The European Union's €750 billion coronavirus rescue package has been hailed as a big step toward a full-blown "banking union," but major obstacles remain.
The EU unveiled its plan to kick-start the bloc's economy in the wake of the pandemic on July 21, marking the first time that the European Commission would issue its own bonds on a significant scale.
It plans to raise €750 billion over two years in long-term debt, so establishing a federal deficit for the EU for the first time. It creates a contingent liability for the 27 member countries based on member states' guarantees and in line with their share of the total gross national income of the union.
That, said Banco Santander SA Chair Ana Botín, is a significant step to something more.
"The probability that we do get a banking union and cross-border consolidation in banking is much higher," she said on Twitter. She credited Germany and Angela Merkel in particular for the move.
In the wake of the eurozone sovereign debt crisis, the EU has transferred responsibility for regulating large EU banks, and resolving those that are failing, to supranational bodies — the Single Supervisory Mechanism and the Single Resolution Mechanism. But a common deposit insurance scheme — seen as crucial to completing the banking union project — is still lacking.
Botín declined to comment further, but a source close to the bank told S&P Global Market Intelligence that the mutualization of debt which the rescue package entailed was key to her thinking.
Her comments came shortly after the European Central Bank Vice President Luis de Guindos said he hopes to see mergers in the European banking market in the coming weeks and months to tackle the problem of low profitability at banks.
The EU package will establish a market and a yield curve for EU debt because of the very long repayment schedule for the common loans which will extend to 2058.
"This deal will create a big pool of European debt and it has already contributed to spread compression between German and weaker countries' bond prices," Nicolas Véron, senior fellow at the Bruegel think tank in Brussels, told S&P Global Market Intelligence.
"This is meant to be a one-off, but few people really believe that — it will be obvious that it makes more sense to refinance the issuance with new borrowing rather than reimburse with painful taxes, so it makes EU debt a permanent feature," he said.
Véron said that the EU deal was a positive sign for a future banking union, but its effect should not be exaggerated.
"Ana Botín is not wrong, but not wholly right either," he said. "I do not see a direct mechanical link between this deal and banking union. It is perhaps an important political symbol, an indication that the will is there to move even further."
ECB and EU chiefs have long urged governments to end political divisions over a full-blown banking union, arguing that it would allow failed banks to be safely wound down without requiring taxpayer bailouts and would make the eurozone more resilient.
Christian Edelmann, co-head of EMEA financial services at financial consultancy Oliver Wyman, agrees with Botin that the rescue package is an important political development, but pointed out that other obstacles to further integration of the bloc's banking system remain.
"This move to issue bonds by the EU creates a European safe asset and from a political point of view that is a big step forward," he told S&P Global Market Intelligence. "What is still missing is a common deposit insurance scheme and that would require political changes which are yet to occur."
Common deposit insurance
Olli Rehn, head of the Finnish central bank, told the Financial Times that the EU's rescue package could pave the way for a deposit insurance scheme, despite long-running opposition from nations such as Germany.
Jacqueline Mills, managing director at the Association for Financial Markets in Europe, said the creation of a substantial market in the EC's own bonds could relieve pressure on the so-called "doom loop" whereby countries and weak banks drag each other down in a crisis, and this could boost the prospects of an insurance scheme. But she said she would not wish to be too optimistic until key elements such as the promotion of the euro and creation of a European safe asset come into place.
"A common deposit insurance scheme has been the big obstacle to progress on banking union. The current recovery package has seen positive market reaction which bodes well for alleviating some of the concerns and complexities on the sovereign/bank nexus which have been a key part of the insurance scheme debate," she said.
Sam Theodore, managing director at Scope Insights, said the EU's rescue package had little bearing on plans for a banking union.
"On the contrary, this time, unlike the last crisis, governments not only mutualize debt, which is revolutionary, but also choose to distribute funds directly to the economy, so not fund the banks which in turn lend to the economy," he said.
Banking union is already relatively well-progressed, Theodore said, with the Single Supervisory Mechanism which grants the ECB a lead supervisory role over eurozone banks and the Single Resolution Mechanism. A common deposit insurance scheme is anyway less of a stumbling block to a union than sometimes perceived, he said.
"The deposit insurance scheme is not that necessary, as a bank in distress will never get to the terminal stage of needing such a scheme's funds — national governments will intervene well before in such an unlikely scenario," he said.
Theodore said what was needed is a eurozone asset management company to handle nonperforming loans emerging solely from the COVID-19 crisis, not legacy NPLs or bad loans from risky business.
Whether the EU's rescue package prompts more cross-border M&A in the banking sector as Botín and de Guindos suggested is another matter, according to Theodore.
He said such deals would be "unnecessary and economically negative" for the sector and for bank clients.
"The future is open digital platforms, interchanges and APIs, not legacy banks with antiquated infrastructures and plenty of physical branches. Not surprisingly it is hard to find a large-scale bank CEO pushing for a cross-border M&A of their bank. They would know better," he said.