17 December 2012

Karl Whelan for ECON Monetary Dialogue: Should monetary policy be separated from banking supervision?

The arguments for separation put forward by European politicians citing conflicts of interest, reputational argument, economies of scope or the numbers of banks in the euro area are weak and ignore the many real benefits from the integration of monetary policy with banking supervision.

Introduction

The decision of the June 2012 summit of euro area leaders to establish a ‘single supervisory mechanism involving the ECB’ re-opened a debate about the appropriate role for central banks in banking supervision.

A number of senior European policy-makers, in particular from Germany, have stressed that there is a conflict of interest between monetary policy and banking supervision. For example, on 4 December 2012, German finance minister Wolfgang Schäuble said ‘Again and again, we have made clear that a Chinese wall between banking supervision and monetary policy is an absolute necessity'.

The most detailed proposal for how a single supervisory mechanism would work, from the European Commission, appears to agree that this separation is an important principle. While the Commission proposes that the ECB be given the task of supervising banks, it also proposes that ‘Monetary policy tasks will be strictly separated from supervisory tasks to eliminate potential conflicts of interest between the objectives of monetary policy and prudential supervision'.

Personally, I am quite surprised that this idea (that conflicts of interest require separating banking supervision and monetary policy) has been so widely accepted so quickly in the debate about how a European banking union might work. While it is true that there was an international debate about this issue during the 1990s and it’s also true that a wide range of different models of banking supervision exist around the world, my sense of past debates on this topic was that the majority of informed opinion favoured the integration of monetary policy and banking supervision. Furthermore, I believe the global financial crisis has swung matters decisively back in favour of central banks playing a key role in supervising banks.

In this paper, I begin by outlining what I see as the numerous arguments in favour of a close involvement of central banks in banking supervision. Having done so, I address the arguments against this position and conclude that, by and large, the potential conflicts of interest that have been cited are minimal and that other arguments against a key role for central banks in banking supervision are weak. I conclude by briefly discussing the current state of play in relation to European banking union proposals.

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