Trying to Square the Circle: The ECB's Janus-Faced Character Post SSM and Its Implications for Effective Banking Supervision

Abstract

The repeated pattern of politically induced lax oversight, insufficient or delayed cross-border information sharing and the obvious moral hazard problems where an ailing national banking system can rely on international aid, that for example culminated in the mutually reinforcing Spanish banking and the European sovereign debt crises in the summer of 2012, prepared the ground for one of the most ambitious regulatory projects in European history: Banking Union. While previously Eurozone Member States strongly opposed centralization in supervision and resolution of credit institutions, suddenly, they praised it as the silver bullet that would serve to internalize the externalities caused by forbearing national supervisors and to align incentives with the far-reaching mutualization of private and public debt. Following remarkable regulatory activism, only three years later the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) had been established as the two major pillars of the new regulatory architecture.

This paper emphasizes one particular and highly contentious feature of the SSM, namely installing the European Central Bank (ECB) as quasi-omnipotent pan-European watchdog. Generally, transferring oversight from the national to the supranational level constitutes a significant step forward in addressing a key impediment to transnational banking supervision – home bias. Yet, vesting this particular institution with the necessary powers to do so, may ultimately undermine, mainly as a function of conflicts of interest resulting from its henceforth two-fold mandate, the effectiveness of the otherwise relatively well-conceived supervisory regime. In fact, these concerns were already voiced when drafting the pertinent regulation, but eventually had to make way for pragmatic reasons. It is certainly true that, in theory, tasking a central bank with banking supervision can be rationalized. However, monetary policy and banking supervision pursue different, potentially colliding regulatory objectives: price stability, the ultimate target of conventional monetary policy, and financial stability, as ideally aspired by state-of-the-art banking supervision, are not fully reconcilable. The ultimate assessment, as to which extent either of the two eventually suffers from bundling both activities under one roof, depends on the adequacy of the institutional safeguards designed to isolate it from the former’s undue influence. Finding a rather mediocre arrangement, finally an alternative solution resting on the full organizational separation of both functions will be sketched.

Keywords: Banking Supervision, Monetary Policy, Institutional Design, Single Supervisory Mechanism, European Central Bank

JEL Classification: G28, E58, D73