The Ecofin meeting of finance ministers and central bank governors in mid-June decided that any new initiatives on the regulatory treatment of sovereign exposures will await the outcome of ongoing work at the Basel Committee. The fear is that EDIS could be used to get easier government financing conditions through outright financial repression or through the use of “moral suasion” on domestic banks. Its concern, not unreasonably, is that the risk-sharing inherent to EDIS could be exploited by impecunious governments. But, at the same time, the German government refuses to endorse the creation of a European deposit insurance scheme (EDIS), a cornerstone in banking union, unless limits are put on banks’ domestic sovereign exposures. In May, the Governor of the Bank of Italy referred publicly to the need to maintain “banks’ ability to act as shock absorbers in the event of sovereign stress.” Even Germany, usually an advocate of strict fiscal discipline, is constrained by the role played by its local banks (the Landesbanken) in financing public-sector activities at local or regional level. Most countries want to keep the option of using national banking systems as buyers of last resort of their sovereign debt. The Dutch EU presidency in the first half of 2016 valiantly tried to make progress but could not overcome the stalemate of entrenched positions. Reducing these holdings is now central to discussions on a more complete banking union. One essential link in this vicious circle is the vast inventories of domestic sovereign debt held by many European banks. But the banking union’s ultimate policy goal, memorably defined by heads of state and government in June 2012 as the “imperative to break the vicious circle between banks and sovereigns,” has not yet been achieved. This has already made a big difference to the many national banking champions that local supervisors had been treating with kid gloves. The eurozone’s banking union has moved from vision to reality in a short period of time, with the European Central Bank now an established supervisory authority for the area’s large banks.
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