Is Germany bringing the European deposit guarantee closer?
In an opinion in the Financial Times on 5 November 2019, the German Finance Minister Olaf Scholz took what amounts to a big step for Germany but only a small step for the European banking union: he acknowledged the need to complete it. The final element needed is a European deposit guarantee. A proposal by the European Commission on this subject has so far been neglected. Implementing such a guarantee requires a step towards more European solidarity. Until now, ‘strong’ euro countries, Germany in the lead, have kept to the side lines. Understandably, they do not want to take this step until banks throughout the Union have been further strengthened. This process is too slow. Scholz now declares that Germany wants to consider “a form of common European deposit insurance”, as part of a broader roadmap. If the minister’s view is supported by the entire German government, this could be an important political breakthrough. But the proposal remains far from a fully-fledged unified deposit guarantee. Scholz only brings the completion of the banking union one step closer.
Deposits must be safe
A deposit guarantee is first and foremost a consumer protection instrument. Collecting deposits is a core task of banks. Anyone who places money in an account at a bank, gives that bank a kind of loan. As with any loan, there is a risk that the borrower - here: the bank - will not repay his debt. Professional market parties can be expected to assess this credit risk themselves. And thus, they can pay for the losses themselves if things go wrong. But for individuals and most companies, this is practically impossible. Economically, it is better if they can simply trust that their deposits are safe. In order to prevent things from going wrong, banks are subject to strict rules, and they are strictly controlled. In the event of failure, deposit guarantees exist. These ensure that every deposit holder can have absolute peace of mind about the safety of his money up to the guaranteed amount - currently 100,000 euros per account holder and per bank.
Deposit guarantees also help prevent problems at one bank from spreading to other banks. If customers of a problem bank withdraw their money en masse, this can cause panic among customers of healthy banks. If they also start to withdraw their money, such a bank run can destroy the entire banking system and cause serious damage to the economy. By helping to prevent such a negative spiral, a deposit guarantee contributes to financial stability.
Final element of the European banking union
Deposit-guarantee schemes arose after the financial crisis and the Great Depression of the 1930s. They proved their worth during the financial crisis of ten years ago. This led to a severe recession, but not to an economic depression. However, the euro crisis brought to light other construction errors in the euro area, such as the lack of unification in the banking market.
After all, the eurozone is a currency union with a unified European Central Bank (ECB), which determines monetary policy for the entire currency union. This policy must reach families and businesses. In the eurozone, the banking system plays a crucial role in this. In contrast to monetary policy, however, the policy towards the banks was still mainly national. The banking crisis also highlighted the close relationship between banks and public finances. Sometimes banking crises undermined public finances, and at other times, derailed public finances undermined confidence in the banking system. The situation varied widely from country to country, with the result that ECB policies no longer had an impact everywhere in the eurozone. It became clear that the currency union could not continue to function without unifying bank policy. As a first step towards a European banking union, the ECB also became responsible for unified banking supervision on 1 November 2014. Since 2015, the Single Resolution Board has also brought the management of crises of major banks to the European level. In the meantime, banking legislation has been considerably tightened up and further harmonised. Banks now feed a Single Resolution Fund, which can finance the resolution of a banking crisis.
However, a genuine banking union also requires the unification of national deposit guarantees. This would bring an important instrument of consumer protection and financial stability to the level of the currency union, alongside regulation, supervision and crisis management. The nationality of a bank would no longer matter. The conditions of competition (level playing field) would become more equal and the restrictions on cross-border banking activities in the currency union would be reduced. Consumers would have a fuller choice of banking services. Without unification, they may be tempted to look for banks from countries with the best deposit guarantee. The recent financial crisis has shown that this increases the instability of the banking system. More cross-border banking activities would increase the stability of the currency union through better risk diversification. In crises, a European deposit guarantee and crisis fund would help prevent national public finances from being affected. Therefore, a European deposit guarantee is seen as an important final element of the banking union.
Key final element of the banking union...
But that final element is still missing. In 2015, the European Commission (EC) put forward a proposal, which for the time being remained a dead letter. The ministers did not go any further than setting up a High Level Working Group to work on “a roadmap for beginning political negotiations”, among other things. Of course, this has to do with money. Gradually transferring national funds to a European fund requires a form of solidarity. For ‘strong’ countries, Germany in the lead, this is difficult. The traditional German position is that Solidität must precede Solidarität. Greater solidarity is only possible when everyone’s house is in order. To this end, banking legislation is made even stricter. Nonperforming loans (NPLs) from the previous crisis must also be further reduced. In June 2019 they accounted for 7.9% of the banking portfolio in Italy, 8.9% in Portugal, 21.5% and 39.2% in Cyprus and Greece (source: EBA). This slow progress towards “Solidität” explains the poor treatment of the EC proposal.
... still not embraced
In the opinion article, German finance minister Olaf Scholz insisted on the need to further strengthen the banking system. His ideas about a European deposit guarantee are part of a four-step plan, which includes the further phasing out of the NPLs as well as the introduction of capital requirements for public debt held by banks. This is a tough job for Italy, but it is receiving support from the French side.
Scholz does not go as far as the EC proposal. He is in favour of a European mechanism of reinsurance between national funds. For the EC, this is only the first step in the gradual transition to full European deposit insurance. This is not the case with Scholz. On the contrary, he continues to emphasise national responsibility. If the reinsurance mechanism were to provide insufficient funding in a crisis, national funds would still have to rely on their own government. The link between the banking system and public finances is therefore not being severed. Implementation of the proposal would therefore only make the eurozone more stable to a limited extent. The European deposit insurance would remain far removed from the American one, in which the Federal Deposit Insurance Corporation has a credit line with the central bank, the Fed. This enables it to deliver on the deposit guarantee, without jeopardising financial stability.
In short, the initiative of the German Minister of Finance has the great merit of being able to trigger the political debate. But it will bring a fully-fledged European deposit guarantee only one small step closer.