The European Banking Union concept

In simple definition, banking union means common regulation and common supervision of European Banks. The reason to consider banking union is twofold. First, a banking union between euro area members would better protect financial stability by correcting a design flaw. A single monetary policy with 17 different banking sectors each independently regulated and supervised was an unsustainable design. Poorly regulated or supervised risk in one banking system should not be allowed to undermine the stability of the aggregate euro system. This weakness can be corrected (but never entirely removed) with common regulation and supervision. Second, a banking union would help resolve the negative feedback loop between weak sovereigns and weak banking system. It would achieve this by facilitating policies such as a common bank resolution vehicle, direct recapitalization capabilities for the EFSF/ESM and a federal deposit insurance system. Such policies, by raising common funds for resolution and insurance and the bailing of bank debt in certain circumstances would also help reduce the direct cost to taxpayers from failing or failed financial institutions. It would be wrong to think that the EU has not been progressing towards closer integration of its banking sectors. Already since the start of the crisis Europe has done the following: created the European Banking Authority (EBA) to improve European oversight of national banking regulators; delivered a proposed EU Directive on bank capital, called CRD41; and this week delivered a proposed EU Directive on crisis management and bank resolution, to create a level playing field for resolution (common parameters for national resolution funds, common rules for bank bond-holder bail-in, etc). This is just the start. European Commission President Barroso proposed a banking union to EU leaders at their informal summit on 23 May 2012. Since taking over as the central bank's president last November, Mario Draghi has already provided a trillion euros in rescue loans, propping up banks and in effect easing government borrowing costs, particularly in Spain and in his home country Italy. Mr. Draghi has warned governments not to expect the ECB to do their jobs for them and has recently put the onus on them to get their finances in order. But if people start pulling their money out of the banks in Greece, Spain and other European countries, Mr. Draghi probably stands ready to provide trillions more in rescue loans. The risk for him is he is playing a game of double or quits. The more money the ECB lends, the bigger the losses if a country were eventually to leave the eurozone. And if the entire eurozone broke up, those losses would have to be shouldered by governments, and that would make it a huge political issue, especially in Germany. The ECB, which has played a vital role in the

crisis so far, stands and falls both on its independence from governments and the need for their total support. The long-standing European Commission President Jose Manuel Barroso has a lot to win, and a lot to lose, from this crisis. He has been lobbying for a comprehensive solution that would give the commission a much bigger role in directing the eurozone's economic policies. Last year he called for a "federalist moment" as he proposed common eurozone government debts to help weaker countries borrow at more favorable rates. More recently, he has backed the creation of a banking union with a single regulator, a Europe-wide insurance scheme for savers' deposits and a single bank bailout fund. His big fear is that if national governments do not hammer out an agreement on closer ties, the euro could fall apart acrimoniously, and that could torpedo the entire European project. The IMF, along with the eurozone governments, has leant a lot of money to Greece and stands to lose if Greece cannot repay them. However, that is par for the course at the IMF, and is probably not something that its new managing director, Christine Lagarde, will be losing much sleep over. Instead, her big concern is that if the eurozone fails to hold itself together, it could spark a global financial crisis and recession similar to 2008-09. Ms. Lagarde has been calling for more leniency towards Greece and other borrowers, and more action in Europe to boost growth. She has also been lobbying the world's other big economies - including the US, China and Japan - to make more of their money available to support the Fund's continuing rescue efforts. Fears and concerns The new technocrat Prime Minister Mario Monti has two big fears. Firstly, although the government was relatively prudent with its finances after joining the euro, it is sitting on huge debts that were run up in the 70s and 80s. An intensification of the eurozone crisis means markets turn their focus on Italy, deemed the next most vulnerable after the bailout countries. Investors then demand high rates of interest in return for lending Italy the money it needs to keep up with its debt repayments. Secondly, Italy's economy is very weak, while its political system remains dominated by vested business interests opposed to Mr Monti's economic reforms. If Mr Monti becomes unpopular with the public, then some politicians - notably former Prime Minister Silvio Berlusconi - may seek to topple his unelected government, potentially prompting political and financial turmoil. Chancellor Angela Merkel appears to be holding all the cards - she presides over Europe's strongest economy and strongest government finances. Any rescue of the eurozone therefore ultimately relies on German money. If Chancellor Merkel provides the money too readily, she fears weaker countries will keep coming back for more, while her own voters may lose patience, but if she does not provide the money, she risks letting the euro fall apart, in which case Germany will face a catastrophe - massive losses on loans already provided by the country's banks, government and central bank to southern Europe, a collapse in demand from Germany's biggest export markets, and an angry political backlash from the country's closest allies. What the French government can afford The newly elected President Francois Hollande has put a big emphasis on the need to stimulate economic growth, aligning him with the southern Europeans and putting him in potential conflict with

Germany. Although France's economy and the government's finances are in reasonably good shape, the country's Achilles Heel is its banks. The French banks have lent heavily to southern Europe, especially Spain and Italy. If either or both of those countries were unable to repay their debts, France's banks could go bust, and it is far from clear whether the French government could afford to rescue them. Spain and the property bubble Since coming to power in December, Prime Minister Mariano Rajoy's biggest headache has become the country's banks. They are facing huge losses on loans they made during a property bubble in the past decade. Although Spain's government does not have debts as big as some, it has had to borrow and spend heavily as the economy slides deeper into recession. It has had to go to the eurozone for loans to help its banks. But there are questions about whether it will be enough, and when the money will start flowing. What's more, critics say it doesn't do anything to make the country's finances any more solid. At the centre of the Euro crisis, Greece Greece is without a political leader, following inconclusive elections in May. Whoever emerges as the new prime minister in the June elections could influence the whole direction of the crisis. Europe has made it clear that to keep receiving the bailout money it relies on, Greece needs to form a coalition that agrees to implement the strict conditions on the loans. Without that, payments would dry up, leaving Greece unable to pay public sector workers, pensioners and suppliers. It would be forced to cut back spending drastically. If the worst comes to the worst, continued political paralysis or resistance to the bailout conditions could see the euro area carry out its threat and eject Greece from the single currency. Greek banks would be cut off from the lifeline funding they get from the European Central Bank and shunned by international markets, triggering a bank run. Date: august 20/2012

Mircea Halaciuga, Esq. 004.0724.58.1078 PROXEMIS - Managementul Riscurilor