EU summit: Broken banks put eurozone in federal mood

Spanish cashpoint - file pic A credit squeeze in Spain is contributing to the country's deep economic malaise

Germany has often been accused of excessive caution in the eurozone crisis, and the EU summit deal on bank supervision reflects that.

France and the European Commission wanted the new supervisory mechanism - the first building block in a eurozone banking union - to be launched in January 2013. But the summit agreement says "work on the operational implementation will take place in the course of 2013".

All along Germany has said the priority is to enforce national budgetary discipline and Berlin is wary of distracting the European Central Bank (ECB) from its basic role - ensuring price stability or, in other words, keeping inflation under control.

The two-day Brussels summit has focused on the plans for a banking union, seen as a key element in restoring confidence in the euro.

The ECB will get new supervisory powers, aimed at nipping in the bud any reckless accumulation of debt by any of the eurozone's 6,000 banks.

Bank failures were at the heart of the devastating 2007-2008 financial crisis. So the idea behind the new structure is to tighten up risk management and regulation across the EU.

Once the new system is in place the new permanent rescue fund, the European Stability Mechanism (ESM), should be able to recapitalise banks directly, breaking the vicious circle of taxpayer-funded bailouts. By 2014 the ESM should have a lending capacity of 500bn euros (£403bn; $648bn).

Economic hardship

The ECB President, Mario Draghi, says Europe's fragmented banking operations are contributing to the current imbalances in the 17-nation eurozone.

Eurozone countries

  • Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, Spain

Cross-border lending has declined, hampering investment and growth. And there has been capital flight from the troubled "periphery" countries, such as Greece and Spain, to "safe havens" in northern Europe.

The UK, Greece, Spain, Italy, Portugal and Cyprus are all in recession. And now Germany, the EU's economic powerhouse, has cut its growth forecast for next year from 1.6% to 1%.

As the leaders met in Brussels there were renewed clashes in central Athens between anti-austerity protesters and police.

Political turmoil is creating a volatile mix in Europe. In Catalonia there is mounting pressure for separation from Spain and in several countries nationalists are polling well.

Collective scrutiny

With Europe in crisis how could a banking union help?

Under the European Commission's plan, a single supervisory mechanism (SSM) would come first, followed by a joint resolution scheme - that is, an agreed method for winding down failing banks - and finally a joint deposit guarantee scheme.

Athens street protest, 17 Oct 12 Greek journalists, lawyers and doctors went on strike on the eve of the summit

Setting up the SSM alone is expected to take about a year. It has been agreed that the legal basis for it will be finalised before January.

Germany was unhappy about the SSM supervising all 6,000 banks in the eurozone, but it has lost that argument. It wanted the SSM to look after just the big transnational, "systemic" banks.

But the Commission points out that smaller banks have also created big headaches for the EU - banks like Northern Rock, the German Landesbanks and weak Spanish regional banks called "cajas".

UK concerns

Meanwhile, the UK - the main financial centre in the EU - wants legal safeguards to protect the powers of the Bank of England, in relation to the ECB's new role.

The UK government is also anxious not to be outvoted in a new supervisory structure that could potentially favour the eurozone countries.

A Commission official said it would "not be legally possible for the UK to have a veto".

But he added: "the Commission wants to ensure equal treatment as far as legally possible".

Poland and Sweden - like the UK, among the 10 outside the euro - have made it clear they will scrutinise the voting arrangements, to guard against the emergence of a "two-tier" Europe.

The draft summit conclusions appear to reflect those concerns.

They speak of "equitable treatment and representation of both euro and non-euro area member states participating in the SSM".

Further down the road, there are likely to be tensions over the bank resolution scheme and joint deposit guarantee scheme.

Jointly protecting depositors' cash involves a mutualisation of risk. The idea is to prevent any run on the banks in one country spreading to other eurozone countries.

But Germany, the biggest contributor to eurozone bailouts, has warned that pooling eurozone debt through "eurobonds" - another form of mutualising risk - could be illegal. The Maastricht Treaty bans direct state-to-state transfers.

German Chancellor Angela Merkel faces an election next year and bailing out weaker eurozone partners is politically toxic. Many German taxpayers are unhappy about the bailouts.

Weak 'periphery' countries

There have been some encouraging signs for the markets recently.

The interest charged on Spanish sovereign debt has dropped below the danger level, easing fears that Madrid will need a bailout imminently.

The ECB says it is ready to buy the sovereign bonds of struggling eurozone countries to help bring their borrowing costs down - and has set no limit on those purchases. But those countries must first request the help and commit to strict budget discipline.

Greece remains a big worry, as EU leaders await a key report from the troika - the EU Commission, ECB and International Monetary Fund (IMF).

Without another loan instalment from the troika next month Greece will face bankruptcy, and it may eventually have to leave the euro. Its debts total 325bn euros. The IMF says Greece needs extra time to meet the reform targets it has signed up to.

A report proposing deeper eurozone integration is on the table at the summit, including the possibility of a separate eurozone budget (called "fiscal capacity"), a eurozone finance ministry and limited pooling of short-term sovereign bonds.

The report, masterminded by Mr Van Rompuy, is likely to be turned into a detailed roadmap in December.

It is a drive for joined-up economic thinking, but controversially implies a more federal eurozone. Many voters might view that with suspicion.

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