Berlin and Brussels seem poles apart ahead of German poll

European finance ministers meet
tomorrow in Vilnius
for the first time since June for their six-monthly "informal" gathering.

Traditionally, informal council meetings are an opportunity for ministers to convene, take stock and engage in general discussion about the economic situation, without the pressure of decision-
making. The euro zone crisis changed all that. As ministers sought to contain the crisis, even informal settings became a forum for action.

Nonetheless, tomorrow’s meeting in the Lithuanian capital, which continues until Saturday lunchtime, is likely to be a straightforward affair.

The reason is not just the relative calm in the markets as the prospect of a euro zone break-up has receded. The real reason is next week’s German election.

The fact that the meeting takes place a little more than a week before Germany’s federal election has changed the dynamic of the meeting.

Observers expect little of substance to emerge when euro zone finance ministers gather for the euro group, followed by the Ecofin meeting of all 28 member states. For months, the view in Brussels has been that no significant decision on the economic crisis will be taken until after the German election.

The euro zone crisis took something of a back seat in the early stages of the election campaign, although it emerged on the domestic political landscape in recent weeks, propelled in part by German finance minister Wolfgang Schäuble's suggestion that Greece would need a third bailout when its programme finishes at the end of next year.

But while German
politicians may be keen to
steer clear of an issue that is highly sensitive politically, the rest of Europe is watching.

Germany's position on
the euro zone crisis, and its prioritisation of an EU-wide response to the economic situation, is vitally important for Europe.

Signs of discontent
The last six months have shown worrying signs of an increasing divergence between Germany and Brussels on the idea of banking union, Europe's main policy response to the financial crisis. The first real signs of discontent from Berlin
surfaced at the last informal meeting of finance ministers in Dublin in April, when they agreed to consider the possibility of treaty change to assuage concerns from Berlin that the establishment of a pan-European bank supervisor could be in breach of EU treaties.

Schäuble articulated Germany’s concerns about the scale of the euro zone’s plan for a banking union the following month, calling for a “two-step” approach to banking union.

More tensions surfaced in June when the European Commission announced its plan for a Single Resolution Mechanism , a centralised body which – once the ECB has taken over direct supervision of banks – will decide when European banks are wound down or restructured.

Separately, European finance ministers will tomorrow continue their discussion on which class of creditors would be hit in the event of a bank restructuring.

Germany is against the Single Resolution Mechanism idea, arguing in a joint communique with France that a more decentralised system involving national resolution authorities should make the final decision on bank resolution.

The idea of a common EU deposit insurance scheme – the so-called third pillar of banking union after the establishment of a single supervisor through the Single Supervisory Mechanism and the bank resolution rules – is now in effect dead in the water, amid concerns about pooling of liability.

Reluctance
Germany's reluctance to embrace the scale of banking union originally envisioned when the plan was announced more than a year ago has put Berlin at odds with Brussels and Frankfurt. The European Central Bank has echoed calls from Brussels for more centralisation as it prepares to take over the supervision of Europe's biggest banks next year.

It also raises questions about Europe's commitment to
the idea of banking union, something that is regarded by analysts and investors as crucial for the economic credibility of the bloc.

Already there has been a delay in the timetable for implementation, with the head of the 17-member euro group, Jeroen Dijsselbloem, confirming last week that the Single Supervisory Mechanism, which paves the way for the ECB's assumption of a supervisory role, will not be up and running until October 2014.

While the euro zone is enjoying a period of relative calm, next year’s banking stress tests could severely unsettle markets. The ECB is due to undertake asset-quality reviews early next year ahead of the European Banking Authority’s stress tests.

Already, the ECB has indicated that the EU must have backstops in place to deal with any shortfalls that may arise from the tests.

What these backstops might be is likely to emerge as a point of discussion in future months, as debate continues about where the responsibility lies
for liabilities incurred under national supervisory systems.