Banking union won’t cope with euro zone crisis, warns economist

Banking union infrastructure puts Ireland at a disadvantage to larger member states

Europe’s banking union will be unable to cope with systemic crises in the euro zone, a senior German economist has warned, unless the winding-up of failing banks can be financed via the European Stability Mechanism bailout fund.

Prof Sebastian Dullien, a senior policy fellow at the European Council on Foreign Relations, says the banking union's infrastructure leaves smaller member states, such as Ireland, more exposed financially and their banks at a disadvantage.

In a paper, How to Complete the Banking Union, published this week, Prof Dullien argues the single resolution mechanism fund to wind-up failing banks could cope with providing a few dozen billions in an emergency – but not with a systemic crisis. Nor does it have a clear way of accessing capital.

No level playing pitch

As a result, he says, the banking union is far from a level playing field for all. “If new problems loom in Irish banks, Ireland has to reckon with a bail-in [of creditors and investors], whereas a problem at Deutsche Bank would be declared systemic and the German government would inject capital,” said Prof Dullien, professor of international economics at Berlin’s University of Applied Sciences. “Ireland is not in a position to do that for its banks given its financial situation, therefore investors will know that Deutsche Bank has an advantage over Irish banks.”

With bail-ins more likely in Ireland, he forecasts investors would find core euro countries like Germany a more attractive investment. That, in turn, would exacerbate existing imbalances and prolong problems in capital-starved banks.

In discussions with officials in Brussels, the European Central Bank and EU finance ministries, Prof Dullien discovered disparities in how they read identical banking union rules.

Berlin officials adopt a restrictive reading of when public money can be pumped into ailing banks while Paris, he noted, adopts a more liberal approach. These differences will come to a head when the European Commission and parliament review the rules, he says.

The German economist argues for the establishment of a European fund – with participation of all EU institutions – to assume responsibility for resolving outstanding problems in banks, resembling the US Troubled Asset Relief Programme (Tarp). This would, he suggests, obviate need for a European deposit insurance fund – a bone of contention in Germany, where public savings banks are wary of plunder.

Preferential terms

But creating a new European capacity for providing extraordinary support will trigger debate about the resolution mechanism. To counter market doubts about its efficacy in a systemic crisis, Prof Dullien suggests allowing it borrow from the ESM bailout fund under preferential terms. That will face stiff resistance from Germany. Just as problematic, he said, is a lack of urgency.

Derek Scally

Derek Scally

Derek Scally is an Irish Times journalist based in Berlin