Executive Summary

Two mainstream parties in Greece managed to achieve a majority in the weekend’s elections and are likely to form a government of national unity to press ahead with the terms of the country’s bailout. A Greek default has however not been ruled out.

Earlier this month, the European Commission adopted its package on bank recovery and resolution with the aim of putting banks on a stronger footing to face down future crises.

German Chancellor Angela Merkel has made it abundantly clear that a banking union is impossible without first establishing a fiscal union – an idea resisted by France and Italy, not to mention the UK.

The Spanish bailout and the uncertainty in Greece have pulled the Eurozone closer to a banking union, and it remains to be seen whether it can be designed in a way that suits both the weaker and stronger economies and does not undermine the EU’s single market in financial services.

It was the most eagerly anticipated European election in recent times. Greece - a country of 10 million people making up less than 2% of the EU’s GDP - commanded the attention of newsrooms around the world.

However, this was no ordinary election. The future of the Euro was at stake.

There has been widespread relief, not least in Berlin, that the two ‘mainstream’ parties have managed to achieve a majority between them. They are likely to form a government of national unity in order to press ahead with the terms of the country’s bailout, although they will still insist that the EU, the ECB, and the IMF cut them some slack.

Uncertainty still remains, however. A government has not yet been formed, and the possibility that Greece could default is still very much a prospect.

More power to Barroso and his EBU

The reason why the world held its breath last night is clear: a victory for the anti-bail-out party, Syriza, would have had a huge impact on Europe’s banking system.

Some €44bn (£35bn) of bank deposits have already been withdrawn from the country's banks since April last year. If New Democracy fails to form a government, a run on the banks would be inevitable.

This only gives more power to Commission President Barroso’s call for a European banking union. Weak banks in Greece – but also in Spain – have made it relatively easy for a customer to move their money to a bank in another country where the banks are stronger.

Although up to €100,000 of deposits are guaranteed, it is the banking system within each country that ultimately maintains the guarantee. A European banking union would, amongst others, guarantee deposits, giving the Eurozone banking system a level of stability.

Earlier this month, the European Commission adopted its package on bank recovery & resolution with the aim of putting banks on a stronger footing to face down future crises.

The 156-page document lays out in three stages the preventative measures that banks must put in place, together with detailed recovery plans should they get into difficulty. It then makes provisions on early intervention and debt restructuring to save an ailing bank and finally enables national authorities to take control of any bank that must be wound up, in whole or in part.

Over-estimating political will?

President Barroso has said the necessary fundamentals can be put in place for a banking union made up of large and systemically important banks within a year – but he seems to be over-estimating the political will.

German Chancellor Angela Merkel has made it abundantly clear that a banking union is impossible without first establishing a fiscal union – an idea resisted by France and Italy.

Moreover, Sabine Lautenschläger, Vice-President of the Bundesbank, believes that a common banking authority would be impossible without a collective budget policy.

“Remorseless logic”

Although the UK Chancellor George Osborne has talked about the “remorseless logic” of greater Eurozone integration, a banking union for the Eurozone would put the UK – home to the world’s leading financial centre - in an almost impossible situation

Prime Minister David Cameron is clear that the UK Government “wouldn’t ask British taxpayers to stand behind the Greek or Spanish deposits… It is not our currency, so that would be inappropriate”.

However, Cameron is anxious to secure safeguards for the City of London where it is operating outside a European banking union.

Whether he will succeed is an open question. A host of new banking rules that only apply to Eurozone countries would certainly lack credibility if the EU’s largest exporter of financial services is not included.

Indeed, according to British Liberal Democrat MEP and Chair of the Parliament’s Economic & Monetary Affairs Committee Sharon Bowles, if a Eurozone-only banking union goes ahead, “the single market in financial services ceases to exist”. In that scenario, wider questions about UK membership of the EU arise.

A divided Eurozone

France remains the most vocal supporter of a banking union. Last week, French Finance Minister Pierre Moscovici said that the aid package of up to €100 billion for Spain's banks is just the first step towards a banking union.

Newly-elected French President François Hollande is forming an alliance with Italian Prime Minister Mario Monti, on integrating the banking sector as well as the partial pooling of sovereign debts through the creation of Eurobonds. Ms Merkel, beginning to look isolated, has for her part lost patience with the increasingly high expectations on Berlin alone to foot the bill.

No turning back

It is unclear how the competing positions on further integration will be reconciled.

The Spanish bailout and uncertainty in Greece have pulled the Eurozone closer to a banking union. Yet whilst there is certainly “remorseless logic” to the idea, it remains to be seen whether it can be designed in a way that suits both the weaker and stronger economies and does not undermine the single market in financial services, with the City of London sitting outside the Eurozone.

As with so many episodes in the Eurozone drama, the past two weeks have seen disaster loom large, only to be averted at the last moment.

Eurozone leaders have dodged the bullet at the weekend’s Greek elections re-run – described as a “financial Cuban missile crisis” - but some fundamental decisions still need to be taken.

Nothing less than a credible and definitive recovery plan will do.

Contact Kevin.Doran@grayling.com