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Editor’s blogOctober 24 2014

AQR only the start for a eurozone banking union

The results of the European asset quality review are due, but regardless of what they unearth there is still much work to be done before a banking union is a realistic possibility.
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The results of the asset quality review (AQR) for eurozone banks are due on October 26. Five years late, the AQR and accompanied stress testing should (barring any major shocks) finally pave the way for a more stable European banking system and eventually a banking union. The latter is essential if the eurozone is going to thrive (with healthy banks advancing credit) and, arguably, without it the eurozone may not survive.

But there is still a long way to go. To function properly a banking union requires a lot of elements. These are a single regulator, a resolution mechanism, deposit insurance, a common rule book and a lender of last resort.

For the eurozone to survive it requires, in the absence of fiscal union, at least some kind of sovereign debt restructuring mechanism and a way of breaking the feedback loop between banks and indebted sovereigns.

This is a big ask, and given the current parlous state of EU politics the outcome is likely to fall some way short of what is really needed. The current timetable is for the single supervisory mechanism (SSM) to kick in on November 4, the single resolution mechanism (SRM) on January 1, 2015, and its bail-in provisions a year later.

Bankers are concerned that with the advent of the SSM and, in spite of its name, they will now be subject to more than one regulator – the European Central Bank, the host country regulator and, for foreign banks, their home country regulator as well. To work properly it needs a common rule book which the European Banking Authority (EBA) is tasked with producing. The EBA has identified 100 areas where there are national deviations from Capital Requirements Directive IV (the EU format of Basel III) so it has its work cut out.

More problematic still is the SRM, which by its very nature has, to be effective, to be streamlined and be able to move decisively over a weekend if a bank gets into trouble. Speedy and effective action is not exactly the EU’s forte and it is hard to imagine a national government and national regulator standing meekly aside as the central authorities resolve a major local bank.

In a recent Citi paper – Stumbling towards banking union – the authors say: “The biggest risk… is that… the SSM and SRM will turn out to be dysfunctional, plagued by poorly assigned powers and responsibilities, complex and time-consuming decision-making procedures and nationally driven politics.” The Citi team says that its bigger fears are with the SRM as “through the involvement of the European Council its decision-making processes are subject to political interference and delays”.

On top of this there is a widespread view that the fiscal resources available to recapitalise banks are inadequate. Meanwhile, proposals on deposit guarantee schemes are more concerned with harmonising national schemes than creating the desired single eurozone area scheme.

Worst of all the exposure of banking systems to sovereigns remains, and with sovereign debt zero-risk weighted this is unlikely to go away. The best that can be said about the AQR and the banking union is that the direction of travel is correct – there is a long way to go before it all arrives in the right place. 

Brian Caplen is the editor of The Banker.

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