Translating Politics into Technocracy: The European Banking Union in a Global Perspective

The European Banking Union in a Global Perspective

William O’Connell, DAAD/AGI Research Fellow

Peter Rashish, Vice President; Director of the Geoeconomics Program at AGI

The EU Banking Union is typically understood as a product of the unique politics of European integration. Yet two of the “three pillars” of the Banking Union – the Single Resolution Mechanism and the failed European Deposit Insurance Scheme – were shaped not only by intra-EU politics, but by the need to comply with a set of global standards on cross-border bank resolutions which were negotiated after the 2008 crisis. Accordingly, addressing the too-big-to-fail problem in the EU requires a regime which is both compatible with those of major non-EU financial centres, while also overcoming the usual barriers to EU integration: small states versus large states, northern states versus southern states, and Germany versus France. The result is a Banking Union where the deepest cross-border financial integration is paired with a patchwork of rigid, incompatible, and often incoherent national and EU-level crisis management frameworks.

This webinar explores how the EU bank resolution regime has developed through a process of translating the political issues inherent in crisis management into a series of technical puzzles: once at the global level, and then again through EU institutions. As with all translations, key elements are lost. The shortcomings of the Banking Union are therefore not simply a function of uniquely European politics, but rather a product of larger issues stemming from the delegation of complex and deeply political global governance problems to transnational technocratic authorities.

William O’Connell
William O’Connell is a PhD candidate in the Department of Political Science at the University of Toronto. His research focuses on the politics of international finance, global governance, and the political economy of multinational corporations. Prior to pursuing his PhD, William worked as a policy analyst for the Government of Canada.

O’Connell’s dissertation research focuses on the history of cross-border bank failures and the development of the post-2008 regime for resolving too-big-to-fail banks. His work examines the extent to which cooperative relationships among individual technocrats, or between regulatory agencies, can compensate for or overcome more politicized barriers to international cooperation. More broadly, his dissertation explores the limits of the ‘soft law’ process typical of modern global governance in responding to international crises. Some of William’s other research has focused on the implications of the rise of China’s dominant consumer market on foreign censorship (published in Review of International Political Economy) and the regulation of cryptocurrency markets, for which he has made several media appearances.

Event Summary

History of Crisis Management

Until the 2008 financial crisis, most countries lacked a separate bankruptcy recovery regime for banks and focused more on crisis prevention than on crisis management. The status quo began to shift after the Basel Committee on Banking Supervision (BCBS) and Financial Stability Board (FSB) began to publish an annual list of Global Systemically Important Banks (G-SIBs) in 2011. Acting in their respective guidance capacities, BCBS’ and FSB’s publication draws attention to the outstanding too-big-to-fail interdependence between financial institutions and the functioning of the global economy. As a result, recently developed comprehensive resolution regimes for G-SIBs are technical and complex in nature, requiring international competition. Moreover, the credibility of these mechanisms rests on the technical ability and the political willingness of responsible bodies to intervene. The FSB’s Key Attributes of Effective Resolution Regimes (2011) grappled with these matters to put forward internationally agreed norms that solved all technical challenges but failed to settle political questions. Although reforms made by the framework of the Key Attributes have made G-SIB resolutions technically possible and reduced the scope of discord, resolution regimes are still marred by political challenges.

The Resolution Regime of the European Banking Union

The consequences of the European sovereign debt crisis have shaped EU politics over the last fifteen years. The eurozone debt crisis’ ensuing bank-sovereign doom loop led to chronically weak banks with large budget deficits in mostly southern European member states. To address this problem, however,  involved grappling with the structure of the Eurozone itself: the mismatch between a single European market and national fiscal authority has very serious implications for the efficacy of a resolution. As a result, member states agreed to strengthen financial integration via the implementation of a Banking Union in 2014. This project originally had three pillars: the Single Supervisory Mechanism (SSM), the Single Resolution Mechanism, (SRM), and the European Deposit Insurance Scheme (EDIS). Unfortunately, the proposed EDIS was a non-starter, and no serious progress has been made since 2014. On another level, the dearth of harmonized national deposit insurance schemes also creates the problem of different creditor hierarchy models across Europe.

The Single Resolution Mechanism

The outlook of constructing the SRM was ill-fated by axes of contestation between Germany and France, northern states and southern states, and large states and small states. Different approaches to internationalization, deposit insurance, aversion to bailouts, fiscal capacity, bank supervision, and a variety of other factors all signaled low levels of progress toward producing the SRM. Public outrage over bailouts combined with the parameters set by Key Attributes in fact led to a mechanism with a complex, six-step decision-making process with the potential for disagreement and termination.

Resolution execution under the SRM has several important shortcomings.

  1. Complete reliance on the bail-in mechanism essentially wipes out shareholders and converts a portion of bondholders into shareholders in order to recapitalize the failing bank. Although banks need capital to survive, the SRM fails to consider the equally essential role of liquidity. Modern bank failures deal with liquidity shortages long before insolvency issues arise, meaning a source of liquidity is vital to ensure critical operations are maintained as the resolution regime is carried out. Although bail-ins are useful tools to reduce moral hazard and ensure losses are not borne by taxpayers, the Single Resolution Mechanism makes this financial relief mechanism mandatory before any public money or resolution liquidity can be put up. By restricting regulators from pursuing options besides a bail-in, even greater losses could be imposed on a market that is already in a downward spiral.
  2. Pre-positioning bail-in capital between home and host states not only incurs excessive and unnecessary costs by requiring more capital in general, but it also indicates a lack of trust. In a crisis, cooperation may be threatened.
  3. More broadly, the Single Resolution Mechanism is only applicable to the largest banks in the EU. Europe’s medium-sized regional banks, which operate across borders, are the missing middle. Many of these non-G-SIBs are both too big to liquidate through a general corporate insolvency yet too small to resolve; bailouts are the only option in their case.

Analysis of the EU’s Resolution Regime

The Financial Stability Board’s guidelines in Key Attributes (2011) made resolution a feasible option, but the political challenges of intervention still serve as a roadblock to its implementation. Moreover, the EU’s fiscal mismatch adds an additional layer of bureaucracy to bank resolutions, making regimes less flexible and reduced in scope. Ten years after the Banking Union’s implementation, the EU has only achieved half of its original three pillars. Despite the outstanding flaws of contingency planning so far, tremendous progress has been achieved globally and incremental progress has been made in the EU. Moreover, regulators have accepted the inevitable moral hazard tied to too-big-to-fail financial institutions. As a result, orderly resolution of one European G-SIB is now conceivable in a technical sense.

Questions and Discussion

The discussion after the presentation revolved around whether more could be done to deter banking crises, if the byproducts of a more sophisticated capital market really solve some of Europe’s banking issues, recommendations for public lending institutions in Germany, the presence of moral hazard, and deposit insurance schemes.

This event is supported by the DAAD with funds from the Federal Foreign Office.

June 22, 2023

Building a Smarter German-American Partnership