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Eurozone Banking Union

Eurozone Banking Union

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Non Paper: Eurozone Banking Union A. Introduction 1.

The June European Council made an important first step towards a Eurozone banking union with the agreement for a single Eurozone supervisory mechanism based around the European Central Bank (and to be proposed on the basis of Article 127(6) of the Treaty) alongside the possibility for the ESM to recapitalise directly Eurozone banks (subject to the ESM voting mechanism and a range of conditions being fulfilled). There was a clear recognition that a Eurozone banking union was needed to address financial stability and fiscal challenges within the monetary union, rather than as a consequence of the single market. At the same time, as a Eurozone banking union will impact the single market, Leaders agreed that concrete measures will be necessary to preserve its unity and integrity. 2. This paper focuses primarily on the supervisory dimension of a Eurozone banking union. 3. It is essential that the new institutional structures have strong legal and democratic foundations and are constructed in a consensual manner to ensure their short- and longterm credibility. Adherence to the following principles will assist in this. • In a monetary union banking contagion can spread rapidly from one part of the currency 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 the single currency as a whole. In addition, responsibility for supervision and resolution should be aligned with fiscal responsibility – this clearly applies both to 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 would confidently withstand legal challenge. A single market legal base would not be appropriate for measures to integrate banking supervision or to introduce any degree 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 time with new financial sector developments. Exercise of this judgement will need to be accompanied by wide ranging powers to collect information directly from all Eurozone banks. This necessary wide ranging executive authority of the ECB should 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 movement of capital within the EU should be firmly entrenched in the founding legal instruments, as well as an unambiguous objective to support the single market. State aid rules must be respected. And the design of the banking union should clearly tackle the implicit guarantee for banks which is a major distortion to the single market; tackling implicit subsidies will mean that over time bank funding costs increase (whilst some sovereign funding costs should decrease).

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Macroprudential tools will be essential to address imbalances within the Eurozone and a proper framework will be needed within the Eurozone, with the ECB able to exercise wide-ranging macroprudential flexibility on its own authority.

B. Features of a banking union 4. The single rulebook of core minimum standards underpins the single market. A Eurozone banking union goes further and would ideally rest on three pillars specific to the single currency: centralised supervision led by the ECB within the Eurozone; a single Eurozone deposit guarantee scheme with a common fiscal backstop; and a common Eurozone resolution fiscal back-stop and authority (perhaps based around the ESM). To be most effective the banking union should include all deposit takers within the Eurozone. 5. Each of these pillars is complementary. In countries with national currencies, the responsibilities involved in each of these pillars, along with the lender of last resort function, is exercised at the national level. Ideally, the Eurozone, through banking union, 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 the relevant responsibilities – could happen quickly and that therefore a more sequenced approach towards the eventual objective will probably be necessary. However, it is important 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 financial systems due to the risks that they pose to the single currency. Likewise, redenomination 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 ECB supervision as the first, essential, building block of the Eurozone banking union. The mutualised backstop (via the ESM recapitalization facility already agreed) and centralised lender of last resort arrangements coupled to national supervision are an unstable arrangement Over time and subject to necessary transition arrangements, a Eurozone banking union would best be underpinned by a single Eurozone deposit insurance scheme. 8. The banking union will need more than technocratic institutions. Strong mechanisms for 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 banks given the synergies between monetary policy and prudential supervision and the specific Treaty base (Article 127(6)) which provides for the ECB to conduct prudential supervisory tasks. The ECB has its own explicit status in the Treaty with the capacity to take 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 the counterparty 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 to exercise wide macroprudential and microprudential discretion. Wide ranging flexibility will be key, as it is very unlikely that intrusive supervision of complex, global institutions 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 assumption of these powers will need to be accompanied by a programme of development of supervisory capability and a sharp increase in centralised supervisory resources drawing on the practices and experiences of the best aspects of the EU’s diverse supervisory culture. D. Scope of supervision 11. The scope of supervision should apply to all Eurozone banks, as should in time the scope 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 systemic instability. The examples of the Spanish Cajas and German Landesbanks illustrate the fact that small and medium-sized banks may in aggregate pose significant risks to Euro area financial stability, and medium sized institutions may do so individually in times of stress. 13. Coverage should be comprehensive for reasons also of equity and coherence. It would seem odd to apply macroprudential powers (e.g. with respect to mortgage lending) to a sub-category of institutions which may not form the majority of the macroprudential risk 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 Eurozone Member States and staff in national supervisory authorities are then transferred to the ECB, becoming its employees. • A devolved model in which power and responsibility are devolved from the ECB 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

to national authorities (with the ECB having the ability to reverse the delegation if concerns arise). 16. A fully centralised model has the benefits of clarity and simplicity, but would be a major operational undertaking and would turn the ECB from a central bank operating with and through national authorities into a very different type of organisation. It would also cut across principles of subsidiarity and possibly proportionality. 17. A devolved model has the advantage of retaining locally delivered responsibility. If there were a failure of supervision it would be clear where the fault lay. However, it would suffer from two serious defects. First, if the allocation of powers between the ECB and national Eurozone supervisors was enshrined in legislation, the ECB would be legally constrained in its ability to impose its view on national supervisors – this would undermine one of the purposes of a banking union, which is precisely to address risks that are transmitted across banks within the monetary union. Second, a provision to call back devolved powers if certain conditions are met could quickly become an unusable “nuclear option”. Such a model is unlikely to lead to genuinely mutualised control and supervision of Eurozone banks. 18. A delegated model would appear to the best way forward. Under this model the ECB would perform a significant number of functions centrally, for example centrally receiving and analysing supervisory returns, undertaking its own assessments and inspections, commissioning expert persons’ reports on any aspect of a bank’s operations that was a cause for concern. These roles could be performed particularly for the largest, most complex cross-border banks. Other tasks could be delegated, such as on-site inspections, certain balance sheet assessments, bank staff competence assessments and so on. And for smaller banks a much broader range of functions could be delegated. But ultimately the ECB centrally could override any decision taken by a national authority and reverse a delegation. The degree of delegation will need to be dynamic over time. 19. The rights of intervention of the ECB should be wide ranging and not limited only to emergency cases – they need to be wide ranging and preventative in scope. In order to protect the ECB’s reputation and credibility, the ECB should not be put in a position where it has responsibility and accountability for supervisory outcomes without comprehensive powers to shape and determine those outcomes. F. Macro-prudential policy 20. A clear lesson from the crisis is that authorities need wide ranging macroprudential powers in order to help tackle emerging systemic risks and so apply standards which exceed core minimum EU regulatory standards. Exercise of these powers should as far as possible be on an independent basis from any executive body. Both the European Parliament and Council have taken significant steps to ensure that this flexibility is embodied in CRD4/CRR. Recent experience further strengthens the case for such macroprudential flexibility. Insisting on a blanket one-size fits all approach will exacerbate macroeconomic imbalances within the Eurozone, hindering the long-term resolution of the crisis. Moves to a Eurozone banking union raise questions not about the need for macroprudential powers but how those powers will be exercised within the Euro area.

21. It would make sense for the ECB, as the micro-prudential and monetary policy authority, to be responsible for the use of macro-prudential tools for the Eurozone. This will ensure proper coordination within the Euro area. Consideration would need to be given to the decision-making mechanisms around the exercise of macroprudential powers, in particular how powers relating to a subset of the Euro area are exercised. 22. The intimate interaction between macro- and micro-prudential supervision further strengthens the case for the scope of ECB supervision to cover all banks. If a national authority retained macro-prudential oversight of say 75% of its banking system and the ECB the residual 25%, there would need to be cooperation mechanisms to ensure that risks, e.g. a bubble in the mortgage market, are addressed in a consistent way. 23. It will also be important to agree the relationship between macro-prudential oversight in the Eurozone, in other Member States and the internal market. For non-Eurozone Member States, the flexibility embodied e.g. in the Council text on CRR/CRD4 remains essential. The Eurozone banking union does not in any way change the case for this flexibility (indeed it strengthens it), particularly as it applies to non-Eurozone Member States who need to be able to engage in effective macroprudential and macroeconomic management to tackle systemic risks in their economies on their own authority. The deployment of macro-prudential tools within the Eurozone should be subject to the same oversight by the ESRB as applies to those outside the Eurozone. The ESRB Secretariat, currently based within the ECB, will need to operate independently from the other parts of the ECB. For both Eurozone and non-Eurozone Member States, coordination can be ensured through the ESRB, particularly where flexibility is being exercised that exceeds the agreed thresholds in CRD4. G. Detailed design issues 24. Whatever model is chosen certain key issues would need to be addressed. These include: • • • • • • • • Governance and culture Independence Participation of non-Eurozone Member States Accountability mechanisms Diversity of the ECB’s workforce Supervisory approach Relations with third countries Transitional issues

25. Governance and culture. ECB governance arrangements will need to be designed to provide for effective and accountable supervision. As a supervisory authority, acting in its capacity as a home, host, or group level co-ordinating supervisor, the ECB will be taking a very large number of decisions. The kind of decisions include: authorisation, de-authorisation, mergers, review of business models, assessments of culture, capital and liquidity standards, technical risk model assessment, anti-money laundering controls, examining quality of senior management, effectiveness of boards and so on.

26. Whatever the formal position, the number and range of decisions means that, in reality, they will not be taken by the Governing Council or Executive Board. The ECB will need to ensure that the effective decisions (although for legal reasons they may be classed as recommendations) are taken at the appropriate level, with proper oversight, and that they can be speedily and transparently challenged on their merits and not just on their legality. Also it will be important to explore solutions which provide for speedy and objective challenge of the ECB’s supervisory decisions, for example an individual may wish to appeal a decision by the ECB not to grant them “fit and proper status”. 27. Consideration will also be needed as to whether the ECB’s current powers are adequate for it to exercise effective supervision. It would seem that the Treaty does provide for the ECB to be able to impose periodic penalties and for powers of search and seizure, and so the ECB could assume the powers currently allocated to national authorities. The ECB would also need to exercise powers over takeovers, e.g. ensuring prudential fit and proper concerns are addressed. 28. The culture of the ECB as supervisor will be critical in determining how effectively it discharges its new functions. A commitment to better regulation principles, transparency in procedures and processes, evidence based supervision aided by economic analysis where appropriate will be important in enhancing the quality of supervision within the Eurozone as a whole. 29. Independence. Within a banking union the ECB might end up with a number of distinct roles: • • • • • • As a monetary policy authority; As a central bank with oversight responsibilities for certain aspects of financial stability and certain market infrastructures; As an authority with Eurozone resolution responsibilities possibly in conjunction with the ESM; As a Eurozone supervisory authority for the banking union; As the home of the Secretariat of the European Systemic Risk Board; As an EU institution which provides opinions on certain European financial services legislation.

30. The ECB’s independence is guaranteed by the Treaty, with its decisions subject to legal scrutiny by the European Court of Justice. It is important that this independence is maintained. But it is equally important that governance and decision making procedures reflect the fact that as a supervisory authority it will be taking many more decisions and a wider range of decisions, some of considerable significance, some less so. Many of the decisions that appear financially unimportant may nonetheless directly affect the rights of individuals or firms. Different countries have taken different approaches to deal with these governance issues.

31. In the UK it is envisaged that the different public interests involved in independence for monetary policy and supervisory purposes will be reconciled by establishing the Prudential Regulation Authority (PRA) as a subsidiary of the Bank of England, with its own Chief Executive and Board (with a majority of independent non-executive members). In addition to the non-executive directors, the Board will comprise the Governor, as chair, the chief executive of the PRA, the deputy governor responsible for financial stability, and the chief executive of the Financial Conduct Authority. It will be a separate legal entity from the Bank, and will be legally responsible and accountable for the exercise of its statutory functions. This means that the PRA will have operational independence for the day-to-day regulation and supervision of firms.

32. This approach to governance may not be directly applicable to the ECB given the ECB statute. Nonetheless, locating supervision in a subsidiary is not the only way of achieving the policy goal of achieving the right mix of governance, decision making, oversight and challenge for the ECB’s very different future roles.

33. One way to realise the benefits of locating supervision within the central bank while maintaining speedy and transparent decision-making would be to establish an operationally distinct supervisory board within the ECB. This board could be chaired by a senior ECB executive, with appropriate representation on its Committee balanced by independent non-executive membership. This would give the authority greater opportunity to involve independent experts in significant decision-making and appeals (ensuring ECHR compliance while preserving operational efficiency), supported by appropriate supervisory sub-committees to oversee significant supervisory decisions. The critical design issues are to ensure that: • those involved in day to day supervision of a firm, i.e. the gatherers of evidence, are not solely responsible for taking important supervisory decisions (including those affecting the rights of individuals and firms) those who do take important decisions are not conflicted;

decisions can be appealed quickly on their merits to a separate body within the ECB comprising independent experts, potentially as well as senior ECB staff.

34. Participation of non-Eurozone Member States. Any Euro-out Member States that choose to participate in full in the ESM and any subsequent mutualisation of fiscal risk and from the beginning in the supervisory aspects of banking union should also be full members of the supervisory board. If observer status is to be afforded to nonparticipating Euro-out Member States, all non-Euro Member States should be included as observers.

35. Accountability. Supervision covers a number of policy areas and therefore gives rise to multiple lines of accountability. When redesigning its supervisory system, the UK legislation provides for the following lines of accountability for the PRA, in addition to the role of the EBA in relation to compliance with Union law: • • • • • to the Court of the Bank of England for administrative and certain policy matters; subject to full audit by the National Audit Office (NAO), with accountability to the Public Accounts Committee (PAC) of the House of Commons; to account for its actions to the Treasury Select Committee of the House of Commons; a power for the UK Treasury to order independent inquiries and reviews into economy, efficiency and effectiveness; a new requirement for the supervisor to make a report to the Treasury, to be laid before Parliament, where there has been supervisory failure.

36. Over and above the accountability of the ECB generally, accountability of the ECB for the discharge of its supervisory functions will need to reflect the different public policy issues that supervision raises. In relation to its supervisory functions, it will be important for there to be accountability to national institutions as well as European ones (particularly during the period when deposit insurance and fiscal backstops are not fully mutualised). These accountability mechanisms provide a mechanism for the ECB to explain its policies and actions, and would not cut across the ECB’s independence. Accountability mechanisms could include: • • the Governing Council of the ECB for management accountability of the supervisory board; the Commission and the EBA as regards the integrity of the single market;

the Eurogroup/Council as regards the efficiency and effectiveness of ECB supervision. We would envisage that the council would be able to require independent enquiries and reviews into aspects of ECB supervision that were a cause for concern; these could include general issues of economy, efficiency and effectiveness, but they could also be quite focused and specific where there was a concern that ECB supervision might not be identifying or mitigating specific risks; the European Parliament, for the discharge of its supervisory functions; National parliaments – until there is full mutualisation of banking sector risk at the Eurozone level, it would be important that the transfer of supervisory responsibility to the Eurozone level did not result in a reduction in the ability of national parliaments to hold hearings, be furnished with evidence both written and oral. In particular in the event of a failure of a bank, the ECB would need to attend any hearings that national parliaments held into that failure.

• •

37. Workforce diversity is also a key European objective, one which the European Parliament is rightly pressing on the banks. The same principle should apply to regulatory and supervisory authorities. The creation of a new supervisory structure in the ECB offers an important opportunity to embed strong diversity principles (potentially in legislation) in the ECB’s human resources practices and ensure a balanced composition in its workforce (for example with respect to gender) dealing with supervisory matters from the outset. The ECB will also want to draw in expertise from across Member States and ensure an appropriate balance of nationalities.

38. Supervisory approach. There are many different models of supervision, but a dearth of research studies that would provide objective data on the impact which different models of supervision have on addressing risks arising from discrete banking activities conducted under different market structures and competitive conditions. 39. Common minimum regulatory standards are needed to provide a framework for effective supervision and a level playing field for competition. For this reason the single EU rulebook is an important feature of the single market. But rules on their own cannot remove or manage risk. Rules are also exception generating. The greater the detail with which a rule is specified, the greater the focus on the particular areas which the rule (wittingly or unwittingly) excludes, and the less capable the rule is of addressing the risks of innovation. A process of ever greater rule specification therefore results in an approach to business which focuses more on legal compliance (and spotting loopholes) and less on risk identification, informed supervisory judgement and mitigation. Furthermore, the very diversity in the sophistication of markets and institutions across

the Euro area suggests that detailed supervisory rules would not capture risks in some firms or markets, and would be disproportionately burdensome for others. 40. Given the diversity across the Euro area and the exception generating character of rules, a judgemental approach to supervision will be essential. ECB officials will need to be empowered to make such judgements. One key lesson of the financial crisis is that supervision, operating within a framework of regulatory standards, needs an appropriate focus on the larger picture and be robust about coming to judgements about what activities are and are not acceptable for a bank to undertake, given its particular level of management competence. 41. Third countries. On behalf of Eurozone Member States, the ECB should have lead responsibility for relationships with all third countries in which banks falling under its group/home supervision operate. Third country exposures carry considerable fiscal risk for the banks concerned (e.g. US subprime exposures at the start of the crisis, potential deposit insurance exposures for Eurozone banks’ deposits in third country branches). Therefore consistent with the goal of ensuring alignment of fiscal responsibility with supervisory responsibility, within the Eurozone the ECB should lead on third country interactions. The ECB will necessarily need to play a leading role in global supervisory colleges involving Eurozone banks. 42. Transitional issues are also fundamental. There could be a sequential approach to the ECB’s assumption of micro-prudential supervisory powers. One approach that could make sense is to prioritise ECB supervision in the first instance: • • to Eurozone G-Sifi and Sifi banks as these are often some of the most complex cross-border institutions; and any Eurozone bank (however large or small) that has received state aid since 2007 as clearly these are institutions where supervision may well have failed and where the issue of a sovereign-bank linkage is potentially most acute.

43. This list would entail around 100-150 Eurozone banks, a number that should be manageable in the first steps towards common supervision. It would also include banks in just about every Eurozone Member State giving the Eurozone banking union greater legitimacy from the outset. 44. The ECB would then extend its direct supervision of Eurozone banks that met its threshold in a step-by-step manner over, say, a three year period. The ECB could have a right of intervention over all Eurozone banks from day one as well as full access to any information it requests. 45. It would be critically important to take active steps to ensure that during the period of transition, the supervisory footprint over firms was maintained. This requires at a minimum that there is a good degree of continuity of staff involved in supervising

particular firms, no matter where the ultimate location of their work or identity of their employer. 46. The CRD4/CRR provisions around banking sector transparency are also relatively weak. Some Eurozone Member States have argued that during (and indeed beyond) the transition to a banking union they believe that banks should exhibit far greater transparency to give assurance about their solvency and liquidity position as they enter an integrated framework. This may also give greater comfort to Member States to engage in mutualisation of risk if there is transparency about the degree of risk being assumed. There is a case for these stronger transparency measures applying across the EU, e.g. with respect to risk-weighted asset calculations, explanations of differential use of accounting rules. H. Conduct supervision 47. The ECB will be a micro- and macro-prudential supervisor. Conduct supervision, however, will continue to be the responsibility of national Eurozone supervisors. That will raise the question of how to deal with issues which could be seen as either prudential or conduct. Misselling of products is one such example. Sometimes the best tool to address such failures has significant prudential implications, e.g. changing the risk management framework used by a firm or even changing the management of the firm. Where such misselling is on a wide enough scale, the cost of redress can be sufficiently high as to have balance sheet consequences, and while the conduct supervisor’s prime objective is rightly securing prompt redress, the prudential supervisor may have concerns about scale and timing of any penalties. Whilst any twin peaks system has to operate with such tensions, within a Eurozone banking union these will also be overlaid by the fact that the responsibilities are split between the member state and the Eurozone level. There will need to be agreed mechanisms for coordination and decision-making, and one that does not instil an imbalance in the system, with the conduct authority always being overruled by the prudential supervisor. I. Internal market 48. A banking union, although not a single market measure, could have a significant impact on the internal market. The ECB has an essential role in advising on formulation of EU financial services legislation. Once it is a supervisor as well as a monetary authority, its influence on EU single market legislation is likely to increase. It will be important for all supervisors in the EU (including the ECB) to respect fully the principles of nondiscrimination, freedom of establishment and free movement and capital within the EU and support the strengthening of the single market. 49. Financial services are also global in nature. For example banks in the Eurozone and the wider European Union operate globally and in a range of currencies (EU and third country currencies) – indeed open, global multicurrency financial markets and banking services are essential for European corporates and trade and for the operation of a global reserve currency. 50. The EBA should continue as the technical standard setter for the EU. If there is a delegated or devolved model of ECB-led supervision, it would make sense for national Eurozone authorities to retain their seats in the EBA. An appropriate role for the ECB

in the EBA will also need to be articulated. Clearly, however, it would not be a sustainable position for Eurozone members of the EBA (or indeed any party) to exercise an automatic qualified majority over EBA decisions. So the governance and voting mechanisms in the EBA will need to be reviewed at the same time as legislation is agreed to transfer supervisory powers to the ECB. It will be important to ensure that the new voting arrangements provide no automatic qualified majority, including in circumstances where the number of countries joining the banking union increases over time. 51. Symmetry of treatment (in process and substance) will also be essential for the operation of powers of binding mediation. An asymmetric approach whereby the ECB (perhaps on grounds of its independence) cannot be overruled when there is a dispute, but non-Eurozone supervisors can be subject to EBA binding decisions would not be a sustainable long-term basis for the single market. The special treatment currently enjoyed by group supervisors with respect to binding mediation decisions (i.e. they can only be overruled by a QMV) will probably need to be changed. Given that the EBA can only exercise powers which relate to ensuring compliance with EU law, greater use of panels could be explored. 52. And the nature of home-host relationships will need further detailed consideration. With the ECB as single supervisor the notion of a host supervisor for banks operating only within the Eurozone will fall away. But many non-Eurozone countries will retain host supervisory responsibilities and the ECB will assume those responsibilities for Eurozone operations of non-Eurozone banks. Again, symmetry of treatment will be essential. 53. There should be a clear principle that senior appointments to institutions of the 27 Member States are decided upon by all 27 Member States. The ESRB since its creation has benefited from two outstanding Chairs (the current and previous ECB Presidents). There are questions, however, as to whether (formally at least) all 27 Member States should have a say in the appointment of the ESRB Chair (as they do for Vice-Chairs) and any consequent impact on management of the ESRB Secretariat and resources. ESRB procedures will also need to be adjusted to deal with circumstances in which the ESRB may wish to issue recommendations to the ECB’s supervisory arm or recommend a change of approach as regards a macroprudential decision taken by the ECB Governing Council. An important principle will need to be that there is symmetry of treatment between the macroprudential authorities in Eurozone and non-Eurozone Member States. J. Mutualised Deposit Guarantee Scheme 54. Greater risk sharing of the fiscal backstop for the DGS could provide a further underpinning for a Eurozone banking union. Mutualisation of risk along these lines would not be a single market measure and therefore a non-single market legal base is needed (for example, Article 352). The proposals as regards the Deposit Guarantee Schemes Directive and Recovery and Resolution Directive will need to be amended accordingly to remove the elements that relate to mutualisation of risk and present them in a single legislative proposal under an appropriate different legal base.

55. To avoid moral hazard, deposit insurance funds should not be used to bail-out creditors. These funds should be strictly limited to support depositor payouts and the exercise of strictly defined resolution authority powers in the event of a bank failure. 56. It also needs to be recognised that no deposit insurance is going to be sufficient to cover the scale of insured deposits if large systemically important banks fail (several hundred billion Euros for the largest Eurozone banks). Deposit insurance, which is ultimately guaranteed by the taxpayer, provides one of the largest sources of explicit guarantees for such banks. One powerful way of reducing considerably the fiscal impact of this ‘guarantee’ (and so tackling a significant distortion to competition) and associated fiscal risk is to introduce insured depositor preference, i.e. ensuring that insured depositors rank above other unsecured creditors in the creditor hierarchy. This will have an impact on bank funding costs in those Member States where such provisions are not already in place, but only to the degree that an explicit state guarantee is being removed. Furthermore insured depositor preference would significantly reduce the fiscal risks associated with a mutualised deposit insurance scheme, strengthening the political buyin across the Eurozone to the development of a banking union. It further limits the channel of contagion to the rest of industry, which would have to provide ex-post funding to top up schemes that have been exhausted. K. Resolution 57. A banking union will ultimately require a resolution fiscal back-stop and resolution authority. The backstop does not need to be funded ex-ante; indeed there are strong arguments against such an approach. Arrangements will be needed to address the key questions of which institution, or institutions, manages the resolution and shoulders the accountability. Some of these functions will involve the ESM; some may involve the ECB. The ESM will need some control mechanisms to address the risk of overly politicised decision making, as it takes on the possibility of directly recapitalizing banks. In order to ensure the integrity of the single market, state aid controls will remain essential. 58. Mutualisation of resolution financing raises similar questions to mutualisation of deposit insurance. A single market legal base is not appropriate for such steps, since they are driven primarily by monetary union and financial stability concerns and involve the establishment of a free-standing supranational obligation, not the harmonisation of national law. 59. Furthermore, it is critical that a Eurozone resolution authority has sound democratic accountability, with the individuals in charge being able to take decisions rapidly which have far-reaching fiscal and distributional implications and a sound basis in law. This includes decisions in relation to cooperation with third countries in the event of a crisis, given the significant fiscal consequences which derive from such decisions. 60. There must also be complete clarity as to who is in charge in a crisis. To put the question most bluntly, which individual goes on television to explain to the public in affected Member States what action is being taken to address a crisis in a particular bank? Does that individual have public and democratic credibility?

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