Banking union is a sham that solves nothing

December 19, 2013 4:59 pm

European banking union is a sham that solves nothing

By Sony Kapoor

The idea is a distraction from more pressing issues, writes Sony Kapoor

The drumbeat of banking union has drowned out more important and urgent conversations on tackling the severe crisis in Europe. Given the earnestness with which EU leaders talk about the importance of “making progress on banking union”, citizens could be forgiven for thinking it is God’s gift to mankind – or at least that it might stem the eurozone crisis.It will do nothing of the kind. The banking union package agreed this week is at best a distraction from tackling the crisis. At worst it may even be counter-productive in the longer term.

Banking union as an idea emerged at the peak of the euro crisis, when Greece’s departure from the eurozone was a real possibility and the prospect of a large-scale depositor flight from Spain’s fragile banks kept EU policy makers awake at night. Given Germany’s veto of eurozone bonds in particular, and fiscal pooling in general, banking union was floated as an alternative. This would supposedly put European banks on an even keel under the protective umbrella of European supervision, European capital support and European deposit insurance.

By hinting at the sharing of risks arising from banks, policy makers sought to reassure panicking depositors and investors to keep their money in peripheral banks. It was a clever idea that communicated that EU politics was not completely deadlocked in the face of the crisis, when the truth was otherwise. But it was the promise made by Mario Draghi, president of the European Central Bank, to “do whatever it takes” to ease market panic. Anyone who credits any progress on banking union with restoring confidence is being disingenuous.

Germany was sceptical, having recognised banking union as fiscal union by the back door, which it was. Others thought it was an essential building block for a well-functioning monetary union over the longer term. But its loudest proponents have continued to sell it as a means to tackle both present and future crises. The fact that European policy has been reduced to a one-horse race with all bets on making progress on banking union shows how successful these enthusiasts have been.

Since Germany’s early veto of sharing the risks and costs posed by so-called legacy problems in peripheral banks, policy makers in Europe freely admit banking union will be of very limited, if any, relevance in addressing the present crisis. What then is the urgency that justifies squandering all our scarce political capital on this one project?

It has surely distracted us from measures that could actually help with our immediate problems. Even worse, we may end up exacerbating exactly the problems that caused the eurozone crisis in the first place.

The EU had put the cart before the horse by pushing for integration of financial markets, while product, service and labour markets remained deeply fragmented. The run-up to the financial crisis saw a shadow banking union at work, under which excess German (and other) savings chasing higher yields flowed freely across borders. They helped inflate asset price bubbles in Spain and Ireland, and allowed the Greek government to go to town with its borrowing.

Cross-border flows of finance in the eurozone were, until that fateful day in September 2008, proudly considered to be a metric of the success of the European project. Little attention was paid to how the money was actually invested or the effect this had on the real economy. Almost overnight, this badge of honour became “imbalances”. This recognition that integrated financial markets driving the now notorious current account imbalances were problematic came too late; as did the fact that a fragmented real economy lacked compensatory mechanisms to adjust.

The single most important lesson from the eurozone crisis has been the urgent need to minimise this gap between an integrated financial sector and a fragmented real economy. This was the driving force behind the report on the future of the single market by Mario Monti, the former Italian prime minister, which has now disappeared from sight. The banking union brigade has sucked the oxygen out of all discussions on renewing the single market, service sector integration or improving labour mobility.

Whatever little is agreed at the European Council this week on banking union will do nothing to mitigate the deep crisis in which the eurozone remains mired. By exacerbating the yawning gap between relatively well-integrated finance and the reality of divided product, service and labour markets, it may even increase the build-up of risks in the future. The sham banking union on the table would do little to protect us against these.

The writer is director of Re-Define, a think-tank