Evolution of EU economic governance – issue 2

The end of the calendar year is always a busy time in the EU’s economic governance cycle because it sees the start of the annual ‘semester’ process through which the EU tries to coordinate the economic policies of member states. The first stage was the publication of the Commission’s 2016 annual growth survey (AGS) and associated documents on the 26 November 2015 and its assessments of national budgetary plans of eurozone countries.

In parallel, follow-up work on the Five Presidents’ report – explained in the previous UKandEU quarterly digest – continues, with proposals published late in November for the establishment of a European Deposit Insurance Scheme (EDIS) and for completing banking union. The conclusions of the European Council meeting on the 17 and 18 of December 2015 call on the Council to work swiftly on advancing the Commission proposals emanating from the Five Presidents’ report and single out those on banking union. The ambition is to report back in the first half of 2016.

The 2016 ‘semester’ cycle of economic governance

Drawing on its autumn macroeconomic forecasts, the 2016 annual growth survey begins the annual ‘semester’ process by setting out priorities for the year ahead. The three highlighted in the AGS are:

  • Re-launching investment which covers the ‘Juncker’ plan for the €315 billion fund as well as a range of specific initiatives in each member state. The text also refers to the importance of completing banking union and accelerating progress on the Capital Markets Union, one of the current Commission’s major projects to deepen the single market.
  • Pursuing structural reforms with the aim of boosting the growth and job-creating potential of the EU. To some extent, this priority can be regarded as a move beyond the crisis management of recent years, because it shifts attention to the underlying determinants of prosperity, including productivity and the performance of labour markets.
  • Responsible public finances nevertheless reiterates a theme prominent in the three previous issues of the AGS of the imperative of fiscal consolidation. However, as several social NGOs seem to have noticed, the tone is much less about ‘austerity’ and there are signals that greater account will be taken in future of the social consequences of economic developments.

As might be expected, the verdicts rendered by the Commission on the draft budgets for 2016 submitted by eurozone members range from positive to worrying, distinguishing between those currently subject only to the preventive arm of the Stability and Growth Pact, and those already subject to the corrective arm and thus in an Excessive Deficit Procedure. Among the first group, five countries (Estonia, Germany, Luxembourg, the Netherlands and Slovakia) are deemed to be compliant with the rules, while four others are given the somewhat less positive verdict of ‘broadly compliant’ (Belgium, Finland, Latvia, Malta). However, a third group is adjudged to be at risk of non-compliance (Austria, Italy and Lithuania).

Of the five countries in the ‘corrective group’ the Commission is most positive about Ireland and Slovenia and foresees them switching next year to the ‘preventive’ group, but expresses concerns about France and Spain, both of which are expected to remain in excessive deficit. Portugal, presumably because of the problems in forming a new government, had not submitted plans on time, while Cyprus and Greece are exempt from this particular exercise because they are still under macroeconomic adjustment programmes. The Commission assessment concludes that the euro area’s fiscal position will improve marginally in 2016, but it also draws attention to a possible adverse impact on the headline fiscal indicators of the high level of immigration.

Deposit insurance

The original scheme for banking union, seen as vital for the long-term viability of the euro, envisaged a single mechanism for supervision of banks, a common approach to resolution of failing banks and the establishment of a pan-European deposit insurance system. Although the first two components were agreed in 2014 and are progressively being implemented, there has been strong resistance from likely creditor countries to the third because of fears that they would be stuck with too big a share of the costs. The compromise suggested in the Five Presidents’ Report was for the bulk of deposit insurance to remain at the national level, but for the creation of a supranational fund able to step in if national funds were unable to cope, as happened in Cyprus in 2013.

Setting-out the options for deposit insurance at the end of October 2015, Schoenmaker and Wolff argued that supporting national deposit guarantee schemes through liquidity or bailout funds would do nothing to break the ‘doom-loop’ between banks and sovereigns that they regard as the compelling rationale for banking union. They then summarise the pros and cons of reinsurance as opposed to a full European guarantee scheme. Reinsurance would accurately reflect the fact that some of the regulation of banks will inevitably remain national, and leave the initial burden with the national system, but would induce national authorities to retain their own supervisory rules and practices, inhibiting financial integration. A fully-fledged European system would mean that the nationality of a bank would no longer determine its riskiness, but could aggravate moral hazard by allowing national authorities to shirk their responsibilities and is likely to need a European (or eurozone) level fiscal backstop.

The Commission’s new proposal is to introduce common deposit insurance in three stages:

  • For the first three years, the national deposit insurance schemes of member states which take part will be able to draw on the common fund if they become overstretched
  • In a second period of four years, the risks will be co-insured by the national schemes and the EDIS
  • Common deposit insurance would then become fully operational in a third stage

The proposal contains a number of conditions aimed at limiting moral hazard risks that participating national schemes will have to respect, including provisions for how the resources of the national scheme are raised and stipulations on how to mitigate the risks of banks failing. The plan is, nevertheless, that EDIS be mandatory for eurozone members, but also open to non-eurozone countries that choose to opt-in. It remains to be seen how many of the latter are tempted, but the probability is that at least some will be, with the result that the UK will be in a relatively small minority in not participating.

Unsurprisingly, objections to what is, in effect, a form of mutualisation of risks have been raised by certain member states, notably Germany. Employing a device occasionally resorted to in EU wheeling and dealing of a ‘non-paper’, Germany let it be known prior to the publication of the Commission proposals that it would prefer to see more effort to prevent risks before countenancing a move to mutualise risk through deposit insurance. The conclusion reached is that the time is far from ripe: ‘to now start a discussion on further mutualization of bank risks through a common deposit insurance or an European deposit reinsurance scheme is unacceptable’. However, German opposition puts it at odds with the ECB, which supports a move to EDIS, and even some of Germany’s allies such as the Netherlands and Finland seem to be less robust in their opposition, according to a Bloomberg report of a public meeting of finance ministers on 8 December 2015.

Since the Commission proposal envisages a move over a number of years from a reinsurance model to a fully Europeanised DGS, it offers time to resolve the moral hazard risks, but as Schoenmaker and Wolff observe it ‘raises questions as regards transition problems as well as governance when some national policies remain in place’. A book just published by Ansgar Belke and Daniel Gros draws on US experience to explain how banking union can help to mitigate shocks. They note the potential for conflicts between having a single resolution mechanism at the eurozone+ level, but separate national deposit guarantee schemes and point out that the burden-sharing problems in the event of a cross-border bank becoming insolvent are especially tricky. Their reasoning underpins the logic of the reinsurance approach proposed for the first stage of EDIS.

Assessment

The core message from the various documents published by the Commission is that the gradual recovery from the euro crisis is continuing and that the many governance reforms are bedding-in. A debate is now emerging around how far the eurozone should go in deepening. According to some descriptions, one way of interpreting the manner in which the Commission has chosen to advance the agenda set out in the Five President’s Report is ‘deepening by doing’. There are also suggestions that we are now witnessing something of a shift from governance by reference to rules, such as the deficit limits of the Stability and Growth Pact, to institutional development by creating new bodies and policy instruments, notably to underpin banking union – see, for example, some of the answers given by witnesses to questions from members of the House of Lords Sub-Committee on Financial Affairs as part of an inquiry into Completing EMU it is conducting.

In a new essay, Christian Odendahl of the Centre for European Reform argues that the line should be drawn at financial integration, together with certain collective functions associated with macro-prudential oversight and a lender of last resort function. His view is that where closer integration is warranted it should be done decisively, a stance that highlights the flaws inherent in incomplete measures which subsequently have to be revisited. He is more sceptical of the need for closer integration of structural policies because of a ‘political need for such policies to remain under national democratic control. If there is a role for the European Union, it is within its usual remit: providing an outside assessment of policies, and using the single market, consumer protection and competition tools to break up vested interests’.

Agreeing EDIS is bound to be difficult and there are likely to be attempts to curb some of the ambitions in the Commission proposal, possibly including the move to a third stage. Moreover, as stressed by BBVA research banking union needs further work in areas such as reconciling rule-books and international standards, as well as in establishing a common fiscal backstop – something they describe as politically difficult, albeit necessary

For latter-day Kremlinologists, it is noteworthy that the phrase used in the December 2015 European Council Conclusions about making progress  on ‘the Banking Union, to enhance financial stability in the euro area’ makes no explicit reference to deposit insurance, even though that is one of the key proposals on the table. Apparently, an earlier draft of the conclusions did refer to deposit insurance, but it was taken out at German insistence….

The conclusion to draw is that the political differences that have been visible throughout the euro crisis continue. They have to be regarded not so much as a source of regret as an inescapable fact of EU decision-making. Consequently, in seeking to reform some of the trickier aspects of economic governance, flexibility and imagination will be needed if the EU (and, within it, the Eurozone) is to arrive at a consensus that offers more than the lowest common denominator.

This piece by Iain Begg, Professorial Research Fellow at the European Institute, London School of Economics and Political Science and senior fellow on The UK in a Changing Europe, is the second of four pieces he is writing on the evolution of EU economic governance.

You can read Professor Begg’s first digest here

Disclaimer:
The views expressed in this explainer are those of the authors and not necessarily those of the UK in a Changing Europe initiative.

View all explainers
x

Subscribe to our fortnightly newsletter

Get a round-up of The UK in a Changing Europe’s latest analysis pieces, videos, explainers, podcasts, reports, events, infographics and more, written by the organisation’s director Anand Menon. PS his mum says it’s "quite good".




Sign up to our newsletter





View our latest newsletter