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Adding a single resolution mechanism to a single supervisory mechanism is, in my opinion, not just a good idea, but one whose time has come. Control and liability should go hand in hand. But a European resolution mechanism likewise needs harmonised standards and instruments, which are currently being developed with the EU’s Bank Recovery and Resolution Directive (BRRD). The third pillar of a banking union – a European deposit insurance scheme – is currently not regarded as a priority task.
Single Supervisory Mechanism
For this, a fundamental political consensus has been achieved. A formal resolution in Germany is still pending, but I trust that the Single Supervisory Mechanism Regulation will enter into force in the late summer so that, in the second half of 2014, the European Central Bank (ECB) can start supervising banks in cooperation with national supervisors.
I expect major benefits from the forthcoming European cross-border supervision of banks. An advantage of the SSM is that it will draw on a broader and better basis of information across the eurozone, thereby making it possible to reveal undesirable developments more quickly. However, the SSM also has some major weaknesses: The fact that the final say on central decisions taken by the ECB – and thus also in the SSM – rests with the Governing Council of the ECB. It is true that these decisions will be prepared in a Supervisory Board, composed of representatives of all eurozone national supervisory authorities and central banks, and that the Governing Council of the ECB can only accept or reject the proposals. This governance structure, however, is quite complex and does not allow a clear dividing line between monetary policy and supervision to be drawn. The Single Supervisory Mechanism Regulation only goes as far as EU primary law allows.
I therefore see the ECB facing conflicting aims: price stability and a stable banking system. This conflict of aims can threaten the ECB’s "internal independence". Over the medium to long term, I believe there is no getting around changes to primary law to improve the governance structure and to draw a clear line between the monetary and supervisory functions.
Single Resolution Mechanism
This issue takes on a new dimension in the context of joint supervision. After all, within a cross-border supervisory structure, there also has to be a common restructuring and resolution regime in order to achieve a balance between liability and control. To that end, we have to establish a central European resolution agency and a joint European resolution fund. In order to make such a single European restructuring and resolution regime lawsuit-proof, a change to primary law is required here, too.
Hierarchy of liability
We need to define the hierarchy of liability clearly and ex ante:
Shareholders should be the first to bear losses; if that does not suffice we must not hesitate to bail in junior and senior debt holders as well. The big issue is currently whether there should be a "depositor preference". A privately financed resolution fund is a further line of defence. All banks supervised directly by the ECB would have to contribute to this joint European resolution fund, which would supersede national regimes in the medium term. As a last resort, however, the fund could request public financial assistance for example, from the ESM, as there could be threats which, in extraordinary cases, could require recourse to public funding. I see no compelling reasons, however, why the costs of bank restructuring should be shifted entirely to the European level. Although we will be centralising supervision in Europe next year, other factors such as economic and fiscal policy will remain largely the responsibility of individual nations.
Direct recapitalisation through the ESM
Although we will be centralising supervision in Europe next year, other factors such as economic and fiscal policy will remain largely the responsibility of individual nations. And, as long as that is the case, the arguments for shifting losses completely to the European level do not appear to be compelling.
The Balance Sheet Assessment provided for by Article 27 of the SSM Regulation also acquires major significance in this context: this article requires the ECB to assess the portfolio quality of the banks it will be supervising in future. What the regulation does not say, however, is what happens if hidden losses are disclosed. I have two things to say about this.
I consider the Balance Sheet Assessment to be very important. For it to be successful, we should base our assessments of banks’ balance sheets not only on supervisors’ judgements. We should also enlist outside specialists – external auditors – for a quantitative assessment. Not only in order to restore market participants’ confidence in the European banking industry, but also to minimise reputational risk for the ECB. All supervisors in Europe are familiar with ad hoc examinations. These are precisely the instruments we should be using here. This is the only way we can avert the suspicion of national supervisors taking too much account of national special circumstances.
My other remark follows on directly: it concerns the legacy risks of banks supervised under the SSM. As these risks were created in the past, under the responsibility of individual Member States, they should be borne in a national context, too.
Changes to primary law
I have twice mentioned changes to primary law in the context of the banking union: once referring to the SSM and again with regard to the SRM. I am indeed aware that many are recoiling at the thought of changing primary law, as it is a long and winding road. Ultimately, however, the project of creating a banking union is similar to the creation of the single monetary policy. And, we did things properly then and started by establishing a sound legal foundation. If it was good enough for establishing a monetary union, it will be good enough for a banking union.
That notwithstanding, I think the SSM and a restructuring and resolution mechanism should be launched prior to changing EU primary law. However, we should start working on amendments to primary law right away, given the foreseeable difficulties and the amount of time this endeavour will probably take.