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Eurozone Banking Union

Eurozone Banking Union

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Published by TelegraphUK

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Published by: TelegraphUK on Sep 14, 2012
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Non Paper: Eurozone Banking UnionA.Introduction
1.The June European Council made an important first step towards a Eurozone bankingunion with the agreement for a single Eurozone supervisory mechanism based aroundthe European Central Bank (and to be proposed on the basis of Article 127(6) of theTreaty) alongside the possibility for the ESM to recapitalise directly Eurozone banks(subject to the ESM voting mechanism and a range of conditions being fulfilled). Therewas a clear recognition that a Eurozone banking union was needed to address financialstability and fiscal challenges within the monetary union, rather than as a consequenceof the single market. At the same time, as a Eurozone banking union will impact thesingle market, Leaders agreed that concrete measures will be necessary to preserve itsunity and integrity.2.This paper focuses primarily on the supervisory dimension of a Eurozone bankingunion.3.It is essential that the new institutional structures have strong legal and democraticfoundations and are constructed in a consensual manner to ensure their short- and long-term credibility. Adherence to the following principles will assist in this.
In a monetary union banking contagion can spread rapidly from one part of thecurrency zone to another – it should be recognised that this is a primary driver of the need for common banking supervision to protect the integrity of thesingle currency as a whole. In addition, responsibility for supervision andresolution should be aligned with fiscal responsibility – this clearly applies bothto EU banks’ operations within the EU and in third countries.
Mechanisms to ensure political accountability and democratic legitimacy must be addressed transparently in the new structures.
The proposed reforms must be credible with a sound legal base that wouldconfidently withstand legal challenge. A single market legal base would not beappropriate for measures to integrate banking supervision or to introduce anydegree of risk mutualisation (e.g. through a single fund or mutual lending between national funds).
The new supervisory arrangements must be effective and efficient and allow for wide ranging discretion and judgement by the ECB, which will evolve over timewith new financial sector developments. Exercise of this judgement will need to be accompanied by wide ranging powers to collect information directly from allEurozone banks. This necessary wide ranging executive authority of the ECBshould also be subject to some form of appeal mechanism.
The Eurozone banking union must not undermine the single market. The principles of non-discrimination, freedom of establishment and free movementof capital within the EU should be firmly entrenched in the founding legalinstruments, as well as an unambiguous objective to support the single market.State aid rules must be respected. And the design of the banking union shouldclearly tackle the implicit guarantee for banks which is a major distortion to thesingle market; tackling implicit subsidies will mean that over time bank fundingcosts increase (whilst some sovereign funding costs should decrease).
 
Macroprudential tools will be essential to address imbalances within theEurozone and a proper framework will be needed within the Eurozone, with theECB able to exercise wide-ranging macroprudential flexibility on its ownauthority.
B.Features of a banking union
4.The single rulebook of core minimum standards underpins the single market. AEurozone banking union goes further and would ideally rest on three pillars specific tothe single currency: centralised supervision led by the ECB within the Eurozone; asingle Eurozone deposit guarantee scheme with a common fiscal backstop; and acommon Eurozone resolution fiscal back-stop and authority (perhaps based around theESM). To be most effective the banking union should include all deposit takers withinthe Eurozone.5.Each of these pillars is complementary. In countries with national currencies, theresponsibilities involved in each of these pillars, along with the lender of last resortfunction, is exercised at the national level. Ideally, the Eurozone, through bankingunion, would move to a similar exercise of responsibilities at the Euro level.6.It is recognised that it is unlikely that such a move – a complete lining up all of therelevant responsibilities – could happen quickly and that therefore a more sequencedapproach towards the eventual objective will probably be necessary. However, it isimportant to note that the status quo is unsustainable. As recent event have shown,Eurozone members are now, in effect, ultimately responsible for each other's financialsystems due to the risks that they pose to the single currency. Likewise, re-denomination risk – a risk not faced in national currency systems – has huge and particular implications for the financial systems of euro countries.7.It is, therefore, necessary to proceed quickly with a move to centralised ECBsupervision as the first, essential, building block of the Eurozone banking union. Themutualised backstop (via the ESM recapitalization facility already agreed) andcentralised lender of last resort arrangements coupled to national supervision are anunstable arrangement Over time and subject to necessary transition arrangements, aEurozone banking union would best be underpinned by a single Eurozone depositinsurance scheme.8.The banking union will need more than technocratic institutions. Strong mechanismsfor democratic and political accountability will also be required along with appeals procedures.
C.Design of ECB supervision
9.The ECB is the appropriate organisation to assume supervision of Eurozone banksgiven the synergies between monetary policy and prudential supervision and thespecific Treaty base (Article 127(6)) which provides for the ECB to conduct prudentialsupervisory tasks. The ECB has its own explicit status in the Treaty with the capacity totake wide ranging discretionary decisions. It has market credibility and expertise.Designed correctly, a Eurozone banking union should strengthen the ECB’s
 
independence, not least as the ECB will gain a much greater insight into thecounterparty risks to which it is exposed through monetary policy operations.10.The ECB will need strong, integrated powers over all Eurozone banks and the ability toexercise wide macroprudential and microprudential discretion. Wide ranging flexibilitywill be key, as it is very unlikely that intrusive supervision of complex, globalinstitutions will be effective if the ability to act is constrained by highly detailed and prescriptive rules (for example Pillar 2 decisions require considerable discretionary judgement and are not amenable to heavily codified or legalistic rules). The assumptionof these powers will need to be accompanied by a programme of development of supervisory capability and a sharp increase in centralised supervisory resources drawingon the practices and experiences of the best aspects of the EU’s diverse supervisoryculture.
D.Scope of supervision
11.The scope of supervision should apply to all Eurozone banks, as should in time thescope of a mutualised fiscal backstop and deposit insurance scheme.12.Furthermore, seeking to limit the banking union merely to the largest banks, or cross border banks could lead to gaming behaviour and other distortions. There is also ample precedent to suggest that it is not only the largest banks that may cause systemicinstability. The examples of the Spanish Cajas and German Landesbanks illustrate thefact that small and medium-sized banks may in aggregate pose significant risks to Euroarea financial stability, and medium sized institutions may do so individually in timesof stress.13.Coverage should be comprehensive for reasons also of equity and coherence. It wouldseem odd to apply macroprudential powers (e.g. with respect to mortgage lending) to asub-category of institutions which may not form the majority of the macroprudentialrisk that needs to be addressed. And applying ECB supervision to only a subset of  banks (e.g. global SIFIs) could mean that many Member States in the Eurozone have banks that are not subject to ECB supervision, blunting the impact of the Eurozone banking union and fragmenting the deployment of macro-prudential tools.14.The principles of subsidiarity and proportionality can be built into the model for supervision and the approach to transition to the new arrangements.
E.Delivery of supervision by the ECB
15.There are three broad models that might be used to provide for ECB supervision:
A fully centralised model under which the ECB sets up offices in all EurozoneMember States and staff in national supervisory authorities are then transferredto the ECB, becoming its employees.
A devolved model in which power and responsibility are devolved from theECB to national supervisory authorities, with weak provisions for call-back should certain standards not be met.
A delegated model under which the ECB has ultimate control of supervision for all banks with a number of centralised functions but with certain tasks delegated

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