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Europe’s Bogus Banking Union

LONDON – After a 16-hour marathon negotiating session ending on March 20, politicians, technocrats, and journalists were all keen to declare the deal on the final piece of Europe’s banking union a success. But appearances are deceptive. While the “banking union” may soon exist on paper, in practice the eurozone banking system is likely to remain fragmented along national lines and divided between a northern “core,” where governments continue to stand behind local banks, and a southern “periphery,” where governments have run out of money.

Think back to June 2012. Spain’s busted banks threatened to drag down the Spanish state, as Ireland’s had done to the Irish state 18 months earlier, while panic tore through the eurozone. European Union leaders resolved to break the link between weak banks and cash-strapped governments. A European banking union would move responsibility for dealing with bank failures to the eurozone level – akin to America, where distressed banks in, say, Florida are dealt with by federal authorities with the power to bail in bondholders, inject federal funds, and close down financial institutions.

But, a month later, the European Central Bank finally intervened to quell the panic. That saved the euro, but it also relieved the pressure on Germany to cede control of its oft-distressed banks. Since then, the German government has used its clout to eviscerate the proposed banking union; all that remains is a shell to keep up appearances.

For starters, it will not apply to the huge losses incurred during the current crisis. The ECB will directly supervise bigger eurozone banks starting in November (the first step of the banking union), and now it is assessing the strength of their balance sheets. If this exercise is conducted properly – a big if – undercapitalized banks that are viable would be forced to raise additional equity, from bondholders if necessary, while unviable ones would be wound down.