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Originally published Tuesday, March 19, 2013 at 7:48 AM

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EU makes important step toward banking union

The European Union on Tuesday cleared a major legal hurdle toward establishing a full banking union to stabilize its financial system, just as investor confidence was hit hard by a controversial seizure of a part of all bank deposits in Cyprus.

Associated Press

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The ECB is a travesty and a clown car. I hope such a union never happens for the sake... MORE

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BRUSSELS —

The European Union on Tuesday cleared a major legal hurdle toward establishing a full banking union to stabilize its financial system, just as investor confidence was hit hard by a controversial seizure of a part of all bank deposits in Cyprus.

European Parliament lawmakers, the European Commission and national representatives in Brussels reached an agreement on the laws establishing a centralized banking supervisor that will operate under the aegis of the European Central Bank, officials said.

"This is a first fundamental step toward a real banking union which must restore confidence in the eurozone's banks and ensure the solidity and reliability of the banking sector," said EU Internal Market Commissioner Michel Barnier.

EU leaders agreed last year to establish the joint banking supervision, which would lay the groundwork to set up after 2014 a common deposit insurance scheme and an authority with powers to dissolve or rescue financial institutions.

Under the plan, the ECB will be overseeing the bloc's biggest, most interconnected banks, with national watchdogs primarily supervising the rest. The ECB will, however, have the power to intervene in any credit institution in any member if it deems it necessary.

The so-called single supervisory mechanism will at first include all 17 eurozone nations, but is open also to the remaining 10 European Union nations, which have their own currencies.

The joint banking supervisor also paves the way for Europe's bailout fund, the European Stability Mechanism, to give aid directly to ailing banks - a measure that is vital to helping Europe dig out of its three-year-old debt crisis, caused in part by shaky financial institutions.

Many governments had to bail out their banks in the wake of the 2008-2009 financial crisis, which then weakened the government finances, forcing several eurozone nations to seek rescue loan packages from their European partners and the International Monetary Fund.

This "is the core element of banking union and a vital step in breaking the vicious link between the banks and the sovereigns," said Irish Finance Minister Michael Noonan, whose country currently holds the rotating EU presidency.

The tiny eastern Mediterranean island nation of Cyprus has just become the latest example of banks dragging down their national governments: Cyprus applied for a bailout after its banks - which amassed balance sheets worth about eight times the country's annual economic output of (EURO)18 billion ($23.3 billion) - got in trouble and needed a capital injections of about (EURO)10 billion ($13 billion) that the government couldn't provide.

To finance the bank recapitalizations, the eurozone and the IMF on Saturday forced the Cypriot government to levy a one-time tax on all people having a bank account in Cyprus - from pensioners to big investors - to net (EURO)5.8 billion ($7.5 billion), plunging the country into a political crisis.

The unprecedented measure has also diminished investors' confidence in the European banking sector, making it plain that the bloc still has a long way to go toward a unified banking system that will be governed by the same rules and backed-up by a Europe-wide deposit guarantee.

"The case of Cyprus reminds us that the banking system in Europe is vulnerable and still very fragile," said Hannes Swoboda, the European Parliament's center-left caucus leader.

Swoboda said the incident shows that joint banking supervision can only be the first step toward a full banking union. "We urge the Commission to speed up work on a European resolution mechanism to deal with future bank failures in order to complete what has been achieved today," he said.

But a joint resolution and bailout entity is still met with skepticism in countries like Germany, Europe's biggest economy, where leaders fear their money could be used to bail out banks in other countries. They therefore insist that the ESM should only be allowed to rescue banks who got in trouble after the ECB's joint supervision has taken effect, excluding problems of the past that have dragged down banks and then government finances in countries such as Ireland, Greece, Spain and Cyprus.

The agreement struck Tuesday still needs formal approval by EU ministers.

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Juergen Baetz can be reached on Twitter at http://www.twitter.com/jbaetz

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