23 November 2012

ECB/Draghi: Rationale and principles for financial union

Speaking at the 22nd Frankfurt European Banking Congress, Draghi said that the establishment of a Single Supervisory Mechanism would represent a major step towards a financial union, but that a common resolution regime and an independent European resolution authority would also be needed.

The crisis has highlighted a fundamental inconsistency between the single monetary policy of the euro area and the responsibility of national authorities for financial policies. The single currency needs a single financial system that is not fragmented along national lines.

Moreover, for the effective functioning of the single monetary policy, and therefore for delivering price stability in the euro area, banks are key in transmitting monetary policy impulses to the real economy. It is important to avoid significant differences in transmission arising from the countries in which banks happen to be located. Yet such fragmentation within Europe’s financial system has occurred as a consequence of the sovereign debt crisis.

The relationship between the credit of sovereigns and that of their financial system is well understood; it runs both ways. Divergence in sovereign credit has resulted in divergence in bank funding conditions at the national level. This in turn has brought about differences in lending conditions, which hamper the transmission of monetary policy.

Banks facing funding pressures react by tightening the lending conditions for firms and households, which ultimately leads to a breakdown in the relationship between lending rates and monetary policy rates that prevails in normal times.

The adverse feedback loop between banks and sovereigns also has negative effects on efforts to re-establish fiscal sustainability. Countries undergoing fiscal adjustments are increasingly penalised by financial markets because of their additional burden of supporting domestic banks.

Against this background, the need to break the loop between banks and sovereigns at the national level, by taking responsibility for financial stability to the European level, becomes evident. This is why a financial union is a necessary step to improve investors’ confidence. By restoring financial stability, it also provides the most effective response to the fragmentation of Europe’s banking markets. Monetary stability, financial stability and defence of the single European market are all closely linked.

The principles and key elements of a single supervisory mechanism

The single supervisor should possess all the qualities necessary to guard against these risks on a durable basis. It should be rigorous and even-handed, free from local pressures and interests. It should have the vision and take on a broad-ranging approach, independently assessing the situation of individual banks in a systemic context.

Rigorous separation of monetary and supervisory policies

The first principle is the need for rigorous separation of monetary and supervisory policies. The proposal of the European Commission provides for the establishment of a separate Supervisory Board within the ECB, which will include representatives from national authorities. This proposal allows for a pooling of supervisory expertise and knowledge, and will help to ensure that decision-making lines on monetary and supervisory policy are clearly separated.

To separate day-to-day activities, the Governing Council will define internal procedures, making a clear distinction between the monetary and supervisory functions within the organisation. We can build on a wealth of experience in this field, looking at best practices from the many central banks in Europe and around the world that combine supervisory and monetary policy functions.

Independence and higher standards of accountability

The second principle is the need to safeguard the ECB’s independence, implying higher standards of accountability. Independence is not a new concept to the ECB. Neither is accountability. We are proud of our independence, and in the context of supervision, the ECB needs to be safeguarded from external interests and national bias. With the activation of article 127/6, the provisions of the Treaty are extended to the new supervisory task. These include independence in the preparation of supervisory assessments. In addition, the ECB as supervisor will enjoy operational independence, as foreseen by the Core Principles of the Basel Committee on Banking Supervision with which it will be compliant. It is essential that independence extends to all members of the Supervisory Board. Such independence in the assessment is crucial for the credibility of the supervisory system.

Complete range of supervisory instruments

The third principle is that the single supervisor should possess a complete set of supervisory instruments. All banks established in participating Member States would in principle fall within the remit of the single supervisor. This is important to ensure a level playing field. It will also prevent fragmentation in the financial system, which is precisely what we are aiming to repair.

The single supervisory mechanism should also strengthen the single European market. Therefore, all Member States, also the ones that have not adopted the euro, should have the possibility of participating in the single supervisor. I am confident that the proper legal framework that serves this objective can be identified and adopted.

How European banks can benefit from a single supervisor

Let me now address what I see as the main implications for banks. A strong area-wide supervisor, capable of acting quickly and effectively, can restore and uphold business confidence in all banks, regardless of their location. It can therefore contribute to a revival of interbank and credit markets.

Second, the single supervisor should ensure homogeneous supervision, convergence of practices, a level playing field and therefore a reduction in banks’ compliance costs. An important element to achieve convergence is the single rulebook that the EBA is developing. But ensuring convergence of regulation is not enough. Supervisory practices also need to converge. The envisaged creation of a single supervisory handbook by the EBA is complementary to this approach. Best practices should become standard practices. The single supervisory handbook should also ensure that in cases where banks are supervised in a decentralised manner within the system, practices are consistent across countries.

Third, the single supervisor will more easily identify cross-country linkages and exposures, and therefore contribute to a reduction of systemic risk.

The next steps towards a financial union

The establishment of a Single Supervisory Mechanism would represent a major step towards a financial union. But in case we were need to resolve financial institutions, we want to be able to do so without taxpayer money and without disrupting the payments system, even in the case of systemically important institutions. For that we need a common resolution regime and an independent European resolution authority.

The existing legislative proposal on bank recovery and resolution is a development in the right direction, and the ECB supports its rapid adoption. It would best be implemented through an independent European Resolution Authority, immune from national bias and national vested interests.

Full speech

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