Explained: Why the EU’s banking union is still unfinished business

Financial markets can’t seem to shake off the jitters sparked by the spectacular collapse of Silicon Valley Bank (SVB), the biggest American bank to fall since 2008, and the government-brokered takeover of Credit Suisse, Switzerland’s second-largest lender.

Despite repeated assurances from policymakers, stocks of European banks continue to be hit by the ongoing turmoil, with shares going down again after having seemingly recovered.

Deutsche Bank, Commerzbank, Société Générale and BNP Paribas are among those who have seen their value take a plunge in recent days, adding to the state of general disquiet.

Inevitably, the latest news has shed light on an uncomfortable question that has for years beset the eurozone: Why is the banking union still unfinished business?

The banking union dates back to 2012, a time when the eurozone was going through a devastating debt crisis that challenged the survival of the single currency itself.

“We affirm that it is imperative to break the vicious circle between banks and sovereigns,” EU leaders said in a joint statement signed on 29 June 2012.

Eurozone banks were considered to have excessively close links with their home countries because they were mostly buying bonds from their own governments, rather than diversifying across the bloc.

This concentrated exposure to sovereign debt was compounded by the fact that retail deposits were protected first and foremost by domestic legislation.

This co-dependence meant that as soon as banks were in distress, the problems could easily spill over into the national government – and vice-versa.

The banking union was designed to weaken this bank-sovereign connection and inject a fresh European dimension by harmonising rules, reducing fragmentation and ensuring taxpayers’ money was not further used to rescue failing banks.

The political impetus led to the project’s first two pillars – the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) – to be agreed upon relatively fast. 

The SSM granted the European Central Bank stronger powers to monitor the health of eurozone banks, while the SRM set up a common fund – paid by banks themselves – to address insolvent institutions.

But the brand-new structure was left limping, as the third and last pillar remained conspicuously missing: the European Deposit Insurance Scheme.

A persistent stalemate

Under current EU rules, deposits of up to €100,000 are protected in case of a bank failure.

This protection, however, is provided at a strictly national level, reinforcing the bank-sovereign cycle.

In 2015, the European Commission proposed the creation of the European Deposit Insurance Scheme (EDIS) in order to guarantee all deposits across the eurozone enjoyed an equal level of protection, regardless of the bank’s location and the country’s fiscal health.

EDIS would introduce a collective, supranational safety net built upon domestic provisions and paid for by banks according to their level of risk.

In practice, this EU-wide protection layer would dissuade clients from desperately withdrawing their deposits as soon as bad news hit a bank, as was the case with Silicon Valley Bank.

But the sharing of banking risks across borders was rejected by Northern European countries, who argued the eurozone’s financial health needed considerable improvements before setting up EDIS.

“An agreement on a common deposit insurance was hampered by the weak state of the banks in some peripheral countries, with Germany fearing that it would have to pay for Italian banks,” said Daniel Gros, a senior fellow at the Centre for European Policy Studies (CEPS).

“The present turmoil is not caused by the absence of a third pillar, but by the fact that deposits have become much more volatile than anticipated by regulators (and markets).”

For Nicolas Véron, a senior fellow at Bruegel, the opposition is based on a deep-seated contradiction: while countries “pay lip service” to European ambitions, they are keen to retain national control.

“In a way, governments are of two minds,” Véron told Euronews.

“On the one hand, they understand that completing the banking union is necessary for the eurozone to be resilient, and they want the eurozone to be resilient sincerely. But at the same time, there are so many aspects of the linkages they have with national banking sectors that they like and don’t want to get rid of.”

The persistent stalemate has raised doubts over the 2015 proposal, which technically remains on the table despite numerous rounds of unsuccessful negotiations.

“We still think EDIS is a good idea. But as it’s with the co-legislators now, it’s part of the normal decision-making process,” a European Commission said.

As an intermediate step, the EU’s executive is working on a “common framework for bank crisis management and national deposit guarantee,” in line with the conclusions of a 2022 euro summit.

But that framework is set to fall short of a fully-fledged European scheme, consolidating the missing pillar as the elephant in the room.

In reaction to the latest financial jitters, some EU leaders, such as French President Emmanuel Macron and Dutch Prime Minister Mark Rutte, called for the completion of the banking union but without offering a clear answer to break the impasse.

“This kind of thing only makes progress when there’s a big crisis. And sorry if what I say sounds too cynical, but I think at this point there isn’t a big banking crisis in the eurozone,” Véron said.

“This is great news because it suggests the European Central Bank has been doing a decent job as a supervisor. Maybe we’ll discover tomorrow morning that some eurozone banks have big problems. But at this point, it hasn’t been the case, even with what’s happened in the marketplace.”