Completing the Banking Union

On 11 October, the Commission presented its Communication attempting to set out a path on how an agreement on completing the Banking Union could be achieved. Together with the Capital Markets Union, the Banking Union aims to achieve deeper financial integration which, the Commission says, would allow the Economic and Monetary Union to better cope and absorb future crises.


Following President Juncker’s speech in the State of the Union address on 13 September 2017, the European Commission wishes to push forward for a stronger Economic and Monetary Union. The financial and economic crisis shed light on the weaknesses in the set-up of the monetary union, revealing the existence of an unwanted link between the sovereigns and the national banks, or a “doom-loop”.  The European Commission therefore initiated the Banking Union to break the link between the national banks and Member States’ taxpayers, preventing them being the first port of call when it comes to bailing out banks.

Several measures have already been established in terms of applying common standards for European banks and reinforcing their regulatory and supervisory architecture. Yet the European Commission wishes to push for further integration, with the ultimate goal of completing the Banking Union by 2019. 

In November 2016 the Commission issued its Banking Package, which it says is intended to realise the objectives agreed on in a 2016 Council Roadmap. The proposals presented under the package would amend Regulation (EU) No 575/2013 (Capital Requirements Regulation - CRR), Directive 2013/36/EU (Capital Requirements Directive IV – CRD IV), Directive 2014/59/EU (Bank Recovery and Resolution Directive - BRRD) and Regulation (EU) No 806/2014 (Single Resolution Mechanism Regulation - SRMR).

The package would aim to reduce risks in and further strengthen the EU banking sector. This would be done by incorporating outstanding elements of the regulatory framework and standards developed within the Basel Committee on Banking Supervision (BCBS) and the Financial Stability Board (FSB). These include more risk-sensitive capital requirements, a binding Leverage Ratio (LR), a binding Net Stable Funding Ratio (NSFR), and the Total-Loss Absorbing Capacity (TLAC) for Global Systemically Important Institutions (G-SIIs), which would be integrated into the existing Minimum Requirement for own funds and Eligible Liabilities (MREL).

Furthermore, through its proposals the Commission said it aimed to make the existing rules more proportionate, reduce the administrative burden where possible and improve banks’ lending capacity.

The package is however still under discussion by both the Council and the European Parliament. Through its Communication, the Commission calls on the European Parliament and Council to seize what it considers to be a political momentum, in order to make progress in discussions.

However, the Commission also recognises the concerns over and diverging views in establishing those measures. Therefore, this Communication’s general aims are twofold: it pushes for both risk reduction and risk sharing measures. The objectives of the Communication are to facilitate negotiations, taking into account Member States’ concerns, while still preserving the benefits of the Banking Package. 

After briefly describing the current state of the Banking Union, this briefing presents the main remarks and measures presented in the Commission Communication, as well as their rationale and intended aims. 

The Banking Union: what is it?

Following the economic and financial crisis, the European Commission wished to pursue certain initiatives to ensure it would not happen again. It established that it would have to answer to three root causes of the crisis: the banks’ behaviour, weaknesses in banking regulation and shortcomings in supervision. The Banking Union aims for stronger prudential requirements for banks, clear rules for ailing banks and improved depositors’ protection. In addition, the European Institutions intended to shift supervision at the European level by establishing a single framework for bank crisis management and setting up a common system for deposit protection. The Banking Union would constitute three pillars; the first two are already in place and fully functional.

In its Communication, the Commission briefly expands on the Banking Union’s three pillars and highlights where additional measures should be agreed in order to complete the Banking Union by 2019.

Completing the Banking Union: what it means

1.       Single Supervisory Mechanism (SSM): working as intended

The first pillar is the Single Supervisory Mechanism (SSM), which established the system of banking supervision, comprised of the European Central Bank and the national supervisory authorities. It has two objectives. On the one hand, it aims at strengthening the banking system through the identification and assessment of relevant risks, and ensures that action is taken to address identified weaknesses.  On the other hand, it pushes for further financial integration by developing harmonised supervisory methodologies and approaches, as well as by applying a consistent supervisory framework.

The SSM has been fully implemented. Together with the Communication, the Commission presented a Report reviewing the overall application of the Regulation that set up the SSM (Regulation (EU) No 1024/2013). The Commission notes that the ECB and the National Competent Authorities have the necessary tools to supervise banks and exercise their coordination and oversight functions.  The Report outlines mainly three conclusions. First, the Commission concludes that the ECB has taken up fully its supervisory role and has managed to establish its good reputation as a supervisory authority. The Commission indicates that no major issues were identified related to its independence. Second, the Commission concludes that the interactions between the ECB and the National Competent Authorities (NCAs) encountered no major issues and that their cooperation has evolved gradually. Lastly, the Commission argues that the overall effectiveness and quality of supervision has generally improved. The Commission adds that it found some shortcomings, such as organisational challenges, but these would be corrected through actions taken by the ECB or through amendments that are currently being negotiated by the Council and the European Parliament.

2.       Single Resolution Mechanism (SRM): adding the backstop

The second pillar established the Single Resolution Mechanism (SRM) which laid down rules on the restructuring of banks when they are failing or are likely to fail. It ensures that a bank failure would not harm the broader economy or cause financial instability, while seeking to guarantee minimal costs for taxpayers and the real economy in the case of an ailing bank. It is the Single Resolution Board’s (SRB) task to ensure the orderly resolution of banks. Where necessary, a Single Resolution Fund (SRF) could be used to ensure the SRB can carry out its tasks and exercise its powers. The SRF is being built up gradually, with contributions from credit institutions and certain investment firms, with the objective of being fully equipped by the end of 2023. As the SRM was established, Member States agreed in the European Council’s conclusions of December 2012 that a common backstop would be added to the SRF. A backstop would serve as a ‘safety net’ that would be activated in cases when one or more banks are failing even after imposing losses on the bank’s shareholders and creditors, and in spite of strict supervision there is still a need for more resources due to the Single Resolution Fund’s incapacity to meet the demand. In other words, the backstop would be used as a last resort. The Communication specifically underlines that its main aim is not to be used as a default option. It aims rather to establish confidence in the European banking sector by creating the backstop which would thus protect taxpayers in the event of a crisis. The Commission stresses that the backstop should become operational as soon as possible.

3.       European Deposit Insurance Scheme (EDIS): a changing approach?

The Commission presented a proposal aiming at establishing a third pillar of the Banking Union, namely the European Deposit Insurance Scheme (EDIS), in November 2015.

This third pillar would complement the existing national deposit guarantee schemes (DGS) which already ensure that all deposits up to € 100 000 are protected all over the EU, in the event of a bank failure. EDIS, as a single deposit insurance scheme would therefore ensure an equal and high-quality protection of all depositors across the Banking Union as it would have more resources than national deposit guarantee funds to cope with large local shocks. The Commission argues that it would overcome the misalignment of centralised bank supervision and resolution in the Banking Union on the one hand, and national deposit insurance on the other.

Under the proposal, EDIS would be introduced in a gradual manner in three phases. The first phase, the re-insurance phase, would last three years. During this period, EDIS would be available only when a national Deposit Guarantee Scheme has first exhausted all its own resources. EDIS would thus be used as a provider of extra funds to a national scheme, and only at a certain level.  Any EDIS funds would be carefully monitored and would be used only if the Member States concerned complied with the DGS Directive.

To lay down the basis of full insurance for national schemes and to ensure an equal level of protection, the second or co-insurance phase would be established. This phase would aim to build a progressively mutualised system: a national scheme would not be required to exhaust its own funds before accessing EDIS funds. The latter would intervene from the moment bank depositors needed to be reimbursed. In other words, it would mean more risk-sharing between national schemes through EDIS. It would start at a 20% level and would increase gradually over a four-year period. 

Finally, to enable EDIS to be a fully mutualised system, the Commission proposed the full insurance phase as the third and final stage of EDIS, by increasing its share of risk up to 100%. This means that, in this final stage, EDIS would fully finance the protection of bank deposits in the Banking Union, in close cooperation with national DGS.

Although this proposal was issued by the European Commission as far back as November 2015, discussions in the Council and the European Parliament have revealed divergent positions and concerns. There are four main considerations.  Firstly, regarding the designs of the EDIS at its final stage; secondly, when such a system should be set up; and thirdly, the degree of legacy issues and moral hazards risks present in national banking systems.  Last and most importantly, there are significant concerns regarding the need to ensure that banks are sufficiently robust on a standalone basis before sharing the potential burden of bank failures within the Banking Union.

This means that risk reduction measures (presented under the November 2016 banking package) and risk sharing measures (such as EDIS) should go hand in hand. Consequently, the European Commission, while underlining that it still stands behind its original proposal, suggests in its Communication the establishment of EDIS in a more gradual manner, taking into account the progress made with regard to risk reduction and tackling legacy issues. 

Firstly, the Commission suggests that the re-insurance phase could only provide liquidity to the national DGS gradually and would leave the national DGS to cover the losses. The Commission indicates this would enable it to ensure protection to depositors from the beginning, as well as considering legacy and moral hazard concerns. 

Secondly, the Commission suggests adding further steps before moving to the next phase. Accordingly, the co-insurance phase would be introduced only when certain conditions are met. An Asset Quality Review (AQR) would be conducted at the end of the reinsurance phase. The AQR would ensure a low level of Non-Performing Loans (NPLs) and address the Level III assets, which are defined as being typically illiquid.  The Commission argues that this will ensure that legacy risks are addressed within the banking sectors where they were generated before the start of the co-insurance phase. 

It also suggests that further adjustments to the Directive on deposit guarantee schemes (DGSD) could also be considered. The harmonisation of national deposit schemes would go hand in hand with the establishment of the EDIS. According to the Commission, that would enable not only the correct functioning of the EDIS, but also a correct exchange of information and cooperation among national DGSs, the Single Resolution Board (SRB) and the European Banking Authority (EBA).

Additional measures

1.       Addressing Non-Performing Loans (NPLs)

Loans are non-performing when 90 days or more pass without the borrower paying the agreed instalments or interest. As banks then need to set aside additional capital, assuming that a loan will not be paid back, their lending capacity is hampered. The European Commission reports the overall decline of NPL ratios within the Banking Union while pointing out that the level, structure and causes of NPLs differ across national banking sectors. The Commission therefore emphasises the European dimension of this issue. It argues that weak growth in some Member States, due to high levels of NPLs, might affect economic growth elsewhere in the EU. Moreover, investors’ perception of the value and soundness of all EU banks is often influenced by weak balance sheets in just a few.

An Action Plan to address NPLs was adopted by the ECOFIN Council in July 2017 and welcomed by the European Commission. The Commission announces that, in line with the Action Plan, it intends to present a package of measures to tackle NPLs in 2018. The package would include a blueprint for how national Asset Management Companies (AMCs) can be properly set up, measures to further develop secondary markets for NPLs and measures to enhance the protection of secured creditors, and improve the data availability and comparability to foster transparency on NPLs. The Commission also aims to undertake a benchmarking exercise of loan enforcement regimes to establish a better intelligence exchange between Member States and supervisors concerning the delays and value-recovery banks experience when faced with borrowers’ failures. Lastly, a Report would be provided to the Member States with the possible introduction of minimum levels of provisioning banks should make for future NPLs.

2.       Developing Sovereign Bond-Backed Securities (SBBS)

To further weaken the link between banks and their sovereigns, the Commission wishes to develop securities backed by Eurozone government bonds, or Sovereign Bond-Backed Securities (SBBS). SBBS would pool sovereign bonds from different Member States, in order to support further portfolios and diversification in the banking sector.  The European Commission believes it could enhance cross-border risk sharing by spreading risks more widely across investors and across borders in the EMU. Following and contributing to the ongoing work on SBBS within the European Systematic Risk Board (ESRB), the Commission will consider putting forward a legislative proposal to enable the development of SBBS in 2018.


As the end of its legislative term is approaching, the Commission calls on the European Parliament and Council to swiftly advance the outstanding elements of the Banking Union, and stresses that the current momentum should not be lost in order to reach a political agreement to complete the Banking Union by 2019.

Next Steps

The Communication has been sent to the European Parliament and the Council for consideration. Either or both institutions may decide to formally respond in the coming months.

Additional Facts

  • Communication from the Commission to the European Parliament, the Council, the European Central Bank, the European Economic and Social Committee and the Committee of the Regions on completing the Banking Union – COM(2017)592
  • Press Release from the Commission on EU Banking Reform: Strong banks to support growth and restore confidence – 23 November 2016
  • Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) 806/2014 in order to establish a European Deposit Insurance Scheme – 2015/0270(COD)
  • Outcome of the 3555th Council Meeting on Economic and Financial Affairs of 11 July 2017 – 11156/17 - PR CO 42