Last week much of the what’s-the-future-of-Europe talk centered around the question of banking supervision. The European Central Bank (ECB) will only make good on its offer, announced earlier this month, to purchase government bonds if European leaders can agree to make bailout funds part of the effort. And the leaders agreed in June that new bailout measures to support Italy and Spain would only go ahead if significant steps were first taken towards setting up a central banking supervisor.
The banking supervisor, leaders and investors hope, will cut the feedback loop between troubled European sovereigns and their banking systems, which own large clumps of domestic government bonds. Yet investors worry that setting up such a body too fast could compromise its effectiveness at a crucial moment for already troubled lenders in Italy and Spain.
As with so many other political conflicts in Europe right now, battle lines appear to be forming between Germany and a coalition of peripheral states led by France. The latter coalition supports a banking union under the guidance of the ECB, whereas Germany would prefer to form a separate organization. At the same time, Jean-Claude Juncker, president of the Eurogroup, the meeting of European finance ministers, has cautioned against acting too quickly on any proposals, remarking on September 18, “I am for thorough preparations, not for the hasty introduction of a banking union.”
But if European leaders are going to stick to their insistence on a banking supervisor, they have little choice but to act speedily. Bloomberg calculated that €326 billion ($425 billion) in deposits flowed out of banks in Spain, Ireland, Portugal, and Greece in the 12 months ending July 31, putting those banking sectors on shaky footing. While the ECB has previously offered, and could continue to offer, cheap funding to help those banks stay afloat, there are some unintended consequences: for instance, in lowering collateral requirements to promote borrowing from its reserves, it encouraged banks to take on debt issued by governments that are on the border of insolvency and debt restructuring. Nor would the ECB’s help by itself return such banks or their governments to solvency, as economic conditions in many peripheral states continue to deteriorate. EU leaders are stuck between a rock and a hard place: whether to quickly set up a supervisor that may be too weak, or put off those plans and take joint decisions to bolster the fragile financial positions of the periphery.