Common Banking Supervision in the Eurozone: Strengths and Weaknesses

In this paper we analyse various instances of supervisory centralization either implemented or proposed in Europe in the aftermath of the financial crisis and the sovereign debt crisis. Our central thesis is that supervisory fragmentation is a cause of systemic risk, as cooperation amongst national authorities is bound to fail in crisis situations, while the absence of common resolution mechanisms and common deposit guarantee schemes aggravates the costs of a banking crisis and increases the chances of a bailout. We argue, in particular, that the current European supervisory architecture introduced in 2010 substantially belongs to the model of ?enhanced? cooperation, despite including elements of the other two models of supervisory centralization (lead supervisor and single supervisor), and is the outcome of a political compromise. Presently, European supervisory authorities, including EBA, coordinate the national ones, rather than supervising financial firms directly. National authorities cooperate in a network (the ESFS) under local mandates and are therefore prone to domestic biases, particularly in crisis situations. The situation will be different under the Banking Union when the Single Supervisory Mechanism (SSM) is in place. We argue, however, that the SSM includes elements of cooperation and delegation, which will help the ECB to perform its tasks as a central supervisor, but will also give rise to conflicts of interest and information asymmetries. Moreover, the SSM will be limited to the eurozone, so that the enhanced cooperation and lead supervisor?s models will nevertheless apply in the relationships with other countries. The ECB will also have to cooperate with EBA that will keep its regulatory and mediation tasks, as already provided by the 2010 reforms. As a result, cross-border banking groups will often be subject to substantial supervisory fragmentation. The seriousness of these weaknesses could be tempered by an extension of the Banking Union to a sufficient number of non-euro countries under the regime of close cooperation. However, we show that the incentives for these countries to opt into a similar regime are modest and that there could be greater incentives to stay out of the SSM and exploit the voting power of non-euro countries within the EBA?s Supervisory Board.