Bogged-Down Banking Fight Leaves EU Vulnerable to Relapse

Bogged-Down Banking Fight Leaves EU Vulnerable to Relapse

Europe’s march toward a banking union began in the early morning hours of June 29, 2012, during an overnight summit that pitted Germany against Spain and Italy over their plea for more help against the raging debt crisis. The 13 1/2-hour meeting resulted in a deal that introduced the possibility of aid to banks from the euro firewall fund. In return, leaders said the European Central Bank should take over financial supervision in the 17-nation currency bloc.The emergency eased after ECB President Mario Draghi’s pledge a month later to do “whatever it takes” to save the euro; so did officials’ urgency to turn the pledge into policy. The June 2012 proposal has set the stage for bigger battles, leaving the region vulnerable to a relapse as the prospect of direct aid to banks is pushed further into the future.

“When you talk about fully fledged banking union, you’re talking about real political union and some degree of fiscal union,” said Guntram Wolff, director of the Brussels-based Bruegel research group. “It’s a huge step. We are not there yet.”

The banking union effort now hangs on the question of who decides when a bank fails and how to divvy up the losses. European Union finance ministers resume their wrangling next week at a meeting in Vilnius, Lithuania.

“It is by completing a real banking union that we will ensure the long-term stability of the financial sector,” Dutch Finance Minister Jeroen Dijsselbloem, head of the euro finance ministers’ group, told lawmakers in Brussels yesterday.


The struggle over banking policy has reflected the same north-south divisions that have roiled EU firefighting efforts since Greece’s 2009 budget blowout lit the fuse of the crisis.

Germany and the Netherlands have resisted wiping out bank investors when institutions in their countries’ fail, shielding senior bondholders at the expense of taxpayer funds. They’ve also demanded that crisis-stricken countries like Ireland, Spain and Cyprus cede financial control in exchange for bailouts.

When Europe’s banking system is at its most stretched, either a central authority will need to shut a bank down or financial markets will do it for them, said Lorcan Roche Kelly, chief Europe strategist at Trend Macrolytics LLC.

“The problem is when the market closes a bank down, that’s the equivalent of carpet bombing — they try to close all the other banks down,” Roche Kelly said. “It’s either you declare war or you have war declared on you.”

Losses Tallied

EU banks racked up nearly 1 trillion euros ($1.3 trillion) in crisis-related losses between 2007 and 2010, almost 8 percent of the then 27-nation bloc’s gross domestic product. Between October 2008 and October 2011, governments made available 4.5 trillion in approved bank assistance, according to the European Commission, including 409 billion euros in asset relief and recapitalization.

The cost of insuring financial debt is almost back to pre-crisis levels; the Markit iTraxx Financial Index of credit-default swaps on the senior debt of 25 European banks and insurers fell to a 21-month low of 121 basis points in January from 357.5 basis points in November 2010. It now trades at 147 basis points.

As foreseen by EU leaders, Full-fledged banking union has three stages: supervision, resolution and deposit guarantees. They chose oversight, the most politically feasible, as the place to start. They made it the primary condition for when banks could have direct access to the European Stability Mechanism, the euro area’s 500 billion-euro firewall fund.

‘Vicious Circle’

The link between supervision and direct aid at the June 2012 summit superceded bank shutdown plans that had been proposed just weeks earlier by Michel Barnier, the EU’s financial services chief. Euro-area leaders further raised the stakes by affirming “that it is imperative to break the vicious circle between banks and sovereigns.”

A key part of this initial push was aimed at helping Spain and Ireland. By giving the banks direct access to rescue money, they sought to free up national governments to fix their economies without losing access to financial markets.

The June 2012 summit statement made specific reference to Ireland. Euro-area finance ministers soon after clarified that Spanish banks would be eligible for the financial fund once the supervision structures were in place.

These promises alone didn’t calm markets. Spain’s financial sector bailout still had to go through the Spanish government books, and bond yields kept surging to as high as 7.6 percent. After Draghi’s pledge of unlimited support two days after Spanish yields reached their peak, followed by the ECB’s subsequent rollout of its Outright Monetary Transactions program, markets finally eased.

German Opposition

In September, Barnier unveiled his proposal for the single supervisor, with generally broad support from the ECB and nations after consultations that included the U.K., which has the bloc’s biggest financial sector, though won’t be directly under the new regime. Barnier backed off from the long-term vision for joint deposit insurance due to German opposition.

Key battlegrounds emerged right away. Germany began to argue for a two-tiered system of national and cross-border banks, while the U.K. worried about the new supervisor’s impact on the European Banking Authority, an agency established by the EU in 2011 to draft technical standards, coordinate the work of national regulators and settle disputes between them.

These conflicts were initial signs of the seesawing that has been a hallmark of the banking union debate: leaders pledge to work together, then individual nations push back seeking self-serving carveouts.

Legacy Assets

On Sept. 25, Germany and the Netherlands and Finland asserted that so-called legacy assets — the pre-existing problems weighing down bank balance sheets — shouldn’t be eligible for EU-wide bailouts.

EU leaders attempted to keep the ball moving forward by re-declaring how important it is to break the bank-sovereign link, at summits in October and December 2012. These statements acknowledged the vicious circle when financial markets drive up bond yields in countries with troubled banks, who in turn often find their own balance sheets weighed down by domestic debt.

By this point, with EU bond yields declining, the prospect of direct aid from ESM in time to help Spain or Ireland was a distant memory.

Spain worked through the bulk of its banking bailout, using just 41 billion euros of the 100 billion allotted to it. Dijsselbloem in January declared that Spain didn’t want to transfer its banking debts to the ESM after all.

Irish Aims

Ireland also put its ESM ambitions on the back burner, focusing instead on negotiations with central bankers on different part of its bank bailout. In February, Ireland reached a deal with the ECB on promissory notes used to bailout Anglo Irish Bank Corp., with the prospect of an ESM-linked bank-debt deal pushed out to 2014 or later.

On March 15, EU leaders once again reaffirmed “it is imperative to break the vicious circle between banks and sovereigns.”

Within 24 hours, euro finance ministers re-cemented that link by proposing a 10 billion-euro bailout for Cyprus that would force losses onto all depositors, including those covered by EU deposit insurance guidelines. This plan led to a bank run, riots in Cyprus and market turmoil.

The euro area redesigned the Cyprus bailout a week later, returning to a plan they had initially jettisoned as too severe. The final deal called for closing down Cyprus Popular Bank Pcl and restructuring Bank of Cyprus, forcing heavy losses onto unsecured creditors and requiring the imposition of capital controls for the first time in the euro zone to halt bank runs.

Treaty Doubts

Against that backdrop, nations and the European Parliament made a deal to set up the euro bank supervisor, only to have Germany put up last-ditch objections related to the EU’s governing treaties.

In Dublin in April, finance ministers promised to give all due consideration to future treaty changes in exchange for getting the deal through. On April 18, 2013, the supervisor passed all political hurdles and was sent to the European Parliament for final passage.

Countries immediately started arguing over whether the ECB supervisor can start operating without a bank-resolution framework in place, and Germany stepped up its objections to any kind of risk-pooling without treaty change.

Direct Recaps

The euro-area finally agreed on ESM direct recapitalization guidelines in June. Under pressure from Germany, nations agreed that only 60 billion of the ESM’s 500 billion-euro capacity can be used for the purpose. They also said that private creditors must take losses first and that the whole system won’t be available until after the bank-resolution law comes into force.

EU nations then hashed out a common position on common standards for bank resolution that would, for the first time, make it standard practice to force losses on private investors before governments step in. These rules, which still need to be negotiated with the European Parliament, also set the stage for an even bigger debate over a joint resolution scheme for the banks subject to ECB supervision.

To cap work before Europe’s summer holidays, Barnier rolled out his plan for a Single Resolution Mechanism — the agreed-on Phase II of the great banking union project — to immediate pushback from the Germans.

“There have been some achievements that would have been unthinkable two or three years ago,” said Bernhard Speyer, co-head of Deutsche Bank Research. “On the one hand we have made progress, on the other hand Germany and other governments are holding back from going the whole way.”

To contact the reporters on this story: Rebecca Christie in Brussels at; Jim Brunsden in Brussels at

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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