The banking union is a fundamental pillar of a monetary union. In the eurozone, the banking union was built recently, while in the United States it has been present for much longer.
First of all, it is important to understand the concept of banking union and how this happens. The reasons why a bank may have losses are essentially two: credit risks (i.e. when borrowers fail to repay the previously obtained loan) market risks (when the value of the securities held decreases).
If the losses are excessive, the bank’s value drops to 0 or even takes a negative value. When the bank records significant losses, it triggers what is known as a disastrous process that is “bank runs”: all account holders and depositors go to withdraw the sums of money deposited in the bank in crisis.
Although a bank is insolvent, it may continue to operate; in this case it would be called zombie bank. Obviously, the work of this bank is a danger since the capital is 0, but as it no longer has capital, the bank could be tempted to take extreme risks with the hope of restoring liquidity.
Faced with a banking crisis, we have several solutions: liquidate the bank, therefore sell all the assets in its possession. Obviously, all proceeds from it are distributed to creditors. The first to be redeemed will be the bonds (senior securities), then the mezzanines (i.e. the mix of shares and bonds) and finally the shares (junior securities). It is here that the concept of Haircut takes over, that is the cut, therefore the part of the title that is not reimbursed. The major haircut is done on equities.
In reality, liquidating a bank is not easy. Very large banks are often not allowed to resort to this solution because there is a fear that, from a bank liquidation, a risk of contagion will arise for the entire financial system (TBTF: too big to fail). For this reason, those banks that cannot go bankrupt must resort to “restructuring” with the intervention of the State (through the use of instruments to return to solvency), these restructuring can be: – granting money (cash) to the bank in difficulty , even if it is not a solution for a bank that is already facing serious difficulties; – purchase “toxic” assets from the troubled bank by granting government bonds to the latter, therefore the state purchases the bank’s sub-optimal bonds by granting the latter good bonds. – Provide the bank in difficulty with liquidity or government securities in exchange for shares of the bank itself, therefore the government can recapitalize a bank by acquiring shares of the bank itself. – Nationalize the bank, i.e. the state acquires the entire equity package of the latter. Obviously, saving a bank has a cost, often very high.
The main criticism is made towards the bail-out technique concerning the moral hazard behavior of the big banks, which are sure of saving the state and this pushes them to have a more “sporty” financial attitude. Thus, we could say that the shareholders of large banks are more protected than those of smaller banks. Precisely for this reason the idea exists that the bail-in must precede the implementation of bail-out, therefore the bank bailout must start primarily from within, that is from capital in the form of reserves, to share capital (that of shareholders).
Daniel Gros made an important comparison between the bailout of banks in the United States and that in Europe and explains why the banking union is necessary and fundamental for monetary union. The comparison starts from Nevada (USA) and Ireland; both have similar dimensions and GDP. In both, the banking crisis arose from a suffering linked to the bad debt of mortgages. In the case of Nevada, the crisis was addressed at the federal level, in the European case at the national level. Nevada, in fact, remained out of crisis management and suffered, normally, only the consequences related to costs. In Ireland, the state took charge of the crisis by transforming a banking crisis into a sovereign crisis. There are two elements that diversify the United States from Europe: – The banking union present in America, where the federal state deals with bank restructuring. Therefore, a banking crisis in Nevada is not faced by the state of Nevada but by the United States. In Europe, however, there is no banking union, or at least not in a complete sense, therefore a crisis of an Irish bank will be borne by the Irish state. – the American system is more integrated than the European one. In the United States there is a greater rooting by banks in American territory. So if a bank records losses in Nevada, it can be offset by the revenue recorded in other states. In Europe there is a low banking integration, therefore the smaller countries do not receive transfers from the larger ones. While in America, with the federal state, the bank and the state take over the costs of a small business. Precisely because of these transfers from the federal budget, the American GDP undergoes lower collapses for the same crisis than in Europe. Furthermore, in America many banks are borne by foreign entities who bear the burden of losses and, of course, of gains. In light of what has emerged, Daniel Gros highlights the importance of an INTEGRATED BANKING SYSTEM. A BANKING UNION IS MORE IMPORTANT THAN A TAX UNION.
By. Domenico Greco