EU Summit: Another Plan to Plan

German Chancellor Angela Merkel set the stage for this EU summit by stating “this is not a summit where we will make decisions, but we will prepare decisions for December.” Unlike other EU summits in recent years, this one didn’t occur against a backdrop of high drama and rising sovereign bond yields. EZ policy makers still have their work cut out for them, with pressing issues to address—whether to release the next loan tranche to Greece, whether Spain should or will request assistance—as well as longer-term topics such as steps toward a banking and fiscal union. Some progress was made on determining next steps toward a banking union but the agreements reached at this EU summit were not all steps forward  and raise as many questions as they answer.The focus at the EU summit on Thursday was the establishment of the ECB as a Single Supervisory Mechanism (SSM). At the June EU summit, policy makers announced that the SSM would be established by January 1, 2013. This timetable was also reflected in the draft conclusions for the latest EU summit, leaked to the press on Wednesday (before the summit started), which said that policy makers would agree to complete the SSM by year-end, meaning that it would be up and running by this deadline. After the first night of negotiations in Brussels, however, policy makers announced they would agree on the legislative framework for the SSM by the end of 2012 and gradually implement it over the course of 2013. Ecofin will determine the details of the legislation. Policy makers also made some progress on setting the terms of the SSM’s purview. Germany has been in favor of the SSM only supervising systemic, cross-border banks. Spain, on the other hand, has favored the SSM supervising all EZ banks. EU leaders agreed on Thursday evening that the SSM would be able to intervene in any bank in the EZ. This does not mean that the ECB will supervise all banks directly though. As Merkel said in her final press conference on Friday, some banks will be supervised directly by the ECB, but for other banks the national bank supervisor will be the first port of call.

On Friday, EU leaders also offered some clarity on the issue of the ESM covering legacy assets. In her press conference Merkel stated “There will not be any back-dated direct recapitalization. If recapitalization is possible, it will only be possible for the future.” As she was stating this, Spanish prime minister Rajoy highlighted in his press conference that the EUR40 billion recapitalization for Spanish banks would not be an onerous burden for the Spanish state, amounting to only four percentage points of GDP in his estimation. Simultaneously, Irish prime minister Enda Kenny indicated during his press conference that there had been no discussion on which bank assets might be covered by the ESM. The apparent confusion on this matter might indicate further discussion on this issue, but the German position will win out. Even if direct bank recapitalizations for Spain and Ireland would not have represented a game changer in terms of either country’s debt sustainability, the negative feedback loop between banks and sovereigns has not been broken. This is a step backwards, in my view.

Some aspects of the SSM were determined, but at least as many remain unclear. One example is the timing of direct bank recapitalizations from the ESM. On Thursday before the summit, Merkel said very clearly in the Bundestag that the SSM must lay down a track record to prove it is effective before direct bank recapitalizations can take place. She is incentivized to delay direct bank recapitalizations until after the German elections in September 2013, given that using ESM money for foreign banks would be unpopular with German voters. In contrast, Hollande and some other EZ leaders (particularly Spain’s and Ireland’s) want direct bank recapitalizations to occur immediately once the SSM is up and running. In the press conference following the first night of the EU summit, European Council President Herman Van Rompuy said that Ecofin would establish the criteria to determine whether the SSM is effective.

A question also remains about what relationship non-EZ countries will have with the SSM. They could join the SSM given that a number of them have banks operating in the EZ—but what representation would they then have at the ECB for bank supervision?

Another issue to be parsed is the Chinese wall that some argue must be erected between monetary policy at the ECB and bank supervision at the ECB. Without it, an inherent conflict of interest could arise, particularly when winding a bank down might impact financial stability.

The other key aspects of a banking union—a bank resolution scheme and an EZ-wide deposit guarantee scheme—were not specifically addressed at this EU summit, but the European Council called for a rapid adoption of these measures in the final summit communiqué.

All in all, this summit has teed up a number of issues surrounding the creation of the SSM and a banking union that policy makers will have to thrash out in the lead-up to and during the EU summit in Brussels in December. EU leaders hardly addressed the issue of a common EZ budget, but Van Rompuy highlighted that this too will be discussed in December. This discussion will undoubtedly highlight deep divisions between France and Germany, with the former believing burden-sharing and debt-pooling are  a starting point for fiscal union and the latter believing it is the end point. It remains unclear whether EU policy makers will finish up 2012 with a crisis-fighting bang, or whether the agenda for the final EU summit for the year will prove too ambitious. The track record would certainly suggest the latter.