The Cypriot catastrophe shows just how far away the euro zone is from creating its much-touted “banking union”. There was no euro zone supervision of Cyprus’ big banks, no transnational approach to put them into controlled bankruptcy, no common deposit insurance and no flow of bank rescue funds from abroad.
Instead, there was weak supervision by the Central Bank of Cyprus and a mad scramble to carve up the banks’ assets on national lines. Nicosia was left to shoulder the whole cost of protecting small depositors and the euro zone said that none of its bailout cash could be injected into the troubled banks.
Optimists hope the fiasco will provide the euro zone with the impetus to complete its banking union. But it is equally possible that core countries such as Germany, Finland and the Netherlands will become even more reluctant to absorb the liabilities of bust peripheral banks.
Indeed, Jeroen Dijsselbloem, the Dutch finance minister who runs the Eurogroup, suggested last week that the treatment meted out to Cyprus could be a model for other bailouts – though he later said his words had been taken out of context.
Last summer at the height of the panic over Spain’s banks, the euro zone embarked on the initial step towards banking union. The idea was to break the “doom loop” under which weak banks were dragging down weak governments and vice versa. Leaders agreed that the European Stability Mechanism (ESM), the zone’s bailout fund, could be used to recapitalise bust banks — but only once an effective supervisory mechanism was in place. The European Central Bank was chosen to be that supervisor.