The Euro Zone Needs Common Deposit Insurance

(Bloomberg View) -- For the past year, euro-zone leaders have vowed to take steps to complete Europe's monetary union. The 19 countries share a single currency and a central bank, but they still lack all the necessary mechanisms to deal with major imbalances and shocks. While some members would like to have more fiscal transfers and a common safety net for the banks, others worry about subsidizing laggards and encouraging moral hazard.

The European Council at the end of June is widely seen as the last opportunity for some time to agree on an agenda of reforms. Afterwards, politicians will start to campaign ahead of the elections for the European Parliament next spring. With euroskeptic forces on the rise across the currency union, mainstream parties will have little appetite for negotiations over institutional reform in the run-up to the vote.

Political leaders won't say what would count as a success in June. But I would argue that the real test is whether the euro zone agrees to a roadmap for common deposit insurance. This would show that European governments are willing to go further in supporting each other in the event of a crisis.

The creation of joint deposit insurance has been on the agenda at least since European leaders agreed to transfer responsibility for banking policy from national to EU level in 2012. This project -- referred to as Europe's "banking union" -- is formed of three pillars: the joint supervision of significant banks, a framework to wind down failing lenders, and the creation of a European pot of money to guarantee deposits of up to 100,000 euros ($122,000). While the euro zone has taken the first two steps, the third has proven elusive. Germany and other low-debt countries such as the Netherlands fear they could be on the hook for troubles in banks in weaker member states.

These concerns are largely misplaced. Germany and the Netherlands have had their own recent history of severe banking crises. Joint deposit insurance would benefit them as much as Italy or Spain. A common safety net would also reassure all depositors that they will see their money back in case of a crisis; that helps reduce the risk of bank runs in all euro-zone countries.

So far, the holdouts aren't buying that argument. The European Commission had put forward an ambitious proposal for a European Deposit Insurance Scheme (EDIS), but then had to water it down significantly in the hope of reaching some consensus.

Leaders are discussing others ways to deepen monetary union ahead of the June summit too. There is talk of providing a backstop to the Single Resolution Fund (SRF), the pot of money used to wind down banks in crisis. At the moment, this is capped at 55 billion euros, an amount which will only be reached gradually. A meaningful backstop would see, for example, the SRF able to take money from the European Stability Mechanism (ESM), the much larger euro-zone rescue fund. The EU would then have significant firepower to deal with a large bank in crisis (though, in the case of a very large lender such as Deutsche Bank, there would remain concerns over the impact of a failure on the rest of the financial system). Another idea is to turn the ESM into a more flexible institution, which is capable of lending money to countries without them committing to fiscal adjustment and a full set of structural reforms.

Neither proposal will make or break the June summit. Any changes to the ESM will likely be a relabeling exercise. And leaders already agreed to the idea of strengthening the SRF a long time ago. In any case, its role in providing additional risk-sharing between governments is limited because the fund can only intervene after equity and bond investors have suffered hefty losses through a process called "burden-sharing." 

A roadmap to common deposit insurance is therefore the sign investors need to be convinced that the euro zone is serious about deeper integration. This does not have to happen at once. As Mario Centeno, president of the Eurogroup of finance ministers, said at the spring meetings of the International Monetary Fund and World Bank in Washington last week, deposit insurance could initially exist alongside national funds, for example through a mechanism of co-insurance. European money would be called upon only when the national funds are depleted.

It is also possible to mitigate the risks that countries abuse this safety net. The European Central Bank explored in a recent paper how contributions from individual banks might be linked to the precariousness of their balance sheets. This way lenders will have an incentive to cut risks in order to pay a smaller contribution. Future steps towards a less conditional deposit insurance scheme could be linked to progress in limiting bank risk: for example, reducing the amounts of nonperforming loans, risky derivatives, or excessive sovereign debt on their balance sheets.

Even such a modest proposal will face serious resistance in Berlin in June. Olaf Scholz, Germany's new finance minister, told a gathering in Washington that progress on deposit insurance was "more difficult" than implementing changes to the SRF. In Berlin, German Chancellor Angela Merkel was cautions, saying that joint deposit insurance could only be introduced "in the distant future."

The euro zone cannot afford to be so patient. A failure at the June summit would make it harder for pro-European politicians to convince voters that the euro zone has strong institutions capable of weathering a serious crisis. Doubts could translate into big wins for euroskeptic parties in the elections for the European Parliament, which, in turn, would make it harder to pass institutional reforms in the future. The euro zone could soon regret wasting this window of opportunity.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg View. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times. 

To contact the author of this story: Ferdinando Giugliano at fgiugliano@bloomberg.net.

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