Banking Union: a powerful reform

A single policy or reform can rarely achieve multiple objectives simultaneously. The Banking Union is potentially such a policy. First, the Banking Union can solve the credit supply malfunctioning within the euro area, namely it can permit the monetary policy impulse to be transmitted more uniformly across the Union. Second, the Banking Union can solve the credit demand malfunctioning within the euro due to the uncertainty on the future existence of the eurozone.

A short narrative

Consider Figure 1 that shows on the left panel the 1-month Libor on the euro (and the dollar). The crises in the euro periphery that resulted in the sequential bailouts program of Greece, Ireland and Portugal are closely related to the increasing tension in the european interbank market. The right panel of Figure 1 plots the spread between the Italian and the German bonds and shows that shortly after Portugal's bailout the tension precipitated in a fully fledged financial crisis. Figure 1 also shows the approximate dates of the ECB main interventions. These interventions have been highly successful in lowering tensions in the interbank market, first by intervening directly in the banking sector and second by announcing the OMT.  Figure 2 shows fixed investment spending for Germany, France and Italy together with the MFI interest rates on loans on new businesses. Fixed investment is basically the only component of spending that co-moves during that period in the three largest economies of the euro area (other spending components, or say unemployment exhibit a different, more idiosyncratic, behaviour). Fixed investment decreases after what could be labeled a large uncertainty shock (the increase in the btp/bund spread). The observation that fixed investment in UK increased (not shown) after the shock is an indication that the uncertainty concerns the euro. The Banking Union would signal a very strong commitment to the euro and potentially reverse the negative uncertainty shock. A positive certainty shock could even boost investment. The right panel of Figure 2 shows that the normalisation in the interbank market has not yet  been transmitted uniformly to the real economy across the three countries. The Banking Union should permit a more uniform transmission of the monetary policy allowing credit conditions to be more harmonised across the euro area.


Click to enlarge