Euro: Institutional Safeguards Need Further Enhancement
Institutional setups have been improved in response to the euro crisis. However, more remains to be done.
Looking at the Economic and Monetary Union (EMU), the regulatory framework has improved since the euro crisis. In response to the heightened financial market stress of the last seven years, member states have improved institutional setups. The Banking Union's (BU) first and second pillars make the banking sector more stable, capitalized and resilient to shocks. The permanent European Stability Mechanism (ESM) now helps to deal with temporary funding problems, providing conditional lending to countries that lose market access. Finally, fiscal rules have been strengthened via the new 2012 Fiscal Compact, which stipulates guidelines and monitors fiscal adjustments and debt trajectories of euro-area members.
Michael Strobaek, Global Chief Investment Officer at Credit Suisse, provides his views on the stability of the euro zone after the debt sovereign crisis:
The toolbox has thus been extended, but more remains to be done to complete the imperfect institutional framework of the monetary union. Crucially, a reduction of ECB's quantitative easing (QE) next year could re-expose the common currency to problems. Fine-tuning safeguards will be an important subject of debate going forward. Below, we emphasize the important reforms still pending and the expected impact of the reforms we consider likely to emerge.
Progress Made on the Banking Union
The Banking Union is one of the biggest reforms currently being implemented. The first two pillars, namely the Single Supervisory Mechanism (SSM under the ECB) and the Single Resolution Mechanism (SRM), are already operational and seek to monitor and potentially close weak or failing banks in an orderly fashion. The third and final pillar, a common European Deposit Insurance Scheme (EDIS), is under negotiation. The SSM has had some success in identifying capital shortfalls, prompting corrective action from banks and improving the overall health of the banking sector.
Euro Deposit Insurance still Unlikely to Come
By contrast, the SRM seeks to decouple monetary policy and sovereign support from banking, while ensuring the orderly resolution of failed or failing banks without using taxpayer funds. Under the new rules effective since the beginning of 2016, equity, bonds (both senior and junior) and deposits above EUR 100,000 must be "bailed in," up to a value of 8 percent of total liabilities. Only after the bail-in can state money be injected into a bank. The first practical closing of failing banks this summer saw mixed results. While market volatility remained low and panic was averted, the practical rules applied in various ways showed that there are still loopholes in the banks' bail-in rules that need to be addressed (see Box below).
Regarding the common deposit insurance, we think a joint pan-euro scheme is still unlikely to be agreed upon in the near future. A joint scheme would arguably better protect retail depositors in the entire euro zone, lower the overall cost for banks, and make the financial system more stable with a net break between sovereigns and banks. But northern countries are still worried that they would largely shoulder the cost and instead are pushing for greater harmonization of schemes at the national level.