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ViewpointJanuary 2 2014

Banking union from the perspective of 'New Europe'

The rise of pan-European banking groups makes supervision at a European level appropriate. But crises still start locally, and local supervisors must retain adequate powers to act independently.
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Banking union from the perspective of 'New Europe'

The idea of banking union has important implications for the EU. It is a political project towards greater integration, which also increases the impact of the strongest and the most effective institution – the European Central Bank (ECB). The stable growth of the EU depends on financial sector stability.

The EU has suffered much in recent years due to light-touch financial supervision at a national level. In many cases there was interdependence between the weak condition of public financial management and the easy regulatory approach to the banking sector. The lack of fiscal discipline caused public debt to increase, financed by the banking sector with government approval. This shifted the balance of power in the relations between governments and banks.

Banking union has gained strong support across the EU members at the general conceptual level. However, the devil is in the details. Despite wide support, expectations of the banking union are still different between the countries or regions. The major worries are around competencies and responsibility.

Home and host divide

Are EU members homogenous in financial sector development? Will unified rules for the banking sector increase equality or will they undermine trust and slow the pace of integration? No two countries are the same in the EU. However, there is an obvious split in terms of the origin of capital in the financial sector – it is between home and host countries.

The border between home and host countries in the financial sector lies in the historical division of the continent. The transition economies of the eastern EU – 'New Europe' – suffered for 50 years from central planning and the communist economic experiment. It eliminated financial intermediation and financial institutions. The reforms started in 1989 rebuilt the market economy with the transfer of know-how and capital from other countries. The average share of foreign assets in the banking sectors in New Europe has risen above 70%, while it is about 25% in the old EU countries. It leaves New Europe more exposed to exogenous shocks originating in more developed economies, including through the procyclical behaviour of foreign bank parents and the political will of their home authorities. The recent crisis has proved this. The contagion effect can be diminished by the independence and strength of the local financial supervisor.

The banking union is obligatory for eurozone members and voluntary for the rest. But those participating voluntarily have a much smaller share in the decision-making process because the institutional framework of banking union is built around the ECB. Division into a two-speed Europe is a real threat.

And yet, the countries of New Europe are not fully independent from the solutions and actions of the Single Supervisory Mechanism (SSM) and ECB. Micro- and macroprudential supervision is being developed and standards are being implemented for the whole banking system within the EU. The institutional structure will over-represent the point of view of home countries. Moreover, the New Europe countries, as host counties, will be under the rules of banking union because their banking systems are dominated by banks from the eurozone countries. This reduces the importance of whether they are in a banking union or not. The consequences will be similar for both groups.

Banking union starts with the SSM. Microprudential supervision is a necessary step, but there are still a lot of controversies around the single resolution mechanism and common deposit guarantee schemes. Addressing the questions of competence and responsibility is vital to build a compromise.

The local origin of crises

The economic history of the world contains dozens of crises. They had local, cross-border or global consequences. But reflecting on the past indicates that they all had local origins. Underestimating the first spark causes the fire.

The conclusion from this is that the banking union, in particular, should be a well-defined division of powers and responsibilities between European and national levels. Both are important and both are needed. Neither can be effective without each other.

The growth of banking groups at an international level means that it is appropriate to use EU institutions for their effective supervision. But each market has its specific features and countries’ interests can sometimes be contradictory. They have their specifics that should not be bypassed or averaged out inaccurately. The first warnings should be recognised by local supervisors and communicated up the chain.

Supervision should be adequate. Too restrictive, and it is not conducive to improving competitiveness and development. Too mild, and it can overheat the economy and lead to crisis events. Adequacy should be determined locally in return for more restrictive general rules. European rules should be established as minimum criteria. The local authority should have the final say on fine-tuning capital buffers, liquidity norms and risk management standards due to differences in economic development and stages of the business cycle. In general, less developed countries with weaker fiscal positions should have more restrictive individual standards in banking supervision.  

Stanislaw Kluza is a Professor at the Warsaw School of Economics. He was the founding chairman of the Polish Financial Supervision Authority and a former finance minister.

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