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This summit was a challenge for the European leaders. First, they had initiated a new conversation on growth and had to deliver on it. Second, they had to address flaws in the Eurozone set-up at the origin of the ‘doom loop’ between bank and sovereign crises. Third, they had to answer growing market anxiety about Spain and Italy.

On growth, the summit has delivered the expected: (i) a new emphasis on the objective, but (ii) no real strategy and (iii) inflated numbers. It is easy to dismiss the whole outcome because (ii) and (iii). Especially, it was necessary to recapitalise the EIB to avoid precipitous deleveraging and it is positive to commit to making better use of the structural funds, but the outcome of these decisions is  second-order macro-economically. To speak of elephants while delivering mice is a strange communication strategy and it is unlikely to elicit confidence. As discussed here it would have been more useful to reach consensus on the pace and instruments of euro-area rebalancing. However the emphasis on growth should not be considered of negligible value. The European leaders will be accountable on their ability to deliver it, so we can expect further, hopefully deeper discussions on the issue in the months to come.

Banking union is a big move. A banking union is not a mere technicality. It is the true complement to a monetary union. It is a sort of fiscal union, though one that does not rest on spending, but on the mutualisation of a contingent liability. It also implies breaking with the long-standing intimate, cosy and sometime perverse relationship between banks and public authorities at national level.  

The idea was nowhere in sight a few months ago (except, of course, in the writings of academics and think tanks. See here the dedicated webpage on our own contributions). There is now a commitment to put it in place. The first sentence of the statement is a telling recognition of the nature of the problem: “We affirm that it is imperative to break the vicious circle between banks and sovereigns”. The decision to ditch the desirable but implausible project of a banking union for the 27, which the Commission supported for too long, and to focus instead on the euro area is to be commended. The reference to Art 127(6), which makes it possible to task the ECB with supervisory responsibility, is an unambiguous indication that banking union is contemplated for euro area banks and that the ECB will be the supervisor.

The statement is however excessively short on the implications of this move. Lots of important dimensions need to be worked out if a true banking union is to be created. In our recent banking union paper we list the choices that need to be made. They are many and complex. After the Eurogroup on 9 July hopefully defines the discussion agenda, negotiations will need to take place at sustained pace over summer and beyond. The credibility of the whole process will depend on the precision of the negotiation agenda. Difficult issues are the supervision of smaller banks,crisis resolution, the shape of deposit insurance, the nature of the fiscal backstop, the involvement of euro candidate countries and, last but not least, the transition to the new regime.

Moving to the short term, the decisions taken are likely to be a true relief for Spain. Though some will regret the delay in allowing the ESM to recapitalise banks directly, I see it positively. The first EFSF disbursements will be in the form of loans to the Spanish state, so Spain will shoulder the cost. But Spain can – and it should pay for mistakes made at the time of the bubble. Markets will not worry if Spain increases its public debt by 30 or 40 billion euros. What made them nervous, and needed to be address, was the catastrophic risk of a much larger cost. The agreement makes it possible to mutualise this risk – as well as the upside if losses happen to be contained. This is exactly what was needed. Together with removal of seniority status, a big boost to bond markets.

The gain for Italy is more ambiguous. The agreement opens the way to interventions by the ESM on the bond markets, but discounting the €100bn earmarked for Spain the ESM has only €400bn left (and will need some of it for countries under assistance programme) while the size of the Italian bond market is 1.5tr. The bet is that the relief for Spain and the agreement that the ESM could intervene to support Italy without further conditions will suffice to reduce spreads lastingly. Let us hope they will.

On the whole this is an ambitious outcome. Two challenges will now have to be faced. One is technical: to agree on the various dimensions of banking union and to come up with a credible proposal within a very short time frame. The other one is political: even informed public opinion in the member countries is totally unprepared to what this new policy regime may mean. As citizens and national parliaments gradually realise what all that may imply for them, some backlash has to be expected. There is a risk of another half-backed solution; It is to be hoped that having taken a major decision, the heads of state and government find the right words and explain what it means to all those they are accountable to and convince them that to stop half-way would not solve any problem.