Ifo Viewpoint No. 140: Guarantees for Europe's Ailing Banks

Hans-Werner Sinn
Munich, 03 December 2012

After heated discussions over the summer, everything has gone quiet on the topic of a banking union. But the air of calm is deceptive. Behind closed doors the EU Commission and representatives of troubled economies are still energetically pressing ahead with the idea. Since it has been stipulated that a banking supervisory authority must be set up before ailing banks can be rescued using ESM funds, there is now a rush to set up something that can be called a banking authority as quickly as possible. This could have dire consequences.

It seems likely that the new supervisory authority will be attached to the European Central Bank (ECB). This is problematic insofar as it would create the irresistible temptation for all concerned to provide ailing banks that really should be shut down with fresh credit from the printing press.

In fact, the ECB has already massively financed ailing banks by accepting weak collateral in return for refinancing loans, leading to huge Target imbalances. Its books are loaded with potentially nonperforming credit claims. Bundesbank President Jens Weidmann criticised this course of action back in February in a letter to ECB President Draghi. If the ECB is left to decide whether to declare a private bank insolvent, wind it up and write-off its own claims against this bank; or to declare that the bank is worth being rescued with ESM funding, there can be no doubts as to which way its decision will fall. This is effectively like giving the seller of a clunker the right to decide whether the car should pass its roadworthiness inspection.

Minority rights in the new supervisory authority may perhaps help to mitigate the foreseeable disaster. The introduction of such rights, however, is out of the question. It is more likely that the decision-making structures in the new supervisory authority will mirror those of the ECB Council. In other words, all countries will once again have equal voting rights, regardless of whether they are big or small. Those national central banks that have outvoted the Bundesbank for the last two and a half years will retain their majority – and will also be able to decide which European banks are worth bailing-out with money from the ESM.

There is, of course, a blocking minority in the ESM if large programmes are at stake. However, this presumably does not apply to individual decisions such as whether to save specific banks. Politicians have provided for this scenario in their formulation of the ESM Treaty. Simple majorities will likely be sufficient in such cases. This paves the way for a bail-out of over-indebted banks with the help of money from taxpayers in those European countries whose economy has thus far remained healthy.

There is also a drive to remove all legal barriers. This is most clearly illustrated by the EU Commission’s proposal to restructure and wind-up lending institutions and investment firms highlighted by my colleague Harald Hau from INSEAD. Article 52 of this proposal declares (in confusing language) that write-off losses for creditors (called the “Bail-in tool”) should be used so as to maximise the value of creditors’ claims, and that it should be allowed not to impose such write-off losses on the debtors until 1 January 2018.

The EU Commission obviously wishes to give the ESM the role of providing a sort of state guarantee to the Eurozone's troubled banks. The creditors of these banks would then have no need to fear continued or even greater lending to these banks, since the ESM would offer a free form of credit default insurance. In view of the fact that the very same EU Commission recently banned state guarantee for German state banks (causing the WestLB’s demise), this change in direction is nothing less than grotesque. Germany is forced to withdraw its state guarantee to its own banks and now instead has to provide it to troubled private banks in other countries.

If this really does come to pass, the savings of the northern economies, whose taxpayers stand behind the ECB and the ESM and bear the corresponding risk, will be directed towards the less solid economies, where it no longer wishes to flow due to bad experiences in the past. The misinvestments that have already brought the Eurozone to the brink of ruin will thus continue.

Instead of a banking supervisory authority, the Eurozone is currently developing a central planning authority that can steer capital flows and could seriously threaten the development of the European economy.

This text is based on a German article published under the title “Weitere Garantien für Südeuropa”, WirtschaftsWoche, No. 46, 12 November 2012, p. 42.


Prof. Dr. Dr. h.c. mult. Hans-Werner Sinn
Präsident a.D. des ifo Instituts