Largely ignored by public opinion, the European Commission has drafted a new directive on bank resolution which creates the legal basis for future bank bailouts in the EU. While paying lip service to the principle of shareholder liability and creditor burden-sharing, the current draft falls woefully short of protecting European taxpayers and might cost them hundreds of billions of euros. Further lobbying by banks is likely to make things only worse.
The new banking union plans may thus turn out to be another large step towards the transfer of distressed private debt on to public balance sheets – something which pleases the capital markets and may help to explain their new confidence.
The European Central Bank has already provided extra refinancing credit to the tune of €900bn to commercial banks in countries worst hit during the crisis, as measured by its payment system known as Target. These banks have in turn provided the ECB with low-quality collateral with arguably insufficient risk deductions. The ECB is now in the same position as private investors. It is guaranteeing the survival of banks loaded with toxic real estate loans and government credit. So the tranquillity is artificial. Ultimately, the ECB undermines the allocative function of the capital market by shifting the liability from market agents to governments.