Man in charge of EU banks predicts rocky road ahead

Wolfgang Schäuble is Europe’s most experienced frontline political leader and little happens in the EU without his say so. His championing of the newly agreed banking union puts his reputation on the line, writes Kyran Fitzgerald

Europe’s leaders this week reached agreement on a unified system of bank supervision across the eurozone under which the ECB will be granted the power to directly regulate between 150 and 200 banks, Ireland’s State-aided banks among them.

The ECB will be given the power to examine the books of all banks across the eurozone and a new agency is being created to supervise the winding down of financial institutions considered insolvent.

The Frankfurt authorities will be expected to assume these new functions in the spring of 2014, by which stage it is expected there will finally be clarity on the outstanding issue of Ireland’s legacy bank debts.

This week’s announcement represents an important step on the road to a European banking union, and ultimately to a political union. All sorts of questions have been raised as a result.

The ECB has many critics. It is viewed by many as a dysfunctional organisation despite some undoubted achievements, particularly in the early days of the financial meltdown in late 2008 and more recently under its president, Mario Draghi.

For years, the bank stood by while an asset price bubble developed across much of Europe, with disastrous consequences. Its defenders assert that it lacked the necessary tools.

It will now be expected to develop detailed supervisory capabilities from scratch while building a cooperative relationship with national central banks.

Fears have been expressed that with the ultra-cautious ECB at the helm, attempts to revive lending in liquidity starved countries like Ireland could be smothered at birth, simply prolonging domestic recession and with it, the sovereign debt crisis.

What is clear is that a regime of tight financial supervision is at the heart of the German plan to mastermind a disciplined recovery across the eurozone.

As the latest Brussels summit of European leaders drew to a close yesterday, German chancellor Angela Merkel reiterated, yet again, that recovery across the eurozone will be a painful, long, drawn-out affair. A cheery Christmas message from Berlin.

At Merkel’s right hand is her finance minister, Wolfgang Schäuble, a man who recently turned 70 and is Europe’s most experienced frontline political leader.

Little happens in Europe without Schäuble’s say so. A complex figure, he has recently poured cold water on Irish ambitions to secure a writedown of its legacy bank debts, arguing that to do so could unsettle the bond markets and reduce the conviction that Ireland is on the road to recovery.

It remains to be seen whether this is all simply a negotiating ploy aimed at postponing an awkward reckoning until after Germany’s general election in September, or something more fundamental.

The Irish Government has indicated that failure to secure a deal would make a second bailout inevitable.

Writing in the Wall Street Journal this week, Schäuble acknowledged the eurozone had been “riddled with design flaws” that caused it to “come close to collapse”.

He argues that “to make the monetary union crisis resistant, we need deeper economic and monetary integration”.

“With the fire-fighting mostly over, we are now rebuilding a sturdier edifice from the foundations up.

“Germany has been at the forefront... the first to suggest a permanent European safety net for states (the European Stability Mechanism), setting up a European bank supervisor, granting the economic and& monetary affairs commissioner new power, directly electing the European Commission president.”

He is scathing about the treaty establishing monetary union, arguing that a “toothless stability pact failed to prevent an explosion of (national) budget deficits”.

The Germans view profligacy as the prime cause of eurozone woes. Schäuble puts it bluntly: “Moral hazard is not benign. Setting the wrong incentives would mean stabbing reformist governments in the back. By suggesting that uncompetitive econ-omic structures can endure, we would buoy the populists, scapegoat seekers, and illusion peddlers who lurk on the fringes.”

And yet, it is the Greeks who secure debt forgiveness while the striving Irish are left to whistle.

Schäuble essentially promises blood, sweat, and tears, a long haul to recovery which, he says, cannot come via the printing press or eurobonds. He insists the reforms are working and that the eurozone “could eventually emerge as the most dynamic of major Western economies”.

Clearly, the German inflation-busting reforms under the former chancellor, Gerhard Schröder, are viewed as a model, which is ironic given that it was the German unification project, pushed by Schäuble and his leader, Helmut Kohl, which pushed Germany heavily into the red, two decades ago.

Leading economist Paul de Grauwe of the London School of Economics argues that what Europe needs is more by way of real solidarity. German-style discipline on its own will not suffice. De Grauwe accepts full fiscal union is far away, but that a more modest goal of a partial pooling of debt could be achieved in the interim.

But Schäuble and the German government, as currently constituted, appear opposed to a eurobond solution, fearful that it will simply encourage a relapse into Berlusconi-style recidivism. In de Grauwe’s view, a banking union is the key to ending the “deadly embrace between the sovereign and the banks, the so-called doom loop — a feature of the crises in Ireland and Spain.

Schäuble did, however, provide backing to ECB president Mario Draghi, when he moved in September to pledge unlimited purchases of the bonds of crisis-ridden eurozone sovereigns. This move succeeded in dampening down the crisis.

This week’s move is a vital prerequisite to securing German assent to some pooling of debt on the road to a greater union which the current political establishment in Germany favours. It has been broadly welcomed in Dublin — but subject to caveats.

Dermot O’Leary of Goodbody Stockbrokers describes it as a “welcome move in the direction of a (European) banking union. The agreement struck can be seen as a pleasant surprise. The plan for a banking union agreed in June was heralded as a measure that would break the loop between the sovereign and the banking system. There are gradual moves in this direction and this decision is the latest.”

However, O’Leary ended by sounding a note of real doubt. “Importantly, the question of legacy assets was not mentioned. These moves may be enough to ensure burden sharing in the euro area in the next banking crisis. It remains to be seen whether it will apply to the current one.”

Merrion Stockbrokers economist Alan McQuaid expressed concern that direct involvement by the ECB in bank supervision could result in more bureaucracy, with the bank putting pressure on local Irish banks to be “overly diligent” when entering into loan approvals.

On the positive side, he believes involvement from Frankfurt should discourage institutions here from entering into cosy deals with favoured customers.

“There is still the element of the cosy cartel, ‘cute hoor’ syndrome in Ireland. People look at Ireland and scratch their heads. It is not necessarily a bad idea to have an outsider looking in,” McQuaid said.