Fernando Restoy: Remarks on banking union
Remarks by Mr Fernando Restoy, Deputy Governor of the Bank of Spain, at the round table
"Systemic risk and securities markets", II International Conference on Securities Markets,
held by the Comisión Nacional del Mercado de Valores (CNMV), Madrid, 14 September
2012.
* * *
Let me first thank the organisers for their kind invitation to participate in this event held by the
CNMV, of which I was Vice-Chairman from 2008 until my recent appointment in the Banco de
España. I also had the privilege to participate in the highly successful conference organised in
2011. A glance at the quality of the papers and speakers in the programme of this conference
is sufficient to confirm that the organisers have succeeded in maintaining the high standards
achieved last year. Our Chairman today, Oscar Arce, deserves much credit for that. I am sure
that the CNMV's new top management - who will be taking over in a few weeks - will continue
to support this event, as the President Julio Segura and myself did the first two editions.
The current financial crisis has shown up numerous deficiencies in the functioning of the
global economic and financial system. Many of those deficiencies are the consequence of
imperfect rules, policy mistakes and inappropriate conduct by private agents. Some of those
deficiencies are the subject of an on-going policy debate and of regulatory reform which, with
varying degrees of ambition, is taking place in different jurisdictions.
However, in addition to imperfect rules and policy actions, the crisis has revealed a series of
institutional deficiencies which need to be eliminated in order to restore economic and financial
stability.
The clearest example in this regard is probably the European institutional framework. Over the
last three years we have witnessed how the perception of country risks has climbed to very high
levels as a consequence of both sovereign credit risk as well as the so-called redenomination
risk. This development has impeded the adequate functioning of monetary union by leading to
sizeable differences in the financing conditions for agents located in different States within the
monetary union and by instigating the renationalisation of financial markets.
There can be no doubt that much of what has happened is directly linked to the significant
macroeconomic and financial imbalances accumulated by several euro area countries, as well
as to the emergence of vulnerabilities within the financial sector. It is also clear that the main
remedy for those destabilising developments lies in effective adjustment of domestic policies,
which is currently being implemented in those countries suffering the most significant stress.
But, at the same time, the elimination of any perception of redenomination risks can only be
fully accomplished if - in addition to the required domestic policy action - the central bank is
fully and credibly committed to intervening in sovereign markets as far as is necessary to
avoid the pricing of sovereign risk becoming self-fulfilling. In that regard, the recent
announcement by the European Central Bank of its determination to conduct unlimited
intervention in the sovereign secondary markets, provided effective conditionality is fulfilled,
constitutes a significant step towards the normalisation of market conditions in the euro area.
Yet, the return to a smoothly operating monetary union cannot be completely achieved by
simply relying on ad-hoc reactions by policy-makers. Institutional arrangements must be
reviewed in order to restore adequate incentives for domestic authorities to prevent the
reemergence of destabilising imbalances and to ensure that any residual risks arising in
specific jurisdictions that could affect the area as a whole would be addressed by integrated
mechanisms operating at the euro area level. The recent changes introduced in the European
Union to strengthen the requirements and the mechanism for the surveillance of domestic fiscal
policies and structural reforms, together with the creation of the EFSF and the ESM - which
we now know will be soon be launched - are good examples of the required institutional
reforms.
At the same time, a specific source of risks for the smooth functioning of monetary union that
needs to be addressed directly is the financial instability experienced in specific jurisdictions.
As we have seen in the last few years, the deterioration of the perceived solvency of
financial institutions located in specific countries within the monetary union can have
spillover effects across the financial sector as a whole, can contribute to a disorderly functioning
of wholesale markets and can put great stress on the public finances of the countries affected.
Consequently, the soundness of financial institutions is of systemic importance within the
monetary union and should therefore be preserved through the appropriate integrated crisis
prevention and resolution mechanism.
Against this background, a consensus has emerged of unprecedented strength on the need
to take steps to create a banking union. The first step would be the adoption of a single
supervisory mechanism. A regulatory proposal for such a mechanism has been released this
week by the European Commission.
The proposal has three main features. First, the assignment to the ECB of supervisory
responsibilities for all banks in the euro area, and possibly also for banks in countries
outside the euro zone willing to enter into cooperation arrangements with the ECB. Second, the
adoption of mechanisms to ensure that the ECB's supervisory tasks are strictly separated
from the conduct of its monetary policy. Third, the involvement of national supervisors in the
preparation and implementation of decisions.
The proposal is in my view well founded. In particular, it makes sense to subject all financial
institutions in the euro area to a single supervisory mechanism. Recent experience shows that
the instability of medium-sized or small institutions with limited links to other European
institutions may sometimes generate disruption at both the national and the euro area level.
Moreover, the coexistence of different supervisory regimes for institutions sharing the same
market place may generate competitive distortions, which should be avoided.
Similarly, it is important to establish institutional mechanisms to mitigate any potential conflict
between the objectives pursued by the supervisory and the monetary policy functions. I believe
that the crisis has already helped to allay our concerns about the extent to which those
conflicts could actually arise in practice. Indeed, most central banks have understood that
financial stability considerations should be taken into account when designing monetary policy
measures without challenging the priority that should be given to the price stability objective.
In any case, from a procedural point of view it seems reasonable for the Governing Council
of the ECB - the interest-rate setting body - to make relatively extensive delegations to the
Supervisory Board envisaged in the draft regulation as the operational body through which the
ECB will exercise its new supervisory functions.
Finally, on the involvement of national supervisory authorities, the draft regulation envisages a
model under which the ECB will have ultimate responsibility for the tasks conferred on it by
the new regulation. In performing the new functions, the ECB will however take full
advantage of the expertise of national authorities. The principle under which national central
banks and supervisory authorities are to help in preparing and implementing decisions is an
essential ingredient of the new supervisory mechanism. At the same time, it is probably
reasonable to develop that model in such a way that the principle of delegation is flexibly
used so as to take into account the different nature of the supervised financial institutions and
the specific supervisory functions to be performed. Although the involvement of national
authorities should always be required, the ECB should normally participate more directly when
institutions of systemic importance and actions of a strategic nature are involved.
The draft regulation foresees that the ECB will start performing its functions through national
supervisors already in January next year and that the new system will be fully operational in
2014. That is quite a demanding timetable. I can well understand the need to speed things up
as much as possible as the new system should already be being used to help solve the
problems the euro area is facing now. That includes the possibility it will open for direct
recapitalisation of financial institutions requiring public aid by the European Stability Mechanism,
thereby helping to mitigate the destabilising association of sovereign and financial risk.
It is probably reasonable to expect that the overall supervisory framework should evolve over
time beyond January 2014. In particular the distribution of responsibilities between the centre
and the national authorities could naturally change as a result of the accumulation of expertise in
the ECB and the progress made in developing the other two pillars of banking union: namely,
an integrated resolution regime and a common deposit guarantee scheme.
Indeed, the idea that a fully effective banking union requires also the establishment of those
two additional components is quite compelling in my view. Moreover, it could be argued that
the combination of a centralised supervisory mechanism with decentralised resolution
schemes may generate some dysfunctionalities and incentive compatibility issues.
More importantly, the mitigation of destabilising financial risks and of their impact on
sovereign risks requires not only a strong crisis prevention scheme, but also an effective
common crisis resolution regime. Even if banks are supervised under a common system,
episodes of financial distress may still deteriorate the perceived cohesion of the eurozone if
purely domestic mechanisms are used to restructure or resolve weak banks and to protect
depositors. That is conceptually contradictory with the goals of a banking union. In that context,
the communication by the Commission to shortly make legislative proposals in this area above
and beyond the Directives which are currently under discussion is obviously welcomed.
In any event, there is a lot of work to be done in the short term to put in place the new
unified supervisory mechanism. At present, important differences remain between the
and
characteristics of the national supervisory models which affect powers, means, practices
procedures. The use of permanent on-site supervision, the link between off-site supervision and
on-site inspections or the powers of the supervisory authority (if any) in relation to accounting
regulations, are simply some examples. Differences between national supervisors also exist
regarding the availability of data. To give you an example, Central Credit Registers - which in
our experience are a highly valuable source of information for prudential supervision purposes -
are not yet available in all jurisdictions.
The EBA has played a very important role by improving cooperation between national
supervisors and promoting supervisory convergence. But these improvements fall short of the
needs of an effectively unified supervisory system. Substantial and swift progress in this field
is therefore needed.
Let me just finish by making a general comment. It is obvious that the creation of a banking
union poses enormous challenges for Europe that will require strong political support and
effective cooperation among all authorities involved. The good news is that if we look at the
process of European integration from a historical perspective, we realise that this is not the
first time that the way forward has been highly complex. And, past experience has regularly
shown that the response has always been to deepen integration and increase the transfer of
national powers to the Union as the best - and possibly only - way to preserve all the
achievements made so far.