The crisis-based EU financial regulatory intervention: Are we on the top of the prudential wave?[1]

Christos Vl. Gortsos

Professor of International Economic Law, Panteion University of Athens

Visiting Professor, Europa-Institut, Universität des Saarlandes, and Law Faculty, National and Kapodistrian University of Athens

(professor.gortsos@gmail.com)

Abstract

The new EU framework pertaining to financial regulation, supervision and oversight is a ‘child of crisis’ and, to be more precise, two crises: the recent (2007-2009) international financial crisis, and the current fiscal crisis in the euro area, which erupted in 2010. It addresses most of the causes of these crises by introducing a set of extensive rules aimed at three primary goals: enhancement of financial stability, of market efficiency, transparency and integrity, and of consumer protection. It has also established two pan-European mechanisms for the micro-prudential supervision and resolution of (at least) systemically important credit institutions and investment firms, within the framework of the European Banking Union.

Within this context, the present article focuses mainly on the new aspects of EU banking regulation and supervision.

Keywords

· banking regulation and supervision

· financial stability

· European Banking Union

· Single Supervisory Mechanism

· Single Resolution Mechanism

· European Capital Markets Union

1. The new regulatory and supervisory framework: a general overview

1.1 A new legislative process

Since 2008, several legal acts have been adopted by EU financial regulators (i.e. mainly the European Parliament, the ECOFIN Council, the European Commission and to a certain extent also the European Central Bank (‘ECB’)), which reshaped the regulatory and supervisory framework pertaining to the EU financial system. The legislative process for adopting such acts has also been improved. This is due to two factors.

(a) The first is the amendment to the Treaties through the Lisbon Treaty. According to Article 289 of the Treaty on the Functioning of the European Union (TFEU), in force since 2009, the European Commission maintains the right of initiative for proposing legislative acts (the acts formerly called ‘basic legal acts’), while the European Parliament and the Council have the main political responsibility to adopt Regulations (which are directly applicable) and Directives (which need to be transposed into national legislation).

The new Article 290 TFEU introduced the instrument of delegated acts, which may be adopted by the Commission without following the ‘Comitology procedure’ (still necessary only for the implementing acts under Article 291 TFEU, according to the provisions of Regulation (EU) No 182/2011 of the European Parliament and of the Council “laying down the rules and general principles concerning mechanisms for control by Member States of the Commission’s exercise of implementing powers”^[2]). This Article provides that a legislative act of the European Parliament and of the Council may delegate to the Commission the power to adopt such acts, including ex ante and ex post restrictions on this delegation.^[3]

Particularly as regards the provisions of European financial law, in Declaration No 39 annexed to the Treaties, the Commission states its intention:

“to continue to consult experts appointed by the Member States in the preparation of draft delegated acts in the financial services area, in accordance with its established practice.”

(b) The second factor is the adoption, on 24 November 2010, by the European Parliament and the Council of three (3) Regulations establishing the three ‘European Supervisory Authorities’ with a view to strengthening the efficiency of micro-prudential financial supervision in the EU:

· the European Banking Authority (‘ΕΒA’) under Regulation (EU) No 1093/2010 of the European Parliament and of the Council of 24 November 2010 “establishing a European Supervisory Authority (European Banking Authority)(...)”,^[4]

· the European Insurance and Occupational Pensions Authority (‘EIOPA’) under Regulation (EU) No 1094/2010 “establishing a European Supervisory Authority (European Insurance and Occupational Pensions Authority)(...)”,^[5] and

· the European Securities and Markets Authority (‘ESMA’) under Regulation (EU) No 1095/2010 “establishing a European Supervisory Authority (European Securities and Markets Authority)(...)”.^[6]

These three Authorities, a by-product of the 2009 de Larosière Report,^[7] are mainly regulatory authorities with some specifically designated supervisory powers.^[8] They succeeded and replaced the three Committees (CEBS, CESR and CEIOPS), which were established on the basis of the 2001 Report of the Lamfalussy Committee (“Final Report of the Committee of Wise Men on the Regulation of European Securities Markets”).^[9] As a result:

· the ‘sectoral approach’ with regard to European institutional arrangements concerning the financial system’s micro-prudential supervision was maintained,^[10] and

· the creation of the ESFS did not, literally speaking, lead to the creation of supranational supervisory authorities of the financial system at EU level.

The tone is set in recital 8 of each of the establishing Regulations, which stresses the need to upgrade the role of the Lamfalussy Committees, since:

“the Union has reached the limits of what can be done within their context.”

In principle, however, financial micro-prudential supervision remained national, even though financial regulation was for the most part gradually Europeanised. Padoa-Schioppa (2004, p. 121) refers to this state of affairs as ‘European regulation with national supervision’. In the same line, Lastra (2006, p. 298) characteristically notes:

“There is an inevitable tension in the current EU structure: a national mandate in prudential supervision, combined with a single European currency and a European mandate in the completion of the single market in financial services”.

These Regulations, along with Regulation (EU) No 1092/2010 of the European Parliament and of the Council “on European Union macro-prudential oversight of the financial system and establishing a European Systemic Risk Board” (ESRB),^[11] and Regulation (EU) No 1096/2010 of the Council “conferring specific tasks upon the ECB concerning the functioning of the European Systemic Risk Board”^[12]:

· converted the proposals of the 2009 de Larosière Report into rules, and

· established the ‘European System of Financial Supervision’ (‘ESFS’), which entered into operation on 1 January 2011.^[13]

1.2 The main elements of the new regulatory and supervisory framework

In the author’s view, the legal acts adopted in order to enhance the stability of the disrupted EU financial system, market efficiency, transparency and integrity, as well as consumer protection in financial services are categorised in two groups, since they address problems relating to two different crises (even though the first partly triggered the second).

1.2.1 Regulatory responses to the recent (2007-2009) international financial crisis

(a) The first group contains a set of legal acts adopted as a regulatory response to the recent (2007-2009) international financial crisis.^[14] For the most part, regulatory measures in this set were taken over from the international financial reform agenda, mainly the work orchestrated by the Financial Stability Board (‘FSB’) and soft law rules adopted by international fora, such as:

· the Basel Committee on Banking Supervision on micro- and macro-prudential banking regulation,^[15] and

· the International Organisation of Securities Commissions (‘IOSCO’), whose work deeply influenced the full revision of EU capital markets law (which is not the subject of this article).^[16]

Pure EU interventions were rare, with the exception of Directives adopted in the field of consumer protection in financial services^[17] and the new Directive (2014/49/EU) on deposit guarantee schemes (‘DGSD’).^[18]

(b) This crisis also highlighted the need for improved transparency and monitoring not only in the traditional banking sector, but also in areas where non-bank credit activities take place, known as ‘shadow banking’.^[19] Following consultation on a Green Paper in March 2012, on 4 September 2013 the Commission adopted a Communication on “Shadow Banking – Addressing New Sources of Risk in the Financial Sector”, setting out its roadmap to limit the emergence of risks in the unregulated or less regulated financial system, particularly risks of systemic nature through the shadow banking sector’s interconnectedness with the banking system through contagion risk.^[20] On the same day, the Commission also submitted a Proposal for a Regulation of the European Parliament and of the Council “on Money Market Funds”, one of the actions recommended by the above-mentioned Communication.^[21]

(c) The issue whether banks should be allowed to provide investment services, and to what extent, has been and still remains a source of major debate:

· in some states (such as the EU member states^[22]), these services can be provided by banks unconditionally, according to the ‘universal banking system’,^[23] while

· in others limitations are put in place.^[24]

This issue re-emerged in the wake of the recent (2007-2009) international financial crisis. The United States have already enacted legislation limiting the power of banks to provide investment services, according to the provisions of the ‘Volcker Rule’, which is implemented by Title VI of the 2010 “Dodd-Frank Wall Street Reform and Consumer Protection Act”.^[25] The same applies in the United Kingdom on the basis of the ‘Vickers Report’,^[26] as well as in Belgium, France and Germany.^[27]

In the EU, in November 2011, a High-level Expert Group was set up (“High-level Expert Group on structural aspects of the EU banking sector”) in order to assess the need for structural reform of the EU banking sector, chaired by Erkki Liikanen, Governor of the Bank of Finland (hence also “Liikanen Group”). In particular, its mandate consisted in determining whether, in addition to ongoing regulatory reforms, structural reforms of EU credit institutions would strengthen financial stability and improve efficiency and consumer protection.^[28]

On the basis of the Report submitted by the Liikanen Group,^[29] on 29 January 2014, the European Commission adopted a Proposal for a Regulation “on reporting and transparency of securities financing transactions” to:

· prevent the largest credit institutions from engaging in proprietary trading, and

· give supervisors the power to require those credit institutions to separate other risky trading activities from their deposit-taking business.^[30]

1.2.1 Regulatory responses to the current fiscal crisis in the euro area

The second group contains legal acts adopted as a regulatory reaction to the current fiscal crisis in the euro area, which became manifest in 2010.^[31] In particular:

(a) The main by-product of this response, as regards financial law,^[32] was the establishment of the European Banking Union (‘EBU’), and, in particular, of:

· the Single Supervisory Mechanism (‘SSM’),^[33]

· the Single Resolution Mechanism (‘SRM’),^[34] and

· the Single Resolution Fund (‘SRF’).^[35]

On the other hand, the ‘single market’ element of the EBU, notably the new Capital Requirements Directive (‘CRD IV’),^[36] the Capital Requirements Regulation (‘CRR’),^[37] the Bank Recovery and Resolution Directive (‘BRRD’)^[38] and the DGSD, is a by-product of the recent international financial crisis.^[39]

For an overview of the legal acts pertaining to the EBU, see below Table 1.

The creation of the ‘EBU’ is a very ambitious political initiative, which was tabled at the Euro Area Summit of 29 June 2012, amidst the current fiscal crisis in the euro area. The main rationale behind this initiative is summarised in the following sentence of the Summit’s Statement:

“We affirm that it is imperative to break the vicious circle between banks and sovereigns.”^[40]

(b) A related issue was whether the recapitalisation of credit institutions faced with insolvency (albeit viable according to the evaluation of supervisory authorities) could be assigned directly to the European Stability Mechanism (the ‘ESM’), thus curbing the public debt of Member States in which such credit institutions are incorporated. The ESM, based on an Intergovernmental Treaty signed by the nineteen (19) euro area Member States, is a successor to the European Financial Stability Facility (‘EFSF’),^[41] and is fully operative since 8 October 2012.^[42] Its current legal basis is (the new) Article 136, paragraph 3 TFEU.^[43]

(i) Under the regime in place until December 2014, the ESM could provide financial assistance to euro area Member States for the purpose of bank recapitalisation, albeit only indirectly. However, such assistance increases the Member States’ public debt.

(ii) On 10 June 2014, the euro area Member States reached a preliminary agreement on a new instrument, the ESM ‘Direct Recapitalisation Instrument’ (the ‘DRI’). This instrument became fully operational on 8 December 2014, after the completion of the necessary national procedures by the euro area Member States, by a unanimous Resolution of the ESM Board of Governors.^[44] The aim of the DRI is the preservation of the financial stability of the euro area as a whole and of its Member States, by catering for those specific cases in which an ESM Member experiences acute difficulties with its financial sector that cannot be remedied without significantly endangering its fiscal sustainability due to a severe risk of contagion form the financial sector to the sovereign. Thus, such financial assistance must seek to remove the risk of contagion from the financial sector to the sovereign, thereby reducing the effect of a vicious circle between a fragile financial sector and a deteriorating creditworthiness of the sovereign.

1.3 The threat of over-regulation

It would necessitate a precise cost-benefit analysis of each and every single legal act adopted, as well as their actual implementation and enforcement, in order to assess adequately the overall efficiency and effectiveness of the new EU financial framework (for a brief cost-benefit analysis, see just below under 3). In principle, however, the legal framework pertaining to financial regulation, supervision and oversight is definitively more robust.

Nevertheless, the use of the term ‘over-regulation’ is not inappropriate in this case. In this respect, the following remarks deserve attention:

(a) EU financial law (mainly administrative in nature, if viewed from the perspective of national law) currently covers almost every single aspect of financial activity. More regulation, however, does not linearly lead to higher levels of financial stability, market efficiency, and consumer protection. Effective supervision and enforcement are conditions sine qua non towards that end. These have to be ensured by:

· the ECB (within the SSM),

· the national competent supervisory authorities in the fields of banking (again within the SSM), capital markets and insurance, as well as,

· to the extent they are competent for this, the EBA, the ESMA and the EIOPA.

(b) Financial actors are confronted with a heavy regulatory burden, in terms of both systems and procedures, and (any other) cost. This is a result of the overall agenda which they have to comply with. The type of business model is decisive on this. Obviously, institutions and groups operating according to the universal banking model are more heavily affected. The same applies, a fortiori, to systemically important financial firms, which are the addressees of rules specifically designated for them.

(c) The compliance costs imposed on financial actors (including the heavy cost of raising substantial amounts of own funds to meet the new capital adequacy requirements) under the new EU financial framework will inevitably have a negative impact on the pricing of the financial services they provide (mainly in lending and capital markets transactions), no matter how much of the regulatory cost will be internalised by the actors themselves (to the detriment of their shareholders in this case).

When assessing the efficiency of the reform agenda, relative compliance costs imposed on EU financial actors must also be taken into account within a globalised and highly competitive environment. Accordingly, in the presence of differences in regulatory costs between the EU and other international financial centres, a significant part of financial activity will tend to migrate outside the EU (if it has not already done so). This makes an even stronger case for enhanced international cooperation and coordination, placing it very high on the agenda of EU institutions and bodies in the context of their international discussions.

2. Resilience of the new framework

(a) Traditionally, the majority of regulatory reforms undertaken in order to address (recent and/or current) crises and problems in the financial sector are mainly backward-looking. Accordingly, new institutions and rules are usually ‘children of crisis’. The conditions that led to the establishment of the Basel Committee (in 1974), the FSB and the G20 (in 1999)^[45] and the adoption of the ‘Basel I’ and ‘Basel III’ Capital Adequacy Frameworks are only the most striking examples thereof.^[46]

In addition, it is reminded that the use of macro-prudential financial oversight was strongly advocated by international financial institutions (such as the BIS) since the beginning of the decade of 2000,^[47] but was only included in the agenda after the recent (2007-2009) international financial crisis.

(b) As already mentioned, the new EU financial framework is also the child of not one but two crises. It was adopted hastily, under enormous political pressure (reflecting a widespread loss of public confidence in the financial system, at least in some Member States). It addresses most of the causes of these crises, by introducing a set of extensive rules aimed at three (3) primary goals:

· enhancement of financial stability,

· enhancement of market efficiency, transparency and integrity, and

· enhancement of consumer protection.

It also established two pan-European mechanisms for the micro-prudential supervision of (at least) systemically important credit institutions and the resolution of credit institutions and investment firms, respectively, to assist in the achievement of these goals.

(c) To the extent that the new EU financial framework extensively regulates and thus restrains financial activity (maybe to the limits of a market economy) in order to ensure the achievement of its primary goals, it can be argued that the overall risk exposure of the EU financial system is curtailed. Nevertheless, it would be premature to judge its resilience under circumstances of new, unforeseeable crises. Apart from stress arising from inside the system (which is the main focus of the new framework), crises might also be due, indicatively, to:

· persistently negative developments in the real sector of the EU economy (which would strongly affect all sectors of the financial system),

· a generalised sovereign debt crisis (thus far averted),

· the negative spill-over effects of geopolitical developments in the region (an aspect which until recently was not taken into account), or

· from inappropriate macroeconomic (fiscal and/or monetary) policies.^[48]

(d) The flexibility enabling it to withstand a new crisis on the basis of the existing legal framework will heavily depend on the way supervisory, resolution and other designated authorities will exercise the powers conferred upon them, and the effectiveness of their cooperation. The complicated procedures that have been introduced in certain cases (most strikingly, bank resolution procedures under the SRM) raise doubts as to the effectiveness of actions to be undertaken (often within a very short period of time, e.g. resolving a bank over a week-end).

Another aspect of flexibility is the adaptability of the existing legal framework. This depends:

· firstly, on the effectiveness of the legislative process, and

· on the ability of EU financial regulators to recognise, without undue delay, imminent threats and react promptly, since recognition and reaction lags are harmful.

3. A brief cost-benefit analysis

3.1 The benefits

(a) The main comparative advantages of the new EU financial framework are the following:

· the positive signalling effect of a prompt and mainly decisive regulatory response by European institutions to the causes of the two crises,

· its adoption without an amendment to the TFEU, which would compromise the speed of reform and the flexibility to resort to an Intergovernmental Agreement (on the SRF, even with abstention of two Member States) if the TFEU did not provide the appropriate legal basis,

· its compliance with international financial standards, subject to the constraints arising from the fact that other international financial centres may not have complied with such standards, and

· its ‘unbiased approach’, in the sense that new rules have been adopted across the board, applying to all four sectors of the financial system (banking, capital markets, private insurance, and payments).

In addition, a ‘two-speed approach’ to regulation has been avoided, since the majority of the rules of the new EU financial framework, and definitely those on the single market, apply to all 28 Member States. It arises only with regard to:

· micro-prudential supervision, to the extent that the SSM Regulation applies in principle only to ‘participating’ Member States (i.e. those whose currency is the euro), and

· resolution as regards the application of the SRM and the SRF (but not of the BRRD).

(b) In the author’s view, however, the biggest achievements are two: the establishment of the SSM and the adoption of the resolution framework. In particular:

(i) The academic debate on the creation of supranational supervisory authorities for the European financial system can be basically traced back to the early 2000s (after the start of the EMU), and its prospect was even embedded in the Maastricht Treaty (Article 105, paragraph 6 TEC, currently Article 127, paragraph 6 TFEU). At a political level, this prospect was put forward, for the first time, in 2009 by the de Larosière Report, following the onset of the recent international financial crisis, only to be rejected.

It was the current fiscal crisis in the euro area which acted as a catalyst for conferring certain designated banking supervisory tasks on the ECB within the framework of the SSM. This development alleviates one of the main asymmetries of the EMU, notably that the monetary and foreign exchange policies in the euro area are conducted at supranational level, while banking supervision remained national. The crisis clearly revealed the importance of the EBU to the stability of the euro area and to the effective transmission of a single monetary policy, whose conduct within the EMU was complicated due to the fragmentation between the financial systems of euro area Member States.

(ii) The second major achievement was the adoption of the resolution framework. When one or more credit institutions are exposed to insolvency, and if a ‘private sector solution’ cannot be found, supervisors and governments face a ‘trilemma’ between the following options:

· to wind up the credit institution(s), in which case they risk negative contagion to the banking system (in the form of bank runs), and the deposit guarantee scheme must be activated, or

· to recapitalise the credit institution(s) by means of public funds, i.e. the main option during the initial phase of the crisis but subject to budgetary constraints and strong public disapproval and pressure, or

· to resolve the credit institution(s).

With the implementation by 2015 of the BRRD Member States have at their disposal, for the first time, a comprehensive set of rules (harmonised at EU level) on the recovery and resolution of credit institutions (and investment firms), which also apply to systemically important ones (the main target group). Furthermore, the establishment of the SRM (whose implementation commences in 2016) centralises key competences and resources for managing the failure of credit institutions and investment firms in the euro area and in other Member States participating in the SSM and tackles the risk of further fragmentation of the single market resulting from only national financial supervisors being in charge of resolution of national financial firms.^[49]

There are good reasons to expect that resolution will become the new norm in the context of the above trilemma.

3.2 The costs

(a) The major − though intended – drawback of the regulatory agenda is a by-product of the conditions under which it was adopted: the very short time frame. Almost none of the legal acts adopted contain a robust cost-benefit analysis of their impacts.

(b) Other comparative costs are the following:

· as a result of the rapid adoption and implementation of several legal acts simultaneously, an enormous compliance burden imposed on financial actors,

· in more detail, a need for credit institutions to raise significant amounts of new capital within a relatively short period of time, and meet the new liquidity requirements imposed on them, leading some to reconsider their business model, and

· the fact that the achievement of its three primary goals may compromise, at least in the short run, the positive contribution of the financial system (and in particular of its banking sector) to the real sector of the economy, in terms of both borrowing costs and available credit.

(c) Finally, an inconsistency problem arises to the extent that all legal acts of the new EU financial framework contain national discretions to be used either by all of the 28 Member States, when transposing EU Directives into their national legislation, and by their supervisory, resolution or other designated authorities according to specific provisions of Directives and Regulations. It is then up to the EBA, the ESMA and the EIOPA to ensure that EU financial law is implemented in a uniform manner across all Member States through its technical standards and its soft law instruments.

4. In particular: an evaluation of the SSM framework

4.1 General considerations

(a) As already mentioned, the European Banking Union (EBU) and the SSM are ‘children’ of the current fiscal crisis in the euro area, which erupted in 2010. The European Commission’s proposal for the creation of the SSM, on the basis of the political decisions taken on 29 June 2012, was tabled on 12 September 2012 and was completed in October 2013 with the adoption of the SSM Regulation of the Council, with the extensive influence of the European Parliament during the ‘trialogue’ discussions. It initiated a process that will bring about a significant breakthrough in the functioning of the banking system in the euro area, without TFEU amendment.

(b) Within this context and according to Article 1, first sub-paragraph, the SSM Regulation confers on the ECB specific tasks “concerning policies relating to the prudential supervision of credit institutions” (a passage taken over verbatim from Article 127, paragraph 6 TFEU):

· with a view to contributing to the safety and soundness of credit institutions and the stability of the financial system within the EU and each Member State, which is the objective of the ECB under the SSM Regulation, and

· fully taking account of and having the duty of caring for the unity and integrity of the internal market, based on equal treatment of credit institutions with a view to preventing regulatory arbitrage.

The micro-prudential supervision of certain (and in particular the most systemically important) credit institutions incorporated in euro area Member States was conferred on 4 November 2014 on the ECB, which is called upon to carry out the relevant specific tasks^[50] in cooperation with the national competent authorities within the SSM,^[51] along with the other tasks already conferred upon it, particularly in relation to:

· the definition and implementation of the single monetary policy in the euro area (within the framework of the ESCB),^[52] and

· the contribution to the macro-prudential oversight of the European financial system according to the provisions of Council Regulation (EU) No 1096/2010.

(c) The SSM Regulation’s framework is a substantial step for the creation of the EBU, the final stage of which includes the setting up, as already mentioned, at euro area level of:

· a Single Resolution Mechanism by 1 January 2016,

· a Single Resolution Fund for covering funding gaps, provided that a decision is made for the resolution of unviable credit institutions (and/or investment firms) by 1 January 2016 as well, and

· a single deposit guarantee scheme (still pending).

The establishment of the SSM, the SRM and the SRF constitute bold institutional novelties. Especially the creation of the SSM is a reform element, that of improved financial supervision, that was not addressed adequately during the first sub-period since 2008. It should be recalled that the 2009 de Larosière Report, which was elaborated in order to identify the causes of the recent (2007-2009) international financial crisis, highlighted weak financial supervision as a major cause.^[53]

It is worth recalling that even this Report concluded that (contrary to macro-prudential oversight) micro-prudential supervision should not be assigned to the ECB,^[54] a proposal that has been rejected with the establishment of the SSM.

However, resolution tasks remaining on a national scale, while supervision is centralised, would pose considerable risks. In this regard, the International Monetary Fund has starkly stated that:

“(…) without a strong SRM complementing the SSM, the credibility and effectiveness of the banking union would be jeopardized”.^[55]

Thus, the SRM should be viewed as supplementary to the SSM and these two components of the EBU should be considered together, as shared liability for bank resolutions requires centralised supervisory oversight.^[56] Additionally, in the field of burden sharing, which has been an essentially contested point of resistance to establish the EBU, the SRF constitutes a solid institutional response and one of the remedies against the fragmentation of the single market.

(d) The establishment of the EBU is also the driving force behind the very recent discussions pertaining to the creation of a European Capital Markets Union (‘CMU’).^[57] On 22 October 2014, during his speech at the Joint EIB-IMF High Level Workshop, Yves Mersch, member of the Executive Board of the ECB, highlighted the possible, and desirable, infrastructure of an upcoming CMU, defining it as the proper follow- up to the sea change the EBU brought to the European banking and financial markets and as an appropriate action in the struggle to restart growth in the heavily traumatized European economy, which is, currently, described as “a plane flying on one engine, the bank financing.”^[58]

4.2 A brief cost-benefit analysis

4.2.1 The benefits

In principle, the provisions of the SSM Regulation are positively evaluated by the author:

(a) The ECB’s function as supervisory authority over credit institutions in participating Member States is expected to have several positive effects. Without doubt, the ECB has the necessary expertise for discharging supervisory tasks over euro area credit institutions, particularly taking account of:

· its unquestionably successful contribution to the management of the recent international financial crisis, and

· its substantial contribution to addressing the current fiscal crisis in the euro area as well.^[59]

(b) There is no doubt that the legal acts adopted constitute a development of utmost importance to the EU internal market, and beyond. Once the authorisation and micro-prudential supervision of credit institutions incorporated in participating Member States is assigned to the ECB, government influence over credit institutions in these Member States will be significantly weaker.

The conditions under which these credit institutions will invest in domestic sovereign bonds is expected to change substantially, since their dependence on Member States’ influence (where applicable) will be kept under bounds. Weaning national banking systems from government influence could thus become an important springboard for creating institutional conditions leading to an EU fiscal union, provided the necessary political will exists.

Here, it is worth pointing out the need to amend, in due course, the provisions of the CRR, which stipulate, in relation to the calculation of capital requirements for credit risk (mainly under the Standardised Approach, still used by several credit institutions, especially the least sophisticated ones), that claims on Member State governments, if denominated in the local currency, have a zero percent (0%) risk weight.^[60]

The experience from the ‘voluntary’ haircut on Greek government bonds has proven that these provisions are now ineffective (apart from the fact that credit institutions are given perverse incentives when implementing capital adequacy rules).^[61] Greek credit institutions suffered extremely severe losses from their participation in the Private Sector Involvement (‘PSI’) as far as their holdings of Greek government bonds are concerned. On 20 April 2012, the four (4) largest Greek credit institutions (representing more than 60% of the Greek banking sector’s assets at that time) announced losses of €27.9 billion, which totally depleted their own funds and led to their recapitalisation by public funds through the Hellenic Financial Stability Fund.^[62]

(c) The ECB has been granted extensive powers in order to pursue its objectives and fulfil its tasks under the SSM Regulation. These include:

· investigatory powers, including requests for the provision of information, the conduct of general investigations and the conduct of on-site inspections,^[63]

· specific supervisory powers with regard to the authorisation of credit institutions and the assessment of acquisitions of qualifying holdings in them,^[64]

· supplementary supervisory powers,^[65] and

· the right to impose administrative sanctions.^[66]

Accordingly, mergers and acquisitions in the banking sector will be subject to approval by the ECB rather than national competent authorities. With this in mind, the European banking landscape will be shaped at supranational level in the next few decades, and, most definitely, this decade. In the author’s view, this may lead to a greater degree of concentration in the European banking system and, as a result, to a very significant decline in the number of credit institutions operating across euro area Member States.

(d) Of particular importance, from an institutional point of view, are also the SSM Regulation’s provisions with regard to the independence and accountability of the ECB as a supervisor.^[67] The Regulation reaffirms the independence of the ECB, as laid down in the TFEU and the Statute, and enhances its accountability vis-à-vis not only the EU institutions (and in particular the European Parliament on the basis of the provisions of the relevant Interinstitutional Agreement), but also the national parliaments.

4.2.2 The (potential) costs

Nevertheless, the new institutional and regulatory framework needs to be treated with some scepticism as well. There are two main reasons for this:

(a) Conferring supervisory competences over financial system participants to a monetary authority generally raises concerns of conflicts of interests, particularly putting into question the ECB’s ability, in its capacity as monetary authority, to consistently pursue its primary objective of maintaining price stability.^[68] There is no doubt that the provisions on the separation of monetary policy and banking supervision functions, a central principle of the SSM Regulation (Article 25),^[69] is a safeguard embedded into the new framework in order to avoid such conflicts and the resulting potential reputational risk for the ECB.

In that respect, it should also be taken into account that to date the ECB, as an institution, is deemed both efficient and credible by market participants by reason of its successful conduct of monetary policy. This ‘accumulated’ credibility, at least initially, should also benefit the conduct of its new supervisory tasks.

(b) One cannot preclude the (undesirable) eventuality of one or more systemically important financial institutions under ECB supervision becoming insolvent in the first few years of the ECB’s term of office as supervisory authority, which might also be attributed to a deficient performance of its duties. In such a case, the ECB’s reliability as an efficient monetary authority would be strongly called into question (not only in terms of substance, but mainly from a political point of view), with all the negative consequences that this would entail for the sustainability of the euro area.

This aspect of reputational risk is, of course, a visible risk for all central banks with statutory competence on micro-prudential supervision over credit institutions, and it is one of the main concerns as to the assignment of such competences to them. Ultimately, the onus of the efficient performance of the extensive range of tasks that have been conferred on the ECB will be on the ECB itself.

5. An assessment

In the author’s opinion, the new framework, which applies to all 28 EU Member States, with the exception of the rules on the EBU institutions (SSM, SRM, and SRF) that are confined mainly to euro area Member States,^[70] is characterised by the following:

(i) It is more robust, consistent in principle, and has curtailed the overall risk exposure of the EU financial system.

(ii) Its biggest achievements are the establishment of the Single Supervisory Mechanism (SSM) and the adoption of the resolution framework (BRRD).

(iii) Its major − though intended − drawback is the very short period of time within which it was adopted (albeit justified given the circumstances under which it was introduced).

(iv) The legislative process has definitely been improved, enabling the adoption of rules by EU institutions with a more active involvement of supervisory bodies, through the three ‘European Supervisory Authorities’ (EBA, ESMA and EIOPA), which de facto have definitely superior technical knowledge of the subject-matters.

(v) It transfers considerable powers from Member States to EU institutions and bodies, mainly within the institutional framework set by the Treaties.

(vi) It imposes substantial compliance costs on financial actors, including a heavy cost of raising more own funds to meet capital adequacy requirements.

(vii) Finally, it is also worth pointing out the following on this new framework:

· it would be premature to judge its resilience under circumstances of new, unforeseeable crises,

· the framework is too recent to be in need of immediate revision, even though developments in the relevant international agenda must be constantly kept under close watch,

· its flexibility enabling it to withstand a new crisis must be assessed both on the basis of the existing legal framework and with regard to its adaptability, and

· in the light of differences in regulatory costs between the EU and other international financial centres, the case for enhanced international cooperation and coordination is even stronger in order to avoid regulatory arbitrage.

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TABLE 1 The key legal sources of the three main pillars of the European Banking Union
	Prudential supervision and regulation of credit institutions	Resolution of non-viable credit institutions	Deposit guarantee schemes
European ‘Single Mechanisms’	Single Supervisory Mechanism: · Council Regulation (EU) No 1024/2013 (‘SSM Regulation’) · ECB Regulation (EU) No 468/2014 (‘SSM Framework Regulation’) · other ECB legal acts (see below Table 3)	Single Resolution Mechanism and Fund: · Regulation (EU) No 806/2014 of the European Parliament and of the Council (‘SRM Regulation’), and Commission delegated and implementing acts · Intergovernmental Agreement (2014) (‘SRF’)	No initiatives as yet
Harmonisation of substantive rules (‘single rulebook’)	· Regulation (EU) No 575/2013 of the European Parliament and of the Council (‘CRR’), and Commission delegated and implementing acts · Directive 2013/36/EU of the European Parliament and of the Council (‘CRD IV’), and Commission delegated and implementing acts	· Directive 2014/59/EU of the European Parliament and of the Council (‘BRRD’), and Commission delegated and implementing acts	· Directive 2014/49/EU of the European Parliament and of the Council, and a Commission delegated act

TABLE 2 Legal acts of the ECB on the Single Supervisory Mechanism (other than the ECB Framework Regulation)
Legal basis (Article of the SSM Regulation)	Subject matter	Legal act	Date of entry into force
A. Legal acts pertaining to the operation of the internal bodies established by the SSM Regulation
Article 25, paragraph 2, and Article 26, paragraph 12	Supervisory Board	Decision 2014/179/EU (ECB/2014/1)	24 January 2014
Article 26, paragraphs 1, 2 and 5	Supervisory Board	Decision 2014/427/EU (ECB/2014/4)	6 February 2014
Article 26, paragraph 12	Supervisory Board	Rules of Procedure	1 April 2014
Article 24	Administrative Board of Review	Decision 2014/360/EU (ECB/2014/16)	15 June 2014
Article 25, paragraph 5	Mediation Panel	Regulation (EU) No 673/2014	20 June 2014
B. Legal acts pertaining to other aspects of the SSM
Article 4, paragraph 3, and Article 33, paragraphs 3 and 4	‘Comprehensive assessment’	Decision 2014/123/EU (ECB/2014/3)	6 February 2014
Article 7	‘Close cooperation’	Decision (ECB/2014/5)	27 February 2014
Article 18	Sanctions	Regulation (EU) No 469 2014	15 May 2014
Article 6, paragraph 2	Provision of supervisory data to the ECB	Decision (ECB/2014/29)	19 July 2014
Article 25, paragraphs 1-3	Separation of monetary and supervisory functions	Decision (ECB/2014/39)	18 October 2014
Article 30, paragraph 2	Supervisory fees	Regulation (EU) No 1163/2014	1 November 2014