The three following reforms should be implemented if euro area policy-makers want to make the rules governing the area coherent.
- Put in place a European deposit insurance scheme (EDIS). This much-debated topic is essential for the Banking Union as it is the only way to ensure that banks depositors benefit from the same guarantees regardless of where they are located. In other words, EDIS is a condition to build citizens’ confidence in the resilience of the banking system and to avoid bank runs and their destabilising effects.
- Give the Single Resolution Board (SRB) direct and full authority for the execution of bank resolutions, including in the case of non-systemically important banks. This is essential in a context where the current system has shown its limits when it comes to putting an end to the socialisation of banks’ extreme losses, even in cases when the banks to be resolved are of small size.
- Reform the rules and apply non-zero risk weights to sovereign risk in the calculation of banks capital requirements. The current zero risk weight fiction is the source of a major economic distortion in the functioning of euro area financial markets as the doom loop it creates between banks and sovereigns feeds financial instability. Contrary to what many voices say, if announced sufficiently ahead of implementation time, such a reform would not trigger a financial market panic: the market would simply do its job of putting a price on sovereign bonds without a regulation creating unwelcome distortions. Alternatively, if policy-makers believe collectively that markets could not cope with a banking regulation reflecting economic reality, they should question the wisdom of continuing to finance their deficits through market mechanisms (namely by issuing tradable bonds).