On 7 November 2019, the Eurogroup has welcomed a new initiative by Olaf Scholz, the German finance minister, in the view of unlocking the completion of the banking union. For years, such completion has been subject to polarised views with regards to the way to carry out the setting-up of the last pillar of the banking union: the Deposit Guarantee Scheme. This article aims at explaining why European states have so much difficulties to agree on a proposal, what the German initiative entails and what the next challenges for the European Union are. 

If we had to describe the status of the banking union today, we would compare it to a car that is missing a wheel. Maybe the car could make a few kilometres without its last wheel, but at some point, the entire car will break down. This illustrates perfectly the three – and not four – wheels,  usually called pillars, of the banking union. Despite the reiteration of the importance of its completion by politicians, the banking union is still missing its last pillar: The European Deposit Guarantee Scheme. This obviously is the hardest part of the process for Member States, especially for the ones that are in great financial and economic shape, as this would require a high level of solidarity. The Deposit Scheme actually aims at protecting depositors’ deposits. This means that if a bank is resolved, but also even if a bank goes into bankruptcy or insolvency, the money that people put into the bank would always be returned to them. The original idea would be to create a pan-European insurance funded by all Eurozone Member States that would come into play every time a bank fails anywhere in the Euro Area. The proposal for such a risk-sharing mechanism however encountered strong resistance at European level, especially from a group of states led by the Netherlands calling itself the « New Hanseatic League ». Those states argue that risks should be reduced in the less financially sound Member States before any attempt to share the risks altogether would be carried out. 

Addressing the flaws of the European banking sector pre-crisis

When the sovereign debt crisis erupted at the end of 2009, many doomsayers speculated the collapse  and the end of the Eurozone. The vicious circle between sovereigns and banks and the original flaws in the design of the Euro were seemingly condemning the single currency project as a whole. Yet, ten years later, the Euro is still standing and has not collapsed. The end of the world has not happened. On the contrary, rather than destroying it, the crisis has given rise to an ever-closer integration in the Economic and Monetary Union. One of the main objectives of the overhaul at European level aimed at tackling the main actors that contributed to the disruption of financial stability: banks. During the sovereign debt crisis, Europe realised that banking management was sorely lacking regulation and supervision. Those flaws needed to be remedied and eventually gave birth to the European banking union. What was not really correctly understood before the crisis is that having a single integrated market entails interdependence. This means that what happens in one Member State has consequences on all others. This problem was very much disregarded before the crisis and exactly explains what the aims of the first two pillars of the banking union are.

Because supervision was decentralised, it failed to efficiently supervise pan-European banks

The Single Supervisory Mechanism, the first pillar, deals with banking supervision. It was set up specifically to tackle the pre-crisis discrepancy between banking supervision and the European banking sector which was highly integrated. In other words, because supervision was decentralised, meaning that each Member State was supervising its national banks, it failed to efficiently supervise pan-European banks (those that had an international scope and were providing services in more than one Member State). A bank such as the Dutch ING, operating not only in the Netherlands but also in Belgium, Italy or France, was only supervised by the Dutch authorities. This was problematic as national authorities simply did not have the necessary means to efficiently supervise pan-European actors and thus only focused on ING operations in the Netherlands. Therefore, they never got a full picture of what was going on. With the introduction of the Single Supervisory Mechanism, it was decided to subordinate all banks of the Euro Area to the European Central Bank, which becomes the sole entity responsible for supervision. 

While the first pillar deals with crisis prevention, the second concerns crisis management. This means that rather than focusing on setting up a framework to prevent banks from failing, you focus on what happens when a bank actually fails. The Single Resolution Mechanism fulfils this function. It is the European answer to the core problem of the sovereign debt crisis: the vicious circle between sovereigns and banks. When a bank fails, especially one of the larger banks, this has enormous consequences, not only economically but also socially. For this reason, it was inconceivable for Member States to let their large national banks fail; they thus started to bail them out with taxpayers’ money. This move deepened the crisis as it highlighted another problem: Governments’ finances were not as sound as they seemed. The objective of European reforms was to break that link between banks and sovereigns. The Single Resolution Mechanism set up a procedure called « Resolution ». This procedure aims at the proper and orderly winding-up of a bank in order to be sure that the failure of such bank has the least domestic impact possible.

What about the third pillar?

What happened after the setting up of the first two pillars? Well, nothing much. Since 2014 and the setting up of the Single Resolution Mechanism, the banking union is in standstill. At least with regards to a complete European deposit scheme. In 2015, the European Commission introduced a proposal based on a Directive to bring national deposit schemes closer. But, as underlined earlier, the polarisation between risk reduction and risk sharing has been locking the completion of the process since. Such an incomplete union may be very dangerous. Indeed, all the deposit schemes are currently decentralised, meaning that each Member State has its own deposit scheme. The problem is that when a large bank fails, the national deposit scheme may have severe difficulties to reimburse depositors and eventually default. This risk is still present today and may have disastrous financial and social consequences. Even though we have the first two pillars of the banking union, there is still some room for banks to collapse. That is why it is of paramount importance to complete the banking union. 

Pooling money would make the system more resilient to shocks

The solution advocated by risk sharing proponents is to integrate national deposit schemes together into a European Deposit Guarantee Scheme. The underlying rationale for this is that pooling money would make the system more resilient to shocks. In practice, this would work like an insurance. Every Member State subscribes and when the need is required, the European insurance steps in. So, in the case where one of the Member States faces a banking resolution or insolvency, the insurance fills the gap and reimburse depositors with the money pooled in the European deposit scheme. This way, depositors will always be able to get their money back while not damaging national funds.

Here is the problem of risk reduction proponents. Indeed, those Member States, including the New Hanseatic League, fear they would need to pay for the “bad students” among Member States. They are afraid of not benefitting from this European deposit scheme because they are more financially sound Member States with less risks of default.. This is the reason why they first want a reduction of the risks by less financially sound Member States before any integration may happen at the level of deposit schemes. 

What does the Scholz initiative propose to unlock the completion of the banking union?

On the 7th October 2019, the European Central Bank hosted a banking conference in Frankfurt where German finance minister Scholz presented the initiative of a European reinsurance deposit scheme based on repayable loans within a broader package of reform proposals. The idea is to create a scheme which would step in only when national deposit schemes have been exhausted. This would mean to create a complementary European deposit scheme in addition to national schemes.

Scholz himself stated that such proposal was “no small step for a German finance minister”

Such a proposal was warmly welcomed especially because the German state was firmly standing against risk-sharing mechanisms before any risk reduction. Indeed, Germany formerly prevented the setting up of a pan-European deposit scheme. It argued that German citizens should not insure depositors of other riskier parts of the Eurozone. The President of the Single Supervisory Board (the organ responsible for managing the Single Supervisory Mechanism within the European Central Bank) Andrea Enria stated that such initiative was a positive step and might result in the  necessary political impetus to eventually complete the long-incomplete banking union. Scholz himself stated that such proposal was “no small step for a German finance minister”.

The fact is, as pointed out by Leonid Bershidsky, writer at Bloomberg opinion, that the proposal is not as far-reaching as it seems, nor as generous with regards to European depositors. Indeed, if a Member State has exhausted its national deposit scheme, this would mean that it would probably already receive assistance from the European Stability Mechanism. German taxpayers will not be paying anytime soon for other European depositors. This very much contrasts, as stated by Olivier Guersent, the European Commission’s Director General for financial services, with the original Commission proposal which envisaged the gradual integration of national deposit schemes into a common European scheme. And this is not only a little ambitious proposal but also raises the issue that Germany will only agree on the reinsurance scheme under certain conditions, such as the revision of the sovereign debt treatment.

Nevertheless, the proposal may not be able to secure a sufficient majority in Berlin in order to pursue negotiations at the European level. Yet, the first objective on the agenda is to establish a road map by the end of the year in the view of reaching a political agreement in the future. Such agreement, as stated by Andrea Enria, because of the expected length of negotiations, would unlikely be concluded before the end of his term, which ends in 2024.

Scholz remains however optimistic and hopes to reach an agreement or at least a roadmap by the end of the year. He sees a window of opportunity when the new Commission and the new Parliament start their mandate in order to resume work on the matter. 

One may wonder why such a move was carried out only now as Germany was standing starkly against such a scheme. This is even more surprising as Scholz’s initiative comes up in a context where German citizens already perceive Southern Europe as a burden that they needed to bail out after the financial crisis. In addition, it also endangers political harmony between SPD and CDU, partners that used to be on the same foot on this matter. 

Angela Merkel seems to be as positive as her finance minister, underlying in a statement made in Rome, that the initiative shows Germany’s willingness to move towards the completion of the banking union and start negotiations on the third and last pillar. Anyway, it remains to be seen whether or not actions will follow words or if Germany is merely paying lip-service.

Minh Luca Wang is a Master student at ULB’s Faculty of Law.