Eurozone governance

Commentary on Irene Finel-Honigman's article: And the key question is whether a stronger eurozone will split the EU apart

Opinion piece (Europe's world)
Philip Whyte
20 June 2013

The friction between what Irene Finel-Honigman calls "economic rationale" and "political will" has been the driving force behind European integration. But now the eurozone crisis has transformed the nature of this interaction; its underlying spirit is no longer positive and optimistic – "how can we bring Europe closer together?" – and instead it is essentially fearful – "how can we stop Europe from falling apart?". The monetary union's design flaws have been cruelly exposed by the aftermath of the worst financial crisis since the 1930s, so greater institutional integration is needed if the eurozone is to work better. 

Europe's tragedy is that the democratic acceptance of such integration appears to be weak. Unlike the US, the eurozone is not a currency union embedded in a full political federation. All sorts of critical functions that in the US are performed at federal level are carried out at national level in the eurozone. This decentralised configuration reflects national political realities, but it is also what has made the eurozone so unstable since the financial crisis erupted in 2008. As solidarity is weaker across state borders in the eurozone than in the US, the stresses and strains of Europe's shared currency have been borne individually by its member-states, not collectively by a federal centre. One effect has been the emergence of the 'death spirals' between weak banks and weak sovereigns that have cast the eurozone's future into doubt.

Market confidence in the eurozone stabilised in the second half of 2012. This was down to two factors. One was increased confidence that the eurozone was backed by a European Central Bank (ECB) that under Mario Draghi's leadership had fewer misgivings about acting as a lender of last resort. The other was the perception that European political leaders were finally becoming more serious about repairing some of the eurozone's design flaws – and particularly about breaking the death spirals. Central to this perception was the commitment by EU leaders in mid-2012 to consider a 'banking union' that is due in 2014 to transfer responsibility for key tasks relating to banking from the national to the European level. 

Finel-Honigman cites two such functions – banking supervision and deposit protection – and devotes most of her discussion to the first. However, she says less about a third task (recapitalisation) and entirely neglects a fourth (resolution). This is unfortunate because the existence of federal instruments for winding up or recapitalising insolvent banks in the US, and their absence in the eurozone, is surely what explains the very different experiences of the two currency unions since 2008. What the eurozone needs is not just a common banking supervisory architecture and deposit protection system. It also needs a common authority that can 'resolve' insolvent banks by winding them up (if possible) or recapitalising them (if necessary).

What EU leaders agreed to last December was to transfer responsibility for supervising European banks to the ECB, which will take over responsibility for supervising the largest banks, and have 'ultimate responsibility' for the rest with day-to-day supervision remaining with national authorities. This year will be the year in which this new architecture is put into place, but the federalisation of the resolution and deposit protection functions is still a long way off. And member states will continue to argue about whether the European Stability Mechanism – an instrument that some see as an emerging fiscal backstop to the banking system – should be used to resolve ‘legacy issues’ in countries like Spain. 

An important question that Finel-Honigman touches on is whether the institutional reforms needed to stabilise the eurozone will drive a wedge inside the EU-27. It is a question that has yet to be addressed, but one that has to be borne in mind as the integration of the eurozone deepens.

Philip Whyte is Senior Research Fellow at the London-based Centre for European Reform.