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Banking Union
19 November 2012

Douglas J Elliott: Key issues on European banking union - Trade-offs and some recommendations


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The body of this paper addresses a host of detailed questions about the design of the banking union, laying out the views of different analysts and the proposals from official bodies, as well as providing Elliott's own views and recommendations.


Overview

European leaders have committed to moving towards a banking union, in which bank regulation and supervision, deposit guarantees, and the handling of troubled banks will be integrated across at least the euro area and possibly across the wider European Union. This is quite positive for two reasons. Most immediately, it will help solve the euro crisis by weakening the link between debt-burdened governments and troubled banks, where each side has added to the woes of the other. In the longer run, it will make the “single market” in European banking substantially more effective.

Unfortunately, it is much easier to endorse the concept of a banking union than it is to design and implement one. Banks are central to the European financial system, supplying about three-quarters of all credit, and are therefore critical to the functioning of the wider economy in Europe. Their supervision is not just a technical issue; it requires many subjective judgements that have serious implications for credit provision, economic growth and jobs. Choices about how much credit banks provide, and to whom, strongly affect the relative performance of national economies and individual businesses and families. Not surprisingly, national governments have been extremely reluctant to give up control over more than €30 trillion of bank assets and are doing so now only because of the severity of the euro crisis. Designing integrated bank supervision will require fighting out how power will be divided among various European institutions and national authorities.

Nor is it the case that we know the right answers and have merely to summon the political will to push them through. Financial regulation is a balancing act, requiring judgments about the relative importance of many things, including:

  • Dealing with the short-term euro crisis versus long-term improvement of the “single market” in financial services in the EU.
  • The trade-off of economic growth and financial safety. It is well established that many safety margins in banking carry with them an economic cost.
  • The efficiency of supervisory centralisation versus the benefits of local knowledge.
  • The efficiency of a single regulator versus the benefits of multiple specialised regulators, such as for consumer protection or specialised financial institutions like savings banks.
  • Supervisory independence from political interference versus accountability.

These choices are inherently subjective, since they require trading off one set of policy benefits for another. (In most cases, we do not even have sufficiently developed theory to know the magnitude of the trade-offs.) Adding to the political difficulties, some aspects of a banking union directly involve the allocation of costs of significant magnitude and the risk of future costs that could be even higher. This is particularly true for the establishment of integrated deposit guarantee funds and the creation of new rules and funding sources for resolving banks on the edge of insolvency. Naturally, divvying up the pain and the risk will be very complicated, with all sides arguing cogently for minimising their own share.

Full working paper



© The Brookings Institution


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