My presentation at the University of Sterling (MSc Banking and Finance) on the current state, the considerations and the future prospects of the Euroarea Banking Union.

1. BankingUnion:
Lessons FromTheEuroareaCrisis
Guest Lecture
BFIP08D: Research Methods – Dissertation
MSc Banking and Finance
Dr. Theodoros Stamatiou
SeniorEconomist
EconomicAnalysis&
FinancialMarketsResearch
EurobankErgasiasSA
tstamatiou@eurobank.gr

2. 2

3. 3
Word cloud generated from the literature used for the current presentation

4. 4
1. Introduction
The analysis that follows will evolve around three lines:
v The euroarea (EA) sovereign debt crisis
Multi-year debt crisis that started in 2009 with Greece on the aftermath of the 2008 crisis. Several EA
countries were unable to re-pay their sovereign debts. A number of them asked for external help from
the other EA governments, the European Commission and the IMF. These debts came as a result of:
1. Chronic competitiveness problems
2. Decisions in the banking sector prior to the crisis (namely bubbles in the real estate market
financed by cheap bank loans)
3. Problems in the architecture of the euroarea
The countries involved: Greece, Ireland, Portugal, Cyprus (the program countries), Spain and Italy
v The concept of a bank
A bank is a firm that accepts deposits and make loans (not a credit union, friendly loan society or
building society, (Bank of England, 2018)). At the end of each (banking) day: Assets = Liabilities, in the
opposite case if Assets > Liabilities the bank lends the excess funds, if Assets < Liabilities the bank asks
for a loan from the interbank market.
v The EA banking union
The banking union is the transfer of responsibility for banking policy from the national to the EA level,
initiated in 2012 as a result of the fragility of numerous EA banks and the identification of vicious
circle between credit conditions and the sovereign credit of their respective home countries.
NOTE: GR used as an example below because it was (and still is) the most stressed EA economy.

5. 5
itraxx 5-yr CDS spreads of senior European financials
May 2010
1st
Greek
bailout
program
Dec. 2011
ECB announces
3-yr LTROs
Mar. 2008
Northern
Rock
Bear
Sterns
Incidents
Sep. 2008
Lehman Brothers
collapse
bps
May 2012
Greek
Elections
Mar. 2013
Monte dei
Paschi
incident
Jul. 2012
Draghi:
“whatever it
takes”
Source: Bloomberg
Feb. 2016
Worries over
global financial
sector &
economic
recovery
June 2016
June 23rd
BRexit
referendum
2. The facts: Development of the recent crisis and EU
Financials 5YR CDS spreads
v Uncertainty Risk declined after M. Draghi’s 2012 of “doing whatever it takes”
proclamation and ECB’s QE program but still above 2007 level.
1
June 2017
Banco
Popular
Español S.A
SRM
Resolution

6. 6.4% -3.8%
1.0%
7.7%
-16.9%
-5.3%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
EZ GR
6
2. The facts: EA credit growth on the decline
Source: ECB, Bank of Greece
Credit Growth Rate
(EA, GR, %) • EA credit growth rate
declined and even
turned negative
between 2007 and
2014. At 1.0% yoy at the
end of 2017 despite the
low interest rates. Both
credit demand and
credit supply (ECB Bank
Lending Survey)
tightened significantly as
a result of the crisis.
• GR credit growth rate
behavior declined more
dramatically until 2012
(-16.9% yoy) and despite
a significant rebound
until 2014 still remains
below zero. At -5.3% yoy
at the end of 2017.
Sep. 2008
Lehman Bros
collapse
May 2010
1st GR
bailout
program
Feb 12
2nd GR
bailout
program
Aug.15
3rd GR
bailout
program
v Declining EA credit growth constitutes a problem for the real economy
2
EA

7. 7
1. The facts: EA bank assets stabilized recently
Source: ECB, Bank of Greece
Growth rate of Bank Assets between 2006 and 2017
( EUR bn, %)
• EA Bank Assets: between 2006 and
2017 increase of only 3% manly as a
result of low credit demand and supply
conditions, low or even negative GDP
growth (i.e. lower income => lower
consumption, lower savings &
investments, etc).
• GR Bank Assets: decline due to:
a) deleveraging and b) flight of
deposits (lower liabilities) as a result of
the crisis (people tried to sustain their
living standards by “burning” their
deposits), fears of a Grexit scenario,
and / or implementation of capital
controls (realized scenario due to the
mistakes of the 1st half of 2015).
• Financing of GR bank assets became
more expensive as deposits decreased.
The banks financed their assets by
tapping the BoG’s Emergency Liquidity
Assistance Facility (ELA).
ELA
(EUR bn, %)
3.0%
-23.0%
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
EA GR

8. 8
2. The facts: Consolidation process in the EA banking sector
Growth rate of # Banks between 2006 and 2017
(# of institutions, %)
Source: ECB
• Number (#) of credit institutions:
The number of credit institutions
declined both in EA and GR
between the end of 2006 and 2017,
mainly as a result of:
• Consolidationof the sector mainly
due to:
1. Search for higher profitability
2. Search for efficiency
3. Lower credit demand and
higher regulation standards
4. Insolvencies (this was not
only the case of GR but also
of the broader EA periphery
and early on in the crisis of
DE.
3.0%
-23.0%
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
EA GR

9. 2.1%
-4.5%
1.9%
4.1%
-9.1%
2.5%
-10.0%
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
EZ GR
9
2. The facts: Real GDP growth decline from 2008 onwards
Source: European Commission
Sep. 2008
Lehman Bros
collapse
May 2010
1st GR
bailout
program
Feb 12
2nd GR
bailout
program
Aug.15
3rd GR
bailout
program
Forecasts
Real GDP Growth Rate (EA, GR, %) • Decline in EA & GR
GDP growth rate as
a result of:
1. Lower credit
growth (feedback
loop)
2. Uncertainty over
the prospects of the
financial sector
3. Lower demand for
loans due to lower
growth
expectations
4. Competitiveness
gaps among EA
members and GR
5. Fear of a GRexit
scenario
GR Real GDP declined by 26.4% between the end of 2007 and the end of 2016 (with the exception
of 2014 (positive rate of 0.7%)).
EA

10. 10
2. The facts: Significant INCREASE in EA unemployment
8.3%
12.0%
7.9%
10.7%
27.5%
18.7%
7.0%
12.0%
17.0%
22.0%
27.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
15.0%
EA GR
Source: European Commission
Unemployment
(EA, GR, %)
• Real GDP decline led to a
significant increase in
unemployment and vise
versa
• EA unemployment increased
from 7.5% in 2007 to 12.0%
in 2013. At the end of 2017 it
was at 9.1%
• GR unemployment
increased from 8.4% in 2007
to 27.5% in 2013
1. Low competitiveness,
GDP and credit growth
decline and regulation
rigidities in the
domestic labor
market the main
reasons for the
differential between
EA & GR.
2. GR unemployment at
the end of 2017 was at
21.8%.
Real GDP => Unemployment => Disposable Income =>
=> Real GDP => NEXT STEP (?)

11. 11
2. The facts: EA unemployment still ABOVE its 2007 level
21.8%
9.1%
0%
5%
10%
15%
20%
25%
30%
GR ES PT CY SK IE IT EA LV LT FR SI EE BE FI NL MT LU AT DE
2007 2013 2017
Unemployment remains above its 2017 level, especially, in EA periphery => NEXT STEP (?)
Source: European Commission
Unemployment
(EA, GR, %)

12. 12
2. The facts: Fall in GDP led to an increase in NPEs
Source: European Banking Authority
Non Performing Exposures
(EU, % total loans)
Definition:
Non Performing Exposures (NPEs) include Non
Performing Loans (NPLs) (i.e. bank loans past
due 90 days) plus exposures that are unlikely to
pay", which are designated as "non-performing"
on the basis of qualitative criteria, although they
are either performing or are less than 90 days
past due.
Real GDP => Unemployment => Disposable Income => NEXT STEP INCREASE ON BANKS’ NPES
Non Performing Exposures (NPEs)increase not fora sole bank but for thebanking sectors of a
series of EAmembers. Not a single country banking problembut a EA problem. 3

13. 13
v IRELAND
ê Housing market
ê Rescue of Banks è rise of public
debt
ê High private debt
v PORTUGAL
ê Low competitiveness
ê Large fiscal deficits, but not debt
ê High private debt
v SPAIN
ê Low competitiveness
ê Housing market
ê Small savings banks
ê High private debt
ê High unemployment
v GREECE
ê Low competitiveness
ê Public sectorè rise of public debt
ê High fiscal deficits & debt
ê High unemployment & NPEs
v ITALY
ê Low Competitiveness
ê Public sector è rise of public debt
ê High debt
ê High unemployment & NPEs
v CYPRUS
ê Housing market and exposure to
Greece
ê Low competitiveness
ê Rescue of banks è rise of public debt
ê High fiscal deficits & debt
ê High unemployment & NPEs
2. The facts: EA crisis origins not uniform across countries

14. 14
67.0% 85.2%
33.2%
67.2%
170.1%
2.0%
22.0%
42.0%
62.0%
82.0%
102.0%
122.0%
142.0%
162.0%
182.0%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
EA IE GR ES
Debt to GDP
(% of GDP)
2. The facts: EA crisis resulted in increase of public debt
v Banking sector’s collapse led to increase of public debt in Ireland and Cyprus.
v Unsustainable public debt led to restructuring (PSI) and collapse of banking sector in Greece.
v Two-way feedback: Bank failure è public sector debt & public sector debt è bank failure
PSI: Private Sector Involvement (PSI) in early 2012, restructured GR public debt and led to significant losses
for domestic and EA banks 4Source: European Commission

15. 15
3. Need for EA Intervention? Optimum CurrencyAreas
v Let’s summarize:
1. Uncertainty Risk declined after M. Draghi’s 2012 of “doing whatever it takes”
proclamation and ECB’s QE program but still above 2007 level.
2. Declining EA credit growth constitutes a problem for the real economy
3. Non Performing Exposures (NPEs) increase not for a sole bank but for the banking sectors
of a series of EA members. Not a single country banking problem but a EA problem
4. Two-way feedback: Bank failure è public sector & public sector è bank failure
v The question that arises here is why we are interested in all these and how they created the
background for the creation of a banking union.
v The answer is the sustainability of the European Monetary Union (EMU), the sustainability of the
euro
v Banking Union is necessary for EMU/EA survival, leading towards anOptimumCurrencyArea
Definition:
Optimum Currency Area: The Theory of Optimum Currency Areas (OCA, (Mundell, 1961)) states that a monetary
union will only survive if the benefits of more economic integration due to adopting a common currency exceed the
disadvantages caused by the loss of the exchange rate instrument. If this condition is not met and an economy is hit
by an asymmetric shock, sufficient flexibility in factor markets can solve the problem. Flexibility should pertain to two
aspects:
1. Fully liberalized labor, capital and product markets in the currency area
2. Common internal market rules that will ensure level-playing field
The aforementioned requirements hold for the EA member states?

16. 16
v Deviations fromOptimumCurrencyAreas requirements include:
1. Labor and product markets that were not fully liberalized due tointernal political frictions
in EAmember states
2. Capital markets that were fully liberalized before the crisis but stopped being so after the
eruptionof the crisis as a result of the uncertainty
v Eruptionof the crisis highlightedthe above shortcomings.The ones relatedwith labor and
product markets were addressedvia the implementationof various economic adjustment
programs inthe EAperiphery countries.
v EA’s piecemeal and delayed response to the multiple internal crises was drivenprimarily bythe
fear of instituting moral hazard, whichallowed,among other items, the Europeanbanking
problems to dragon
v EA’s authorities started focusing onthe need ofinstituting a banking union(and introducing
more drastic liquidity measures like the ECB’s Public Sector Purchase Program (PSPP-QE
program)after half measures like the liquidity provided bythe LTRO and theTLTROfacilities
had limited results only.
2. Need for ECB Intervention? Deviations from Optimum
Currency Areas
Definition:
Long Term Refinancing Operations (LTROs) was a process by which the ECB provided financing to EA banks in the
aftermath of the first stage of the respective sovereign debt crisis. The ECB provides liquidity to banks on a regular
basis but the LTRO and the TLTRO that followed in 2014 had longer maturities compared to the regular process.
Major part of these funds went to support of EA periphery sovereign bonds thus making the connection between the
banking sector and the sovereign stronger (!!!).

17. 17
3. EA Response: Steps towards a banking union

18. 18
3. EA Response: Steps towards a banking union
v A banking union was necessary for EA survival, leading towards anOptimumCurrency
Area. It was based ona three pillar approachunder a commonrule (Single Rule Book):
o 1st Pillar:The Single SupervisoryMechanism
o 2nd Pillar:The Single ResolutionMechanism
o 3rd Pillar:The EuropeanDeposit Insurance Scheme
v Timeline of banking unionimplementation:
o June 2014: EAHeads of State &Government agreedto create a banking union.
o November2014:Creationof theSingle Supervisory Mechanism (fully operational
from the start)& the Single ResolutionMechanism.
o January 2015: Single ResolutionMechanism gradually becomes operational (fully
operational in2016)
o March 2018: EuropeanDeposit Insurance Scheme still not operational.
Definitions:
1. Public Sector Purchase Program (PSPP): After establishing the banking union and in the context of the 2012
proclamation of “what ever it takes to save the euro”, the ECB started implementing its quantitative easing
program, namely the Public Sector Purchase Program aiming at purchasing member states government bonds
under certain rules.
2. PSPP & GR: GR was exempted from the PSPP from early 2015onwards (still exempted) as a result of a) not
having the necessary credit rating and b) because its debt was deemed us unsustainable.

19. ESM
19
3. EA Response: Elements of the banking union
SINGLE RULE BOOK
1st Pilar:
SINGLE
SUPERVISORY
MECHANISM
2nd Pilar:
SINGLE
RESOLUTION
MECHANISM
3rd Pilar:
EUROPEAN
DEPOSIT
INSURANCE
SCHEME
Source: European Commission, ECB, Eurobank Research

20. 20
3. EA Response: The Single Supervisory Mechanism
The Single Supervisory Mechanism (SSM) constitutes the 1st Pilar of the Banking Union it comprises
the ECB and the respective EA national authorities. Its main tasks include:
v Authorization / withdrawal of all credit institutions in the banking union
v Qualifying holdings for all credit institutions in the banking union
v Governance supervision for significant institutions
v Compliance with EU prudential rules for significant institutions
v Supervisory review for significant institutions
v Supervisory tasks related to recovery plans and early intervention for significant institutions
v Macro-prudential risk supervision for significant institutions
Definitions
1. Significant institutions: Currently 118 banks (representing almost of 82% of total EA banking assets) from the EA
are considered based on certain criteria as significant.
2. Qualifying holdings: a) Participation in a bank can be described as a “qualifying holding” when it represents 10%
or more of the bank’s shares and/or voting rights or crosses the other relevant thresholds (20%, 30% or 50%)
and b) obtaining rights to appoint the (majority of) the management board or other means of providing
significant influence over the management of the bank. The SSM approval process aims to ensure that only
suitable shareholders enter the banking system in order to prevent any disruptions to the smooth functioning of
the banking system (SSM, 2018).
3. Macro prudential risk: This type pf risk refers to the macroeconomic risks caused by financial instability / shocks
in the financial sector. For example the Lehman Bros default in September 2008 caused wide macroeconomic
instability

21. 21
3. EA Response: The Single Supervisory Mechanism
SSM in action: 2018 EA Stress Tests
v The ECB will examine 37 euro area banks as part of the 2018 EU-wide stress test conducted
with the European Banking Authority (EBA). In line with the EBA’s selection criteria, these
significant banks, represent 70% of total EA banking assets.
v The ECB will conduct its own stress test in parallel for those significant institutions not
covered by the EU-wide EBA stress test.
v The ECB stress test will also support macro prudential supervision.
v The results of the stress test will provide stakeholders and the public with information about
the resilience of banks, notably their ability to absorb shocks and meet capital requirements
under adverse macroeconomic conditions.
v The EU-wide stress test will be conducted according to the EBA’s methodology, templates and
scenarios. Results of individual banks are expected to be published by 2 November 2018.
v The four significant Greek banks will undergo the same EBA stress tests. In order to complete
the test before the end of the Third Economic Adjustment Programme (August 2018), the
results are expected to be published in May.
q The preparations for the stress tests for Greek banks started almost a year ago and
included a) dry runs of the full exercise based on macro assumptions with stress
scenarios close or venmore stressed than the ones finally published by the ECB, b)
empirical forecasts regarding the lifetime provisions of certain bank assets, etc.
q The current stress test is the fourth one for the Greek banks from 2011 onwards.

22. 22
3. EA Response: The Single Resolution Mechanism
The Single Resolution Mechanism (SRM), an independent European Union Agency since January
2015, constitutes the 2nd Pilar of the Banking Union. Its main tasks include:
v Bank resolution planning for significant banks under the SSM definition
v Bank resolution decisions/resolving institutions that is failing or likely to fail
v Application of EU resolution and State Aid framework (bail-in tool)
v SRM acts on basis of early warning
How the resolution of a failing or likely to fail bank is applied in practice?
v The SRM has the power to restructure failing banks to preserve critical functions via for
example:
1. Sale of business including core and / or non-core operations
2. Creation of a bridge bank
3. Separation of bank assets to performing and non-performing / impaired ones)
4. Bail-in/ recapitalization of the failing bank / bridge bank conditional on certain procedures.
Definitions
1. Bank resolution: Resolution is the restructuring of a bank by a resolution authority through the use of certain
tools in order to safeguard public interests, including the continuity of the bank’s critical functions, financial
stability and minimal costs to taxpayers (SRM, 2018)
2. Bridge bank: is a vehicle set up by the SRM to acquire the shares or the assets and liabilities of one or more
entities in resolution, with a view to sell to market buyers. Shareholders and creditors have no rights on the
bridge bank

23. 23
3. EA: The Single Resolution Mechanism
The Single Resolution Fund (SRF) has been established in 2014. Where necessary, the SRF may be
used to ensure the efficient application of resolution tools and the exercise of the resolution
powers conferred to the Single Resolution Board (SRB) by the SRM Regulation.
v The SRF is a common backstop for bank crisis management financed by the industry (after to
8% bail-in and up to max 5% of bank liabilities)
v The plan is for the SRF to be funded over 8-year period with contributions from banks (until
2023) to reach 1% of all covered deposits. As of 30 June 2017, the SRB had collected €6.6
billion from 3,512 institutions in annual contributions for the SRF. In total, the SRF holds an
amount of €17.4 billion.
The SRF may be used only to the extent necessary to ensure the effective application of the
resolution tools, as a last resort. Its main tasks include:
v Guarantee the assets or liabilities of the institution under resolution;
v Make loans to, or to purchase assets of, the institution under resolution;
v Purchase assets of the institution under resolution;
v Make contributions to a bridge bank and an asset management vehicle;
Finally note that the use of the SRF is permitted only for the resolution scheme: shall not be used
to absorb the losses of an institution or to recapitalize an institution.
Single Resolution Board: The Single Resolution Board (SRB) is the central resolution authority within the banking
union. Its mission is to ensure an orderly resolution of failing banks with minimum impact on the real economy and
public finances of the participating Member States and beyond

24. 24
SRM in action: The case of Banco Popular EspañolS.A
v Due to its stressed liquidity situation, the European Central Bank (ECB) had decided on 6
June 2017 that Banco Popular was “failing or likely to fail” and notified the SRB
accordingly.
v The SRB and the Spanish National Resolution Authority – FROB – decided that the sale
was in the public interest as it protects all depositors of Banco Popular and ensures
financial stability.
v The resolution scheme enteredinto force on the same day, following the endorsement
by the European Commission.
v On 7 June 2017, the Single Resolution Board (SRB) transferred all shares of Banco
Popular Español S.A. (Banco Popular) to Banco Santander S.A (Santander).
v This means that Banco Popular continued to operate under normal business conditions
as a solvent and liquid member of the Santander Group with immediate effect.
3. EA Response: The Single Resolution Mechanism
The consolidation of the Greek banking sector:
Consolidation of the Greek banking sector occurred between 2011 and 2014 and it was conducted outside of
the SRM framework. Essentially the Greek banking sector consolidation was a pilot for the SRM process.

25. 25
3. EA Response: The European Deposit Insurance Scheme
The European Deposit Insurance Scheme (EDIS) constitutes the 3rd pillar of the banking union.
The European Commission published back in 2015 a proposal for the EDIS for the protection of
deposits below EUR 100,000 across the euro area in case of liquidation or resolution of failing
banks. The proposal followed a three stage approach:
v At an initial stage (from 2017 to 2020), priority to national deposit quarantine schemes and
then (if the national intervention is not enough) participation of the EDIS.
v At an intermedium stage (from 2020 to 2024), EDIS contribution will gradually increase
compared to the national deposit guarantee schemes.
v At the final stage (from 2024 onwards), the protection of the deposits will be fully financed
by the EDIS
v EDIS funding from the euroarea banks: Contributions will vary based on size and risk of each
individual institution.
Purpose of the reform: Such a guarantee will break the link between uncertainty created in
depositors by EA-local sovereign or credit crises.
Bad incentives, the case of moral hazard: At the same time EDIS creates incentives for institutions
and / or sovereigns to undertake more risk at the cost of others. Better regulation via the banking
union is the only alternative.
Why we do not stick to the national deposit guarantee schemes: In case of no EDIS national
authorities will have control of the local backstop. Their first priority will be to protect national
interests and priorities and not the free movement of capital and deposits across euroarea.

26. 26
EDIS
National
DIS
3. EA Response: The European Deposit Insurance Scheme
Source: European Commission
European Commission’s EDIS proposal

27. 27
The single rulebook is the backbone of the banking union and of financial sector regulation in
the EU-28 in general. It consists of legal acts that all financial institutions (including
approximately 8300 banks) in the EU-28 must comply with. The rule book includes:
v Stronger prudential requirements for banks, introduced under the Capital Requirements
Directive and Capital Requirements Regulation
v New recovery and resolution framework for banks, established under the Bank Recovery
and Resolution Directive
v The functioning of national Deposit Guarantee Schemes (DGSs), enhanced by the Deposit
Guarantee Scheme Directive
v Delegated and implementing acts by the Commission
v Technical Standards related to the role of the European Banking Authority
3. EA Response: The Single Rule Book
Capital Requirements Regulation:
1. Capital Requirements: The regulation requires banks to have set aside enough capital to cover unexpected
losses. Tier 1 capital is considered to be the going concern capital. The going concern capital allows a bank
to continue its activities and keeps it solvent. Tier 2 capital is considered to be gone concern capital. The
gone concern capital allows an institution to repay depositors and senior creditors if a bank became
insolvent. A total amount of capital that banks and investment firms are required to hold should be equal
to at least 8% of risk-weighted assets.
2. Liquidity requirements: Financial institutions must hold sufficient liquid assets to cover net liquidity
outflows under gravely stressed conditions over a period of 30 days.
3. Leverage: Leverage is the relationship between a bank's capital base and its total assets. A bank's assets are
'leveraged' when they exceed its capital base.

28. 28
3. EA Response: The European Stability Mechanism (?)
v The European Stability Mechanism’s (ESM) mission is to provide financial assistance to EA
countries threatened by severe financing problems (ESM, 2018). This assistance is granted only if
its proven necessary to safeguard the financial stability of the EA as a whole and of the ESM
members.
v Recent example of ESM assistance: the 3rd Economic Adjustment Program for Greece. The
economic adjustment programs implemented before 2015 in Greece, Ireland and Portugal were
financed by the ESM’s predecessor the European Financial Stability Facility (EFSF).
v How the ESM enters the discussion on the banking union?
v Well the answer has to do not with the failure of a sole bank but with the failure of the banking
sector of a country. The SRM is responsible for facilitating the resolution of banks not banking
sectors. Its mandate and financial capacity do not permit such an endeavor.
v There were suggestions that the role of such rescues will pass to the ESM but still with no tangible
results. The ESM’s mandate currently permits the rescue of a banking sector directly on very
special circumstances.
v What happened in practice? After the disastrous first six months of 2015, the Greek Government
enforced the implementation of capital controls and this led to the failure of the 4 systemic banks
in Greece.
v The ESM provided rescue funds indirectly to the banks via the Greek government. Direct provision
of funds was averted due to moral hazard considerations.
v Such a behavior not sustainable in the long run; it creates uncertainty over who will be
responsible to rescue a failing EA banking sector in the future.

29. 29
3. EA Response: Progress of the banking union

30. 30
Rule
Making Supervision
Lender
of Last
Resort
Deposit
Insurance &
Resolution
Fiscal
Backstop
Ministry of
Finance
Supervisory
Agency
Central Bank
Deposit Insurance &
Resolution Authority
Ministry of
Finance
EC & EBA ECB
NCBs
(source of conflict
with ECB)
SRB & (EDIS)
(not complete & interaction
between NDIS & SRB creates
conflict)
ESM
(direct
recapitalization not
permitted due to
moral hazard
considerations
Source: Adapted from Shoenmaker, D., (2016), The Banking Union: An Overview and Open Issues
3. EA Response: Progress of the banking union
Agencies in the current EA Banking Union framework

31. 31
3. EA Response: Progress of the banking union
v The EA crisis led – even though with a significant delay – to the creation of the banking union.
v The banking union – on an abstract basis – addresses the need for the break-up of the link
between the financial / banking crisis and the sovereign crisis (beware again that this is not a one
way relation) & contributes to the improvement of the EMU towards an Optimal Currency Area.
v The figure above summarizes the current situation of the banking union.
v But what is happening in the real world?
v The first two pillars of the banking union are already operational and producing results. The 2018
stress test is already under way and a well defined resolution framework is already in place and
tested. Potential sources of conflict in the current structure:
1. SSM, ECB, NCB: Banking Supervision is shared between the ECB and the National Central
Banks. This might create a source of conflict (for example when the National Central Bank
wants to protect the domestic bank from a potential resolution, etc).
2. SRB, NDIS: SRB and National Deposit Insurance Schemes might also create a potential
source of conflict (for example when a domestic bank fails the NDIS might have the
incentive to delay expecting that the SRB/SRM will cover the cost of the failing bank).
v SSM: SSM’s supervisory role is limited on the banking sector. What about other financial
intermediaries? The shadow banking system?
v ESM: The European Stability Mechanism (ESM) cannot act as a potential backstop/rescue fund
(with the exception of the case of systemically risk). This creates uncertainty (but the opposite
creates moral hazard).

32. 32
3. EA Response: Progress of the banking union
v But what is happening in the real world (Continued)?
v EDIS: The 3rd Pilar, the European Deposit Insurance Scheme is still missing. Even though there
are arguments supporting that the actual implementation of the deposits insurance scheme is
not so important anymore due to better supervision (SSM) and the existence of a clear
resolution framework (SRM), at the end of the day only a well defined euro-area deposit
insurance scheme will prevent the occurrence of a future bank run.
v EDIS: Moreover, as long as the deposit insurance remains at the hands of the national
authorities there will be always the incentive to use it in order to intervene in the domestic
banking system and thus create the ground for a deviation from the optimal rules of the
game.
v The next steps?
v Necessary steps for the move towards a fully operational and efficient banking union include:
1. Credible solution for the moral hazard considerations and continue towards establishing
the European Deposit Insurance Scheme.
2. Establishment of the ESM’s function as a backstop for future banking crises.
3. Elimination of the role of the national authorities on banking union related issues
(supervision, resolution, provision of rescue funds, deposit insurance).
v The figure belowsummarizes the functions of a fully operational and efficient (“completed”)
banking union.

33. 33
Rule
Making Supervision
Lender
of Last
Resort
Deposit
Insurance &
Resolution
Fiscal
Backstop
Ministry of
Finance
Supervisory
Agency
Central Bank
Deposit Insurance &
Resolution Authority
Ministry of
Finance
EC & EBA ECB (SSM) ECB EDIS ESM
Source: Adapted from Shoenmaker, D., (2016), The Banking Union: An Overview and Open Issues
3. EA: Progress of the banking union
Agencies in a “completed” EA Banking Union framework

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4. Concluding Remarks
v The question that arises easily here: Is that enough? The banking union constitutes the safety
net for the EMU? NO
v In addition to the still open issues of the banking union that need to be addressed in the
following period, the EU authorities should also pay attention to:
o The efficient approach of the NPEs/ NPLs issue that creates significant risks for the
capital of the EA banks as well as for the real economy.
o The still pending Optimum Currency Area issues, including:
1. The convergence of the member states – and especially of the periphery countries
– in terms of competitiveness.
2. The fiscal surveillance of the member states. Even though significant progress has
been observed already, the fiscal surveillance mechanisms still remain untested.
3. The economic governance of the euro area including the proposals for a common
ministry of economics, etc.

35. 35
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