Why does a row in Davos about Italy’s budget threaten dreams of Europe’s ‘Banking Union’?

29 January 2019

In this cold and dark month of January, we celebrate the anniversary of what many in Europe’s finance world hail as the guiding star for the advancement of the fintech revolution: Open Banking.

What is the ‘Open Banking’ concept?

Open Banking is part of broader efforts by the EU to integrate the markets of financial services, which includes broader aspects of ‘banking’ through a finalised ‘Banking Union’. However, an insightful piece from Davos in the Telegraph from Friday suggests that the division among European Leaders about fiscal rules in the Eurozone (i.e. the money that single states spend in their budgets) make a true and final ‘Banking Union’ near impossible.

So why would autonomous state budgets – let’s take the plans of Italy’s new populist government as an example – hinder a Banking Union from becoming a reality?

To understand the Banking Union, we have to go back to the Eurozone crisis. As we all remember, some Eurozone states were in significant financial trouble partly because they had to bail out their banks by taking over their toxic debt.

As a response, the Euro area designed plans for a ‘Banking Union’, and it has already managed to push two of its three pillars across the line already (more or less):

  1. Making the European Central Bank the main supervisor for the largest banks in the Eurozone (this is the Single Supervisory Mechanism – SSM)
  2. Introducing a set of rules and fixed procedures that come into play when a bank is in significant financial trouble (the Single Resolution Mechanism –SRM)

However, the big issue is the planned third pillar of the ‘Banking Union’ – which would see banks of all Eurozone member states pool their resources that secure deposits for savers. Think of this as an insurance for your deposits: through this mechanism you will always know that the money you have with your bank (up to €100,000) will be repaid even if that bank goes bust. These kinds of insurance mechanisms already exist on a national level. However, the new rules for a European-wide mechanism would, for example, see the French banking sector participate in repaying the customers of, say, an Italian bank that had to close its doors for good.

That makes sense… but what’s stopping it become a reality?

Bearing in mind the health of national banking sectors can differ quite dramatically among the countries in the Eurozone, it is a controversial proposal.

Take Italy as an example – the government is taking out more debt than agreed with its EU partners, and some say that this puts Italy’s fiscal stability at risk. The majority of Italy’s debt is owned by Italian banks. As giving out loans to Italy becomes riskier, the financial stability of the banks that give out those loans is put at risk as well.

This is why EU leaders at Davos criticise both Italy and the EU, which didn’t take proper action over Italy’s budget breaches, because they are not sticking to the rules. And rules which are not stuck to are the greatest fear for an increasing union of the European banking sector. This is why, according to the Telegraph, the Dutch Prime Minster at Davos said “it [is] impossible to deliver a full banking union […] without first assuring that the rules are respected and the financial system is safe.”

Why should banks and the fintech sector care?

Large banks are keen for clarity on a single banking market and a single set of rules across European countries as a facilitator for mergers and acquisitions. They want to consolidate the sector to create larger banks that find it easier to compete with US giants as well as implementing their digital strategies – not least because of the threat they see arising from innovative and agile young fintech companies.

The irony of it all could be that what was designed to become a more resilient market with greater competition (see: Open Banking) could turn into a system that makes it much harder for small competitors. It will also create mega banks, which are far ‘too big to fail’. Although, we know how that turned out pre-2008….