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Kempen's Commentary: Will there finally be a European banking union?

15 November 2019


Something remarkable happened last week. The German finance minister Olaf Scholz wrote in an article in the Financial Times that Germany is prepared to support a European deposit guarantee scheme. This system would be an important step in the completion of the European banking union. This process started in 2014 by shifting bank supervision to the European Central Bank (ECB). In addition, agreements were made about the way in which banks that get into trouble should be rescued or dismantled. But the banking union has never been finalised, as a European guarantee system has not been realised yet.

Why a European system?
The major advantage of a European deposit guarantee system is that it regulates the guarantee for savings (up to € 100,000) at a European level. This reduces the interdependence between banks and governments. This dependence, which fully manifested itself in the Euro crisis, arises because governments can get into trouble when they have to save banks, and banks can get into trouble when governments come under pressure, due to the large amount of government bonds that banks possess.

Why does it take so long?
Traditionally, the Northern European countries believe that banks must first clean up and strengthen their balance sheets before a European guarantee system can be established. Currently, ECB statistics show that the percentage of bad loans on the bank balance sheets (non-performing loans) is steadily declining. For example, the percentage in Italy has halved in the last three years from 16 to 8 percent under the influence of a guarantee plan that allows banks to sell their bad loans with a state guarantee. A similar plan was recently introduced in Greece, aimed at reducing the percentage of bad loans (which is still around 40 percent).

This trend increases the stability of the banks. But what hasn’t changed is that especially Southern European banks still hold large amounts of government bonds from their own country. The reason for this is that government bonds are currently considered risk-free assets for banks (and for insurers). So, no capital buffer is necessary. And this was precisely what minister Scholz also proposed: the introduction of capital requirements for government bonds, based on concentration and credit risks. Italy immediately reacted with disapproval, which reversed the roles: Germany is now pro and Italy against.

Mario Draghi recently said that the end of the ECB’s potential to stimulate the economy is near. In his opinion, governments must take over and pursue increase in spending. Anticipating this new situation, it would be wise to reduce the interdependence between governments and banks and quickly realise the banking union.

The author

Michel Iglesias del Sol

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