News that the European Parliament finally agreed the terms for ‘banking union’ on 20 March 2014 raised lacklustre cheers from the world of finance. The ‘union’ here is regulatory, taking the management of troubled big banks out of the hands of the many national authorities and putting it into the hands of the few European authorities. That is a big deal, as far as the control of the industry is concerned. However compromises and complexity make this a deal that needs a little unpeeling to understand.

Q: How is banking union defined?

A: Central supervision of the 6000-odd banks in the Eurozone and the central management of resolution in the event of bankruptcies.

Q: So the United States of Europe begins in the world of financial regulation?

A: The perception is that Europe needs a common standard for dealing with supervision and bankruptcy if its banks are to regain the confidence of counterparties, investors and most importantly the public whose earnings have funded the industry and its employees.

Q: So who regulates the banks now?

A: They are still overseen by national competent authorities, but there are two new mechanisms centrally controlled in Europe. Firstly, the existing European Banking Authority (EBA) had its role and powers adapted so that it is able to create a single rule book and enforce a balanced approach to supervision across states, but with specific supervision tasks now conferred upon the European Central Bank (ECB).

It has responsibility for authorising banks, compliance with elements of the Basel capital adequacy rules, including capital, leverage and liquidity requirements, and supervision of financial conglomerates. If a bank so much as comes close to regulatory capital requirements the ECB can make it take remedial action.

Two new regulations were put in place, one to give the ECB powers and the other to amend the EBA’s role. They were formally adopted under the creation of a bank Single Supervisory Mechanism (SSM), led by the ECB, and officially adopted by the European Union after being published in the Official Journal on 29 October 2013.

Q: Does that mean the national regulators are getting second guessed?

A: In a way – if they aren’t seen to be doing their job as Europe expects then banks can effectively be taken away from them and managed by Brussels centrally. It gets rid of any regulatory arbitrage. It also means that countries that are economically stable and bureaucratically competent aren’t stuck supporting the banks of basket-case political outliers whose governments have been forgetting to do things like collect taxes. Or govern.

Q: And what if a bank goes bust?

A: The latest decision on 20 March provisionally set up the Single Resolution Mechanism and fund, which can be used by the Single Resolution Board (SRB) which encompasses permanent members, the European Commission (EC), the Council of the European Union, the ECB and national resolution authorities.

Q: That sounds more like crowdsourcing than decision making…

A: There are over 100 people involved in making a decision but there are time constraints that ensure a decision is taken one way or the other. Germany’s finance minister, Wolfgang Schauble, pressed to ensure that Council members – finance ministers of member countries – had a say, rather than Brussels officials.

Q: So what happens then?

A: If the ECB says that a bank is failing and other banks / funds are not willing to support it, the SRB sets up a resolution scheme, the necessary resolution tools and funds. The EC has to assess the scheme and its decision can be subject to approval the Council of the European Union depending on the level of public interest in saving the bank or the funds involved. If the Council or the EC does object then the Board has to amend the plan. The scheme itself gets managed by any national resolution authorities.

Q: Who’s paying for all this?

A: The banks. Over a ten-year period, banks will be hit by a levy of 1% on deposits, which will accumulate to a target of €55 billion. Of course, Europe already has a €500 billion bailout fund in the state-backed European Stability Mechanism (ESM). By the end of 2014, around €60 billion will be available to support teetering banks.