Scientific advisor to the Economic Analysis Council (CAE) to thePrime Minister and Senior Lecturer at Paris 1 Panthéon Sorbonne University, Jézabel Couppey-Soubeyran discusses recent advances in financial stability for BS Initiative.
Victor L.’s article on our website highlights the progress made in banking supervision through the European Banking Union project. What do you think of this project?
The Banking Union was sorely needed and should have been implemented much earlier. When the European system of central banks was set up, it was believed that a monetary pillar could be established without a banking union pillar, which was a mistake.
This banking union has three components: the creation of a single supervisor, the establishment of crisis resolution mechanisms, and the redesign of a European deposit guarantee fund.
For the moment, only the first component has made significant progress. The second and third components will take longer to become effective, as they involve a form of fiscal union that is still a long way off.
The question is whether, with regard to the first component, we are moving in the right direction. A single supervisor has been set up and the ECB has been designated to take on this role. Initially, the plan was to appoint a supervisor for all banks in the European Union, but in the end, the scope was limited to the eurozone. This is the first limitation on the effectiveness of such a mechanism.
During discussions within the European Council, it was decided to restrict direct supervision to only the largest banks in the eurozone (around 200 banks). This means that the so-called single supervisor will only supervise the 200 largest banks in the eurozone, while the other banks will continue to be supervised by national authorities. So, in the end, it is not really a single supervisory mechanism.
In your opinion, is the European Central Bank (ECB) the institution best placed to fulfill the role of single supervisor entrusted to it in order to ensure financial stability?
First of all, there was little choice but to give the ECB this role of single supervisor. Initially, the ideal candidate was the European Banking Authority (EBA), as recommended in the de Larosière report. However, the EBA struggled to establish itself, no doubt because it was not given the necessary resources (insufficient budget) and also perhaps because it failed to demonstrate its effectiveness and authority during the European stress tests (particularly in the case of Spanish and Irish banks). This reduced its supposed ability to take on this supervisory role. The only other institution that had the necessary credibility to take on this role at the time was the ECB. It was therefore deemed preferable for the ECB to take over the supervision of banks within the eurozone.
However, a central bank is not the best micro-supervisor. A central bank has a macro culture, which is that of monetary policy, and does not have the culture of on-site and on-the-spot checks that a micro-prudential supervisor may have. One could say that a central bank uses a kind of macroscope to analyze developments in the monetary and financial system, while the supervisor has to look at things under a microscope. There is therefore a significant cultural difference between a central bank and a micro-supervisor. This means that the ECB will have to make a considerable effort to adapt.
There are certainly central banks that already perform this dual role. This is generally due to a certain tradition, as in the countries of Southern Europe, which have not been any more resistant to financial instability. This is also the case in developing countries, where the combination of functions is mainly linked to problems with the pool of human capital.
The important point is that when the central bank is responsible for banking supervision in these countries, its scope of supervision is generally very narrow. It usually only supervises banks, not insurance companies or markets. This means that we have a sectoral supervision model. However, the trend before the crisis was towards the establishment of integrated models in which the supervision of all regulated financial intermediaries (banks, insurance companies, investment firms) and even markets was entrusted to a single authority (such as the FSA in the United Kingdom until the crisis). Financial globalization has led to a high degree of integration between banking and finance. Supervising such a system with separate authorities cannot be effective. A sectoral organization of supervisory mechanisms is not suited to the integration of banking and financial activities.
In response to the crisis, the current trend of transferring powers to the central bank is therefore not necessarily the right one. Before the crisis, there was an awareness that sectoral supervision was not suited to the high degree of integration of the finance industry, but now, in the rush to respond, this aspect seems to have been forgotten.
Are there not some positive aspects to this?
At first glance, one might say that this is not such a bad thing, as it forces central banks to become more involved in an area that they had neglected before the crisis, namely financial stability. But should central banks’ involvement in financial stability lie in the microprudential supervision of banks? Probably not.
It would be more natural for central banks to take responsibility for macroprudential policy, which is more consistent with their macro-monetary culture.
Of the more than 6,000 banks in the eurozone, only those of a significant size that could pose a systemic risk (around 200) are subject to supervisory mechanisms. Is this sufficient?
Large institutions pose a systemic risk. But size is clearly not the only criterion for « systemicity. » There are small banks that also have a systemic dimension, such as small regional banks that are closely linked to each other and are essential for financing businesses in the region, some of which have this systemic dimension. One example is the famous « landesbanken » in Germany. However, these banks will escape ECB regulation. This is precisely what Germany wanted, as it favored a size criterion to reduce the scope of ECB supervision so that these regional banks would escape the scrutiny of the new supervisor.
This raises questions about the future effectiveness of the supervisory mechanism within the banking union. There are undoubtedly a large number of institutions which, despite their small size, may contribute to systemic risk in the eurozone and which will not be directly supervised by the ECB, but will remain under national supervision. And that does not constitute a single supervisory mechanism.
Still on the subject of banking union, do you think that bank wills will have a sufficiently disciplining effect?
This is the second part of the banking union: resolution mechanisms and the implementation of wills. I think these are absolutely necessary tools, which can be found in Title 2 of the French Banking Act—the implementation of preventive recovery plans, or what we might more succinctly call bank wills. This will undoubtedly help to simplify the capital and financial structures of financial institutions and force them to manage their risks differently.
But could this replace macroprudential action? I don’t think so. There is no magic formula, no single instrument that can instantly restore and guarantee financial stability for decades to come. A whole range of instruments is needed: microprudential instruments, macroprudential instruments to complement the former, and a closer look at the structure of the banking market and its excessive concentration. Few bankers, or even competition authorities, recognize this last point. They generally consider that the market is effectively oligopolistic but that the large institutions compete fairly strongly with each other. We need to analyze the effects of banking concentration on financial stability in greater depth and involve the competition authorities, which have taken a back seat in this story and will not intervene in the resolution plans (under French banking law, there is no provision for them to intervene).
There are other instruments that have not yet been considered and to which the banking lobbies are fiercely opposed: additional taxation of bank balance sheets or a special tax regime for income associated with banking activities. This is entirely feasible, as banks contribute little to tax revenues compared to their profit growth in recent years.
We would like to thank Jézabel Couppey-Soubeyran once again for her time.
Interview by Victor L. and Julien P.
