Q&A: What Can We Expect from the European Banking Union? - "Fiscal Stability and Sustainable Growth Remain a Distant Hope in Europe"

What began in 2007 as a crisis in the financial sector quickly expanded into a government debt crisis that continues to plague the politics and economy of Europe. The banking system has a double-edged role: While it is partially responsible for the problem, it is also a critical aspect of the European strategy for resolving the crisis. By establishing a European banking union, policy-makers hope to restore the financial stability of the eurozone. Yet in view of the serious problems faced by various eurozone states, how is such a banking union supposed to help? ZEW financial economist Sascha Steffen discusses the European banking union, shedding light on both its strengths and weaknesses.

With its banking union project, the European Commission hopes to provide a "secure and solid financial sector in the domestic market". How will the taxpayer benefit?

The banking union consist of three components: a Single Supervisory Mechanism; a Single Resolution Mechanism for illiquid banks, which will come into effect in January 2016; and, since recently, a Deposit Guarantee Scheme. The goal is to ensure a stable financial sector and stable economic growth. Through the reform, it is hoped that Europe will no longer need taxpayer money to prop up ailing banks. Accordingly, policy-makers hope to put a stop to the potentially ruinous downward spiral that can result when governments step in to cover bank liabilities. For bank customers, not much will change on the surface. While bank services may become more expensive due to costs associated with more robust regulation, the banking union is certainly not the sole cost driver. However, customers are also taxpayers and will be impacted if, say, money from German taxpayers is used to bail out Greek banks. Ultimately, you can only spend each euro once.

The goal of the Deposit Guarantee Scheme is to ensure that the savings of everyday citizens are not arbitrarily risked. Thus, it seems we are paying for greater financial security by foregoing a degree of financial sovereignty.

A Deposit Guarantee Scheme is needed in order to avert disastrous bank runs. In Greece we saw how billions of euros were rapidly withdrawn as it became obvious that the bankruptcy of the country – and, by extension, its banks – was a legitimate possibility. The liquidity problems that the banks were already suffering thus became dramatically worse, accelerating the path toward bankruptcy. A Deposit Guarantee Scheme probably could have prevented this scenario. However, if a similar situation occurs again, a Deposit Guarantee Scheme would mean that we are jointly responsible for the banks’ liabilities. Accordingly, taxpayers could suffer loses without Europe's national governments having any say in the matter.

In light of the dangers posed by the design of the banking union, does it have any chance of success?

The main goal of the banking union – that is, to ensure financial stability and economic growth in Europe – will indeed not be reached over the short to mid-term. The banking union started with a stress test that aimed to ensure that all of Europe's banks are stable according to a single appraisal method. And where are we today? Greece remains on the brink of bankruptcy, and the country's banks are insolvent. As the banking union was introduced about a year ago, the forecasts were much different. The banks that experienced the greatest losses as part of the stress test were located in Italy and Greece.

Which countries will benefit from the plans of the EU Commission?

Greece, Italy, Ireland, Portugal and Spain are among the countries that will benefit from the banking union; these countries were also the major beneficiaries of the introduction of the euro, and have since amassed tremendous public and private sector debts. Among Europe's stable countries are member states such as Germany, the Netherlands and – at present – France. It is undoubtedly correct that banks on the eurozone's periphery are "riskier", as they have lots of bad debts on their books and they are located in countries prone to crisis. But there are ailing banks in every country, and Germany is no exception. The key question is: Have we successfully identified them? In this regard, I am sceptical.