The EU lacks an efficient supervisory framework for its vast financial industry, and the gap between what is needed and what exists is widening.
To pave the way towards European financial integration, the Financial Services Action Plan was launched in 1999 with the aim of creating a regulatory framework for a single financial area. The European Commission, hoping to speed things up, published a White Paper on financial services policy covering 2005-2010.
There has been clear progress on integration, as financial institutions across Europe have begun to realize the benefits of economies of scale. Yet the industry has acted more quickly than regulators and supervisors have been able to respond.
At first, banks' cross-border operations were small, which meant that that they were mainly supervised in their own countries. But, over the last decade, major European banks have acquired foreign banks through such mergers as the acquisition by Spain's Banco Santander of the UK's Abbey National, Italy's UniCredito of Austria's Hypovereinsbank and Holland's ABN-AMRO. This raised questions about prudential supervision, chiefly whether sufficient resources exist to check whether the institutions are financially sound. Nordea, for example, was created by merging four major national banks, and some 70 percent of its business is outside its legal domicile, Sweden. This is a process that is likely to accelerate.
Changes in the way banks are organized have put extra pressure on supervisors. Banks have begun to de-centralize essential functions, relocating market and treasury operations, liquidity and capital management, and risk management, for example, in different countries. Banks nowadays create products and IT platforms to serve their customers in all their countries of operation; so separate prudential assessments of units in these cross-border groups, be they subsidiaries or branches, is hardly rational.
More than 60 percent of banking assets in Europe are now in the hands of fewer than 50 multinational European banks. In Eastern Europe, most new EU members' banking sectors are owned by banks based elsewhere in the EU. In short, the main part of Europe's banking assets, liabilities, and risks are concentrated in these large banks.
The current decentralized supervisory framework, with several independent "host" supervisors for subsidiaries and the parent bank's home supervisor as primus inter pares, is clearly unsatisfactory. Capital adequacy and liquidity risks should be assessed on a group level, rather than country by country; how capital and risks are divided between countries is less important.
Under EU law, the home supervisor deals with a bank's operations as a whole -- meaning the parent company and its subsidiaries. But the tools and powers available for home country supervisors are inadequate. Recent attempts to remedy this under the Capital Requirements Directive have been disappointing, even though it was plainly the best that could be achieved politically given EU countries' differing views on prudential supervision.
Host community supervisors look at business units in isolation from the international group to which they belong. They have their own national rules and regulations to apply, and every financial supervisory authority (FSA) in Europe has its own practices and traditions. Even when implementing directives, EU member countries are often tempted to "gold-plate" them by introducing extra rules. This adds to their complexity and cost, and compounds inefficiency.
Europe's financial industry wants a cost-effective, transparent, and competitively neutral supervisory framework that will foster market integration, create greater financial stability, and provide for crisis management. But Nordea's recent history suggests that this is likely to take time. The regulatory infrastructure includes supervision, deposit guarantee, the lender of last resort, and emergency liquidity assistance. These are interlinked, and stakeholders include central banks, FSAs, national treasuries, and deposit guarantee funds. Nordea tried to get the deposit guarantee rules changed to create a level playing field in which a cross-border merger would not distort competition between banks. The Commission showed sympathy and understanding, but in the end it passed the problem on to national governments.
EU member governments obviously want to minimize the risk of being called on to save a cross-border bank in trouble. So who would have to take the lead in such a situation? Would it be the home country FSA, with its responsibility for consolidated supervision, even though it would have only limited powers? Would host supervisors try to ring-fence the losses to include only those in their own country? What role should central banks and national treasuries play in a cross-border European banking collapse? Is it even possible to deal with such a situation on a purely national basis?
To pose these questions is to conclude that there is no practical alternative to a European FSA with the sole authority to supervise multinational financial institutions, including all their subsidiaries and branches within the EU and globally. This would not spell the end of national supervisors, as many national FSAs would likely work as partners of the European supervisor. National banks would continue to be supervised by national FSAs, and consumer protection would also remain subject to national supervision.
The problem is that currently there is a lack of convergence and coherence between national supervisors. And that is because perceived national interests still have the upper hand over the wider interests of an integrated European marketplace.
Markku Pohjola is deputy group chief executive officer of Nordea, the Nordic and Baltic Sea regional banking group.
Copyright: Project Syndicate
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