House of Lords - European Banking Union: Key issues and challenges

European Banking Union: Key issues and challenges - European Union Committee Contents

Chapter 2: The Single Supervisory Mechanism And The Role Of The ECB

22. On 12 September 2012, the Commission published its Proposal for a Council Regulation conferring specific tasks on the European Central Bank (ECB) concerning policies relating to the prudential supervision of credit institutions[24] (referred to as "the ECB Regulation"). The proposal forms the central plank of the Single Supervisory Mechanism, and Box 3 sets out its main components.

BOX 3

The main components of the ECB Regulation[25]

· The conferral on the ECB of specific tasks concerning policies relating to the prudential supervision of all euro area credit institutions.

· A non-euro area Member State and the ECB could enter into 'close cooperation'. The ECB would then carry out its supervisory tasks in relation to credit institutions established in that Member State.

· The ECB would have 'exclusive competence' for a list of prudential supervisory tasks including authorisation and licensing, oversight of compliance with prudential regulatory requirements, conducting stress tests, consolidated supervision of groups, and early intervention. The ECB would be responsible also for coordinating and expressing a common position of the competent authorities of participating Member States in EBA decision-making contexts.

· The ECB and the national prudential supervisors would together form the Single Supervisory Mechanism. National supervisors would be required to assist the ECB and comply with its instructions. National supervisors would remain responsible for supervisory tasks not transferred to the ECB.

· The ECB's supervisory objectives would be the promotion of the safety and soundness of credit institutions and the stability of the financial system, with due regard for the unity and integrity of the single market.

· An ECB Supervisory Board would be set up to achieve due separation between the supervisory and monetary policy functions. The ECB Governing Council would remain ultimately responsible for supervisory decision-making, subject to the possibility of delegation to the Supervisory Board of clearly defined tasks and related decisions.

· The ECB would be required to act independently in carrying out supervisory functions. It would be accountable to the EU Institutions and to the Eurogroup.

Why is a Single Supervisory Mechanism necessary?

23. The June 2012 Towards a Genuine Economic and Monetary Union report argued that a Single Supervisory Mechanism was essential to ensure the effective application of prudential rules, risk control and crisis prevention throughout the EU, thereby ensuring that the supervision of banks in all EU Member States was equally effective in reducing the probability of bank failures and preventing the need for intervention by joint deposit guarantees or resolution funds.[26]

24. The significance of this proposal was widely appreciated. Karel Lannoo, Chief Executive Officer, Centre for European Policy Studies, stressed the importance of eliminating the "home bias" prevalent in national supervision.[27] HSBC argued that without a single supervisory framework it would be difficult to justify the application of European funds to support failing banks.[28]

25. Mr Enria regarded the proposal as "a key element of the pathway to restoring viability in the banking sector."[29] Ambassador Boomgaarden stressed that many banks would welcome central supervision as creating a level playing field and reversing the "renationalisation of banking" that had taken place since the crisis took hold.[30]

26. The introduction of a Single Supervisory Mechanism is a necessary step if confidence in the EU banking sector is to be restored. Whilst it does not in and of itself constitute a full banking union, it is an important first step in that direction.

27. Given the systemic weaknesses in the euro area banking sector that the financial crisis has brought to light, a system of single banking prudential supervision is now urgently required. The significance of this proposal as a first step towards a full banking union should not be underestimated. The following questions need to be addressed:

· Is it appropriate for the ECB, as is proposed, to take on prudential supervisory tasks and, if so, what will the impact be on its monetary policy responsibilities?

· What will be the impact on the ECB's governance structure?

· Which banks should be directly supervised by the ECB, and what will be the impact on the role of national supervisors?

· What accountability mechanisms need to be put in place?

· What will be the impact on non-euro area Member States?

· What is a realistic timetable for these reforms to be introduced?

· Do these reforms require treaty change?

A supervisory function for the ECB?

28. The key element of the proposal is for the ECB to take on supervisory powers over euro area banks. Several witnesses were strongly in favour. Mr Lannoo argued that, if the ECB was to continue providing liquidity to the market, then it also had the right to possess the necessary information on national banking systems. He felt that, of all the institutions in the euro area, it was the one with the most political credibility.[31]

29. HM Treasury asserted that the ECB was an appropriate organisation to take on the central supervisory role.[32] They pointed out that 11 out of 17 central banks in the euro area already perform microprudential supervision. They made the comparison with the proposal in the UK to transfer supervision to the Bank of England, and said that the crisis had highlighted the importance of uniting monetary policy and supervisory functions in one body.[33]

30. Others had significant concerns. Kern Alexander, Professor of Law and Finance, University of Zurich, felt that the ECB was ill-suited to the role because of the restrictions on its function under the EU Treaty. In his view, it would be more logical for the EBA, ESMA and insurance authorities to work together to undertake surveillance of the whole system.[34] Mats Persson, Director, Open Europe, feared that, given that many euro area banks rely on cheap ECB liquidity to stay afloat, the proposals could in fact reinforce the link between sovereign states and the banks.[35]

31. Mrs Bowles told us that many in the European Parliament would have preferred the EBA to take on this role,[36] although she and Mr Lannoo acknowledged that this could be problematic because of the Meroni Doctrine.[37] Thomas Wieser, President, Euro Working Group, was more pragmatic, arguing that central banks taking on supervisory functions was "a second-best solution" but that, in the current circumstances, it was the best way forward.[38]

32. The Vice-President of the ECB, Vitor Constâncio, told us that the ECB had long believed that it should be involved in supervision. He argued that there was a "global tendency to shift supervision ... towards central banks", citing recent developments in the US (through the Dodd-Frank Act) and the UK.[39] In his view, it was no longer possible to distinguish the microsupervision of individual institutions from what was going on in the financial sector as a whole. Although he conceded that there was a potential risk to the central bank's reputation and the potential for conflict with its monetary policy role, he believed the risks were exaggerated, at least in the ECB's case, because its mandate made clear that "price stability comes first".[40]

33. While we acknowledge that there are arguments on both sides of the debate, it is our view that the ECB is best placed to take on supervisory responsibilities. The ECB retains greater credibility than other EU institutions and, as the current global trend in this direction shows, the financial crisis demonstrated the importance of drawing together responsibility for supervision and monetary policy within one institution. However, it should be noted that some, for instance in Germany, argue that the ECB's 'one country, one vote' decision-making rules are ill-suited for the supervision of national banking sectors of widely differing size. Ambassador Boomgaarden told us that there was no such proposal "on the table at the moment".[41] However, Mr Rathi said that this was a "live discussion" and that the larger euro area Member States were arguing for greater recognition of the size of their financial sector.[42]

34. There is an active debate about the appropriateness of a central bank taking on supervisory functions alongside its core monetary policy role. The US and the UK themselves are moving towards drawing such functions together in one organisation, and the majority of national central banks within the euro area already do so. A Single Supervisory Mechanism is vital if confidence in the euro area is to be restored. Giving this responsibility to the ECB is the only viable option. However this would represent a momentous step, creating a significant concentration of power in one institution, with huge implications for the ECB's role. Given the ECB's overriding focus on the euro area as opposed to the EU-27, it would also have consequences for the shape of the EU as a whole.

Supervisory powers, monetary policy and the ECB governance structure

35. Drawing together supervisory and monetary policy functions in one organisation is transparently fraught with difficulties. Both Mr Persson and Professor Alexander warned that the ECB might be tempted to use monetary policy inappropriately, by lowering interest rates or loosening liquidity conditions, in order to stabilise the banking sector.[43] Mr Wieser said that the firewalls between the two functions needed to be as "tall, thick and impenetrable" as possible.[44]

36. The Commission's proposal acknowledged the danger of a conflict of interest. It proposed that, in relation to supervisory tasks, "all preparatory and executing activities within the ECB will be carried out by bodies and administrative divisions separated from those responsible for monetary policy. To this end a supervisory board will be set up that will prepare decisions on supervisory matters. The Governing Council will be ultimately responsible for taking decisions but may decide to delegate certain tasks or decision-making power to the supervisory board."[45]

37. Ahead of the October 2012 Summit, it was reported that the European Council's legal service had concluded that the proposal went beyond the powers permitted under law to change governance rules at the ECB. The legal service found that, without altering EU treaties, it would be impossible to give the Supervisory Board any formal decision-making powers, since such powers are vested in the ECB Governing Council. It was reported that the legal service had sketched out a possible legal compromise whereby the Supervisory Board could prepare draft supervision decisions, so long as the final say remained with the Governing Council.[46]

38. The October 2012 Summit Conclusions stressed the "need to ensure a clear separation between ECB monetary policy and supervision functions".[47] Following the Summit, Mr Constâncio revealed that a compromise had been agreed to reinforce the separation by minimising as much as possible the role of the Governing Council in supervision.[48] Ambassador Boomgaarden confirmed that "we are on the way to doing this inside the ECB but with a separate supervisory body."[49]

39. There should be neither a conflict of interest, nor a perception of a conflict of interest, between the ECB's supervisory and monetary policy tasks. We recognise the difficulties in designing a structure that overcomes this dilemma whilst at the same time complying with the legal requirements of the Treaty on the Functioning of the European Union (TFEU) and the ECB Statute. As negotiations progress, the following principles should be observed:

· The need for full separation of personnel between the supervisory and monetary policy tasks;

· The need to grant the proposed Supervisory Board wide decision-making autonomy;

· The need to minimise the role of the Governing Council in relation to supervision as far as is possible under the Treaty framework;

· The need to ensure that it is clear which body within the ECB has ultimate responsibility in a crisis.

Without such principles the credibility of the Single Supervisory Mechanism will be significantly undermined. Whether these principles can be observed without recourse to treaty change is open to question.

Which banks should the ECB supervise and how should its relationship with national regulators work?

40. The effectiveness of the SSM will be determined by the extent and nature of the supervisory regime. In other words which banks will be supervised, and to what degree? We were told that there were some 6000 banks in the euro area (and 8000 banks across the EU as a whole).[50] The majority of witnesses argued that all 6000 euro area banks should be brought within the Single Supervisory Mechanism,[51] although Rosa Lastra, Professor in International Financial and Monetary Law, Queen Mary University of London, suggested a 'Champions League model' with only the larger institutions subject to European supervision.[52]

41. There are sound reasons for an inclusive approach. Smaller and medium-sized EU banks, such as Northern Rock in the UK, or the cajas (regional savings banks) in Spain, found themselves at the centre of the financial crisis.[53] Barclays pointed to the dangers created by the significant interdependence of banks that had come to light during the financial crisis.[54] Others stressed the need for supervisory consistency across all banks.[55] Mr Enria told us that, if banks of all sizes were not included, in a moment of distress there might be a flight of deposits from one set of banks to the other.[56]

42. Given the resource implications and the need for expertise in national banking cultures, most acknowledged that it would not be possible for the ECB to be engaged in intensive supervision of all 6000 banks.[57] Mr Pisani-Ferry suggested that a reasonable compromise would be for the ECB to have the necessary authority to cover all banks whilst delegating supervision where appropriate.[58] Barclays described this as a 'hub and spoke' model, relying on national supervisors acting in effect as a branch of the ECB.[59]

43. Such a system would require close and effective cooperation between the ECB and national supervisors.[60] However, some witnesses foresaw tensions.[61] Philip Whyte, Senior Research Fellow, Centre for European Reform, suggested that the ECB would have fewer qualms about closing down an insolvent German Landesbank than German authorities would have.[62] Prior to the October 2012 Summit there had been much reporting of German objections to an inclusive model because of the impact on Landesbanken (regionally organised state-owned institutions specialising in wholesale banking). Ambassador Boomgaarden stressed that European supervision should concentrate on the systemically important banks, with the majority remaining under the national supervisory authorities.[63]

44. The Summit Conclusions stated that "the ECB will be able, in a differentiated way, to carry out direct supervision."[64] Mr Constâncio confirmed that the ECB would directly supervise the 25 or 30 most significant banks, and that supervision would be decentralised to national supervisors for other banks. However, national supervisors would act in accordance with approved guidelines and would be required to follow the ECB's instructions. In addition, the ECB would have authority to call in any banks that required more direct attention.[65]

45. Mr Whyte was not clear how this compromise would work in practice. He was concerned that there would continue to be "policies of forbearance driven by local political considerations."[66]

46. The Financial Secretary to the Treasury agreed that, initially, the ECB would be supervising the supervisors, but emphasised that this was an important first step.[67] He also stressed that it was not proposed to create a set of institutions divorced from national supervisory authorities requiring "a whole set of people to be magicked up from nowhere."[68]

47. It is unrealistic to expect the ECB to engage in intensive supervision of all 6000 euro area banks. Yet the dangers created by the significant interdependence of banks that came to light during the financial crisis demonstrate that it is not only large credit institutions that pose a threat to the financial sector. A sensible compromise would be for the ECB to direct the conduct of supervision by national supervisors, and for the ECB itself to focus on day-to-day supervision of only the largest cross-border and systemically important banks, but with the power quickly to assume responsibility for the supervision of smaller banks as required.

48. This model can only work if there is close and positive cooperation between the ECB and national supervisors. The ECB must also have the means to eliminate national supervisory bias where it occurs. The proposed supervisory arrangements must be stress-tested against conditions of acute crisis, setting out clearly who is in charge, the relationship between the parties involved, and how the chain of command will operate. Given that a banking crisis originating amongst participating Member States would inevitably spread to London and the single market as a whole, the Government must ensure that the UK is able to influence decisions on the design of the supervisory framework.

Accountability of the ECB

49. Article 130 TFEU sets out the independence of the ECB as follows:

"When exercising the powers and carrying out the tasks and duties conferred upon them by the Treaties and the Statute of the ESCB and of the ECB, neither the European Central Bank, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Union institutions, bodies, offices or agencies, from any government of a Member State or from any other body. The Union institutions, bodies, offices or agencies and the governments of the Member States undertake to respect this principle and not to seek to influence the members of the decision-making bodies of the European Central Bank or of the national central banks in the performance of their tasks."

50. The Commission proposal stated that the ECB would be subject to strong accountability mechanisms to the European Parliament and the Council/Eurogroup, including regular reporting requirements, answering questions and the presentation of an annual report.[69] President Van Rompuy stressed that the ECB was more accountable to the European Parliament than people thought, although he foresaw an evolution of the European Parliament's role.[70]

51. Others argued that the accountability provisions did not go far enough. Philippe Lamberts MEP told us that it was unhealthy in a democracy to concentrate too much power in one institution. He and Professor Alexander were concerned that the ECB might find it difficult to adapt from its "corporate culture of non-accountability".[71] Mr Enria stressed the need for "parliamentary control of the use made of European taxpayers' money. It cannot be only the Council or closed circles of civil servants who oversee the process."[72]

52. We also considered whether the ECB needed to be accountable to national parliaments as well as the European Parliament. Professor Lastra expressed concern about the lack of sufficient accountability mechanisms in the EU as a whole, and stressed the need for accountability at a national level.[73] Ambassador Boomgaarden argued that there was a need for "democratic legitimisation" at national level for decisions to close down a bank or change its management.[74]

53. The October 2012 Council conclusions baldly stated that "accountability takes place at the level at which decisions are taken and implemented."[75] However Mr Constâncio acknowledged that the ECB's interaction with the European Parliament and the Council would have to be more frequent and open than had been the case with monetary policy, and that the ECB would need to be "totally open" about the supervisory decisions that it took.[76] We also note Mr Constâncio's own appearance before us as a useful illustration of how an accountability mechanism of the ECB to national parliaments could operate.

54. HM Treasury highlighted three other issues that needed to be addressed. First, the lack of any internal appeal mechanism in the ECB. Second, a system where the only legal redress was to the European Court of Justice which, given that cases can take two years to work through the system, would not help credit institutions under threat of imminent closure. Third, the question of who was in charge in a crisis when issues of democratic accountability were at their most profound.[77]

55. The principle of ECB independence is a necessary one in terms of the ECB's core monetary policy role. Effective banking supervision also requires independence, but independence in the supervisory context must be balanced by strong accountability mechanisms.

56. The ECB will become an exceptionally powerful institution if it takes on the proposed supervisory powers. Four principles of accountability need to be borne in mind:

· That the ECB should be fully answerable to the Council and European Parliament for the supervisory decisions that it undertakes;

· That an effective, calibrated and streamlined mechanism of accountability to national parliaments should be established, in particular in relation to individual supervision decisions that have a significant impact on an individual Member State's banking sector. It must be for national Parliaments to set out how any new accountability structures and frameworks should operate in practice;

· That an effective appeals system should be established within the ECB, with a timely and appropriate system of external legal challenge;

· That the accountability mechanism should be able to operate speedily and effectively at moments of acute crisis.

57. Judged by these principles, the accountability provisions in the original proposals are patently weak. The ECB must retain full independence in the exercise of its monetary policy role, as well as operational independence in relation to the supervisory function. We also acknowledge the legal constraints presented by Article 130 TFEU. Nevertheless, the case for a strong accountability mechanism is overwhelming. We are heartened by the ECB's acknowledgement that stronger accountability provisions are required.

The impact of the proposal on non-euro area Member States

58. The Commission proposal suggested that Member States that have not adopted the euro but wished to participate in the banking union would be able to enter into a close supervisory cooperation agreement with the ECB subject to meeting certain conditions. Where such a Member State entered into supervisory cooperation, the ECB would carry out the supervisory tasks conferred on it as regards the credit institutions established in the Member State. A representative of the Member State would be able to take part in the activities of the Supervisory Board.[78]

59. The UK has indicated that it will not participate in the SSM (see Chapter 5). Thus, for the UK, the only change should be that its dealings with other supervisors on home-host issues, consolidated supervision and related matters may be with the ECB rather than individual national supervisors. Yet concern has been expressed to us about the danger of competence creep, whereby the ECB may seek to exert more authority than that presently held by existing national bank supervisors.[79]

60. Other non-euro Member States are likely to wish to participate in the SSM.[80] Mark Harding, Group General Counsel, Barclays, suggested smaller non-euro Member States would benefit from the credibility that the ECB would provide. He also suggested that Sweden may prefer to be involved because of its links with the Finnish banking system.[81] Mr Whyte cited the example of Nordea, which is headquartered in Sweden, but is the largest lender in Finland.[82] We note that German and Austrian-owned banks enjoy a dominant position in several central European Member States.

61. The main bone of contention for Member States such as Sweden, Poland and Hungary has been how to ensure that they would have a full and equal role in the decision-making process. The ECB statutes make clear that only euro area Member States have a vote on the Governing Council, which would legally be required to have the final say in any supervisory decisions under the model proposed by the Commission. Commissioner Barnier told us that "legal obstacles" meant that he had not been able to provide sufficient provisions in the original text. He believed, however, that there was "a degree of flexibility so that we might be able to improve this proposal."[83]

62. We have referred to reports that the Council legal service raised doubts about the legality of the proposed governance structure. It was also reported that the legal service concluded that participating non-euro area Member States would be legally unable to vote on any ECB decisions. However the legal service's compromise suggestion, referred to above, would have allowed non-euro area Member States to be given full voting rights in the drafting of advice in the Supervisory Board for the Governing Council to act on.[84]

63. The October 2012 Council conclusions referred to the need for "equitable treatment and representation of both euro and non-euro area Member States participating in the SSM."[85] Following the Summit, Mr Constâncio told us it had been agreed to make amendments, but that the precise proposals had yet to be agreed.[86]

64. Nikhil Rathi, Director, Financial Regulations and Market Services, HM Treasury, told us that this remained a sensitive element of the negotiations.[87] Following the November 2012 meeting of EU finance ministers, the Swedish finance minister, Anders Borg, was reported as stating that "either you must change the treaty so it's clear that every member is treated equitably or you need to move it outside of the ECB."[88]

65. Many non-euro area Member States may wish to participate in the Single Supervisory Mechanism. The UK has made clear that it will not do so. It is important that those non-euro area Member States who do wish to participate enjoy de facto equality with euro area Member States in the ECB decision-making process. The constraints imposed by TFEU may mean that this ultimately requires treaty change. Interim arrangements need to be devised that are satisfactory to those non-euro area Member States who wish to participate.

The timetable

66. An explicit link was drawn at the June 2012 European Council between the proposals for a Single Supervisory Mechanism and any move to allow the ESM to recapitalise banks directly. This link was made in the context of the dire prospects of the Spanish banking sector. In order to allow direct recapitalisation to take place as soon as possible, the SSM was subject to an extremely ambitious timetable, with final agreement sought by the end of 2012.

67. The majority of witnesses criticised the timetable, variously describing it as "unviable",[89] "very aggressive", "totally unrealistic",[90] "hopelessly optimistic"[91] and "utterly stupid".[92] Mr Whyte said that it was "pie in the sky" to think of this timetable as part of the solution to the Spanish banking crisis,[93] and warned that discussions on the banking union could become an excuse for not addressing the Spanish problem.[94] On the other hand, Mr Enria argued that "when you are in a crisis, policy makers need to get their act together and deal with the issue on the table fast."[95]

68. Ahead of the October 2012 European Council, President Van Rompuy told us that he hoped to get much of the detail agreed by the Spring of 2013.[96] The European Council subsequently agreed that SSM should be taken forward as a matter of priority, with the objective of agreeing on the legislative framework by 1 January 2013. Work on operational implementation would then follow during 2013.[97]

69. The Summit conclusions were widely seen as a necessary compromise in light of German concerns, articulated by Ambassador Boomgaarden, that the SSM "has to be successfully established and working effectively before any direct recapitalisation of banks in the euro area by the ESM can take place."[98] He stressed that "quality goes before speed", and that direct recapitalisation could only occur once other elements, including a single rulebook and a legal framework, were in place.[99]

70. Following the Summit, Mr Constâncio told us that it was intended that effective supervision would commence in early 2014. He acknowledged that any operation to directly capitalise banks would be delayed until then.[100] Mr Rathi warned that there were many different interpretations as to what the commitment to agreeing a 'legislative framework' by the end of 2012 actually meant.[101]

71. Following the meeting of EU finance ministers on 13 November 2012 it was reported that a German-led bloc had demanded that ministers "concentrate on getting the proposal right, rather than obsessing with a fixed timetable". Commissioner Barnier was reported to have conceded that a deal in December was "possible but difficult" and that, in any case, establishing the SSM was "a necessary, but not a sufficient condition" for direct recapitalisation of banks to take place.[102] The German finance minister, Wolfgang Schäuble, repeated his concern about moving too quickly at a further meeting of finance ministers on 4 December.[103]

72. Given the complex and controversial nature of the Single Supervisory Mechanism proposals, the timetable for reaching agreement on the proposals by the end of 2012 was wholly unrealistic. The revised aim of agreeing a legislative framework by the end of 2012 remains extremely ambitious, and, even if achieved, will leave significant questions as to how the mechanism will work in practice still to be addressed. The rushed timetable was a direct consequence of the political decision to link implementation of the SSM with the perceived need urgently to recapitalise the Spanish banking sector. This link is a contentious one which constrains the ability to assess the SSM proposals on their own merits. The need to agree legislation quickly does not obviate the requirement for effective scrutiny. The decline in Spanish bond yields since the ECB began to intervene in the secondary markets has eased the immediate pressure for recapitalisation, yet Spain's prospects remain uncertain. The banking union proposals must not become an excuse for inaction on that front.

The case for treaty change

73. We have referred a number of times to the difficulties that the Commission has faced in seeking to keep its proposal within the constraints of TFEU. In particular, the fraught negotiations about the governance structure, the role of the Supervisory Board and the Governing Council, and the voting provisions for non-euro Member States have been made much more complex by the desire to avoid necessitating treaty change.

74. Negotiators continue to seek a way to provide the necessary safeguards within the constraints of the Treaty. It remains to be seen whether such efforts will bear fruit. We fear that the overriding imperative of avoiding treaty change may produce deficient legislation with counterproductive consequences.

75. In its design of the proposals the Commission has been constrained by the need to avoid necessitating treaty change. We remain to be convinced that an effective mechanism can be designed within existing treaty constraints. European legislators may ultimately have to decide whether treaty change is a price they are willing to pay in order to bring about banking union. Adopting deficient and counterproductive legislation by way of compromise would be the worst of all possible outcomes.

24 Defined as an undertaking whose business is to receive deposits or other repayable funds from the public and to grant credits for its own account; or an electronic money institution. See Article 2(3) and Article 4(1) of Directive 2006/48/EC. Back

25 COM (2012) 511. See EMs 13682/12, 13683/12 and 13854/12. See also Appendix 5 for more details. Back

26 Towards a Genuine Economic and Monetary Union, June 2012, op. cit. Back

27 Q 65. Back

28 HSBC. Back

29 Q 82. Back

30 Q 177. Back

31 QQ 56-9. Back

32 HM Treasury. Back

33 QQ 221, 236. Back

34 QQ 106, 108. ESMA is the European Securities and Markets Authority. Back

35 Q 197. Back