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Friday, June 15, 2012

A eurozone banking union will fundamentally change the rules of the game for Britain in Europe: Is Cameron ready to pull another veto?

Over on the Telegraph blog, we argue:
Talk of a banking union for the eurozone has become fashionable. Many, including the British government, see the idea as a way to provide some sort of backstop for the eurozone, where shaky banks remain a huge threat not only to the single currency, but also to the British economy.

Banking union, as a concept, has merits – it tries to deal with the ever elusive question: what happens when cross-border banks fail? But, viewed from London, a banking union is also political dynamite. It cuts to the heart of both a key national industry and Britain's future place in the EU as the eurozone integrates further.

There are only embryonic proposals on the table at the moment, and a lot is unclear. A banking union could involve a wind-down mechanism, resolution fund and deposit guarantee scheme – all on a cross-border basis. It could also take various different institutional shapes, putting the Commission, the ECB or national capitals respectively at the centre (expect turf battles). All of these vital decisions will take a lot of negotiation and time to sort out and may involve EU treaty changes – while there’s huge resistance in some member states, not least Germany. It may not be politically possible to achieve.

Regardless, the UK cannot take part in the banking union itself: politically, it would involve a massive transfer of powers to the EU, which no British government will go anywhere near. Economically it would be virtually impossible too, given the disproportional risk accounted for by the City of London, which neither side would be willing to accept. Instead, in a scenario reminiscent of David Cameron’s December veto, the question is whether London will simply nod through the changes (whether a Treaty change or not, the UK will have veto over at least some elements) or whether it will name a price for its approval.

George Osborne and No 10 have said they will seek safeguards to ensure that “British interests are secured and the single market is protected… anything affecting the single market should be agreed by all 27.” But is Cameron really willing to veto the same union that he is calling for?

Because if, according to UK wishes, a fully-fledged banking union indeed materialises, it’s very difficult to see how it would not cut right across the single market. The most obvious risk is over ‘location policy’ – whether in future a certain firm or financial activity must be supervised by eurozone authorities in order to do business there. This would essentially serve as a massive barrier to UK firms doing business in Europe – in an extreme case, the City of London would effectively become ‘offshore’ for the purposes of trade with euro countries.

But more probably, for a banking union based on cross-border liabilities to really work, it would need to be backed by perfectly harmonised regulations, to avoid a bank in one country essentially free-riding off the back of guarantees by taxpayers in another country. This is precisely why the Germans are so sceptical – without a single set of rules the banking union would spill over to fiscal union but without the corresponding central controls. Not only because backstopping banks is a big part of state liabilities, but also because banks flush with new eurozone-wide guarantees could lend to their domestic sovereigns at incredibly low rates, essentially providing artificial subsidies to states and removing market pressure for reform (sound familiar?). That would give rise to moral hazard of ridiculous proportions.

Instead, the eurozone will need a ‘single rulebook’ for banks, which may or may not be compatible with the current rules governing the single market in financial services. For example, to counter free-riding risks, individual countries could have no discretion whatsoever on capital requirements for banks. It would be a single target for all euro countries, with zero flexibility. This may not be a disaster for the UK – it could even be a benefit. But it could also go the other way, ending with an in-built eurozone majority voting to apply the single eurozone capital target for the EU as a whole, which could be substantially different to the needs of the UK. A eurozone banking union would also alter the basic relationship between the home and host countries of cross-border banks (i.e. subsidiaries), shifting the previous fragmentation from national borders, to the euro/non-euro divide.

Again, this may or may not be a problem for the UK, but the point is that inherent in the creation of a full-scale banking union is the fragmentation of the EU single market – which means that, if you’re sat in London, you should tread extremely carefully around the issue. A compromise may be possible (though it won’t be pretty) which would allow for the gap between the eurozone and the single market to remain narrow (we’ve suggested some potential compromises here). But the political dilemma for the UK government is clear: is it prepared to use another veto to block a banking union absent UK-specific safeguards – risking being perceived as hampering efforts to save the euro? Or will it simply nod through potentially game-changing proposals, risking the wrath of its backbenchers?


Rollo said...

Cameron will be torn between his approach to the EU, as king of the Quislings, anxious to ensure a federal state with central control in Europe; and his own voters, who voted him in at least in part because he pledged a referendum on our membership. He will try to slime his way through this maze; but do not count on him doing anything useful.

Jesper said...

Sweden wishes to introduce legislation that forces banks to have higher capital adequacy ratios. A bit similar to what Switzerland has introduced. However, due to EU-membership Sweden is currently prohibited from doing so: It has been claimed that forcing Swedish banks to become safer is violating EU-rules regarding competition....

Patrick Barron said...

"That would give rise to moral hazard of ridiculous proportions."

There is no "single rule book" or harmonization of regulations that can prevent massive moral hazard. The whole idea of providing a backstop for banks is fallacious. Banks get in trouble for very good reasons, and there is no justification for saving them from their own incompetence with taxpayer money.

Charleston Voice said...

It's a regional POLITICAL UNION your masters want, and a monetary union is just a near term goal. A WORLD UNION will follow.

Rik said...

1. A banking union anyway is a very low probability event. Massive guarantees from the North; not solving much anyway (see Mr Davies blog in the FT);etc..
2. At best realistically is mainly a centralised bankregulator.
Which will subsequently be again a de minimum.
3. Looking at the PIIGS banks they have at present several weaknesses (to say it friendly) of which most cannot be solved.
4. Overexposed to rubbish sov debt. Is basically impossible to solve at this moment. With high and heavily correlated risks.
5. Overexposed (and heavily) to own national sov debt. Also impossible to solve.
6. Undercapitalised, often hidden in too low reserves and provisions for bad debt, via dodgy accounting rules and simply borderline or over borderline cheating. Need recap looks extremely difficult.
7. 4,5,6 are basically the problem now. These can only be solved by riskspreading (means de facto dumping massively PIIGS sov debt and especially own sov debt), resp. creating a bad bank or simply make proper provisions. Require massive recap operation (so will not happen).
8. Basically a long term solution and won't do much now.
9. For the European accountguarantee (next to being politically and likely legally a no go up North) this is only part of the problem. The main part likely being banks going bust for everybody (not only smaller private accountholders) and possible exchange exposure (likely the biggest problem in Greece now at the moment). Only do be solved by massively increasing the sort of guaranteed accounts and guarantee in Euros both look again totally unrealistic (as the German de facto will have to do that).

Rik said...

Re the UK.
1. We basically donot know which sort of banking union we are talking about. The proposals will never be passed the way they look now. Mt guess if there will be one it will be one regulator with more oversight over national ones.
2. So for the UK combination of wait and see and simply communicating its own wishes looks the best.
3. Strategically proposing this without consulting the main banking country, its CB, and its main banks was a huge strategic miss.
4. A minimum EC regulator (imho the most likely outcome if accepted anyway) is likely for the EZ a step forward.
A proper and full scale one totally unrealistic.
For the UK it basically means more red tape (assuming a likely revised proposal).
5. For the UK probably best not to join and assure that rules are compatible, so not require a double check/audit if you want to do business in the EZ.
6. Good opportunity to bring structure of EU up. And start discussing undercap of Southern banks (undercap in the 'market' way not the dodgy accounting way that is now used).

christina Speight said...

Will Cameron produce a veto? Who knows ! There's no way of fathoming his utter duplicity.

BUT if he wanted to restore health to Europe as a whole he would announce our withdrawal from the EIU which would destroy the whole bureaucratic and undemocratic monster at a single stroke. But he would have to be resolute! Has he got the guts? I doubt it and thus Europe - dragging Britain with it - will descend into the new dark ages just as Greece already has, with meaningless elections, mass poverty and gradual breakdown of drugs and health services.

The solution lies in Cameron's hands provided he acts decisively and doesn't continue his soft soap of the architects of this disaster - the EU leaders.

Jesper said...

An example of the efficiency of the commission when it relates to regulating banks: