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The Eurozone’s Imperfect Banking Union

Greene, M., (2014), “The Eurozone’s Imperfect Banking Union”, Open Markets, 20 February.

The ECB is currently gearing up to look under the hood of Eurozone’s 128 largest banks in an asset quality review and stress test before taking over supervision of the biggest banks. There is immense political pressure on the ECB from national supervisors to not find any big capital holes in the banks. If big capital holes were discovered, there is no cash available to fill them. Consequently the ECB is likely to err on the side of leniency in its inspection of European bank balance sheets.However, banks cannot avoid crystallizing losses for NPLs forever. Now that the SSM has been established, the second step towards banking union is to determine what to do when losses are accepted and a bank gets into trouble.European policymakers have agreed on a roadmap for what to do when a bank has a capital hole, to come into effect in 2016. First, banks are encouraged to raise their own capital in the markets. If this is not possible, banks must impose a loss on their creditors amounting to as much as 8 percent of the bank’s liabilities. This bail-in rule is the single most important developments so far in the banking union. It means that banking debt no longer necessarily gets foisted onto the state’s balance sheet by an immediate bailout. Consequently, the doom loop between banks and sovereigns has been weakened.

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