December 9, 2012 6:30 pm

Debate rages on eurozone banks supervisor

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It has no direct experience of supervision, no dedicated staff for the job, and faces outright hostility from some of its putative charges. Other than that, the European Central Bank is ideally placed to take over the supervision of 6,000 banks in the eurozone.

The establishment of a single supervisor for the currency union’s banks has been widely greeted as a sound idea as a first step towards a “banking union” that could prevent a repeat of the vicious downward spiral in which banks and sovereigns have found themselves embraced during Europe’s debt crisis.

The ECB, set up in the image of the Bundesbank as a guardian of price stability, is on the one hand ill-equipped to take on the task without significant institutional changes. On the other, it is the obvious place to start creating a eurozone-wide regulator.

But debate rages over how to go about establishing such a supervisor, and the speed at which to go. Europe’s finance ministers meet on Wednesday in an attempt to agree a way forward, with the role of the ECB at the centre of discussion.

Mario Draghi, ECB president, insisted last week that the bank was a “passive subject” in the argument, as long as its minimum conditions were fulfilled.

“[The ECB] should be in a position to carry it out in a decisive, firm, complete and strong manner without any reputational risks,” he said. “And ... new tasks should not be mixed with our monetary policy tasks – delivering price stability in the medium term – which for us remains the primary task.”

He made clear that being a decisive supervisor included oversight of all 6,000 banks – a move fiercely opposed by Germany’s small savings banks – but indicated that the smaller the bank, the more ECB supervision would in fact resemble current national arrangements on a day-to-day basis.

If German political opposition to small bank supervision can be overcome this week and a deal is reached in Brussels, that would set in motion the process by which the ECB begins to hire relevant staff and finalise an internal structure. But Mr Draghi’s soothing words – that small banks need fear little since they will still mostly deal with their national supervisor – also contain the seeds of a bigger problem, say critics.

In the evolving banking union structure, a single supervisor comes first, followed by a eurozone-wide – or EU-wide – banking resolution mechanism, and then, theoretically, a single deposit guarantee scheme.

Since the latter two involve the chance of taxpayers from one country having to pay up for the mistakes of a bank in another, they are far more controversial than the single supervisor. So much so that the single deposit guarantee scheme appears to have all but dropped off the agenda, again in the face of German opposition.

But the risk for the ECB is that the second element, bank resolution, will not follow until some as yet unspecified time after it takes on responsibility for supervision. That would make the ECB the central supervisor, but one entirely reliant on national bank resolution arrangements – and enforcement.

“That is the worst of all possible options,” said Alistair Darling, former UK chancellor who oversaw the British bank bailouts. “The biggest single thing you need to do to sort this out is to be master of your own house.”

Thomas Huertas, a former chair of the European Banking Authority who now works for Ernst & Young, adds: “If you don’t have the threat of sending the bank into resolution, your hands are tied as a supervisor.”

The European Stability Mechanism bailout fund will to some extent act as a backstop until a resolution scheme is in place, but as one senior EU official says: “Once you scratch the surface of this proposal you quickly realise that this will not work without a European resolution mechanism. Until then we’ll be crossing our fingers.”

There is not yet a single rule book for banks, so the ECB will also initially face a patchwork of national rules, or harmonised ones that have been implemented differently. Add in the ECB’s consensus-based decision making – which it wants to carry over into supervision by creating a supervisory board overseen by its paramount governing council – and another fear is that the resulting structure would prove unwieldy in a crisis.

Mr Draghi says “thousands of lawyers” have concluded that existing EU law allows the ECB to take on supervision without requiring a round of treaty change feared in Europe’s capitals.

But a clear refrain emerging from the Bundesbank, which in principle supports banking union and itself plays a role in domestic bank supervision, is that it would be better to undergo treaty change in order to enshrine the principle that a single supervisor is not beholden to the ECB’s interest rate-setting governing council.

“If politicians really want a banking union, then they will be able to make the necessary political decisions swiftly,” Jens Weidmann, Bundesbank president, told Germany’s Welt am Sonntag newspaper.

While critics have focused on the dangers of an ECB supervisor losing its monetary policy nerve once it knows what effect an interest rate decision could have on a given big bank, the insight into banks’ books could also inform policy making that at present has remarkably little access – and few powers to demand it.

Benoît Cœuré, an ECB executive board member, acknowledged that monetary policy must be kept separate from supervision. But, speaking last month, he added: “Separation does not mean isolation. Certainly there needs to be communication between the two parts ... There are strong complementarities between central banking and supervision.”

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