The principle of the Banking Union is
easy to state: it transfers the supervision
of Eurozone banks, and the power
to wind them up, to European authorities,
using a common European fund
financed by European banks.
This project was launched in June 2012
during Spain’s crisis, when Eurozone
leaders vowed to “break the vicious
circle between banks and sovereigns”,
represented in the adjacent graph.
For example, in Ireland the collapse of
the banks almost bankrupted the state,
and in Greece the quasi insolvent state
wrecked the banks. The circle worked in
The Banking Union is based on three
• Firstly a single rulebook: the Bank
Recovery and Resolution Directive
(BRRD) harmonizes the supervision and
resolution rules in the Eurozone, and the
Deposit Guarantee Schemes (DGS) guarantees
a reimbursement to citizens by
national governments of up to €100,000
in case of bankruptcy.
• Secondly a single supervision mechanism
(SSM): the European Central Bank
(ECB) directly supervises the largest
banks (banks that hold 85% of Eurozone
assets) and coordinates the whole
system. The SSM passed through the
European Parliament in 2013 and will be
implemented by the end of the year.
• Thirdly a single resolution mechanism
(SRM): if a bank faces financial distress,
the ECB will report it to the Single Resolution
Board (SRB) based in Brussels and
funded by levies on banks (€55billion
over eight years, in order to cover approximately
1% of the total assets).
The Board will make decisions such as appointing
a special manager or increasing
the bank’s capital. The whole process is
designed to take place in only 48 hours.
With this system, bail-outs (banks saved
with taxpayers’ money) should be avoided,
as shareholders and large depositors
are the first to contribute.
The rulebook applies to all 28 member
states, while the SSM and SRM are
mandatory only for Eurozone members.
However, other countries from Europe
can choose to participate.
This system should have several positive
effects. The sovereign/banks spillover
effects should be weakened. Banks’ exante
risk-taking should be dampened,
as was observed following the creation
of the Orderly Liquidation Authority
(OLA) in the US in 2010 (see Ignatowski
and Korte (2014)).
One should also observe less financial
fragmentation, that is cross-border
inter-bank lending, and more homebased
asset portfolios for banks. The
fragmentation of the European financial
market was caused by the crisis, but was
preceded by a long period of integration
that is far from being reversed. This is particularly
a problem for monetary policy,
as the transmission of central bank decisions
is heavily reliant on an integrated
financial market. As fragmenta
tion decreases, transmission of policies
to where they are most needed will improve
(Ruparel 2014). In a steady state,
an integrated architecture for financial
stability in the euro area would bring
a uniformly high standard of enforcement,
remove national distortions, and
mitigate the buildup of risk concentrations
that compromises systemic stability
(Goyal et al 2013).
However, the current Banking Union
faces several shortcomings that might
hamper its action. There is a plain lack of
financial resources. The Resolution fund
of €55billion will be built over 8 years to
backstop a banking sector of more than
The SRM could only refund a few medium-
sized financial institutions. According
to Willem Buiter, chief economist for
Citi, €1 trillion is needed; according to
OpenEurope, between €500 and €600
billion – in any case at least 10 times the
amount of the future fund.
Moreover, the “too-big-to-fail” problem
remains unsolved. If the resolution fund
is not well furnished and/or the system
is too complex to be efficient and credible,
incentives are not sufficient to alter
banks risk-taking behavior.
Ignatowski and Korte (2014) observe
a threshold-effect: the introduction
of the OLA in the US had a significant
effect on the overall risk-taking in the
banking sector, just not for the largest
and most systematically important
Laeven et al. (2014) found that the six
largest banks (Citigroup, HSBC, etc.)
have a distinct, seemingly risky business
model: they have lower capital,
less stable funding, more market-based
activities and are more organizationally
complex than smaller banks.
These banks create most of the systemic
risk in the current financial system
through negative externalities for both
financial markets and the real economy.
Thus the design of the banking union
might need to be complemented with
other ex-ante measures to limit large
and complex financial institutions’
In addition, a lot of important data
required for the analysis of monetary
policy are not available. In particular,
much of the data needed to track systemic
risk is not published, notably the
international dimension and linkages
between banks (see Cerutti et al. (2011).
In the aftermath of the financial crisis,
world decision makers are leading in
Recent initiatives that aim to improve
aggregate banking statistics and gather
better institution-level data are welcome,
but the complexity of the system
means that required data will not be
available for some time, notably data
concerning shadow banking.
The IMF and FSB have jointly issued a
report to the G20 finance ministers and
central bank governors recommending
the creation of a common reporting
template for globally systemically important
financial institutions (G-SIFIs).
Since we do not know how long this
transparency and information sharing
process will take, the efficiency of the
Banking Union’s decisions is presently
hindered by this lack of data.
The Banking Union seems to be a step
in the right direction; in case of financial
distress in the banking sector, countries
should not be jeopardized, leaving taxpayers
to pay the bill.
However, doubts arise on its ability to
mitigate future spillovers, notably due
to a credibility issue: is a resolution fund
of €55billion sufficient to backstop a
banking sector of more than €30 trillion?
What will really happen if banks
do not meet solvency requirements? So
far it is hard to judge, but one will soon
be able to do so when first resolutions
are made. .
Angelini, P., Grande, G., Panetta, F., 2014.
“The negative feedback loop between
banks and sovereigns” Bank of Italy Occasional
Papers, No. 213
Cerutti, E., Claessens, S., McGuire, P.,
2011. “Systemic Risks in Global Banking:
What Available Data Can Tell and What
More Data are needed?” IMF Working
Goyal, R., Brooks, P. K., Pradhan, M., Tressel,
T., Del’Arricia, G., Leckow, R., Pazarbasioglu
, C., 2013. “A Banking Union
for the Euro Area” IMF Staff discussion
Ignatowski, M., Korte, J., 2014. “Wishful
thinking or effective threat? Tightening
bank resolution regimes and bank risktaking”
ECB Working Paper Series No.
Laeven, L., Ratnovski, L., Tong, H., 2014.
“Bank size and systemic risk”, IMF Staff
Discussion Note 14/04