June 29, 2012 7:14 pm

Eurozone off on journey to central control

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Eurozone leaders have embarked on a process to surrender sovereign control of banks to a powerful central supervisor within six months, in a political pledge that kick-starts highly complex talks to forge a nascent “banking union”.

Proposals will be hastily drawn up over this summer to give the European Central Bank ultimate power to oversee euro area banks. While leaders chose to empower the ECB in Frankfurt as the new supervisor, there are a host of unanswered questions, including defining its exact powers, the banks it covers and its relations with countries outside the new regime. “It is a big decision that opens a Pandora’s box,” said one senior official involved.

François Hollande, the French president, hailed a historic deal that would be “a reality” by 2013. But some German officials are urging caution over the timetable and Angela Merkel of Germany, while endorsing the principle, pointed out all 27 EU countries still have a veto.

The question will be whether the strong political commitment to cede power – made in the early hours of the morning at a Brussels summit – will survive months of gruelling negotiations. Creating a eurozone bank supervisor is a precondition to using the European Stability Mechanism, Europe’s permanent bailout fund, to inject capital into banks directly.

One of the most sensitive points – not addressed in the statement – is scope. Mr Hollande wants “all the banks” in the eurozone to be covered. But most national authorities are alarmed at having to give up power and Germany is facing intense political pressure to maintain control of the politically powerful regional saving banks.

Germany’s politically influential savings banks association, representing more than 400 local banks, said pan-European ECB supervision would be “disproportionate” unless confined to systemically-relevant banks.

One option is to maintain an existing network of national bank supervisors under the ultimate authority of the ECB, which would have day to day responsibility for the biggest banks. If necessary, under certain circumstances, the central authority could reach into the patch of national supervisors.

Other thorny issues include appointing a resolution authority, which would be able to intervene and wind up a failing bank, if necessary against the wishes of a national government.

While Brussels now encourages separate resolution and supervision authorities, EU leaders have not addressed the issue of whether this should be the ECB and how it would interact with existing EU bailout funds.

As part of these reforms, the ECB would also need to restructure to ensure its new bank responsibilities do not damage the independence of its core central bank functions.

It will also need to define how it relates to other EU authorities and resolves disputes over enforcing rules, given it will wield formidable power. This will entail a revamp of the European Banking Authority, a pan-EU body that mediates between national supervisors.

The supervisor may stretch beyond the euro area. The UK is standing outside the supervision regime and is calling for “safeguards” to protect the single market. But other non-euro area countries – whose economies are reliant on eurozone based banks – could still join.

Some big EU banks uncomfortable with a system that excludes the UK. “London as Europe’s strongest financial centre has to be included. Financial crises don’t stop at the channel,” said Andreas Schmitz, president of Germany’s association of commercial banks including Deutsche and Commerzbank.

While taking bold steps towards establishing a eurozone supervisor, EU leaders were more coy in endorsing measures to share risk for underwriting deposits – a key pillar of a banking union. “ Madame Merkel has had a very tough line on this issue of bank guarantees,” said Mr Hollande, in an indication of the complex negotiations ahead.

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