Q&A: The eurozone's banking union
Following agreement among European finance ministers in the early hours of Thursday morning, the eurozone is gearing up to strengthen its banking sector by introducing a more unified set of rules and protections. Below are some common questions - and answers - setting out what we know about its planned workings.
What is the "banking union"?
It consists of three parts:
- A common banking supervisor (or "single supervisory mechanism"): This job goes to the European Central Bank, which will be given the power to monitor the health of and the risks taken by all the major banks within the eurozone, and intervene if any gets into trouble.
- A common resolution framework: If a bank anywhere in the eurozone gets into trouble, the process of bailing it out - or, in a worst case, letting it go bust - would be managed by a common "resolution authority", with the cost borne by the eurozone governments collectively.
- A common deposit guarantee: Anyone who puts money in an ordinary bank account anywhere in the eurozone would have their money (up to a limit, expected to be 100,000 euros) guaranteed by a common eurozone fund.
Only the details of the common banking supervisor has been agreed at the summit.
What powers will the supervisor have?
According to the proposal, the eurozone central bank will "have direct oversight of eurozone banks, although in a differentiated way and in close cooperation with national supervisory authorities".
The ECB, in its new role as supervisor, will monitor the health of banks within the eurozone (but not the UK), and be able to intervene when a bank is in trouble.
Countries such as the UK and Sweden, outside the euro area, can enter into "close co-operation arrangements" with the ECB if they choose to.
In contrast to the European Banking Authority, which sets the rules under which all banks in the EU (including the UK) must work within, the ECB would be able to impose its will on the national banking regulators.
A compromise agreement was reached giving the ECB direct oversight of banks with assets greater than 30bn euros ($39bn; £24bn).
There was some debate about whether the ECB should be directly responsible for all 6,000 eurozone banks or just for the biggest banks.
The European Commission wants the ECB to be responsible for all the banks, arguing that during the financial crisis, even relatively small banks such as Dexia and Northern Rock got into trouble and threatened the entire financial system.
The German government wants the ECB to have a more limited role. German Finance Minister Wolfgang Schaeuble does not want the ECB to have powers over his country's savings banks (Sparkassen) or the regional Landesbanken, which play an important role in public policymaking in Germany.
The German Chancellor, Angela Merkel, is also concerned not to overburden the ECB with too many responsibilities too quickly. The ECB may, for example, delegate a lot of the day-to-day supervision work to the national bank regulators.
Another concern for Germany is that the ECB's new supervisory powers should be strictly separate from its existing monetary policy powers - so that, for example, the ECB won't be tempted in future to set interest rates too low in order to help out banks that are in trouble.
Under the compromise, the ECB will oversee banks representing more than a fifth of a state's GDP.
How will the "common resolution framework" work?
If a eurozone bank got into trouble, the process of rescuing it - or, in the worst case, putting it though a kind of bankruptcy procedure - would be carried out by a pan-European "resolution authority" - potentially the ECB, or an agency reporting to it.
As part of any rescue, the eurozone governments would require the bank's existing shareholders and lenders to take a lot of the losses - as was the case with Spain's recent bank bailout.
All eurozone banks would also be required to contribute annually to a common fund that could be used to absorb the cost of a bailout - and therefore reduce the cost to taxpayers.
To the extent that taxpayer money is also needed to absorb losses, or has to be put at risk by buying new shares in a troubled bank in order to provide it with more capital, then this would be provided by the eurozone governments collectively, irrespective of which country the bank is based in.
This taxpayer money is expected to be provided by the eurozone's recently inaugurated permanent bailout fund - the European Stability Mechanism.
What is bank capital?
When banks make losses on their loans and investments (their "assets"), it means that they have less money to repay their investors.
These "investors" include ordinary people who have put their savings in a deposit account at the bank, other financial institutions who have lent the bank money, and the bank's shareholders.
The bank's capital is the value of its shareholders' investments, based on the bank's financial accounts.
It is calculated by taking the value of all the bank's assets, and subtracting from it the value of everything the bank owes to its depositors and lenders.
The shareholders are the first in line to take losses on their investments. Each time the bank makes a loss on a loan it has made, the shareholders suffer an equal loss on the value of the bank's capital.
If the losses are so big that they eat up all of the bank's capital, the bank is insolvent - its assets are no longer worth enough to repay all of the deposits and loans that the bank owes.
For this reason, the bank's capital is a measure of how much loss the bank can potentially absorb without going bust.
How will the common deposit guarantee fund work?
Currently each eurozone country operates its own national deposit guarantee scheme. During the crisis, all EU countries agreed to raise the amount of each deposit that they guarantee to 100,000 euros.
The summit discussion paper - put together by the EU's various bigwigs - talks about a "harmonisation" of these national schemes, which presumably involves setting the same rules in each country for who gets guaranteed how much and when, and what the banks in each country must contribute to the scheme.
It is unclear if, and how much, these national schemes will then be guaranteed by all of the eurozone's governments collectively.
A maximalist version might create a single deposit guarantee scheme with an blanket guarantee from the eurozone. A minimalist version may retain the existing national schemes, and give each one a limited guarantee from the eurozone's bailout fund.
Whatever the case, the eurozone banks will also be required to make big regular contributions to the scheme (on top of their contributions to the common resolution fund), in order to minimise the cost to taxpayers.
When will all this happen?
The eurozone governments want to have the legal framework for the common banking supervisor in place by 1 January 2013.
The ECB will then have up to 12 months to put in place its new supervisory department, and take over active duties by 1 January 2014.
Some kind of common resolution arrangement should also be in place by then, backed by the eurozone's bailout fund.
In order to keep to this schedule, the legal framework will need to be designed in a way that avoids the need for a change to existing European treaties.
A treaty change would open a whole new can of worms - it would need to be negotiated with all the EU governments, including the awkward UK. And it would then need to be ratified by all of the EU parliaments.
In the long run, however, a treaty change looks unavoidable if the ECB is to be given adequate authority, and if the resolution framework and deposit guarantee scheme are to be given enough financial backing to see off a future financial crisis.
However, it seems likely that Germany would delay this until much greater integration has been achieved in other areas - including economic policy and government spending rules.
Germany's constitutional court has made clear that a national referendum will be needed for any treaty change that obligates Germany to cough up even more money for the common European good than it has already agreed to give the eurozone bailout fund.