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Banking union is the flavour of the month. Faced with investors who doubt the ability of some eurozone sovereigns to make good on their debts, the 17 members of the single currency have agreed to work together to channel aid directly to troubled lenders. But the deal is conditioned on the creation of a single banking supervisor, empowered to crack down on risky banks, no matter where they are located.
Setting up an impartial expert to oversee the banks could well be a key step toward restoring trust. Freed from local political concerns, a central supervisor might well have a clearer view of the problems and the fortitude to take the almost certainly unpleasant decisions needed to solve them.
But well-informed banking supervisors can’t be summoned with the wave of a wand, and key eurozone finance ministers this week repeated calls for something to be put in place by the end of the year. Given that tight deadline, the options are pretty limited. The fledgling European Banking Authority, which opened its doors just over 18 months ago, currently sets standards but it has no legal authority to supervise banks. Its mandate to create a stable and level playing field throughout the single market also runs counter to taking on a specific eurozone role.
The European Central Bank is seen by many as the only operator with the credibility and resources to crack down hard on recalcitrant lenders. The current plan is for the ECB – or some offshoot – to take charge of the bigger, cross-border institutions while smaller banks would continue to be supervised locally. That arrangement – which parallels the UK plan to hand supervision back to the Bank of England next year – raises concerns about an overly powerful central bank trying to do too many jobs at once. It also contains a problematic fudge. Small banks can be dangerous too. Witness the woes of the Spanish regional savings banks and the 2007 depositor run on Northern Rock, a middle-sized UK lender.
No matter whose name is on the door, tough oversight does not come cheap. When the UK Financial Services Authority shifted from a “light touch” approach to “intensive supervision” in the wake of the 2008 financial crisis, it had to hire hundreds of new supervisors. The watchdog now has more than 1,000 people in its unit dedicated to the safety and soundness of banks and insurers.
By contrast, the EBA has 70 people in its London office and hopes to get above 100 by the end of the year. The ECB is far more substantial and has experience with sending staff to Spain to deal with its ongoing crisis. But even so, policy makers have said the central bank would almost certainly have to rely on staff recruited from the national regulators it is displacing. That could pose a problem, because so much of banking supervision is discretionary – watchdogs routinely have to tailor rules to the circumstances of individual institutions.
The EBA’s much criticised stress tests have already made clear how difficult it can be to enforce uniform definitions – let alone standardise supervision – across wildly different banking systems. When calculating capital requirements, many Nordic banks, for example, assign a much lower risk weight to residential mortgages than do institutions in the UK or Spain. The Nordics may be right that their loans are safer because their loan-to-value ratios are lower. But bankers are far too fond of pulling out “you don’t understand our local market” card, and Sweden had its own banking crisis in the 1990s.
Recent events have also highlighted the difficulties associated with relying on local regulators to enforce EU or international standards. Confronted with parts of the global “Basel III” capital rules, some Continental regulators have repeatedly sought to water down the rules, rather than force their local banks to comply.
The solution may lie across the Atlantic, where US bank supervisors have long had to cope with a far-flung and varied network of financial institutions. The Comptroller of the Currency and the Federal Reserve swear by their armies of “field examiners” – teams of up 35 people who work on location at large US banks. The examiners function like police officers on the beat and serve as a critical early warning system for upper level regulators. There are risks, of course – on-site supervisors are, if anything, even more vulnerable to going native – and many US banks got into trouble even with regulators on the scene.
But given the alternatives, sending teams directly from the ECB in Frankfurt seems like a dish worth tasting. Without boots on the ground, it would be awfully tough for a regulator to call a bank’s bluff from thousands of miles away.
Brooke Masters is the FT’s Chief Regulation Correspondent
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