Understanding... Banking Union

One of the lessons learned from the financial crisis that emerged in 2007/8 is that when a bank in Europe goes bust the effects can reach far beyond the immediate threat to depositors and shareholders. The crisis, which revealed the extent to which irresponsible behaviour in the banking sector could undermine the foundations of the financial system, turned into the Eurozone crisis in 2010/11. Member States tried to address the systemic fragility of their banking systems through national policy tools, but it became clear that, for those countries that shared a currency and were therefore more interdependent, more had to be done. So at the Euro area summit in June 2012, the European Council agreed to ‘break the vicious circle between banks and sovereigns’ and decided to create a banking union that would allow for centralised supervision and resolution for banks in the euro area. But what exactly is banking union and how does it work?

Supervision and resolution

The banking union was conceived to ensure that banks are stronger and better supervised and, should problems arise in the financial sector, they can be resolved more easily and without using taxpayers' money. It is made up of the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM), both of which are mandatory for all euro area Member States and open to all other countries in the EU. 

Under the SSM, which became operational in November 2014, the European Central Bank (ECB) has become the banking supervisor for all banks in the euro area, directly responsible for supervising the approximately 123 largest banking groups. To help lay the groundwork for the SSM, an Asset Quality Review was carried out, involving an in-depth expert examination of some € 3.7 trillion of euro area banks’ assets. A series of stress tests were also carried out. The aim of the exercises, which were concluded in October 2014, was to assess the resilience of EU banks in the face of adverse economic developments, in order to understand remaining vulnerabilities and give the ECB a clearer idea of the banks' financial health. The stress tests and the comprehensive assessment together helped to dispel doubts and restore confidence in EU banks.

Impartial supervision at Union level under the SSM will make bank failures much less likely. When they do occur, however, the SRM will make it easier to deal with them. The SRM will cover banks overseen by the SSM/ECB. It is made up of a board, the Single Resolution Board (SRB) and a fund, the Single Resolution Fund (SRF). Once informed by the ECB that a bank is in trouble, the Board will be responsible for taking most decisions on the best course of action and will prepare for the resolution of the stricken bank. The fund, which will amount to € 55 billion within eight years, will be financed by all the banks in the banking union countries. For situations when the SRF is not sufficiently funded by the banking sector, an effective common backstop will be developed, which will facilitate borrowing by the SRF. The euro area banking sector will ultimately be liable for repayment by means of levies, including ex post.  The Single Resolution Board, which has been operational since the beginning of the year and will be fully operational (with a complete set of resolution powers) from January 2016, is the final piece in the banking union jigsaw.  So a single EU authority will have the powers and resources to protect taxpayers from banks' failures.

One set of rules

Both the supervisory and resolution mechanisms are underpinned by a set of common rules for banks in all 28 Member States, known as the ‘single rulebook’. These rules are designed to prevent bank crises from happening in the first place, for example by increasing the amount of capital that banks are required to have (Capital Requirements Directive/Regulation) and when they do happen, providing a common framework to manage the process of winding the banks down (Directive on Bank Recovery and Resolution). The rules will also help protect consumers if banks should get into difficulty. For instance, deposits of up to € 100,000 are guaranteed throughout the EU, which should help to prevent panic withdrawals if a bank is in trouble. Whereas the current Deposit Guarantee Schemes (DGS) are national in nature, the Commission will review the functioning of the DGS Directive by 2019 and see whether, in the context of the banking union, a single, pan-European, DGS should be set up.

In the coming years, a well-developed and fully functioning banking union will ensure the overall stability and transparency of the financial system in the euro area, with a positive impact on the entire EU, and it will help rebuild confidence in banks and support the growth of the EU economy.

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