An Imperfect Union: The Void Underpinning Europe’s Banking Market

October 17, 2025 - Written by Talha Haroon

When Monte dei Paschi di Siena (MPS) secured control of Mediobanca in a €16bn share-and-cash offer in late-September, it marked a striking reversal for a lender that required a state-backed rescue eight years earlier. Italian Economy minister Giancarlo Giorgetti, who earlier this year described the deal being “in the interests of the Italian economy”, highlighted the transaction as the culmination of efforts to return MPS to private hands and consolidate Italy’s financial sector.

Similarly, across the Pyrenees, Spain’s Prime Minister Pedro Sánchez announced in May that the Spanish government would open a public consultation into BBVA’s €18bn bid for Sabadell, underscoring how large-scale consolidation can become politically tainted. While these deals can be seen as events confined to national spheres of M&A activity, taken together, they underscore a deeper paradox: economic consolidation in Europe is advancing, but almost exclusively within national borders.

The creation of pan-European champions capable of standing alongside American conglomerates or China’s state-backed giants remains elusive, constrained less by market appetite than by the incomplete architecture of the EU’s Banking Union (BU). As Europe grapples with this structural thorn of its competitiveness conundrum, the imperative to commit to truly pan-European institutions will determine not only the fate of its banks, but the credibility of Europe’s economic union itself.

A Hollow Structure: Europe’s Banking Union without its Final Pillar

 The EU Banking Union was conceived in the aftermath of the eurozone crisis to break the destructive loop between weak banks and overstretched sovereigns. As Danièle Nouy, first Chair of the ECB’s Supervisory Board remarked in 2016, one of its initial aims was to “increase financial stability and protect the taxpayers who have had to support failing banks far too often.” Consequently, two central pillars were proposed: the Single Supervisory Mechanism (SSM), which transferred oversight of the euro area’s largest banks from national authorities to the ECB, with the intention of ensuring consistent standards; and the Single Resolution Mechanism (SRM), a common authority empowered to restructure or wind down failing institutions in an orderly way. Together, these pillars were intended to create the conditions under which cross-border consolidation could proceed, with the assurance that failures would be contained through common risk-sharing arrangements. However, the absence of a crucial third pillar – a deposit insurance mechanism – has left the Banking Union incomplete; depositor protection remains tied to national balance sheets, which undermines financial integration and leaves investor confidence less than enthusiastic.

To plug this confidence gap, the European Commission proposed the European Deposit Insurance Scheme (EDIS) in 2015. The scheme was designed to chart a cautious path forward, beginning with limited reinsurance of national systems with the aim of ultimately evolving into a fully mutualised fund financed by risk-based bank contributions. The underlying principle being that a euro deposited in a bank in Milan or Paris should be just as safe and monetarily secure as one placed in a bank in Frankfurt or Brussels, severing the Gordian knot of national interest and depositor confidence. Yet as financial economists Véron and Schnabel note, the proposal has not “met sufficient consensus among euro-area countries, producing a deadlock in policy discussions.”

The main causes are two-fold: deep-seated political mistrust and basic structural differences between banking systems. Northern EU states, led by Germany and the Netherlands, host banks with stronger balance sheets and broader deposit bases. Germany’s largest lender, Deutsche Bank, reported a CET1 ratio of 14.2% in mid-2025, continuing a steady upward trend, while Dutch institutions such as ING maintained ratios above 14%. Both stand well clear of the 4.5% EU regulatory minimum, reinforcing the view that banking systems in northern capitals are fundamentally resilient. From their perspective, undertaking the insurance risks of continent-wide banking activity would mean underwriting the legacy problems of southern banking systems still scarred by the eurozone crisis. For instance, Germany’s former finance minister Wolfgang Schäuble warned as early as 2015 that risk-sharing without prior risk-reduction would serve “only those who have made no effort.” That stance has largely endured: while the Bundesbank acknowledged in 2024 that a common deposit insurance scheme could “strengthen confidence in depositor protection and thus reduce the risk of bank runs,” its president Joachim Nagel has more recently emphasised structural reforms, warning that “the double counting of capital…and parallel minimum requirements reduce the buffers actually available, [which] in turn, can lead to supervisors releasing buffers but banks not being able to use them.” Essentially, due to disparities in banking blueprints across the continent, robust institutions and taxpayers in wealthier nations contend that they should not be compelled to backstop weaker national banking systems elsewhere.

By contrast, southern European governments such as Greece or Italy see the absence of EDIS as entrenching the systemic inequality of their respective systems. Their banks, often carrying higher levels of non-performing loans (NPLs) and relying more on wholesale funding, face higher borrowing costs and tighter margins stemming from depositors distrusting the insurance guarantees tied to their unsound national balance sheets. In Italy, for example, NPL ratios have fallen sharply since the eurozone crisis but still stood above 4% in early 2025 – nearly double the levels in Germany or the Netherlands. Markets interpret this as greater credit risk: even profitable southern banks must pay more to borrow and offer higher deposit rates to reassure savers, eroding profitability compared to northern peers. The consequent is a two-tier banking market where northern banks enjoy trusted national backstops, while southern banks are sidelined for legacies of crisis that a common European guarantee was meant to overcome.

Italy’s central bank has repeatedly warned of these distortions: the Bank of Italy’s 2024 Governor’s Report identifies financial market fragmentation as a principal euro-area vulnerability, highlighting how differences in deposit or protection skew investor perceptions across the board. Similarly, Banque de France Governor François Villeroy de Galhau has called for a “Financing Union for Investment and Innovation,” building on the Capital Markets/Savings & Investment Union agendas. He argues that pooling savings at the European level and directing them into green and digital transitions would see the EU close its investment gap with global competitors whilst contributing to region-wide development. However, the absence of a shared deposit guarantee raises guardrails in actualising successive proposals – banks are stymied due to divergent perceptions, drastically undermining the potential of a unified European banking market.

This political stalemate over EDIS and the wider Banking Union carries tangible economic costs. Deposits remain unevenly ring-fenced, stalling cross-border integration and limiting banks’ ability to operate at scale. The result is a banking sector that is resilient within individual countries but fragmented at the continental level. According to the Association for Financial Markets in Europe, more than €475bn of capital and liquidity remains trapped within national borders, a stark measure of the price of inaction. At a moment when investors are reassessing destinations amid US uncertainty and intensifying competition from China’s state-backed giants, Europe’s immobilised capital leaves its lenders unable to match the scale, efficiency, and global reach of their counterparts.

The Need to Mutualise Trust

 To move from national consolidation to genuine European integration, policymakers must confront the paradox of progress in absence of completion: Europe’s banks are stronger than ever, yet still constrained by national borders. The recent wave of mergers across the continent signals an ambition to reshape individual domestic markets, but it delimits integration to the extent of sovereign frontiers. As the BU’s Single Resolution Board (SRB) Chair Dominique Laboureix remarked earlier this year, “such large figures [in banking activity] and growing interconnections call for a European solution.” Completing EDIS provides that solution, though it requires not only financial alignment, but the mutualisation of trust that transforms aspiration into concrete realities.

 Yet trust, as history reminds us, cannot be legislated into being; it must be cultivated through reciprocity and restraint. A phased EDIS, anchored as much in the measurable convergence of capital adequacy as in the management of sovereign exposures, could balance risk-sharing with responsibility – offering an olive branch in Europe’s North–South divide. Mario Draghi, the lodestar for EU aspirations towards competitiveness, has remarked that Europe’s fragmentation is not an inevitability but a determined policy choice. As a result, whether the EU chooses to liberate its stock of capital and nurture truly pan-European players, or to persist with a patchwork of nationally guarded champions, will determine whether it has the appetite to lead on the world's economic stage.

Written by Talha Haroon

Analyst and Editor