Where was the EU?

A new body to prevent another Cyprus.

Slow-motion bank run in Cyprus (Photo: Hasan Mroue/AFP/Getty Images)

Slow-motion bank run in Cyprus (Photo: Hasan Mroue/AFP/Getty Images)

Earlier this week a bailout agreement with the European Union and the International Monetary Fund was finally reached for Cyprus. Many wealthy depositors will take a hit, but the deal will prevent the tiny country’s financial system from collapsing, for now.

Ironically, though, just a few days earlier, another EU body announced a measure designed to prevent such crises once and for all. The European Parliament and Commission struck a provisional deal to create a single banking supervisor for the EU. “This is the first fundamental step towards a real banking union, which must restore confidence in the eurozone’s banks,” trumpeted one official. But the EU’s response to Cyprus, just the latest flare-up in its debt saga, raises questions about how committed EU members are to long-term solutions.

The banking union is a much-ballyhooed effort to shore up stability across the EU and break the vicious circle between bank debt and sovereign debt that sank Greece and Ireland. An ideal union would include some form of cost-sharing among EU members when banks need rescuing, and an EU-wide deposit guarantee, which provides assurance to citizens their savings are protected. But the initial reluctance of the EU to pony up the relatively miniscule amounts to rescue Cyprus (the EU originally insisted on a tax on all depositors to raise €5.8 billion) suggests that formalizing such arrangements will be difficult. “I’m not very optimistic,” says Paul De Grauwe, head of the European Institute at the London School of Economics. “All I see is resistance.”

The first step toward a banking union empowers the European Central Bank to oversee the 6,000 banks in the eurozone and intervene when necessary. The potential next steps, creating a shared mechanism to recapitalize failing banks and a common deposit guarantee, are tougher sells. Wealthy countries like Germany and Finland are already tired of rescuing their indebted southern neighbours.

€ 5.8 billion
Value of Cypriot bank deposits that would have been foregone under a rejected EU bailout deal

Some argue an EU-wide supervisory authority will decrease the need to pool resources for bank failures. “The ECB will be much, much tougher and more effective at early bank intervention,” says Zslot Darvas, a research fellow at Belgian think-tank Bruegel. Still, he concedes there will be failures and, as such, burden-sharing agreements are necessary: “It’s a pity there are currently no prospects for that.”

But by establishing a single supervisory authority, the EU has essentially committed itself to following through on the other aspects of a banking union. If a financial institution fails under an EU-wide regulator, that ultimately means it’s the EU’s responsibility to clean up after it. “Otherwise the regulator and the EU as a whole don’t carry the burden for their own mistakes, and that’s a major governance problem,” says John Fitzgerald, a professor with the Economic and Social Research Institute in Dublin. He admits the handling of Cyprus is a bad sign, however. “How they’ve gone about this doesn’t bode well for reaching sane decisions on a banking union.”