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Poland and the Czech Republic are deeply concerned about the banking union being proposed at Thursday’s EU summit, with the Czech premier warning on Wednesday that his country would not accept a measure that could be “extremely damaging” for its economy.

The warning from Petr Necas reflects anxiety across central Europe that the region could be hurt by the creation of a common system of banking regulation and deposit insurance aimed at shoring up the EU banking system.

While that idea may seem attractive in Brussels, it finds little traction in Warsaw and Prague.

The reason is the high level of foreign bank ownership in countries such as the Czech Republic, where almost 90 per cent of the banking sector is owned by west European banks, and Poland, where the proportion is about two-thirds. Banking regulators worry that pan-European regulation would make it easier for parent banks to drain liquidity from their often well-funded central European subsidiaries – potentially causing economic problems in the countries where these are based.

“Voluntary intra-group financial support agreements will enable financial groups to transfer assets between entities when one member of a group suffers financial difficulties,” says a European Commission staff impact assessment of the proposed plan.

Well-capitalised central European affiliates could make a tempting target for parent banks in the event of another crisis. In Poland, core tier one capital – a measure of financial strength – is 12.9 per cent, while in the Czech Republic it is 14.5 per cent; Polish banks last year recorded their highest ever profits

“Should it come into effect as introduced, Czech financial institutions, and indirectly also Czech public finances, would serve as a potential source of liquidity for countries outside the Czech Republic,” said Mojmir Hampl, deputy governor of the Czech National Bank. “The Czech subsidiaries of foreign banks, which are sound, would need to aid their sometimes ailing mother companies.”

Poland has been more circumspect than the Czech Republic, which, with the UK, was the only country to balk at joining the EU’s fiscal compact three months ago. Jacek Rostowski, Polish finance minister, said recently that Poland would not block a banking union if it was limited to eurozone countries, but that Poland would make a decision about joining only once the form of the union was made clear.

Wojciech Kwasniak, deputy chairman of the Polish Financial Supervision Authority, the banking regulator, also worried that the proposal could make it difficult for regulators to control banks, “particularly controlling liquidity and capital flows between local banking subsidiaries and their foreign parents”.

Regulators in Prague and Warsaw faced a threat of liquidity outflows during the first wave of the crisis in 2008, and then again last year, but have managed to use a combination of moral suasion and legal threats to keep banks from doing so.

“Foreign banks are formally Polish companies, and under Polish law it would be illegal for management to make decisions that harm the company,” said Andrzej Raczko, a former finance minister and now a senior official at Poland’s central bank.

However, Erik Berglof, chief economist of the European Bank for Reconstruction and Development, said banking union aimed to prevent the recurrence of situations where banks would need to move capital from subsidiaries to parents. Mr Berglof has been a driving force behind the so-called Vienna 2.0 initiative, designed to ensure deleveraging in central Europe by west European banks was orderly and co-ordinated.

“What is important is to remember that we are trying to address the underlying problem, and trying to create a more stable banking system for Europe, so … that the kind of faults that Poland and the Czech Republic are exposed to would be less likely, or at least there would be ways of dealing with them at the European level.”

Copyright The Financial Times Limited 2017. All rights reserved.

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