EUROPE COMPASS WEEKLY UPDATE DECEMBER 17, 2012

Solidarity summit

The European Council agreed on December 14 to establish a single supervisory mechanism (SSM) for the banking system within the euro-area. The first sentence of its conclusions explains that this outcome reflects the desire for "deeper integration and reinforced solidarity". Many observers will regard that statement as ironic. The results of the summit were less than was anticipated when the European Council met last June. Instead of offering a fully fledged set of legislative proposals for banking supervision, resolution and deposit insurance, it only seemed to sketch the broad principles for just one of these three pillars of a European banking union. Indeed, the conclusions provide little details on how SSM will work, beyond insisting that it should be "effective".

Space for backsliding

This qualification is important, because the June 29 Euro-Area Summit Statement provides for the European Stability Mechanism (ESM) to inject capital directly into troubled banks only "when an effective single supervisory mechanism is established". Hence, the goal of moving towards ESM-financed direct recapitalisation is clear. Nevertheless, governments looking to offload financial responsibility for their troubled banks will have to wait until March 2014, if not later. The press release after the Economic and Financial Affairs (Ecofin) Council that met on December 12 to prepare the European Council summit paints a sombre picture as to the timing: "The ECB will assume its supervisory tasks within the SSM on March 1, 2014, or twelve months after the entry into force of the legislation, whichever is later, subject to operational arrangements." Such phrasing leaves plenty of space for further backsliding.

Limited integration

The press reporting from the summit shows some of the limits of "deeper integration". The ECB will have nominal responsibility for all monetary financial institutions in the euro-area, but its direct oversight will extend only to banks that have assets worth more than 30 billion euros (39 billion dollars) or represent more than 20% of the home country's GDP; primary responsibility for the remaining institutions will stay in the hands of national authorities; and the terms under which the ECB could assert control over smaller banks that it nevertheless regards as strategically significant remain unclear. The prospects for some of the more ambitious proposals for common deposit insurance or some kind of centralised fiscal authority are small. Deposit insurance has not dropped off the agenda entirely, but it is more likely to be tackled through European requirements for national programmes than through a new common institution; as for centralised fiscal resources, the conclusions pledge merely to present by June 2013 a roadmap for "ex ante coordination of major economic policy reforms" focused on ensuring competitiveness and growth. Even the idea of creating a common banking resolution facility leaves little room for implicit transfers across countries. The Council conclusions make it clear that the goal is to protect taxpayers. The resolution mechanism will be financed from "contributions by the financial sector itself" and, should that prove inadequate, any public assistance would be "recouped by means of ex post levies on the financial industry". The ECB should have the necessary resources to enforce its supervisory authority, but the wealthier member states should not have to pay for that to be effective.

Internal market

Still, it would be wrong to place too much emphasis on the ironic aspects of this agreement. The Council has expressed solidarity -- just not solidarity of the redistributive sort. Instead of calling for ever more shared or centralised resources, it has emphasised the solidarity of the internal market. As explained by Nobel-prize winning Swedish economist Gunnar Myrdal, this form of solidarity -- market solidarity -- expresses itself not through transfers from richer to poorer, but through the creation of a level playing field. And on this count, the Council summit has much to offer.

Ins and outs

The most important concession made at the summit was on decision-making in the European Banking Authority (EBA), which the Ecofin Council agreed "would retain its competence for further developing the single rulebook and ensuring convergence and consistency in supervisory practice". The ECB will not be allowed to dominate EBA discussions; indeed, newspaper reports suggest that decisions within the EBA will be taken by a double-majority of those member states inside and those outside the SSM. This parity of treatment applies within the SSM as well; non-euro-area countries that choose to join the single supervisory arrangements will gain a voice in decision-making within the ECB supervisory council equal to those of existing euro-area participants. Again, this does not sound like solidarity in the conventional redistributive sense, but it is a clear concession to countries like the United Kingdom and Sweden that otherwise would be disadvantaged by institution-building within the euro-area. Similar concessions were made to other countries depending upon their circumstances. The reference in the European Council conclusions to "differentiated, growth-friendly and sound fiscal policies" is one example; the requirement that member states "ensure the appropriate involvement of their parliaments" is another. What emerges from the text is a broad acceptance within the Council that the politics of adjustment differs from one country to the next. Hence, while member states should all follow the same rule-book for participation in the single market, the interpretation of the rules should accommodate national differences and so "ensure a level playing field between member states which take part in the SSM and those which do not".

Euro-area in turmoil

The European Council summit also takes place within the broader context of turmoil within the euro-area. I dealt with the situation in Italy in my last note, in which I argued that the European context is much stronger now that it was a year ago. The same point applies to Greece, Cyprus and Slovenia. On December 13, the Eurogroup formally accepted Greece's efforts to meet the conditions of its assistance and so cleared the way for the European Financial Stability Facility to release assistance worth 49.1 billion euros; 34.3 billion will be paid out before the end of the year and the remainder in the first quarter of 2013. The Eurogroup also announced the same day that it planned to work out the details of an assistance programme for Cyprus by mid-January, while at the same time providing assurances that the country's financial resources should be sufficient to carry it through the interim. Slovenia was not mentioned explicitly, but its current economic and political situation suggest it may also need assistance. Should that be the case, a European framework already exists -- both to provide financial resources and to stabilise sovereign debt markets. This framework is not the most generous that could be imagined. But it is arguably sufficient to preserve the internal market. More important, it is acceptable politically within the member states. By this measure, the European Council is correct to describe the summit as offering both deeper integration and reinforced solidarity. The agreement does not offer new transfers from richer to poorer countries but that was never what the European Council intended.

Please note that the Europe Compass will now go on holiday for two weeks. The next note will circulate on January 7, 2013. In the meantime, the Europe Practice at Oxford Analytica wishes you the compliments of the season.

Dr Erik Jones Head of Europe ejones@oxford-analytica.com www.oxan.com Tel: +44 1865 261600