EC money

Proposals to centralise the eurozone’s banking system have had a sistinctly mixed response

In brief

The European Commission is trying to push through proposals to give supervisory and regulatory powers over all eurozone banks to the European Central Bank, but the short timeframe and the sheer amount of change it would entail is causing concern.


In September this year the European Commission published a proposal outlining its belief that the EU should move towards a union of its banking system.

It is not a new suggestion – many people have suggested that there should be greater co-ordination in the way Europe’s banks are regulated and supervised and the subject has surfaced several times in the past four years, most recently by Nobel prize-winning economist Joseph Stiglitz at the International Bar Association conference in Dublin. Stiglitz told assembled lawyers that a fiscal union in the EU would help the economy and create greater solidarity.

In a communication to the European Parliament and the European Council in September, the commission said the EU had “responded decisively” to the financial crisis, making improvements to Economic and Monetary Union [EMU] and trying to make financial institutions and markets more resilient.

Joseph Stiglitz
Joseph Stiglitz

“Completing this reform of the EU regulatory framework is essential but will not be sufficient to successfully address significant threats to financial stability across the EMU,” the commission added. “Further steps are needed to tackle the specific risks within the euro area, where pooled monetary responsibilities have spurred close economic and financial integration and increased the possibility of cross-border spill-over effects in the event of bank crises, and to break the link between sovereign debt and bank debt and the vicious circle which has led to over €4.5tr [£3.6tr] of taxpayers money being used to rescue banks in the EU.”

The communication went on to call for a banking union “to place the banking sector on a more sound footing”. This would entail moving banking supervision to the European level, along with a common system for deposit protection and integrated bank crisis management.

Acts of union

The commission has set out two legislative proposals. The first would lead to the establishment of a single supervisory mechanism for the banking sector by giving the European Central Bank (ECB) specific tasks relating to the prudential supervision of credit institutions. The second would adapt the regulation setting up the European Banking Authority (EBA).

In its communication the commission notes that creating a banking union should not be at the expense of the single market.

‘[New rules] have to be applied in the same way across the whole Union, through coherent and convergent supervision of credit institutions by national supervisors and the ECB,” states the commission. “The single rulebook should be underpinned by uniform supervisory practices. Different supervisory handbooks and supervisory approaches between the member states participating in the single supervisory mechanism and the other member states pose a risk of fragmentation of the single market, as banks could exploit the differences to pursue regulatory arbitrage.”

The first step towards achieving banking union is the single supervisory mechanism which relates primarily to banks in the eurozone and would see the ECB supervise all of them. However, non-euro member states would also be able to participate in the single supervisory mechanism if they wished.

This aspect of the proposals has already been questioned by lawyers. In a September briefing note, Mayer Brown states: “Countries outside the eurozone, such as Sweden or the UK, may pass domestic legislation to subject their regulators to supervision by the ECB, but those countries will be questioning whether such an arrangement gives legal or supervisory certainty, given that the ECB powers under the Treaty [on the Functioning of the EU] do not extend to them and so any agreement to bind themselves to ECB decisions can only be, as the proposal seems to recognise, voluntary. Countries outside the eurozone and their banks may question whether even such an agreement would permit the ECB to exercise powers that the Treaty explicitly does not give it.”

Linklaters finance partner Edward Chan agrees that non-eurozone countries will probably stay out of the single supervisory structure for the time being.

Slaughter and May’s note on the proposals states that, while the UK seems unlikely to join the single supervisory mechanism, several banks operating in the UK are subject to supervision within the eurozone.

“Aspects of prudential practices, understandings and relationships on which eurozone banking groups may have come to rely could be challenged, and discretions which might previously have been exercised one way by a national regulator could, potentially, be exercised in another way by the ECB,” states Slaughters’ note.

The firm also notes that while the ECB would be responsible for a range of prudential supervisory tasks, national supervisors would retain responsibility for operational and conduct matters.

“Much of the day-to-day supervisory work will have to be carried out by national supervisors, both because it is national supervisors that have the necessary resources and relevant experience to supervise effectively and because, in stark contrast, the ECB plainly does not,” says Slaughters.

Passport controls

The impact on ‘passporting’ – the mechanism helping an institution to set up activities in other member states – is one aspect of the proposals where the impact is unclear. According to a commission explanatory note, as the ECB will be taking on the role of home and host state, supervisor institutions will no longer need to notify the ECB if they want to begin operations in another member state.

The proposals, says White & Case in a note on the subject, raise several “practical questions”.

“These relate, in the first instance, to building up the ECB’s human and organisational resources for supervision,” the US firm continues. “Beyond this, the division of labour between the ECB and competent authorities may raise questions about arrangements, for example, for passporting and, potentially, enforcement action.”

The draft regulations have been proposed against the background of the financial crisis. The commission seems certain that its suggestions will help in any future crises.

“Reinforced supervision within the banking union will help improve the robustness of banks,” the commission states in its communication. “If a crisis nonetheless occurs it is necessary to ensure that institutions can be resolved in an orderly manner and that depositors are assured their savings are safe.”

On top of the single supervisory mechanism the commission is therefore proposing a single resolution mechanism to co-ordinate resolution tools in the event of a crisis.

“This mechanism would be more efficient than a network of national resolution authorities, in particular in the case of cross-border failures, given the need for speed and credibility in addressing banking crises,” says the commission. “It would be a natural complement to a single supervisory mechanism.”

Chan says the proposals are key to the security of the eurozone: “If you accept that the eurozone is here to stay, some degree of banking centralisation is inevitable. That’s the price that you need to pay to save the eurozone.”

Switch hit

The timeline for implementing the changes is extremely short and has already caused comment within the EU. The commission wants the regulations to come into force in January, with some banks moving to the new regime in July 2013 and the rest by January 2014.

“The ambitious timetable for the implementation of these reforms is inextricably linked to the political exigencies of the eurozone crisis” notes Slaughters.

Chan points out that the EBA is a relatively new body, and moving some elements of supervision from the EBA to the ECB seems “rather abrupt”.

“It seems slightly odd that, having spent a long time setting up these European super-regulators, you suddenly switch to something else,” Chan says. “It’s not entirely clear how they’re going to do it.”

Germany is a notable critic. Skadden Arps Slate Meagher & Flom’s briefing notes that in addition to raising issues with the timetable, Germany has concerns about the degree of centralisation at the ECB and the scope of banks under ECB supervision.

The ambitious timetable, states Mayer Brown, will make for a tough autumn of negotiation between member states.

“It remains to be seen whether it will be possible to agree a framework for common supervision that is credible, legally robust and provides for effective supervision as well as being politically acceptable within such a tight timescale,” the firm argues. “It would seem that common supervision ought to be accompanied by common fiscal backstops but it is by no means certain that these even more contentious aspects of a banking union will be agreed.”

Mayer Brown adds that change to the EU treaty would enable more detailed and “credible” proposals to be put forward, but politics stand in the way of such change.

Politics may, as with so much in the EU, also stand in the way of the commission’s proposals being implemented as they stand, and could have an impact once they are put in place, suggests Slaughters.

Agile or fragile?

“At a socio-political level, with the transfer of power comes an implied assumption of responsibility,” the firm states. “We might therefore expect that, in the future, responsibility (in the sense of political culpability) for the failure of any significant eurozone banking group and the resulting economic disruption that could flow from that failure, will more readily be placed, rightly or wrongly, onto the ECB and, by popularist extension, onto ‘Brussels’.

“In one sense, therefore, the centralisation of prudential supervisory responsibilities, while at once creating an ever closer union, has the potential, somewhat counter-intuitively, to make the eurozone, and therefore the EU, a more fragile union,” Slaughters concludes.