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Since the last global/European financial crisis some fifteen years ago, the European Commission has put in place a number of initiatives to create a safer financial sector, i.e. the “banking union” for the European single market. These initiatives form a single rulebook for all financial players in the EU-27; it also includes: stronger prudential requirements for banks, improved protection for depositors, as well as some rules for managing failing banks, etc.
Background
Among numerous sectoral “unions” within the European Union’s architecture there is one that affects citizens’ everyday life. It is the banking union that ensures that banks in the member states are strong and supervised in an efficient way. However, there are some differences in the EU’s banking union and the capital markets union.
The EU-wide banking union is a complex structure, which consists of numerous “building blocks”, such as e.g. supervisory mechanism, with a system for deposit guarantees and integrated crisis management framework; and a single supervisory mechanism, which has been regarded as a significant priority’s instrument. The Commission has established some measures to create a safer financial sector, which could form a single EU-wide rulebook to include the states’ financial institutions. They additionally included stronger prudential requirements for national banks, improved protection for depositors and rules for managing failing banks.
Reference: https://ec.europa.eu/info/business-economy-euro/banking-and-finance/banking-union/what-banking-union_en/
A special Commission’s website devoted to complex “banking union” issues includes the following “regulatory items”: a) single supervisory mechanism, SSM which gives the European Central Bank certain supervisory tasks over the EU and the member states’ financial systems; b) single resolution mechanism, SEM, which serves as a central EU-wide institution for bank resolution in the member states; c) European deposit insurance scheme aimed to protect retail deposits in the banking union; and d) sovereign bond-backed securities, SBBS to remove unjustified regulatory impediments to securities’ development; it is a new financial instrument (from April 2019) which is assisting in reducing risk in the banking union by supporting further portfolio diversification in the banking sector.
More in: https://finance.ec.europa.eu/banking-and-banking-union/banking-union_en
On SBBS in: https://finance.ec.europa.eu/banking-and-banking-union/banking-union/sovereign-bond-backed-securities-sbbs_en
As the consequences of the financial crisis for the eurozone have shown, a deeper integration of the banking systems was needed; therefore two EU-wide additional “unified mechanisms” have been established for banks, mainly for the eurozone with a voluntary participation of other states: a single supervisory mechanism, SSM (from 2017) and a single resolution mechanism, SRM (final version in 2019).
On supervisory mechanism in: https://ec.europa.eu/info/business-economy-euro/banking-and-finance/banking-union/single-supervisory-mechanism_en
On resolution mechanism in: https://ec.europa.eu/info/business-economy-euro/banking-and-finance/banking-union/single-resolution-mechanism_en
Additional references to: Commission Communication in: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52012DC0510; as well as in: http://ec.europa.eu/internal_market/finances/policy/map_reform_en.htm
On EDIS in: https://ec.europa.eu/info/business-economy-euro/banking-and-finance/banking-union/european-deposit-insurance-scheme_en
However, there were some problems in the banks that needed closer attention; they presented risks to the banking sector in the states, as the so-called non-performing loans (or “NPLs”, which are bank loans that are subject to late repayment or are unlikely to be repaid by a borrower), and sovereign bonds (so-called sovereign-bond-backed-securities, SBBS); in April 2019 the European Parliament endorsed the final agreement on the comprehensive set of reforms proposed by the Commission.
On NPLs in: https://ec.europa.eu/info/business-economy-euro/banking-and-finance/financial-supervision-and-risk-management/managing-risks-banks-and-financial-institutions/non-performing-loans-npls_en
On sovereign bonds in: https://ec.europa.eu/info/business-economy-euro/banking-and-finance/banking-union/sovereign-bond-backed-securities-sbbs_en; and https://ec.europa.eu/info/publications/180524-proposal-sbbs_en
Regulative foundation for the EU banking union
At the post-financial crisis and the euro area debt crisis it became clear that deeper integration of the banking system was needed for the euro area countries, which are particularly interdependent. The banking union applies to countries in the 21 euro area (with the lately joined Bulgaria and Croatia); non-euro area countries can also join.
On the basis of the European Commission roadmap for the creation of the banking union, the EU institutions agreed to establish: a) single supervisory mechanism (SSM), and b) single resolution mechanism (SRM) for banks. Over €4,5 trillion of taxpayers’ money being used to rescue banks in the EU during the complexities of the link between sovereign debt and bank debt.
More in the roadmap Communication (2012) at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52012DC0510
Additionally, on SSM in: https://finance.ec.europa.eu/banking/banking-union/single-supervisory-mechanism_en;
On SRM in: https://finance.ec.europa.eu/banking/banking-union/single-resolution-mechanism_en
In October 2017 the Commission published a Communication from the Commission called “Completing the banking union”, which initiated the adoption of measures to tackle remaining risks in the banking sector and suggested new actions to reduce non-performing loans while assisting banks to diversify their investment in sovereign bonds. The communication also aimed to give new impetus to the negotiations on the European deposit insurance scheme (EDIS) and structured the steps towards the setting up of a “last resort common fiscal backstop for the single resolution mechanism”.
Reference to: https://ec.europa.eu/finance/docs/law/171011-communication-banking-union_en.pdf
Then, in April 2023 the European Commission adopted a proposal to adjust and further strengthen the existing EU bank crisis management and deposit insurance (CMDI) framework, with a particular focus on medium-sized and smaller banks. The reform intends to specifically strengthen the SRM and paves the way for further progress on completing the banking union.
More in legislative proposals at: https://finance.ec.europa.eu/publications/reform-bank-crisis-management-and-deposit-insurance-framework_en
Finally, the Commission also published in 2023 its second single supervisory mechanism report. The report concluded that, overall, the SSM works well and is now a well-established supervisory authority, which delivers on the objectives set out when it was created. Hence, the banking union’s structure is presently composed of: SSM and SMR coped with EDIS and SBBS.
More on the report in: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52023DC0212.
Main banking union’s components
The first two components (or ‘pillars’) of the banking union – the SSM and the SRM – are now in place and fully operational; however, the work on the banking union was ongoing since its third pillar, the European deposit insurance scheme (EDIS), which was proposed in 2015. However, the legislative process has been put on hold for more than seven years by the European Parliament and Council. The EDIS provided stronger and more uniform insurance covering all retail depositors in the banking union. The EDIS proposal builds on the system of national deposit guarantee schemes (DGS) regulated by Directive 2014/49/EU; this system ensured that all deposits up to €100 000 are protected through national DGS all over the EU.
More in Commission Communication (2017): https://finance.ec.europa.eu/publications/communication-commission-completing-banking-union_en
In completing the banking union the EU made the following steps: on 18 April 2023 the European Commission adopted a proposal to adjust and further strengthen the existing EU bank crisis management and deposit insurance (CMDI) framework, with a particular focus on medium-sized and smaller banks. The reform will strengthen the SRM and paves the way for further progress on completing the banking union.
The Commission also published its second single supervisory mechanism report, which concluded that “overall, the SSM works well and is now a well-established supervisory authority, which delivers on the objectives set out when it was created”.
Source and citation from: https://finance.ec.europa.eu/banking/banking-union/what-banking-union_en
To a certain degree, all four pillars of the banking union (SSM, SRM, EDIS and SBBS) are now in place although the whole system is too complicated for the banks in the member states to be fully operational. For example, in the single supervisory mechanism it is the ECB which is responsible for supervising all banks; however, recent examples in the Baltic States’ banks (even relatively small ones) have shown that “difficulties” can have significant negative impacts on the financial stability of the member states. ECB exercises supervision of banks and credit institutions together with the national supervisors and the European Banking Authority, EBA.
Global financial integration and the EU single market have enabled the banking sector in some member states to outgrow national GDP, resulting in institutions which are “too-big-to-fail” and “too-big-to-save” under existing national arrangements. On the other hand, experience shows that the failure of even relatively small banks may cause cross-border systemic damage. Furthermore, as soon as the bank “runs across borders”, that can critically weaken national banking systems, further damaging the fiscal standing of the sovereign and hastening funding problems for both. The Commission underlined that a banking union should include a more centralized management of banking activities, with a “common mechanisms to resolve banks and guarantee customer deposits”. Hence, the ideas of supervisory and risk reduction measures have been adopted at the end of 2018.
More in: https://ec.europa.eu/info/publications/180606-report-banking-union-risk-reduction-measures_en/
Two “unions” in cooperation for banking and capital markets
The Commission suggests the following perspectives in the banking union: – adequate legislation for the practical implementation of the banking union; – controlling transformation and implementation deposit guarantee schemes in the states, as well SMEs access to the credit institutions, prudential supervision of credit institutions and investment companies; – creating a framework for the recovery and resolution of credit institutions and investment firms; – increasing prudential supervision of credit institutions from the ECB’s side; and – amending certain provisions of the EBA’s regulations.
However, there are some differences in the EU’s banking union and the capital markets union. Thus, the EU-wide initiatives for a safer financial sector include the following directions: a) stronger prudential requirements for banks, b) improved protection for depositors, and c) rules for managing failing banks.
Whereas, the capital markets union is an idea of creating a single market for the “European capital” with the ultimate aim of “getting existing money” (i.e. investments and savings) flowing across the EU-27 states, so that this “flow” can benefit the member states’ consumers, investors and companies. Therefore, the capital markets union is supposed to: = provide businesses with a greater choice of funding at lower costs and provide SMEs in particular with the financing they need; = support the post-pandemic socio-economic recovery and increase employment; = offer new opportunities for savers and investors; = create a more inclusive and resilient national economy; = help Europe deliver its new “green deal” and digital agenda’s transitions; = reinforce the EU-wide global competitiveness and autonomy; and = make the whole EU financial system more resilient and stable.
More in: https://finance.ec.europa.eu/capital-markets-union-and-financial-markets/capital-markets-union/what-capital-markets-union_en
International banking regulations
The EU-27 member states are applying the Basel III standards since January 2025; in mid-2024, the EU institutions completed implementation phase of these standards into the member states’ legislation. The new rules represent a vital step in strengthening stability and resilience of the EU-wide banking sector. Besides, the Basel standards are aimed at facilitating European economic growth, competitiveness as well as preserving the banking sector’s global level playing field.
More in: https://www.integrin.dk/2024/07/31/basel-iii-and-the-eu-banking-sector-strengthening-financial-stability-and-resilience/
There are the following main Basel III principles:
= Minimum capital requirements: Basel III accord increases the minimum capital requirements for banks from 2% in Basel II to 4.5% of common equity, as a percentage of the bank’s risk-weighted assets. There is also an extra 2.5% buffer capital requirement that brings the total minimum requirement to 7% in order to be fit into the Basel’s rules. Thus, banks can use the buffer when they face financial stress, but using the buffer can lead to even more financial constraints when paying dividends.
= Counter-cyclical measures: in 2015, the Tier I capital requirement increased from 4% in Basel II to 6% in Basel III; the latter includes 4.5% of Common Equity Tier 1 plus 1.5% of additional Tier 1 capital. These requirements were originally meant to be implemented starting in 2013, but banks have had until January 2022 to implement the changes.
= Leverage ratio: Basel III introduced a non-risk-based leverage ratio as a backstop to the risk-based capital requirements. Banks are required to hold a leverage ratio in excess of 3%, and the non-risk-based leverage ratio is calculated by dividing Tier 1 capital by the average total consolidated assets of a bank. For example, the US Federal Reserve Bank fixed the leverage ratio at 5% for insured bank holding companies, and at 6% for Systematically Important Financial Institutions (SIFI), in order to conform to this requirement.
= Liquidity requirements: Basel III introduced the use of two liquidity ratios, including the Liquidity Coverage Ratio, LCR and the Net Stable Funding Ratio, NSFR; the former requires that banks are supposed to hold sufficient highly liquid assets that can withstand a 30-day stressed funding scenario, specified by the supervisors. This standard was introduced in 2015 at only 60% of its stated requirements and it was expected to increase by 10% each year until 2019, when it takes full effect. The NSFR mandates that banks maintain stable funding above the required amount of stable funding for a period of one year of extended stress.
Source and reference: https://www.delphix.com/glossary/basel-iii