What will the ECB banking union look like?

Wolfgang Münchau has the scoop:

This banking union will produce the financial sector equivalent of austerity – a secular credit crunch.

To see this, one needs to understand how banking union is going to work. The European Central Bank, in its role as supervisor, has started a comprehensive assessment of the banking sector. As part of this exercise, it assesses financial risks, takes an in-depth look at balance sheets, and subjects banks to stress tests. This exercise is going to end with a demand that some banks raise their capital.

But without a common fiscal backstop, it lacks credibility. The ECB will be in no position to demand that banks raise capital if there is no backstop. It would risk financial instability if it exposed a bank as undercapitalised that has no access to outside capital. The resolution fund will not be able to help because it will not be fully mutualised for a decade. At the start all risks will remain within the member states.

Unlike the Federal Deposit and Insurance Corporation of the US, the eurozone’s resolution fund will have no credit line.

…Economically, this is 1990s Japan all over again, probably worse given the periphery’s dire economic state. The banking system in the eurozone will not be able to supply the economy with sufficient credit, except in creditor countries. The economic consequences of what finance ministers hailed as a “historic” decision will be substantially negative.