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What Is the Banking Union

In response to the 2008 financial crisis, EU is establishing a unified rulebook for financial players across the EU's 27 countries. This rulebook includes heightened prudential standards for banks, enhanced depositor protection, and mechanisms for managing failing banks. This foundation laid the groundwork for the Banking Union.

Given the evolving financial crisis into the euro area debt crisis, deeper integration of the banking system became crucial for the interconnected euro area countries. This led to the establishment of a Single Supervisory Mechanism (SSM) and a Single Resolution Mechanism (SRM) for banks in the banking union. While the first two pillars of the banking union, SSM and SRM, are fully operational, the third pillar, the European Deposit Insurance Scheme (EDIS) or Crisis Management and Deposit Insurance (CMDI) , is yet to be implemented.

Despite the progress, the EDIS legislative process has been delayed for over seven years. In April 2023, the European Commission proposed strengthening the EU bank crisis management and deposit insurance framework, with a focus on smaller banks, to enhance the SRM and advance the banking union's completion. The Commission's second single supervisory mechanism report also affirmed the SSM's success and effectiveness.

Bank Crisis Management

The European Union's bank crisis management framework aims to ensure the stability and resilience of the financial sector, protect depositors, and minimize the potential impact of bank failures on the broader economy.

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The goals of EU bank crisis management can be summarized as follows:

1. Financial Stability: One of the primary goals is to maintain the stability of the financial system. By effectively addressing and resolving the crisis situations of individual banks, the EU seeks to prevent the spread of financial contagion that could lead to systemic risks and destabilize the entire banking sector.
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2. Depositor Protection (CMDI): Protecting the interests of depositors is a key objective. Crisis management measures are designed to ensure that depositors' funds are safeguarded and that depositors have access to their funds, even in the event of a bank failure. This helps maintain confidence in the banking system.

3. Minimize Systemic Impact: The crisis management framework aims to minimize the systemic impact of bank failures. By resolving failing banks in an orderly and controlled manner, the EU seeks to prevent a domino effect that could disrupt financial markets and impact economic stability.

4. Resolution in an Orderly Manner (SRM): The goal is to resolve failing banks in a way that avoids the need for taxpayer-funded bailouts. Instead, the emphasis is on using the resources of the failing institution itself, as well as the Single Resolution Fund, to facilitate a smooth resolution process.

5. Effective Supervision and Oversight (SSM): Effective crisis management requires strong supervision and oversight. The EU's framework includes mechanisms for coordinating and cooperating with national supervisory and resolution authorities, as well as centralizing authority through bodies like the Single Resolution Board (SRB).

6. Minimize Disruption to Services: The goal is to ensure the continuity of critical banking services, even during a crisis. Measures are taken to minimize disruptions to essential financial services, payments, and lending activities that are crucial to the functioning of the economy.

7. Fair Treatment of Creditors: The crisis management framework seeks to ensure fair and consistent treatment of creditors, including shareholders and debt holders. This may involve using resolution tools like bail-ins, where creditors contribute to covering losses before public funds are used.

8. International Cooperation: Given the interconnectedness of global financial systems, the EU's crisis management goals also involve cooperation and coordination with international counterparts and bodies to address cross-border banking crises effectively.

9. Maintain Public Confidence: Building and maintaining public confidence in the banking system is vital. By demonstrating a credible and effective crisis management framework, the EU aims to reassure the public, investors, and market participants that the financial system is resilient and capable of withstanding shocks.

European Deposit Insurance Scheme (EDIS) - Crisis Management and Deposit Insurance (CMDI)

1. European Deposit Insurance Scheme (EDIS)

The European Deposit Insurance Scheme (EDIS) is a proposal aimed at creating a common deposit insurance framework for banks within the European Union. Its primary goal is to enhance depositor protection and promote financial stability across EU member states. EDIS is a component of the broader EU banking union initiative, which seeks to establish a more integrated and harmonized banking and financial system across the member states.

Key features and goals of EDIS include:

- **Deposit Protection:** EDIS aims to provide a consistent level of protection to bank depositors across all EU member states. It would ensure that depositors' funds up to a certain threshold are safeguarded in case of a bank failure.

- **Risk Reduction and Risk Sharing:** EDIS is designed to contribute to both risk reduction and risk sharing. Risk reduction involves measures to reduce the likelihood of bank failures and improve the stability of the banking system. Risk sharing refers to the idea that financial burden should be shared collectively across EU member states, rather than falling solely on the affected country's resources.

- **Phased Implementation:** The implementation of EDIS was proposed to occur in several phases, allowing for a gradual transition to a fully integrated system. The first phase would involve the establishment of a national deposit insurance system in each member state, followed by the establishment of a European Deposit Insurance Fund (EDIF), which would provide financial support in case of significant cross-border bank failures.

- **Mutualization:** The ultimate aim of EDIS is to achieve a level of mutualization where the EDIF would be funded by contributions from both national deposit insurance systems and a European component. This would lead to the pooling of resources to manage and cover potential losses from bank failures.

2. **Crisis Management and Deposit Insurance (CMDI)

"Crisis Management and Deposit Insurance" (CMDI) seems to be a broad term that could encompass various aspects of how a country or a region handles banking crises and protects depositors. It could include a combination of regulatory, supervisory, and resolution measures aimed at maintaining financial stability and safeguarding depositor funds.

In the context of the EU, CMDI would likely refer to the combined approach of managing banking crises and ensuring the availability of effective deposit insurance mechanisms. This approach would involve:

- **Supervision and Regulation:** Implementing strong regulatory frameworks and effective supervisory mechanisms to prevent excessive risk-taking by banks and ensure their financial soundness.

- **Crisis Management:** Developing plans and mechanisms to manage banking crises in an orderly manner, including resolution strategies that minimize the use of public funds and protect critical financial functions.

- **Deposit Insurance:** Establishing deposit insurance systems that provide a level of protection to depositors in the event of bank failures. These systems are intended to maintain confidence in the banking system and prevent bank runs.

- **Coordination:** Coordinating efforts among national authorities, central banks, and relevant EU institutions to ensure a unified response to banking crises and deposit protection.

It's important to note that the specifics of CMDI would depend on the regulatory framework and policies of individual countries or regions, as well as any regional initiatives such as those within the European Union. For the most accurate and up-to-date information, I recommend consulting official EU documents and sources related to banking and financial regulations.

Sovereign bond-backed securities (SBBS)

The European Union is actively engaged in eliminating unwarranted regulatory barriers that hinder the advancement of SBBS (Simple, Transparent, and Standardized Securitization), a novel financial instrument. SBBS has the potential to mitigate risk within the banking union by facilitating additional diversification of portfolios within the banking sector.

Sovereign bond-backed securities (SBBS) are a novel financial instrument backed by a diversified portfolio of euro area central government bonds. They have been proposed as a solution to address the challenge of banks having concentrated sovereign exposures, which can create vulnerabilities in the banking and fiscal sectors.

During the euro area debt crisis, the "doom loop" illustrated how a bank's financial troubles could negatively impact its home government's fiscal outlook, and in turn, weaken the banks holding its bonds, often those within its jurisdiction.

SBBS could mitigate this issue by enabling banks to diversify their sovereign holdings and reducing the link between banks and their home governments. This would enhance risk-sharing among investors and across borders without entailing mutualization of risks and losses among euro area countries. Instead, only private investors would share potential risks and losses.

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In May 2018, the Commission introduced a legislative proposal aimed at facilitating the emergence of an SBBS market. The proposal's objective is to ensure equitable treatment by eliminating unnecessary regulatory barriers and providing SBBS with the same regulatory standing as national euro-area sovereign bonds. This includes aspects such as capital requirements, eligibility for liquidity coverage, and collateral usage.

This initiative is designed to lay the groundwork for the organic growth of the SBBS market, thereby increasing the supply of euro-denominated, low-risk, and highly liquid assets. Banks and other financial entities investing in these assets will enjoy improved portfolio diversification and reduced sovereign bond portfolio risk, contributing positively to the overall stability of the financial system.

In April 2019, the European Parliament endorsed the final agreement encompassing a comprehensive array of reforms proposed by the Commission, including those related to SBBS.