07 February 2013

Bundesbank/Lautenschläger: European Monetary and Financial Union - What is needed in terms of banking supervision?

European banking supervision – the “why”

Loosening the links between banks and sovereigns is vital if the euro area is to be made more stable. But how do we get there?

First, pinpointing excessive risk concentrations is essential. A European banking supervisor can weaken the nexus between sovereigns and banks by monitoring and putting a brake on the build-up of excessive risks, whether in specific economic sectors or in government financing – even if this can only be done in medium term.

Second, in order to insulate banks from weak public finances, we need not only appropriate supervision but also suitable regulation; regulation that will prevent banks from taking on excessive risk through state financing. Such regulation should, for instance, include upper limits for lending to governments. It should also encompass appropriate capital backing for government bonds – which is another proposal made by Stefan Gerlach, incidentally.

But the Single Supervisory Mechanism and suitable regulation are just two elements of a banking union, and there are also other means available for severing the link between sovereigns and banks. The third tool in this respect is a European recovery and resolution mechanism for banks that has access to “European” funds. In this context, it is necessary that any such mechanism ensure that investors are first in line to bear the risk of their investment decision. Taxpayers must be spared the burden of other people’s investment decisions – at the national level and even more so at the European level – for as long as there is no proper balance between liability and control.

European banking supervision – the “how”

With regard to the governance structure, there is a problem that cannot be fully resolved under the current framework – the strict separation of monetary policy from banking supervision within the ECB. Such a separation is not possible without amending the ECB’s institutional framework as enshrined in primary law – a step that has been carefully avoided so far.

With the goal of strictly separated functions in mind, the current proposal establishes two new bodies within the ECB: first, a Supervisory Board with representatives from the ECB and from national authorities; second, a mediation panel which includes one member from each country that participates in the Single Supervisory Mechanism. Now, what are the tasks of these two bodies?

The Supervisory Board submits proposals for supervisory decisions to the Governing Council. The Governing Council, in turn, can only agree or disagree, but will not be able to amend these proposals. If the Governing Council disagrees, it will be up to the mediation panel to resolve differences of opinion. The panel will decide by simple majority whether to accept the proposal in its original form or not.

And in order to actually separate the two functions, it would be imperative for the Supervisory Board to have the final say in all supervisory decisions. However, under prevailing primary law, the ECB Governing Council must have and will have the last word on banking supervisory decisions.

There are additional problems I would like to focus on: because of prevailing primary law it is problematic that the Governing Council is supposed to only accept or reject decision-making proposals from the Supervisory Board, but to be unable to influence the proposals. If the Governing Council, consisting of the ECB board members and the governors of the EMU central banks, is responsible for supervisory actions, it also has to be in a position to shape the measures being taken.

Additionally, the independence of the ECB and its Governing Council would be restricted if it were obliged to regard the decision of the mediation panel as binding.

The problems I have just set out highlight the crucial importance of a principle which the founders of the Eurosystem were keen to safeguard: the independence of the ECB, and of its governors. If the governments decide to mandate the ECB with additional tasks, this basic principle still applies, as long as the treaty is not changed. Thus, if the ECB is mandated with banking supervision, the Governing Council of the ECB will be the one deciding on all relevant supervisory matters, as long as there are no changes in primary law. This implies that – following a common principle of reason – those responsible for a decision need to be able to shape that decision.

Full speech

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