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Greece and the missing banking union

The Greek Crisis is a crisis rather than a problem due to the vulnerability of Greek banks. While the banks have deep problems, this column argues that these would have been mitigated if a fully operational banking union were in place. A full banking union requires joint banking supervision, joint bank resolution, and joint deposit insurance. The EZ only has the first so far. Completing the banking union must be part of any long-term solution.

Greek banks are at the centre of the current crisis. They have been surviving only with the help of emergency liquidity from the ECB, and they might soon be forced into another restructuring, or worse. And yet, it is not the banks’ own problems that have led to the massive capital flight over the past few weeks. Rather, it is the political uncertainty surrounding the country and its policymakers. That’s what induces people to queue to withdraw their money.

This problem would have been mitigated had EU policymakers been able to put in place a fully operational banking union by now. A full banking union normally comprises three pillars: joint banking supervision, joint bank resolution, and joint deposit insurance. Not in Europe, though. The current EU setup resembles, at best, a one-legged stool. A Single Supervisory Mechanism (SSM) was eventually agreed, and has been running for a few months now. The second pillar, called Single Resolution Mechanism (SRM), will not be operational before January 2016. The third pillar, an EU-level deposit insurance, will not be forthcoming at all, at least not in the near future.

How would a genuine banking union help Greece? Greek banks suffer from a legacy problem: they hold a disproportionate amount of Greek sovereign debt (Acharya et al. 2014, Beltratti & Stulz 2015). As the state finances deteriorate, banks have insufficient high-quality collateral to justify further emergency funding by the ECB. A properly run SSM would never have permitted a Greek bank to concentrate assets in risky sovereign debt, so that the deterioration in a single sovereign’s credit rating would not have created the liquidity issues that the Greek banks now face. Consider the present situation in Puerto Rico by way of contrast. If Puerto Rico defaults, it will not bring down the local banking system (despite Puerto Rico being stuck in a monetary union with the US without much fiscal union).

An operational and credible EU resolution mechanism would have meant that Greek banks could be properly handled in times of crisis. In particular, if applied correctly, the vital parts of retail banking could have been saved – bank failure does not entail the closure of personal banking (Gordon and Ringe 2015). This would have taken off the pressure on depositors to run for their money.

Finally, Greek deposits are guaranteed up to €100,000, but the state’s finances are insufficient to make this insurance credible. The Greek deposit insurance fund amounts to only €3 billion, which is not enough to cover demand of all depositors wishing to withdraw their money. The state finances are empty anyhow. A Single Deposit Insurance Scheme, by contrast, would have presented a credible cushion for all Eurozone members’ budgets, which would have been an insurance that merits its name.

In short, a true banking union would have disentangled the banks from the sovereign, which would have been very helpful for Greek banks in their current dire situation. But more than that, a true banking union wouldn’t just be helpful for Greek banks, but for the country as a whole. If Greece were to default but the banking system survives, the state economy may contract but it won’t collapse; tourism will not go away because tourists can use the ATMs and their credit cards; the payment system is not at risk. Moreover, a functioning banking union would have created, ex ante, some disciplining of sovereign borrowing because there wouldn’t have been a captive buyer of domestic sovereign debt. A banking union would, in other words, have separated the (business) operation of banking from the (political) calamities of the country.

And so the banking union’s incompleteness and slow set-up emerge as a source of weakness for Greek banks and the entire country. Negotiators on both sides, and in particular those putting the break on the joint deposit insurance, are to blame for this impasse. The problem, of course, is how to deal with the present transition issue. The current thinking appears to be for the European Stability Mechanism (ESM) to swap out the Greek sovereign debt held by the banks for good collateral, in support not of Greece but of the banking union, during this transition period. Such emergency measures do not resolve the deeper structural problems outlined here in the setup of the banking union, however, which remain to be addressed in order to stabilise the Greek banking system on a long-term basis.


Acharya, V. V., I. Drechsler and P. Schnabl (2014), “A Pyrrhic victory? Bank bailouts and sovereign credit risk”, Journal of Finance 69, pp. 2689-2739

Beltratti, A. and R. M. Stulz (2015), “Bank Sovereign Bond Holdings, Sovereign Shock Spillovers, and Moral Hazard during the European Crisis”, NBER Working Paper No. 21150.

Gordon, J. N. and W. G. Ringe (2015), “Bank Resolution in the European Banking Union: A Transatlantic Perspective on What It Would Take”, Columbia Law Review 115, pp. 1297-1369

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