Front Matter
Author:
Rishi Goyal https://isni.org/isni/0000000404811396 International Monetary Fund

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https://orcid.org/0000-0002-5853-9207
,
Ms. Petya Koeva Brooks
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Mahmood Pradhan https://isni.org/isni/0000000404811396 International Monetary Fund

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Mr. Thierry Tressel
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Mr. Giovanni Dell'Ariccia
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Ceyla Pazarbasioglu https://isni.org/isni/0000000404811396 International Monetary Fund

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Front Matter Page

European Department, in collaboration with the Legal, Monetary and Capital Markets, and Research Departments

Contents

  • EXECUTIVE SUMMARY

  • I. CONTEXT

  • II. HOW WOULD A BANKING UNION HELP?

  • III. WHAT SHOULD THE BANKING UNION LOOK LIKE?

  • IV. HOW DO WE GET THERE?

  • V. DEALING WITH THE “OUTS”

  • VI. CONCLUSIONS

  • BOXES

  • 1. European Union: Existing Framework for Financial Stability

  • 2. The European Commission Proposal and EU Council Agreement

  • 3. Resolutions of Fortis and Dexia

  • 4. A Systemic Risk Exception for Europe

  • 5. Legal Considerations

  • FIGURES

  • 1. Euro Area: Financial Market Integration and Fragmentation

  • 2. Euro Area: Diverging Funding Costs

  • 3. Euro Area: Sovereign-Bank Loops

  • 4. Euro Area: Target 2 Balances

  • 5. Banks under Supervision

  • References

Executive Summary

  • A banking union—a single supervisory-regulatory framework, resolution mechanism, and safety net—for the euro area is the logical conclusion of the idea that integrated banking systems require integrated prudential oversight.

  • The case for a banking union for the euro area is both immediate and longer term. Moving responsibility for potential financial support and bank supervision to a shared level can reduce fragmentation of financial markets, stem deposit flight, and weaken the vicious loop of rising sovereign and bank borrowing costs. In steady state, a single framework should bring a uniformly high standard of confidence and oversight, reduce national distortions, and mitigate the buildup of concentrated risk that compromises systemic stability. Time is of the essence.

  • Progress is required on all elements. A single supervisory mechanism (SSM) must ultimately supervise all banks, with clarity on duties, powers and accountability, and adequate resources. But without common resolution and safety nets and credible backstops, an SSM alone will do little to weaken vicious sovereign-bank links; they are necessary also to limit conflicts of interest between national authorities and the SSM. A single resolution authority, with clear ex ante burden-sharing mechanisms, must have strong powers to close or restructure banks and be required to intervene well ahead of insolvency. A common resolution/insurance fund, sized to resolve some small to medium bank failures, with access to common backstops for systemic situations, would add credibility and facilitate limited industry funding.

  • The challenge for policymakers is to stem the crisis while ensuring that actions dovetail seamlessly into the future steady state. Hence, agreeing at the outset on the elements, modalities, and resources for a banking union can help avoid the pitfalls of a piecemeal approach and an outcome that is worse than at the start. The December 2012 European Council agreement on an SSM centered at the European Central Bank (ECB) is an important step, but raises challenges that should not be underestimated. Meanwhile, to delink weak sovereigns from future residual banking sector risks, it will be important to undertake as soon as possible direct recapitalization of frail domestically systemic banks by the European Stability Mechanism (ESM). Failing, non-systemic banks should be wound down at least cost, and frail, domestically systemic banks should be resuscitated by shareholders, creditors, the sovereign, and the ESM.

  • A banking union is necessary for the euro area, but accommodating the concerns of non-euro area European Union (EU) countries will augur well for consistency with the EU single market.

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A Banking Union for the Euro Area
Author:
Rishi Goyal
,
Ms. Petya Koeva Brooks
,
Mahmood Pradhan
,
Mr. Thierry Tressel
,
Mr. Giovanni Dell'Ariccia
, and
Ceyla Pazarbasioglu