Why there won't be a proper EU banking union anytime soon

You have to hand it to them: European finance ministers have done a remarkable job of not fouling things up recently.

They’ve managed (for the time being at least) to string together a sequence of summits ending not in discord and recrimination but in broad-based agreement. They’ve taken some genuinely encouraging steps on Greece. And while the euro is still in (possibly terminal) trouble, they have probably done enough to tide the system well into the New Year, and maybe even until after the German elections next autumn, although that’s probably optimistic.

So is the latest of these agreements – the deal sealed in the early hours of the morning to create a pan-European banking regulator – as impressive as it at first sounds? Notwithstanding the fact that achieving any kind of agreement in Brussels is never easy, sadly the answer is no.

A recap of what’s been agreed: from 2014 (it will take a while for the whole thing to go through national parliaments) the European Central Bank will be responsible for regulating the bigger Eurozone banks. Britain and other non-euro members will be outside this sphere of regulation, and have achieved safeguards to protect them from the regulations (which involves a system of double-majority voting that may well serve as a prototype for how Britain may conduct itself on the fringes of the EU in the future).

Is this enough to save the euro? No. Clearly, banking union is a key part of the mission to create a more function currency area. After all, part of the way in which the Eurozone is tearing itself apart is manifested in the banking system, where depositors are pulling money out of the weak countries and putting them into bank accounts in the rich ones. In a properly unified banking system you shouldn’t necessarily feel that your money is less safe in one region than another.

But clearly unifying your system of supervision, as happened last night, is only one part of the answer. Another is to have a unified system of bailing out banks in trouble. That has been partly agreed, although there are still some question marks about precisely where the money would come from.

But far more important than all of this is a common system of deposit insurance. So that, just as in the UK there are protections on savers’ deposits in UK banks, there would be a centrally-funded system which would insure the first, say, €100,000 of an individual’s deposits. When people talk about a banking union being the solution for some of the euro’s problems, this deposit insurance system is what they really mean.

And so far there is nowhere near agreement on how to create, implement or fund a system of deposit insurance across the euro area. There are two good reasons for this. The first is that it is, in essence, another system of fiscal union. If Germany provides some of the cash which eventually goes to depositors in Greek banks, that is not so different from German taxpayers providing cash which goes into the Greek Treasury. So there is a whole Pandora’s Box of political problems there.

The second reason is that there’s an argument that even if you did set up a deposit insurance system it would actually cause the euro to collapse in and of itself. How? Because at the moment if you’re a Greek depositor, there’s an in-built disincentive for your country not to leave the euro, since if it did your deposits would be redenominated into new drachmas. They would be likely to be weaker, so you would become poorer overnight – particularly if, as will be the case for some people, some of your debts are still denominated in euros.

However, if there were a common deposit insurance scheme, it’s difficult to conceive of it not protecting savers’ deposits, even against denomination risk. If, under those circumstances, Greece or Spain left the euro, it’s feasible that deposits would be protected, kept the same value in euros. Meanwhile, with everything else in the country redenominated into cheaper drachma, those euros would go even further. In other words, there’s an in-built incentive for Greek depositors to get their country out of the single currency.

I should add that this isn’t my own argument but one made privately by senior UK ministers to European finance ministers. They believe it is one of the reasons why no progress has been made on this fundamental core of any future banking union.