Europe’s Banking Union

Breaking Out of the Vicious Circle

When a bank goes bust in Europe, it doesn’t just threaten depositors and shareholders. Wobbly banks can drag down the national governments that try to rescue them. European Union leaders pledged to attack this vicious circle in June 2012, in the third year of a debt crisis that almost broke apart the euro bloc. They vowed to centralize bank supervision and crisis management for the first time, an effort seen as the biggest transfer of sovereignty since the creation of the common currency. Policy makers are united in the goal of what they call the banking union: ending taxpayer bailouts and taking key decisions out of national hands. But first they had to agree on who decides when a bank has failed, who pays to clean it up and how to divvy up the losses. Plus they had to convince Germany that it won’t end up paying the bill.

The Situation

In the first step, the European Central Bank will begin oversight of euro-area lenders Nov. 4, after completing a three-stage review, including stress tests, to root out ailing banks. More problematic is a plan to pair the ECB with a central authority in charge of saving or shuttering lenders, taking that power from national regulators from Berlin to Paris. In December 2013, EU finance ministers laid out a blueprint for a new agency backed by a 55 billion-euro ($76 billion) industry-financed resolution fund. The plan hands most decisions on failing banks to a board of EU authorities and national representatives. Turning the agreement into law required months of wrangling with the European Parliament on how to best speed up decision-making and how quickly to pool funds. EU lawmakers struck a deal on legislation in March, and the final agreement included a plan to back up the fund with a credit line.

Source: Eurostat

The Background

The toxic link between banks and their national governments — sometimes called the “doom loop” by economists — worked in both directions during Europe’s debt crisis: Greece’s budget blowout crippled its lenders through their holdings of the government’s debt, while weak banks forced Ireland into a bailout and threatened the finances of Spain. EU taxpayers made 4.5 trillion euros available in approved bank assistance in the three years starting in October 2008, equivalent to more than a third of the bloc’s gross domestic product. Germany had racked up 287 billion euros of debt by the end of 2012 supporting financial institutions and markets. Individual countries didn’t have a good way to regulate banks that operate across the continent, and the EU doesn’t have the power of the U.S. Federal Deposit Insurance Corp. to shut down and clean up the region’s sick lenders. The lack of a central banking authority exacerbated Europe’s slow recovery from its longest-ever recession.

The Argument

The banking union had to overcome objections from Germany, the biggest EU nation, which pushed to keep more decisions and financial responsibility away from central authorities and protect its own taxpayers. While the plan for the new agency goes a long way toward making the banking industry responsible for its own risks, it leaves open some of the thorniest questions. Negotiators still need to hammer out rules for how much each bank will pay into the resolution fund, and smaller banks are pushing for exemptions. It sidesteps the issue of whether the EU will make public funds available to bolster the system when the money raised from banks runs out. Over the next decade, EU countries will face the challenge of rewriting the bloc’s basic laws to create new institutions, on par with the ECB, to manage the banking union.

The Reference Shelf

First published Dec. 20, 2013

To contact the editors responsible for this QuickTake:
Patrick Henry at
Leah Harrison at