A Good Deal for Germany?

Germany’s stance against the banking union

Tiernan Albanese, Sebastian Schneider, David Brouwer

December 2017

Banking union and what it means for Europe

After the Eurozone crisis of 2012, the idea of a banking union emerged to deal with the problems that caused this crisis, ensuring that a systemic crisis of this magnitude is mitigated in future times. By some, this was seen as the next logical step after the monetary union of the euro area. The term ‘banking union’ is a rather vague term – so let’s define it further: Banking union is a framework, involving a common single supervisor and a joint effort to work together on regulatory matters to improve the financial stability of the Eurozone as a whole. A common single supervisor implies a common set of rules by which all dominant banks in the euro area are to play. This also applies to German banks even though they have traditionally been seen to abide by strict regulatory conditions. Along with a single supervisor, a banking union aims towards a more ubiquitous resolution process and increased risk-sharing amongst member states. So far, the banking union has taken shape in the form of two pillars, with a third to be soon implemented.

Source: Website of Oesterreichische Nationalbank (2017)

The two pillars upon which the banking union has been built are the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM), with the final to be the European Deposit Insurance Scheme (EDIS). The SSM relates to the consistent joint supervision of banks by the European Central Bank (ECB) and the national regulators with the ECB having the overall authority. Under the SSM a distinction is made between significant, and less significant banks, the significant needing to meet conditions generally regarding the size of their balance sheets, but not directly the overall risk they undertake. The number of significant banks under supervision of the ECB is 120 out of the almost 6,000 financial institutions in Europe.[1] The remaining banks are subject to the supervision of their national financial authorities, on behalf of the ECB. The goals of the ECB acting as the supervising entity are to ensure that there is financial stability in the European banking system by preventing the build-up of risk.

The SRM is there to ensure an orderly restructuring of distressed banks with the aim to prevent a failure ultimately leading to government handouts, funded by taxpayers. Europe has always held this predilection that the failure of a bank signifies a failure of the system as a whole. Naturally, this provides incentives to bailout banks, no matter how large or small. In case of a bank failing, despite the SSM, the SRM is meant to ensure that such bailouts are funded by those who got themselves in the mess to begin with – the constituents of the banking system – rather than the taxpayers. This should be achieved by filling a resolution fund with contributions from the financial industry.

Not yet in effect, the EDIS is the final building block of banking union and is aiming to protect the financial system from bank runs by implementing a euro-area-wide insurance fund, displacing responsibility of deposit insurances from the member countries to the ECB. The EDIS is to be funded by contributions of the banking sector. The deposits under the EDIS will be insured for up to €100,000, similar to the national deposit guarantee schemes currently in place. But is this entirely fair, especially for a country who last saw a bank run in 1931?[2]

Too much of a burden

The banking union should be an efficient resolution to create stability in the European banking landscape, promoting economic growth. However, a complex banking system as we see in Germany requires a more tailored fit than that of the rulebook imposed by the banking union.

The German banking system is comprised of 500 private banks, 976 cooperative banks, and 412 public saving banks.[3] 1,688 of these are considered as less significant by the ECB, making up 48% of the total financial institutions classified as less significant in the euro-area.[4] This is unique in the aspect that the German banking system is constructed in a way such that it provides local economies with a structure that’s relevant to their financial needs. German consumers attach a large importance on a rapport built between them and their local bank to fulfil their banking needs.[5] It’s by no stretch of the imagination to deduce that a ‘one size fits all’ approach may not be the most appropriate for such a sophisticated banking system. The rules that are suited for international banks aren’t intended to suit these local banks that are central to the country’s strong regional industries. German small banks have become over-regulated, unfairly constraining them with rules mostly relevant to systemically large financial institutions.

Source: Nicolas Veron’s calculations based on ECB (2014)

Another issue the Germans have is that with a single supervisor in place, policymakers and regulators that should be acting on behalf of the ECB, may actually act in the interest of their domestic banking industries, ultimately neglecting their responsibility to act in the best interest of the euro area. Financial systems differ greatly across Europe. A single supervisor lacks the knowledge and tools necessary to fulfil the duties of an optimal supervisory structure, not acknowledging the macroeconomic differences across the euro area. There’s also the issue of conflicting political perspectives when constructing regulatory policies. For instance, economic frictions may create political conflicts of interest when deciding on monetary policy. As an example, the ECB could relax monetary policy in order to avoid the winding up of banks in economies that are struggling.[6] What may be good for Greece, may not be good for Germany.

German banks also oppose the SRM and EDIS. These two pillars of banking union require consistent financial contributions by the banking sector into funds as a safety net for when times get tough. The contributions, however, aren’t calculated on a basis that takes into account the riskiness of the institutions. This is especially problematic when looking from the German perspective, since the German banks have shown resilience through various stress tests conducted by the ECB in 2016.[7]. The general consensus between them is that they are continuously lifting the heavy load, while other economies are barely pulling their weight, and yet are reaping all the benefits. This belief resonates further for small to medium sized banks.

You can imagine why there is such a diversity of opinion. How would you feel paying for someone else’s insurance?

These aren’t the only problems, though. Even with the strict regulatory conditions that binds the banking union, we will never get rid of moral hazard completely. Sovereigns may be tempted to push their debt onto the balance sheets of domestic banks. They may also feel like they no longer need to monitor their local bank industry as thoroughly since these banks now have access to these centralised pre-cautionary mechanisms meant to prevent bank failure. Domestic central banks may be less inclined to put in the supervisory work needed to ensure a stable banking environment. It might be that regulators take a more laid-back position with someone else doing their job for them.

Where do we go from here?

The next step to take in assuring a successful banking union is to continue to build the Eurozone’s rescue funds in order to sufficiently handle the failure of a systemically important bank. To achieve this, the euro area first needs to be properly established as an optimal currency area. This mainly means ensuring that participating members first align their business cycles. Financial prosperity should be shared by all participating members and likewise for the burden of financial distress. This would allow for the ECB to better direct monetary policy to respond to business cycles in the area as a whole. Participating members also need to improve their risk-sharing capabilities, fairly redistributing capital in the areas that need it without burdening taxpayers.

These thoughts are shared with the president of the European Commission, Jean-Claude Juncker. In his words:

“We need to reduce the remaining risks in the banking systems of some of our Member States. Banking Union can only function if risk-reduction and risk-sharing go hand in hand.” [8]
-- president of the European Commission, Jean-Claude Juncker

Germany is always going to feel like they are getting the rough end of the stick until these issues are first addressed. We need to first create a system where countries like Germany feel comfortable contributing to rescue funds. Like mentioned before, it will be a fairer distribution of the burden if the contributions made by the banks are based on the risks they take.

Banking union is meant to integrate the European banking system and market economy and reduce the risk that this banking system will contribute to future crises. Achieving this requires significant risk-sharing by the members involved, and Germany is never going to want to accept the responsibility for the toxic assets held by banks in other countries. While a unified banking system is a goal that the euro area should undoubtedly stride to achieve, it requires a little more effort from weaker participating members before Germany puts all of its eggs into the basket of banking union.


[1] ECB. (2017). Number of monetary financial institutions (MFIs) in the euro area : September 2017. Retrieved from https://www.ecb.europa.eu/stats/ecb_statistics/escb/html/table.en.html?id=JDF_MFI_MF M_LIST
[2] Veron, N. (2016). In defense of European deposit insurance. Retrieved from https://piie.com/blogs/realtime-economic-issues-watch/defense-european-depositinsurance
[3] Deutsche Bundesbank. (2016). Bankstellenbericht 2016. Retrieved from https://www.bundesbank.de/Redaktion/DE/Downloads/Aufgaben/Bankenaufsicht/Dokum entationen/bankstellenbericht_2016.pdf?__blob=publicationFile
[4] Veron, N. (2014). Europe’s single supervisory mechanism: Most small banks are German (and Austrian and Italian). Retrieved from http://bruegel.org/2014/09/europes-singlesupervisory- mechanism-most-small-banks-are-german-and-austrian-and-italian/
[5] Wilson, J., Wiesmann, G. & Barker, A. (2012). Germany’s small banks fight union plans. Retrieved from https://www.ft.com/content/efc129b0-3b00-11e2-b3f0-00144feabdc0
[6] ECB. (2013). Monetary policy and banking supervision. Retrieved from https://www.ecb.europa.eu/press/key/date/2013/html/sp130207.en.html
[7] Bankenverband. (2016). 2016 stress test results: German banks resilient despite tough stress criteria. Retrieved from https://bankenverband.de/newsroom/presse-infos/2016- stress-test-results-german-banks-resilient-despite-tough-stress-criteria/
[8] European Commission. (2017). Factsheet: Completing the banking union. Retrieved from ttps://ec.europa.eu/info/sites/info/files/171011-banking-union-factsheet_en.pdf