This is how the German elections could break the stalemate of the European Banking Union

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The project to harmonize European banking rules and unify the sector to make it more competitive at the global level could be rejuvenated if the Social Democrats win in the next German elections.

Olaf Scholz, tthe party candidate and The German finance minister is the favorite to win the September 26 vote to succeed Angela Merkel, whose 16 years as chancellor are drawing to a close. Germany is Europe’s largest economy and wields significant political clout, but it has long opposed the European banking union.

Germany has so far set conditions and “makes most of the problems at the table” during negotiations for the banking union, although it has said it wants to finish the project, PaweÅ‚ Tokarski, senior partner at the EU / Europe research division of the German Institute for International Affairs and Security SWP, said in an interview. The last round of talks in June failed again, Tokarski noted.

At the heart of Germany’s opposition to banking union is the European Deposit Insurance System, or EDIS. The Europe-wide shared deposit system is designed to intervene in the event of failure of national guarantee funds, which are in place to protect deposits. EDIS is controversial in German politics over concerns that Germany might actually subsidize bank failures in other eurozone countries. Scholz broke with Germany’s skeptical stance towards EDIS at the end of 2019 with a proposal for a compromise on deposit guarantees and a plan to complete the banking union.

Banque de France Governor François Villeroy de Galhau and ECB Supervisory Board Chairman Andrea Enria also spoke of the urgent need to complete the banking union. The lack of an integrated eurozone market is detrimental to European banks, which have to contend with global rivals with much deeper and more efficient home markets, such as US banks, Enria said in a speech on the 9th. September.

In Brussels, Scholz is considered the most favorable candidate for further integration of banking and capital markets in Europe, said Rebecca Christie, non-resident member of Brussels-based economic think tank Bruegel, in an interview.

Despite Scholz’s backing, there has been little progress in EU banking union talks over the past two years, but that could change if Scholz’s Social Democrats, or SPD, form a new government with more pro-EU coalition partners, Carsten Brzeski, global macro head for ING Research, said in an interview.

Party correspondence

Opinion polls show the SPD in the lead with 26% of the projected votes; followed by Merkel’s Christian Democratic Union, or CDU, with 21%; and the Greens in third place with 16%. This puts the Greens on the line as a potential coalition partner with the SPD.

The Greens called for risk-sharing in the eurozone and the completion of the banking union, Tokarski said.

Another likely coalition partner is the Free Democratic Party of Germany, or FDP, currently fourth in the polls with 11% of the expected vote. A grand coalition between the SPD and the CDU, as in the last Merkel cabinet, is “extremely unlikely” and all indications point to a tripartite coalition government, Tokarski said.

If the SPD wins the election, one of the likely outcomes will be a so-called traffic light coalition with the Greens and the FDP. It will be the best configuration to move forward on the issue of banking union if the FDP, which is more conservative in the matter, remains a junior partner, said Silvia Merler, head of research at the Algebris Policy and Research Forum, who writes reports and recommendations on European economic policy. If the next German finance minister is from the FDP, one can “forget the major advances on the question of banking union”, declared Tokarski.

Weak German banks

What could give impetus to the debate on banking union at the national level is the weakness The German banking system, which has struggled to stay competitive due to low interest rates, high cost-to-income ratios, lack of digitization and market pressure from challengers, Brzeski said.

Scholz’s push in 2019 to complete the banking union was seen as a response to the diminished relevance of German banks to global markets, including the country’s two largest listed lenders, Deutsche Bank AG and Commerzbank AG, both of whom are suffering a major restructuring. The German government still has a stake of over 15% in Commerzbank.

Earlier in September, Deutsche Bank CEO Christian Sewing called for further market integration in Europe and the completion of banking union plans and EU capital markets in particular. “We must finally take advantage of Europe’s economies of scale,” Sewing said, adding that Europe needs big, strong banks, otherwise it will be too dependent on US financial institutions. Currently, JPMorgan Chase & Co. and Bank of America Corp. On their own, they are as valuable on the market as the 18 largest European banks combined, Sewing noted.

Deutsche Bank’s market cap is currently nearly 18 times that of JP Morgan, according to data from S&P Global Market Intelligence.

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Although EU politicians understand the impact of market fragmentation on national banks, it will not be easy to find common ground on the remaining banking union reforms. “It’s a very difficult project to move forward, especially because the parts that remain are very complicated and very controversial,” said Bruegel’s Christie.

In addition to agreeing on common deposit guarantees, EU member states will need to agree on attaching a certain level of risk to sovereign debt on the bank books, which is currently a risk-free asset. It’s a “no go” for Italy given the country’s legacy with its post-crisis bad debts, Tokarski said.

Political sentiment in other key member states such as Italy and France will play a key role and elections are coming up in both countries, Merler said. France will hold a presidential election in 2022 and Italians will go to the polls for general elections in 2023.

Therefore, even with strong support from Germany, the banking union will likely take several more years, analysts said.

Germany and France would likely benefit the most from the completion of the project given that the total bank assets concentrated in the two countries are greater than the total in the rest of the euro area.

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At the top of the agenda

Political pundits are wondering how much banking union could feature on Scholz’s agenda if he were to become chancellor. More urgent national and European issues could hinder and push the debate on banking union further. Unless there is another banking crisis, banking union would likely be lower priority than other issues like climate change and investment needs, ”Brzeski said.

Climate policy was a key topic during the election campaign, with the Green Party quickly gaining popularity and turning the traditional two-party race for the German Chancellery, between the social and the Christian Democrats, into a three-way contest.

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