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Forget Brexit – banking looks set to kill the EU dream

While public attention has focussed on the British vote to leave the European Union, an even deeper crisis has been brewing in the EU banking sector.  Italian banks are desperate for a new round of bailouts, while similar crises are worsening for Spanish and Portuguese banks.

All three countries pose a challenge to the EU fiscal pact that was agreed in 2011 as a response to the 2008 global banking crash.  The pact required banks to go through a “bail-in” process before any further central bank bailouts can be provided.  However, these bail-ins – which require shareholders and bondholders (including depositors in some cases) to lose their money – look set to result in bank runs of the kind witnessed in 2007/8, as investors desperately seek to withdraw their money ahead of any threatened bank collapse.

According to Simon Nixon at the Wall Street Journal this threat is generating a crisis of legitimacy in the EU even deeper than the crisis caused by Brexit:

“The EU is primarily a system of legally binding rules agreed among governments and enforced by a supranational court. But what happens when a sizable number of citizens decide EU rules are harmful to their interests—or worse, prevent national governments from fulfilling their duty to protect their citizens?”

The governments of Italy, Portugal and Spain have each sought exemption from the EU fiscal charter – which has already been harshly applied to Greece – in an attempt to avoid a possible bank collapse that might well spread into the wider EU and global banking sector.  However, thus far German intransigence has prevented any relaxation of the rules.  This said, according to Nixon there are growing demands for some “flexibility”:

“But excessive flexibility also brings risks. Both the fiscal and banking rules were designed to prevent fiscal risks spilling over among member states and were a crucial part of the political bargain that paved the way for the ECB’s bond-buying program.”

It is unlikely that the EU will risk allowing banks in member states to collapse.  So some kind of “fudge” that gives the appearance of the rules being applied while banks are bailed out through some backdoor mechanism is most likely.  But as Nixon warns, while this may temporarily fix one of the EU’s growing existential crises, it will only do so at the cost of its own legitimacy.

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