23 October 2013

Schäuble: The Banking Union – another step towards a tighter-knit Europe

Their minds focused by the crisis, European leaders have embarked upon a comprehensive renovation of their institutions. The joint governance and surveillance that underpin monetary union have been much reinforced. Perhaps the most impressive architectural change under way in Europe is the establishment of a Banking Union. While the crisis played to different scripts in different countries, there can be no lasting recovery anywhere without a healthy banking sector. Only profitable, well-capitalised banks can fulfil their role as lenders to the economy. And only well-regulated, supervised and incentivised banks can play their part in ensuring an efficient allocation of capital throughout the continent.

A key to recovery

The case for a single supervisory mechanism (SSM) was easy to make. A supranational supervisor with sufficient resources and clear responsibility for overseeing the continent’s largest banks would be less likely to let problems fester until they were too entrenched to be addressed easily. A single resolution regime based on clear bail-in rules, meanwhile, would create stronger incentives for banks, their owners and their creditors neither to take nor to tolerate excessive risks. And it would better protect taxpayers should a bank still fail.

The Banking Union is thus on course to becoming a pillar of the EU. However, it emphatically is not and cannot be a mechanism to redistribute the burden of yesterday’s crisis among its participants. Whatever legacy issues come to light now will have to be tackled nationally. And while the Banking Union will include a limited joint fiscal backstop for Member States in the shape of loans or capital from the European Stability Mechanism (ESM), these will be last-resort instruments to be used in extreme circumstances after other sources of capital have been exhausted – and that only subject to appropriate policy conditionality.

So, how much progress has been made? 

In terms of the SSM, the European Central Bank (ECB) in Frankfurt is expected to start its supervision work in the second half of next year, and will be responsible for directly overseeing cross-border and systemically relevant banks across the eurozone. It will apply one unified rulebook derived from the Basel III agreement for all banks. Smaller and purely domestic banks will continue to be supervised at the national level.

Work on establishing a Single Resolution Mechanism (SRM) is less advanced and the undertaking far more complex. The European Commission’s proposal on the SRM, released in July, will need major amendments before the European Council can reach an agreement. Beyond the minutiae, my view is that in order to succeed, the SRM will need to fulfil four requirements:

• It must protect the fiscal sovereignty of the member states and shield taxpayers thanks to a clear bail-in regime.
• It should set finely calibrated incentives conducive to keeping banks healthy in the long term, not least by deterring governments from enacting policies likely to fuel asset price bubbles or damage bank balance sheets.
• It must establish fast and predictable mechanisms to deal with those problems that do materialise.
• It will have to be legally unassailable.

Targets to meet

If one agrees on these goals, a number of conclusions follow. The first is that, as a deterrent to excessive risk-taking, any resolution set in motion should require a bail-in element along the lines described in the recently adopted Bank Recovery and Resolution Directive.

Second, the SRM should strike a delicate balance between centralisation and delegation. It should be centralised enough to ensure swift agreement in complex cross-border resolutions yet leave enough margin of manoeuvre for national authorities to execute these resolutions in an area – insolvency law – that has yet to be properly harmonised.

Third, and in order to make resolution decisions hard to challenge, the SRM should not be given more competence than necessary and can be justified under the current EU treaties. The powers granted to any central authority and the capacity of any central industry-financed resolution fund should be limited and well defined. It would be a fatal mistake to anchor the SRM on tenuous legal foundations and one that could end up toppling the entire edifice. Such a Banking Union – a supranational supervisor flanked by a tightly coordinated system of resolution authorities with a central board ensuring consistent and effective implementation of cross-border resolution, and a system of national resolution funds, backed by clear bail-in rules and buttressed by last-resort national and mutual fiscal backstops – is as far as we should go under existing treaties.

Carefully crafted, it would work. But should all EU Member States agree to a small number of narrowly defined treaty changes, it could go much further. Such amendments would not only allow for the creation of a truly centralised resolution authority but also for a more efficient and clearer separation between the supervisory and monetary functions of the ECB. This would make it much easier for EU Member States outside the eurozone to join and thus avoid fragmenting the European single market for financial services. Such a Banking Union could ultimately grow to fill the borders of the single market, as it indeed should do in the logic of European integration.

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