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October 26, 2012

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Home » Business » Biz Commentary

Eurozone's banking union 'agreement' falls short

By Alastair Wilson and Matt Robinson | October 26, 2012, Friday | Print Edition

AT the summit in Brussels last Thursday, European Union leaders committed to "the objective of agreeing the legislative framework" for a single bank supervisory mechanism before the end of the year.

However, stark disagreements were apparent in many officials' post-summit announcements regarding the design, desirability, and implications of this potential mechanism. The continuing dissonance among EU leaders on a "banking union" will continue to undermine sovereign creditworthiness within the euro area and of stressed countries in particular.

Creation of the proposed banking union, which necessitates resolving many operational and technical issues, would be credit positive for weaker euro area governments. The banking union is an important part of a wider suite of planned and proposed changes aimed at strengthening the euro area regulatory framework and its resilience to financial crises.

Euro area authorities' move toward shared responsibility for maintaining financial stability will be an important factor in normalizing financial markets, demonstrating their collective commitment to implementing reforms and willingness to pursue broader economic and fiscal integration.

But progress toward any supranational governance structure that requires large countries to relinquish elements of sovereignty in important areas of policy is inevitably slow.

European leaders agreed to finalize the legislative background work for the new supervisory mechanism by year end, aiming to make it operational "over the course of 2013." While the timetable is slower than the European Commission's recently proposed timeline, the pragmatic approach bodes well for ensuring the single supervisor's sound structure and constituents' support for its future operations. Nevertheless, we consider even this revised timetable will prove challenging.

However, politicians' and officials' statements suggest an intentionally ambiguous compromise, rather than any clear consensus within the euro area on how to break the credit nexus between sovereigns and their banking systems.

In post-summit interviews, officials from Germany, Spain, France and Italy offered conflicting views about when the single supervisor would be deemed "effective" and therefore allow lending from the European Stability Mechanism (ESM) directly to banks. Meanwhile, continuing vocal opposition makes it increasingly unlikely that the ESM will assume responsibility for legacy assets, limiting Spain's chances of preventing banking sector recapitalization needs from effecting the sovereign's balance sheet and diminishing the prospect that Ireland can expect any relief from its bank support-induced sovereign indebtedness.

Following the summit, it appears highly unlikely that the ESM's direct bank recapitalization function will be activated before Germany's September 2013 elections. ESM loans directly to banks would significantly support the creditworthiness of stressed euro area sovereigns. Conversely, policymakers' continuing lack of clarity regarding ESM loans will undermine investor confidence in stressed sovereigns given their lingering potential bank-recapitalization exposures, which increases the likelihood of destabilizing market volatility and other risks.

Alastair Wilson is chief credit officer for Europe, Middle East and Africa at Moody's Investors Service. Matt Robinson is director of sovereign research at Moody's Investors Service. The opinions are their own.

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