Completing the Banking Union

By Barbera Reisenhofer and Daniela Jaros

While the Eurozone crisis started as banking crisis which turned into a sovereign debt crisis simultaneously leading to the crisis of the monetary union, the first measures taken (bilateral loans to Greece, the EFSF, the ESM, the ECB’s SMP and later OMTs, the Six-Pack and the TSCG) were primarily meant to stabilize and contain the ongoing crisis. The Banking Union, however, completed through the recent agreement on the Single Resolution Mechanism (SRM), is a further, forward-looking step. More than to contain, it is meant to prevent crises of the kind just experienced. It has rightly been described as the most ambitious integration project since the creation of the single currency as it leads to its members transferring the control of their biggest banks to the supranational level.

The Banking Union consists of two pillars – the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM).

1. The Single Supervisory Mechanism (SSM)

The only feasible way of setting up the SSM without a treaty amendment was basing it on Art. 127 (6) TFEU and therefore establishing it at the ECB. The ECB’s competences with regard to monetary policy on the one hand and banking supervision on the other hand remain, however, strictly separated. The legislative framework so far comprises a Council regulation establishing the SSM at the ECB and setting its outer limits and a regulation adjusting the original European Banking Authority to the new framework. As for the material functioning of the supervision through the ECB, and in particular the division of tasks between national supervisory authorities and the ECB, the SSM Framework Regulation still needs to be adopted by the ECB.

All Member States whose currency is the Euro agreed to participate in the SSM; others are invited to join. The newly established Supervisory Board will take up its duties in November 2014. For each participating Member State, ‘significant banks’ were identified that shall be directly supervised. Estimations say that around 130 credit institutions representing almost 85% of total banking assets in the euro area will fall under the direct supervision of the ECB.

The rationale of the SSM is of course the disentanglement of the relationship between governments and their domestic banks, both in terms of political influence and financial interdependence. While this objective merits all efforts made to be achieved, it still remains to be seen how day-to-day supervision of a heterogeneous group of banks will function in practice.

2. The Single Resolution Mechanism (SRM)

The Banking Union is not complete with the SSM, since the next step to be taken is the establishment of a joint mechanism for dealing with banks on the verge of bankruptcy. The overall aim is to preserve financial stability even in times of crisis while making it unnecessary to use billions of taxpayer money to rescue so called “systemically important” banks – banks whose collapse would put a serious threat to financial market stability.

The basis of the mechanism is a harmonized set of rules on crisis management – the Bank Recovery and Resolution Directive (BRRD). Under the BRRD recovery and resolution plans (“living wills”) for banks must be drawn up in order to better prepare banks as well as supervisors for a possible financial deterioration of the bank. Furthermore, the BRRD contains the requirement to establish national resolution authorities, who can make use of special resolution tools like the bail-in tool to deal with insolvent banks. (In a “bail-in” the losses of the bank are born by its creditors – as opposed to the frowned upon “bail-out”, in which losses are covered by taxpayer money.) The banks must also contribute to resolution funds that can be used to finance resolution proceedings.

The Single Resolution Mechanism (SRM) builds upon the rules of the BRRD, however, it is only applicable to the Member States of the SSM. The basic concept of the SRM is that a resolution authority at EU-level should be charged with taking resolution decisions for all banks in the Eurozone. Furthermore, there will be a Single Resolution Fund for all the SSM-States. The central body of the SRM is the Single Resolution Board. In the Board five permanent members as well as representatives of the national resolution authorities prepare draft resolution decisions. However, the Board – as an agency of the Union – may not take final resolution decisions. Under the Meroni doctrine of the ECJ, discretionary decisions involving a margin of political judgment may only be taken by an institution of the Union. As resolution decisions always contain such a discretionary element, it is necessary to involve either the Commission or the Council. The Trilogue agreement of March 20th came up with a solution that involves both institutions: The Commission may object on discretionary aspects of the Board’s draft decision. The Council can either argue that the resolution is not in the public interest or that the resolution fund should be used differently; both of those objections may only be raised on proposal of the Commission. If neither Commission nor Council object within 24 hours after submission of the Board’s draft, the decision becomes final and must be carried out by the national resolution authorities. While this mechanism sounds fairly complicated, there is hope that the strict limitations to the objections and the tight timeframe will strengthen the position of the Single Resolution Board as the central player in bank resolution. It is expected that both the BRRD and the SRM will be formally adopted this month. If things go according to plan, the SRM will be fully operational from 2016.

From a practical point of view the optimal solution for a Single Resolution Mechanism would have been the establishment of a fully independent resolution authority. However, it was clear from the start that this was not possible within the current legal framework of the European Union. It is somewhat disappointing that the second best option – the involvement of either the Commission or the Council – was not agreed upon. To involve both institutions in the way described above might not be a disaster, however, it certainly reduces the efficiency of the decision making process, which in turn does not help the chances of successfully resolving systemically important banks.

*This post was co-authored by Daniela Jaros