The financial crisis that emerged, first in the United States and then in Europe, in 2008 showed that irresponsible behaviour by market participants can undermine the foundations of the financial system, leading to a lack of confidence among all parties, in particular consumers, and potentially severe social and economic consequences. As a response to the crisis, several EU Directives and Regulations were adopted or updated, forming a single rulebook for EU financial services, which is the foundation of the European banking union. The legal instruments in the single rulebook ensure that there is strong regulation in all EU Member States, guaranteeing a level playing field for banks and a real single market for financial services [see section 6.6.1].
Already since 2009, the EU had started preparing the advent of a banking union. Thus, in 2009, a programme was established, for the period from 1 January 2010 to 31 December 2013 and, in 2014, it was renewed for the period from 1 January 2014 to 31 December 2020, aiming to support the activities of bodies which contribute to the achievement of the policy objectives of the EU in relation to supervisory convergence and cooperation in the field of financial services and in relation to financial reporting and auditing [Regulation 258/2014].
These measures, examined under the 'Freedom to provide services in the EU' [section 6.6] and under 'Banking services in the EU' [section 6.6.1], were the first steps towards the establishment of the European banking union (EBU). In fact, the banking union consists of two main instruments, the Single Supervisory Mechanism and the Single Resolution Mechanism, which are based upon the single rulebook, mentioned above.
The first pillar of the banking union is the Single Supervisory Mechanism (SSM), which grants the European Central Bank (ECB) a supervisory role to monitor the implementation of the single rulebook and, hence, the financial stability of banks based in states participating in the banking union.
In order to provide for a single supervisory mechanism, two Regulations confer specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions in Member States whose currency is the euro and allows other Member States to establish close cooperation with the ECB [Regulations 1022/2013 and 1024/2013]. These Regulations aim at contributing to the safety and soundness of credit institutions and the stability of the financial system within the Union and each Member State, with full regard and duty of care for the unity and integrity of the internal market based on equal treatment of credit institutions with a view to preventing regulatory arbitrage.
The ECB will ensure a truly European supervision mechanism that is not prone to the protection of national interests, will weaken the link between banks and national finances and will take into account risks to financial stability. It will ensure that the single rulebook is applied consistently and coherently in the euro area. The ECB took over its new role as single supervisor in November 2014. In preparation for its new task, the ECB carried out a comprehensive assessment of significant banks and the balance sheets of those banks.
The ECB has direct supervisory competence in respect of credit institutions, financial holding companies, mixed financial holding companies established in participating Member States, and branches in participating Member States of credit institutions established in non-participating Member States that are significant [Regulation 468/2014/ECB]. The national competent authorities (NCAs) of participating Member States are responsible for directly supervising the entities that are less significant, without prejudice to the ECB’s power to decide in specific cases to directly supervise such entities where this is necessary for the consistent application of supervisory standards. The ECB can impose sanctions in its various fields of competence, including in particular the implementation of the monetary policy of the Union, the operation of payment systems and the collection of statistical information [Regulation 2157/1999/ECB, last amended by Regulation 469/2014/ECB],
However, the conferral of supervisory tasks on the ECB relating to credit institutions in some of the Member States should not in any way hamper the functioning of the internal market for financial services. Therefore, the European Supervisory Authority (European Banking Authority) (EBA), established by Regulation 1093/2010 [last amended by Directive 2015/2366], maintains its role and retains all its existing powers and tasks: it should continue to develop and to contribute to the consistent application of the single rulebook applicable to all Member States and to enhance convergence of supervisory practices across the Union as a whole.
On the other hand, according to Directive 2013/36 [last amended by Regulations 2016/98 and 2016/99], overreliance on external credit assessment institutions (ECAIs) should be reduced and the automatic effects deriving from them should be gradually eliminated. European institutions should therefore be required to put in place sound credit-granting criteria and credit decision-making processes. They should be able to use external credit ratings as one of several factors in that process but they should not rely solely or mechanistically on them. Moreover EBA, the Member States' central banks and the ECB, without making the process easier or less demanding, should provide for the recognition of more credit rating agencies as ECAIs in order to open the credit rating market, actually dominated by three non-European institutions, to other undertakings [see section 6.6.3].
The second pillar of the banking union, the Single Resolution Mechanism (SRM), which complements the Single Supervisory Mechanism (SSM), is based on uniform rules and a uniform procedure [Regulation 806/2014, last amended by Regulation 2015/81]. The Single Resolution Mechanism should ensure that – not withstanding stronger supervision - if a bank subject to the SSM faced serious difficulties, its resolution could be managed efficiently with minimal costs to taxpayers and the real economy. The SRM should apply the strict rules of the bank recovery and resolution Directive (BRRD) [Directive 2014/59, last amended by Regulation 2016/1712, see section 6.6.1].
If called by the ECB, the Single Resolution Mechanism would work as follows:
· The ECB, as the supervisor, would signal when a bank in the euro area or established in a Member State participating in the Banking Union was in severe financial difficulties and needed to be resolved.
· A Single Resolution Board, consisting of representatives from the ECB, the European Commission and the relevant national authorities (those where the bank has its headquarters as well as branches and/or subsidiaries), would prepare the resolution of a bank. It would have broad powers to analyse and define the approach for resolving a bank, which tools to use, and how the European Resolution Fund should be involved. National resolution authorities would be closely involved in this work.
· On the basis of the Single Resolution Board's recommendation, or on its own initiative, the Commission would decide whether and when to place a bank into resolution and would set out a framework for the use of resolution tools and the Fund. For legal reasons, the final say could not be with the Board.
· Under the supervision of the Single Resolution Board, national resolution authorities would be in charge of the execution of the resolution plan.
· The Single Resolution Board would oversee the resolution. It would monitor the execution at national level by the national resolution authorities and, if a national resolution authority did not comply with its decision, it could directly address executive orders to the troubled bank(s).
A Single Resolution Fund (SRF) would be set up under the control of the Single Resolution Board to ensure the availability of medium-term funding support while the bank was restructured. It would be funded by contributions from the banking sector, replacing the national resolution funds of the euro area Member States and of Member States participating in the Banking Union, as set up by the Bank Recovery and Resolution Directive [Directive 2014/59]. The Fund has a target level of €55 billion and can borrow from the markets if decided by the Board in its Plenary Session. The Fund would be owned and administrated by the Board.
The Commission's role would be limited to the decision to trigger the resolution of a bank and the decision on the resolution framework, thereby ensuring its consistency with the Single Market and with EU rules on state aid, and safeguarding the independence and accountability of the overall mechanism.
However, situations may arise when the SRF is not sufficiently funded by the banking sector, especially in the initial period but also in the steady state. In order to ensure sufficient funding, the Eurogroup and Ecofin Ministers agreed for Member States participating in the SSM/SRM to put in place a system by which bridge financing would be available as a last resort and in full compliance with State aid rules. In the transition period, bridge financing will be available either from national sources, backed by bank levies, or from the European Stability Mechanism (ESM) in line with agreed procedures [see section 7.3.3]. The arrangements for the transition period will be operational by the time the SRF is established, including the setting up of possibilities for lending between national compartments.
In any case, bank deposits in all Member States will continue to be guaranteed up to €100,000 per depositor per bank even if a bank fails. This guarantee gives savers a sense of financial stability and means that they do not rush to make excessive withdrawals from their banks, thereby preventing severe economic consequences. Individuals and small businesses with deposits of more than EUR 100,000 will benefit from preferential treatment ("depositor preference"). They will not incur any losses before other unsecured creditors and, therefore, are at the very bottom of the bail-in hierarchy. Member States can even choose to use certain flexibility to exclude depositors fully from the bail-in of a bank in difficulties.
Furthermore, depositors will have their money paid out more quickly, within 7 working days (down from 20), and national deposit guarantee schemes will be much better financed to back up their guarantees, notably through a significant level of ex-ante funding: 0.8% of covered deposits will be collected from banks over a 10-year period. If the ex-ante funds prove insufficient, the Deposit Guarantee Scheme will collect immediate ex-post contributions from the banking sector, and, as a last resort, the deposit guarantee scheme will have access to alternative funding arrangements such as loans from public or private third parties. There will also be a voluntary mechanism of mutual borrowing between deposit guarantee schemes from different EU countries.
The ECB and the European Banking Authority are carrying out a comprehensive exercise to assess the state of banks and stress-test them before the Single Supervisory Mechanism becomes fully operational in November 2014.
If capital shortfalls are identified for banks in the banking union the existing agreed cascade for recapitalisation gets underway: in a first instance, banks should raise capital on the markets or through other private sources. Should this not be sufficient, public money could be engaged at national level, under strict conditions and in line with State aid rules. In the second instance, if national backstops are not sufficient, instruments at the European level may be used, including the European Stability Mechanism.
As in the banking union all banks are subject to the same supervisor and to the same resolution mechanism, confidence in all EU banks should increase. Banks' market credibility will depend on their specific risk profile and less and less on the financial strength of the Member States where they are based. This should make it easier for banks in all Member States to access funding on equal terms which in turn makes it easier for them to lend once again to households and businesses across the EU.
7.4. Appraisal and outlook
As happened with the first attempt at establishing an economic and monetary union in Europe, in 1971, the launch of the euro coincided with a highly adverse international economic and monetary situation: the terrorist attacks in New York and Madrid, the sizeable devaluation of the dollar, wars in Afghanistan and Iraq on Europe’s doorstep and high energy prices, probably related to these wars. In this adverse global situation, the euro has shielded the economies of the euro area from competitive devaluations, galloping inflation and an increase in the prices of imports, more than 60% of which come from other euro countries. It is highly probable that if European economies had not the shield of the euro, they would have been in a much worse situation than the one in which they found themselves when the euro became the strongest currency in the world.
Despite the adverse global situation, the second effort at creating a European economic and monetary union was an unquestionable success, particularly in view of the great challenge of the changeover to the single currency. Not only was the physical introduction of the euro a historic event, it also represented an unprecedented strategic, logistical and practical challenge. Despite these difficulties and the Cassandras' catastrophic prophesies, the euro was circulated successfully, thanks to an exemplary planning and cooperation of national and European authorities.
Moreover, in spite of the great advance of multinational integration brought about by the EMU, national sovereignties have not suffered unduly. The Member States, which have moved to the third stage of EMU, have undoubtedly lost the autonomy of their monetary policy, since they are no longer at liberty to use the two main levers of this policy - exchange rates and interest rates (a freedom which they had already lost to a large extent, due to the interdependence of the European economies). At the same time, however, they lost responsibility for the parity of their currency and the equilibrium of their balance of payments, while enjoying shared responsibility for the parity of the euro against the currencies of third countries and the equilibrium of the collective balance of payments of the euro-zone countries. However, balance of current payments constraints exist for the zone as a whole. Therein lies the importance of the close coordination of economic policies.
Price stability, which is a vital prerequisite for EMU, is also favourable to growth and the efficient use of the pricing mechanism for the allocation of resources. National budgetary policies and consequently government finances are subject to certain constraints anchored in the stability and growth pact. The most direct "static gain" of the EMU is the ending, within the unified market, of all transaction costs inherent in the use of several currencies, costs representing between 0.3 and 0.4% of the GDP of the Union. Travellers, who previously lost important amounts in the exchange of their currency for those of the countries they visited, should particularly welcome these gains. "Dynamic gains", which cannot be measured directly, could take two forms: those resulting from heightened productivity and those generated by the elimination of the uncertainties concerning the long-term evolution of exchange rates.
In addition, the euro allows a better balance of the international monetary system, dominated for half a century by the dollar, which serves as a reference currency for almost 60% of world trade, whereas American exports represent around 12% of world exports. Its economic and commercial weight (16% of world exports) entitles the Union to play an important role in the necessary review of the international monetary and financial system. This review should focus on methods of crisis prevention and management, improved governance of the international monetary and financial system, development assistance and debt relief for developing countries.
Since 2008, however, Europe and in particular the young eurozone suffer from the harmful consequences of the global recession. European economies suffered greatly from the global financial and economic crisis, which began with the subprime mortgages and the toxic mortgage backed securities, in the United States in mid-2008 and soon hit the whole world. As a result of these external and unpredictable circumstances, all EU Member States were hit by recession and rising levels of unemployment.
The global crisis demonstrated the weakness of the European economic and monetary union. It suffers, in particular, from disequilibrium between its strong monetary wing and its feeble economic one. The euro area is a monetary union working under a single monetary policy and coordinated but decentralised economic policies. While monetary policy management is the exclusive responsibility of the European Central Bank, economic and budgetary policies are a national prerogative. However, in an integrated monetary and economic zone, overspending and deficient restraint of inflation rates in some countries inflict a collective cost borne by all the countries sharing the same currency. This was revealed, at the end of 2009, when the Greek crisis, partly caused and amplified by the global crisis, touched other euro area countries and affected the euro itself [see section 7.3.2].
Despite the difficulties of decision-making between 17 Member States with different economic situations and, hence, different interests, many measures were taken, which were not provided by the Treaty on the Functioning of the EU and were considered unthinkable before the crisis and the attacks of the global markets on the weak-links of the eurozone and the euro itself. In 2010 was created the European System of Financial Supervisors (ESFS), which gathers entities exercising financial supervision at national and EU levels: the European Systemic Risk Board; the European Banking Authority; the European Insurance and Occupational Pensions Authority; and the European Securities and Markets Authority [see section 6.6]. At the same time was adopted the Euro Plus Pact, which aims to achieve a new quality of economic policy coordination, with the objective of improving competitiveness, thereby leading to a higher degree of convergence [see section 7.3.2]. The same goal is sought by the strategy "Europe 2020" and the "European Semester".[see section 7.3]. Within two years, from 2010 to 2012, were also created: the European financial stabilization mechanism (EFSM) and the European Financial Stability Fund (EFSF), temporary measures, which, in June 2013, were replaced by the European Stability Mechanism (ESM) [see section 7.3.3].
Within two years, from 2010 to 2012, were created: the European financial stabilization mechanism (EFSM) and the European Financial Stability Fund (EFSF) that led to the European Stability Mechanism (ESM). At the same time were created: a European System of Financial Supervisors (ESFS), which gathers entities exercising financial supervision at national and EU levels; the European Systemic Risk Board; the European Banking Authority; the European Insurance and Occupational Pensions Authority; and the European Securities and Markets Authority [see section 6.6]. At the same time was adopted the Euro Plus Pact, which aims to achieve a new quality of economic policy coordination, with the objective of improving competitiveness, thereby leading to a higher degree of convergence [see section 7.3.2]. The same goal is sought by the strategy "Europe 2020" and the "European Semester". Finally, it was decided to create a single banking supervisory mechanism and to allow the ESM to inject capital into banks directly, i.e. without the interference of governments and no cost to public budgets [see section 7.3].
The new rules on the banking union, in force since 1 January 2014, allow for early intervention when banks face problems. Bank supervisors are accorded an expanded set of powers to enable them to intervene if an institution faces financial distress (e.g. when a bank does not respect or is about not to respect its regulatory capital requirements), but before the problems become critical and its financial situation deteriorates irreparably. These powers are set out in the recovery plans of banks and include the possibility of dismissing the management and appointing a special manager, convening a meeting of shareholders to adopt urgent reforms, and prohibiting the distribution of dividends or bonuses. Other measures which the relevant supervisor can insist on are requiring the bank to reduce its exposures to certain risks, increase its capital, or implement changes to its legal or corporate structures. The ECB as single supervisor will supervise the early intervention in coordination with the relevant resolution authorities.
Together with the new EU wide regulatory framework for the financial sector [see sections 6.6 and 6.6.1], the banking union is a big step in the economic and monetary integration of the EU. It will put an end to the era of massive bailouts paid for by taxpayers and will help restore financial stability. This, in turn, creates the right conditions for the financial sector to lend to the real economy, spurring economic recovery and job creation.
The next steps that should be taken soon to complete the institutional framework of the economic union are: a single deposit guarantee scheme in all Member States; a single mechanism for assessing the financial risks; expansion of surveillance in risky financial products, such as hedge funds; and the creation of a European credit rating agency to break the American monopoly in this area. In parallel, the role of the European Central Bank should be expanded to enable it to pump fresh cash for the needs of the ESM and therefore of Member States and their banks. These steps will gradually open the way for the issue of Eurobonds, so that all euro area Member States could borrow from the world markets at the same rate, slightly higher than the rate at which borrows now Germany, which for this reason stubbornly refuses this essential step towards a true single economic policy.