Tuesday, June 26, 2012

Eurozone's banking union will not be credible; FDIC-type fund seems out of reach

There has been a great deal of discussion about the Eurozone's so-called "banking union" that would create pan-Eurozone banking regulation and depositor protection.
NYTimes: The summit, which will be followed by a separate meeting of euro zone leaders on Friday, is expected to focus on agreeing on the elements of a banking union, which is seen as a concrete step even though it would not come into operation until 2013 at the earliest. Those elements would include a system to liquidate insolvent banks, a central deposit guarantee fund, and a bigger supervisory role for the European Central Bank, among other measures.
The issue with any such arrangement is that the euro countries' banking systems are just too big for their "home" economies.
Barclays Capital: - Nobody questions the credibility of the US government as a rescuer of last resort of the US banks. And that is because the US banks’ total liabilities only represent 1x the GDP of the US. Where it becomes problematic is when the system gets too big, and that goes to the heart of the problem with Europe's banks; simply put, they are much too big for their individual sovereigns to protect credibly.
[for example] The largest US bank – JP Morgan – has liabilities equal to 13% of US GDP. By contrast 20 European banks have liabilities of more than 50% of their home country's GDP.

Source: Barclays Capital

That would mean that the Germans and other stronger economies would in effect have to backstop deposits in Spanish (and other periphery) banks.
Barclays Capital: - ... deposit protection must mean, for example, German taxpayers becoming liable for bailing out Spanish savers. Anything short of that, in our view, renders a union almost irrelevant for today’s crisis.
Some have suggested that this deposit guarantee come from an FDIC-like European entity that taxes banks and builds up a large capital base to provide this protection. This way no one country would be responsible for making whole the depositors of another nation.

However there is a major problem with this approach. The Germans (and others) already have such entities and would not want to simply contribute the capital they've built over the years to the rest of the union. Some in Germany have referred to this as "looting of the German banks' deposit insurance funds". That means the entity would need to be capitalized "from scratch". But to create a Eurozone's version of the FDIC with credible capitalization would take years.
Barclays Capital: - In the long run, funding a deposit guarantee scheme can come from charging the banks a fee, but near term the maths suggests it has to come from taxpayers. The eurozone has €11trn of deposits. Taxing 20% of all banks’ profits for half a decade would still leave the scheme with assets below US FDIC levels.
And a one shot capital infusion worth hundreds of billions is simply not possible at this stage unless you plunder the EFSF/ESM.

With a tax scheme in place, all the German banks would need to pay this large fee for years, even though they already have a credible domestic program. There is little chance German politicians would agree to this. Even if such an entity were to be established and funded, some of Eurozone's banks are so large (the French banks for example), the entity would need to be capitalized considerably better than the FDIC.

In the mean time the taxpayers of some nations would be on the hook for deposits in other countries - there is simply no way around that. It is therefore highly unlikely that the voters of the stronger Eurozone economies will support such policies and that a credible depositor protection scheme is even possible.

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