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Key Issues on European Banking Union Trade-Offs and Some Recommendations

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GLOBAL ECONOMY & DEVELOPMENT WORKING PAPER 52 | NOVEMBER 2012 Global Economy and Development at BROOKINGS KEY ISSUES ON EUROPEAN BANKING UNION TRADE-OFFS AND SOME RECOMMENDATIONS Douglas J. Elliott Global Economy and Development at BROOKINGS Douglas J. Elliott is a fellow in the Economic Studies program at the Brookings Institution and a member of the Brookings Initiative on Business and Public Policy. This paper was prepared within the framework of “The Future of Europe and the Eurozone” research project conducted by the Brookings Global Economy and Development program. Support from the Stavros Niarchos Foundation, New York and ESADE in Barcelona is gratefully acknowledged.* Acknowledgements: I would like to gratefully acknowledge the support of Kemal Derviş and the Global Economy and Development program at the Brookings Institution. Kemal suggested the paper and provided the funding and considerable en- couragement, as well as helpful suggestions. Many others have provided useful comments along the way, includ- ing: Domenico Lombardi, Carlo Bastasin, Martin Baily, Nicolas Veron, Guntram Wolff, and a number of officials and others who would prefer to remain anonymous. Justin Vaisse, Antonia Doncheva, Galip Kemal Ozan, Annick Ducher, and Mao-Lin Shen went still further and assisted with excellent editing comments. In all cases, the opin- ions, and any errors, remain my own. * Brookings recognizes that the value it provides is in its absolute commitment to quality, independence and im- pact. Activities supported by its donors reflect this commitment and the analysis and recommendations are not determined or influenced by any donation. CONTENTS Overview ..............................................................................1 Background ...........................................................................6 What is a “banking union”? ..........................................................6 Why is Europe considering it? .......................................................6 How does a banking union intersect with moves to a fiscal union?. .9 How would a banking union affect monetary and macroprudential policies? .............. 10 What has been agreed to date on steps toward a banking union? ........................ 12 Does starting with integration of bank supervision make sense? ........................ 14 What is the right geographic scope of the banking union? .............................. 15 Recommendation ............................................................... 16 What are the potential legal bases on which to establish the banking union?. 17 Bank Regulation and Supervision .......................................................20 How are banks regulated and supervised now? .......................................20 Role of Political Authorities. 21 Current Supervisory Arrangements ............................................... 21 Role of Central Banks ............................................................22 Who should supervise banks under a banking union? Why? .............................23 Recommendation ...............................................................25 What should the ECB’s role be? Why? ................................................26 How should national and European supervision be coordinated? ........................28 Recommendation ...............................................................30 Bank Resolution ...................................................................... 31 How are troubled banks handled now? ............................................... 31 How should the resolution of troubled banks work under a banking union? Why?. 31 Goals of a bank resolution framework ..............................................32 What European-level entity should handle bank resolution? ............................32 Recommendation ...............................................................35 Which banks or other financial institutions should the resolution authority cover?. .35 What powers should the resolution authority have and when should it intervene? ........35 Who should pay? Why? ............................................................36 How should the resolution authority be funded? ......................................38 Issues related to ex ante funding ..................................................39 Issues related to ex post funding ..................................................39 How should existing bank losses be handled? .........................................39 What control should national governments have on resolution decisions? Why? ...........40 Deposit Guarantee Fund ............................................................... 41 How are bank deposits guaranteed now? ............................................. 41 How should this change under a banking union? ...................................... 41 Recommendation ...............................................................42 What would happen if a country were to exit the euro?. 42 Interactions between Supervision, Resolution and Deposit Guarantee Structures ............44 How do decisions about these three areas affect each other? ..........................44 The Politics of a Banking Union .........................................................45 How does the banking union look in political terms? ...................................45 How are the various political conflicts likely to affect the shape and timing of the banking union? ...........................................................................45 The U.K. and the Banking Union ........................................................47 How would a banking union affect the workings of the European Union Institutions: council, commission and parliament? .......................................................47 Can the banking union be effective without the principal European financial center? ......47 Can London remain the principal European financial center without being in the banking union? 48 Would a banking union push the U.K. toward withdrawal from the EU? ...................48 Timeline .............................................................................50 References ..........................................................................52 Endnotes ............................................................................54 KEY ISSUES ON EUROPEAN BANKING UNION TRADE-OFFS AND SOME RECOMMENDATIONS Douglas J. Elliott OVERVIEW and individual businesses and families. Not surpris- ingly, national governments have been extremely re- uropean leaders have committed to moving to- luctant to give up control over more than €30 trillion Eward a banking union, in which bank regulation of bank assets and are doing so now only because of and supervision, deposit guarantees, and the handling the severity of the euro crisis. Designing integrated of troubled banks will be integrated across at least the bank supervision will require fighting out how power euro area1 and possibly across the wider European will be divided among various European institutions Union. This is quite positive for two reasons. Most and national authorities. immediately, it will help solve the euro crisis by weak- ening the link between debt-burdened governments Nor is it the case that we know the right answers and troubled banks, where each side has added to and have merely to summon the political will to push the woes of the other. In the longer run, it will make them through. Financial regulation is a balancing act, the “single market” in European banking substantially requiring judgments about the relative importance of more effective. many things, including: Unfortunately, it is much easier to endorse the con- • Dealing with the short-term euro crisis versus long- cept of a banking union than it is to design and imple- term improvement of the “single market” in finan- ment one. Banks are central to the European financial cial services in the EU. system, supplying about three quarters of all credit, • The trade-off of economic growth and financial and are therefore critical to the functioning of the safety. It is well established that many safety mar- wider economy in Europe. Their supervision is not just gins in banking carry with them an economic cost2. a technical issue; it requires many subjective judg- ments that have serious implications for credit provi- • The efficiency of supervisory centralization versus sion, economic growth and jobs. Choices about how the benefits of local knowledge. much credit banks provide, and to whom, strongly • The efficiency of a single regulator versus the ben- affect the relative performance of national economies efits of multiple specialized regulators, such as for KEY ISSUES ON EUROPEAN BANKING UNION 1 consumer protection or specialized financial insti- and it paves the way for a future expansion to include tutions like savings banks. the whole EU. On the downside, there will be many complications from combining members who use • Supervisory independence from political interfer- ence versus accountability. the euro with ones who do not, including the need to coordinate among multiple central banks and to give These choices are inherently subjective, since they appropriate weight to the views of non-euro members require trading off one set of policy benefits for an- of the banking union. other. (In most cases, we do not even have sufficiently developed theory to know the magnitude of the trade- Who should be the main European-level supervisor? offs.) Adding to the political difficulties,
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