What is the European banking union and will it prevent a future banking crisis?

The banking crisis of 2007 and 2008 laid bare vast inadequacies in the structure and practical supervision of domestic financial institutions and the financial system. It also revealed shortcomings in risk management at a large number of financial institutions. Many of these operated across borders, and the national supervisory mechanisms were not designed to handle the strong interlinkages between European financial markets.

As a result, the governments of many countries were forced to intervene to prevent the financial system from collapsing. In the Netherlands, the Dutch government intervened in systemically important banks such as ABN AMRO, ING and SNS (renamed de Volksbank in 2017). This had huge repercussions for the national budget and, by implication, taxpayers.

To avoid a future need for government intervention in the banking sector, the member states in the euro-area agreed to establish the European banking union. As a result, responsibility for supervising the largest banks is now no longer a task for national supervisory authorities in a manner of their choosing. Instead, supervision is at an EU level and performed by the European Central Bank. The fact that all the major banks in the member states are now supervised in the same way reduces the chances of bank failure. And if Eurozone banks do run into financial difficulties, the aim will be to resolve the problems without passing on the costs to national governments and taxpayers.

More about:

Introduction: European measures to prevent a new banking crisis

Ever since the start of the crisis, EU officials have discussed ways and means to prevent repetition. In May 2009, the European Commission proposed a series of reforms to create a new institutional supervision framework. The new European System for Financial Supervision (ESFS) came into effect in January 2011.

The ESFS encompasses macro- and micro-prudential supervision. Macro-prudential supervision is concerned with preventing and curbing systemic risks to financial stability emerging from macro-economic developments. The European Systemic Risk Board (ESRB) plays a central role in macro-prudential supervision.

Micro-prudential supervision aims to limit the risks posed to individual institutions. Micro-prudential supervision is performed by several European sector-specific authorities, one for the banking sector, a second for insurance companies and occupational pension providers, and a third for securities institutions and markets.

More information:

European system of financial supervision (ESFS) - Factsheet European Commission
Macro-prudential supervision - Factsheet Netherlands Court of Audit (25-03-2020)
Micro-prudential supervision - Factsheet Netherlands Court of Audit (25-03-2020)

European banking union and its 3 pillars

The launch of the European banking union in 2012 marked the most important step taken by the EU to prevent a new banking crisis.
As shown below, the European banking union consists of 3 pillars.

1st pillar: Single Supervisory Mechanism
The first pillar of the banking union is the supervision of banks. The Single Supervisory Mechanism is an arrangement between the European Central Bank (ECB) and the national supervisory authorities in the euro area. The ECB has taken over responsibility for the supervision of significant banks, i.e. banks with a balance sheet total of at least €30 billion, from the national supervisory authorities. National supervisory authorities are responsible for supervising all other financial institutions, e.g. medium-sized and small banks in their respective countries.

2nd pillar: Single Resolution Mechanism
The Single Resolution Mechanism (SRM) is the second pillar of the banking union. It was established to ensure the effective resolution of euro-area banks that find themselves in serious financial difficulties, without national governments or taxpayers having to foot the bill. One of the resolution tools available to the resolution authorities is a bail-in. In a bail-in, shareholders, bondholders and savings deposit holders (with savings exceeding €100,000) bear their share of the losses arising from the failure of the bank. Another option is to sell the failing bank, either in full or in part.
As under the SSM, a European organisation, the Single Resolution Board (SRB), is directly responsible for the resolution of significant banks in the euro area, and national resolution authorities are responsible for the resolution of medium-sized and small banks in their own countries.

A Single Resolution Fund (SRF) financed by euro-area banks was established in 2016. Its resources can be used to resolve banks in financial trouble. The ambition for the end of 2023 is that the SRF will be worth 1% of the value of the eligible deposits held by the participating banks, estimated at €80 billion by 2024. The fund was worth nearly €78 billion at the end of 2023.

3rd pillar: European Deposit Insurance Scheme (under construction)
In addition, the European Commission is planning to set up a European deposit insurance scheme. This is the third pillar of the banking union to protect European savings deposit holders up to a specified amount. Although the European Commission tabled proposals to this effect in November 2015, they had not been approved by the EU member states or the European Parliament as at the end of 2023. Until they are, the European deposit insurance scheme remains a matter for national authorities only.

Future Banking union

On 18 April 2023, the Commission presented new proposals to strengthen the rules on problem banks. These proposals focus specifically on medium-sized and smaller banks. The objective is to prevent governments having to step in to save ailing banks using taxpayers’ money. The package comprises proposals for each step to be taken in the event of banks being considered as failing or likely to fail (‘FOLTF’).

As several member states had difficulty with the proposals, negotiations are expected to be difficult and protracted. As at the end of 2023, no decisions had yet been taken.

More information:

Banking union - European Commission information regarding the European Banking Union
Single Supervisory Mechanism - European Central Bank information regarding about the Single Supervisory Mechanism (SSM)
Single Resolution Board
Single Resolution Fund grows by €11.3 billion to reach € 77.6 billion - Size of Single Resolution Fund (06-07-2023)
Commission proposal for a European deposit insurance scheme (EDIS) (24-11-2015)
Banking Union: Commission proposes reform of bank crisis management and deposit insurance framework
Banking Union: Commission proposes reform of bank crisis management and deposit insurance framework - European Commission press release (18-04-2023)

Recapitalisation of banks by the European Stability Mechanism (ESM)

Since 2012, the European Stability Mechanism (ESM) has offered a means to recapitalise banks indirectly. The ESM is a permanent emergency financial assistance fund providing loans to EU member states that run into financial difficulties. In an indirect recapitalisation, a government applies to the ESM for aid, which it passes on to banks facing financial difficulties. Spanish and Cypriot banks have been recapitalised in this way.

In June 2014, the Eurogroup agreed to create the option of allowing failing banks to borrow money from the ESM without government intervention. In other words, it created an instrument for the direct recapitalisation of banks by the ESM, which has a maximum recapitalisation capacity of €60 billion. The instrument can be used if a bank fails to meet the ECB’s capital requirements (or is likely to do so in the future), and if this poses a grave threat to financial stability in the euro area. Another condition for the use of this instrument is that all other private and (national) public remedies have been exhausted.

On 4 December 2019 the Euro group decided that the ESM could also serve as a backstop for the Single Resolution Fund (SRF), providing funding for the resolution of failing banks. The ESM treaty has been adjusted accordingly. A backstop means that if SRF-resources are exhausted, the ESM can lend money to the SRF to finance resolution.

This mechanism was initially intended to become operational on 1 January 2024, but in practice the Single Resolution Board has been able to use it since 2022.

The maximum loan capacity has been set at €68 billion.

More information:

Have the European emergency funds achieved their objectives, and when will the loans be repaid? - Netherlands Court of Audit on emergency funds
‘Just in case’: the direct bank recapitalisation tool - European Stability Mechanism about direct bank recapitalisation tool
ESM Treaty Reform - Explainer for the Single Resolution Fund

Since the introduction of the European banking union, significant banks in the Netherlands have been supervised by the ECB in conjunction with the Dutch central bank (De Nederlandsche Bank, DNB) as the national supervisory authority. DNB remains responsible for the supervision of medium-sized and small banks in the Netherlands. We audited DNB’s supervision of these banks in 2017 and found that it is well organised. DNB’s supervision is intensive and strict. Where banking supervision is concerned, the Ministry of Finance does not exercise all its powers as DNB’s supervisor. The introduction of the Single Supervisory Mechanism for banks has impeded supreme audit institutions’ ability to independently audit banking supervision. We worked together with the supreme audit institutions of Cyprus, Germany, Finland and Austria and published a joint report on the European banking union on 14 December 2017.

We also audited DNB’s preparations for the possible failure of medium-sized and small banks, and published our audit report in 2019. We found that, although progress had been made with resolution planning for medium-sized and small banks, not all plans had been completed. Since March 2019, DNB has prepared and endorsed resolution plans for the vast majority of Dutch medium-sized and small banks. The plans comply with statutory requirements, but are brief. We also found that the Minister of Finance, who is responsible for supervising DNB’s resolution activities, does not fully supervise DNB. As a result, he does not have up-to-date information on the general state of resolution planning for medium-sized and small banks in the Netherlands. Precisely because DNB is still in the process of fleshing out its role as the national resolution authority, we had expected the minister to play a more active role in supervising DNB’s resolution activities, also in the light of his responsibility for the stability of the financial system and his role as the national treasurer.

We performed this audit in conjunction with the supreme audit institutions of Austria, Estonia, Finland, Germany, Portugal and Spain. A joint report on resolution planning was published on 16 December 2020.

The European Court of Auditors published a report on resolution planning on 14 January 2021.

More information:

Supervision of banks in the Netherlands - Report Netherlands Court of Audit (27-09-2017)
Bank resolution in the Netherlands - Report Netherlands Court of Audit on Bank resolution in the Netherlands; How does DNB prepare for possible failure of medium-sized and small banks (12-12-2019)?
Report of the Task Force on European Banking Union to the Contact Committee of Supreme Audit Institutions of the European Union and the European Court of Auditors (PDF) - Joint report by supreme audit institutions of Cyprus, Germany, Finland, the Netherlands and Austria on Supervision of medium sized and small banks (14-12-2017)
Preparation for resolution of medium-sized and small banks in the euro area - Joint report by supreme audit institutions of Germany, Estonia, Finland, Austria, the Netherlands, Portugal and Spain (16-12-2020)

Impediments to independent audits by supreme audit institutions (audit gaps)

The European Court of Auditors (ECA) has only limited access to the European Central Bank (ECB), the European supervisory authority. This is because the ECA’s mandate is limited to auditing the ECB’s operational efficiency of management, which in the ECB’s opinion excludes the actual supervision of banks. Supreme audit institutions in the euro area with a mandate to audit the supervision of and preparations for the resolution of medium-sized and small banks are also facing more restrictions on their access to data. These are commonly referred to as ‘audit gaps’. This applies particularly to the ECB, which does not share information with supreme audit institutions. The Single Resolution Board (SRB) also restricts the access of supreme audit institutions to the information they need for their audits. In addition, the supreme audit institutions of ten euro-area countries have either no, or an only limited, mandate to audit the supervision of medium-sized and small banks.

In August 2019, the ECA and the ECB reached agreement on a Memorandum of Understanding (MoU) to improve the ECA’s access to ECB information. Click here for further information.

We consider the MoU to be a meaningful first step towards improving the independent external audit abilities of supreme audit institutions. Although the ECB seems to have become less reluctant to release information, the MoU bridges only some of the gaps that we identified in supreme audit institutions’ ability to perform independent external audits of prudential supervision. Not only has the MoU not altered the ECA’s limited formal mandate, but the ECB also reserves the right to ask the ECA to explain why it has requested certain information. In a national context, this restriction does not apply to our audits of DNB’s prudential supervision of medium-sized and small banks. Furthermore it is not clear what implications the MoU has for the rights of supreme audit institutions to access relevant ECB information, as the MoU does not say anything about this.

More information:

Memorandum of Understanding between the ECA and the ECB regarding audits on the ECB's supervisory tasks (2019)

Supervision of banks

Europese Rekenkamer

Contact Committee

Prudential supervision of medium-sized and small (“less significant”) institutions in the European Union after the introduction of the Single Supervisory Mechanism (PDF) - Report of the Task Force on European Banking Union to the Contact Committee of Supreme Audit Institutions of the European Union and the European Court of Auditors (14-12-2017)

Austria

Bericht des Rechnungshofes Österreichische Bankenaufsichtsarchitektur (PDF), Reihe BUND 2017/20

Resolution of banks

European Court of Auditors

Contact Commitee

Preparation for resolution of medium-sized and small banks in the euro area (PDF) - Report of the Task Force on European Banking Union to the Contact Committee of Supreme Audit Institutions of the European Union and the European Court of Auditors (16-12-2020)

Estonia