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Thursday, December 15, 2016

EU’s Single Banking Supervision Mechanism: Challenges to the Democracy of Member Countries

Speaking at the London School of Economics Tommaso padoa-Schioppa, member of the Executive Board of the European Central Bank in 1999, observed that with the creation of a single currency, Euro and a single central banking competence (ECB) for a group of countries that are still exerting their own sovereign power in many key areas, the centuries-old anchor of the money, the sovereign, had been given up.


And with it emerged a new type monetary order: the coincidence between the area of jurisdiction of monetary policy and the area of jurisdiction of banking supervision is no longer in force. In other words, there is no single authority which is accountable to manage two public functions viz., managing the currency and controlling the banks. Now the irony is: it is the banks who hold large stock of money that performs the well-known functions namely, means of payment, unit of account and store of value and the monetary authority that is supposed to ensure price stability cannot exercise supervising authority over these banks. Which means, it has no direct knowledge of “its” banking system.


Under these circumstances, EMU had evolved a system of its own to supervise banking system that essentially rested on two principles: one, supervision of banks of each country is the responsibility of the “home country” and two, cooperation among banking supervisors of the individual countries to safeguard “openness, competition, safety and soundness of the banking industry. In other words, banking supervision in Euro area is now made the responsibility of such institutions which have no monetary policy functions. 


That aside, banks being ‘multi-product’ firms, operate in many markets including domestic, continental and global and euro had only speeded up the process of internationalisation of banks from the Euro zone. Cumulatively, these developments have subtly demanding for model of supervision that eliminates the division of the geographical and functional jurisdiction between monetary policy and banking supervision.


And, the global financial crisis 2008-09 that had shown how rapidly financial crisis of one country can spread to another country threatening the very stability of banking system of Euro zone had made one thing amply clear: the impossibility of simultaneously achieving financial stability, financial integration and maintaining national financial policies, particularly in an integrated financial market such as European monetary union.


This crisis ultimately led to the establishment of Single Supervisory Mechanism (SSM) as per the agreement arrived at by the ECOFIN Council on 13 December, 2012. Under the SSM, ECB will assume the responsibility of supervising all the banks in the Eurozone with of course, a clear demarcation between its monetary tasks and banking supervisory tasks so as to eliminate the scope for the conflicts of interest between the objectives of monetary policy and prudential supervision. 

Though establishment of SSM that was aimed at completing the economic and monetary union is a far reaching change embraced by the Euro countries, it did rise certain apprehensions—particularly, concerns about ‘democratic-deficit’—among the member countries. But first, let us examine what role SSM is supposed to play so as to understand its unintended consequences: ‘democratic-deficits’ embedded in the system that are potential enough to stir conflicts among the member countries.  SSM, consisting of the ECB and the national supervisory authorities of the participating countries, aims to ensure safety and soundness of the European banking system, increased financial integration and stability, and consistent supervision. In the process, ECB defines a common approach to day-to-day supervision, takes harmonised supervisory actions and corrective measures, and ensures consistent application of regulations and supervisory policies. Under this arrangement it conducts supervisory reviews, on-site inspections and investigations; grants or withdraws banking licences; ensures compliance with EU prudential rules and sets higher capital requirements wherever warranted to counter any financial risks.

Currently, Italy with the third largest economy of Eurozone, is facing a severe challenge from its banking system. Monte dei Paschi is passing through troubled times for years: even two State-bailouts involving Euro 8 bn could not improve its market capitalization. Its nonperforming loans stood at 21.5% of its total loans, and remember, it’s after making provisions. A  State risk has thus become inevitable. But, Italy is constrained by European Union ‘resolution’ rules. Of course, Italy has written to ECB to give it more time to rescue Monte dei Paschi bank. Indeed, the divergence in the performance of member countries within the single-currency zone like Greece, Portugal, Italy, Spain, etc., is now posing many challenges.  One such daunting challenge for Italy now is: How to reconcile the domestic-demand for bailing out the bank with that of the EU rules that insist for bail-ins rather than bail-outs? And with the defeat of Renzi, Pundits fear that Euro-zone is slowly moving towards a greater calamity: yet another financial crisis.  

Thus the arrangement of SSM—as Jean Monnet, the French political economist once observed, “The change that comes from change cannot be predicted”—has thrown open new challenges: EU citizens’ concern for and frustration over the ‘democratic deficit’ under SSM has assumed alarming proportions. This discomfort has only got further accentuated with ‘Brexit’. Policy makers are today wondering that if EU people’s frustration from these deficiencies are not addressed, the very stability of EU/EMU alliance maybe threatened.


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