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Germany Still Thorn in Side of Eurozone Banking Union

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After Germany’s elections, when Chancellor Angela Merkel eked out another win but her party failed to retain uncontested control of the government, the stage was set for a battle over a number of issues that are hotly contested in the country. One of those issues is the proposed eurozone banking union.

Merkel, head of the Christian Democratic Union (CDU), found herself in the position of having to negotiate with the Social Democrats (SPD) on where funding will come from to help failing banks, and when and by whom those banks would be shut down. Germany has been steadfastly opposed to surrendering control to the European Union, insisting instead that any joint body with the authority to shutter failed banks has to be separate from the European Commission. Otherwise, Berlin has said that the EU treaty would need to be changed to accommodate such a plan, and that its own laws would require changing as well since ceding control outside the country goes against its constitution.

Also at issue has been any use of the European Stability Mechanism (ESM) to help failed banks, rather than the Single Resolution Mechanism (SRM)—a common resolution fund being built by banks for just such eventualities.

The compromise that was reached could put a spanner in the works of progress toward a banking union, since it incorporates both of those positions. While most of the European community supports use of the ESM until the SRM has been built up to a useful size, Finland supports Germany against any such use. However, with France in particular championing the concept of an ESM/SRM bailout, Spain, Italy, Portugal and Belgium are coming in on the side of France.

Germany has two dogs in this fight. First is the fact that Germany doesn’t want any outside agency having a say over if and when any of its own banks should be shuttered despite having some banks in dire need of assistance. The new political coalition has specified in its governing agreement that local and regional banks must be excluded from the ECB’s supervision. That could cause problems for Germany if ECB stress tests reveal flaws in the German banking system, and that’s a distinct possibility.

Second, Berlin is opposed to allowing the ESM to function as a backstop for the SRM. Never a fan of having to bail out another country’s banks, Germany has followed a strict austerity-plus-haircuts strategy that has made it vastly unpopular among weaker Eurozone states, particularly when its own humming economy is taken into account.

But change could be in the wind. While in general German banks are stronger than those of other countries in the Eurozone, there are exceptions, and stress tests could shine a light on those exceptions.

The ECB’s stress tests began in November. They are expected to reveal some weaknesses, as well as highlight the fact that there are so many banks in Germany that it is hard for them all to be profitable, particularly in a low-interest environment. To top it off, many among that superabundance of banks are just the sort of smaller, predominantly domestic institutions Germany does not want subject to the control of the EC.

“Fitch expects Germany to have the largest number of banking groups regulated directly by the ECB, and the second-largest volume of assets [after France],” stated Analyst Bridget Gandy of Fitch Ratings in a research report. “This is not surprising, given that Germany is the largest Eurozone economy, but it is also a function of its fragmented three-pillar banking system and substantial international exposures of its large banks. Fitch expects 65%-70% of German banking assets to be directly regulated by the ECB, at the lower end of the country range, and around 40% of its retail sector to remain under national supervision.”

With regard to funding troubled banks, Germany already provides support to its own. Analyst Enam Ahmed of Fitch pointed out in June research that “Problems in the Dutch and German banking sectors have been predominantly in large banks. So although direct public support to distressed institutions in both countries has been concentrated on relatively fewer banks, the size of the intervention per bank has been bigger.”

“The extent and financing of deposit guarantees varies widely across the [eurozone] region. Countries like Belgium, Germany, France and Portugal have ex-ante funding through contributions from their financial sector. The amount of funding already raised under the national schemes is only a fraction of the deposits covered by the guarantees, but they are not designed to cope with a systemic crisis,” according to Ahmed.

While Fitch stated that potential negative developments for banks in strong countries as a result of a single supervisor for eurozone banks “could include higher required contributions to resolution funds if these become centralized for all eurozone banks [and] enhanced reporting requirements by the ECB would mean higher regulatory costs as well,” it added that “a single resolution mechanism (SRM) with a single authority for eurozone banks will need to be established. Centralized decision-making on when (ECB) and how (resolution authority) a bank should be resolved should help to reduce national political considerations around resolving a bank and achieve more efficient resolution of weak banks.”

Germany’s opposition notwithstanding, the latter objective is something that the eurozone could benefit from.