24 November 2015

Commission unveils its plan for common deposit insurance

The European Commission has today unveiled its long expected proposal for a common deposit insurance scheme. The key points are:

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  • Initially a “re-insurance” plan between July 2017 and July 2020, where national deposit guarantee schemes will continue to support covered deposits (deposits up to €100,000) but could draw support from the European scheme if their funds were exhausted. (See graph above).
  • From July 2020 to July 2024 it would be a “co-insurance” scheme where the national and European schemes work in conjunction to backstop covered deposits. The European scheme will initially foot 20% of the bill, but this will increase over the four years.
  • From July 2024 the European fund would fully backstop covered deposits.
  • Banks will fund the European scheme and any contribution can be deducted from contributions to national schemes. Riskier banks will pay in more from the start.
  • Other risk management measures such as the requirement to fully implement current rules on deposit guarantee schemes and bail-ins (to avoid free riding) and keep certain risks (such as exposure to domestic sovereign) diversified.
  • The European scheme would be administered by the Single Resolution Board, and therefore would presumably be located in the Commission.
  • Decisions will be taken via simple majority with each member having one vote.
  • By 2024 the fund will total 0.8% of covered deposits in Banking Union banks, or around €43bn. Banks will pay in around €6.8bn per year (12.5%) to get to this total.

Clearly, plenty of questions remain around the details. Not least – how exactly will the money be raised from banks? Does this mean a Eurozone-wide bank levy or some version of a financial transaction tax? Furthermore, exactly how banks will be classified in terms of “risk” and therefore how much they will need to pay in, is also unclear. This seems like quite a task and will require a significant review of a number of banks by the ECB. Finally, it really is not clear what happens if the European fund were to run out of money. The suggestion is that it could raise further contributions from banks. But ultimately, the fundamental question is, who is backing all this? Does it have a direct credit line to member states and/or the ECB? Neither seems to be the case.

What difference would such a scheme make?

The scheme has been long mooted and is widely seen as the final pillar of the banking union (along with single supervision and single resolution) which should help break the sovereign-bank loop.

The size of the fund might be a bit smaller than expected at 0.8% of covered deposits.  Similar funds in other countries look to provide around 1% to 2% pre-funded. Furthermore, many funds have direct credit lines with their national treasuries or central banks. The US Federal Deposit Insurance Corporation has a $500bn credit line with the US Treasury, for example. Ultimately, whether the fund is seen as credible in terms of size will depend on who is underwriting it and how quickly such funds can be drawn up if needed in a crisis.

Such a deposit guarantee scheme does have a role to play in completing the banking union and helping to break the sovereign-bank loop, but it should not be overestimated. There are plenty of other issues which need to happen first, primarily the completion of a clear and credible bail-in approach which has been proven in practice. While rules are in place on this, many countries have not implemented them and they remain complex and unproven. There likely also needs to be greater separation between banks’ capital and their own sovereign – not only through the holdings of domestic sovereign debt but also through tackling the direct claims on sovereigns created by deferred tax credits. Frankly, the single supervisor and resolution have done little to break the sovereign-bank loop, so it’s not entirely clear that this plan would do any better.

Furthermore, many of the problems around deposits fleeing banks have come about not because of the uncertainty over deposit schemes but due to re-denomination risk. Fundamentally, banks in Greece (and to a lesser extent Portugal and Ireland) lost deposits because of fears that they might crash out of the Eurozone. A deposit scheme such as this does not tackle that risk. Such a risk cannot be removed unless covered deposits are guaranteed in Euros indefinitely, an impossible proposition.

Is the Commission’s plan dead on arrival?

Even before the plan was published, it had been slammed by Germany, with a Finance Ministry spokesman saying:

It is not a secret, that on the basis of the discussions thus far, we have some questions that are unanswered. These start with the legal basis…we have a few big question marks there…The point must be that we minimise risks in the banking sector, and not that we share out and mutualise risks.

The comments were backed by Austrian Finance Minister Hans-Jörg Schelling who said that the Commission’s proposal “is not the right way to go at this stage.” Even Eurogroup Chief and Dutch Finance Minister Jeroen Dijsselbloem, who explicitly supports the plan, said he expects it to run into a “number of blockades”.

This is a very similar situation to the one we saw with the Banking Union. Germany came out strongly against the Commission’s original proposal which was essentially a big power grab by the Commission. The view here is likely to be similar. The Commission has insisted this time is different, since the mutualisation only takes place in the future and via funds paid in by banks. As such, it seems to have already rejected the idea of moving any parts which involve mutualisation outside the EU treaties and into an intergovernmental agreement as was done with the Single Resolution Fund.

While the proposal does try to take some account of Germany’s concerns in terms of reducing risk beforehand and pushing mutualisation down the line, it seems unlikely to be agreed in anything like this form. That said, this is a priority for the Eurozone and something will have to be agreed. A watered-down version with more emphasis on “re-insurance” and less on mutualisation, as well as less control for the Commission, seems possible at this stage.

What does all this mean for the UK?

The proposal only applies to the Banking Union states (Eurozone and any non-Euro members that have joined). As such, the UK is exempt. But there are a few points worth watching.

The legal justification is once again Article 114, the single market article, as with Banking Union. Reading the logic and justification, it seems that from now on anything related to the Banking Union will be hung on the original use of this Article. There is some reason for concern here, as this essentially creates a precedent for creating many Eurozone institutions/policies using single market grounds (as we warned it would). That said, Germany may also oppose this approach, as it did before, although it is more concerned about the mutualisation precedent.

This also means that Treaty change is not foreseen, which given the mutualisation might surprise some (again the Germans). Transferring such powers to the EU under a single market article might itself be a worrying precedent to set.