Banking union – or Potemkin village? by Philip Whyte
Since mid-2012, the eurozone crisis has been in remission. The period of relative calm which has prevailed since then has not been the product of an upturn in economic fortunes: until the recent summer uptick, the eurozone had suffered six consecutive quarters of declining activity and rising unemployment (a result in part of synchronised fiscal austerity across the region as a whole). Instead, the period of peace has reflected two factors: the increased willingness of the European Central Bank (ECB), under Mario Draghi’s presidency, to act as a lender of last resort to governments; and a belated recognition by European leaders that the eurozone suffers from design flaws that need correcting. Sadly, the success of the first factor appears to have had unfortunate consequences on the second. A design flaw that was not spotted by critics when the eurozone was launched, and that only became apparent after the 2008 financial crisis, was the instability of a fiscally decentralised currency union backed by a limited mandate central bank. This configuration, it turned out, gave rise to stresses in the eurozone that did not arise in the US. The most destabilising of these was the emergence of ‘doom loops’ in which fragile banks and fiscally weak sovereigns undermined each other. Reducing memberstates’ vulnerability to these spirals required the eurozone to establish a banking union. The trouble, however, is that the ECB’s success in lowering government bond yields in countries like Spain and Italy appears to have reduced the
sense of urgency felt by European leaders to build a banking union. Constructing a banking union was never going to be an easy task, not least because it raises the same underlying political sensitivities as Eurobonds (an idea that was abandoned by EU leaders for being too far ahead of its time). The original blueprint for a banking union outlined by Herman Van Rompuy, the president of the European Council, in June 2012 envisaged four pillars: a common authority to supervise banks across the eurozone; a single resolution authority to restructure or wind up insolvent banks; a joint fiscal backstop to recapitalise banks; and a deposit protection scheme jointly funded by eurozone