Whether responsibility for banking supervision in the EU lies with national central banks or with separate agencies, it must be able to stand up to pressure, argues Jean Lemierre.

Only eight years ago, a financial crisis in Russia sent shock waves across the whole of central Europe and the former Soviet Union, shaking to the very core an embryonic financial system that had been born out of the collapse of the Berlin Wall in 1989. Since the 1998 crisis, progress in re-establishing sound banking sectors, the lifeblood of these reforming economies, has been remarkable. Improvements have been strongest in the most advanced transition countries, the eight central and eastern European nations that joined the EU in 2004.

But the progress has not been restricted purely to that region. Banks across virtually the whole of the European Bank for Reconstruction and Development’s (EBRD) area of operations now enjoy better legal protection, courts are better at enforcing laws, and banking supervision and regulation have become more effective.

That element of banking supervision is paramount. Sound regulation engenders a sense of trust not only in the financial sector itself but beyond into the whole economy.

Supervision is crucial

Strong supervision is as crucial as the independence of central banks to steer monetary policy, whether in countries in the developed G7 or the developing countries of the former Soviet bloc.

Central bank independence will be regularly questioned. But, despite intermittent pressures, it survived at the powerful German Bundesbank, in whose image the European Central Bank (ECB) was formed. It will also survive at the ECB, whose monetary umbrella now covers Slovenia, since the start of this year – the first of the former command economies to sign up to the euro.

So what is the best way of safeguarding the probity of that other plank of financial stability, banking supervision? The debate has been sparked in part by several countries that have moved through initial phases of transition and, for political or pragmatic reasons, are now reviewing where responsibility for banking supervision should reside. Should it rest as in many countries under the aegis of the central bank or is it better served in a separate, equally independent agency? Should the model of a determinedly independent UK Financial Services Authority, or the numerous regulatory authorities of the US, be exported worldwide?

The main argument for keeping supervision under the auspices of a central bank is that it is responsible for monetary policy, a smooth payments system and often also for maintaining financial stability. These tasks are all closely intertwined with the banking system, which makes it logical to leave banking supervision to a central bank.

It can be equally cogently argued that the banking supervisory function should be allocated to a separate agency on the basis that conflicts of interest may arise between different central bank tasks. A central bank may be hesitant to raise interest rates because this may lead to the bankruptcy of a large bank, even though an interest rate rise may be necessary from an overall economic perspective. Another argument is that mistakes in banking supervision may put a blemish on the reputation of the central bank. And another is that too much power will be concentrated in one organisation if the central bank performs so many tasks.

Professionalism is key

For me, the crucial argument is not where banking supervision resides but under what conditions.

The basis of sound supervision rests with the professionalism of the people who are responsible for it, the quality of the training they receive and their ability to stand up to pressure from wherever it may come. Banking supervision has to exist within a credible institutional framework.

In countries with only a recent history of institution building, it may be preferable not to risk fragmentation of that burgeoning pool of professional talent in a number of different organisations pursuing similar if not identical aims. Synergies and economies of scale can be tapped into by containing both functions under the one umbrella.

Governments, however, may want to avoid the potential conflicts of interest and choose the alternative route. So they should, if that is their preferred course. But by taking this step they must be ruthless in their determination to ensure that there is no dilution of the supervisory agency’s authority and in guaranteeing the same level of professionalism, expertise and independence.

Jean Lemierre is president of the EBRD.

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