Despite extended talks and very public bickering over the necessity of moving toward a banking union – and how such a union might work – the European Parliament last week finally voted to approve rules that will govern the move. However, a banking union presents a number of challenges to both countries and banks in the region. Here are the top three.
1. Stress Tests
Between May and November, when the European Central Bank assumes authority over the 128 largest banks in the eurozone and gains some oversight over another 6,000, banks will undergo stress tests to see just how healthy they are.
The European Banking Authority has said that banks must be able to prove that capital reserves will not fall below 5.5% of assets should another economic crisis hit. New regulations that have already begun to take effect have caused banks to shed loan portfolios, branches and even whole books of business as they attempt to divest themselves of potentially risky holdings and reduce their size.
The top 30 banks alone have already seen reductions of 2 trillion euros ($2.76 trillion) in 2013, with more to come in 2014. In some cases this is part of a restructuring of banks’ business. UBS, for example, is moving back toward traditional private banking as it abandons newer and riskier trading activities.
New requirements aren’t the only challenge presented by stress tests. If banks are too successful in fulfilling the new requirements and pass the tests with flying colors, the tests’ very credibility could be at issue – something the banking authority is familiar with, since its previous more lenient regulations allowed banks to appear healthy even as collapses were looming. In January, a Keefe, Bruyette & Woods analysts’ report indicated that in a simulated stress test, 27 of the ECB’s 128 banks failed.
Still, so many banks have cut exposures and boosted capital ratios by such large numbers that it is expected they will make a respectable showing.
2. Deposit Guarantees
When the European Parliament voted to approve legislation on the banking union on April 15, it included deposit guarantees for accounts below €100,000 ($138,130) and for short-term deposits of up to €200,000, which would protect, for instance, homeowners who have just sold a residence.
However, those who have larger or longer-term accounts could end up on the hook for funds above those amounts, as they did in Cyprus when banks collapsed in 2012-2013. Regulations don’t specifically include or omit larger depositors; as a result, in the event of trouble, there’s sure to be a major uproar should problems arise, as depositors clamor to have their assets protected while banks and governments seek to recover losses via those same assets.
Meanwhile, authorities will not only have to provide account holders with their money within seven days of a bank closure but will also have to provide subsistence amounts to those account holders within five days. Countries will be obligated to review banks’ efforts to amass national deposit guarantee funds, but the rules don’t take effect till 2015 – and countries can postpone deadlines for satisfying the regulations till the middle of 2016. The pooled guarantee funds are supposed to amount to €44 billion within the next 10 years.
3. The Single Resolution Mechanism (SRM).