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Western EuropeMarch 3 2014

German coalition tensions over banking union

The new 'grand coalition' of conservatives and socialists in Germany may have a huge majority in the Bundestag, but there are already disagreements over the extent of national powers in the functioning of the eurozone banking union.
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German coalition tensions over banking union

Back in October 2009, German chancellor Angela Merkel needed only three weeks of negotiations between her conservative bloc and the Free Democrats to sign her second coalition agreement. High on the priority list were tax-cuts for business and making the Bundesbank the lead bank supervisor.

As it turned out, her finance minister Wolfgang Schäuble, after much haggling over reforms to national bank supervision, gave up in utter frustration. The Bundesbank would not accept the role of lead banking supervisor, arguing that this would imply a certain control by the German government and undermine its independence in monetary policy. As a result, Germany’s federal financial supervisory authority, Bafin, wound up with more responsibilities and far more staff.

But as Angela Merkel enters her third term as chancellor, things are quite different from 2009, with the German public now weary from years of bailing out euro member countries and banks.

There are common policy goals in the ‘grand coalition’ agreement, under which Ms Merkel and the Social Democratic party leader Sigmar Gabriel as vice-chancellor want to govern together for the next four years. In terms of Berlin’s European stance, there was a key message from the coalition: individual EU countries should be responsible for winding down banks.

Bank accountability

A high priority is to ensure that the owner and creditors of failing banks are held accountable, not just taxpayers. New EU regulation requires owners, creditors and depositors – the latter of more than €100,000 – to cover the cost of bailing out or winding down failed banks.

For taxpayers and savers in the largest eurozone member country, it is especially important that the coalition agreement demands even more than this of a European resolution mechanism. The coalition agreement insists on bank resolution where national governments should maintain a major say and keep overwhelming financial responsibility. It opposes any form of jointly guaranteed debt in the eurozone wherever possible, including eurozone bonds and a debt redemption fund. And it pushes for a European financial transaction tax, which is meeting hefty protests from Germany’s banking industry. 

In the coalition negotiations, the Social Democrats demanded that the new government retract any commitment (made by Ms Merkel at the European Council level) to use funds from the European Stability Mechanism for direct bank restructuring. The politically influential German savings and co-operative banking sector put pressure on negotiators for more protection against the new European banking union bureaucracy of regional banking structures. 

One thing can already be said about Angela Merkel’s new term; never before did her party have such a majority to work with. Since the end of last year, the conservative party bloc under Ms Merkel and the Social Democrats under Sigmund Gabriel have a grand coalition with a breathtaking parliamentary majority of about 80% in the Bundestag, the lower house. The new grand coalition could in theory take on major challenges domestically and on the European crisis front. Whether it will do so is another question.

Two-step approach

Looking forward, it is worth remembering how Ms Merkel, on September 22, 2013, won the biggest election victory since German reunification in 1990. She campaigned against joint eurozone debt and for the continuation of her rather tough policy of aid to struggling eurozone countries in return for economic reforms.

In negotiating and implementing these policies on the European stage, Ms Merkel had Wolfgang Schäuble, now 71, a political veteran serving in many positions for decades, as finance minister on her side. For those asking about the implications of the new coalition government for the ongoing work on the European and global finance stage, one circumstance is crucial. Ms Merkel’s party was able to keep Mr Schäuble at the helm of the finance ministry and thus in charge as Berlin’s chief negotiator on euro rescue operations and the remaining pillars of Europe’s banking union.

During the election campaign and the protracted grand-coalition negotiations, Mr Schäuble pleaded for a two-step approach for European banking union, especially for setting up the second pillar, a single bank resolution mechanism (SRM) and fund (SRF). In view of the complexities around a three-pillar banking union – a single supervisor, a single resolution regime and a single deposit guaranty system – he argued in a letter to Michel Barnier, EU commissioner for internal market and services, for a two-step approach. That means first building an interim framework before getting to a ‘steel-framed’ set up after the necessary EU treaty changes.

When Mr Barnier presented the proposal for SRM and SRF in mid-2013 with the European Commission (EC) appointing itself as the sole authority with the power to shut down banks, Ms Merkel shot back reminding the EC “that for this, there is no legal basis”.

Struggling for resolution

Since then, the government has been struggling to negotiate a European bank resolution and fund structure that would not use Article 114 of the Treaty on the Functioning of the EU (TFEU). In the German government’s view, this only allows for the harmonisation of EU law to support the proper functioning of the internal market, which encompasses all member countries and does not aim to foster the specific objective of financial stability for just part of the EU.

Pointing to a probable negative judgement by Germany’s constitutional court when using Article 114 TFEU, Mr Schäuble eventually got the backing of all eurozone governments of a bank resolution structure where the fund with its fiscal implications would be based on a new intergovernmental agreement, as it was done earlier with the European Stability Mechanism.

On the road to European Council agreement, Mr Schäuble had to overcome powerful opposition from the EC and from EU member countries. When on December 16, 2013, he got a compromise deal under which another intergovernmental agreement on the functioning of the SRF would strengthen the legal basis, this was from a German perspective a major achievement. That the complicated structures and resolution processes would be sharply criticised was expected. Not only in German government circles but also in the banking industry there was a sigh of relief with the expectation that a bank resolution mechanism could be in place before the coming European Parliament election in May this year. But as coalition agreements go, it may not be long before the first cracks appear.

Parliamentary challenge

On January 16, 2014, leaders of the political groups in the European Parliament and its negotiating team firmly rejected the intergovernmental agreement approach to the SRM in the European Council. On top of other objections, in their view “it undermines the community method and the ordinary legislative procedure”.

For Mr Schäuble, the European Parliament’s rejection was a major blow. Not only did the Social Democrats and Green members of the European Parliament come out against the proposal, but also conservative members of the European Parliament in the Merkel camp, who advocated more power for European institutions. This put Mr Schäuble in an awkward position.

“I have a hard time understanding the logic of the parliament’s argument. On the technical level, there is no ‘federal’ budget in Europe to provide the fiscal backstop required for the SRF, the bank-sponsored fund to be created under the SRM. With national parliaments and governments being asked to sponsor possible backstops of bank resolution, having the direct decision-making line from the national level to the SRM is a sine qua non,” says Achim Dübel, a financial risk consultant and former World Bank official.

Things got worse when a letter from Social Democrat finance spokesman Carsten Schneider to the rapporteur of the European Parliament was leaked to Süddeutsche Zeitung newspaper, aligning Social Democrat members of the Bundestag to criticism of the agreement of the European Council to the single resolution regime. Mr Schneider backed amendments such as shortening the 10-year transition period and enlarging the envisaged size of the fund to more than €55bn. He also demanded that bank levies should be harmonised and not tax-deductible.

“The SRM will involve a single resolution fund of €55bn. American or Asian banks will not be faced with such a significant burden. Moreover, to impose ‘fair’ bank contributions to the single resolution fund can be a very demanding endeavour, as the riskiness and systemic importance of individual banks will be hard to judge,” says Gerhard Hofmann, a managing board member of the German co-operative banking association BVR and a former head of bank supervision at the Bundesbank.

Back-door eurobonds

What Ms Merkel and Mr Schäuble must consider as going against the grand coalition agreement is Mr Schneider’s demand for a rule change to allow the fund to borrow in the capital markets. This would mean allowing debt mutualisation and Eurobonds through the back door, via the bank resolution fund.

In the coming battle, Mr Schäuble can remind Martin Schulz, the European Parliament’s president who hopes to become the next EU president, that he was a key Social Democrat negotiator of the grand coalition consensus. And this consensus in the coalition agreement also included the complicated SRM/SRF hybrid structure under which national governments will maintain a major say and keep overwhelming financial responsibility in the resolution process, moving to European burden sharing only over a long transition period of 10 years.

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