Cross-border banks require a single regulator

 

One of my most reliable sources in Brussels warned me some time ago that banking supervision is going to be the next controversial issue in economic policy. I was a little sceptical at the time, since financial regulation tends to be a fairly technical subject somewhat removed from the public debate.

But my interlocutor’s assessment now seems fair as the European Union finds itself called upon to make decisions on the regulation of merged cross-border banks such as Unicredit/HVB or BNP Paribas/Banca Nazionale del Lavoro. Europe’s current approach to this problem is to set up a lot of committees with similar sounding names to co-ordinate national supervisors.

It may be an uncharitable comment to make, but it appears to me that the purpose of keeping banking regulation anchored at the national level is at least in part motivated by the desire to keep people in jobs. In an increasingly integrated European banking market, efficient regulation is becoming more difficult – and the problem is going to get much worse.

We should not be surprised, therefore, that banks have found ways to exploit this rather confused situation. When Barclays announced last month that it was in talks to buy ABN Amro, it said discussions had started to ensure that the Dutch central bank could act as lead regulator for the combined group. In other words, the two banks have been negotiating about who regulates them. That tells you a lot about the state of banking supervision in Europe.

With the arrival of the euro, responsibility for monetary policy was transferred from national central banks to the European Central Bank. But this did not apply to banking supervision, which remained under national control – either within the central banks themselves or with independent supervisory agencies.

The world has since changed. The market share of cross-border banks has risen steadily since 1999. From 2000 to 2004, cross-border banking mergers and acquisitions accounted for only 14 per cent of all M&A activity in the eurozone. In 2005-2006, this proportion went up to 38 per cent. According to a 2005 survey, there are 33 banks with significant cross-border activities, which accounted for more than half of the eurozone’s banking assets.* It is only a matter of time before such groups become the norm, and this has serious implications for regulation.

So how are the Europeans responding to this change? They have done quite a lot, except the right thing. In particular, they established new ground rules to improve the cross-border co-ordination between national regulators. The 2005 capital requirements directive, for example, established minimum standards for banks operating in the EU.

At the moment, the consolidating regulator of a cross-border bank is empowered to gather and share information but cannot act outside its national jurisdiction. Some want to strengthen the supervisor’s powers by extending them to other member states. This approach faces huge legal and political difficulties. Imagine what would happen if the Germans closed down an Italian bank, or vice-versa.

So if you want to go down the national route and avoid the creation of a single European banking supervisor at all costs, you invariably end up with a hugely complex and potentially unworkable system. I am aware that national regulators are in constant discussions with each other. They have even stress-tested their systems through simulation games. But no matter how much you fine-tune the system, national regulators ultimately decide on grounds of national interest, and this may not be an optimum strategy in an integrated market.

The underlying reason why member states are reluctant to transfer sovereignty over bank supervision is the still-popular notion of the national champion bank. A European-wide regulator would probably not protect such champions in the long run.

Just contrast this thinking to the 1980s, when the number of industrial cross-border mergers started to increase. The EU responded then by setting up a central merger regime, a one-stop shop to which companies could take large cross-border deals. National anti­trust agencies continue to exist but have been relegated to dealing with smaller national cases. This has worked well and the EU ended up with a better anti­trust system as a result. But banking is different. It is one of the last bastions of economic patriotism in Europe.

So what is the outlook for a decentralised banking supervision system? As long as there is no crisis, the system can obviously be made to work. But at some point, supervisors have to take tough decisions – such as whether a bank should be bailed out or closed. It may well be that one supervisor wants to bail out a bank and another does not; or that both back a bail-out but cannot agree on how to split the costs. This conflict became apparent last week, when tensions arose in one of those high-level EU committees over whether or not to specify the percentages governments have to contribute in such cases.

When you opt for a national-based system, this is the kind of discussion you are going to get. Good luck with this! My prediction is that this system will last until it fails its first big test.

*Financial Integration in Europe, Strengthening the EU Framework for Cross-border Banks, p.33ff, ECB, March 2007, www.ecb.int

The Financial Times Limited 2007

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