By Jim Brunsden, Jeff Black and Rebecca Christie - Jul 25, 2012 2:01 AM GMT+0400
Europe’s quest to sever the link between Spain’s fiscal fate and its failing banks hinges on an obstacle-strewn race to hand greater powers to the European Central Bank.
Until euro-area leaders overcome German doubts, ECB concerns, and turf battles everywhere, Spain will remain on the hook for a bailout of its banks of as much as 100 billion euros ($121 billion). Policy makers want to protect taxpayers from losses so potentially big they risk bankrupting governments, as happened in Ireland and Iceland.
The European Central Bank headquarters in Frankfurt,. Photographer: Hannelore Foerster/Bloomberge
July 24 (Bloomberg) -- Steven Major, head of fixed-income research st HSBC Holdings Plc, talks about European fixed-income strategy, contagion risks, and the outlook for Spain and Greece. He speaks with Manus Cranny on Bloomberg Television's "Last Word." (Source: Bloomberg)
Adair Turner, chairman of the U.K. Financial Services Authority (FSA). Photographer: Jason Alden/Bloomberg
“We have got to cut the fatal loop between sovereigns and banks, which will otherwise bring the euro-zone project as it exists now down,” Adair Turner, chairman of the U.K. Financial Services Authority, said in a London speech yesterday. The euro area needs “rapid progress” towards a central fund that can directly recapitalize banks, he said.
Officials are working against a self-imposed September deadline to thrash out plans that would hand oversight of lenders to the ECB as the first step in a campaign to break a cycle of banks and sovereigns fuelling each others’ debt woes. Spain’s role as middleman in the bank bailout has helped send its borrowing costs to euro-era record, with its 10-year yield above 7.5 percent. Germany’s is about 1.2 percent.
“The day a Spanish bank can put a big fat sign in its window that says ’regulated by the ECB,’ the risk of deposit flight declines,” Erik Nielsen, global chief economist at UniCredit Bank AG in London.
EU Commitments
European Union taxpayers have provided 4.5 trillion euros in capital injections, guarantees and other forms of support to their lenders since the 2008 collapse of Lehman Brothers Holding Inc., contributing to the weakening of public finances.
In drafting the measures, the European Commission is navigating demands from the ECB that the plans mustn’t meddle with its independence, and competing calls from lawmakers that with greater power should come greater central bank accountability. At the same time, the ECB is being prodded to take on a bigger role because of its duty to support the euro.
A plan to move toward a banking union won support from EU leaders at a June 28-29 summit when they pledged to allow the European Stability Mechanism, the euro area’s firewall, to lend directly to banks once nations have deepened supervisory ties. The initiative ignited debate in Germany, with some politicians and banks warning they amount to backdoor pooling of debt that will remove pressure on profligate nations.
German Taxpayers
Germany’s savings banks last month said setting up a deposit guarantee program would create “a situation in which German savers could be liable for saving foreign banks.” Similarly, lawmakers in Berlin have demanded assurances that their contribution to Spain’s banks will be channelled through the Spanish government and will not pass directly to lenders.
Plans for centralized bank oversight go to the heart of a split among EU nations. French President Francois Hollande, Italian Prime Minister Mario Monti and Spain’s Prime MinisterMariano Rajoy are pressing for sharing of liabilities against resistance from Germany, the Netherlands and Finland. Britain has no interest in participating.
Drafting the plan has fallen to the commission, the 27- nation EU’s executive arm. According toMichel Barnier, the EU’s financial-services chief, officials are working on a text that would make the ECB the supervisor for all banks in the euro area, as well as in other participating EU countries.
Bank Supervisors
This has left the commission seeking to define a slimmed- down role for national authorities. It is also assessing how far it can dictate what tasks the ECB delegates to the local level, and what role should be played by the European Banking Authority, a London-based independent agency that coordinates the work of national regulators and settles their disputes.
A supervisory system with the ECB at its center would still have to rely on work done by national supervisors, Draghi told European Parliament lawmakers on July 9.
Barnier told lawmakers this month that the commission is working on the division of labor, including how the plan for a supervisor will fit in with other parts of a banking union advocated by the EU and International Monetary Fund.
“It’s quite worrying that the direct recapitalization of euro-zone banks hinges on what is likely to be a messy and drawn-out process in establishing a pan-European banking supervisor,” Nicholas Spiro of Spiro Sovereign Strategy in London said in an e-mail.
‘Biggest Loser’
“Spain could end up being the biggest loser from any delays given that the bail-out loans will remain on the state’s increasingly weak balance sheet until the regulator is up and running,” Spiro said.
The commission intends to present plans for the other elements of the banking union, including the setting up of a central authority in the euro area to handle failing lenders, once it delivers the supervisory proposals.
A separation of responsibilities could allow the ECB to provide short-term liquidity support to banks, while governments would take final decisions on winding down failing lenders. This role could be played by the ESM, whose activation is on hold pending a German court ruling in September, or some other collaboration among euro members.
The ECB can become a banking supervisor yet shouldn’t play the role of a bank resolution authority with access to public funds, Jean Pisani-Ferry, director of research group Bruegel, said in a telephone interview.
“Whatever has fiscal dimensions is not the responsibility of the central bank,” Pisani-Ferry said. “Distributing losses is not something an unelected body can do.”
IMF’s Call
The IMF last week called for an “urgent” transition to centralized supervision in the euro area because national regulators have incentives to bury problems at banks they oversee. The ECB in turn has said that safeguards must be put in place to prevent it being affected by such interests, notably in its setting of interest rates.
Authorities need to find “exactly the arrangement that preserves independence of monetary policy, doesn’t create any conflict of interest and at the same time enforces an effective supervisory mechanism,” Draghi said during his hearing with lawmakers. “If these conditions are not in place then forget about new powers.”
The ECB is also facing an increase in scrutiny from lawmakers, and potentially challenges against its decisions in the European courts.
U.K. Challenge
The U.K. last year became the first EU government to take the ECB to the European Court of Justice, complaining that the bank’s policy of refusing liquidity support to clearinghouses based outside the euro area was illegal.
The number of such cases may increase if the ECB begins taking supervisory decisions, which can be open to judicial challenge.
“To say that the task ahead is complex is probably the understatement of the year,” ECB Executive Board member Joerg Asmussen said in a speech in Brussels on July 17. “We have to get it right.”
To contact the reporters on this story: Jim Brunsden in Brussels at jbrunsden@bloomberg.net;
Jeff Black in Frankfurt at jblack25@bloomberg.net;
Rebecca Christie in Brussels atrchristie4@bloomberg.net
To contact the editors responsible for this story: James Hertling at jhertling@bloomberg.net;
Anthony Aarons at aaarons@bloomberg.net; Craig Stirling at cstirling1@bloomberg.net
