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A New Year’s Banking Union

BRUSSELS – Five years after the outbreak of the financial crisis, Europe’s economic and political situation remains fragile. A mild recession is expected in Europe this year, and unemployment is on the rise. Beyond deficit reduction, we need to implement a €120 billion ($155 billion) European investment plan, and deepen the European Single Market to unleash its growth potential.

But we also need other structural measures. The European Union must put an end to the negative feedback loop between individual member states and their national banking systems. Between 2008 and 2011, EU taxpayers granted banks €4.5 trillion in loans and guarantees. In some countries, the threat of bank recapitalization with public funds has resulted in a drop in market confidence and a huge rise in interest rates.

The European Central Bank (ECB) has taken decisive action to break this vicious circle. Moreover, there is now a consensus that the 17 eurozone countries need a banking union to accompany their common currency. The European Commission has proposed a single rulebook for banks’ capital requirements; mutual support between national deposit guarantee schemes; and Europe-wide rules for resolving failing banks that place the main burden on bank shareholders and creditors, not on taxpayers.

On June 29, European heads of state and government committed themselves to the creation of a single European supervisor for banks in the eurozone. This is good news for both financial stability and public finances: once the single supervisor is in place, supervision will be more credible and impartial, which is important for dealing with ailing banks and managing their return to viability.

The European Commission also put forward a set of legislative proposals to establish the single supervisory mechanism and confer key supervisory tasks on the ECB. This proposal must now be amended and approved as soon as possible by the European Parliament and the Council of Ministers if we are to have a chance of activating the European Stability Mechanism (ESM) and proceeding with the other essential pillars of a banking union.

Further work, however, is still needed in several areas:

  • The scope of the new supervisory mechanism. Some member states favor restricting European supervision to systemically important banks. But the Commission believes that it should cover all 6,000 banks in the eurozone. After all, “systemically important" is impossible to define. The failures of banks like Northern Rock, Dexia, and Bankia are reminders that small and medium-size banks can endanger the entire financial system. And it would be inherently unstable to have two supervisory mechanisms for banks operating in the same market.
  • The participation of non-eurozone countries in the new supervisory scheme. The Commission’s proposal confers powers on the ECB for the supervision of all banks in the eurozone. For non-eurozone countries, the proposals provide for a mechanism to join on a voluntary basis and submit to the ECB’s authority. But the EU treaties make it complicated to give these non-eurozone countries full voting powers. I do not see any political problem with giving these countries a full voice in shaping the decisions of the European supervisor, but creativity will be needed to find a legally sound and fair solution.
  • National supervisors’ role in the new system. Clearly, the European Council has decided on a paradigm shift: powers are moving to the ECB. But national supervisors will be members of the board that will take key decisions, which they will prepare and implement. In the current negotiations, we can still fine-tune the roles of the European and national supervisors, but ultimate authority must rest with the ECB.
  • Non-eurozone EU members that do not want to join the single supervisory mechanism. These countries have expressed concerns about the new powers conferred on the ECB. In particular, they question the ECB's voting rights within the European Banking Authority, which will remain in charge of developing a single rulebook for all 27 countries in the EU’s single market and enhancing convergence of supervisory practices. We need to find ways to preserve fully the influence of non-eurozone countries within the European Banking Authority.
  • Democratic accountability for the ECB’s new supervisory powers. The ECB must, of course, maintain its full monetary-policy independence, despite its new role. So a key question is how, in addition to giving an important role to the European Parliament, national parliaments can play their part in overseeing supervisory decisions.
  • Timing. According to some EU countries, the Commission’s proposal is too ambitious to enter into force at the beginning of 2013. But an effective single banking supervisor is a prerequisite for the ESM’s direct recapitalization of banks. Only with this possibility and strong unified supervision will Europe be in a position to break the vicious circle between banks’ balance-sheet weakness and sovereign debt, and thus resolve the eurozone crisis.

Entry into force in January 2013 would bring about supervision by the ECB of banks that have received or requested public funding. Only in July 2013 would all banks of major systemic importance be subject to ECB supervision. The remaining banks would be subject to the new mechanism at the start of 2014.

Intense discussions are normal for such a high-stakes project. Countries like Germany, Finland, and the Netherlands are right to argue that rapid progress cannot come at the expense of the new supervisory structure’s quality. But EU countries have to stick to the commitment that they made in June and strike a deal in time for a gradual entry into force in January 2013.

Read more from our "Sticking with the Banking Union" Focal Point.