European Banking Union: EUC Report

Lord Desai Excerpts

Thursday 24th January 2013 Lords Chamber

[Lord Desai]

My Lords, I, too, join other noble Lords in thanking my noble friend Lord Harrison for an excellent report. I shall not talk about either Mr Cameron or the UK but want to concentrate on the banking union. One question I want to pose is why the eurozone members thought, in the middle of the crisis, that a solution to the problem was a banking union. If you think about the financial crisis, both the US and the UK had a banking union—they were each a single banking union—but it did not prevent a collapse. Having a single banking regulatory authority, in our case the FSA, did not prevent the collapse. It is very good that structures are created but we ought to ask whether those structures actually do the job they are supposed to do.

I remember in your Lordships’ House about two years ago, or maybe more, sitting in a discussion about the European system of financial supervision. A huge structure was set up for a banking authority, an insurance and occupational pensions authority, and a securities and market authority. It is obvious that none of those things helped when the crisis came—or they certainly did not make any impact in preventing anything that happened. We are now adding another institution and, as noble Lords have pointed out, there will be problems in respect of the overlap between the EBA and the ECB.

The basic problem here is that we are only slowly understanding the nature of the euro, which, in a sense, is a private currency. It is not a national currency, such as sterling or the dollar, where Governments have more control over money creation. Euros can be created only if the ECB is approached by a commercial bank that gives collateral, sovereign debt or something else, and counterpart money is created. As the noble Lord, Lord Flight, said, it is like a gold standard but without the Californian or Australian mines suddenly adding more gold to the total supply. In particular, the strong deflationary character of the euro was understood only when the crisis started. Until then, nobody quite understood what the euro was all about. It is a currency for which there can be no democratic accountability, because the whole Maastricht treaty was designed, on the lines of the Bundesbank’s authority, to have the central bank immune from any democratic control, which was thought to be the standard of monetary responsibility.

I think the ECB is a marvellous institution—right now it is the only institution which is working at the eurozone level, and it did a splendid thing by having its outright monetary transactions authority save Spain from seizing up. However, we have to understand that we have created a currency in the eurozone which will be permanently deflationary. Unless you break the Maastricht treaty and allow the ECB to directly monetise sovereign debt, it will remain deflationary.

As far as I can see, something miraculous will happen to our competitiveness, but, by and large for the next 10 years or so, the eurozone will be stagnant. It will be more or less a 0%-to-1% growth-rate economy. Let us remember that Napoleon looked at a map and said, “There is China; there’s a sleeping giant; let it sleep”. Well, that is going to happen to the eurozone. I am not a Eurosceptic—I am a great admirer of the EU—but this is what we have constructed for ourselves. Let us remember that, in the gold standard, you could thrive only with extremely flexible labour and commodity markets; now, you cannot.

As many noble Lords know, the EU is not a genuine single market as yet and we are still waiting for the Lisbon treaty recommendations on flexible markets to be implemented. In that context, a deflationary currency has a problem. One of the problems facing the banking union, as the report quite properly points out, is that you cannot envisage the ECB looking after 6,000 banks. The ECB will look after the big players, especially those which have cross-border operations. It will be like the Premier League—I think the previous speaker said something about the Premier League council. The problem here is that you will have to be the national supervisory authority of those banks to concede power to the ECB. There will also be macroprudential problems. Those large banks will also have connections with smaller banks within their own territory, which will then be supervised by their national authorities. It is not clear that co-ordination between national authorities, which will be guarding the smaller banks, and the ECB, which will be guarding the larger banks—the hub-and-spoke idea that people are talking about—has been worked out as yet. You will therefore have to devise a set of engagement rules between the various national regulators and the ECB, because, as far as I know, the national regulators need not legally be subservient to the ECB—they may be, but they will not be. That is going to be a substantial problem.

Along the way, in a deflationary climate, there might also be mergers and consolidation. Those 6,000 banks will not remain 6,000 banks; we will probably see consolidation. I wish that we had fewer banks in Europe than we have right now, because if you have got a single currency, why do you need so many different banks? It is not clear to me how the ECB will deal with the trickier problem of the dynamics of consolidation, mergers and acquisition and still maintain its authority as a regulator.

Where the issue will finally come to a head is in whether banking union will help the recapitalisation of banks which could possibly fail. When in June 2012 the proposal was made to speed up banking union, the idea was that it would somehow make it easier to recapitalise banks. As the noble Lord, Lord Flight, pointed out, there are difficulties about that, because we lack in the eurozone a genuine pooling of risk. Governments are not willing, so far, genuinely to pool risks. They would rather that each Government look after their local failing banks and recapitalise through issuing more sovereign debt, which the market may not want to buy at any reasonable price.

If so, what happens to the larger banks which are being directly supported by the ECB? Who will bail out the larger banks? We then go back to the national rule. I do not think that Deutsche Bank will fail, but if it was about to, would that be Germany’s or the ECB’s responsibility? Would the money come from the European stability mechanism? How will that be done?

The banking union throws up a number of interesting issues. We are still in the early days. It is not at all clear to me that, having said, “Let us have a banking union”, all problems are solved. The problems of the banking union are just beginning.

As I do not want to speak for more than 10 minutes, all I can say is that I hope that the noble Lord, Lord Harrison, is there to give us the next report when things get worse—or better.