Europe often has grand gestures at the ready for its greatest moments. When countries switched from their national currencies to the euro, every citizen received a small bag of new euro coins. The European Union’s expansion into the former Soviet eastern bloc was celebrated with a spectacular light show at the German-Polish border.
Nothing of the sort will happen on Tuesday – no celebration, no fireworks, no gifts. And yet the continent is about to reach another historic turning point.
From that day on, the European Central Bank will be in charge of supervising the 120 most important banks in the 18-country monetary union, including 21 German lenders. Banks play a central role in a capitalist economic system, because they determine where the money goes. In the coming weeks, the euro zone member states will lose control over the cardiac chamber of their economies. Germany’s largest lender, Deutsche Bank, will no longer be supervised by German financial regulators but by a European authority wielding substantially more power.
The ECB's core purpose has changed - monetary policy and bank supervision will now be housed under the same roof.
The step was an inevitable outcome of the financial crisis, which demonstrated that sharing a common currency also meant common supervision of banks. As a result of the varied financial entanglements within a monetary union, German taxpayers can be forced to bail out Spanish banks in the event of a crisis, and vice-versa. In other words, the health of the banking sector is no longer purely a national issue.
The banking union is the European Union’s biggest integration measure since the introduction of the euro. It is also a massive experiment in economic policy.
No one knows exactly how secure the banks actually are – the new supervisory agency will have to get its feet wet first. The ECB’s core purpose has also changed – monetary policy and bank supervision will now be housed under the same roof.
Danièle Nouy, the head of the ECB’s new Supervisory Board, has little time to lose. The petite, blond Frenchwoman is one of the key figures in the experiment.
At a press conference at the ECB’s headquarters in Frankfurt last month, she delivered the results of the ECB’s first major financial examination. Ms. Nouy’s staff, together with thousands of outside experts, had spent months scrutinizing the balance sheets of Europe’s biggest banks.
The ECB’s “stress test” examined the banks’ loans and analyzed the risk of those loans not being repaid in the event of an unexpected shock to the euro zone’s economy – a rise in unemployment, a sharp decline in corporate revenues or a drop in real estate prices. The goal was to ensure that the banks’ finances are clean before the ECB assumes its supervisory role.
Ms. Nouy’s figures are, in fact, relatively gratifying. When the audit began, many banks lacked the capital to cope with the potential losses they would suffer in a crisis. In the meantime, however, most of these lenders have found new investors, have set aside profits and sold off problematic loans. As a result, the ECB eventually concluded that only 13 institutions still lacked sufficient funds to weather a crisis. According to the ECB figures, the total remaining shortfall amounted to only €9.5 billion ($11.9 billion), a sum the banks will likely be able to raise without government assistance.
The step was an inevitable outcome of the financial crisis, which demonstrated that sharing a common currency also meant common supervision of banks.
This means that banks are now in a position to supply the economy with sufficient credit once again. But it won’t put an end to the economic crisis. Most euro countries are not stagnating because banks are keeping credit tight. Instead, businesses in many countries with high unemployment are hardly borrowing at all anymore, because no one is buying their products. Still, the stabilization of banks at least creates the conditions for sufficient lending to facilitate strong growth in the future.
Most experts believe that the crisis scenario of the ECB’s stress test was sufficiently plausible, even though the simulation did not include the kind of severe economic collapse that occurred after the Lehman Brothers bankruptcy. With the audit’s completion, regulators have never had so much data about European banks at their disposal.
This still doesn’t eliminate the risk of a major bank failure. Many European banks earn significantly less money than their competitors in North America. Finally, it’s a reality that a bank’s business relationships are so complex that sometimes not even its senior executives are fully cognizant of all the potential risks they face.
Only one bank in Germany failed the test, and even this one has already improved its capital buffers sufficiently since the audit began. However, the situation would have been worse if the ECB used a stricter benchmark for capital ratios, such as the already-agreed “fully loaded” capital requirements that will take effect in Europe in a few years. Under this benchmark, five German banks would have failed the test, including two regional state-owned banks.
The mere completion of the stress test does not translate into smooth sailing from now on.
The ECB, with its complete lack of experience in bank supervision, has had to hire about 900 new employees in the last few months. As usual in Europe, the procedures are complicated. Each bank will be supervised by a team headed by an ECB representative but staffed primarily with employees from the national regulatory agency. These multinational teams will have to review national regulations and the texts of contracts, which are often unavailable in translation.
Under the new supervisory agency’s rules, a chief regulator cannot come from the country in which the bank he or she supervises is based. Anne Lécuyer, a Frenchwoman, will be the chief regulator for Deutsche Bank, Germany’s largest bank.
In the past, financial watchdogs were often closely aligned with the banks they supervised. For instance, it was long an open secret in international financial circles that Irish bank regulators were generous in their auditing practices, because the government in Dublin was trying to attract foreign lenders.
National regulators are being deprived of power, just as the Bundesbank, Germany’s central bank, was deprived of economic power after the euro was introduced. ECB employees see themselves as the ones who will now be setting the tone. “This will take some getting used to for everyone involved,” said government officials in Berlin.
The ECB this week started moving into its new headquarters, a high-rise building in the eastern part of Frankfurt. But the Supervisory Board will remain in downtown offices, because there isn’t enough space in the new complex. The arrangement suits the central bank’s executives, because the spatial separation underscores the idea that bank supervision and monetary policy are two different fields of responsibility – and should remain that way.
While the two departments are separate, it can be helpful for monetary watchdogs to be able to access the financial regulators’ data when making interest-rate decisions. This is why many countries have combined the relevant responsibilities within their central banks.
But the structure also creates potential conflicts of interest. For instance, there is a risk that a central bank will be tempted to keep battered financial institutions afloat with cheap money. This, in turn, could result in interest rates being kept low for longer than would be economical advisable.
In a crisis scenario, ailing banks need to be quickly restructured or liquidated. Although the euro zone now has a resoultion mechanism to wind down failing banks – another key plank of Europe’s new banking union – there are questions over how effective this will be in practice.
That’s why many experts advocate a strict institutional separation between monetary policy and supervision. However, this is not possible in Europe, because the European treaties would have to be amended to provide the Supervisory Board with its own decision-making powers. Instead, the Supervisory Board’s decisions will have to be signed off on by the ECB’s Governing Council and its president, Mario Draghi. Amending the E.U. rules to allow supervisors to make their own decisions is not politically feasible at this time.
By assuming bank supervision, the ECB becomes the most powerful economic authority in Europe. Now it’s time for it to take advantage of its new power.
This article first appeared in Die Zeit. Mr. Schieritz writes about economic and political themes for Die Zeit. Mr. Storn is a Die Zeit editor based in Frankfurt, Germany’s financial capital. To contact the authors: email@example.com and firstname.lastname@example.org