The Cyprus lesson on banking union

Lots of authors pointed out that the Cyprus deal highlighted the fact the EU does not have a banking union and that it probably will never have proper banking union one. While this observation is correct, there is something more worrying than that. Seeing, how complicated it was for Cyprus politicians to come up with a some sort of a deal, and that they did so only once they were days away from financial and economic meltdown of their country, makes me think how everything would look like if there indeed would be a banking union in Europe.

First note, that even if there would be full-fledged banking union, the authorities would be surely loath to simply bail out Cyprus banks without imposing losses on the creditors. Indeed the set of rules to be implemented in 2018 for dealing with failing banks provides for sharing the costs with the creditors of the problematic institutions. This would mean, that even in situation with banking union, uninsured depositors would be hit, albeit (probably) to a lower degree. The big question is whether the Cyprus political system and, even more, the Cyprus society would accept this? One does not have to be skeptic to be hard-pressed to imagine this. The truth is that as in the present situation, Cyprus would not have a choice but to budge. Nevertheless, the resentment towards EU would be even stronger than now, because the deal would be completely (as opposed to partially) made in Brussels, a favorite target of public rage.

However, what about the situation when the sovereign has to capacity to protect the creditors in banks? It is hard to imagine that Germany would ever allow EU institution to impose losses on the depositors - reaction similar to the reaction of Belgian politician to demands of Oli Rehn would for sure be forthcoming. But similar logic goes for the less controversial case of other creditors (such as bond holders) as long as they would be concentrated in Germany. The EU institution would then find it hard to prevent mutualization of losses on the national level since it would not really concern it (its money would not be used).

What this analysis is aiming to show is that even if EU has fully functioning institutions of banking union, the link between sovereign and banks is unlikely to be completely destroyed. This is because EU institutions simply lack the public legitimacy of domestic political institutions and hence they decisions are viewed as decision of outsiders. It is akin to girlfriend of your brother making decisions about the organization of your common home – while she is related to the family, when push comes to show, she is not part of the family.