Abstract
Given the various shortcomings of the current European monetary unification project, especially as shown by the international financial crisis which began in 2007–2008, various measures for its respective solution were successively proposed and implemented, including the establishment of a European banking union, which seemed not only necessary and urgent but also inadequate and unsatisfactory, in order to make the European Economic and Monetary Union solid and safe. Given all these reasons, “the puzzle is yet to be completed.”
[Summary: 1—An inadequate and incomplete European monetary union and the aim of the banking union; 2—The financial crisis, the European democratic deficit and the need to reform the Euro area; 3—The continuing fragmentary European financial system and the urgency to establish a banking union to recover the Economic and Monetary Union; 4—The insufficiencies of the European banking union; 5—Towards a more perfect banking union?]
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- 1.
The determination to establish a single currency in the European Economic Community (EEC) had rearisen in the late 1980s in the context of revitalizing European economic and political integration. In 1988, a committee chaired by Jacques Delors, then president of the European Commission, was set up to propose steps for creating an economic and monetary union. The ensuing report laid the foundations for such a union, resulting in the adoption of the 1992 Maastricht Treaty. The main provision of the Maastricht Treaty, which came into effect on 1 January 1999, was to implement the new single currency, the Euro, but not immediately for all member States, as this depended on the convergence criteria that needed to be met before the countries were allowed to join (11 countries out of 12 on 1 January 1999, 19 countries out of 28 since 1 January 2015). See Fukuyama (1992, esp. 287–) and Gonçalves (2010a).
- 2.
In his famous article of 1961, Mundell raised an innovative question—on what economic criteria could the decision by various regions of the world to adopt a common currency be based—and responded with a cost-benefit analysis: the benefits of adopting a single currency include a reduction of the transaction costs generated by the existence of various currencies and a gain in the liquidity of the currency attributable, mainly to the expansion of its area of transactions, from which the financial markets would also benefit. The potential disadvantages would come from the elimination of the exchange rate between participants (it would no longer be possible to let the exchange rate absorb shocks asymmetrically, affecting the various regions or countries of the union). The analysis highlighted the criteria that monetary union must meet: absence of frequent and large-scale asymmetrical shocks, mobility in the factors of production, export diversification and a degree of economic openness. For an open and diversified economy, the benefits of joining a monetary union in terms of gains in liquidity and financial stability can offset the additional adjustment costs that could result from joining the union. See especially Mundell (1961, 1963) and Kenen (1969).
- 3.
According to the optimistic view, the relationship between the degree of economic integration and the occurrence of asymmetric shocks determines whether or not progress towards integration leads to economic convergence. In a cost-benefit analysis, as trade integration increases, the degree of symmetry between the participating countries increases, becoming more alike and facing fewer asymmetric shocks. See European Commission (1990).
- 4.
Hence, in the long run, the prospects for a monetary union, including all European Union member Sates, will be bad; but, as Paul de Grauwe notes, that conjecture leads to an anomaly, because it implies that a lowering of trade integration can bring the EU into an optimal currency area. Thus, if the EU countries were to go back and disband, monetary union would become attractive. From the discussion of the Krugman model, authors such as De Grauwe have concluded that even if integration causes more asymmetric shocks, this may lead to increasing net gains for a monetary union for all member States. See de Grauwe (2014, pp. 70)and Krugman (1993).
- 5.
In the 1960s, literature on OCA theory identified various criteria from the debate on the merits of fixed against flexible exchange rate regimes, namely price and wage flexibility, mobility of product factors including labour, financial market integration, the degree of economic openness, diversification in production and consumption, similarities of inflation rates, fiscal integration and ultimately political unification. For instance, the higher the degree of economic openness, the higher the probability of changes in international prices of tradables being transmitted to the domestic cost of living, which would reduce the potential for money illusion by wage earners, as noted by McKinnon (1963). Then, the nominal exchange rate would be less useful as an adjustment instrument. Moreover, economic openness needs to be assessed along different dimensions, including the share of tradable versus non-tradable goods and services, the marginal propensity to import and the degree of openness vis-à-vis the countries with which it will share a single currency. Moreover, high diversification in production and consumption dilutes the possible impact of shocks specific to a particular sector, providing protection against a variety of disturbances, as pointed out by Kenen (1969). Furthermore, external imbalances could arise from persistent divergences in domestic inflation rates, derived from economic policies, structural developments in labour market or social preferences, including inflation aversion. See Dellas and Tavlas (2009) and Mongelli (2008).
- 6.
According to Chari, Dovis and Kehoe, symmetric countries gain credibility when joining a monetary union only when the shocks affecting credibility are not highly correlated; they propose an amended optimal currency area criterion which is considered more relevant than the classic one. See Chari et al. (2013) and Dellas and Tavlas (2009).
- 7.
As stated by the Treaty of the European Community (TEC, now Treaty on the Functioning of the European Union—TFEU, after the revision of the Treaty of the European Union signed in Maastricht), a State has an “excessive deficit” when this is so declared by the European Council following a report by the European Commission and an evaluation by the Monetary Committee and the Excessive Deficit Procedure (EDP) starts when a country’s deficit and general government debts respectively exceed 3 % and 60 % of GDP. Nevertheless, the EDP allows the Commission and the Council to consider the broader fiscal situation of member States.
- 8.
As von Hagen and Eichengreen noted, the bailout could be ex ante, in which case the European Central Bank (ECB) would keep interest rates low to lighten the debt-service burden, or ex post, in which case the ECB would monetise the government’s debt. Or through both means, particularly in acute and persistent government debt crises. Either way, non-restricted fiscal policies could cause inflationary pressures that the ECB would find difficult to combat. The opposite situation could happen: extreme fiscal constraints could generate deflationary stress difficult to resist by the ECB, as last years’ ECB monetary policy experience demonstrated. See Hagen and Eichengreen (1996).
- 9.
- 10.
There are other weaknesses and limitations of OCA. Most studies are applied to sovereign countries but OCAs may not correspond to national frontiers, due to non-homogeneities within countries (US States, German Länder, Spanish comunidades, Italian regions); the discussion by many authors of the benefits and costs from sharing a single currency was “incomplete at best and quite vague and hazy at worst” (Mongelli 2008); early studies could not have predicted the growing importance of services in post-industrialised economies—they are more diversified, diffused and fragmented, therefore more similar across Europe than the manufacturing sectors; nor predicted the pervasive role of institutions inhibiting product and market flexibility and mobility; and last, but most likely not the least, the erosion of the conceptual framework of the OCA, based on the belief that monetary policy is an effective policy instrument which could help carry out business cycle stabilisation, facilitating the adjustment of relative wages and prices after some shocks with a less costly response than tolerating some unemployment through austerity policies. Buiter (1999) calls the argument that monetary and fiscal policy could successfully manipulate aggregate demand to offset private sector shocks the “fine-tuning fallacy”. The rational expectations revolution, the monetarist critique and literature on the inflation bias postulating the long-run ineffectiveness of monetary policy helped change this perception. See Dellas and Tavlas (2009), Mongelli (2008, pp. 4–6), and Buiter (1999, p. 181).
- 11.
After the launching of the European Economic and Monetary Union and the Euro, the weaknesses and limitations of the OCA theory were gradually addressed and tested with the use of new advancements in economics and econometrics, in order to study, for instance, the transmission of shocks, output synchronisation, financial flows, etc. Over and beyond its many weaknesses and limitations, as Mongelli notes, the OCA theory has merits as an organising device and as a catalyst for analysis: “without the OCA theory there may not have been such a systemic scrutiny of so many economic features, which are after all the building bricks of monetary unions; going back to the analogy of EMU with a laboratory, this OCA patient has survived but it has been radically transformed over recent decades”. See Mongelli (2008, pp. 7–9) and Frankel and Rose (1998).
- 12.
- 13.
At the debate of the public bail-out of IKB, a medium-sized lender, on 29 July 2007, Jochen Sanio, German banking supervisor, warned of “the worst banking crisis since 1931”, in “Germany rescues subprime lender”, Financial Times, 2 August 2007.
- 14.
Banking weaknesses and sovereign credit dynamics have been connected in a perverse country by country feedback loop, involving excessive implicit and explicit government guarantees on banks and high domestic biases in bank portfolios of European Union sovereign debt, as in Greece (94 %), Spain (90 %), Portugal (79 %) or Italy (78 %), in 2011. The result was national fiscal and banking problems feeding each other, which is incompatible with a sustainable monetary union. Eventually, on 29 June 2012, the leaders of the Eurozone countries made an unprecedented commitment when they, on 29 June 2012, issued a statement starting with the words “We affirm that it is imperative to break the vicious circle between banks and sovereigns”. They officially acknowledged their intention to break the “doom loop” of mutually reinforcing deterioration of credit conditions hampering weaker member States and banks based in their territory. See Véron (2012).
- 15.
Some authors, such as Nicolas Véron, have discussed whether the policy errors of the Commission were or are less damaging than the absence of decisions: “Challenges of Europe’s fourfold Union”, hearing before the U. S. Senate on “The future of the Eurozone: Outlook and lessons” (1 August 2012). See Véron (2012).
- 16.
According to Richard Bellamy, “the crisis has thereby also contributed to rising public disillusionment with established political systems at all levels” and, “historically, economic downturns may always have affected public confidence”, asking if the Eurozone crisis is eroding trust in the Union in an unprecedented manner and, in that case, if political union is the source of the problem or its solution. See Bellamy (2012, 3 ss).
- 17.
The views are diverse about the appropriate answer to this enormous problem. Some consider that greater political unity within the EU is both a practical necessity and a moral obligation if the Euro-crisis is to be managed in a way that respects the conditions of justice and democracy, although they differ on the equilibrium between those two principles. Others fear that such a move risks combining the financial with a political crisis, because not only are the economic disparities among the States in the Eurozone difficult to deal with efficiently, but also the political cultures and identifications for European citizens are similarly too contrasting to accommodate an effective common democratic system. Just as those who advocate greater political unity would not deny the diversity of the EU and, in many aspects (as with its different languages), would celebrate it, those who emphasise the political and economic aspects of this diversity would not deny the need for cooperation to solve common problems or that mutual recognition implies a degree of social solidarity. See Bellamy (2012, 3 ss).
- 18.
“In European politics as in domestic politics two profound disagreements over policy need not imply that one side is more committed to co-existence within a common political framework than the other—separatism being by and large the exception rather than the rule—merely that both sides have different views of how that framework should be structured and run so as to best support the interests of its members”. See Bellamy (2012, 3 ss).
- 19.
Federal Constitutional Court of Germany, Press release No. 72-2009, “Act approving the Treaty of Lisbon compatible with the Basic Law; accompanying law unconstitutional to the extent that legislative bodies have not been accorded sufficient rights of participation”.
- 20.
The European Commission has a stronger accountability to the European Parliament, but in other domains, including competition policy, with frequent and important connections to this subject, in which the Commission can decide in favour or against concrete proposals for acquisition or capitalisation of financial institutions. See Véron (2012).
- 21.
The Independence of the ECB is laid down in the institutional framework for the single monetary policy, in the Treaty and in the Statute with the purpose of maintaining price stability. Neither the ECB nor the national central banks, nor any member of their decision-making bodies, are allowed to seek or take instructions from EU institutions, from any government of a member State or from any other body or agency. According to article 130 of the Treaty, EU institutions, bodies, offices and agencies and the national governments of the member States must respect the principle and not seek to influence the members of the decision-making organs of the ECB.
- 22.
N. Véron notes that an early call for stronger European executive policy-making capacity in the context of the Eurozone crisis came from the then-president of the ECB, Jean-Claude Trichet, in his speech “Building Europe, building institutions”, upon receiving the 2011 Charlemagne Prize in Aachen, 12 June 2011. See Véron (2012).
- 23.
This institutional transformation should not yet be called “political union”, in proper or definitive terms, as some propose (Véron), although “it would entail the recognition of a political space at the European level and not only in individual member States”. Certainly, this would be a new step or steps towards economic and inevitably political integration, but not necessarily or probably the ‘last’ and ‘decisive’ step or degree of international economic and politic integration, concluding in a complete political union, with the fading of the national member States…
- 24.
Cf. Article 123, paragraph 1 of the TFEU and Article 21, paragraph 1 of the Protocol on the Statutes of the European System of Central Banks and of the European Central Bank. This prohibition does not, however, prevent the ECB from intervening in the secondary markets, in particular under the provisions of the so-called OMT programme.
- 25.
Banks in Spain, Italy, Portugal and Ireland now hold more than 700 billion of domestic sovereign debt on their books while in 2007 this was around half that amount. See Geeroms and Karbownik (2014, p. 3).
- 26.
See Geeroms and Karbownik (2014, p. 3).
- 27.
The Single Supervisory Mechanism (SSM) was established following the adoption of Regulation (EU) No. 1024/2013 of 15 October, which gave the ECB the power to oversee significant credit institutions in the euro area countries and other States which, although not having adopted the euro as their currency, wish to be part of this collaboration,
- 28.
under which, since January 2016, resolutions must be primarily financed by shareholders and bank creditors—in applying the “bail-in” principle according to which losses should firstly be borne by the hareholders and the creditors and not use State funds—and may, as a supplement, receive financing through the Single Resolution Fund (SRF), resulting from banking sector contributions made by banks over the next 8 years and which, when they reach the funds target-level, will enable it to hold about 55 billion EUR, or about 1 % of covered deposits in the euro area.
The Single Resolution Mechanism (SRM) is intended to prevent the resolution of banks affecting systemic stability and the financial situation of the countries in which they operate. Under the terms of the SRM, it is up to the ECB to trigger the resolution process and decide whether a bank is at risk of bankruptcy, as a result of Regulation (EU) No. 806/2014 of the European Parliament and of the Council of 15 July, establishing uniform rules and procedures for the resolution of credit institutions and certain investment firms under a Single Resolution Mechanism and a banking Single Resolution Fund which amends Regulation (EU) No. 1093/2010.
In this context, the Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014, concerning bank recovery and resolution (BRRD), which provides for ways of resolving credit institutions without recourse to taxpayers being necessary.
In April, the European Parliament also approved the CRD IV package, consisting of the banking Directive 2013/36/EU on Capital Requirements (CRD) and Regulation (EU) No. 575/2013 concerning Capital Requirements (CRR) Tradutor: error no original? Requisites de Fundos Próprios duas vezes. This new package transposed into Community law the prudential capital requirements for credit institutions and investment firms, reinforcing the rules of capitalization and liquidity of banks, the rules on remuneration practices and incentives for granting credit, in particular to SMEs.
- 29.
It is intended that in the future, this will be the European fund to ensure the resolution of financial system entities.
It should be noted that to access this fund, the “toxic” banks should apply losses to their main creditors, including senior debt holders (something not found in the large redemptions in this crisis).
This implies that the central authority, the Single Resolution Board (SRB)—independent agency of the European Union which became operational in January 2016—is in the final instance responsible for the decision to initiate the resolution of a bank and to exercise directly the resolution function in relation to all institutions subject to the direct supervision of the ECB or with cross-border activity in the euro area, while at the operational level, the decision will be executed in cooperation with the national resolution authorities.
All this encapsulates a central problem of the Banking Union, namely its lack of democratic legitimacy.
- 30.
We therefore agree with those who say that the single resolution mechanism cannot be seen as the magic bullet capable of solving systemic risk issues. The European Union is totally inexperienced in this field, as in the past, bank failures were resolved without recourse to resolution mechanisms, either through public intervention (the case of Ireland or Sweden in the early 1990s) or nationalisations (see the case of BPN in Portugal). Thus, see Véron and Wolff (2013, p. 2).
- 31.
The Single Deposit Insurance Fund (SDIF) was created following the approval of Directive 2014/49/EU on deposit insurance systems, which contributes, along with the SRF and the European Stability Mechanism (ESM), to the third pillar of the Banking Union. On the possible creation of this mechanism in the context of the banking union, see Gros and Schoenmaker (2014, pp. 529–554).
The aim with this mechanism is to harmonise the rules on deposit insurances established at a national level so that a Member State has a deposit system that achieves a capitalisation level corresponding to 0.8 % of covered deposits, within 10 years.
However, at the present time, the third pillar has not moved forward with the European Union having limited itself to ratifying the conditions under which this fund should operate in each country.
- 32.
For a discussion on the realisation of the three pillars of the banking union, see Pisani-Ferry et al. (2012).
- 33.
See Geeroms and Karbownik (2014, p. 10).
- 34.
It involved, in order to harmonise prudential supervision—the 1st pillar—Article 114 of the TFEU as the appropriate legal basis. In addition, to establish the single supervisory mechanism, Article 127, paragraph 6 of the TFEU was invoked.
However, there are well-founded doubts regarding the resolution mechanism.
Indeed, the establishing of this mechanism—unlike the supervisory mechanism—is not expressly provided for in the text of the Treaties, which to some extent is connected to the fact that any resolution mechanism especially applicable to banks should be considered as an alternative to the insolvency regime which is still a matter dealt with by the Member States—unlike what happens, for example, in the USA.
Admittedly, it is the case for some, that the legal basis for the establishment of the single resolution mechanism can be implicitly extracted from Article 114 of the TFEU concerning the harmonisation of legislation among Member States.
When reading Regulation No. 806/2014—which created the Single Resolution Mechanism and the banking Single Resolution Fund—it can be seen that it was approved by taking into account precisely Article 114 of the TFEU.
It turns out that this regulation does not explicitly provide competences to the Union in this area.
Most doctrine considers it essential to revise the Treaties in this respect, so that the Banking Union is not, at the outset, doomed by the lack of an appropriate legal basis regarding the single resolution mechanism. On the lack of a suitable legal basis in the TFEU for the creation of the single resolution mechanism, see Véron (2013, pp. 5–7).
- 35.
It should be recalled that the Parliament was directly involved in the legislative process that led to the creation of the banking union but it had only an advisory role in relation to the legislation concerning that matter. See Howarth and Quaglia (2013, p. 119).
- 36.
See Article 271, paragraph d) of the TFEU which awards competence to the CJEU to hear disputes concerning the implementation of obligations under the Treaties and the Statutes of the ESCB and of the ECB by the national central banks. See Duarte (2006, pp. 149–176).
- 37.
See President of the European Council, Herman Van Rompuy (2012).
- 38.
Raising a similar issue, see Howarth and Quaglia (2013, pp. 114–117).
- 39.
The three European financial supervision authorities, in operation since 1 January 2011, are independent although accountable to the European Parliament, the Council of the European Union and the European Commission. Apart from these three authorities (EBA, ESMA and EIOPA), the European System of Financial Supervision (ESFS) also comprises the European Systemic Risk Board (ESRB) as well as the Joint Committee of the European Supervisory Authorities and the national supervisory authorities. The objective of the European supervisory authorities is “to improve the functioning of the internal market by ensuring appropriate, efficient and harmonised European regulation and supervision”, whilst the national supervisory authorities remain in charge of supervising individual financial institutions. See esp. Regulation (EU) No. 1092/2010 of the European Parliament and of the Council of 24 November 2010 on European Union macro-prudential oversight of the financial system and establishing a European Systemic Risk Board.
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Rodrigues, N.C., Gonçalves, J.R. (2017). The European Banking Union and the Economic and Monetary Union: The Puzzle Is Yet to Be Completed. In: da Costa Cabral, N., Gonçalves, J., Cunha Rodrigues, N. (eds) The Euro and the Crisis. Financial and Monetary Policy Studies, vol 43. Springer, Cham. https://doi.org/10.1007/978-3-319-45710-9_16
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