EU leaders punt on thorny issues

October 19, 2012: 3:00 PM ET
eu summit
European Council President Herman Van Rompuy has outlined sweeping reforms for the troubled euro currency union. But implementing his "vision-thing" is going to be a long-term process.
NEW YORK (CNNMoney)

European Union leaders took a step forward on the path toward a banking union at their latest summit, but they delayed more politically fraught decisions until the next meeting.

After a late night discussion in Brussels Thursday, EU leaders committed to a Jan. 1 deadline to hammer out details for a Single Supervisory Mechanism for eurozone banks, which they said will be implemented some time next year.

The legislation would give the European Central Bank the ability to oversee the region's roughly 6,000 banks, in addition to its existing mandate to manage interest rates and contain inflation.

Establishing the single supervisor is a prerequisite for the ultimate goal of recapitalizing banks in the euro area with bailout funds from the European Stability Mechanism.

In theory, the ESM would be able to inject capital directly into banks without driving governments deeper into debt.

This is particularly important for Spain, which has already requested up to €100 billion to help fill the €59 billion hole left in the nation's banking sector by a major property bust.

Related: Wall Street still spooked by Spain

Ireland, where the government was bailed out in 2010, after assuming much of the nation's bank debt, also stands to benefit.

But there are many thorny questions that need to be resolved before the legislation can be written into law, let alone implemented.

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For one, the ECB is a eurozone institution, and it remains unclear whether it will have authority over banks in EU nations that do not use the single currency. Britain, in particular, is uncomfortable with this idea.

In a statement, EU leaders stressed the need for a "single rulebook."

There is also the question of so-called legacy assets. Officials from Germany, Finland and Denmark suggested last month that bailout funds should only be used to repay future bank debt, rather than resolve existing banking problems.

What's more, Germany and other EU nations appear to be at odds over the scope of the supervisor's authority. Berlin reportedly wants the supervisor to focus only on "systemically important" banks, as opposed to the smaller institutions that hold much of the bad debt in the eurozone.

"There are still major obstacles on the path to full banking union in the eurozone," said Jonathan Loynes, chief European economist at Capital Economics.

Beyond the banking union, EU leaders pledged to continue working on more integrated budget policies, as well as steps to boost economic growth and create jobs.

Related: Spain's precarious future

Eurozone leaders welcomed the progress Greece has made in talks with international creditors, saying Friday that finance ministers will make a decision on additional rescue funds for Greece once that nation's lender have completed their review.

But the lack of progress on these issues has raised the stakes for the next EU summit in December, according to Fitch Ratings.

Fitch said prolonged delays on structural reforms "could damage the credibility of policy makers' efforts to solve the eurozone crisis and increase the eurozones' vulnerability to market pressure."

Still, the agency said a short delay would be manageable thanks to the ECB's recent commitment to buy potentially unlimited amounts of sovereign debt, a move that has calmed the markets since September.

Spain, in particular, has benefited from the promise of ECB intervention in the bond market, where yields on the 10-year bond have moved closer to 5% from the lofty 7% levels seen in July. It also remains to be seen if the Spanish government would agree to the ECB's conditions, which include committing to a formal bailout program.

"The ECB continues to hold the fort," said Nicholas Spiro, director of London-based consultancy Spiro Sovereign Strategy. "But the eurozone crisis has entered a more political phase in which the future of the single currency area hinges on far-reaching institutional reforms."

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