IMF Tells Europe to Speed Up on Banking Union

Last Updated: 14, February 2013

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The eurozone must act quickly towards setting up a single banking regulator to oversee banks across all 27 European Union states as policy paralysis or backsliding in the current environment could derail confidence and economic recovery, an International Monetary Fund staff paper said on Wednesday.

In a report on Europe’s progress towards setting up a common banking union, the IMF on Wednesday warned of the dangers of leaving the integration project half-finished, either through political compromises or a loss of momentum.

European leaders had in December agreed on a framework for the creation of a Single Supervisory Mechanism, or a common banking regulator, in what was the biggest step towards financial integration since the introduction of the single currency.

As part of the agreement expected to take effect in March 2014, banks with more than 30 billion euros in assets, or 200 of Europe’s biggest banks, will be placed under the direct oversight of the European Central Bank, which will act as chief supervisor.

The agreement would also allow the ECB to directly recapitalise weaker banks or close down eurozone banks that do not follow the new rules for prudent banking.

However, there remains uncertainty over the pace and ambition of member states, particularly with the reluctance of Germany and other economically-strong countries to put themselves on the line for the fiscal mismanagement of their eurozone counterparts.

The IMF staff note, titled A Banking Union for the Euro Area, said the banking union should eventually also include common backdrops and a common safety net for depositors.

While the proposals have met with strong opposition from net creditor nations who want to limit sharing risk, the IMF warned that “missing elements would result in an incoherent banking union and, at worst, an architecture that is inferior to the current national-based one.”

Acknowledging that a “banking union is obviously not a panacea”, the IMF said it can be pivotal in fighting the current crisis by breaking the vicious loop between sovereign and bank costs.

The IMF added:

[quote] Agreement on burden sharing and ESM direct recapitalization must also not be delayed … Policy paralysis or backsliding in the current environment could derail confidence and the recovery. [/quote]

While recognising the technical difficulties and challenges of such big institutional transitions, the IMF said a well-defined timetable with strict deadlines at the outset would remove uncertainty and bolster confidence in the political willingness to build a robust financial stability architecture.

To allow the supervision regime to function properly in the medium term, the IMF suggests that the eurozone within the next year agrees burden-sharing agreements.

Without these, there would be dangerous conflicts of interest when handling the collapse of banks.

“Conflicts over the distribution of losses could arise, as the fiscal consequences of co-ordinated supervision remain national. The incentives would be to shift the costs of resolution, delaying action and jeopardising the achievement of least-cost resolution,” according to the paper.

Asked over what period of time Europe would need to complete its banking union steps, Rishi Goyal, an official who helped draft the report, told the Wall Street Journal “five years, I think, seems realistic and one that would be credible to markets.”

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