The European Commission is now getting serious. It is seeking to set up, alongside the Single Supervisory Mechanism and the Single Resolution Mechanism, the third pillar of the banking union: a European Deposit Insurance Scheme (EDIS). 2024 is the deadline set by the Commission for completion of a European scheme protecting bank deposits; it will comprise a single European fund out of which depositor funds can be guaranteed up to €100,000 per depositor and bank if an institution fails. An EU directive already sets this limit for the national deposit guarantee schemes, yet thus far there has been no joint fund into which each country pays a contribution and from which bank depositors can be reimbursed in a bank failure event.

The European Commission is creating the EDIS as a European-level cushion to offset the impact of a potential crisis which would affect a member state’s banking system and overwhelm its national deposit insurance scheme. It is ultimately about sharing risks within the EU. The idea is to make banks less dependent on the state of their home economy and to strengthen depositors’ confidence in Europe’s banks.

While this would appear to be quite a reasonable and worthwhile initiative at first glance, on closer inspection it is a more than problematic undertaking. The main drawback of creating a single deposit insurance scheme, a three-stage process scheduled to begin in 2017, is that it is altogether premature: key conditions for this European project are not even met right now.

In essence, it is a question of the balance between liability and control, which would be disrupted by a European deposit protection scheme. Although banking supervision has been Europeanised, national economic policy still has a major bearing on domestic banks’ financial situation. And the legal framework - such as insolvency legislation - is still far too different from one European country to the next. This impacts directly on the burdens that would weigh on institutions in an insolvency event and is thus a major determinant of their risk situation. A European deposit insurance scheme is thus contingent on stronger European control over national economic policies and a harmonised European legal framework.

There is one other thing that must not be forgotten: stable banks are the best way to protect deposits. Much has been done towards this end. One item left on the agenda is to sever what are, in many cases, very close ties between banks and sovereigns: in some countries, banks are heavily exposed to their sovereigns. Government bonds are regarded as risk-free and are therefore exempt from capital requirements. This is wrong, however. Indeed, such preferential treatment is one of the key reasons why banks are so dependent on their home country’s economic situation. Therefore, severing the sovereign-bank nexus needs to be accompanied by an end to the preferential treatment by regulators of exposures to sovereigns. If this problem is not addressed, a European deposit protection scheme could lead to sovereign debt being de facto communitised; this would mean introducing Eurobonds through the back door. That is something which must be avoided at all costs.

There are entirely justified reasons to create a European deposit protection scheme. But if we put the cart before the horse, so to speak, we are bound to stumble. To prevent this from happening, we will need to get the sequence right. The obvious first step is that the agreed recovery and resolution measures for credit institutions have to be implemented throughout the EU before we set about negotiating a third pillar of banking union. Second, sovereign risk has to be reduced in bank balance sheets, and the preferential regulatory treatment of government bonds has to be done away with. Third, we need genuine progress in economic policy integration, including a harmonised insolvency regime.

As long as these minimum requirements are not met, the best option I see is to leave deposit protection to the responsibility of national authorities. In July this year, the EU Deposit Guarantee Directive was implemented in Germany. This means that one deposit protection framework harmonised throughout Europe has already been enshrined in national law, at least. So we are already well-equipped. A joint European deposit protection scheme is a nice idea, but now is not the time for it.