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The first step in Europe’s banking union is achievable. But it won’t be easy.

Eurozone leaders are firmly committed to a banking union, at least on paper. But do Member States agree on the current proposals? And what do these proposals leave out? This column argues that a dangerous combination of disagreements between Member States over contentious issues and pitfalls in the design of new institutions may well ensnare the Eurozone along its faltering path towards recovery.

The leaders of Eurozone countries issued an unprecedented commitment on 29 June; the statement began, “[w]e affirm that it is imperative to break the vicious circle between banks and sovereigns” (Euro Area Leaders 2012). This statement officially acknowledged leaders’ intention to break the ‘doom loop’ of the mutually-reinforcing deterioration of credit conditions afflicting weaker member states such as Spain and the banks headquartered in them. Severing this feedback loop will require a transfer of vast parts of banking supervision and policy apparatus from national- to European-level in the form of a new banking union. This transfer is probably a prerequisite for maintaining the integrity of Europe’s monetary union in any crisis-resolution strategy. Of equal importance is that leaders’ failure to deliver on their pledge would severely impair investors’ already-damaged confidence in the ability of Eurozone governments to act collectively.
The action plan outlined in the June statement defines a sequence of two explicit steps.
• The ECB should first be endowed with broad supervisory powers and thus become the anchor of a ‘single supervisory mechanism’ for participating Member States.
• Once the single supervisory mechanism is deemed effective, the European Stability Mechanism (ESM) -- the Eurozone’s newly-established intervention fund -- would be able to recapitalize banks directly. Corresponding instruments are yet to be clarified, but would probably include common equity.
Å woefully-incomplete plan
Sadly, this plan is unsatisfactory. Making European-level crisis-management (including bank recapitalizations by the ESM) contingent on the establishment of a permanent institutional infrastructure (that is,, an effective single supervisory mechanism) looks like a delaying tactic. It smacks of a political leadership in denial about the urgency of the present situation. Moreover, Eurozone leaders’ proposed sequential plan does not include crucial features necessary for a credible banking union; such as a European banking charter, a resolution authority and federal deposit insurance.The policy framework seems incomplete. In spite of these frustrating flaws, the June statement remains Eurozone leaders’ boldest reaction to the crisis so far. They must now translate this pledge into concrete decisions.
Three major issues of contention
On September 12, the European Commission did its bit by publishing a legislative proposal for the establishment of the single supervisory mechanism1. Three major issues of contention have emerged in the negotiations among Member States.
What will be the single supervisory mechanism’s geographical limit? The 29 June statement identifies article 127(6) of the European Union’s Lisbon Treaty as the legal basis for the initiative. This means that the new supervisor will be part of the ECB. But non-Eurozone Member States, including some of Central Europe and Scandinavia, may legitimately want to join. Indeed, they have a veto over decisions under article 127(6) and are entitled to a voice in the new system’s governance. They will surely want to ensure the safeguarding of their taxpayers’ interests. Although the UK has unambiguously declared it would not join the single supervisory mechanism, it remains that the approach should be as inclusive and flexible as possible.
To what extent will monetary policy be independent? Banking policy and monetary policy are linked yet are ultimately different in kind. This justifies different geographical perimeters within the EU; one for currency union and one for banking union. There is a legitimate concern that adding politically charged supervision to the ECB’s responsibilities may compromise its cherished independence. The supervisory function should therefore be strictly separated from the rest of the ECB. Full institutional autonomy may be a possibility, but should be considered during future reforms.
• German savings and cooperative banks oppose being brought under the remit of a new European supervisor’s authority. These banks are local banks subject to a different policy regime from commercial banks. Given Germany’s pivotal position in all Eurozone discussions, some of its idiosyncrasies may have to be accommodated. Perhaps there is a need for a separate European supervisory framework for local, non-commercial banks.
Taking bold decisions
Negotiators also need to ensure that the new supervisor’s governance is less dysfunctional than that of the ill-fated European Banking Authority. The Authority’s clumsy decision-making process was hampered by its reliance on diplomatic compromises among Member States, despite its high-quality staff. Effective supervision requires that controversial decisions be made quickly. Decisions must be made whilst also guaranteeing genuine accountability to democratic institutions (Carmassi et al. 2012). At the same time, the legal basis for new arrangements must be robust and include mechanisms for judicial review2.
Conclusions
Creating Europe’s single supervisory mechanism is only one significant step of many on the long path to crisis resolution and banking union. Compromise is possible, but will be difficult. Eurozone leaders must not lose the momentum created by their 29 June statement. The fact that they recently reaffirmed the commitment to reach a final legislative decision before the end of this year is somewhat reassuring. Yet, much hard work remains if the EU is to achieve the banking supervisory frameworks it so badly needs for sustaining financial stability and the single market.
References
Carmassi, J, C Di Noia and S Micossi (2012) “Banking Union: A federal model for the European Union with prompt corrective action”, Policy Brief No. 282, CEPS.
Euro Area Leaders (2012), “Euro Area Summit Statement” 29 June.
Véron, N (2012) “Europe’s single supervisory mechanism and the long journey towards banking union” Bruegel Policy Contribution, 16, October.
Footnotes
1 Cf. Véron 2012; a recent briefing paper prepared by Bruegel for the European Parliament’s Committee on Economic and Monetary Affairs.
2 Further legal debate is needed on whether this is best achieved under article 127(6) or other Treaty provisions.

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