European banking union will be no friend of vibrant financial services

Wolfgang Schäuble, the German finance minister, recently said that “we can only achieve political union if we have a crisis”. His idea is to exploit the Eurozone’s sovereign debt problems to confer additional powers on the EU. And his most recent project is the “single supervisory mechanism” – otherwise known as banking union. EU finance ministers are meeting this week to thrash out the details.

The argument goes that, if Europe directly finances the recapitalisation of Greek and Spanish banks, these institutions should fall under the supervision of a single authority. Schäuble asserts that national regulators lack the incentive to be strict, and that a European supervisor is needed to prevent moral hazard. But he is wrong, and the UK is wrong to be sympathetic.

Firstly, the incentive to be strict depends almost entirely on the price of bail-out loans. A lender of last resort ought to lend at a penalty. The problem here is not national regulators but the European Stability Mechanism (ESM) – the body meant to provide financial stability in Europe. If the ESM charged punitive rates of interest, instead of subsidising loans, moral hazard would disappear.

Secondly, proponents of banking union suggest that national bank supervision creates a vicious circle due to regulatory capture. According to this story, banks persuade regulators to be lax in exchange for promising to buy government bonds at low interest rates. When a banking crisis causes a budgetary crisis, therefore, the collapse of bond prices feeds back to bank balance sheets, thus aggravating the banking crisis. European bank supervision, it is said, would prevent regulatory capture and interrupt this cycle.

But this justification is also unconvincing. The budgetary problems of most southern Eurozone countries were not caused by a need to support banking. Greece, Portugal and Italy did not have to bail out banks during the financial crisis. Moreover, regulatory capture may be stronger on a European level. By shifting lobbying upwards, interest groups can escape the attention of voters – their rivals in influencing policy. One recent study concluded that “the EU is now more lobbying-oriented than any single European country.”

Professor Roland Vaubel is the author of The European Institutions as an Interest Group.

Originally published in City AM. Read the full article here.

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