Europe is putting the finishing touches on a new banking union, with the aim of restoring confidence in the euro area's banks, reviving lending and ensuring the common currency's survival. It's a step forward that doesn't go nearly far enough.
In approving a raft of banking-union legislation this week, the European Parliament has ratified an important understanding: If the member states of the euro area want to share a currency, they'll have to share some risks and responsibilities. Among other things, they must pool the resources needed to rescue a bank whose collapse could overwhelm a government's finances, as well as create a central authority to supervise banks throughout the euro area.
Unfortunately, the new laws fall short. Consider the Single Resolution Fund, set up to help recapitalize banks if their losses exceed what their shareholders and creditors can absorb. It will contain 55 billion euros, with authority to borrow more in an emergency. The euro area's largest banks have assets exceeding 1 trillion euros, and borrowing from private investors would be difficult in a crisis. Rescuing a bank that big would require a lot more money.
The banking union was also supposed to guarantee deposits throughout the euro area. That way, concerns about one country's ability to make good on its guarantees wouldn't cause depositors to flee, as happened in Greece and Spain in 2011. That provision has been dropped, apparently because countries have their own deposit-insurance plans. So in a crisis, it could happen again that a euro in a Greek bank (say) would be worth less than a euro in a German bank. That isn't what "common currency" was supposed to mean.
The supranational authority vested in the European Central Bank leaves much to be desired as well. If the ECB wants to take over a failing institution and inject money from the resolution fund, the banking union's member states have the power to block the move. Picture a situation in which France's largest bank, BNP Paribas SA, ran into trouble: Germany and the others would decide whether to contribute to the rescue of a French national champion.
Despite the calm that has prevailed since mid-2012, when ECB President Mario Draghi promised to do "whatever it takes" to hold the euro system together, Europe has no time for half-measures. Malaise in the banking sector has already done immense damage to the economy: Lending to nonfinancial companies in the euro area is down 8 percent over the past two years (see chart), and slow growth has made it extremely difficult for governments to reduce their debt burdens. Should the crisis flare up again, Europe's leaders will find themselves behind the curve once more, arguing over reforms that could take months or years when markets require action in days or hours.
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