The eurozone crisis is not finished

By Wolfgang Münchau

The renationalisation of banking means that the monetary union is still unsustainable

What does it tell us about a eurozone banking union if the member states are rushing to pass unilateral legislation on financial regulation? France and Germany have, in short succession, proposed measures to ringfence banks’ proprietary trading activities. The two countries have co-ordinated their moves with each other, but with nobody else. Would not a ringfence be a power any self-respecting banking union would want to usurp?

The answer is that banking will remain a national activity in the eurozone for all economically relevant purposes. The European Central Bank will become the common bank supervisor. This has indeed been agreed. But there will be no common deposit insurance. The resolution system likely to emerge later this year is also flawed. It will end up protecting only the taxpayer of the creditor countries from bank failures in the debtor countries. But it will not accelerate the resolution of the eurozone’s undercapitalised banks. My suspicion is that the ultimate intent of the Franco-German legislation is to secure the position of their national champion banks.

The proposed legislation aims to force banks to put their proprietary trading (that is, trades made on their own accounts rather than on behalf of a customer) into separate legal entities. But this does not affect market making, for example. Erkki Liikanen, the governor of the Finnish central bank, proposed a full separation in his European Commission report, published in October. The commission has been planning an EU-wide directive, but the Franco-German action has now pre-empted the outcome.

The current banking scandal in Italy is a reminder of why a comprehensive regime is needed. Banca Monte dei Paschi di Siena is the world’s oldest bank – but this long history has not prevented rogue traders from undertaking reckless derivatives trades, which have led the Italian government to step in with a guarantee of €3.9bn.

A separation of investment and commercial banking along the lines of America’s Glass-Steagall Act will, of course, not solve all problems in banking. Even if the act had not been partially repealed, Lehman Brothers would still have gone under in 2008, and the world economy would still have crashed. But at the very least, a full separation of investment and retail banking would have saved the Italian taxpayer from the MPS scandal.

The most important signal sent by the unilateral legislation in France and Germany is the lack of political will to sort out the banking mess, which is at the heart of the eurozone crisis. Instead, governments are seeking refuge in symbolic gestures.

In the wake of the immediate crisis, the priority should have been the recapitalisation of the banks with public money, the closure and merger of weak banks, and to ensure that banks are not trying to adjust their balance sheets by running down loans to companies. This is what is happening in southern Europe now. My estimate is that the eurozone’s banking system is undercapitalised to the tune of €500bn to €1tn. The problem is not only Spanish banks, but also German and French ones, which have been more skilful at hiding their losses. If the recovery turns out to be as shallow as I expect, these losses will show up not too long from now. 

The priority now should be to end the continuing fragmentation. The ECB’s Outright Monetary Transactions programme was officially justified as an effort to unclog the eurozone’s transmission of monetary policy. After six months, we know that it brought down government bond yields, but did absolutely nothing to improve the transition mechanisms. Companies in northern Italy continue to suffer from higher interest rates on bank loans than their Austrian neighbours. Only a fully-fledged banking union could end such discrimination. But that would require common deposit insurance and effective bank resolution policies. Neither is going to happen.

The other priority should be to do what the Franco-German legislation purports to do, but on a grander scale: provide adequate insurance that banks do not bring down the economy and hold taxpayers at ransom. A combination of full separation of investment and commercial banking, bail-in rules, and transparency requirements would be a useful, yet possibly still incomplete, series of steps.

None of this is happening – and yet a lot of people have become more optimistic about the eurozone, in some cases even euphoric. Hardly a day passes by without someone declaring the end of the crisis. But its two most dangerous aspects are unresolved – zombie banks and macroeconomic adjustment. OMT has actually contributed to making the banking crisis worse, by taking away the political pressure to create a genuine banking union. The pressure was clearly present in July last year, but had evaporated by September.

The renationalisation of banking means that the monetary union is as unsustainable today as it was in July last year – and now the policies needed to fix this problem have been abandoned.

 Copyright The Financial Times Limited 2013.