Banking union: Europe clears critical hurdle

The European Central Bank in Frankfurt, Germany
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The European Central Bank in Frankfurt, Germany

Europe took a significant step forward in its ambitions to create a single banking framework for the euro zone on Thursday after EU lawmakers granted new powers to the European Central Bank to oversee the currency bloc's banks.

The plan approved by an overwhelming majority of the European Parliament will allow the ECB in Frankfurt to oversee around 6,000 banks in the 17 euro zone countries.

While Thursday's vote completes the last legislative step towards ECB supervision, many more challenging obstacles remain before banking union - which also hopes to establish a single euro zone authority to wind up bad banks - is finalized.

(Read more: Europe's new banking union: why you should care)

"Today marks a real step forward in setting up a banking union," said ECB President Mario Draghi, adding that the central bank would push ahead rapidly with hiring the staff and building the institutional capacity to supervise the banks.

Banking union, conceived as a three-stage process involving a single bank supervisor, a single resolution authority and a single deposit-guarantee scheme, is the most ambitious project launched since the region's debt crisis and is designed to provide a stronger underpinning to the single currency project.

It marks a new phase of deeper integration among the euro zone countries, but also comes with complex issues of sovereignty, with Germany, the euro zone's most powerful member state, concerned about an over-centralization of powers.

(Read more: Barroso hails EU recovery, MEPs slam 'fairy tale')

"The single supervisory mechanism is a lynchpin of a deeper economic and monetary union," European Commission President Jose Manuel Barroso said after the vote. "Now our attention must turn urgently to the single resolution mechanism," he said.

After more than three years of financial market turmoil following the bailouts of Greece, Ireland, Portugal and Cyprus, establishing a more unified banking system in the euro zone is seen as critical to defending against future crises.

The ECB is due to begin its supervisory responsibilities in a year's time, giving it a clear deadline to establish the right checks and oversight mechanisms to monitor the banks.

The parliament's vote opens the way for the ECB to conduct a review of banks' loan books, a so-called asset quality review. The review will take a detailed look at whether banks have set aside enough cash to deal with debts unlikely to be repaid.

(Read more: European Union launches clampdown on shadow banking)

At the same time, member states will have to resolve a disagreement about whether countries or a central European authority should have the final say in shutting or restructuring a bad bank, and how to establish a fund to pay for resolution.

Taxpayers across much of Europe have had to pay for a series of deeply unpopular bank rescues since the financial crisis that spread across the bloc to threaten the future of the euro. EU leaders are determined that should not continue.

The European Union spent the equivalent of a third of its economic output on saving its banks between 2008 and 2011, using taxpayer cash but struggling to contain the crisis and - in the case of Ireland - almost bankrupting the country.

German slap down

While Thursday's vote marks an important step forward, doubts remain about whether banking union can succeed, and whether it will be completed in time to prevent another crisis.

Germany, Europe's biggest economy, has tried to limit the scope of the ECB's supervision and restrict plans for an independent authority and fund to deal with failed banks, worried that it will end up footing the bill.

Berlin attacked the European Commission's proposal for an independent authority as going against EU law and has publicly criticized the plan in a potential setback.

(Read more: More action needed to end 'too big to fail')

The European Parliament has also sought to increase its influence in the crisis response, threatening to delay its approval of ECB supervision unless the supervisor shared details of its decision-making with the European Parliament.

And in the back of policymakers' minds is the knowledge that financial markets are watching to see how banking union comes together. Too much delay could further undermine confidence.

"We think the schedule is very tight, especially since the issue is still very controversial among member states," said Philippe Gudin, an economist at Barclays Research.

"Any delay on the agreement would postpone the single resolution mechanism until after the arrival of the new European Commission in October 2014," he said.

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