The future of banking resolution - English

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By Juliane Mendelsohn9.10.2014Economics

The banking union and banking resolution promise a shiny future for the EU and its common currency, but the reality looks a lot bleaker.


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I am going to use the banking union to describe a larger trend in politics. I happen to read a lot about banks, even though I don’t like them; I prefer burgundy dahlias, but nobody has ever asked me a thing about dahlias. It is the the trend in politics to self-celebration and a sense or pretense of achievement that is entirely detached from cause or reason.

I visited the German Bundestag on Monday afternoon to attend public hearings on the future of banking resolution. The new mechanism of recovery, resolution and recapitalization forms an essential part of the banking union, which enters into force in November when Danièle Nouy and her Single Supervisory Mechanism take over the supervision of the eurozone’s 130 largest and most significant banks. It also promises to put an end to the phenomenon otherwise known as _“too big to fail”_. I repeat: promises.

Although I was more interested in the matter at hand than the bureaucratic (for lack of a better word) “architecture” and the bureaucratic (for lack of a better word) “political culture”, I share the amazement and astonishment of the economists on the panel at the contentedness of parliamentarians in the face of sketchy legislation and proposals that simply cannot work. Not even if you turn them upside down and look at them from a different angle or keep repeating impressive words like “bail-in”, “liability cascade”, “living will”, or “fiscal backstop” (though I admit they sound more impressive when surrounded by a sea of German).

So how is this going to work?

In order to resolve banks without any greater hassles in the future, banks, much like real humans (except that the latter are mortal) will be drawing up resolution plans (so-called “living wills”) in advance. To date, regulators are still puzzled by the complexity of large banks. They have no overview of their multiple subsidiaries, cash managements systems, or numerous IT systems. Fortunately, all of this information will now be laid down in these wills (which for obvious reasons cannot be disclosed).

Sounds too good to be true? I kid you not: one of the “academics” actually said that he praises this proposal for being so closely connected to reality and for following the logic of the market and the principle of self-regulation. I didn’t know academics still said these kinds of things (at least not since the nineties or 2008).

Who is going to pay?

In an attempt to avoid future bail-outs, the reliance on public funds and on the taxpayer’s money, the new law creates a hierarchy of debtors, the so-called “liability cascade”. Shareholders, bondholders, and depositors with assets of over €100,000 will be held liable first, then the European resolution fund (which will be set up over the next decade) will step in, and then, only in rare emergencies, the European Stability Mechanisms.

There are, however, numerous exemptions from this rule, ranging from secured liabilities and derivatives over interbank loans to, of course, spontaneous exemptions in the face of larger systemic risks (meaning just about any crisis); they leave me wondering whether these rules will ever be applied in the face of a serious crisis. Even if they are, the current funds are still not nearly as large as they should be. If a bank like the Deutsche Bank or BNP Paribas with total assets surmounting to 500 billion euros were to default, billions of euros would still have to be sourced.

If all else fails?

In light of the fact that all of these rules might fail, the European Stability Mechanism (the bailout mechanism originally put in place to rescue illiquid and insolvent states) will now also be used to recapitalize banks directly. Instead of being perceived as a bad omen because it creates exactly the kind of guarantees the banking sector should be moving away from, it was celebrated as a positive development. Finally, the ESM can be used to fulfill its true purpose: putting an end to the deathly connection between states and banks (the so-called “doom loop”).

Admittedly, this is a noble cause. Unfortunately, the ESM doesn’t hand out money for free. The Troika will still want to sign detailed Memorandi of Understanding (aka austerity treaties) with the receivers of these funds, and they aren’t going to settle for banks. If banks receive these funds but states sign the promises, this doesn’t dissolve the interdependencies between them; it enhances them.

If there were no alternatives, then I guess the sheer volume of this legislation could be a cause for celebration. I have said this before and I know I sound naïve, but I really do believe that big banks could be broken up and that politics could be about big ideas, or just stuff that works.

Where have all the flowers gone?



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