With the continuing problems of banks holding large amounts of sovereign bonds as well as high NPL levels, the prospects for completing an EU banking union are poor, writes Brian Caplen.

Maybe it is good news that eurozone banks are more focused on their home markets than they were before the currency crisis – even though it turns the idea of a single banking market on its head. Maybe it is good news, too, that banking consolidation in the eurozone has failed to take off.

The prospect of a large bank failing with the architecture, of the banking union incomplete is far from edifying. ​W​hile there has been some progress in areas such as the harmonisation of bail-in hierarchies and ironing out national differences in regulation, the to-do list still looks long and difficult.

In terms of the architecture there is the vexed question of a European Deposit Insurance Scheme (EDIS) and the proper funding of the Single Resolution Fund. But nothing much can be done about the former until the underlying problems – high legacy non-performing loans and the doom loop of bank holdings of sovereign debt – are solved. Germany for one will not agree to the sharing of risk that an EDIS implies without considerable progress on risk reduction.

A recent report from S&P notes that seven eurozone countries have bank holdings of home government securities above 100% of their sector’s common equity Tier 1 capital. They are Slovakia (647%), Italy (292%), Slovenia (179%), Belgium (168%), Portugal (166%), Malta (134%) and Spain (109%).  

One highly creative proposal from the European Commission includes the creation of European sovereign bond-backed securities (SBBS) in which a special purpose vehicle would issue tranches of bonds backed by a pool of eurozone sovereign bonds. As there would no joint liability this would not be the long-mooted – and again rejected by Germany – eurozone Eurobond. But S&P considers it would have the opposite of the intended effect of increasing the supply of AAA denominated assets. “…we believe they will probably reduce the supply of AAA rated assets instead, since some AAA rated sovereign bonds are likely to be repackaged into lower rated SBBS”, says the agency.

Then there is the Single Resolution Fund, which will not be fully funded until 2023 and even then the target amount of €55bn might be insufficient to deal with a systemic crisis. Finally, there is still the idea floating around that banks could sell bail-in bonds to retail investors even though retail-held bank bonds were such a difficult issue in the recent Italian bail-outs.

In Germany, the politics has become more difficult, not less, since the recent election and the likelihood of rapid progress on any of these issues seems small. This means more improvisation and breaking of the no bail-out principle if a eurozone bank gets into trouble. 

Brian Caplen is the editor of The BankerFollow him on Twitter @BrianCaplen

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