IMF for the First Time Made an Overall Assessment of the EU
Adelina Marini, December 28, 2012
The eurozone rescue from the severest crisis since the creation of the single European currency more and more resembles a bitter medicine of "deeper integration" (an euphemism of federalisation) which the EU has to take in small sips regularly and which with the first symptoms of betterment is being pushed away. After in June the European leaders agreed to create a banking union, the unleash of enthusiasm for more federalisation came somewhat natural, the emanation of which was in the autumn with Jose Manuel Barroso's notorious State of the Union Address in the European Parliament that has later crystallised in a blueprint of three steps that outran a much less ambitious and cautious report by Herman Van Rompuy, created with the help of the chiefs of the central bank, the Eurogroup and Barroso himself.
But the federal medicine proved too bitter to be swallowed by the more and more impatient voters who need not just a lump of sugar to swallow it easily but a radical change of treatment. This is why the next spoons of it are left for later if the symptoms would allow it. The year has ended with the adoption of a mechanism for common European supervision over banks in the eurozone which can be perceived as a great victory but we should have some reservations because its outline is yet to be finished until it starts functioning in the spring of 2014. By then, many things can change in order to achieve a milder taste.
According to Philip Whyte, a senior research fellow at the Centre for European Reform in London, to accept that the eurozone suffers from a structural flaw that can only be corrected by more federalism is politically explosive. In his analysis, he points out that a more federal structure goes at the heart of sovereignty because it allows European bodies to dictate the fate of national banks, putting taxpayers' money at the disposal of the eurozone to solve problems in other member states. This is the reason, the analyst believes, why it takes so much time to accept the idea of a banking union and all its implications.
It is clear that a fully fledged banking union in the euro area will not emerge any time soon, Philip Whyte writes, because political constraints are too big. Acquiescing a partial federalisation, embodied in the supervisory mechanism for the banks, however, will not solve the problems, the analyst is convinced underscoring that the rest of the bitter medicine - direct recapitalisation of banks, creating a resolution mechanism and deposit guarantees - cannot be avoided. Moreover, he explains, partial solution creates another problem - destabilisation of the EU27 by diminishing the status of the non-euro countries.
And if Mr Whyte is an analyst with an independent think-tank, moreover based in Britain and putting a focus on British-EU relations which are not a high fashion right now, a similarly sounding voice is supposed to echo louder in Brussels, Berlin, Paris, Rome and the other EU capitals. A key partner in the eurozone travails in the past 3 years has been the International Monetary Fund which was bestowed upon, for the first time, non-typical functions - from a strait jacket for immature rulers spending generously other people's money, the Fund has turned into an equal partner in the search of strategic solutions, supported by less money. An interesting element of the Fund's behaviour, especially after it was headed by the former French finance minister from the time of Nicolas Sarkozy, Mrs Christine Lagarde. An impressive woman, during whose leadership the IMF has turned into a supporter of federalisation via bolder steps and therefore into a natural ally of the European institutions - the Commission, the ECB and even the European Parliament.
Right at the time when there were frequent exchanges of updated versions of the future supervisory mechanism between Brussels, Washington and Berlin, the IMF sent a team to Europe between November 27 and December 13 on their first mission to make an overall assessment of the soundness and stability of the financial sector in the EU. The mission is a continuation of the experience in 2011 which affected the eurozone only, when the Fund came to the conclusion that the EU's financial stability framework was significantly enhanced and that that happened in the midst of a severe financial crisis which still is capable of weakening the banking system and therefore poses a challenge to the sovereign.
On December 20th, the IMF published the first preliminary results from the mission, pointing specifically that they are subject to change. It will be interesting to see later whether those changes will affect the conclusions or the recommendations, or both. According to the preliminary assessment, the EU is facing huge challenges because of the continuing banking and sovereign crises in some parts of the Union. And although the scope of strategic intentions is significant, the essential details have to be agreed without delay. The crisis has revealed that solving the problems in the financial system at national level could be costly and requires a common European approach. The interlinkages among the EU member states is particularly strong which is why it requires more security in terms of banks' health.
That is why the proposal to create a single supervisory mechanism (SSM) is welcomed by the Fund as a good step. But, similarly to Philip Whyte from the Centre for European Reform, the IMF also believes that this is only part of the solution of the problems. The Fund's recommendations are the construction of the banking union to continue. "SSM is only an initial step toward an effective Banking Union—actions toward a single resolution authority with common backstops, a deposit guarantee scheme, and a single rulebook, will also be essential". All this (without the most important part - the common backstops or funds) is included in the EU working programme the leaders agreed at their last for 2012 summit in Brussels in mid-December.
The IMF also recommends harmonisation of the regulatory structure all over Europe and that should happen quickly; the EU institutions should accelerate the adoption of the Fourth Capital Requirements Directive, the Capital Requirements Regulation, the directives for harmonising resolution and deposit insurance, as well as the regulatory regime for insurance Solvency II. Moreover, the IMF puts a deadline - all this to be ready by mid-2013 to allow the publication of a single rulebook for banking, insurance and securities. The Commission is called upon to increase the resources and the powers of the European Supervisory Authorities because that, according to the Fund, is necessary for the successful strengthening of their operational independence.
Besides, the European stress tests should be broader and instead of focusing only on micro prudential solvency should also be able to identify other vulnerabilities as well, such as liquidity risks and structural weaknesses. The IMF believes that measures should be pursued to separate bank and sovereign risk, including by making the ESM (the permanent eurozone fund) operational expeditiously for bank recapitalisations. Strong capital buffers are also needed to allow banks to perform their intermediating role effectively, to stimulate growth, thus safeguarding the financial stability.
To create a common deposit insurance fund, is another recommendation of the IMF. That fund should preferably be financed ex ante by levies on the banking sector. The deposit guarantee schemes should be granted preferential rights in the creditor hierarchy. The IMF believes that in this way costs will be reduced, especially while guarantee funds are being built.
And if Philip Whyte believes that the leaders were very slow in their walk towards federalisation and a banking union in 2012, in 2013 it is expected that to be happening even slower mainly due to the elections in Germany in the autumn.