Behind the scenes of establishing the European Banking Union; Power guiding capital or capital guiding power?

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Behind the scenes of establishing the European banking union:

Power guiding capital or capital guiding power?

Master Thesis

Student: Rosalinde Kranenburg Supervisor: Dr. P.W. Zuidhof Student number: 10440542

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3.3.1 Rushing the SRM and negotiating the ESM as backstop p.25 3.3.2 Outcomes of the negotiations over the SSM and ESM p.28 3.3.3 The complex negotiations over the SRM and SRF p.29 3.3.4 Outcomes of the negotiations over the SRM and SRF p.32 3.4 Liberal intergovernmentalism and the banking union p.34 Chapter 4: Back to the future: a critical political economy perspective p.38 4.1 Introduction – The socioeconomic context of the banking union p.38 4.2 Shifts in class, paradigm and the hegemonic system from the 1970s p.39

4.3 Financial regulatory reforms in Europe p.42

4.4 Sector interests in a European banking union p.48 4.5 The critical political economy and the banking union p.53

Chapter 5: Conclusion p.58

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List of abbreviations:

AFME Association of Financial Markets in Europe BCBS Basel Committee on Banking Supervision BRRD Bank Resolution and Recovery Directive CESR Committee of European Securities Regulators CRD IV Capital Requirements Directive IV

CRR Capital Requirements Regulation EBF European Banking Federation ECB European Central Bank

ESC European Securities Committee ESM European Stability Mechanism GEBI Group of Experts in Banking Issues IIF Institute of International Finance ISD International Services Directive

MiFID Markets in Financial Instruments Directive SRB Single Resolution Board

SRF Single Resolution Fund SRM Single Resolution Mechanism SSM Single Supervisory Mechanism

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Chapter 1 – Introducing the puzzle of a European banking union

1.1 Introduction to the establishment of the banking union

In 2012, the door was opened towards the most ambitious European integration project since the introduction of the euro in 1999. At the Euro area summit on 29 June 2012 in Brussels, the Eurozone heads of states and governments agreed to establishing a European banking union as part of a series of measures in reaction to the banking crisis in 2008 and the sovereign debt crisis in 2011 (European Council, 2012a). The crucial elements of this project would be a strict centralized supervision and regulation of the banks within the Eurozone and, in addition, a European resolution mechanism supported by a fund to decide over the faith of ailing banks. This was deemed necessary since the crisis revealed the problematic narrow interrelatedness of banks and government finances.

When the financial crisis spread from the United States to Europe, a number of banks within the Eurozone faced bankruptcy. Since many of these domestic banks held on their balance sheets a large share of state debt posing a financial stability risk within the Eurozone, states were left with no other feasible solution than to save their large financial institutions with public funds. However, when the sovereign debt crisis followed in 2011, this led to backlash on the domestic banks. Doubts about the solvency of several Member States negatively affected the position of the banks saved with public funds, leading towards a loss of trust of investors in the banking sector (Merler and Pisani-Ferry, 2012, p.2). The non-beneficial situation of banking problems spreading to sovereigns, and in return sovereign problems spreading to banks was referred to as the ‘doom-loop’ between banks and sovereigns. Moreover, the interdependence of states within the Eurozone sharing a single currency, the insolvency of some of the Eurozone members, such as Greece and Spain, and an accompanying variety in risk premiums for the European funding and lending markets put great pressure on the euro-system. Due to the interconnectedness of the Eurozone economies the large failing banks were seen as causing systemic risk for the stability of the Eurozone as a whole (ECB, 2013a). In spite of the size of cross-border banking systems within the Eurozone, rescuing a bank would still be the individual responsibility of the home country, potentially having large fiscal consequences for the other Member States. Indeed, rescuing the banks in the Eurozone had cost 4,5 trillion euro’s of tax payers money (European Commission, 2012a), and moreover, stimulus measures from governments in response to the banking crisis led to an increase in national debt of 520 billion euro in the Eurozone, and 690 billion euro in the EU as a whole by 2012 (Breuss, 2014, p.4).

The main goal of the proposed European banking union is to break the close link between banks and states in order to prevent tax-payers bearing the costs of big bank failures. The sector itself has to be made accountable for its actions and financial problems. Moreover, systemic risks for

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4 the Eurozone is argued to be avoided by installing a central supervisory and a resolution mechanism for the banks in the Eurozone with a common backstop, based on a single rulebook for all banks within the EU. The mechanism places the banks under central supervision to make sure they act according to the regulatory framework and to signal potential problems at an early stage. Furthermore, the banks need to have a sufficient amount of capital and liquid assets on their balance sheets as a buffer for financial problems. When a bank would find itself in a troubled position it is not able to solve itself, a resolution mechanism agreed between the central and the national supervisory authorities provides for a scheme to resolve the financial institution in an orderly manner. An important part of this mechanism is that banks no longer have to be bailed out with public funds when facing difficulties, because a bail-in mechanism of creditors and shareholders of the bank is agreed upon. In the worst case that this bail-in mechanism proves to be insufficient to cover the costs of resolution, a resolution fund filled by the banking sector itself has to provide for the funding to resolve the ailing bank (European Commission, 2012a). In very last instance, the European Stability Mechanism (ESM) will serve as a backstop to recapitalize a bank under resolution when Member States are not able to finance this resolution. The newly installed mechanisms serve to regain the trust in the banking sector, which has been regarded crucial for financing the real economy, and moreover, for saving the Eurozone (Véron, 2013, p.6-7).

Although the Member States have agreed to the establishing of a banking union, the project has far-reaching implications. A centralized system means that, first, Member States lose part of their national sovereignty over their capital providing institutions to a European regulator. Secondly, the European institutions gain influence by setting up a new supranational institution, and thirdly, the banking sector is subject to stricter central regulation and supervision curbing its activities. An additional fourth implication for some of the Member States is that to regain the trustworthiness of national state finances, budgetary rules and austerity measures have been set as precondition for access to the common mechanisms under the banking union. The Commission and the ECB, as main promoters of the banking union, have put many efforts in consulting the sector involved, drafting the proposals and advocating for more integration regarding the supervision and regulation of the banking sector. In contrast with the assumed natural support of the European institutions for more supranational governance, it is more interesting to look at the agreement of the Member States and the banking sector to the proposal.

The agreement of both the Member States and the sector to the establishing of the banking union poses two related puzzles. Firstly, the banking union removes part of the national discretion over financial regulation and supervision from the Eurozone Member States. One would not have expected sovereigns to surrender autonomy over their national credit-providing institutions, while these are perceived as an important basis for the functioning of the real economy and for providing

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5 national prosperity. Agreeing to a banking union means less power for states to benefit their national economies by balancing banks’ risks and returns, by assisting in competitive banking or by preventing the winding-down of preferred national financial institutions and avoiding foreign banks to absorb national banking assets (Epstein and Rhodes, 2014, p.3). The power of Member State governments over their national financial institutions will decrease with a European banking union. Although the crisis and its effects have provided a pressing imperative towards installing a more prudent supervision of financial institutions and resolution mechanisms, the banking union is a very ambitious integration project while also including access of failing banks to common European funds. An interesting question is therefore why national governments have agreed to transfer an important share of sovereign power over their financial institutions towards a supranational level.

Secondly, when looking at the financial sector usually in favor of deregulation, one would expect major objections to a strict supervisory mechanism, a resolution mechanism including a fund filled by the banks themselves, and enhanced requirements for the banks to adhere to. Paradoxically, this has not been the case in practice. Throughout the negotiations over the establishment of the banking union the main part of the Eurozone banking sector has supported the project and a European banking sector lobby in Brussels has even actively backed the proposals of the Commission and the ECB. In many instances the sector has voiced its support for a European banking union which is in its core meant to restrict banks in their operations and make them adhere to supranational prudential rules, instead of remaining subject to domestic regulators, which have been able to apply some measure of discretionary space to support the banks based within their borders.

The two puzzling issues regarding the establishment of the banking union therefore require further explanation. These issues are, first, that Member States are largely surrendering national sovereignty over their large cross-border banks which they before regarded as crucial to keep within their national power reach and, secondly, the heterogeneous stance of the big banks within the Eurozone in favor of a banking union which is meant to install a stricter supranational regulatory and supervisory authority to avoid imprudent behavior of the banks in their pursuit of capital. This thesis aims to understand the motives for further integration by explaining why the Member States as well as the sector have agreed to a banking union which appears not to be in the direct interest of either of them. Could the banking union be construed as a rational choice of Member States to overcome the negative domestic effects of the banking crisis and sovereign debt crisis? Or is there more to it, and should we take into account the heterogeneous position of the European banking sector as a signal of the presence of other motives outside the national realm in support of more integration? More importantly, if there are indeed other influential non-democratic powers surrounding the decision makers, will the effects of the banking union then ultimately be in the general interest or does the project pose a legitimacy issue for being based on sector interests instead?

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6 Based on the above, the main question we will try to answer in this thesis, is whether we can explain the establishment of the banking union as following from rational considerations of national Member States based on their domestic preferences shaped within a national realm, or if we should look for the origins of these national preferences in a broader context in which financial powers have been guiding the choice for more European integration. In order to answer this question we will explore the motives of the Member States and the banking sector regarding the pursuing of a European banking union and the processes leading towards its establishment to identify the origins of the power determining European integration. More importantly, exploring the power base and the consequences of the establishing of the banking union for the people in the Eurozone enables us to draw a normative conclusion about the legitimacy of this European integration project.

1.2 Methodology

In order to explain the establishment of the banking union, this thesis will provide a closer look at the process of European integration and whose preferences and interests are guiding its outcomes. Based on the research question of this thesis, in the second chapter the theoretical framework provides two contrasting approaches for understanding European integration. Both theories focus on different explanations of European integration regarding the role and place of the actors involved in the integration process, and in this they form a mutual criticism. The first theory is the liberal intergovernmental approach described elaborately by Andrew Moravcsik, which roughly presents a revision of the classical debate between the neofunctionalist and neorealist accounts. This theory explains the European integration process as based on national states’ preferences and their relative power positions in an intergovernmental negotiation process. Moravcsik claims that European integration only occurs when governments see it in their interest to give up sovereignty, based on rational arguments in favour of their domestic economies. These rational choices are based on a given ‘state of the world,’ upon which the Member States are claimed to act rationally in pursuit of their domestic interests (Moravcsik, 1998, p.20).

Contrastingly, the second theory applied to the case argues that we have to dig deeper to find the origins of European integration, by claiming that it is in fact the context that determines the national preferences of the Member States. This theory is the critical political economy as described by Bastiaan van Apeldoorn, Henk Overbeek and Magnus Ryner, which is part of the constructivist approaches within the theoretical field of European integration. The vantage point of the theory is that in order to study European integration we cannot assume a certain context within which policy is shaped as given. It claims there is a socioeconomic context constituting Member State preferences and their opinions regarding European integration (Van Apeldoorn et al, 2003, p.20). The theory

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7 argues that this socioeconomic context is guided by dominant capitalist structural powers in society other than the official decision making powers. It is assumed that these powers are able to shape the national preferences while having the power to insert a dominant economic system into society which is perceived as the best method for creating welfare. Decisions based on supporting this system are therefore regarded legitimate, although these might in fact be guided by narrow capitalist class interests (Ibid). Moreover, this structural power exceeds the different levels of decision making, while forming a transnational network within Europe widely voicing arguments in favour of more integration when this suits their interests. The theory criticizes the mainstream integration theories, among which the theories in the classical debate, for these do not take into account such a socioeconomic context guiding formal decision making powers (Ibid, p.18).

Chapter three and chapter four will assess these claims by respectively looking at the negotiation process based on the Member States national preferences and by identifying potential capitalist class structures shaping these national preferences. Chapter three reviews the intergovernmental negotiation process and its outcomes based on Moravcsiks liberal intergovernmentalism perspective. In the case of the banking union this would mean that the Member States saw it in their national interest to support central supervisory and resolution mechanisms while the perverse effects of the interconnectedness between the Eurozone members and their large banks and the risks of contagiousness were revealed during the crisis. More integration would create a stronger banking sector subject to prudent supervision regarded necessary to counter the negative effects of the crisis on financial stability within the Eurozone. The chapter argues that the banking union in this regard serves the stronger economies within the Eurozone by limiting the negative effects of the narrow interconnectedness between its members, and moreover, it makes governments and banks less dependent on their mutual welfare. Although the system includes access to common funds, in return austerity measures and economic reforms have been imposed on the indebted Member States. The sovereigns have seen it in their interest in the current economically integrated system with its large banks to agree to a banking union in order to manage the risk of bank failure and its consequences for the Eurozone in the future. This approach implies that Member States national preferences and their relative power positions explain the process of more integration. The outcomes are accepted by the Member States for they are assumed to follow from rational choices by national leaders to serve the domestic interests in a given context. Moreover, the effects of the banking union and accompanying crisis measures are accepted as legitimate for stabilizing the Eurozone financial system, although they have far-reaching effects on the lives of individuals within the Eurozone. The interests and powers at a European level and previous integration tendencies are regarded subordinate to the national preferences of the Member States in the negotiation process.

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8 However, the Eurozone contains a large cross-border banking sector and the governance over this sector has over the past decades increasingly been moved towards a central level. When not taking into account the historical and socioeconomic context in explaining the decision towards more integration, it is argued that the chapter might overlook an important explanatory part of European integration. The fourth chapter attempts to fill this gap by exploring the context factors surrounding the establishment of the banking union. The critical political economy approach regards the establishment of the banking union as indeed promoted in the benefit of the Eurozone system, however it argues that this system is rooted in a neoliberal paradigm based on the preferences of a financial capitalist class. It sees the banking union as fitting in a tendency towards more integration, enabling the financial capitalist class to further pursue their capital accumulation strategies. This approach implies that national Member States do not hold the decisive power over European integration, because their perceived national preferences and rational choices are actually based within a dominant economic system shaped by a transnational capitalist class. Nevertheless, the Member States are still regarded relevant for socializing the system within the national realm through which it is legitimized and sustained (Van Apeldoorn et al, 2003, p.36). Elaborating this view, the chapter first assesses the origins of the economic order in society to identify a dominant economic system guiding European integration decisions, and furthermore, how and by whom this system has been constituted. Subsequently, it reviews the development of financial regulation within the EU based on the economic system and whether the preferences of the Member States have changed due to these developments. Finally, several aspects of the banking union are highlighted to assess the claim that the banking union is rather sustaining the capital accumulation strategies of a capitalist class instead of tackling the potential risks of the system for the Eurozone Member States. Based on these chapters, the establishment of the banking union will serve as an example of how European integration occurs and whose preferences best explain its outcomes. This will allow us to critically assess the project regarding its power base and its effects for the Eurozone.

1.3 Relevance

Researching the establishment of the banking union according to the above briefly described European integration theories is relevant, while both theories reach different conclusions about the legitimacy of more European integration and the need to challenge the system in which this

integration occurs. If Member States are the leading actors deciding whether or not integration is necessary and in what direction, this can be legitimized for they are democratically chosen representatives of the national interests in the negotiations at a European level. The liberal intergovernmental approach would not see the transnational and European actors as significantly

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9 influential, because it argues all decisions at the European level can be traced back to the national preferences of states based on their relative power positions within the negotiations (Moravcsik, 1998, p.51). This implies that the consequences of democratic decisions are accepted as legitimate, even though these might have far-reaching effects on the lives of people living within the EU. Contrastingly, the critical political economy theory claims that the context on which the national preferences of Member States are based is shaped by a transnational dominant capitalist power in society (Van Apeldoorn et al., 2003, p.32). This second approach poses a problem for the legitimacy of European integration. When the occurrence of European integration is guided by a

non-democratic dominant power in society shaping decisions with far-reaching effects on the lives of the constituents within European society, this would mean that the constituents are subject to the preferences of the dominant structural power. They do not live their lives in a realm of freedom, but are instead subject to a dominant capitalist system structuring their lives and guiding national decision makers (Van Apeldoorn et al, 2003, p.34). If such a claim is indeed identifiable, this would make us wonder whether the effects of the banking union and its accompanying crisis measures on the lives of individuals within the Eurozone can be democratically justified.

Moreover, another important distinction between the two approaches is that the first implies that the European integration project would be unable to change its direction, while involving loose negotiations in reaction to a given state of the world, the context, which would be unpredictable (Moravcsik, 1998, p.20, 76). The approach does not take into account tendencies over time based on societal economic power structures. When such tendencies are indeed present, this would enable us to identify the elements in society guiding the way in which European integration takes place. More importantly, when a certain conventional economic system guided by dominant capitalist powers in society and directing European integration could be identified, the second approach argues that such a system should be challenged rather than taken as given when proving incapable of addressing the challenges posed by this system. When a system appears to be dysfunctional, identifying the dominant source of power in society would enable us to challenge the system at its basics. The relevance of researching the claims made by the critical political economy approach is that these are focusing on the changeability of a system by identifying tendencies and socioeconomic powers guiding the context surrounding the official decision makers, rather than explaining European integration as reaction to the context without actually understanding it.

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Chapter 2 – Theorizing the origins of power at the basis of European integration

2.1 Introduction – Selection of the European integration theories

In chapter one we were puzzled by the observations that in the case of the banking union the Member States have agreed to surrender autonomy over an essential part of their economies and moreover, that a European banking sector has been supporting proposals in favor of a centralized stricter supervision and regulation. The main question of this chapter is how we can approach these paradoxical observations from a theoretical point of view. What we are trying to find out is whether the establishment of the banking union can be explained by looking at the Member State negotiations based on their national economic imperatives in response to the context within which the negotiations have evolved, or if we have to dig deeper by exploring the context surrounding the official decision makers and the influence of other powerful actors within it. It is therefore relevant to look at the process of European integration from a Member State centered perspective in contrast

to a perspective focused on exploring the context in which the decision making has taken place. In delimiting the theoretical broad research field, while at the same time trying to gain a

better understanding of European integration, the following of this chapter highlights two contrasting theories. As mentioned in the introduction of this thesis, these are Andrew Moravcsiks liberal intergovernmentalism (LI) and the critical political economy (CPE) approach of Bastiaan Van Apeldoorn, Magnus Ryner and Henk Overbeek. The liberal intergovernmental approach mainly covers the classical debate between neo-functionalism and neo-realism by focusing on the power division between the Member States and the European institutions. However, it also adds a more explanatory element by looking at national preference formation within the Member States before entering the negotiations. By doing this, it sheds light not only on the process, but also on the motives of the decision making actors. The conclusion of Moravcsiks observations is that the power determining European integration is rather situated with the Member States in the intergovernmental negotiations based on their national preferences, than with supranational powers trying to influence the process (Moravcsik, 1998, p.18). Moravcsik provides both for an explanation of the European integration process and for an analysis of the Member State preferences, however, his analysis is mainly focused on loose decision making moments and it finds the base of power foremost at the national level. The CPE tries to overcome the focus on one level of decision making and puts emphasis on the socioeconomic context of decision-making by focusing on a transnational dominant class in society which is directing the policy preferences of the formal decision making actors and is present on all levels of decision making. By focusing on this omnipresent context, the theory transcends the distinction between levels of decision making and finds a different dominant

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11 source of power in the EU, other than the formal decision making power at the national and supranational level (Van Apeldoorn et al, 2003, p.20). Moreover, this theory identifies certain integration tendencies over time and discovers patterns related to the preferences of a dominant capitalist class in society.

The former theory focuses on events where the one nation state prevails over the other based on their relative power positions, while the latter explores the historical socioeconomic context surrounding European integration which it sees as determining the direction of it. The main focus of this chapter is thus to gain a better understanding of the two contrasting approaches in order to grasp their diverging views and how they criticize one another’s basic premises regarding ‘who’ or ‘what’ determines European integration. Applying the contrasting explanations for European integration to the case helps us explore the relationship between the actors involved in the process of European integration by placing the dominant power with different groups of actors. In order to provide for a theoretical base, this chapter sets out the main claims of both theories and finally, it highlights the contrasting claims of the two approaches.

2.2 The liberal intergovernmental perspective

Andrew Moravcsik provides us with ‘a rationalist framework of international cooperation,’ based on his findings that national governments are the key actors to determine European integration (1998, p.18). According to him the occurrence of integration depends on whether or not this is in the interest of national governments. The central argument in this approach is that ‘European integration can best be explained as a series of rational choices made by national leaders’ (Ibid). Moravcsik assumes that states act rationally in pursuit of their interests at any given point in time. Following this assumption, he explains European integration as the outcome of interstate bargaining between national states in major intergovernmental negotiations based on their domestic preferences.

Moravcsik approaches European integration as a three-stage process, of which each round is treated separately based on several competing theories. First, the sovereign states form their national preferences, which are based on geopolitical or economic interests. The geopolitical interests would mainly stem from perceived threats to national sovereignty or territorial integrity, whereas the economic imperatives would be shaped by increased opportunities for profitable cross-border trade or the control of capital movements (Ibid, p.26). A very important assumption in this first stage is that the theory appoints the nation-state as the primary political instrument by which international negotiations are influenced. Mainly in this stage Moravcsik has attention for individuals and groups in civil society pursuing certain interests. He claims these groups will foremost emerge in

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12 the national context, in which they will try to influence the national preference formation in the first stage of the process (Ibid, p.35). After this internal process, the national states are assumed to act externally as unitary and rational actors in international negotiations (Ibid, p.22). This rationalism also entails that, even though preferences are supposed to be stable, the states decide on their preferences in response to given ‘states of the world’, meaning that preferences can change over time due to exogenous changes in economic, ideological and geopolitical situations (Ibid, p.23). In short, the national preferences are the leitmotiv of the Member States in the interstate negotiations, which brings us to the next stage.

This second interstate bargaining stage serves to explain the role of Member States and European Union institutions in the negotiation process. In this stage Moravcsik poses the problem whether European integration decisions stem from the effective advocacy of European institutions – thus a supranationalist view –, or from the relative power of Member States to steer negotiations in their preferred direction – an intergovernmental approach (Ibid, p.51). These approaches are highly contrasting since the supranational view assumes that supranational leadership and its supply of information is necessary to overcome inefficient bargaining and to influence the outcomes, while the intergovernmental view claims that patterns of state preferences and power are determining the bargaining process and states have their own resources of information (Ibid, p.55). The intergovernmental theory moreover assumes that Member States are able to be their own political entrepreneurs and to apply their power instruments, such as exiting or vetoing negotiations, linking issues or providing side-payments in order to gain the highest possible benefits (Ibid, p.52).

Although the description of this second stage extensively gives attention to the neofunctionalist supranational bargaining theory, Moravcsik tends to find a more satisfying explanation in the intergovernmental bargaining theory. Supranational bodies could be of importance to interstate bargaining, however, only in their attempts to propose initiatives, to mediate between governments and to mobilize societal groups. They can even attract governments’ attention by initiating policy proposals and providing a range of potential solutions (Ibid, p.56). Neofunctionalists would argue that interstate bargains are not intentionally chosen by the Member States, but are the unforeseen consequences of ‘package deals’ or former large negotiations, and thus can be seen as a process of spillover (Ibid, p.54). Moreover, they argue that the entrepreneurship of supranational officials is necessary to move beyond the lowest common denominator of narrow national or group interests (Ibid). Supranational officials are argued to have essential access to all available information due to a central position in networks of technical, political and legal information to overcome inefficient bargaining (Ibid, p.58).

Moravcsik, on the other hand, does not regard it proven yet that the supranational actors are indeed essential in the process of interstate bargaining. Intergovernmental bargaining theory states

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13 that it is not the entrepreneurship of supranational institutions, but the asymmetrical interdependence caused by different preferences of the Member States that determines the outcomes of the bargaining process. This asymmetrical relationship means that every state assigns value to a certain agreement and this value determines their bargaining space and the extent to which they are prepared to do concessions (Ibid, p.60). Information asymmetry between the Member States is ascribed to the variation in preferences, while they do not need the same information when their preferences lie elsewhere (Ibid, p.57). Moravcsik has mainly found proof for the occurrence of European integration based on intergovernmental arguments and deems supranational influences not of essential relevance.

The third stage of the integration process explains why en when governments decide to give up part of their sovereignty and delegate to, or pool decision-making power in supranational institutions (Ibid). The pooling of sovereignty entails that governments agree to voting procedures which are other than unanimity, whereas delegation means that supranational actors receive the permission to take decisions in some areas autonomously (Ibid). Three possible explanations for national governments to give up sovereignty are an ideological, an informational and a political aspect. First there can be the strongly held belief in a federalist ideology on the part of national actors stemming from historical memories or geopolitical calculations. Germany for example has traditionally been in favor of federalism due to World War memories (Ibid, p.70). A second explanation is the need for centralized technocratic planning, required because the economy becomes more complex, modern and transnational (Ibid, p.71). A third explanation Moravcsik provides us with is the need for credible commitments, which has a political character. This is a strategy to pre-commit governments to a stream of future decisions outside unilateral control, which might be inconvenient at the time being, but which eventually is required to sustain the benefits of European integration. Through pooling or delegation, states commit themselves to enforcing legislation, proving their own credibility or to anticipate on future decisions which are assumed to raise domestic opposition (Ibid, p.73). These solid commitments are preferred over setting precise rules in advance, because the future is uncertain. They might also be used to bind governments to certain decisions before the precise costs and benefits become clear and opposition arises. Institutional circumstances, such as certain norms, principles and procedures are then already set to ease agreements (Ibid, p.74). These commitments also have a political component in the sense that national politicians can scapegoat the supranational institutions or other governments domestically, when unpopular but pre-committed decisions have to be made. However, the national governments have to comply, while the commitment also means that the supranational institutions can easily damage the country’s reputation internationally in the case of non-compliance (Ibid). Governments give up part of their unilateral options to for example veto some proposals, in order to make sure

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14 that all governments will coordinate their behavior in their particular preferred ways and while it reduces the bargaining power of potential opponents of future decisions linked to it (Ibid, p.75).

As said before, Moravcsik has a clear preference to explain the process towards European integration as coming from state preferences in a process of interstate bargaining. He sees states as being able to form their own stable preferences and to generate all the information they need in the deliberations. Accordingly, he argues that decisive events in European integration history have taken place in an intergovernmental setting, while the motives of governments in favor of integration can be seen as strategies towards realizing domestically based preferences (Moravcsik, 1998, 472). Less power and ability is therefore assigned to supranational institutions in the move towards integration. In the above, the most relevant elements of Moravcsiks liberal intergovernmentalism are discussed. The next section will do the same in giving an overview of the theory of the critical political economy.

2.3 The critical political economy perspective

The CPE theoretical perspective follows from the Marxist thinking that the economy forms an important part of the social whole and links economic, political and social developments (Browning and Kilmister, 2006, p.2). It takes the embedded status of the economy even further by asking the question what actually constitutes the economic order in society. The ‘critical’ element of this approach adds to the analysis that the economic aspect embedded in society should be regarded revisable when it proves inadequate in dealing with challenges that the conventional economic system is not able to solve (Ibid, p.3). This claim that a certain dominant economic principle guiding European integration should be challenged rather than taken as given is an essential element of the CPE framework of Bastiaan van Apeldoorn, Henk Overbeek and Magnus Ryner. The scholars criticize the mainstream theories of European integration based on their inability to understand actual social power relations in European integration (Van Apeldoorn et al, 2003, p.18). According to the scholars, dominant powers in society have constituted capitalist market structures, which the mainstream theories, such as LI, take as given. All theories ranging from the classical supranationalist versus intergovernmentalist debate to theories of multi-level governance are argued to fail in explaining the social origins of the current system and to ignore the assumption that there are conditions under which the system can change (Ibid, p.17). The scholars criticize taking for granted the capitalist constructs lying at the basis of society, which would imply that these structures follow from human rational considerations agreeing to the system for the realization of their social lives and that actions from decision makers accordingly would be legitimate (Ibid, p.34-36). However, if these structures are shaped by non-democratic social powers in society, basing the political authority on these would

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15 actually pose legitimacy issues. In contrast with the liberal intergovernmental theory for example, the CPE would argue that state preferences do not form a legitimate basis for negotiating European integration, because these perceived national interests stem from transnational dominant power structures instead of being based on the constituents’ individual interests (Ibid, p.32). Consequently, Van Apeldoorn, Overbeek and Ryner are trying to identify these social powers, where they come from and how they constitute the dominant principles within society (Ibid, p.18). The scholars attempt to unravel which powers in society lie at the basis of our dominant economic thinking, and are therefore deciding the guiding context in which European integration evolves.

CPE is based on (1) a transnational historical materialist argument, (2) a Neo-Gramscian constructivist argument and (3) a neoliberal hegemony argument (Ibid, p.32). To take off with transnational historical materialism, this is rooted in the work of Karl Marx, who focuses on the social relations of production. Historical materialism accordingly has to be understood as ‘the way in which humans have organized the reproduction of their material lives’ (Ibid, p.33). It is foremost based on the claim that we have to look at decision-making in a historical context in which the dominant structural powers in society have been able to secure and pursue their material interests. These processes are embedded in long-term tendencies of the capitalist production mode (Ibid). Important here is that the dominant capitalist class is able to shift from certain groups in society towards other groups. This shift in class is also guiding changes in the hegemonic system, which means that changes in dominant paradigms over time are also influenced by the form class takes on (Ibid, p.32-33). Another important aspect here is transnationalism. This means that the process of integration is not confined to taking place within national boundaries. The scholars refer to the world systems theory of Andre Gunder Frank and Immanuel Wallerstein, who introduce the contradictory argument that capitalism and capitalist class relations are located in a global context, while the political power socializing these capitalist structures is located within national states (Ibid, p.36). This claim highlights the ongoing importance of national states to promote the capitalist class’s preferred ideology (Ibid, p.36). The structural power is identified as a dominant capitalist class in society pursuing their materialist capital accumulation strategies. The form this dominant class takes on can be explained by historical developments in society enabling a certain class to prevail and gain dominance. More European integration is argued to occur when this is in the interest of the dominant transnationally operating capitalist class, which has been able to insert dominant views into society requiring more centralized policies (Van Apeldoorn et al., 2003, p.32).

As argued before, the distinctive premise in the theory of CPE is the notion of ‘critical’. The social criticism implies that when the conventional economic paradigm promoted by the dominant class is not able to meet the challenges in contemporary society, it should be revised, even against the will of the capitalist class in order to safeguard the needs of individuals in society (Browning and

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16 Kilmister, 2006, p.3). When the social powers in society are withholding human beings from expressing themselves and realizing their needs from their preferred strategies, the system has to be challenged. Moreover, for the ideals of democracy and equality in our current European society, the freedom of individuals should indeed be protected, instead of being constrained by the dominant capitalist markets inserting their views in society (Van Apeldoorn et al, 2003, p.34).

The second central premise in the theory is the neo-Gramscian dimension which explains how a hegemonic order in society is promoted and constituted by the agency of a dominant class. Gramsci has developed Marx’ notion of class rule, by assuming that power is rather situated in society with the dominant classes than with the state. The order in society is based on economic structures created by the capitalist class, which are accompanied by a dominant paradigm directing politics. The paradigm is likely to contain ideological and moral elements to justify its dominant economic direction (Ibid, p.37). Kees van der Pijl, who explains this as the processes of commodification and socialization. The point of these terms is that commodification is seen as an individualist process, putting social lives in terms of market relations of accumulation. This, however, threatens social interdependencies in society. Therefore, social regulations have to be put in place by decision makers to regulate the market forces (Van der Pijl, 1998, p.22). For the realization of these elements the power of the state serves as legitimizing to form a hegemonic system, also in the case of European integration. This hegemony requires popular consent, so narrow class interests have to be shaped into the general interest (Van Apeldoorn et al, 2003, p.37). For the spreading of these paradigmatic ideas agency of the dominant social group is of crucial importance. This agency formulates and spreads the intellectual and moral ideas, which leads to them being transformed into a ‘universal paradigm’ binding the subordinate groups into the order shaped by the capitalist block (Ibid). In the integration process, it should be possible to identify decision makers and a capitalist agency promoting ideological ideas in support of the interests of the capitalist class.

Van Apeldoorn, Overbeek and Ryner also take into account some propositions about the neoliberal hegemony in Europe. First the scholars make a point about reaching this neoliberal hegemony, which has been a dynamic process of struggle in which the control of the capitalist class is realized. The scholars refer to André Drainville, arguing that creating a neoliberal system is a process of restructuring by negotiating concessions to the former dominant system (Ibid, p.38). Moreover, this installing of the hegemonic neoliberal system involves three phases, while first deconstructing other ways to structure the economy, secondly, installing neoliberal ideas of liberalization, deregulation and privatization as valid and legitimate and thirdly, consolidating neoliberalism by which the global capitalist system becomes naturalized (Ibid).

Regarding the transnational claim of neoliberalism, the transnational and transatlantic class formation have to be taken into account as important context factors for the process of European

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17 integration. The scholars however highlight that, although a transatlantic link to the dynamic of American capital influences European integration, it does not determine it. Central to the transnational claim is that the transnational processes are understood as simultaneously taking place on a subnational, national and international level within Europe. This has implications for the understanding of sovereignty, governance and statehood in the EU, which are undermined by this transnational capitalist class guiding European integration by penetrating society as a whole with their capitalist structures (Ibid, p.39).

Taken together, the theory claims that we are currently finding ourselves in a neoliberal system, which has gained dominance while fitting with the preferences of a dominant class in society which has been promoting the values of the system as of general importance to benefit the society as a whole. In the process of European integration the Member States therefore base their preferences on this system dictating the way in which the economy and society function.

2.4 Liberal intergovernmentalism versus the critical political economy

The sections above display the two contrasting views used to approach European integration in the case of the banking union. Most striking of the theories is their entirely different focus on the origins of the motives for European integration. In the introduction we identified the support of both the Member States and a European banking sector for a European banking union as puzzling features. The theories are proposing different claims about the role and the place of national and transnational official and non-official powers within the process of European integration. LI puts the Member States at the center in explaining the process of European integration. In the case of the banking union, this would imply that the Member States have based their motives for pursuing more integration on the effects this likely has on their national economies in response to the challenges posed by the current situation. By arguing that the decisions of the Member States are rational responses to given states of the world, LI sees the Member States as dominant and primary actors to decide whether or not European integration occurs. The Member States take into account their national sector interests and the effects the proposed integration has in support of the national economy. The relative power positions of the Member States account for the fact that the Member States with a larger bargaining space have a bigger say in the negotiations and are able to set requirements. Moreover, by viewing the motives for integration according to the context at given moments in time, LI sees European integration as a series of loose negotiations and does not agree with theories arguing that integration tendencies take place outside national control, for being based on preferences outside the national realm and developments over time. It does not view the influence of supranational officials and other powers exceeding the national level as essential in the

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18 process leading towards integration, while the theory argues that national preferences are formed within the national realm before entering the negotiations at the European level while remaining stable during the process. The establishment of the banking union would be explained as a process of Member State negotiations, of which the outcomes are distributed according to the relative power positions of the Member States involved.

CPE has a different view on the role and place of the actors involved in the establishment of the banking union. The theory focuses on identifying a transnational dominant capitalist power, which has been able to shape an economic order in society and to guide an understanding of how the system works while placing their interests at the center of its functioning. By guiding the economic paradigms within society and the relation between the economy and social lives, this dominant social power shapes the context in which official decision makers decide whether to support further integration or not. Instead of focusing on the power of the national Member States, the CPE places a transnational dominant capitalist power at the origins of explaining the Member States attitude towards European integration. Yet, the theory sees the Member States as continuously relevant for socializing the global capitalist structures in society and legitimizing the preferred policies of the dominant societal powers. Regarding the establishment of the banking union, CPE would probably argue that the idea for more integration in a banking union fits in a tendency towards more integration, while this support the capital accumulation strategies of a transnational financial class. Following the theory, to justify the dominant economic direction, this capitalist class has accomplished to shape its narrow interests into a conventional economic paradigm containing ideological and moral elements for the common good. In the neoliberal order this justifying element would be a concept of free market policies to support the freedom of individual expression and development without too much state intervention (Harvey, 2005, p.7). The Member State negotiations over the banking union would be explained as a process of legitimizing more economic integration on a domestic level, since all Eurozone members have either been striving to maintain the means to provide for social goods within the national realm or to have access to common means. Popular consent is indeed required to sustain the economic order in support of the strategies of a capitalist class. CPE therefore does not see the Member States as the basic source of power in society, but rather as the legitimizing power for the underlying capitalist structures, which are actually determining the direction of integration (Van Apeldoorn, 2003, p.37-39).

As already argued in the introduction of this thesis, the most important consequence of explaining European integration based on one of the two approaches lies in a legitimacy aspect. When Member States take into account their national positions to either strive for European integration or not, this can be legitimized because they operate as democratic representatives of their constituents. The CPE however would undermine this legitimacy stance, for claiming that

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non-19 representative informal actors shape the economic order in society guiding these democratic powers. While LI would legitimize a banking union for its perceived beneficial effects for the economic welfare of the Eurozone and to avoid future crises, the CPE would rather question the proposed solutions for solving the challenges which have been posed by the system itself. It claims that instead of responding to these challenges within the context of the dominant system guiding our conception of how the economy works, we should challenge the system when it proves unfit to provide solutions in the benefit of all EU constituents. By exploring the basics and power structures of the system instead of merely the Member States responses to it, CPE attempts to provide for a deeper explanation of European integration and a critical assessment of its consequences.

To assess the claims of both theories, the following chapters will in fact look at the process and the context of the establishment of the banking union. Following LI we will be able to identify the national interests as basis for the banking union and the outcomes of the negotiations should reflect the interests of the stronger Member States as prevailing over the interests of the Member States which have more to gain from the integration project. It should be observable that the reason why the Member States have agreed to a banking union would be that they found themselves in a situation in which more integration would be a rational choice, based on the perceived positive effects on their national welfare. By identifying these elements the theory would reject the assumption that there are guiding influences on the outcomes of European integration outside the national realm.

For approaching the banking union from a CPE perspective, the development towards the actual negotiation process over the project and other powers involved in it are taken into account. Based on the CPE approach, several aspects should be identifiable regarding the establishment of the banking union. The approach focuses on a capitalist construct directing the economic rationality of formal decision makers, for which we should be able to identify a dominant capitalist class pursuing their capital accumulation strategies and an economic system supporting these strategies based on arguments for the general good to justify this system. Furthermore, the change in preferences of national Member States regarding whether or not to agree to European integration should then also be reflected in the strategies of the capitalist class over time, although this might seem to contradict national Member States’ preferences. Reviewing both the negotiation process and the constitution of the context surrounding it will be relevant to explore how the processes and varying interests have led to the establishment of the banking union and if we can value this development as legitimate.

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Chapter 3: On the road to the banking union: an intergovernmental perspective

3.1 Introduction – Member States’ interests in a banking union

The former chapter explained that one classical view to approach European integration is to view each and every integration step as the result of national interests and interstate bargaining. This theory therefore focuses on explaining the establishing of the banking union in terms of national interests. To what extent can the establishing of the banking union be construed as the outcome of national preferences and interstate bargaining? In this chapter we are examining the establishment of the banking union based on a liberal intergovernmental perspective. For applying this theory we will first look at the situation in 2012 that led the Member States to initially agree on installing prudent mechanisms to control the banking sector and to break the link between banks and sovereign debt. It was argued that this doom-loop could be solved with supervisory and resolution mechanisms, which would limit national control over large banks and avoid big bank bail-outs with public funds in case of crisis (European Commission, 2012a). The chapter assesses whether the domestic preferences of the Member States have indeed decided the eventual outcomes of the intergovernmental negotiations over the elements of a banking union and how the negotiation process has evolved. We will explore the concerns of the Member States which seem to have led to compromises over the elements of the banking union in combination with an allover crisis approach based on arguments of economic growth to restore stability in the Eurozone, and domestic reforms to solve the sovereign debt crisis. Based on Moravcsik’s LI this chapter therefore attempts to provide an explanation according to which Member States have apparently made rational choices to tackle the problems within the Eurozone revealed by the crisis. It shows the outcomes of the negotiations and moreover sheds light on its consequences. The chapter finishes by evaluating this explanation by highlighting its blind spots in prospect to the next chapter in which the CPE focus will be dominant.

3.2 The road towards the banking union

Already during the negotiations about the Maastricht Treaty a European banking supervisory system was proposed, however, the allocation of supervisory responsibilities to the ECB and the creation of an EU fiscal backstop were not feasible at the time (Howarth and Quaglia, 2013a, p.120). Yet, the idea for more integration in the European banking sector remained present in the EU. Then from 2008, following the global financial crisis that started in the United States with the bursting of the housing bubble and the collapse of Lehman Brothers, Europe has successively suffered a current

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21 account crisis, a banking crisis and a sovereign debt crisis. The bankruptcy of Lehman Brothers in 2008 caused a series of events which made the interbank market collapse and consequentially had disadvantageous effect on its lending to the real economy (Tridico, 2012, p.17). In the Eurozone, the crisis had a large impact because of the interconnectedness between the countries sharing a common currency. The banking crisis led to stimulus measures from the governments in the form of direct aid, monetary policy operations, overall fiscal support measures and the nationalization of banks. National governments got the role of ‘lender of last resort’ through bank bail-out programmes, which led to an increase in national debt of 520 billion euro in the Eurozone and 690 billion euro in the whole EU by 2012 (Breuss, 2014, p.4). The banking crisis affected public debt to a large extent and especially Eurozone countries such as Spain and Greece had to be saved with European support instruments in order to preserve the common currency. The countries were put under rescue programs and had to agree to austerity measures to rebuild their economies (Ibid, p.1). The global financial and economic crisis highlighted the need for prudential rules and supervision of the financial sector, after which the European Commission started drafting several sets of rules for all Member States.

Already in 2009 the Council of the European Union proposed to establish a Single Rulebook for all financial institutions within the 28 Member States of the EU following from global pressures. As a response to the financial crisis, the G20 countries decided that stricter financial regulation was needed by reforming the global Basel II framework containing banking standards in order to prevent risky investments, bankruptcy and insolvency of banks by setting stricter capital and liquidity requirements. A Basel III was negotiated, which regionally had to be implemented (Atik, 2014, p.297). The Basel frameworks focus on more harmonization and transposed into EU law they have been constraining the power from national discretionary authorities. The rules of Basel III were transposed into a capital requirements regulation and a directive, together known as the CRR and the CRD IV package, which were agreed upon in 2011 and entered into force in July 2013 (European Commission, 2013a). Most important in the legislation were enhanced capital requirements and new liquidity rules. However, because of the variety in national banking sectors within the EU, the tightened rules would have different implications for the Member States (Howarth and Quaglia, 2013b, p.334). When the global capital requirements would be implemented as a minimum requirement, this would mean that better capitalized banks could hold higher reserves, creating a loss of competitiveness on the interbank market for the countries with less well capitalised banks. Although the UK promoted to allow the banks to hold higher reserves, mainly Germany and France were opposed to this idea. In these two core EU countries, David Howarth and Lucia Quaglia found that the German mainly national banking landscape would not be benefitted by the higher requirements and that its large banks were less well capitalized, while the French banks applied

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22 different counting methods which would be banned under Basel III leading to a lower valuation of their capital reserves. For both countries tighter requirements would pose competitiveness issues for the banks based within their borders (Ibid, p.338-339). The countries have exerted their influence on the negotiations over the CRD IV package, and it seems the rules from Basel III have indeed appeared into EU law in a watered down version, because the capital requirements were set at a maximum standard avoiding banks to hold higher reserves, whereas liquidity requirements hardly appeared at all (Atik, 2014, p.319, 327).

So far, the Member States had been able to keep their national discretionary space, while being reluctant to accept measures which could harm their national economies. It was however doubted that the effects of this watered down version of the capital requirements would have the desired effects regarding creating the public good of financial stability and to satisfy markets, for the balance sheets in the EU remained uncertain and an EU-wide resolution arrangement including a unified fiscal backstop lacked (Howarth and Quaglia, 2013b, p.337). Yet, the incentives for the Member States to solve these issues were not pressing until the sovereign debt crisis arose in 2011, highlighting the interconnectedness of the Eurozone for which deeper integration was voiced as the solution. Since the banking crisis had shown the systemic dangers of failing large cross-border operating banks, it seemed irrational to still continue a system of (then) 27 different regulatory authorities with national rules, supervision and rescue measures (Capriglione, 2013, p.7-8). Indeed, after the occurrence of the Eurozone crisis ‘the need for a better governed and deeper economic and monetary union’ was identified by the Commission (European Commission, 2013b). After agreeing to a new economic architecture with the ‘six-pack’ as an instrument to solve the current account and the sovereign debt crises, in 2012 the idea of a banking union to get a grip on the banking crisis gained ground in the Eurozone (Breuss, 2014, p.2). This was a reaction to the identified vicious circle between banks and sovereigns, mainly within the Eurozone for its negative effects on the confidence in the common currency. In 2012 the Eurozone leaders agreed to establish a banking union to restore confidence in the Eurozone banking system and to regain financial stability. Three reasons were set forth for this banking union. First, to break the ‘doom-loop’ between sovereign governments and the banking sector, while rescuing banks during the crisis had cost 4,5 trillion of tax payers money (European Commission, 2012a); secondly, to overcome financial market fragmentation with one common regulatory system and to avoid a national bias in supervision (ECB, 2013a); and thirdly, as promoted by former Council president Herman van Rompuy, ‘to complete economic and monetary union, thus saving the euro and protecting it from future shocks’ (Howarth and Quaglia, 2014, p.125). The European Commission under the guidance of President Barosso further developed this vision when it published a ‘Blueprint for a deep and genuine economic and monetary union’ in November 2012 (Breuss, 2014, p.7).

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23 An argument often used by supranational officials1 in favour of centralised banking regulation and supervision has been the logic of the financial trilemma as observed by Dirk Schoenmaker in 2011. In a discussion paper he describes the elements needed to preserve the public good of financial stability. His key question is how financial stability can be reached in a world of cross-border banking. Schoenmaker identifies a tension of governments still trying to provide this financial stability public good on a national level, while dealing with a globalised financial market. The financial trilemma claims that financial stability, financial integration and national financial policies cannot be reached at the same time (Schoenmaker, 2011, p.1). Financial stability will thus be absent when on the one hand having more financial integration, while on the other hand maintaining diverging national policies. Schoenmaker argues that ‘financial stability is closely related to systemic risk, which is the risk that an event will trigger a loss of economic value or confidence in a substantial portion of the financial system that is serious enough to have significant adverse effects on the real economy’ (Ibid, p.2). He argues that the more financial integration increases through the spread of activities abroad, the less effective national policies become, for which a logical solution would be to move power over financial policies, i.e. regulation, supervision and stability, increasingly towards a central level. Furthermore, to maintain this financial stability, crisis management operations should also be moved to a central European system (Ibid, p.4).

Based on this logic, the banking union was supposed to consist of three major pillars and was mainly set up for the Eurozone, however, it would be open to all EU Member States willing to participate. The three pillars entail (1) surveillance within the ‘Single Supervisory Mechanism’ (SSM), (2) resolution in the ‘Single Resolution Mechanism’(SRM) and (3) deposit guarantee with a Single Deposit Guarantee Mechanism (SDGM). These pillars are based on the Single Rulebook, which directly applies to all 28 Member States in the European Union (Ibid, p.15). In September 2012, a Commission regulation was proposed for installing the Single Supervisory Mechanism (SSM) (European Commission, 2012c), which, after being amended, was agreed by the Council in December of that same year (European Council, 2012b), and was adopted by the Council and Parliament in October 2013 (European Commission, 2013c). The next step was the single resolution mechanism (SRM) for which a regulation was proposed by the Commission in July 2013 (European Commission, 2013d) and which was eventually agreed upon by government leaders in December 2013 (Council of the European Union, 2013a) and adopted by the Council and Parliament in March 2014 (European Commission, 2014a). The sections below will elaborate the negotiation process over the elements of

1_{ECB-officials have on several occasions promoted this view in their support for the banking union. For} instance, in 2013 Executive Board Member of the ECB Benoît Coeuré used the financial trilemma as argument for the banking union in his speech at a conference of the Banco de España (Coeuré, 2013) and also ECB Vice-President Vitor Constâncio highlighted the financial trilemma in his speech at the OeNB Economics Conference in Vienna in May 2014 (Constâncio, 2014).

Behind the scenes of establishing the European Banking Union; Power guiding capital or capital guiding power?