The banking union: flawed by design.

Author:Dammann, Jens
Position:European Central Bank Single Supervisory Mechanism
  1. INTRODUCTION II. THE SSM AND THE CREATION OF A EUROPEAN BANKING UNION III. THE NEED FOR EU LEVEL BANKING SUPERVISION A. Sovereign Bond Crisis and Financial Crisis B. Banking Crisis and Banking Supervision 1. Bias and Regulatory Capture 2. Transnational Banks C. Fear of a Transfer Union D. The Difficult Road Towards a European Banking Union E. The Limitations of the Single Supervisory Mechanism IV. CONFLICTING MISSIONS A. Treaty Constraints B. Price Stability v. Financial Stability V. EUROZONE BANKS ONLY A. Background B. Legal Policy VI. THE LARGEST BANKS ONLY A. Defining Significance B. Legal Policy 1. Small Banks and Financial Stability 2. Shopping for Lenient Supervisors 3. State-Owned Banks 4. Subsidiarity VII. COOPERATION WITH NATIONAL SUPERVISORS VIII. SUMMARY AND CONCLUSION I. INTRODUCTION

    In the European Union (EU), banking supervision has traditionally been the prerogative of the Member States. However, the financial crisis that started in 2008 was merciless in revealing the weaknesses of this approach. The most obvious problems were bias and regulatory capture: national supervisors were unduly generous in an effort to support domestic banks. (1) Another shortcoming concerned transnationally operating banks. Such banks posed severe challenges for a supervisory structure segmented by Member State borders. (2)

    The EU's answer to these problems is the so-called Single Supervisory Mechanism (SSM), adopted by EU regulation on October 15, 2013. (3) Under the SSM regulation, the European Central Bank (ECB) takes on a central role in European banking supervision (4) by supervising the largest Eurozone banks. (5) Less significant credit institutions continue to be primarily supervised by Member State authorities, (6) but even with respect to these less important banks, the ECB now exercises a general oversight function. (7) Moreover, the ECB may at any time decide to assume direct supervision even of less significant institutions. (8)

    The move to the SSM constitutes substantial progress over the status quo ante. However, this Article argues that it is nonetheless deeply flawed. To begin, the SSM regulation places the responsibility of prudential supervision in the hands of an institution, the ECB, which already has the different and potentially conflicting mission of pursuing price stability. Under the Treaty on the Functioning of the European Union (TFEU), (9) the goal of securing stable prices takes precedence over any other concerns of the ECB. (10) The primacy of price stability, properly understood, applies even to the ECB's supervisory activities and makes the ECB less than ideally suited for the task of banking supervision. (11)

    In addition, the scope of authority granted to the ECB in the area of banking supervision is inadequate. The ECB's authority does not extend to banks in Member States outside the Eurozone, unless those Member States choose to cooperate voluntarily. (12) This means, in particular, that U.K. banks will not be subject to the ECB's supervision, even though the United Kingdom, by some estimates, accounts for approximately fifty percent of financial services in the EU. (13) Moreover, only the largest and systemically most important European banks will be directly supervised by the ECB, whereas the less significant institutions will, for the most part, continue to be supervised by Member State authorities. (14) Because the SSM regulation takes a narrow view of systemic importance, current estimates suggest that the ECB will directly supervise only 150 to 200 out of approximately 6,000 European banks. (15) Finally, even where the largest banks are concerned, the ECB will, in practice, have to cooperate with national authorities in a relationship that is unlikely to function well. (16)

    Politically, these limitations may be the result of necessary concessions and deft compromises. From a policy perspective, however, they constitute substantial drawbacks that threaten to undermine the effectiveness of European banking supervision.

    The structure of this Article is as follows: Part II provides some context by situating the creation of the SSM within the broader drive towards a European Banking Union. Part III then discusses the events that led to the enactment of the SSM regulation. Parts IV to VII focus on the various structural deficits of the SSM. Part IV discusses the potential conflict between the ECB's goals of maintaining price stability on the one hand, and financial stability on the other hand. Part V argues that the non-Eurozone countries such as the United Kingdom should also be subject to the ECB's supervisory power. Part VI contends that within the Eurozone, all banks--not just the largest ones--should be subject to day-to-day supervision by the ECB. Part VII explains why the regulation's vision of cooperation between the national authorities and the ECB will probably work poorly in practice. Part VIII summarizes and concludes.


    To understand the SSM and its economic and political significance, it is important to note that the enactment of the SSM regulation constitutes only one--albeit one pivotal--step in a broader march towards the creation of a European Banking Union. Indeed, one can roughly distinguish four components of the EU's potential involvement in the banking sector.

    First, the EU has long been in charge of issuing uniform legal rules governing the supervision of banks. (17) Second, EU institutions bear so-called macroprudential responsibility--the task of monitoring and reducing risks to the financial system as a whole. (18) A 2010 EU regulation created the so-called European Systemic Risk Board (ESRB), which is explicitly responsible for the macroprudential oversight of the financial system. (19) Moreover, the SSM regulation of October 2013 assigns the European Central Bank certain macroprudential responsibilities and powers. (20) In particular, the ECB can specify that credit institutions hold higher capital buffers than those demanded by state law. (21)

    Third, the SSM regulation of October 15, 2013 has assigned the ECB a central role in so-called micro-supervision, i.e. the day-to-day supervision of specific banks. (22) Under the SSM framework, the ECB is in charge of exercising direct supervision over the largest European banks, (23) and it also has a general oversight function in supervising less significant credit institutions. (24)

    Fourth, there is the matter of bailing out or liquidating failing credit institutions. While this issue was long controversial, a political agreement was finally reached in March 2014. (25) Under this agreement, the EU will enact a regulation creating the so-called Single Resolution Mechanism, which is not to be confused with the SSM. (26) As part of the Single Resolution Mechanism, the regulation will create a Single Resolution Fund with a target level of 55 billion Euros. (27) This fund will then be used to resolve failing banks, which may entail restructuring them. (28) At the time this Article was completed, the regulation establishing the Single Resolution Mechanism had not yet been enacted. However, it has already been approved by the European Parliament (29) and will likely be adopted by the Council within the near future. (30)

    In sum, the importance of the SSM does not simply lie in the changes that it brings for European banking supervision. Rather, the SSM is significant because it constitutes a crucial element of the effort to create a European banking union.


    Like most of the other steps towards the creation of a European Banking Union, the SSM was created in the wake of the financial crisis. This is no accident. Rather, it was the financial crisis that provided compelling arguments for the creation of a European Banking Union, and, in particular, for an EU-level system of banking supervision.

    1. Sovereign Bond Crisis and Financial Crisis

      As a preliminary matter, it should be noted that Europe's banking crisis was inextricably linked to Europe's sovereign bond crisis. On the one hand, a Member State's inability to meet its liabilities can endanger that Member State's banks. Many European banks were heavily invested in the sovereign bonds issued by their domestic governments. (31) Accordingly, once the stability of the relevant Member States seemed shaky and the value of their bonds took a nosedive, domestic banks found themselves in dire straits. (32) On the other hand, for some Member States sovereign debt problems were the result of a banking crisis, either because the banking crisis translated into difficulties for the economy or because the Member State sought to guarantee the debts of its domestic banks. Indeed, in three of the cases where the European Stability Mechanism (ESM) had to bail out Member States-- namely the cases of Ireland, Cyprus, and Spain--the sovereign debt crisis was prompted by a banking crisis. (33) Against this background, the EU has a vital interest in preventing further banking crises.

    2. Banking Crisis and Banking Supervision

      Crucially, there are compelling reasons to think that Europe's recurring banking crises have resulted, at least in part, from deficits in banking supervision and that EU intervention is needed to overcome these deficits.

      1. Bias and Regulatory Capture

        To begin, it is now widely believed that national supervisors have been unduly generous in an effort to support domestic banks. (34) If the economic consequences of such laxity were borne solely by the Member State whose administration is to be blamed, there might be little reason for the EU to intervene. However, the financial crisis has made it exceedingly clear that bank failures in a given Member State have the potential to cast the entire European financial system into disarray. In particular, the Spanish banking crisis of 2012 was widely seen to pose a broader risk to the financial stability of the entire...

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