In the last few weeks, the idea of establishing a European banking union has become the latest remedy advanced as a solution to the long-running euro crisis. But whatever the merits of a banking union — and there are many — proposals to establish one raise more questions than can currently be answered.

The motivations of those who advocate a banking union differ markedly. For some, particularly in southern Europe, it is seen as a means of shifting the burden of supporting their indigent banks to those with deeper pockets. For others, especially in the European Union’s Brussels eurocracy, it is seen as another leap forward in the construction of a European super-state.

Taking their cue from the sacred Rome Treaty’s reference to “ever closer union,” the European Commission’s theologians view every crisis as an opportunity to advance their federalist agenda.

The European Central Bank has been more thoughtful, though no less enthusiastic, arguing that a banking union or stronger eurozone-wide supervision should have three objectives:

• Reinforcing financial integration, “mitigating macroeconomic imbalances” and improving the conduct of monetary policy. How a single EU supervisor would address the problem of imbalances is not explained, but it is surely a worthy aim.

• Breaking the link between “banks and sovereigns.” This has been a particularly dangerous feature of the last year.

• “Minimizing the risks for taxpayers through adequate contributions by the financial industry.” This objective could be achieved country by country, but it is certainly arguable that an across-the-board banking levy, or a Europewide financial-transaction tax, would eliminate competitive distortions.

How might these laudable objectives be achieved?

The European Commission has argued that a fully fledged banking union would need to rest on four pillars: (1) a single deposit protection scheme covering all EU (or eurozone) banks; (2) a common resolution authority and common resolution fund, at least for systemically important and cross-border banks; (3) a single European supervisor for the same banks; and (4) a uniform rule book for prudential supervision of all banks.

Anyone who has been involved in banking supervision can see that these four pillars will require careful construction. Many individual countries have taken a generation to develop their own domestic schemes. And, in this case, three big political issues have yet to be resolved:

First, the identity of the single European banking supervisor remains undecided, and the ECB has seen an opportunity for a power grab. Central bankers in Europe have always resented the narrow monetary-policy mandate given to the ECB under the Maastricht Treaty. Banking supervision was not included among the ECB’s objectives, though one article of the treaty gives the system of European central banks as a whole the task of contributing to effective supervision. They now argue that the simplest solution would be to expand that remit and make the ECB the de facto pan-European supervisor.

That is not the outcome favored by the European Commission, which has only just set up the European Banking Authority. The EBA is closely linked to the Commission itself, and is seen as the natural candidate for a broader role.

The Commission has a case, but it also has a problem. During the political horse-trading that preceded the creation of the EBA (together with two equivalent bodies for securities and insurance), it was agreed that the new authority would be based in London. That seemed logical at the time, but not if the EBA’s role is to be broadened. How could a eurozone supervisor be based outside the eurozone?

The second unresolved question is how to achieve a banking union in legal terms. Constitutional change on this scale would normally require a new European treaty. But that would take time, and Europe’s leaders have run out of it.

Furthermore, there is no guarantee that voters in countries that require a referendum on treaty changes would support a further transfer of sovereignty.

So the likely outcome is that, in the EU’s time-honored fashion, the banking union will be constructed using existing powers, finessing the sovereignty question, and avoiding any reference to public opinion. That points toward reliance on the ECB.

The final question is what such a eurozone banking union would mean for the single financial market, and especially for EU countries that are outside the single currency. Many of them would sign up willingly, as they intend to join as soon as possible, in spite of the euro’s difficulties. But that is not the case for the United Kingdom, and London remains the continent’s biggest financial center.

I fear that the French and Germans have now lost patience with the troublesome British, and are reluctant to cut a deal. And Euroskeptic British politicians see this as an opportunity to recast the U.K’.s relationship with the EU; indeed, for some, it means a chance to negotiate an exit.

Opinion in the City of London tends to favor a middle way, which would allow the U.K. to cling to the benefits of the single market, without conceding unified regulation. That will be hard to pull off.

I suspect that a banking union of some kind will be implemented, and soon. Otherwise, the eurozone banking system will collapse. But the consequences of such a step for Europe’s great free-trade experiment could be serious and, if not managed carefully, could lead to Britain’s withdrawal. The political stakes are high, and the outcome is likely to reflect that.

Howard Davies, former chairman of Britain’s Financial Services Authority, deputy governor of the Bank of England, and director of the London School of Economics, is a Sciences Po professor. © 2012 Project Syndicate

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