Friday, 17 October 2008

EU: Monetary policy VIII Financial supervision

European leaders have scrambled heroically to sort out the financial mess. The same leaders are responsible for the rules which let the meltdown happen in the first place and the treaties which make it hard to solve the cross-border problems when they have erupted.

The most important financial institutions are increasingly global or European in scope, but the prudential supervision of credit institutions and the stability of the financial system has deliberately been left to the (in)competent national authorities.

This is the situation pursuant to the existing Article 105(5) of the Treaty establishing the European Community (TEC). It remains the case under the Lisbon Treaty, as you can see from Article 127(5) of the Treaty on the Functioning of the European Union (TFEU).

The obvious solution is banking supervision at European level, but it is as if we lived in medieval times, when every science was a servant to theology (ancilla theologiae). The European System of Central Banks is graciously allowed to assist: to contribute to the smooth conduct of supervisory policies at national level. Able or unable to prevent meltdown, national authorities call the tune although they lack the scope.

The Treaty of Lisbon brings no change to this. In other words, it would require a new treaty (amendment) to remedy the situation. As we have seen, the form (international treaty), decision-making (unanimous agreement) and national approval (ratification) by all member states have made treaty reform a ‘mission impossible’, The logic of international relations has also left the citizens of the European Union as hapless bystanders and spectators.

In addition, since the Nice Treaty there has constantly been a reform project blocking the tunnel, leaving no room for other treaty reforms (except the more technical accession treaties).


With these ground rules, it is no wonder that the EU and EC treaties are hard to read and even harder to master. Treaty reform becomes endless tinkering between member states’ governments, instead of an open and democratic process. In the end, the treaties impose as many self-defeating restrictions on the union, as they grant powers to tackle common problems where the individual governments are out of their depth.


Let us continue with our example.

Some people must have realised that European financial markets require pan-European supervision, but what came out of the treaty treaty-building sausage machine offered only the slimmest of hopes.

Substantially: Only limited (specific) tasks can be transferred to the European Central Bank. Putting in place a European regulator (or major reform) is impossible without reforming the treaty.

Insurance undertakings are wholly excluded from any attempts at supervision with global vision.

Procedurally: Even these limited tasks require unanimous decision by the Council, according to Article 105(6) TEC. The Lisbon Treaty is no help; Article 127(6) would still require unanimity in the Council, and the European Parliament would be downgraded from giving its assent to offering its opinion.

The Treaty of Lisbon takes a small step, but backwards, if seen from the angle of representative democracy.

Earlier we saw that the European Convention proposed the ordinary legislative procedure (European laws), but the tasks would have been as specific (limited) as before, and insurance undertakings as excluded as currently from any possible arrangement.

From a practical point of view, Article III-77(6) of the draft Constitution was more or less a theoretical improvement, perhaps a political signal of the awareness the limits of scattered supervision and multi-jurisdiction financial firms.

Even this degree of temerity was too much for the intergovernmental conference 2004, which clobbered the proposal and reinstated Council unanimity and downgraded the European Parliament to opinion-giver.

The IGC 2007 had practically no room for improvements on the 2004 Constitutional Treaty. On the contrary, the governments prepared the IGC 2007 Mandate with a view to what might be salvaged and what should be jettisoned by the Reform Treaty (as it was then called).


What to do, when doing the right thing is impossible?

Paralysis or muddling through seem to be the options.

About the evolving opinions concerning multi-jurisdiction firms; the European Financial Services Roundtable (EFR), representing major financial and insurance companies, has argued that a more efficient and effective supervision of financial institutions is a key element to improving growth and integration of European financial markets. The appointment of a fully empowered lead supervisor for each financial institution is considered to be a realistic way to achieve this goal.

The EFR issued its third report ‘On the lead supervisor model and the future of financial supervision in the EU ─ Follow-up recommendation of the EFR’, where the arguments were taken further. The June 2005 report is available at:

The EFR pro­posed that the lead supervisor should be responsible for the prudential supervi­sion not only of branches in other EU member states, but also of fully owned (fully controlled) subsidiaries in other EU member states. Supervisors in member states, where systemically important branches and subsidiaries are located, should be taken adequately into account by their being represented in the “college of supervisors”, leading to dialogue between supervisors.

In order to avoid competitive distortions, the lead supervisor concept would have to be applied by all member states. To ensure this, a legislative basis – most probably an EU regulation (directly applicable in all member states) – would have to be creat­ed, said the EFR.

The national central bank corresponding to the nationality of the lead supervisor would be the responsible lender of last resort and would ultimately take the decision on whether to activate the function or not.

The EFR recommend a gradually converging model of deposit insurance schemes, aimed at levelling the playing field without imposing additional burdens on the financial industry.

The EFR presented its criteria to evaluate any supervisory structure (page 10).


Slowly these (half-)measures seem to inch their way towards political and legislative decisions.

Ralf Grahn