European Banking Union, Arcadia Felix

BLEIBEL banking union

Firstly, we’ll need wait a bit. The common supervisor will start to work within a year, the time required to assemble such a complex mechanism.

During that time the ECB, which manages the SSM, will assess the situation of European banking groups whose direct supervision will assume by ad hoc evaluations. If there are problems, as the ECB seems to fear, national supervisors will need to do the cleaning before delivering the banks to the SSM. Obviously each country will carry the costs of the cleaning.

Those evaluations will include a stress tests, supposedly hard and in any case public, although this may complicate private solutions for the revealed problems. So at least during the year of preparation we will not yet live in Arcadia Felix. The mere announcement of the assessments has shaken the markets. British banks will not pass these exams.

In the fall of 2014 the European supervisor will begin to act. There will not be yet a European deposit guarantee fund nor a European resolution authority; since powerful countries do not want them, they might never arrive.

There will be a common regulation unifying national resolution policies. The project on the table builds on two pillars: early detection of the problems, an old dream of the regulators, a recurrent failure of the supervisors; and the principle of full exhaustion of the bank own resources before giving it access to public money. Draghi, with firsthand experience on the subject, shocked the purists by pointing out that this rigid principle will not make things easier.
But let’s not make a big deal about the missing pieces. They are an important issue for those who want to put in common the cost of the bailouts and for those who wish to expand the structures of the European Union as a matter of principle. They are not so crucial to achieve the financial Arcadia Felix, which only works between and for healthy institutions. Knowing that the resolution of the problem banks is well organized and financed does not turn a suspicious bank into a safe one.
With an exception. There are countries whose banks are too big for their Treasuries, which are unable to cover entities’ financial problems. Such banks without a safety net carry an extra risk to creditors. It is not a hypothetical case: remember Iceland, Ireland and Cyprus. The creation of a European resolution authority (with its own money) would provide systemic safety in such cases.
But even medium sized countries such as Belgium or the Netherlands, not to mention the big European Union members, have solved the problems of relatively large entities without external help. A program of public support of around 5% of GDP can remain a domestic matter. Spain, in spite of everything, is presently in the second case, not in the first. Although if the race to the concentration of the system goes on, who knows where it will be in a few years.
There are many aspects of the banking policy that won’t be transferred to the SSM. The EC Resolution lists the overseeing of payment services and financial instruments markets, the prosecution of money laundering and consumers protection. These issues have some relevance in prudential policy; remember the interferences with the treatment of the Spanish banking crisis created by the protection of consumers rights (hybrid instruments, home mortgage credit) .
The SSM will formally be competent to authorize new credit institutions in member countries. But the institutional framework by which entities are governed (the legal model for corporations, the presence of other forms such as cooperatives, foundations, semi-public entities, and so on) remains a local issue. The preference of the Commission by the public corporation, which was imposed on Spanish savings banks, is not shared by many Central European countries. Therefore in Europe very different models of banking systems will continue to coexist. The SSM shall take that into account, as expressly recognized by the EC Resolution.
Notably the macroprudencial policy belongs to the group of policies retained by national authorities, although the SSM can also act by strengthening local measures. Somehow this policy recognizes the persistence of differences of behavior within Europe. But let’s not waste time with that. Neither national authorities, nor the ECB, will dare to adopt such a discriminatory measure against a local banking system as it is the imposition of the counter-cyclical surcharge on its capital adequacy ratio.
The supervisor’s main task is the inspection and its consequences. SSM will necessarily have to use local resources. There will be instructions to unify procedures and criteria, not only for the 130 groups directly inspected by the European supervisor, but also for 6,000 “less important” banks entrusted to national authorities. But currently the countries have very different supervisory cultures. Their full standardization may take a while. It may not even be a good idea.
It is said that the supervision will be done following the “highest standards”. Good for the daily press, but it does not mean anything until someone sets those standards. Each national supervisor defends its own procedures. An example of possible conflict. All banks are subject to two parallel review mechanisms, auditing and direct inspections. Some supervisors lie more than others in the Auditors for, let’s say, accounting issues. That has economic advantages (it reduces the joint cost of supervision) but has also risks (auditors, because of cost, time and commercial pressures, don’t do all required tests). What is the right mix of talent? It is arguable. Countries are solving this matter according to their experience. We don’t know yet what the SSM will do.

Another example. The Spanish dynamic provisions are still an exception in the European prudential policy. The purposes of incorporating them into the accounting regulations of three years ago seem to be stuck. Will be them an “high standard” for the SSM? Will it bury them? Will it go without them except in Spain?
The horns of the dilemma the SSM is facing in such matters, are either to impose cumulatively all the existing supervisory criteria and techniques on everybody (including some that may be unnecessary in other national banking systems), or to impose only the consensus criteria (losing some useful ones along the way). Or, well, let freedom of choice to its supervisory teams and to the local supervisors, to the detriment of the standardization.

Sooner or later the issue will be resolved in some way. Meanwhile, there will be differences between the types of monitoring that is done in the different member States. And it is not sure that the resulting procedure will be the best, at least until the SSM learns the hard way by experiencing bank failures of its own.

Will we arrive finally at the Arcadia Felix? Sorry, but not. Let’s bear in mind two obvious facts. First, having a common supervisor does not guarantee the same level of health for all banks. With the same supervisor there are, let’s say, very solid French banks and less solid French banks. In the Europe of the Banking Union it will be the same. Second, Spanish banks, or the banks of almost any country, have more local clients (depositors and creditors) than clients of any other origin. Therefore if the economic situation of its home country is relatively bad, all the banks of that local system will be negatively affected. This correlation, this “country risk” element, is not compensated by sharing the supervisor with other countries.

If there are no new accidents in the countries more affected by the crisis, or in others that may be shaken by the ECB tests, and if the economic situation gets better, the condition of Spanish banks, which has already improved with the measures adopted, will continue to improve. But the SSM will add very little to that.

*Illustration by: Hassan Bleibel via Presseurop.

About the Author

Raimundo Poveda
Raimundo Poveda is a former Bank of Spain's banking supervision director.

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