Leiden Law Blog

One supervisor to break the vicious link between sovereign debt and bank debt

Posted on by Tom Dijkhuizen in Private Law
One supervisor to break the vicious link between sovereign debt and bank debt Photo: Eric Chan

National governments and the European Union (EU) have responded decisively to the financial crisis over the recent years. Several domestic and European reform initiatives have been taken and the reform of the EU regulatory framework is nearing completion. However, in the opinion of the European Commission (Commission) these reforms will not break ‘the vicious link’ between sovereign debt and bank debt which has already cost taxpayers over €4.5 trillion in state aid measures to prevent bank failures.

This will be the case especially in the Eurozone ‘where pooled monetary responsibilities have spurred close economic and financial integration and increased the possibility of cross-border-spill-over effects in the event of bank crises’. The consequence of this integration is that mere coordination between national supervisors is no longer sufficient. A single supervisory mechanism for banking supervision is necessary to alter the (risk of) fragmentation of EU banking markets, which, in the words of the Commission, ‘significantly undermines the single market for financial services and impairs the effective transmission of monetary policy to the real economy throughout the Euro area’.

Therefore, the Commission published its proposal for a Single Supervisory Mechanism (SSM) on 12 September. This SSM, under which the European Central Bank (ECB) will have all supervisory responsibilities, will have direct oversight of all banks established in the Eurozone and cross-border banking markets. It will also enforce the prudential rules in the Eurozone in one strict and impartial way, thereby creating a Eurozone level playing field with high common standards for banking behaviour. The national supervisors will have to confer their banking supervisory power on the ECB. Noteworthy is that the ECB’s supervisory role is limited to banks established in the Eurozone, although a non-Eurozone country may elect to participate in this mechanism.

This proposal alters the current system which is essentially domestically based. In the Netherlands, the Dutch Central Bank (DNB) is exclusively competent for prudential supervision. Therefore, the DNB is the competent authority that, inter alia, licenses and authorizes or withdraws the authorization of banks and ensures banks’ compliance with the minimal capital, leverage and liquidity requirements. All these prudential supervisory competencies have to be transferred to the ECB, as the national supervisors will only remain in charge of consumer protection, the fight against money laundering and the supervision of third country banks who establish branches or provide cross-border service within a Eurozone country. With regard to the latter, the existing coordination procedures between the home state and host state supervisor will remain in place.

Although the arguments for the SSM seem to be legit, some questions remain. First, there is the problem of scope. Although the ECB will cooperate with other non-Eurozone Member States in order to promote the safety and soundness of banks in all 27 EU Member States, the possibility will remain that supervisory authorities within the EU will act differently. The other problem concerns the supervision of third country banks. If only one supervisor is capable of breaking the aforementioned vicious link, it should not show different faces to different people.

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