Attraverso: ECB's new role as eurozone bank regulator

By Professor Jeffery Atik

Early Thursday morning (December 13) eurozone finance ministers agreed to take a first step toward establishment of a banking union. The agreement will grant supervisory powers to the European Central Bank (ECB) - at least with regard to the 200 or so largest banks headquartered in the eurozone. Large European banks located outside the eurozone (chiefly UK banks) will continue to answer to national authorities. With the accretion of these new powers and responsibilities, the ECB will come to resemble the Federal Reserve which functions as both as a monetary authority and as the chief regulator of large banks operating in the United States.

The political accord reflects a compromise between the competing visions of France and Germany. France had desired a complete transfer of bank supervision to the ECB, effectively extinguishing national regulation. Under this approach all banks located within the eurozone would become 'European' in character. Germany resisted; Germany has been desirous of sheltering its politically powerful regional banks from European control. A reported late-night compromise between France and Germany has resulted in a mixed system - with the eurozone's 200 largest banks falling under the authority of the ECB and the remaining 5,800 or so smaller banks (including virtually all of Germany's regional banks) continuing under the oversight of national regulators.

Still the eurozone finds itself a good distance away from a true banking union. As conventionally understood, a banking union involves three features: common and centralized supervision, a common deposit insurance scheme and a centralized mechanism for taking over insolvent banks. The current decision achieves at best only the first element. Moreover, the EU summit determined to postpone action on the remaining items - deposit insurance and insolvency scheme - for at least six months. These missing features involve politically touchy sharing of financial burdens.

The programmed delay in further innovations may not prove consequential - as the earliest effective date for the ECB's assumption of its new regulatory duties is March 2014. Ostensibly, this gracious implementation period has been created to give the ECB time to acquire the institutional capacity to undertake its new responsibilities. But there is more going on here - reflecting the ongoing political debates.

It now is becoming clear that these new arrangements are prospective only - they are not to be used to clean up the existing mess spread throughout the eurozone. Rather, the current operative understandings presumptively remain in effect: that each eurozone member state (be it Greece, Ireland, or Spain) bears ultimate responsibility for the resolution of its respective failed and failing banks. The relevant member state must continue to supervise, must address depositor claims (or otherwise assure depositors) and remains charged with eventual workout duties.

As the worst moments of the euro crisis recede, so too does the sense of urgency that drove the eurozone to first embrace banking union. The March 2014 date for the ECB's assumption of its new regulatory role appears timed to avoid disturbing German voters during the upcoming Bundestag campaign.

The new arrangements are intrinsically unstable if left incomplete. As things are now set, the ECB will supervise the most important eurozone banks and as such will hold the ability to suspend a bank's operating authority (think of a soccer official's red card). But what follows in such an event is less than clear - particularly in the failure of cooperation from the home member state who would be expected (per current rules) to deal with depositors and other creditors in resolving claims involving the distressed bank. One can easily imagine scenarios where the ECB's determination to pull a bank's license might well be resisted by member state government.

Again, these gaps may be quickly resolved in the upcoming months with further moves by the eurozone member states. But one cannot presume continued action - particular if (imagine this) things improve. Europe's leaders seem confident that the euro crisis storm has passed - Greece and Spain continue to suffer immensely, but there is no longer serious talk about the collapse of the euro (this is reflected by the recent convergence of euro borrowing rates). Economic improvement may restore belief in the euro as a desired element in the overall European plan - but it undermines the more urgent view that saving the euro is needed to avoid further disaster.

Establishment of a eurozone banking union is foremost a response of the euro crisis - a recognition of the inescapable linkage between the health of Europe's large banks and the economies of their respective home member states. The eurozone member states need the banks - the banks are the surest market for their euro-denominated debt offerings. And banks in crisis need (for the moment) their home member states to assure depositors and creditors.

Follow the author on Twitter @jefferyatik

Christina Perrone contributed research assistance.