Germany is hitting the brakes on a banking union crucial to the long-term survival of the euro, on the grounds that it needs a better legal foundation. That position would be a lot more convincing if Germany were doing more to reduce the threat its largest financial institutions pose to the European economy.

The banking union, which European Union leaders agreed in December to create, is supposed to help sever the unhealthy link between banks and governments. Empowering the European Central Bank to supervise financial institutions throughout the euro area could discourage cozy and often corrupt relations at the national level between banks and politicians. Centralizing the authority and money needed to take over and recapitalize banks could keep the troubles of large banks from ruining a nation’s finances -- an all-too-real danger for euro countries such as Ireland and Spain.

German Finance Minister Wolfgang Schaeuble threw this project into doubt last week, saying that a proper banking union would require time-consuming changes in the European Union’s founding treaties -- changes that the European Commission, the treaties’ official guardian, has said are unnecessary. A charitable explanation would be that Schaeuble is being too much of a stickler for detail. A less-charitable analysis is that Germany is balking at ceding power to oversee its banks to a supranational authority and on sharing the costs of healing the euro-area economy.

Potential Threat

Germany’s concerns might be defensible if it were doing a better job of supervising its banking system. German officials, for example, have resisted EU demands to dismantle failed regional banks known as Landesbanken. More troubling is the potential threat presented by Deutsche Bank AG, the largest bank in the euro area, with assets of 2 trillion euros ($2.6 trillion). The bank’s tangible equity -- the bedrock layer of capital -- is so thin that a mere 2 percent decline in the value of its assets could render it insolvent.

A genuine danger of a banking union is that it could encourage institutions such as Deutsche Bank to get even larger. The more havoc their failure would wreak, the more certain they could be that the banking authority would be forced to bail out their creditors at the expense of euro-area taxpayers. The best solution is to require banks to finance their activities with much more equity from shareholders, who would be first in line to absorb any losses. Germany has instead focused on making creditors share losses, a generally good idea that becomes implausible in the case of an institution as large and globally interconnected as Deutsche Bank.

In short, one can’t help but wonder whether Germany is less concerned about the banking union’s effectiveness than about what a truly effective banking union would mean for its largest financial institution. Any sensible regulator would demand that institutions such as Deutsche Bank raise large amounts of equity, a move that -- while good for the health of the financial system and economy -- would adversely affect certain measures of profitability. In turn, that could strengthen calls to break up giant banks into smaller, more manageable units.

As Bloomberg News reports, Europe’s leaders are planning to congratulate themselves on their crisis management at this week’s meeting of the Group of 20 developed and developing nations. Yet judging from the state of their banking union, they have a lot of work to do. We hope other nations’ finance ministers will remind Germany that, as Europe’s self-appointed voice of prudence, it should be leading the way instead of finding reasons to stall.

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