24 June 2012

Sharon Bowles: Banking union is an idea in search of the good

In an op-ed for Bloomberg, Ms Bowles observes that it wouldn't be Europe if a proposal didn't lead to numerous interpretations, giving the concept of a so-called banking union as a case in point.

A case in point is the concept of a so-called banking union, which is clearly intended as a way to achieve mutualisation of the euro area’s debt and help solve the region’s crisis. “Easier than eurobonds; less obvious because it is more complicated” was how some saw it. But the potential weakness of mutualisation was spotted and now we are mired in the manoeuvres to extract something decent from the proposal.

Because taxpayers pick up the tab for mistakes and crises in their own country, supervision and the resolution of failing banks has always rested with individual Member States. Now it has been shown that some euro area countries can’t afford the bill and have few options -- such as the ability to print money -- for standing behind their banking system. The ensuing turmoil has led to the conclusion that bank supervision, not just rule-making, must take account of monetary policy; hence the need for a banking union, especially for the euro area.

How do we blend these ingredients to maximum benefit and to avoid a banking union becoming a vehicle that undermines the single market in financial services?

The European Banking Authority as an agency of the European Commission operates only on delegated power, limiting its ability to make the tough decisions needed of a full-fledged supervisor. The Commission also retains oversight of all its European agencies. By putting the European Banking Authority in charge of banking oversight, power will be concentrated in the Commission, creating conflicts of interest similar to those when individual governments act as bank supervisors. Moreover, substantially expanding the power of the European Banking Authority could require time-consuming changes to the European Union Treaty.

By contrast, the treaty already has provisions for the European Central Bank to act as a supervisor, and this links monetary policy and supervision for the euro area. By extension, this would require a corresponding role for central banks in member nations outside the euro area, such as the Bank of England, to take account of monetary policy in their countries.

This isn’t a question of a level playing field because even euro area countries will have supervisory variations in capital requirements legislation, contributing to local correction of issues such as the Spanish and Irish property bubbles.

However, EU-wide coordination will still be needed, requiring an ongoing role for the banking authority as rule-maker, controlling supervisory variations for all 27 EU countries and continuing in its dispute-mediation role. This is even more the case if ECB supervision is only for large banks.

There are US parallels here: supervision at the state level, but federal oversight for large banks or those requiring resolution after failing. Current EU capital requirements legislation fits this model. Member States have a role on taking economy-wide measures, balanced with EU-level constraints via the Systemic Risk Board or the Commission.

A banking union also envisages mutualisation of bank recapitalisations and deposit-insurance programmes. But this wouldn’t happen for some time because budgetary controls have to prove themselves first, and mutualisation without full integration would pose too much exposure to sovereign debt. Mutualising bank debt is an even greater drag on Member States’ balance sheets than sovereign debt. Changing creditor hierarchies so insured depositors are at the top of the queue if banks fail would help reduce the fiscal risks. Germany may want to exempt all but its biggest banks from contributing, too.

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