The formation of a European banking union should have helped ease Greece's economic woes, but far from putting European banks on an even footing, the so-called union left Greece out in the cold, writes former Greek finance minister Yanis Varoufakis.

The 2007/08 banking crisis weighed heavily on public finances in Europe and the US. However, only in the eurozone have the banking sector’s woes continued to fuel a debt-deflationary spiral.

The European banking union, announced in 2014 amid considerable fanfare, was meant to end the mutual reinforcement of the banking and public debt crises. Unfortunately, it has not.

In a proper banking union, a given bank deposit should have the same expected value independently of where in the union the bank is domiciled. In this sense (and despite the new single rulebook, supervisor and resolution mechanism) the eurozone is most certainly not a proper banking union. Indeed, euros deposited in a German or Dutch bank remain safer than in a Portuguese bank, and a great deal safer (as well as more liquid) than in a Greek bank.

The reason for the differential excepted value of a given bank deposit across the euro area is, of course, the link between a bank’s backstop and the member state’s public finances. The recent Greek bank recapitalisation demonstrates vividly that this link remains powerful in Europe’s banking union.

Before the union...

In 2013, a year before the banking union’s formal introduction, the insolvent Greek state borrowed €41bn (or 22% of Greece’s shrinking national income) from European taxpayers to recapitalise the country’s insolvent commercial banks. There were two errors almost guaranteeing the spectacular failure of that recapitalisation.

First, within months of the recapitalisation, to attract private capital, a fresh share issue was announced in which the state was forbidden from participating by the Troika (the European Commission, the European Central Bank [ECB] and the International Monetary Fund [IMF]). With the new shares offered at an 80% discount over the price tax payers had paid, the Greek state lost approximately €20bn overnight – half of the capital the taxpayers had contributed. Thus, the stressed Greek state, on which the banks continued to rely, was weakened further by the dilution of its equity.

Second, the recapitalisation proceeded before any provisions were made to deal adequately with non-performing loans (NPLs) that the vicious recession had elevated so that they now accounted for 40% of all loans in Greece.

Confirming the danger to the banks’ capitalisation from the burgeoning NPLs, in February 2014, US-based investment firm BlackRock reported that Greece’s banks needed a substantial third recapitalisation. By June 2014, the IMF was leaking a report that this third recapitalisation would require more than €15bn to ‘restore’ the banks’ capital base – a great deal more money than was left in Greece’s second bail-out package. And given that, by the end of 2014, the government would be facing a €22bn bill of mostly unfunded debt repayments (mainly to the IMF and the ECB), a third bail-out of the Greek banks and the Greek state was in the offing. 

Interestingly, by that time (June 2014), the eurozone was meant to have evolved into a banking union. How did this new ‘reality’ manifest itself in the case of the third bank recapitalisation that was in the pipeline? Where the errors of 2013 avoided, or were they repeated?

...and after

By late January 2015, the political fallout from the 2013 failed bank recapitalisation, the continuing recession[1], and the need for a third bail-out had toppled the Troika-friendly Greek government and had brought the Syriza party to government, with the undersigned as its finance minister.

Facing grossly under-capitalised banks and public finances unable to cope with the state’s debt repayments, my priority was to convince the Troika that any new bank recapitalisation should avoid the pitfalls of the first two: new loans should be secured only after Greece’s debt had been rendered viable, and no new public funds should be injected into the commercial banks unless and until a special-purpose institution – a ‘bad bank’ – was established to deal with their NPLs. 

One could be excused for thinking that these were reasonable conditions to propose in view of the banking union Europe had proclaimed at the start of 2014. Alas, the Troika was not interested. Its aim was to crush a government that dared challenge its authority. To this effect, it engineered a six-month-long bank run (December 2014 to June 2015) and shut down the Greek banks on the last day of June 2015, thus causing prime minister Alexis Tsipras’ capitulation to a third bail-out, whose terms and conditions seemed utterly untouched by the principles of banking union.

The first significant action that was taken in the context of Greece’s latest bail-out was the third recapitalisation of the banks, completed in a rush during November 2015. How did it differ from the recapitalisations that had occurred before Europe’s banking union was in place?

Not significantly, is the answer. The only difference was that the books of Greece’s banks were now assessed by the single supervisor, who professed that taxpayers had to contribute another €6bn. However, the two crucial errors of the previous pre-banking union recapitalisations were repeated: the state was prevented from purchasing the shares offered to private investors (thus pulverising taxpayers’ remaining equity) and the management of NPLs (which had by then exceeded 50% of all loans) was postponed for another future date. 

And so, despite Europe’s banking union, Greece’s banks remain burdened by NPLs and rely as much as they always did on public finances weighed under by unsustainable debt that is due, partly, to the nature of the bank rescues[2]. Not exactly a ringing endorsement of Europe’s banking union.

A modest proposal

The omens for a proper, fully fledged banking union are worse than ever. Most recently, the German finance minister threatened the European Commission with legal action if it continues to propose the most essential of a banking union’s features: mutualised deposit insurance.

Berlin’s stated fear is that mutualising credit risk would be tantamount to a massive fiscal union that the present political arrangements of the EU preclude[3]. However, the present dis-union remains indefensible. Is there a third alternative?

Suppose that whenever a bank needs to be recapitalised, the government of the member state in which it is domiciled has an opt-out clause. If it uses it, the bank is removed from its original national jurisdiction and is admitted to a new eurozone-wide jurisdiction (EJ). Once under EJ, the ECB and the single supervisor appoint a new board of directors with a remit to recapitalise or resolve the bank. Any new capital comes directly from the European Stability Mechanism (ESM) in exchange for shares, which are to be auctioned off once the exercise is completed – just as in the case of the troubled assets relief programme in the US.

Note that capital injected into the problem bank does not weigh down the fiscally stressed government. Also, the cosy relationship between local bankers and politicians is broken off – two factors that would have helped Greece, as well as many others, to weather the euro crisis so much better.

A gradual course to proper banking union can be set if Europe establishes a new eurozone-wide banking jurisdiction to be ‘populated’, at first, only by banks whose rescue cannot come without deepening the debt-deflationary process in the member state where they were originally domiciled. Europe needs neither to be stuck in the present banking dis-union nor be compelled to rush into a massive transfer union. The only impediment to activating this modest but effective remedy is the aspiration to retain draconian powers over democratically elected governments through the threat of bank closures (if they dare defy the Troika). Is the maintenance of such power over democratically elected governments worth the dreadful economic and social costs of our banking dis-union?

Yanis Varoufakis is a professor of economic theory at the University of Athens and the former finance minister of Greece.

[1] Nominal GDP declined continuously, from 2009 to this date. In late 2014 and early 2015, real GDP picked up by a small amount but only because average prices were falling faster than nominal GDP.

[2] Note that, despite capital injections of approximately €47bn in the space of  two years (€41bn in 2013 and another €6bn in 2015), the taxpayers' equity share dropped from more than 65% to less than 26%, while hedge funds and foreign investors (for example, John Paulson, Brookfield, Fairfax, Wellington, and Highfields) picked up 74% of the banks’ equity for a mere €5.1bn investment.

[3] Instead of a proper political union, Berlin continued, we should be aiming at reducing risks throughout the union. The problem with this view is that, even if we do this, the legacy debts and banking losses from the previous crisis prevent the recovery necessary to produce incomes with which to build up Europe’s defences against the next crisis.


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