There is some sense in the EU’s new plans to change the way in which banks are regulated. In particular, there are two major problems with the current system of regulation in the EU. Firstly, insured depositors are treated the same way as other creditors. This makes it much more difficult to manage the failure of a bank. We saw in the case of Ireland and the UK that all providers of capital to a bank (except shareholders) were treated in exactly the same way as depositors and saw very little writing down of their capital. Secondly, there is a disconnect between deposit insurance systems, regulatory oversight and central banks. We saw this problem in the case of the failure of the Icelandic banks: nobody was sure who was insuring whose deposits and our own government ended up using anti-terrorist legislation, quite inappropriately, to try to extract assets from the failed Icelandic banks. These co-ordination problems are even worse in the eurozone countries given that the ECB effectively has to make judgements about whether to provide lender of last resort facilities to the banking systems of different countries without having the knowledge about the solvency of the different countries’ banking systems.
However, it is difficult to be optimistic that the EU’s plans will be an improvement. We will probably end up with more regulation and more bureaucratic regulation. The EU will simply not accept that if we can have banks fail safely, we need to regulate them less and not more. Regulation will also become fossilised and difficult to change. Unfortunately, regulation at the international level failed in the crisis and the slowness with which the EU has moved with regard to these proposals shows that reaching agreement about matters to do with financial regulation across 27 countries is more-or-less impossible unless enormous powers are given to an unaccountable bureaucratic body. Proposals such as those that have been made by the EU were made by British think tanks, including the IEA, within a year of the financial crisis starting. Four years on, the EU is eventually thinking about action.
The solution is to move to ‘less Europe’ and not ‘more Europe’. Both deposit insurance systems and regulation should be matters for member countries. However, the idea of a common European passport allowing banks to transact business across the European Economic Area without establishing subsidiaries should be ditched. Countries could still agree common arrangements between themselves – there could be a Dutch, German, Belgian, Luxembourg banking union, for example – but these things should not be imposed at the EU level.
Certainly, there would be costs of this approach. However, the result would be a more stable banking system and a banking system where those countries that wished to remain free of EU bureaucracy could do so. Different approaches to deposit insurance and regulation could be developed and the best could be copied by other countries. The alternative is dirigisme by stealth.
This article was first published by Public Finance.