The big risk

A euro zone budget, a European finance minister, a European deposit guarantee – the ideas from Paris and Brussels on the further development of the Economic and Monetary Union include an ever-increasing mutualization. The answer from Berlin? Due to the sluggish formation of the new government, there is hesitancy but also rising agreement. The term of the hour is risk sharing, which sounds much better than mutualization and now seems to be gaining the upper hand over the previously equally valid principle of risk reduction.

What should be the next step: risk sharing or risk reduction? Nowhere is this question more explosive than in the debate on the European deposit guarantee. The idea is that a European "common pot" should be created from which depositors are compensated in the event of their banks' financial crises. This pot would be able to provide more funds in such a case than the deposit insurance of a single state. Advocates attach great importance to this step in completing the Banking Union, while opponents regard it as a gateway to a far-reaching mutualization of risks in Europe.

The former fear of the continued existence of the euro is gone, stock markets are booming, growth is returning, and unemployment is falling. However, at second glance, one realizes that this is only part of the reality.

Public debt in many countries is still far too high and can only be considered as financeable due to the low level of interest rates. A large proportion of the European debt is financed by banks in these states. Many banks, often the weakest among them, hold a multiple of their equity in bonds issued by the countries in which they reside. If these countries come into payment difficulties, the banks will be in trouble. They are also sitting on mountains of bad loans, which, according to the European Commission, amount to 950 billion euros. A much too high amount of government loans and too many bad loans – a toxic combination. In addition, these stocks are not equally distributed in Europe, but are concentrated primarily in the former and current crisis-stricken countries. In Italy, more than one in ten credit claims are deemed to be in default.

What is the likelihood that the high risks in individual countries would have to be absorbed by the joint deposit guarantee? Not small, already because of their amount. Added to this are weak insolvency laws and their inefficient application, a lack of political will to create conditions for stable banks, and a mild treatment of other creditors in the event of bank losses. A joint deposit guarantee in view of these risks would be more of a transfer mechanism than an insurance policy.

It would create a common European liability for imbalances whose causes are largely the responsibility of individual states. In the end, the deposit insurance might be used for the over-indebtedness of individual states. In addition, there is another fundamental question: what would happen if the common deposit pot were not sufficient to absorb the incurred losses?

Demands for a European solution would then be close by, for example, enabling the deposit guarantee fund to borrow on the capital market or tap into the European Stability Mechanism (ESM). In this case, the way would not be far for a liability of European taxpayers for the abuses of individual Member States.

The common European deposit guarantee is more than a missing puzzle piece in the completion of the Banking Union. It raises the fundamental question of the responsibility of the individual states in the future architecture of the Economic and Monetary Union and thus of the unity of liability and control.

Its introduction would jeopardize the system as long as bank instability is in part underpinned and progress has neither been made in reducing bad loans nor in limiting bank investment in government bonds. Moreover, incentives to reduce risk will decrease significantly once these risks are shared. The well-intentioned idea could inflict serious damage on the European concept. The deposit guarantee should be taken off the agenda and discussed when conditions are met. 

“Its introduction would challenge the whole system. In addition, the incentives to reduce risk will decrease significantly once these risks are shared.”

This article was originally published in German by Handelsblatt under the title "Großes Risiko", January 25, 2018.