COMMENTARY

Summer 2009

by Marek Belka / Wim Fonteyne

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Barry Eichengreen rightly identifies two major challenges that Europe faces in the era of re-regulation triggered by the global financial crisis. The first is to ensure that its views are reflected in international regulatory standards, and the second is to enforce these regulations in its own, largely integrated, market.

His proposed remedy is to make the European Central Bank (ECB) the single consolidated supervisor for the European market. Eichengreen is thus advocating a very different approach to the de Larosière Group (“The “Group”), whose recommendations were endorsed as a basis for action by the European Council in March. The Group proposes a new body – the European Systemic Risk Council (ESRC) – that would be separate but closely linked to the ECB, and whose macro-prudential oversight mandate would mean overseeing risks related to general economic and financial developments. Microprudential oversight of individual institutions would continue to be exercised by national supervisors, brought together in colleges for cross-border groups. These supervisors and colleges would, however, operate under the oversight of three sectoral supranational Authorities, with which they would form a European System of Financial Supervisors (ESFS).

Is Eichengreen’s proposal preferable? Having the ECB function as its representative would give Europe a single voice that is lacking in the Group’s proposals. There are also many reasons to believe that the ECB would be a more effective consolidated supervisor than the standardised colleges the Group proposes, not least because it would centralise information and decision-making, and would more naturally bridge macro- and micro-oversight. The Group’s proposals win on feasibility, however, as they are designed to work around the many existing obstacles and avoid the need for EU treaty changes.

Accountability concerns also argue against taking the ECB route that Barry Eichengreen advocates. Consolidating monetary policy and financial supervision in the ECB not only risks conflicts between both mandates, it might also make the ECB too powerful for its own good. Politicians are unlikely to allow such a powerful institution full independence, especially if it represents the EU on the world stage and when, inevitably, cases of perceived supervisory failure occur. Separate accountability channels for both mandates would be needed.

A more fundamental problem is that – to paraphrase Bank of England governor Mervyn King – pan-European banks are European in life but national in illness and in death. Lender of last resort support remains the responsibility of national central banks, with the fiscal backing of their Treasuries. Dealing with bank insolvencies also remains a national responsibility. The current crisis has shown how high the resulting fiscal costs can be. As long as national Treasuries are directly liable for these costs, they will want control over supervision. This stands in the way of any move toward genuine supra-national supervision and may also impede the functioning of the ESFS, as the constituent national supervisors will continue to face incentives to minimise the costs to their own Treasury.

To ensure the success of the Group’s proposals and to give Europe the option of more fundamental reforms over time, this reality should be changed. What is needed is a cross-border safety net for pan-European banks. Such a safety net must combine a special insolvency regime that ensures the cost-efficient resolution of a failing bank and allocates losses as much as possible to shareholders and creditors, with a privately-funded insurance scheme to fund resolution efforts with a view toward protecting depositors. The safety net should minimise the need for fiscal resources, while having access to them as a back-up option. Such fiscal backing can be provided either through some binding distribution mechanism or through increased availability of fiscal resources at the EU level. Technically this can be done, and the crisis should be motivating European politicians to bite the bullet.