On Wednesday, the Eurozone moved a step closer to a banking union. It revealed a plan for the European Central Bank to regulate banks, a cornerstone of further fiscal integration which is supposed to end years of financial and economic distress in the region.
European Commission President Jose Manuel Barroso unveiled the proposal in his annual “state of the union” address. He outlined a path to closer economic and fiscal integration which is expected to underpin the future of the euro currency.
Barroso said before members of the European Parliament that common supervisory decisions, namely within the Eurozone, had to be made. He added that the proposed single supervisory mechanism was expected to create a reinforced architecture, with a core role for the European Central Bank. In short, it will be supervision for all banks in the Euro area.
The banking reforms, which need the approval of the EU member states, aim to break the link between heavily debt-swamped countries and their struggling banks.
Spain, which is trying to deal with its budget deficit in the middle of a crisis, has already been offered up to 100 billion euros ($128 billion) in European aid. With this money it is supposed to help its most troubled banks.
Countries will have to surrender a degree of sovereignty over monitoring their banks for the plan to be efficient. The proposal has already led to problems with Germany and Britain since this has long been a national responsibility.
A banking union predicts three steps. First, the ECB will get the power to supervise all euro zone banks. Second, a fund to close troubled banks will be established. In the end, a scheme aiming to protect the deposits of citizens across the euro zone will be introduced.
Establishing a common scheme for copying with troubled banks would mark a departure from the previously erratic approach taken by the euro zone’s 17 members. It has confused investors and increased borrowing costs for weaker states.
According to Nicolas Veron, an expert in EU financial policy with think-tank Bruegel, the challenge is huge. He said that the banking reform is a part of a broader agenda of integration that has become even more needed because of the recession.
Delegating powers of supervision to the ECB also makes it possible for banks to receive direct aid from the euro zone’s permanent rescue scheme, the European Stability Mechanism (ESM). Anyway, it is not clear when Spain and others would benefit.
Under the terms of the proposal, the ECB would be in charge of the current fragmented system of national regulators. It will have the power to regulate, penalise and even close banks across the euro zone.
The ECB would also gain powers to supervise the liquidity of banks closely and oblige them to keep more capital to protect themselves against future losses.
It could be complicated to reach an agreement on the terms of the union. Complications may further result in delaying the introduction of the new regime beyond the target set by euro zone leaders, which the beginning of next year.
Germany is against allowing the ECB monitor all euro zone lenders. Berlin says the central bank will have its hands full if it has to supervise all 6,000 euro zone banks. Commission officials note that even small banks can trigger a wider crisis, as happened at Britain’s Northern Rock.
Britain is outside the euro zone and it will not join the scheme. However, many international banks in London have operations in the euro zone that will be affected by the new supervisory powers of the ECB.
London is also concerned that the ECB will impose regulations that could weaken the city’s position as the European financial capital. Countries such as Sweden share the same concerns.
The proposal of the Commission anticipates a phasing in of this monitoring over a year and says the ECB should be able to regulate all banks. The ECB should begin to supervise half of the euro zone banking sector from the middle of next year.
International banks are also worried. The Association for Financial Markets in Europe (AFME) warned against creating tension between those countries inside the banking union and those that stay out.
AFME spokesman Andrew Gowers said that banks do not want to be told where they can or cannot conduct business. For example, if there are restrictions on conducting euro transactions in London, it would be a big problem.
