Draghi cuts the Gordian knot of the Banking Union

Mario Draghi, the President of the European Central Bank, had three messages to send yesterday to Eurozone’s political leaders. He did that while answering journalists’ questions, after the regular monthly meeting of the Governing Council, which left the basic interest rate unchanged at 0.5%. For the first time Draghi puts a big question mark over Eurozone’s much advertised recovery, terming it “weak, uneven and fragile”.

By that he leaves also to be understood  that the ECB will maintain its super accommodative policy, until a sustainable recovery is attained. This is his second message, meaning that he guarantees ample and cheap liquidity for Eurozone’s banks, confirming that, “nobody (in the Governing Council) wants to have a liquidity accident occurring between now and the recovery”. Thirdly but most importantly, he clarified ECB’s position, on the construction of the Single Resolution Mechanism, repelling Germany’s reserves by saying, “We also believe that 114 (of the Treaty of the Functioning of the European Union) provides a sufficient basis for the creation of the single resolution mechanism (SRM)”. In short Draghi drew the discussion on all these three burning issues a step forward, probably trying to rush things, seeing that the formation of a government in Berlin may drag on for weeks. Let’s take one thing at a time starting from the most important one, which is the creation of the Banking Union. Cutting the Gordian knot On 24 September the Sting posted a ground breaking article entitled “Draghi: (building) A bridge from Brussels to Berlin”. Your writer maintained then that Draghi on 23 September, while addressing the European Parliament, was actually proposing a marriage of the opposing thesis held by the European Commission and Germany over the construction of the Single Resolution Mechanism. In this way he delivered the master plan to build the core foundations of the European Banking Union. He said, “A key priority of the agenda for the last quarter of 2013 is to complement it (the Single Supervisory Mechanism) by a Single Resolution Authority and a Single Resolution Fund, as proposed by the European Commission”. However a few minutes later a lawmaker asked Draghi, who will finance the resolution of a major bank, if it goes bust before the Resolution Fund is ready? He answered that “until the resolution fund is fully financed (by the banking industry), it should be able to borrow from other sources, including national ones, to ensure that properly-funded resolution is an option from the start”. In this way he bridged the Commission’s proposal with the reserves of Berlin, by introducing the element of national responsibility in bank resolutions. As everybody knows Berlin hates to share the responsibility of financing the resolution of other countries’ banks and supports a decentralised version of lenders resolution at the national level. Given this, what Draghi proposed to Parliamentarians was that the needed finance should come not only through European Stability Mechanism loans, but also from the country or countries (probably from their deposit guarantee schemes and the government coffers), where the bank does business. At a later stage when the Resolution Fund will be adequately capitalised by the banking industry, it will return the money to its creditors (ESM, deposit guarantee schemes and governments). To be noted that the wealthy ESM is capitalised by all Eurozone countries, with Germany contributing the largest share. Consequently its liabilities are mutual and burden its shareholders accordingly. Final touch This is not the end of the story though. Germany insists that the creation of a centrally financed single bank resolution authority and a single resolution fund, constitute giant steps towards a de facto mutualisation of national risks, not foreseen in the Treaty of the European Union. Yesterday Draghi answered this Teutonic reserve too. He said “We also believe that 114 (of the Treaty of the Functioning of the European Union) provides a sufficient basis for the creation of the single resolution mechanism (SRM)”. Draghi wouldn’t have pronounced such a positive statement without prior consultation with the legal service of ECB. In short what he offered yesterday a complete proposal for the creation of the Banking Union. Guaranteed liquidity As for his other two remarks, one about the “weak, uneven and fragile” economic recovery of Eurozone and the other on the determination of ECB to guarantee the needed liquidity for the entire eurosystem until a strong resumption of activities is attained, they constitute the two sides of the same coin. Draghi also clarified that the next reduction of interest rates is now closer. He revealed that the Governing Council was divided on that yesterday, which is a clear sign that the next month there might be a reduction of the rate to probably 0.25%, from 0.5% now. He obviously estimates that Eurozone is still stagnant and needs all the support it can get to overcome it.