19 December 2012

Eijffinger/Nijskens: Monetary policy and banking supervision

This column argues that the two functions must be separated by setting up a Supervisory Board, operating independently within the ECB, and by granting the new supervisors a solvency instrument that is independent of the interest rate.

As the ECB will become responsible for micr-prudential supervision, we have to assess carefully the consequences for its primary mandate: price stability. Conceptually, both mandates are mutual prerequisites. Price stability is necessary for financial stability, and a stable financial system is required for proper transmission of monetary policy. However, conflicts of interest may arise when the ECB is both bank supervisor and monetary policymaker.

To circumvent these we need to separate the two functions clearly. This can be done by setting up a Supervisory Board, operating independently within the ECB, or by appointing national supervisors as alternates to national central bank governors in the Council. In both cases, a member of the ECB’s Executive Board should be responsible for supervision. Also, the new supervisors should dispose over a solvency instrument that is independent of the interest rate and allows for early intervention in potential problem banks.

Note that this is not the ultimate solution to the problem, as ECB President Draghi will ultimately be responsible for both monetary policy and supervision. Separating both functions is, however, a step in the right direction. In the end, both supervision and monetary policy should be independent from each other as well as from politics.

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