Merler, S. (2014) “Vicious circle(s) 2.0 – while trying to sever the sovereign-banking link, we may be disregarding vulnerabilities from banks’ mutual interconnectedness“, Bruegel Institute, 20 November.
Since the beginning of the crisis – and more so since 2010 – Europeans have been looking at the sovereign-banking “vicious circle”, tying the dismal fates of States and banks together. This has emerged as a characteristic disease during the euro crisis, and one of the stated objective of the European Banking Union project was precisely to remedy it.
The idea was basically to achieve this goal in a twofold way, ex ante and ex post. On one hand, by imposing stronger and harmonised supervisory requirements (e.g. on capital) and by empowering a third-party, independent and hopefully high-quality, supervisor to oversee their fulfillment, thus rebuilding trust in supervision and in the financial sector’s health. On the other hand, if a crisis turned out to be unavoidable, the second principle consisted in limiting recourse to taxpayers’ money as much as possible therefore preventing doubts about the damage that bank rescue would inflict to the state of public finances.
The first principle was translated into practice by the creation of a Single Supervisory Mechanism (SSM) under which, on the 4th of November, the ECB took over supervisory responsibility for banks in the euro area. The second principle concretized by the introduction of the Bank Recovery and Resolution Directive (BRRD) which gives a framework for resolution of troubled banks, and by the creation of a Single Resolution Mechanism (SRM), who should ensure consistent and homogeneous application of it. Among the other provision, the BRRD contains a set of rules for the application of bail-in in bank resolution, strengthening the involvement of private creditor that de facto is already introduced by the amended State Aid framework.
Hence, there has been a remarkable shift in the European mindset about banking crisis, from a first phase in which bail-in was a taboo, to a second one in which it is considered as a new normal and welcome practice. And there is in principle nothing bad about this idea, but the question is whether in rapidly overturning the approach, European policymakers have not overlooked important weaknesses that still exists in the system and could have important consequences in the perspective of applying these new rules.
Relevant posts:
- STRATFOR (2014) “Europe: Building a Banking Union“, Europe’s Economic Crisis Timeline, 30 October.
- Micossi, S. (2014) “Bail-in rules in EU banking union and financial stability“, VoxEU Organisation, 05 June.
- Gordon, N. J. & Ringe, G. (2014) “How to save bank resolution in the European banking union“, VoxEU Organisation, 30 April.