There are two classes of compromise in political life. In the first, your ultimate aim is sweeping change, such as switching the side of the road on which your country drives; but, in the name of expediency, you sacrifice important principles and gradually try to phase in the new rules. This is deadly.

The other involves settling for as much as you can get even when it is less than you want. This is not great either. But often it is good enough to leave everyone a little better off.

The art of the second kind of compromise has been the essence of political life in the European Union. The proposed legislation on banking union, however, is not of that kind. I have been hesitating to make this call but I now believe that it would be best for the EU and the euro zone if this legislation were ditched altogether.

The matter is now in the hands of the European Parliament. A deadline for a compromise in the negotiations between finance ministers and parliamentary representatives is approaching fast. The parliamentarians should simply say no to the proposals and walk away.

At issue is new legislation that would give regulators the power to close down a bank or force it to seek new capital. In December, finance ministers agreed this so-called single resolution mechanism. Parliament and the ministers have since been locked in negotiations, but have made little progress. European agreements always look impossible five minutes before a breakthrough. But this time, the distance between the two sides is especially large.

Under the deal agreed in December, member states would build up a resolution fund over 10 years, covering about 1 per cent of all insured deposits, which amount to about €55 billion. If a bank needs bailing out in the meantime, member states and the fund will jointly foot the bill according to an agreed schedule.

At Germany’s insistence, the fund itself will be incorporated under a separate intergovernmental agreement. It cannot borrow money from the European Stability Mechanism, the rescue umbrella.

A decision to close down a bank has to be agreed over a weekend, while the markets are closed, to avoid creating panic. Under the proposed regime, agreement would be needed from all of the following institutions: the European Commission; the Council of Ministers; the European Central Bank; the supervisory board of the Single Supervisory Mechanism, the new bank supervisor; the executive board of the Single Resolution Mechanism, and its plenary council. I might have forgotten one or two.

The European Parliament has drawn five red lines: the ECB should have the final say about whether a bank fails; resolution decisions should be taken without political interference; there should be no new intergovernmental legislation; the fund should be replenished more quickly; and, most importantly, governments should jointly commit to pay up themselves if the fund's resources prove inadequate.

Technical debate
Step back from this technical debate for a moment and recall why the euro zone needs a banking union in the first place: to prevent doubts about the solvency of national governments from undermining confidence in their banks. Unless the resolution fund has the backstop of further European funding, that cannot happen.

A bad banking union is worse than none. Some advocates miscalculated because they thought of it as a cheap alternative to a fiscal union. But cheap it is not. On my own calculations, the European banking sector needs to raise its capital by at least €1 trillion. I arrive at this number by looking at the total size of all banking sector assets, making a rough guess of the losses to expect in a large financial crisis, and knocking off the bit absorbed by existing capital. Of course, this is very rough but it gives you an order of magnitude.

Alternative
A detailed study by financial economists Viral Acharya and Sascha Steffen came up with an estimate of €510 billion-€770 billion for the shortfall. But this range relates to only 109 banks out of the 128 that would be subject to ECB supervision.

I doubt the ECB will come up with a number anywhere near this high. It would require lots of public money. The EU is not prepared for that.

What is the alternative? My suggestion is that the legislation should be dropped for now. Policymakers should start from scratch after the elections in May – possibly without Germany. This could be done under EU law, under a procedure called enhanced co-operation.

The Germans have adopted a take-it-or-leave-it stance in the negotiations. Banking union, to put it mildly, is not a German priority. Berlin wants neither to pay for the closure of foreign banks nor to allow foreigners to close their banks themselves. If a smaller banking union can be made to work, Germany may join eventually. That carries risks of its own. But it would at least be a start. It would be the second type of compromise, not great but good enough. Otherwise, we will end up letting the lorries drive on the wrong side of the road. – Copyright The Financial Times Limited 2014