21 January 2013

Stefan Gerlach: Banking and fiscal union

The Deputy Governor of the Central Bank of Ireland reflected broadly on why a banking union is important for any monetary union to function well, and why it is natural to locate the SSM with the central bank in such a union.

Why might it be beneficial to have a SSM in a monetary union? To my mind, one important reason is that a greater remove between supervisors and the banks they regulate can help improve the capacity for challenge and ensure a broader, more detached, perspective on the  issues. In particular, it would ensure the independence of the supervisory and regulatory decision-making process from national political pressure, and avoid regulatory capture. For example, a distant supervisor may take action to address risks arising from a bubble in good  times that a national supervisor would come under pressure to overlook. It also seems unlikely that a banking supervisor from, say, Italy or Ireland, sitting in Frankfurt, supervising a bank in Spain or Slovenia will let career considerations influence his or her decisions.

Another reason why an SSM is desirable in a monetary union has to do with the credibility of the supervisory framework. When banks in a country run into trouble or a bubble is forming, outside observers tend to attribute part of the problem to weaknesses in the national  regulatory and supervisory regime. They naturally ask if other undetected problems may be  brewing in the financial system in question. This may lead to deposit withdrawals or to a national risk premium to develop even if the Sovereign has sufficient capacity to backstop the  financial system. To my mind, an SSM, provided it is well-equipped and resourced, is less likely to have its credibility eroded in such a situation.

Indeed, while the debate around banking union is dominated by the capacity of the ESM to break the link between sovereigns and banks, a resolution framework alongside a common deposit guarantee scheme can help ensure that this link does not develop in future crises. The benefits of a resolution framework and fund in ensuring that taxpayers are insulated from the direct costs of resolving banks are clear. However, a common deposit guarantee scheme can be equally important; fears about the ability of individual sovereigns to backstop national deposit guarantee schemes have led to large intra-euro area retail deposit flows during the  current crisis, significantly impacting on funding costs of banks in stressed sovereigns.

An SSM is also likely to be helpful for monetary policy from an information perspective. For instance, in implementing monetary policy, central banks require their counterparties to satisfy certain criteria, most obviously being solvent. Moreover, Emergency Liquidity Assistance shall only be provided to solvent banks. Thus, there is an ongoing need for the central bank to have at least some information about individual banks.

Furthermore, in setting monetary policy it is important to have a sense of how a change in policy is transmitted through the banking system to the broader economy. Also this information flows more easily if the supervisor is not too distant from monetary policy-makers. Similarly, developments in the broader economy may first be reflected in supervisory information which may therefore be useful in setting monetary policy.

Full speech

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