Europe at a Crossroads: Which Path for the Banking Union?

A Preliminary analysis of coherence between European policies and the Banking Union

Written version of the Key Note Speech at the “International Academic Conference on Economics, Finance and Energy: Which Challenges in the Current Geopolitical Framework?”

  1. Introduction

Mr. Chairman,
Dear colleagues and friends,

It is a pleasure for me to accept your invitation and to have the opportunity to debate the following hot issue in the European agenda: the question of whether or not the structure of the Banking Union is consistent with the goals of the Economic and Monetary Union (EMU).

The EMU is undergoing dramatic changes due to the recent financial crisis; in particular, the answer to the instability of the financial markets is reflected in the new framework of the Banking Union and the forthcoming Capital Markets Union.

It is of utmost importance to assess whether this new step towards economic integration is coherent with the foundations of a renewed EMU.

My analysis will focus specifically on the Banking Union, active since November 2014, but the analysis could apply, to a large extent, to the Capital Markets Union process as well. I will firstly recall the dimension of Economic and Monetary Union and the rationality behind the structure of the Banking Union; and secondly, the consistency between the Banking Union and the goals of the EMU are analyzed in the second section, which identifies some possible impasse and critical areas; lastly, I will discuss conclusions and provide recommendations for policy makers and supervisors.

The Economic and Monetary Union and the “Dilemma of the Three Junctions”

There is an evident unbalance between stability, growth and social cohesion in European policies. This “dilemma of the three junctions” is at the base of the empasse currently experienced by European Authorites and Members States.

As for stability, sound budgetary policy of public finances is achieved by setting requirements (fiscal compact) fostering savings in public expenditure, mainly from structural reforms of the welfare state. This appears in contrast with the social dimension of Economic and Monetary Union (EMU): poverty reduction, financial inclusion, income distribution (social impact), and positive environmental impact, suffer from a dramatic reduction in welfare state expenditure.

As for growth in GDP, the goal of fostering investments, in times of savings in public expenditure, means that output must be financed mainly by EU funds and the private sector, both of which are also called to meet social needs.

The outlined situation stresses the role of banks, financial intermediaries and financial markets in financing real economy and the welfare state, and calls for new business models and financial architectures, mainly based on a public-private partnership.

Bank regulation and governance of the EU banking market have become of paramount importance. The above raises the question of whether the prudential regulation and new governance of the Banking Union actually improve stability (European Fiscal Compact requirements), growth in GDP (investments) and social cohesion (job creation, financial inclusion, and wealth distribution).

 2. Which degree of coherence between the Banking Union and the EMU policies?  

The main goal of the recent revolution in the new governance of the EU Banking market stems from the need to ensure a more stable banking system capable of financing the economic growth in European countries.  This objective has been achieved by finalizing the revision of prudential regulation rules applied to EU banks (mainly Crr and Crd4[i]) and by introducing a super-national governance of banking supervision in Europe based on a building block approach: the Single Supervisory Mechanism (SSM), the Single Resolution Mechanism (SRM), the Deposit Guarantee Scheme (DGS)[ii].

The above solution fits within the general framework of the European System of Financial Supervision (ESFS) implemented in 2010,  by the European Parliament and the Council, which established the European  Systemic Risk Board (ESRB) and three European Supervisory Authorities (ESAs) – the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA), together with the joint committee of the ESAs and the ESRB[iii].

The restructuring of the banking market, however, appears to be disconnected from EMU macroeconomic and social targets, as well as the constraints of the fiscal compact, being inspired mainly by the need for ensuring a renewed stability of European banks.

The actual “dilemma of the three junctions” faced by EMU can be summarized as follows: policy makers set requirements to ensure sound budgetary policies and sustainable public finances; regulators set requirements to ensure financial stability; both ask for efficient financial markets fostering growth and social cohesion.

It is then worth analyzing if: (i) the actual regulation of the banking system is capable of ensuring a stable and efficient banking market, consistent with the aim of sound public budgeting, macroeconomic goals and social cohesion; (ii) the new governance of the Banking Union can ensure stability and efficiency to the EU banking market.

3.1 The case of Regulation  

Regulation vs growth and fiscal compact

Regulation on banks, over time, has become very complex and, sometimes, contradictory. Policy makers continue to ask banks to grant credit and to foster investments, while regulators impose more stringent capital and liquidity requirements. Liquidity rules induce banks to invest in government bonds, while the European Central Bank adopts penalty mechanisms if liquidity is not used to grant credit.

At the same time, banking authorities face difficulty in applying the principle of “better regulation”, this resulting in varying amounts of impact on EU banks with major criticism for small banks and small-micro firms.

Prudential regulation rules seem at odds even with the fiscal compact requirements: higher constraints in banks’ ability to grant credit may result in less investments, and thus less chance of respecting the parameters of fiscal compact via the banking system.

The SRM seems not able to balance properly the need for a stable banking market and the fiscal compact.

The bail in approach, aimed at disconnecting the link between bank crisis and public resources is likely to produce negative effects on stability: fueling a climate of distrust among investors, discouraging the attraction of deposits, and ultimately undermining the stability of the banking system.

At the present, nobody would have difficulty in stating that a complex and contradictory system of rules has been built.

The above suggests: (i) a different equilibrium between the need for stability of financial intermediaries at micro level – as well as the stability of the banking system as a whole – on the one side, and fiscal policy on the other side; (ii) a restyling of both prudential regulation rules and budgetary requirements in order to narrow the gap between fiscal compact and regulatory parameters.

 Regulation vs social cohesion

The social dimension is part of the foundation of the EMU and, subsequent to the financial crisis, has become a priority of EU policies[iv].  The shift from “growth” to “sustainable growth” implies that an increase in GDP should be combined with complementary targets, such as social and financial inclusion, job creation, wealth distribution, consumer protection.

With this in mind, examples of “bad banking regulation”, or “missing banking regulation”, can be easily found.  The recalled “bail-in” approach applied to banking resolutions – already experienced in Italy – is producing uncertain effects, both with respect to consumer protection and the distribution of wealth.

Regarding “missing regulation”, significant examples can be found with respect to microcredit and social impact finance.

As for microcredit, it is worth recalling that the 2007 Communication of the European Commission[v] contains an invitation to Member States to create friendly environments to microcredit. As of today, despite microcredit is recognized worldwide as a powerful tool for job creation, in Europe, only few countries – among which are France, Romania and Italy – have implemented government regulation of microcredit.

In the “Guide to Social Innovation” of 2013, the Commission outlines, step by step, what the Governments should do to take the role of market building for inclusive financial markets; in 2015, the G8 Taskforce on Social Impact Investments published a set of policy recommendations useful  for building a social impact investment market[vi]. Nonetheless, very few policy makers in European countries have really understood the potential of social impact finance in solving the short-circuit between growth and fiscal compact constraints, and only the UK is carrying out concrete policies in favor of social impact finance.

Similarly, the attention paid by the European banking authorities to inclusive and social finance is at an early stage and essentially limited to the issues of consumer protection and financial education.  The regulatory issues referred to ethical finance products, social impact investments, as well as financial intermediaries operating in the field of social impact finance appear neglected, as highlighted by the EC and EESC [vii]monitoring reports analyzing the first years of activity of these young institutions.

All this, leads us to stress the need for a decisive action to improve financial education among policy makers and regulators on the issues of sustainable growth and social impact finance; this is the only way to foster new financial models compatible with both sustainable economic growth and the constraints of the fiscal compact.

3.2 The case of Governance

 Governance vs efficiency and stability

The new situation of the Banking Union is based on  this dichotomy: the need  for adopting standardized rules on one hand, and, on the other hand, the need to adapt these rules to different intermediaries across Europe, in order to ensure a level playing field among banks and national banking systems [viii]. Therein lies the issue of multitier governance: the criteria “one size fits all” can only be applied as a result of a mediation process which is strictly connected with a democratic involvement of all member States in the supervisory decisions. When standardized rules have to be applied to different entities, the same person who makes the decision also controls the fine tuning of the rules through a mediation process. For this reason it becomes fundamental that the decisions come from a democratic and transparent mediation process. Different decision processes may lead to different impacts on the national banking system, thus impacting the various banks in different member States as well. The degree of democratic accountability is crucial in ensuring a balanced economic growth among EU member States, as well as wealth distribution and equal treatment among customers and investors.

The degree of multilateralism of  the SSM governance

The Banking Union is an interesting test for the principles of multilateral governance and democratic accountability.  The SSM and the SRM are already in force and by now are already producing concrete effects on the European banking market.

As stated in the Resolution of the EU Parliament of 2013,  “…[the] Banking Union must be based on an enforced and diversified governance …”[ix]. It is then worth exploring whether the governance provided by the European legislator ensures a sufficient degree of multilateralism within the decision making process. The governance of the authorities in charge is likely to affect the democratic degree of this mediation process. The answer to our question  lies in the governance of the new SSM and in the governance of the European System of Financial Supervision (ESFS) as a whole. In the light of the above, two levels of analysis matter: a) the governance affecting the interaction between the SSM and the European Supervisory Authorities (ESAs) – in particular the European Banking Authority (EBA) and the European Systemic Risk Board (ESRB); b) the governance affecting the interaction – within the SSM – between the Joint Supervisory Teams (JST), the National Competent Authorities (NCA) and the Supervisory Board (SB).


To understand how the SSM governance works in terms of multilateralism within the ESFS, let’s have a closer look at the example of the countercyclical capital buffer that banks have to retain to protect themselves from macroeconomic risks: NCAs are in charge of establishing the amount of capital buffer independently according to ESRB indication; the ECB can ask for an additional buffer if it considers the macroeconomic risk higher than what was estimated by NCAs; the ESRB has to ensure monitoring and harmonization between Member States. Theoretically, it appears as a democratic decision process, with different stakeholders involved. But, looking at the governance of ESRB, there is a certain degree of concentration of the decision making in the hands of the ECB, due to a strong presence of ECB representatives in the ESRB: the President of the ECB holds the position of Chair of the ESRB, the First Vice-Chair of the ESRB is elected from among the members of the General Council of the ECB; President and Vice-President of the ECB are members of the General Board of the ESRB; Vice-President of the ECB and four members of the General Council of the ECB are part of the Steering Committee of the ESRB. In addition, it may be the case that the President of the Scientific Advisory will sit in the General Board of the ESRB is the ECB member in the Advisory Technical Committee of the ESRB.

JST vs NCA and SB

To understand possible criticism of the multitier governance in the mediation process of the SSM it is useful to look at the structure of the JST and at how the decision making process functions. Any JST is composed by a number of supervisors,  both representing the ECB and the NCAs, in charge of supervising a single bank of a systemic relevance; the composition of the JST is established by the ECB and it is likely to affect the decision making at two levels: on a day-to-day basis, the decisions taken by the JST are immediately effective. Long term and more structural decisions have to be valued by the Supervisory Board  which operates with a Steering Committee composed of ten members among ECB and NCA representatives. It is clear that if NCAs are strongly represented both in the JST and in the Steering Committee, even if the Steering Committee does not have any formal decision making power, there is a concrete risk that the decision making could be the result of a negotiation between ECB and these few NCAs.

Multilateral Governance and Cost of Financial Supervision

The emerging idea of implementing a funding model of the ESAs and the SSM costs based on the bail-in principle is likely to affect the multilateral governance in the medium term. The costs of supervising the EU banking system can be totally covered by the industry only if the SSM is likely to minimize double costs and overlapping of functions among the different authorities. If this is not the case, additional and overhead costs will be translated from banks to customers; moreover, this phenomenon will create disparity among clients of different banks and banking system, according to the different risk stored in the banks balance sheet. An industry-based funding model is likely to be combined with a process of concentration of the competent Authorities, affecting the governance of the overall ESFS.

4. Conclusions

The road towards a renewed EMU is not only useful but also unavoidable. Nevertheless, it is evident that the new system is dealing with a certain degree of unresolved issues, mainly due to the unfound equilibrium among the three variables of the triangle inspiring the EU policy: stability, growth and social cohesion.

With respect to the Banking Union model, it seems clear that a fine tuning of rules and governance is needed. Standardized, restricted and complicated regulation, on the one side; overlapping functions among the different authorities, the governance and the interactions among them, the costs of the entire system on the other side, are all conditions likely to affect the level playing field among banks, generating instability within the banking system, as well as frustrating consumer protection, financial inclusion and wealth distribution.

The fine tuning of bank regulation and governance in Europe shall go in tandem with a revision of the fiscal compact requirements. It is in the hands of policy makers and supervisors do so it in a timely manner.  Policy makers and supervisors have to operate jointly in rethinking the rationality behind fiscal compact and regulation. As for banking regulation, they both have to asses to what extent standardized rules “can fit all” the first appropriate mediation action is likely to be a revision of the regulatory framework. Furthermore, policy makers and supervisors have to monitor with great attention, since the very beginning, the functioning of the new SSM and SRM. For this purpose, democratic accountability mechanisms and more concrete actions in favor of investors and consumer protection, as well as of social finance are needed.

In the short term, policy makers and supervisors need to take advantage of all their financial and cultural sensitivity to ensure a fair mediation process on a daily basis; in the short term, this is the only way to minimize potential distortions of the actual framework: unless we will share a common culture, it will be the culture of any single supervisor or policy maker to determine the success of the new architecture of the EU banking market and the EMU as a whole.

[i] Reguation (EU) 575/2013 and Directive 2013/36/EU.

[ii] Regulation (EU) 468/2014 (SSM), Directive 2014/59/EU and Regulation (EU) 806/2014 (SRM), Directive 2014/49 EU (DGS).

[iii] Regulations (EU) 1092/2010, 1093/2010, 1094/2010 and 1095/2010 of 24 November 2010.

[iv] EC COM (2013) 690; EC, COM 2011 (682), Guide to Social Innovation, EC (2013); The Social Dimension of Economic and Monetary Union, EPSC (2015).

[v] EC, COM 2007 (208).

[vi] Impact Investment: the Invisible Heart of Markets (2014), available on:

[vii] EC, COM (2014) 508; EC, COM (2014) 509; EESC, ECO 373/2014.

[viii] The arguments of this section are mostly based on the speech held by the author at the Public Hearing at the European Parliament on “Institutional Aspects of the New Rules of the Economic Governance and the Role of Eurogroup”, 5 May 2015.

[ix] Resolution of the EU Parliament on constitutional problems of a multitier governance in the European Union: P7_TA (2013)0598, artt. 4 C., 38 and 40.

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