Euro-Area Reform Plan Held Hostage by Italy-Germany Clash

(Bloomberg) -- The euro area failed to make significant progress on completing its banking union or reforming its bailout fund, as political turmoil in two of its largest economies torpedoed hopes for an agreement.

In talks that went late into the night on Wednesday, finance ministers gathered in Brussels couldn't overcome longstanding differences, missing a goal to finalize a package to strengthen the single currency by year-end. Instead, they made marginal progress, leaving key technical issues open, while only agreeing to keep talking on others.

At stake was roadmap for establishing a joint European deposit insurance program, that would stabilize the financial system by reducing the risk of bank runs. The goal of a more closely-knit banking system in the euro area is to reduce the interdependence between lenders and their home countries.

While such plans had stalled for years amid differences between countries over the need for risk sharing, they got fresh impetus last month after German Finance Minister Olaf Scholz signaled his country was ready to talk about moving forward. But Scholz's proposal didn't garner sufficient support in Berlin and its caveats caused a backlash from Rome.

Germany and like-minded nations had been arguing that before any risk sharing can take place, banks across Europe need to reduce the dangers on their balance sheets. Countries led by Italy, meanwhile, are loathe to agree to anything that would involve banks limiting their exposures to sovereign debt or making a more realistic assessment of the risk of those holdings.

Hopes for a deal were dealt a setback when Scholz, who has been leading the charge for reform, lost an election to lead Germany's Social Democratic party, throwing his political future into doubt.

“We don't yet have a clear roadmap, but we have an opening with a clear commitment to cooperate to bring this discussion to a decision in a realistic time, which appears to be a long one, but will be I think realistic,” EU economy chief Paolo Gentiloni said, referring to the European Commission's five-year mandate that started earlier this month.

Stalled Reforms

Persisting disagreements on the banking union are yet another blow to efforts to ensure the euro area is better prepared to withstand financial turmoil. A push for a budget instrument to stabilize the region's economy in times of crisis, and advocated by French President Emmanuel Macron, was watered down into a tool with insignificant firepower that will only help countries see through reforms.

In another setback for the bloc's efforts to strengthen the euro, a long-planned overhaul of the European Stability Mechanism, which acts as a financial firewall, didn't get the final green light from finance ministers either. This time, the issue was with Italy, whose support came into question when the proposal became a hot-button topic in Rome, driving a wedge between partners in the coalition government.

Italian resistance was focused on a clause in the reform plans that would require all euro-area member states to issue bonds attached to such collective action clauses that critics argue would simplify debt restructuring requests. Ministers on Wednesday agreed in principle on the main aspects of the collective action clauses, while technical work will continue into next year.

Eurogroup President Mario Centeno, who led the ministers' discussion said there were still “a couple of loose ends of legal nature” that needed clarification and that he hoped to agree to the issue early next year.

Italy's parliament is set to vote on the issue Dec. 11, ahead of an EU summit that was supposed to sign off on the new ESM treaty. Instead, leaders meeting in Brussels next week will receive a letter outlining whatever progress has been achieved and setting out the open issues for the way forward.

--With assistance from Alessandro Speciale and Alexander Weber.

To contact the reporter on this story: Viktoria Dendrinou in Brussels at vdendrinou@bloomberg.net

To contact the editor responsible for this story: Ben Sills at bsills@bloomberg.net

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