Formation of European banking union set to allay fears of investors

Demonstrators in Madrid hold up placards saying: ‘Everybody out’; ‘We don’t owe, we don’t pay’; and ‘They rescue the banks and evict people' (Reuters)

The eurozone is preparing to bow to the will of the financial markets as leaders attempt to ease fears ahead of crucial elections in Greece this weekend.

A draft of the text that will be discussed at the European Union summit later this month was leaked showing that national leaders are set to go ahead with a pan-European banking union and closer integration, the two areas where frightened investors have been clamouring for progress. "There is a need for more specific building blocks centred around a much stronger banking and fiscal integration, underpinned by enhanced euro governance," said the draft, which was obtained by Reuters.

Investors have been pulling their money out of banks in struggling eurozone states in recent months, motivated by fears that their deposits could be devalued if the eurozone breaks up. Figures released by the Greek central bank showed that total deposits fell by 17 per cent in 2011. There have also been reports of large withdrawals from the Spanish banking system, for which the Madrid government has requested a bailout of up to €100bn.

Senior European policymakers, including the European Commission President, Jose Manuel Barroso, pictured, have suggested that a move to a banking union, with central guarantees of all deposits, will calm investors. The European Central Bank President, Mario Draghi, has also called for such a union.

However, the leak of the draft yesterday failed to make a positive impression. Spanish 10-year borrowing costs rose again, closing at 6.76 per cent, just below recent record highs. Italy also faced higher borrowing costs, both for the long and short terms. It had to pay 3.97 per cent to raise €6.5bn in one-year money, up from 2.34 per cent last month.