The complexities of a banking union

A report on a banking union’s impact on central and eastern Europe is required reading, and not just for eurozone countries

Mervyn King, the governor of the Bank of England, famously observed that banks are “international in life but national in death”. This message has been heard and taken to heart in the countries of central and eastern Europe that are sometimes described as ‘transition’ economies. 

As they look at the eurozone’s still vague proposals to create a ‘banking union’, the seven countries in central and eastern Europe that are in the EU but not the eurozone, plus the three eurozone members – Estonia, Slovakia and Slovenia – are each asking themselves a difficult question.

What, in the midst of a financial crisis, do such far-reaching changes in the structure of eurozone banking oversight, and ultimately in bank rescue mechanisms and eurozone governance, mean for us?

The global economic slowdown and the eurozone sovereign-debt crisis are hitting the former Communist countries of central and eastern Europe hard, not least because of their financial links.

The Transition Report recently published by the European Bank for Reconstruction and Development (EBRD), a specialist, government-owned lender to the region’s private sector, has some answers. It points out that 72% of the banking assets in those countries are actually controlled by big international institutions in the West, including banks in Italy, Austria and the Nordic countries.

Since 2008-09, these western banks have been intermittently reducing risk by withdrawing loans to the region in response first to the transatlantic financial crisis, and then to the eurozone’s sovereign-debt/banking catastrophe. Economists call this ‘deleveraging’.

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Eric Berglof, the EBRD’s chief economist, said last week that in the past year there have, at times, again been “very dramatic” withdrawals of bank lending from the former Communist states.

“In the past 12 months [to June 2012] many countries suffered significant cross-border deleveraging, some to the tune of over 10% of gross domestic product,” the EBRD noted in its gloomy October report on the region’s economic prospects.

The European Commission’s autumn economic forecasts, which it published last week (7 November), foresee recessionary conditions across the eurozone and the EU this year, and no significant recovery until 2014.

It is no surprise, therefore, that, coupled with the deleveraging tensions, eurozone stagnation is hitting the former Communist countries hard. The Commission projects that every Baltic, central and south-eastern EU country will see slower growth this year, with outright contractions in Slovenia, the Czech Republic and Hungary, as well as in neighbouring Croatia and Serbia. Berglof says this growth crisis has stalled but not yet reversed the region’s processes of transition towards the political, social and economic structures of the West. What is the West’s response?

Time for action

On Thursday (8 November), the leading government-owned development banks operating in the region – the EBRD, the World Bank, and the European Investment Bank – announced a joint €30 billion ‘action plan for growth’.

Earlier this year, reports of the alarming collapse of bank-lending in the region in the fourth quarter of 2011 triggered the launch of the ‘Vienna Initiative II’, a revival of the ‘Vienna Initiative’ of January 2009, which attempted to slow the repatriation of loans.

By bringing banks, governments and bank supervisors together, this revived co-ordination effort is seeking to stem disorderly outflows of bank lending. It began, at least in part, because governments and supervisors in countries such Italy, Austria and Sweden were actually putting pressure on their banks to pull back loans from eastern Europe.

But what about the future, in particular the eurozone’s plans for a so-called ‘banking union’? Such a comprehensive restructuring of the eurozone’s institutions for preventing and managing financial market crises, aimed at stabilising the banking system and the single currency, is destined to have a dramatic impact on the east too.

Ex-communist eurozone and non-eurozone EU member states, as well as countries not yet part of the EU, will be affected. In part this will be because western European banks have a dominant role in their banking systems, and therefore in their economies.

What is being proposed by eurozone leaders is a far-reaching restructuring of the financial and economic governance of the eurozone. This implies shifts in national sovereignty, most eye-catchingly with the plan to shift the ultimate authority for the supervision of 6,000 banks in the eurozone from national supervisors to the European Central Bank (ECB) in Frankfurt.

Eastern Europe’s small eurozone members do at least have a seat at the ECB table, though, arguably, not a very loud voice. But what about non-eurozone member states and neighbouring non-EU member states, in whose financial systems banks from the eurozone play a leading or dominant role?

How should a country such as Poland, a heavyweight EU member but not in the eurozone club and so without a formal policymaking position in Frankfurt, approach plans for a banking union? Like its EU peers in the region, it is committed by treaty to joining the single currency. It wants to have a hand in shaping the decisions and plans being made today for the eurozone of tomorrow. Its bank supervisors, who are deemed to have done a good job recently, will be no happier than those in Berlin or Paris to see supervisory powers over western European bank subsidiaries in Poland going to Frankfurt.

How will this affect the competitive balance between Polish banks, which will not, under current plans, be part of the eurozone’s banking stability union, and the subsidiaries of eurozone banks in Poland that will be included and will therefore have access to official support?

Here, the policy analysis and ideas for reform contained in the EBRD Transition Report from Berglof and Jeromin Zettlemeyer, its director of research, is a tour de force.

The two economists suggest, for example, examining whether non-eurozone EU member states, if they join the proposed ECB-led single supervisory mechanism, could “become full members of the banking union without necessarily adopting the single currency”. These countries could be offered “access to the European Stability Mechanism” – the eurozone’s bail-out fund – and be “allowed access to euro liquidity”, Berglof and Zettlemeyer suggest, through swap lines with the ECB.

Such proposals, and there are others, will certainly put the cat among the Brussels pigeons. They add a layer of complexity to negotiations already deemed dauntingly complex. This does not mean, however, that they can be ignored. Making banks international in death as well as in life was never going to be simple.

Stewart Fleming is a freelence journalist basedin London