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The EU Banking Union: What's the Point?

Professor Moorad Choudhry, Department of Mathematical Sciences, Brunel University
Wednesday, 23 Jan 2013 | 10:24 AM ET
European Union (EU) flags fly outside the the European Commission headquarters in Brussels.
Bloomberg
European Union (EU) flags fly outside the the European Commission headquarters in Brussels.

In the aftermath of an economic recession, it is natural for risk aversion to increase. This is a consistent reaction after all financial crashes. The immediate post-crash period is also when regulation increases, which is paradoxical because banks are pulling back from markets anyway during this time, and so don't necessarily need to be told to do it. But of course, the idea is to generate a more stable infrastructure in time for the next crash…

The post-2008 period has been no different. From Basel III to Volcker and Dodd-Frank to Vickers, and all points in between, banks are being subject to much greater regulation and scrutiny to ensure that the fallout from the next crash is not as severe. And that' understandable.

The proposed EU Banking Union is less clear cut in its objectives. I don't mean its stated objectives, which are perfectly clear. A unified bank regulator will be able to better police banking standards, and balance sheet health, than a collective of 27 national regulators, and will also assist in severing the risk exposure connection between the sovereign and banking sectors. The odd thing though is that this idea gained traction as a result of the euro crisis; in other words, as part of the solution for saving the euro.

Am I missing something here? Am I the only one who sees no coherent logic in any of these objectives, and a great danger that the Union will achieve none of them?

Bank regulators anywhere in the world already have to sign up to minimum standards under Basel rules. Will the EU Banking Regulator have higher standards for capital and liquidity? If so, I stand corrected on that one. But otherwise, why exactly add another layer of bureaucracy to banks that already have regulation coming out of their ears?

Unless and until the world, or the EU, comes up with a plausible alternative to the public sector lender-of-last-resort (LoLR) to bail out banks that get into liquidity difficulty, and then implements it, there is no way one can ever truly de-link the banking sector from sovereign risk. Even assuming banks can become smaller and no longer "too big to fail", systemic risk will remain high and a failing bank – even a small failing bank – may still end up calling on the public purse. It is possible to have an alternative to the central bank LoLR, probably a bank-sector financed central fund, but until one has this alternative in place the sovereign will always ultimately remain on the hook. Imagine that in a few years' time the Spanish real-estate crisis plays itself out in full and a large-ish bank there goes under. How does the newly-formed banking union unwind this without calling on the public purse? I can't see it, especially if said bank has extensive counterparty exposures with other EU banks.

And then our perennial favourite for this column, the euro. The problems of the euro have nothing, really, to do with the banking sector. One cannot have monetary union without fiscal union, it's as simple as that. Address this, with central authority over budget deficits, and the euro becomes long-term viable again. With or without a banking union, this equation stays the same.

There is no shortage of finance sector regulatory bodies in the EU. Do we really need another one? Produce solutions in haste, repent at leisure. Sigh…

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Professor Moorad Choudhry is at the Department of Mathematical Sciences, Brunel University and author of The Principles of Banking (John Wiley & Sons Ltd 2012).

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