19 November 2012

ECB/Cœuré: Towards a consistent, coherent and complete Economic and Monetary Union

Why the euro needs a banking union

Let me begin with the so-called financial or banking union. The heart of the problem here is the fragmentation of the euro area banking system. I will not dwell on the symptoms of fragmentation. They are well known and have been documented, e.g. in the ECB’s reports on Financial Integration in Europe and Financial Stability Reviews, and have covered, among other matters, the renationalisation of interbank markets, dispersion of bank funding costs and bank lending rates along national lines.

Equally well documented is the high correlation between the creditworthiness of banks, as well as their funding conditions, and the creditworthiness of their respective government. The ultimate protection of senior bank creditors, depositors in particular, comes from the fiscal backstop provided – or not – by the sovereign. It is therefore not surprising that the fragmentation of the banking system along national lines only became visible and damaging after the start of the sovereign debt crisis, even though the fault lines had existed beneath the surface.

The fundamental reason why this matters is that the single currency is really single only if the banking system is also single. Money, remember, is the liability of the banking system. Base money, issued by the Eurosystem, is undoubtedly single, but it represents only a fraction of broad money. The remainder is issued by commercial banks. If the credit of the banking system – including deposits – is fragmented along national lines, then so is money.

A genuine banking union is one where the location of deposits does not play a role in the confidence they inspire. This will require three interconnected elements: first, a strong, single supervisory mechanism to prevent crises; second, a common resolution scheme which allows effective and early decisions to be taken if a crisis nonetheless occurs; and third, eventually, a common European backstop which can be called upon in the event that there is still a need for public resources despite the involvement of the private sector. These three elements are complementary and mutually reinforcing.

Two versions of the fiscal union

There exists a link between the notion of a banking union and the second topic highlighted by the four Presidents in June, that is the fiscal union. A fully-fledged banking union, including resolution and deposit insurance, assumes a partial fiscal union. Let me note that this does not imply that the structure and powers of the SSM can only be decided upon when we know the full details of the fiscal union. The SSM as such does not have fiscal consequences, and should be implemented promptly.

What I am referring to here is a first interpretation of the fiscal union: a limited risk-sharing capacity allowing the absorption of idiosyncratic shocks. These shocks cannot entirely be absorbed by national policies alone, given the constraints imposed by the single monetary policy and the lack of an exchange rate. Therefore, there has to be a euro area fiscal capacity, as a form of limited rainy day insurance. Whether other tasks could be assigned to this common fiscal capacity, such as supporting allocative efficiency, is a matter of choice, not necessity.

Let me voice two words of caution. First, such risk-sharing capacity should serve as a complement, not a substitute to fiscal responsibility at national level. It should not undermine the implementation of the strong national fiscal governance rules enshrined in the Fiscal Compact. Second, the fiscal union should be precisely delineated so that is does not mutate into a transfer union. Transferring resources permanently from core to peripheral countries would be tantamount to accepting that economies will not adjust and that countries will not find their way back in the global economy.

This brings me to a second possible interpretation of fiscal union, which refers to a transfer of fiscal governance from the national to the European level, in the form of enforceable control of national budgets.

Economic union

The genuine completion of banking and fiscal unions would ensure that the union and its members are better able than they are now to withstand a wide variety of shocks: cyclical shocks, exogenous asymmetric shocks, as well as, if need be, shocks arising from the banking system.

There exists, however, a final category of shocks to which monetary union must be impervious. They derive from inadequate policies – labour market policies, for instance – or the absence of corrective policies, which amounts to the same. If left unaddressed, this either results in prolonged economic divergence – which is inconsistent with the objectives of the Union, or in permanent fiscal transfers – which is politically unacceptable.

What is necessary here, at the very least, to complete monetary union?

First and foremost, in my view, is the completion of the single market in all its aspects... Second, where macro-economic imbalances occur as a consequence of inadequate policies, those imbalances need to be identified early and corrective action taken. I believe that the surveillance tools are now in place, in particular through the Macro-economic Imbalance Procedure, and that the emphasis should now be on implementation and enforcement by the European Commission.

The interim report on the future of EMU in October suggested that euro area Member States could enter into contracts with EU institutions, under which they would commit to undertake specific structural reforms, on the basis of measurable and verifiable targets. Correctly designed, those contracts could both enhance national ownership and reinforce – rather than weaken – existing economic coordination procedures. There could be a role here for the euro area fiscal capacity, which could provide financial incentives to countries partaking in those contracts.

Political union

The last building block identified by the four Presidents in June is political union. In fact this is not a separate building block – it cuts across the entire discussion on other points. Decisions that have fiscal consequences require democratic backing. Any form of European control over national policies must be based on political legitimacy and strict accountability, in particular vis-à-vis the European Parliament. We at the ECB are very well aware of the need for democratic accountability wherever power is delegated. The ECB’s new supervisory task must be matched by additional reporting and accountability channels.

Yet, I think the general issue here is one of clarification, rather than one of institution-building. The notion that the euro is a currency without a state is in my view misguided. The euro is a currency with a state, only with a state whose branches of government are not yet clearly defined. Here again, let me explain:

As I underlined earlier, the euro was created to serve the single market. That market itself is a political construct. It not only presupposes the freedom to play a part in the market – that would be anarchy. It also presupposes the means to protect that freedom, such as the protection of property rights and the enforcement of contracts. For there to be a single market, there must be a legislative body that establishes the rules and a judiciary that can enforce them. If there is a legislative and a judiciary, there has to be an executive arm to implement their decisions. For a market to function, the three branches of government have to exist. This makes the single market a political union.

What is not yet entirely clear in the case of the euro area, and apart from the ECB which has a clear but limited mandate, is who exactly will execute these powers, and to whom it will be accountable. As we move towards a genuine EMU, this clarification will become ever more necessary.

Full speech

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