resolution authority.

15. In its Roadmap towards a Banking Union, published in September 2012, the European Commission accepted that a complete banking union would require not only a single supervisory mechanism but also an integrated crisis management framework and a common system for deposit guarantees.[18] The proposals for a Single Supervisory Mechanism were published in September 2012, and we analyse them in Chapters 2 and 3. As we show in Chapter 4, the proposals for a European resolution scheme and, in particular, a European deposit insurance scheme, have proved politically contentious for net contributor Member States, notably Germany. As a result, legislative proposals for the second and third legs have yet to be brought forward.

16. Although President Van Rompuy told us that the SSM proposals should be the focus for now,[19] many were doubtful that this was enough. Sharon Bowles MEP, Chair of the European Parliament Economic and Monetary Affairs (ECON) Committee, told us that, "you have not got a proper banking union".[20] The International Centre for Financial Regulation (ICFR) did not believe, in view of the "clear fault lines among Member States", that the full framework was achievable in a single leap.[21]

17. The three-pronged approach, outlined in the June 2012 report, Towards a Genuine Economic and Monetary Union, of a Single Supervisory Mechanism, a common resolution mechanism and a common deposit insurance scheme, constituted a firm and effective foundation on which to base the banking union proposals. This coherent model has already been undermined by political pressure, led by Germany. We regret that the controversial nature of the European resolution scheme, and, in particular, the European deposit insurance scheme, means that it is politically unrealistic to expect all three elements of the banking union to be taken forward quickly or in a united manner.

Who will be the members of a banking union?

18. The stated purpose behind the banking union proposals is to stabilise the euro area and secure the future of the single currency. All 17 euro area Member States will therefore participate.

19. A more complex debate concerns the position of the ten non-euro area Member States, the so-called 'Outs'. The Commission has stated that all such Member States will be able to participate in banking union through a 'close cooperation' agreement. The Financial Secretary to the Treasury told us that the term 'Outs' was itself a misnomer, and that the banking union proposals needed to be viewed in a dynamic rather than a static context. Member States were under different obligations as regards their eventual membership of the single currency, and the extent of their banking sectors' interrelationship with the euro area varied considerably.[22]

20. This conundrum was described by one of our witnesses as the concept of variable geometry:[23] the banking union proposals will apply to euro area and non-euro area Member States in different ways, and non-euro area Member States will not approach the proposals in a uniform manner. Those that intend to join the single currency in due course may very well take a different view from the UK. The UK Government have made clear that they will not participate. Some non-euro area Member States may participate from the start, and others may join later. Membership of the banking union and the single market will not correspond. The strain on the single market will be compounded by the potential impact of the proposals on the relative powers and influence of the ECB (focussed as it will be on those Member States participating in banking union) and the EBA (with its clear remit to defend the interests of the single market as a whole). So, as we consider in Chapter 5, the implications of banking union for the UK, and for the single market as a whole, are profound.

21. In any assessment of the banking union proposals it is necessary to keep in mind the concept of variable geometry. These significant reforms will impact upon euro area and non-euro area Member States, and the banks and other credit institutions that operate within them, in different ways. Non-euro area Member States themselves will not approach the proposals in a uniform manner: it is not clear that many will follow the UK in staying out of banking union.

1 Report by the President of the European Council, Herman Van Rompuy, Towards a Genuine Economic and Monetary Union, June 2012: http://ec.europa.eu/economy_finance/focuson/crisis/documents/131201_en.pdf. Back

2 See Appendix 4. Back

3 European Council, 28/29 June 2012, Conclusions. Back

4 House of Lords European Union Committee, 25th report (2010-12), The euro area crisis (HL 260), paras 21-3. Back

5 Euro area Summit Statement, 29 June 2012: http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131359.pdf Back

6 ibid. Back

7 The President of the European Council (Herman Van Rompuy); the President of the European Commission (José Manuel Barroso); the President of the Eurogroup (Jean-Claude Juncker); and the President of the European Central Bank (Mario Draghi). Back

8 June 2012 European Council conclusions, op. cit. Back

9 Q 40. Back

10 Q 82. Back

11 Barclays. Back

12 HSBC. Back