Thus, a major banking sector problem will cause fiscal distress (as happened in Ireland and Cyprus), and conversely, reckless fiscal management will result in a credit squeeze (as in Greece). It refers to the mechanism – first observed by IMF scholars in 2009 (Mody 2009, Zoli and Sgherri 2009) and then increasingly acknowledged in European policy discussions – by which sovereign risk and bank risk are highly correlated with each other in Europe’s monetary union. That sentence opened the June 2012 summit statement, and was repeated identically on several subsequent occasions. The same leaders, however, associated Banking Union from the start with a clearly stated objective, namely, that “t is imperative to break the vicious circle between banks and sovereigns”. The bank-sovereign vicious circle forms through direct and indirect financial linkages Euro area leaders endorsed Banking Union as their policy at a landmark summit in late June 2012, but waited almost a year until adopting the expression itself.
Its first recorded use in public (Veron 2011) was made outside of officialdom (albeit on a suggestion from a European Commission official, Maarten Verwey), and it was gradually popularised in expert circles and the media. “Banking Union” has become a widely used expression to refer to the project of shifting banking sector policy instruments from the national to the European level, but there is no official or legal definition of what it is or should be. Even the minimalist version, however, entails more reforms than those publicly under current consideration. A narrow interpretation, based on euro area leaders’ past commitments, equates it with breaking the bank-sovereign vicious circle a more ambitious long-term vision for complete Banking Union implies the removal of all cross-border distortions within the euro area banking market. They inevitably raise the question of what criteria should be used to assess the Banking Union’s completeness. These public calls echo those made in more formal settings, in intergovernmental meetings (European Council 2014) and in European Commission communications (European Commission 2015) over the last half decade. Several euro area leaders, including the German chancellor, her finance minister, and the French president, have recently referred to the need to “complete the Banking Union”.
This column is a lead commentary in the Vo圎U Debate " Euro Area Reform"
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