Mon, Oct 22, 2012 - Page 9 News List

The EU is banking on a flimsy legal basis to deepen union

By Howard Davies

The EU is now the proud owner of a Nobel Peace Prize. When the choice alighted on US President Barack Obama three years ago, the Norwegian Nobel Committee was criticized for honoring someone whose achievements were still to come. The committee took that criticism to heart, and this time decorated an institution with a proud past, but a clouded future.

The eurozone is distinct from the EU of course, but it is the union’s most ambitious undertaking to date and it is still struggling to equip itself with the structures needed to bolster a currency union. A common fiscal policy remains a distant dream, as does a genuine political union.

However, Europe’s policymakers claim to be making progress toward a so-called “banking union,” which means collective banking supervision, rather than a merger of banks themselves. Last month, the European Commission announced a plan to make the European Central Bank (ECB) the supervisor of all 6,000 of Europe’s banks.

The reaction among national politicians, central banks and banks themselves was not universally favorable. The Germans want the ECB to focus only on large systemic banks and leave smaller savings banks (like those that invested heavily in subprime mortgages) to national authorities. The UK and Sweden argue that they cannot be made subservient to a central bank of which they are, at best, semi-detached members.

The case for a pan-European supervisor is widely accepted, especially as the European Banking Authority (the EU’s banking regulator) proved feeble at carrying out financial stress tests: the first tests were so weak that even Spain’s now-bankrupt savings banks could pass with flying colors. Europe must break the vicious circle linking distressed sovereign borrowers with banks that are obliged, or at least encouraged, to buy their bonds, which in turn provide the funding for bank rescues.

However, the method chosen by the commission to implement a banking union is fatally flawed. Moreover, according to a leaked opinion from the EU Council’s chief legal adviser, the proposed reform is illegal, because, according to the Financial Times (which received the leak), it goes “beyond the powers permitted under law to change governance rules at the European Central Bank.”

Throughout the crisis, European leaders have tried to respond to the gaps in the monetary union without proposing a new treaty, because they fear that any new treaty proposing more centralization of authority in Brussels would be rejected, either by national parliaments or by voters in a referendum. So they have tried to proceed by intergovernmental agreement, or by using existing treaty provisions.

In the case of the banking union, they plan to use Article 127(6) of the Lisbon Treaty which allows the European Council to grant authority to the ECB to perform specific tasks concerning “policies relating to the prudential supervision” of certain financial institutions in the union. That is a thin legal basis for establishing a pan-European supervisor with direct responsibility for individual institutions and it was clearly not intended for that purpose. Indeed, Germany agreed to the wording only on the understanding that the ECB could not be a direct supervisor.

The consequences of choosing this inadequate, if expedient, route are serious. For starters, the existing treaty cannot be used to create a single European resolution authority, leaving an awkward interface between the ECB and national authorities. Nor can it be used to establish a European deposit protection scheme, which is arguably the most urgent requirement, to stem the outflow of deposits from southern European banks.

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