Wednesday, October 1, 2014
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German Banks on Top

CHICAGO – Overcoming the European Union’s current economic malaise, as almost everyone acknowledges, requires deeper integration, with the first step taking the form of a banking union supervised by the European Central Bank. But Europe’s banking union also requires uniform rules for winding up insolvent financial institutions – and this has become a sticking point.

Germany opposes the new bank-resolution mechanism proposed by the European Commission, generating moral and political support at home by portraying its stance as an effort to protect German taxpayers: Why should the German ants pay for the southern European grasshoppers? In fact, Germany’s position is a ploy to hide its anticompetitive behavior, whereby the government subsidizes German banks and industry at the expense of everyone else – including German taxpayers.

Europe’s common market has been the single greatest success of post-World War II European policy, boosting economic growth and fostering cultural interchange. But a common market requires a level playing field, and the European Commission has worked hard to achieve this in many sectors over the years.

Until now, the main exception was banking. The emerging banking union is not only the first step toward a European fiscal union; it is also the final step toward completing the European common market. Without a common resolution mechanism that levels the playing field, the common market will remain unfinished.

In principle, the EU’s banking rules are common to all member states. In practice, their implementation was, until recently, left to national regulators, who applied very different standards. Most important, while state subsidies in all other sectors are forbidden, they are commonly accepted in banking – not only explicit subsidies, such as Germany’s bailout of several Landesbanks after the American subprime-mortgage crisis, but implicit subsidies as well. Some French banks’ traders openly boast of backing by the French government, which will never let its banks fail.

Unfortunately, this is not just a French or a German problem. All market players know that EU governments will not let big banks fail. This implicit subsidy not only costs each country’s taxpayers billions of euros; it also distorts competition, because not all implicit subsidies are created equal. Regardless of its fundamentals, a German bank would be considered safer than an Italian one, because the German government’s implicit guarantee is much more valuable than the Italian government’s.

As a result, German banks have a lower cost of funding and – all else being equal – higher profitability. To the extent that some of the lower cost is rebated to their clients, even industrial firms in Germany enjoy a lower cost of capital, giving them an unfair advantage vis-à-vis their European competitors.

One way to prevent this distortion would be to create a mechanism to bail out all banks with European money. But this approach would not only leave German taxpayers on the hook; it would also create perverse incentives in the entire European banking system, maximizing instability.

The preferred alternative is to create a common resolution mechanism, which would apply throughout Europe, regardless of a bank’s country of origin. Such a mechanism would prevent the need for government intervention.

The recent proposal by Michel Barnier, the European Commissioner for the Internal Market and Services, is an effort to implement this solution. It provides a common resolution mechanism for all banks in Europe, which forces losses to be absorbed by shareholders, bondholders, and large depositors before any government money is committed. To provide short-term financing to a bank during any restructuring, the Commission’s plan would create a European Fund, putting all banks on an equal footing.

The Commission’s proposal is far from perfect. After a bank’s shareholders are wiped out and its creditors take an 8% “haircut,” the European Fund transforms itself into a bailout fund, justifying some of Germany’s fears. And there is no explicit prohibition of some form of national government bailout.

Even so, the proposal is a step in the right direction. German criticism should be directed at improving it, not at sandbagging it.

German taxpayers have paid dearly for German banks’ mistakes. In 2008, when the Landesbanks were found to be full of American subprime mortgages, the German government bailed them out with a €500 billion ($650 billion) rescue package at its taxpayers’ expense. In 2010, when German banks were badly over-exposed – to the tune of $704 billion – to Greece, Ireland, Italy, Portugal, and Spain, European taxpayers and the ECB helped them to bring most of that money home. The biggest threat to German taxpayers is not southern European profligacy, but their own country’s banks.

In this sense, the banking union is not a scheme to burden German taxpayers with the losses of failed southern European banks; rather, it is a mechanism to render all banks (including German ones) accountable for their own mistakes, thereby reducing the burden that they impose on domestic taxpayers. It is about time that German voters understood that the largest grasshoppers are in the center of their own towns.

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  1. CommentedParrain Boursorama

    The challenge is to grow the money supply while shrinking the banking sector. I don't see how you can shrink the banking sector without causing a debt-deflation spiral.
    Read more at http://www.project-syndicate.org/commentary/europe-s-zombie-banks-and-the-current-recession-by-daniel-gros#LRG341u3Bw51VOUg.99

  2. Portrait of Christopher T. Mahoney

    CommentedChristopher T. Mahoney

    Germany is the regional hegemon. EU rules do not apply to it. Cyprus banks must be solvent, while German banks can live forever on life-support. And pfandbriefe are NOT securitizations--they are 100% government guaranteed! Here is a question: What is the worst pfandbriefe issued by the worst bank, and why hasn't it defaulted? Because German pfandbriefe are too German to fail, while Cypriot bank deposits are "speculative investments". Germany is a libertarian abroad, and a statist at home. Germany has the same problem that all colonial powers have: How do I run my colonies?

  3. Commentedhari naidu

    EU Banking Union will finally eventuate with Bundesbank crying murder all the way to independent stress tests and final separation of Landerbanks and Spaarkasse (SavingBanks) from political control.

    If you didn't know, German State Governments are responsible for creation of Landerbanks and their financing structure.

    Bafin (German Banks Federal Controller) is claiming ECB cannot, at present, legally separate its functions from managing Euro currency and added responsibility of EU Banking Union. But the EU Commission proposition says it can be done and shall be done accordingly including banking resolution authority.

    This is turning out to become a battle royal in Frankfurt(see Otamar Issing's essay). He knows for sure which banks are zombie banks in Germany.

    German experience with federalism is very different from France - a unitary state. France will have serious political problems allowing its national banks to be controlled and supervised by an EU institution. The French Assembly won't sanction or approve it, me thinks.

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