ECB made top cop for eurozone banking system

It will supersede national regulators, which have been accused of being overly protective of banks

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To the European Central Bank’s existing duties – bulwark against inflation, lender of last resort, ultimate guardian of the euro – add another task: top cop for the eurozone’s banking system.

If the European Parliament and eurozone member states approve a plan presented by the European Commission, at the beginning of next year the central bank will become chief regulator of all banks in the eurozone, with the power to impose fines, remove top executives and even revoke banking licenses. The ECB would supersede national regulators, which have been accused of being overly protective of the banks they oversee and reluctant to require the lenders to grapple with their problems.

But before the central bank can begin to tackle the task of regulating the more than 6,000 credit institutions in the eurozone, new staff members must be hired, money must be allocated and a clear structure must be developed to coordinate its work with the national regulators that will continue to handle most of the day-to-day tasks. No one yet has even rough estimates of how many people or how much money the ECB will need to perform the new role.

Even though the European Commission’s proposal for a banking union is a big leap, it does not grant the central bank powers on a par with those of US banking authorities like the Federal Deposit Insurance Corp. Under the current plan, the central bank would not have the resources needed to prevent bank runs or the authority to arrange a decent burial for a terminally ill institution.

The plan for a banking union is a work in progress, assembled in the midst of a fast-moving crisis. It is doubtful whether the central bank’s supervision of banks will do much to ease tension in the eurozone, though it might help in the future. “They need to develop their specific operational expertise,” said Jorg Rocholl, president of the European School of Management and Technology in Berlin. “I think of this as a long-term project that can prevent the next crisis from happening, to break this nexus between banks and states.”

The plan outlined by the European Commission would, if ratified, give the ECB new supervisory powers on Jan 1. But it is likely to take six months from that date for the central bank to build up the capacity to regulate just the biggest, cross-border banks in the eurozone. It could be a year before it is able to supervise all the banks.
In practice, it may take even longer for the ECB to assume its new role. “The timetable sounds optimistic,” said Nicolas Veron, a senior fellow at Bruegel, a research firm in Brussels.

Even so, if eurozone governments manage to quickly approve the proposal, it could bolster confidence that political leaders are addressing flaws in the structure of the eurozone. “It shows the Europeans are actually able to do something together,” Veron said. “That is heartening.”

Fulfilling a condition

Handing supervisory authority to the central bank would also fulfill a condition necessary for the eurozone’s rescue fund, to take a more active role in bank bailouts. The fund, the European Stability Mechanism, would be able to directly supply banks with fresh capital and take stakes in them in return, without having to go through governments that have sometimes dawdled.

It is unclear when the mechanism might be able to take on expanded powers to aid banks, but it could be within months. The mechanism moved a big step forward Wednesday after Germany’s highest court declined to block the country from participating.

Still, Berlin continues to oppose giving power over all of its banks to the central bank. Germany has 1,900 credit institutions, more than double that of any other eurozone country. Many of them are small savings banks, often owned by municipalities that use them to funnel credit to local enterprises – and in some cases as a vehicle for political patronage.

German landesbanks, which are larger than the savings banks but also have close ties to state and local governments, have been particularly vocal in opposing centralized bank supervision.

In a statement, the Association of German Public Banks, which represents landesbanks, said the European Commission’s proposal was “unfocused, not oriented toward the risks of individual banks, and hardly affordable.” Angela Merkel, the German chancellor, expressed similar objections.

Such opposition raises the danger that the ECB will have trouble winning the cooperation of national authorities. Though it will be able to impose levies on banks to finance its regulatory work, the central bank will still be dependent on national regulators for the everyday work of keeping an eye on banks.

Because of opposition from Germany and others, the European Commission did not put forward a plan Wednesday to create a common deposit insurance programme, which is considered essential to preventing bank runs. Eurozone countries have their own deposit insurance programs, but they have been depleted in Greece and Spain.
In addition, the commission did not propose that the central bank be given the power to force a troubled bank to shut down in an orderly way that avoided damage to the larger financial system.

Rocholl of the European School of Management and Technology said it would not be wise to give the central bank so much responsibility all at once, and the creation of a European FDIC is not yet politically feasible anyway. But others fear the central bank will not have all the tools it needs to deal with troubled banks and prevent banking crises.
The ECB said that it welcomed the new responsibility. In a statement, it said it was “an important step towards laying the foundations of a financial market union with the view to ensuring financial stability in the euro area and the European Union.”

One argument for handing supervisory powers to the central bank is that it already has intimate knowledge of eurozone banks. One of its fundamental tasks is to serve as lender of last resort for banks that have trouble raising money on the open market. As a result, the ECB knows which ones are hurting.

But there is also a potential for conflicts between monetary policy and banking regulation. The central bank is supposed to be independent from political influence, but supervising banks is, in Europe as elsewhere, often tinged with politics.

Responsibility for bank regulation “makes the ECB tremendously powerful,” said Sony Kapoor, managing director of Re-Define, a research organization with offices in Belgium and other countries that advises policymakers. “This is taking the ECB deeply into political territory without adequate accountability.”

The central bank would keep its regulatory functions separate from other functions like setting official interest rates. But ultimate authority rests with Mario Draghi, the central bank’s president, and its governing council. In addition, some members of the council would serve on the supervisory board of the new regulator.

Kapoor argued that the top central bankers already had too much to do and would not be able to effectively manage bank supervision as well. “If I am on the executive board of the ECB, and I’m already working 18 hours a day, it’s really going to stretch the capacity at the top,” Kapoor said. “That’s where the bottleneck is going to be.”