It is often noted that Europe's banking union is incomplete, involving a single supervisor but without an adequate single resolution mechanism or central deposit insurance arrangement. However, what, exactly, that “half union” is and how, precisely, the union is taking shape is usually described only in the vaguest terms. This was not the case in Nicolas Veron's (Senior Fellow at Bruegel; Visiting Fellow at the Peterson Institute, Washington DC) exploration of the question Max Watson invited him to PEFM to explore: namely, "Banking Union: Will the ECB's Assessment do the trick?" It is difficult in this short blog to give expression to the mastery with which Veron talked through the complex details of the banking union, its strengths and weaknesses, its present scope and the likely developments downstream. However, it would be an abdication of responsibility not to attempt to give some sense of the fundamental and fascinating trends Veron observed.
Veron began by pointing out that the object of the banking union is to mitigate the forces of banking nationalism, to provide a basis on which Europe can triage banks into survivors, salvageable patients and zombies that need to be killed, and to offer part of the solution to structural instabilities of the single currency. Veron was careful to note that we are still in the early days. The creation of the banking union is no simple administrative task and it will take time to assess how effective the ECB can be within the context of its newly acquired powers. What can be said with more confidence according to Veron is that a Rubicon has been crossed. The banking union will permanently change the European financial system.
Turning to what has been achieved so far, Veron's starting point was that, although a half-union, the banking union is a significant step and it has got going reasonably well. The single supervisory mechanism, among other things, has been founded on a strong legal basis, has recruited effectively, and its work to date has progressed rapidly, albeit with the enabling (and inevitably transient) environment of benign market conditions. This progress was not something Veron had fully expected and it has provided him with some cause for cautious optimism.
Veron also alerted his audience to some of the dangers of the banking union. In particular, as in any regulatory set-up, he noted that the risk of forbearance. There are already some worrying trends in this regard. The object of producing a fully comparable supervisory risk assessment as part of the ECB’s broader review in 2014 has been dropped for technical and political reasons. Veron also highlighted tensions between the use of asset quality review (AQR) and stress tests. The ECB faces resource constraints and political pressures which will push it towards emphasizing the latter, whilst the AQR would provide a more comprehensive and equitable basis for assessing the health of banks across the diverse Eurozone economies. There are other unforeseen problems in implementation, including the manner in which test results are communicated to the markets and the mechanics of actually restructuring banks in light of domestic laws regarding "bail-in" and EU state aid restrictions. There are also issues around the limited perimeter the ECB's current mandate.
Turning to what has been achieved so far, Veron's starting point was that, although a half-union, the banking union is a significant step and it has got going reasonably well. The single supervisory mechanism, among other things, has been founded on a strong legal basis, has recruited effectively, and its work to date has progressed rapidly, albeit with the enabling (and inevitably transient) environment of benign market conditions. This progress was not something Veron had fully expected and it has provided him with some cause for cautious optimism.
Veron also alerted his audience to some of the dangers of the banking union. In particular, as in any regulatory set-up, he noted that the risk of forbearance. There are already some worrying trends in this regard. The object of producing a fully comparable supervisory risk assessment as part of the ECB’s broader review in 2014 has been dropped for technical and political reasons. Veron also highlighted tensions between the use of asset quality review (AQR) and stress tests. The ECB faces resource constraints and political pressures which will push it towards emphasizing the latter, whilst the AQR would provide a more comprehensive and equitable basis for assessing the health of banks across the diverse Eurozone economies. There are other unforeseen problems in implementation, including the manner in which test results are communicated to the markets and the mechanics of actually restructuring banks in light of domestic laws regarding "bail-in" and EU state aid restrictions. There are also issues around the limited perimeter the ECB's current mandate.
Turning to the consequences of the banking union, Veron highlighted the very wide-ranging positive implications of the move. In addition to the prospect of better supervision, there are auxiliary benefits, such as more financial integration, less financial repression, and a new financial geography for Europe. Yet the consequences were not described in terms of unclouded optimism. There are new tensions in the EU's constitutional structure, the dangers of a one-size-fits-all approach, the problem of a "reverse legacy risk" (with national taxpayers potentially on the hook for EU-level supervisory errors), and clear constraints arising from the fact that this is only a half-union.
In a familiar fashion, the discussion that followed split the optimists and the pessimists in the room. Veron was manifestly not describing a self-enforcing equilibrium. On the contrary, he was open about the fact that the banking union had opened a Pandora's box of future institutional challenges. The half-union still looked like an oxymoron to some, even after its details had been elaborated. There were also question marks about the capacity of the banking union to really patch-up the structural flaws in the Euro-zone and the latent political problems facing the continent. Veron was, of course, fully cognisant of the wider issues, regarding the fiscal framework in Europe (on both the revenue and expenditure side), the deep rooted political challenges facing the European project and so on. Perhaps more enlightening was that the questioning drew out Veron's case for why the integration of supervision is more transformative than people often realise. The reason given was that cutting the ties of exclusively national supervision will begin to sever the links between national supervisors and their domestic financial constituencies, creating new supranational relations and a new political economy of financial regulation.
The discussion also naturally pushed Veron to engage in the art/science of prediction for the Eurozone. Veron's reluctance to respond to these prompts with any precise forecasts was revealing, not only in substantive terms, but also as a reflection of the ancient axiom that "Those who have knowledge, don't predict. Those who predict, don't have knowledge."
In a familiar fashion, the discussion that followed split the optimists and the pessimists in the room. Veron was manifestly not describing a self-enforcing equilibrium. On the contrary, he was open about the fact that the banking union had opened a Pandora's box of future institutional challenges. The half-union still looked like an oxymoron to some, even after its details had been elaborated. There were also question marks about the capacity of the banking union to really patch-up the structural flaws in the Euro-zone and the latent political problems facing the continent. Veron was, of course, fully cognisant of the wider issues, regarding the fiscal framework in Europe (on both the revenue and expenditure side), the deep rooted political challenges facing the European project and so on. Perhaps more enlightening was that the questioning drew out Veron's case for why the integration of supervision is more transformative than people often realise. The reason given was that cutting the ties of exclusively national supervision will begin to sever the links between national supervisors and their domestic financial constituencies, creating new supranational relations and a new political economy of financial regulation.
The discussion also naturally pushed Veron to engage in the art/science of prediction for the Eurozone. Veron's reluctance to respond to these prompts with any precise forecasts was revealing, not only in substantive terms, but also as a reflection of the ancient axiom that "Those who have knowledge, don't predict. Those who predict, don't have knowledge."
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