Last Call for a Banking Union in the Euro Area

Abstract

The current monetary policy framework to avert the ongoing financial disintegration in the eurozone and to break the vicious circle that ties up banks and governments in a death grip (liquidity ring-fencing) does not allow effective policies to deal properly with the problems affecting interbank cross-border money market lending or merger and acquisition activities of banks. To promote a real “banking union,” this paper proposes two complementary interventions: a monetary policy intervention and an institutional set-up coupled with common recovery and liquidation procedures. The monetary policy operations, whether through unconventional open market operations or indirect funding of ad hoc vehicles, would need to stabilise the sovereign debt market to break the link between counterparty and country risk, which has boosted adverse selection and frozen the interbank market. Common EU recovery and liquidation procedures, on the other hand, would further promote banks' business integration and international diversification. An independent authority would implement these rules, with access to a resolution fund or a common deposit guarantee scheme.

JEL Classification: E58, E65, G28, G33