Saving banks with your savings

This is the year of the European Banking Union. The European Union designed a surveillance mechanism of big banks and, if need be, their resolution. Banks should be able to fail and to be wound up. The Finance Ministers have agreed, and the European Parliament should approve the plan before the European election. If so, a European Resolution Board will have the competence to put a major bank into liquidation starting on 1 January 2015. In the US banks can be declared bankrupt. Will it be equally possible in Europe? In reality, it is unlikely. The ultimate consequence of the European Banking Union is not bankruptcy but recapitalizing big banks, taking the savings of ordinary citizens as collateral.

In Europe, so-called systemic banks are inextricably interwoven with the financing of public authorities – in particular welfare states - living beyond their means. Since 2011, the European Central Bank (ECB) called upon public authorities and banks to reduce their mutual dependency, but then launched measures that generated precisely the opposite effect. To save the euro and to unclog the financial transmission system the ECB injected 1,1 trillion euro in the European banking sector. Banks were entitled to borrow substantial amounts of money at low interest rates and in return for soft collateral. However, the flow of cheap money did not enhance the granting of credit to companies but instead enabled banks to acquire big amounts of public debts, in particular in Spain, Italy and France. Currently, Spanish banks own 41% of Spanish public debt. ‘We have brought these consequences upon ourselves’, said Jens Weidmann, President of the German Central Bank, openly criticizing official ECB policy.

Furthermore, the results of the stress tests of banks appeared to be overly optimistic, if not fake. Many banks had been declared creditworthy like the Spanish Bankia, but in reality they were tittering on the edge of the abyss. In June 2012, Bankia had to be saved by an emergency credit of 19 billion euro, paid for by the European Stability Mechanism (ESM); a euro Rescue Fund financed by taxpayers’ money. Momentarily nobody in Europe knows how strong or rather how weak European banks are. The banking sector is full of mutual distrust while investors experience major difficulty to obtain loans. The US cleaned its banking sector; financial buffers are considerable and investment money flows again. The European Banking Union is supposed to bring about the same effect. Will it?

The ECB guides the supervision of banks and started scrutinizing the balance sheets of big banks. It has to proceed rigorously. Currently, banks put public debt in their balance sheets as ‘riskless’. So, a bank filling its balance sheets with Greek debt is legally running no risk at all. That is bizarre. Risk of public debt has to be allocated and bigger capital buffers must be required because European banks are still over-leveraged. If the ECB turns a blind eye, financial markets will lose all confidence and the European banking sector has to be expedited to intensive care. For safety reasons the results of the balance sheets scrutiny and the stress tests will be published after the European elections.

The core of the Banking Union is the resolution-mechanism, which prepares failing banks for bankruptcy. The key question is: who decides and who pays? The design envisages a Resolution Board and a Resolution Fund in order to set a procedure of bankruptcy into motion. In case of a bankruptcy, shareholders and big savers (over 100.000 euro) will be the first in line to pay. Thereafter, the Resolution Fund will assist with an amount of 55 billion euro, paid for by the banking sector itself. Oddly enough, the money will only be available by 2025. In real life this so-called ‘bail-in’ is just a minor, protective levee at spring tide.

Many big European banks are ‘political systemic banks’ in their own country because their demise would equally pull down the political establishment. Bankia – a merger of several unprofitable regional banks – had to be saved. If not, the Spanish political elite would go down with it. France would never allow the bankruptcy of its biggest bank, Credit Agricole, which midwives the French agricultural sector. Bankruptcy would ignite a new French revolution selecting Monsieur le President as first candidate for the guillotine. German Landesbanken are ‘holy cows’ in Berlin, because they provide the lubricant for the German federal system by serving the ambitions of regional political elites. If the Resolution Board in Brussels intends to wind down a ‘political bank’ the member state concerned will fiercely resist, supported by allies fearing the same fate for their political banks. So, for political reasons there is only one option: recapitalization!

That option is beyond grasp because the Resolution Fund will remain a paper feature for years to come and the envisaged amount of 55 billion euro is nothing. The balance sheet value of Credit Agricole amounts to 2 trillion euro. Therefore, the ESM – financed with taxpayers’ money – will be forced to assist ‘temporarily’. The ultimate goal of the Banking Union is to create one single European deposit-guarantee fund by 2025, which will allow the Resolution Fund to borrow money on the capital markets, using savings of European citizens as collateral. It then will be able to recapitalize Europe’s ‘political banks’. Finally, both taxpayers and savers of more affluent countries will see their savings being committed to save banks that save welfare states living beyond means.

In case a big ‘political systemic bank’ does get in trouble in the years to come, political pressures increase. Bail-in bringing nothing, the Resolution Funds still being empty and 2025 being too far off, the Banking Union must ‘accelerate’. The EU will appeal to ‘European solidarity’. As a consequence, the single European deposit-guarantee fund has to be established immediately. The net closes and your savings are in it.