Jose Barroso, president of the European Commission, has declared the creation of a banking union to be the most important prestige project in the European Union. Mechanisms will be created to ensure the joint supervision of banks important to the financial system and the joint liquidation of bankrupt financial institutions - all to avoid a banking crisis like the one that followed the Lehman Brothers bankruptcy five years ago.

After months of drawn-out negotiations, European finance ministers formally approved the first pillar on Tuesday (15.10.2013). The European Central Bank (ECB) in Frankfurt, which oversees monetary policy and the stability of the euro, will in future also supervise big private banks.

"It is an important step towards creating a legal framework that will allow the ECB to press ahead with setting up operations for banking regulation," said German Finance Minister Wolfgang Schäuble in Luxembourg.

Dijsselbloem and Schäuble disagree on some points

From next fall, the ECB is to monitor over 130 banks in the 18 eurozone states. "Now we can start looking for a suitable building and start hiring staff. Today is a good day for Europe," said Jörg Asmussen, a member of the ECB executive.

Banks to open accounts

Before the ECB starts supervising Europe's banks, all 130 banks need to undergo a stress test and have their balance sheets checked for risky businesses and non-performing loans. The ECB does not want to inherit financial risks when it takes over responsibility for the banks.

That is also where the consensus among European finance ministers ends: a more contentious issue is what happens after the stress test. As ever, it is all about cost: who will pay for any holes found in the banks' balance sheets? Experts from the EU Commission expect to find some nasty surprises in banks in Spain, Ireland, Italy, Slovenia, Cyprus and Greece.

Some finance ministers from southern Europe believe European taxpayers have to take some of the burden. "That may be the case, but Germany will insist that taxpayers will be spared," warned Schäuble.

After all, the main goal of the banking union is that rather than taxpayers being liable for the banks' risks, the banks' owners should have to cough up. Olli Rehn, European Commissioner for Economic and Monetary Affairs, agrees: "To begin with, the bill should be paid out of private pockets. That includes bank owners, shareholders and creditors."

The ECB will oversee banks in the eurozone

ECB President Mario Draghi estimates the risks in European banks to be much smaller than two years ago. Today, the banks have a lot more equity, Draghi told the annual meeting of the International Monetary Fund in Washington.

Footing the bill

EU finance ministers want to impose a clear pecking order on liability if banks fold or have to undergo restructuring. And national budgets and European rescue funds will be at the end of that chain. There is some disagreement over whether the existing European Stability Mechanism (ESM) could provide fresh capital to the banks. This would mean heavily indebted states would be off the hook, shifting liability to the ESM.

The Irish and Spanish finance ministers are in favor of this solution, but the German finance minister is ruling it out. "The idea of a prompt recapitalization of banks, which does not accord with the German legal situation, can only be explained by lack of knowledge - presumably because people are not listening. I have explained the German legal situation often enough," said Schäuble. "It would be very difficult to change the legal situation in Germany. A lot of persuading would be needed."

The Dutch Finance Minister Jeroen Dijsselbloem, chairman of the Eurogroup, however, envisages a direct injection of capital from the ESM for ailing banks. "The tool for the recapitalization of banks is still under development. At the moment I think that it could be used in exceptional circumstances. Even now, but only in exceptional cases." These exceptional circumstances are so narrowly defined, they practically never happen, according to the German delegation.

Spain's Bankia has been affected by the crisis

Central liquidation authority far off

The third step of the banking union is also still a sticking point. A central authority for the liquidation and the dissolution of bankrupt banks is to be created, and the EU Commission wants to be in the driving seat.

Schäuble rejects the proposal, saying it does not comply with EU law. But other candidates for this delicate task, like the ECB or the ESM, have already declined. Again, cost is the central issue. An authority for liquidation would need liquidation funds to pay the costs of bankruptcy. After all, savers' deposits and small companies should be protected.

Dijsselbloem has promised that he and his colleagues will find solutions for these issues in the coming months, but it remains to be seen whether the solutions can be found ahead of the European elections in May 2014. A newly elected European Parliament will have a say in the matter.

It will take some time until the banking union will be finished. "We must be ready ahead of the next banking crisis," Barroso demanded. "People doubt that we have learned all the lessons from the last banking crisis," Schäuble warned.