This blog is hosted on Ideas on EuropeIdeas on Europe Avatar

Post-Crisis Democracy in Europe

Exploring the EU’s struggle for legitimacy


The Coronavirus crisis as a test to the EU’s fiscal and banking policy reforms

The reforms in the EU’s economic and financial governance structure in response to the Euro crisis have been put to the test by the Coronavirus pandemic. While the resurfacing of the sovereign debt crisis has highlighted the inadequacies of the Union’s fiscal policy reforms, the relative stability of the banking system so far hints at a partial success of the banking union. Philipp Lausberg argues that the EU recovery fund is a step in the right direction, while a completion of the banking union needs priority to prevent a banking crisis should the EU face a post-pandemic recession period.

Man on speaker's chair

Ironically, an uncompleted banking union risks causing a new banking crisis, which could then in turn lead to the necessary institutional reforms. Photo: EC Vice-President Valdis Dombrovskis, European Union 2017.

The Coronavirus crisis as a replay of the Euro crisis?

For many, the last few months came as a replay of events lying back 10 years ago, as the Coronavirus pandemic and its economic implications have raised the spectre of a renewed Euro crisis. Sovereign bond spreads in Italy, Spain and other highly indebted southern Eurozone countries rose sharply, as doubts in their ability to pay back their debts was fuelled by fear of a new recession. Bond yields could be stabilised by European Central Bank (ECB) bond buying for now. But most experts agree that some form of resource sharing is needed to save the Euro in the longer run. This reignited the debate on Eurobonds and recreated the old perceived fault-lines of frugal northern creditor states versus overspending southern debtor states.

But while the focus has been on fiscal and monetary policy, the main culprit of the last crisis has so far not made any headlines – the banks. Financial institutions across the Eurozone have remained remarkably stable despite the heavy shock hitting the economy because of the lockdown measures.  Nicolas Véron has suggested that the introduction of a Banking Union is a major reason for this. My doctoral research confirms that reforms in banking policy introduced in response to the last Eurozone crisis are relatively successful compared to reforms in the fiscal sphere.

Fiscal policy: Inadequate reforms after the Eurozone crisis

The EU’s fiscal policy response to the Eurozone crisis had two main elements: the European Stability Mechanism (ESM), which is a permanent, 500 billion Euro rescue fund to assist Eurozone states threatened by default, and the strengthening of EU budget rules. Apart from providing help for countries with acute solvency issues, this was to create trust in the financial markets, avoiding sovereign defaults, that is, governments failing to pay back their debt. The Stability and Growth Pact (SGP) based on a 3 per cent deficit and a 60 per cent debt limit for EU member states was bolstered by heightened surveillance through the European semester (six-pack) and facilitated rule enforcement by anchoring fiscal discipline in national constitutions (fiscal compact).

But the strengthened SGP has had a mixed record. Its rules kept being broken and none of the offenders were fined. This did not help to increase trust in the financial markets in the EU’s economic and monetary union. While southern EU countries’ efforts to save have been impressive, this was not enough to rise from debt levels as high as 135 per cent in Italy or 176 per cent in Greece. Thus, the vulnerability of some Euro states’ finances has remained high despite the reforms.

Once the Coronavirus crisis hit, the trust of the financial markets quickly dissipated, as doubts on the sustainability of Italian debt resurfaced. The ESM’s 500 billion lending capacity was clearly not enough to guarantee the solvency of a country like Italy with debt almost five times that amount. Like in the Eurozone crisis, it was the ECB that had to save the day through sovereign bond purchases.

Need for a larger recovery fund

What is needed now is a much larger common fiscal instrument based on real burden sharing. Otherwise it will be impossible for indebted southern countries to cope with their debt loads and to save the Euro. The European Council agreement on a 750 billion recovery fund, fully financed by EU-issued debt, of which 390 billion are based on grants rather than loans is a step in the right direction. But the volume of this fund and especially its grant segment should be increased significantly to ensure the stability of Eurozone finances in the long run.

While the weak link in the Coronavirus crisis has been member-state finances, banks have so far proven to be resilient, much due to reforms introduced after the Euro crisis.

Banking policy: Effective supervision but unfinished banking union

The Eurozone crisis had its origins mainly in an under-regulated banking sector. Without strict European regulation, individual states often allowed their banks to engage in risky operations to be able to compete globally. After the collapse of Lehmann Brothers in 2008, overextended banks crashed or had to be bailed out all over the Eurozone. The subsequent debt crisis in the Eurozone periphery was primarily a result of states incurring too much debt while trying to save their banks.

The Banking Union was to remedy this fateful embrace between state finances and banks, and prevent risky banking operations in the future. The Banking Union’s first pillar, a single supervisory mechanism based on the ECB was equipped with the necessary powers to assert common rules for Eurozone banks. This has largely been a success. Unlike the toothless fiscal rules, capital requirements were enforced on Europe’s systemically important banks. By 2020, capital buffers have starkly increased and non-performing loans have more than halved, making banks significantly more resilient than they were before the Eurozone crisis. This can help explain the relatively good performance of financial institutions during the Coronavirus crisis so far.

Completing the Banking Union

But this positive performance might be compromised if a prolonged recession will lead to a spike in corporate bankruptcies and loan defaults that could eat away capital buffers and drive major banks into ruin. The Banking Union’s Single Resolution Mechanism so far only holds a single resolution fund of 55 billion Euro. This is only enough to help ensure orderly resolutions of one or two systemic banks and thus prevent contagion to other banks and the need for bailouts by Eurozone states. Especially since the fund has not yet been backed up by a larger fund like the ESM, as initially planned. The lack of the Banking Union’s third pillar, a European deposit insurance is equally worrying. The European bank recovery and resolution directive prescribes that some loans of a failing bank are left to default (bail-ins) to prevent costly bailouts and assert market discipline. Without a credible insurance of deposits, this could cause depositors to withdraw their money in a bank run which would threaten the entire financial system.

It is therefore imperative to complete and strengthen the Banking Union. As this involves large-scale sharing of resources among member states and their banks, this is however unlikely to happen soon without the pressure of a major banking crisis. Ironically, it is precisely the lack of a completed banking union that could cause this crisis and ultimately push policy makers to make the necessary institutional reforms.


Recent Articles

Why EU institutions alone cannot reform the Common European Asylum System

Published on by | No Comments
Armband of Frontex staff

The aim of the Common European Asylum System (CEAS) is to harmonise asylum procedures across the European Union. As several crises have shown, however, this goal is far from being achieved, and a reform of Europe’s asylum policy is long overdue. Radu-Mihai Triculescu argues that such reform should also incorporate the perspective of street-level bureaucrats […]

The Netherlands doesn’t understand Southern Europe’s pain

Published on by | Comments Off on The Netherlands doesn’t understand Southern Europe’s pain
Hoekstra and Rutte

In the Netherlands, the public underestimates how much Southern Europe has already suffered. And how we benefited ourselves, says Joris Melman, analysing the Dutch stance in the negotiations on the EU’s economic responses to the corona crisis. The Dutch stance in the EU negotiations about the economic response to the corona crisis has sparked criticism […]

The difficult role of consumer groups in the shaping of financial regulation

Published on by | Comments Off on The difficult role of consumer groups in the shaping of financial regulation
tourists taking photos of statue in NYC

Although European financial regulation directly affects citizens as consumers, it is only to a limited extent exposed to public debate. There has also been widespread criticism that European regulators were too close to the financial sector, both before and after the financial crisis. The EU introduced permanent advisory councils, so-called Stakeholder Groups, to include more […]

Promise of democratic renewal or shaky idea? Recommendations for the Conference on the Future of Europe

Published on by | Comments Off on Promise of democratic renewal or shaky idea? Recommendations for the Conference on the Future of Europe
A wooden dome on a public square

Can participatory democracy be the solution to the EU’s democratic deficit? This seems to be the European Commission’s intention with launching the Conference on the Future of Europe. If this is to work, the Conference must however itself be democratically legitimate. Based on past experiences, Camille Dobler gives four recommendations for citizens’ consultations. Can participatory […]

The euro: scapegoated by politicians, supported by the public

Published on by | Comments Off on The euro: scapegoated by politicians, supported by the public
Euro notes in a back pocket

Public opinion has a central role in the politics of the Eurozone. But how do citizens form their opinions? Joris Melman’s original research indicates that opinions on the euro are often embedded in more general political orientations. For most people, the euro is above all a practical artefact in their daily lives, which makes them […]

National parliaments’ role in the fight against corruption

Published on by | Comments Off on National parliaments’ role in the fight against corruption
Illustration/compilation of corruption items

By constraining the powers of executives and developing a political culture of accountability, national parliaments play a key role in the fight against corruption. However, their normative powers may be marginalized in the process of democratic consolidation. Based on original research from three European states, Emilija Tudzarovska-Gjorgjievska argues that weak parliaments contribute to the vicious […]

Critique as an opportunity for legitimation: the case of the EU Emissions Trading Scheme

Published on by | Comments Off on Critique as an opportunity for legitimation: the case of the EU Emissions Trading Scheme
Smoking chimneys in the metal industry

Criticisms directed at the European Union (EU) and its institutions over the past decade have often been interpreted as a sign of fundamental weakness. However, using the EU Emissions Trading Scheme (ETS) as an example, Claire Godet argues that contestation should not be seen as a sign of failure, but rather as an opportunity for […]

From financial crisis to legitimacy crisis?

Published on by | Comments Off on From financial crisis to legitimacy crisis?

In the wake of the financial crisis, EU governments spent taxpayers’ money to rescue European banks. That displaced a financial crisis into political systems by straining public finances and social protections in all EU member states. Some states were brought to the point of insolvency, and the survival of the EU’s single currency, perhaps even […]

  • Recent Posts

  • Tags

  • Latest Tweets

  • UACES and Ideas on Europe do not take responsibility for opinions expressed in articles on blogs hosted on Ideas on Europe. All opinions are those of the contributing authors.