In the desperate search for the euro’s saviour, all eyes have turned to the concept of a “banking union”. Regardless of whether it is a good idea or a bad idea, banking union will undoubtedly cut not only to the heart of a key UK industry — financial services — but also the wider issue of Britain’s future in the EU in the face of further eurozone integration.
However, the typical response of City people, or those in Whitehall for that matter, is confused. On the one hand they love the idea, seeing it as a backstop for shaky eurozone banks that threaten City firms and the British economy alike. On the other, they fear it on the basis that the UK could be left without “a seat at the table” in Europe, meaning that the City would be forced to accept rules written for and by the eurozone. This hardly makes for consistent policy.
A banking union effectively involves three steps: a single rulebook, a single supervisor and a joint backstop (including a deposit guarantee scheme and resolution scheme with a wind-down mechanism). Given the Continent’s vastly differing banking systems and interests, achieving these three steps will be hugely challenging — and probably take years.
Still, the European Commission will kick-start the process this autumn by tabling a proposal to make the ECB the single financial supervisor for eurozone banks, for which there is broad support. While David Cameron has ruled out the UK taking part, with zero chance of it being accepted domestically, he has actively encouraged the creation of a banking union on the condition that “British interests are secured and the single market is protected”. The problem for the UK is that a banking union, if developed to its logical end point, will almost certainly cut across the single market in financial services.
For Britain and the City there are two main risks, the extent of which are unknown at present. First, companies doing business in the euro area could be required to be supervised by eurozone authorities. The ECB has already demanded that City-based clearing houses establish themselves inside the eurozone to be allowed to clear transactions in euros, something the UK has challenged at the European Court of Justice. If such practices become part of a banking union, the City would face a series of hurdles to doing business in the eurozone. The second risk is that the eurozone 17 start to write banking and financial rules for all 27 EU states, using their in-built majority in the Union’s voting system to implement them via the EU institutions.
Here, it is vital to understand the political incentives created by a banking union. To avoid banks free-riding on German taxpayers, Angela Merkel, the Chancellor, is likely to insist on any financial backstop being backed by perfectly harmonised regulations — for example, on capital requirements or bonuses — with little or no national discretion. This could well spill over to Britain, as the eurozone is unlikely to accept an uneven playing field within EU financial services, with the UK having few ways of blocking eurozone-tailored regulation being applied to the single market, even if detrimental or discriminatory.
So what should be done? First, Britain needs a consistent diplomatic position: it cannot both actively call for a banking union and implicitly threaten to veto it, as is the case at present. Second, to avoid the new structure — including the ECB — stepping into single-market territory, the UK needs to work with EU allies to make sure that it is fully accountable. The division of labour between the ECB and the London-based European Banking Authority needs to be made perfectly clear, for example.
However, given the stakes, Britain also needs to think creatively about new institutional arrangements with Europe, not only to guarantee the City’s position as a global entry point to the single market — offered by continuing EU membership — but also to create a space in Europe for those countries not intent on joining the single currency, and also for those that may choose to leave. There are several potential solutions. For example, non-euro members could be given the right to appeal against any proposal at the European Council, where all countries have a veto, if it is deemed to undercut the single market or be discriminatory — a “single-market lock”, if you will.
Such a move may require treaty change, but so will the steps towards banking union beyond the single eurozone regulator. Furthermore, if pitched right, such proposals could draw support from countries on both sides of the eurozone divide, including Sweden, Germany and Poland, given that the motivation would be to protect the single market.
A eurozone banking union is still shrouded in unknowns. But the City, even if it wants things to stay the same, may have to accept that things will have to change.