The recent financial crisis has sent a resonating wake-up call throughout the EU urging all stakeholders to address the growing inconsistencies between Europe’s (fragmented) regulatory and supervisory approaches and the realities of growing financial market integration. These inconsistencies were clearly recognised and documented by the de Larosière Report (de Larosière Group 2009).
Over the past three years, the European Parliament, the EU Commission, and the European Council have formulated numerous proposals to plug the gaps in the regulatory frameworks and in supervisory approaches and architecture. The establishment of the new European Banking Authority on 1 January 2011 is an important milestone in this respect.
Even before the crisis broke out, it had become clear that a fragmented supervisory architecture – with concomitant varying supervisory approaches – was increasingly inadequate for conducting effective prudential supervision in an integrating financial system. The financial crisis further highlighted the inappropriateness of the institutional framework, making bailouts of financial institutions inevitable. The key issue is that a fragmented supervisory structure is increasingly inadequate to fully internalise the negative externalities stemming from cross-border banking (Nieto and Schinasi 2007).
Full internalisation would require far-reaching centralisation of regulation and supervision in the EU. Stepping stones on the road to further internalisation have consisted in establishing cooperative and coordinated decision-making processes. The establishment of the Banking Authority is meant to be a further step in this “iterative process in which EU countries gradually and selectively internalise some of the negative externalities associated with cross-border banking” (Nieto and Schinasi 2007). However, the Banking Authority embraces a model that remains predominantly decentralised and thus requires high levels of cooperation among almost 47 agencies in the 27 EU countries (see Masciandaro et al. 2009 for an analysis of the degree of convergence among national supervisory architectures in the EU).
In such a decentralised setting, the individual governance arrangements of national supervisors and the Banking Authority are important determinants of the supervisors’ incentive structure to cooperate across national borders. In recent research (Masciandaro et al. 2011), we present an in-depth analysis of these issues. We ask: Are the objectives of European Banking Authority as stated in the EU Regulation consistent with the economic objective of internalising potential negative spillovers of supervisors‘ policy action (or the lack of)? And, are its governance arrangements of consistent with the objective of further internalising the potential negative externalities associated with the decentralised supervisory architecture?
European Banking Authority objectives and powers
The mandate of the Banking Authority focuses on establishing high-quality common regulatory and supervisory standards and practices in the EU (Article 1). High levels of harmonisation would reduce the potential for negative externalities of national prudential regulatory policies. This, together with enforcement mechanisms would limit incentives of national regulators to “free ride” on the strengthened supervision of others. In addition, the Banking Authority’s power to “stimulate and facilitate the delegation of tasks and responsibilities among competent authorities” would help in eliminating the problem of lack of incentives of supervisors to cooperate, particularly regarding information sharing.
The Authority is also given the broad objective of protecting the stability of the financial system as a public good. However, given the lack of generally accepted definition of financial stability (Schinasi 2004 and Goodhart 2011) – and the Regulation itself does not provide one – the vagueness surrounding this objective makes its accountability process problematic. More specific is the mandate of providing the European Systemic Risk Board (the centre of macro prudential supervision) with the necessary information for the achievement of its tasks and ensuring a proper follow up to its warnings and recommendations.
Lastly, the Authority is also entrusted with tasks related to consumer protection. Multiple objectives raise the issue of potential conflicts in fulfilling those objectives. Its mandate deals with this potential problem by prioritising the objectives. The primary objectives are the protection of financial stability and the contribution to a consistent level of regulation and supervision throughout the EU.
European Banking Authority governance
Given the above issues regarding the objectives of the newly established Authority, a closer look at its governance arrangements seems warranted. We assess the quality of the envisaged governance arrangements along the dimensions of independence (institutional, regulatory, and budgetary) and accountability (political and judicial), established in Quintyn et al. (2007).
The Authority’s institutional independence can be challenged on four grounds.
- First, by the presence of national supervisors on its board considering that they will be recipients of its decisions;
- Second, by the lack of specification of the grounds for dismissal of its head. The regulation only mentions that the ultimate decision belongs to the powers of the European parliament following a decision of the board.
- Third, the arrangements for legal immunity for its staff – they will have the same statute as staff working under the EU Treaty – might be insufficient, taking into account that the Authority has the power to investigate alleged incorrect or insufficient application of Union law obligations by national authorities and to adopt decisions that affect individual banks.
- Finally, the presence of the EU Commission on the board – albeit without voting power – raises the issue of potential political interference on the policy decisions.
The Authority’s regulatory and supervisory independence is also limited. It is given powers to intervene in the national supervisory processes as described above. In spite of this, the Authority has limited regulatory independence because the directives are elaborated by co-decision between the council, the EU parliament and the commission (Article 15). Moreover, the technical standards that it is supposed to promote need to be endorsed by the commission (a political body) which retains the power to design secondary legislation. These standards will be adopted by means of regulations or decisions and hence need to be legally enforced by the national authorities. In the case of recommendations and guidelines, only in exceptional circumstances of persistent inaction by national authorities, is the Authority empowered to adopt decisions addressed to individual financial institutions (Article 16). Another potentially important shortcoming is that it can only request information on the financial condition of banks from national prudential supervisors and not directly from the institutions (Article 35).
The Authority’s funding mainly comes from the general EU budget and obligatory contributions from national supervisory authorities (Article 62). Hence, it is bounded by the national agency budgets, whose contributions are made in accordance with a formula based on the weighting of their votes in the board, limiting the Authority’s budgetary independence. Furthermore, it’s budget is under the responsibility of its management board in which representatives of the national supervisors are present, an arrangement that can further limit its financial independence.
The Authority’s accountability standards are at the highest levels and thus in sharp contrast with its modest level of independence. The regulation envisages political accountability to the EU parliament and council (Article 3) as well as accountability towards the judiciary branch, ensuring that this supranational body does not operate in a judicial vacuum but instead is held accountable for its powers to influence the national supervisory processes. Last but not least, accountability to the markets (transparency) is taken care of by requiring that secondary legislation and technical implementation standards are subject to public consultation.
In sum, the establishment of the European Banking Authority is certainly a significant step on the road towards fully internalising the potential negative externalities that result from the existing decentralised national supervisory frameworks in an integrated financial market. However, the Authority will most likely not be in a position to address all types of coordination issues listed under its legal objectives because of some limitations imposed by its governance arrangements on independence. In turn, the strong accountability to the EU institutions would facilitate its European mandate, both the upward harmonisation of the national regulatory frameworks and supervisory practices in the EU.
The views expressed in this column are the authors’ and do not necessarily represent those of the Bank of Spain or the International Monetary Fund or its Board
De Larosière Group (2009), “Report of the High Level Group on Supervision”
Goodhart CHA (2011), “Financial Regulation”, in S Eijffinger and Donato Masciandaro (eds.), The Handbook of Central Banking, Financial Regulation and Supervision after the Financial Crisis, Edward Elgar.
Quintyn, M, S Ramirez, and MW Taylor (2007), “The Fear of Freedom. Politicians and the Independence and Accountability of Financial Supervisors”, in D Masciandaro and M Quintyn (eds.), Designing Financial Supervision Institutions: Independence, Accountability and Governance, Edward Elgar.
Masciandaro D, MJ Nieto, and M Quintyn (2009), “Will They Sing the Same Tune? Measuring Convergence in the New European System of Financial Supervisors”, CEPR Policy Insight 37.
Masciandaro D, MJ Nieto, and M Quintyn (2011), “Exploring Governance of the New European Banking Authority: a Case for Harmonization?”, Journal of Financial Stability, forthcoming.
Nieto, MJ and GJ Schinasi (2007), “EU framework for safeguarding financial stability: towards an analytical benchmark for assessing its effectiveness”, IMF Working Paper WP/07/260, International Monetary Fund, Washington, DC.
Schinasi, GJ (2004), “Defining Financial Stability”, IMF Working Paper WP/04/187, International Monetary Fund.