The Conundrum of Solving ‘Too Big to Fail’ in the European Union: Supranationalization at Different Speeds

The international financial crisis highlighted that some banks and financial institutions were ‘too big, too complex, and too interconnected to fail’. These banks, which are generally referred to as ‘too big to fail’, have posed a major public policy problem for policy-makers. In the aftermath of the crisis, policy-makers in the European Union (EU) first introduced reforms to shore up banks’ capital adequacy. In addition, they singled out two areas of regulatory reform as particularly important in order to tackle the policy problem of ‘too big to fail’: bank structure and bank resolution. These two areas have followed different trajectories of reform in the EU. In the realm of bank structural reforms, the proposed EU legislation (not agreed yet) introduced only minimum harmonization of national legislation. Furthermore, it did not create new EU institutions or stipulate a transfer of powers or competencies from the national level to the EU level. Concerning the reform of bank resolution, two pieces of legislation were adopted. The Directive on Bank Recovery and Resolution (BRRD), applicable to the entire EU, harmonized the powers and instruments of national resolution regimes and reinforced the procedures for cross-border cooperation. However, it did not set up new EU institutions, nor did it transfer competences to the EU level. Applicable only to euro area member states, the regulation on the Single Resolution Mechanism (SRM) transferred considerable resolution competences and funding from the national level to the Banking Union level. It also created the Single Resolution Board (SRB), which was given the power to decide on the resolution of ailing banks.

Regarding resolution, the puzzle is to explain why and how the member states were able to overcome their long-standing sovereignty concerns, given the potential fiscal implications of a supranational regime. Even after the establishment of the Economic and Monetary Union (EMU), bank supervision and resolution had remained primarily national competences. Regarding bank structures, diverging national reforms can undermine the level playing field in the single market for financial services and create disadvantages for cross-border banks. A common EU approach, which was resisted by the member states, could mitigate these problems.

This article demonstrates different degrees of progress towards a supranational framework: limited harmonization of the rules on bank structures, but robust progress toward the supranationalization of bank resolution, where the euro area dimension is also considered. What accounts for this variation? Our explanation focuses on the main mechanisms leading to change of the preferences of the key member states in the case of resolution but not bank structure. The change of preferences in the case of resolution resulted from the negative functional spillovers deriving from previous incomplete integration, most notably, the fact that competences for supervision and resolution had remained at the national level, despite the intense financial integration in the EU, particularly in the euro area. Hence, ‘differentiated integration’ in the EU due to EMU membership generated different spillovers for the euro area insiders and outsiders. Political spillovers in the area of resolution derived from the fact that large cross-border banks actively endorsed the supranationalization of resolution. Cultivated spillovers were generated by the Commission’s entrepreneurship and, later on, the ECB’s entrepreneurship with specific reference to the SRM. These spillovers capture well the structural pressures to keep the integration momentum, but the national governments of the member states were not simply at the mercy of structural forces. They weighed the costs and the benefits of supranational policy solutions before agreeing to delegate authority to the EU level. As in the case of bank structural reforms, when governments had domestic options to unilaterally contain financial instability, they sought, at best, minimum harmonization at the EU level.

Lucia Quaglia is a Professor of Political Science at the University of Bologna.

Aneta Spendzharova is an Assistant Professor at the Department of Political Science, Maastricht University.