The European Single Supervisory Mechanism

Euro Area banks need credible financial backstops. The European Stability Mechanism (ESM) could contribute to the performance of this function but the direct recapitalization of Euro Area banks from this source has been made conditional upon common, high quality prudential supervision. Centralised supervision of the banking sector in the Euro Area is intended to be accomplished through the Single Supervisory Mechanism (SSM), the first step towards a future banking union.

Within the SSM, the ultimate authority and responsibility for specific supervisory tasks related to the safety and stability of all Euro Area banks will sit with the European Central Bank (ECB). This approach has been driven by pragmatism and realpolitik, rather than abstract principle: the Treaty on the Functioning of the European Union (TFEU) already caters for the possibility of the ECB conducting supervisory tasks with respect to banks, while in the post-crisis reforms central bank direct involvement in prudential supervision has come back strongly into favour. But just because it was the best option realistically available does not mean that equipping the ECB with the legal authority to act as a prudential supervisor has been a straightforward task. Any evaluation of this new system must take careful account of the boundaries of the legal space within which institutional progress was possible, and give credit for the legal ingenuity deployed. Nevertheless, compromises in certain areas and unresolved tensions in others provide reasons for unease as to the likely effectiveness of the new system.

This article therefore explores the significant legal issues presented by the establishment of the SSM. The article begins by examining the role of the ECB as prudential supervisor, including its scope and powers, and its interaction with national supervisory authorities. While the details of the exact scope of the ECB’s remit were refined during the legislative process and practical issues remain to be resolved, it appears that ECB will principally have direct supervisory powers primarily over “significant” banks, with “less significant” banks remaining under the oversight of national authorities. But the allocation of tasks between the ECB and national supervisors gives rise to concerns. The ECB’s mandate is limited to banks, whereas other financial institutions will remain under national supervision. Further, the allocation of tasks is not always clear: in some areas, national supervisors have powers even over “significant” banks, and the ECB has direct supervisory powers over “less significant” banks. In practice, the ECB may have (at least at the beginning) to place significant reliance on national authorities for the execution of its tasks. Finally, drawing a clear line between supervision (an SSM competence) and bank resolution (a national competence) is a challenging task, and the fact that the SSM will not (at least at the start) be underpinned by a Single Resolution Mechanism could be a significant weakness.

The article subsequently examines the ECB’s internal governance, independence and accountability arrangements. The details of the governance arrangements for the ECB are potentially troubling: while a separate body (the Supervisory Board) is created for supervisory matters, the fact that the Governing Council retains the final decision-making power may create undue institutional complexity. It also does not fully accord with the ring-fence that should be maintained between supervision and monetary policy, and raises concerns as to the participation of non-Euro area member states which opt into the SSM (but are not represented on the ECB Governing Council). In terms of accountability, questions remain, notwithstanding that weaknesses in the initial proposal of the Commission, especially with regard to accountability at national level, more extensive transparency, and an internal review process, were improved during the legislative process.

The article also considers the implications of the SSM for the non-Euro Area Member States which opt into the SSM. Compared to the original Commission proposal, later versions of the framework place the “Pre-Ins” in a much better position. This includes rights for “Pre-Ins” to terminate the close cooperation agreement with the SSM, and to express disagreement with decisions of the Governing Council and the Supervisory Board. Nevertheless, as long as non-Euro Area Member States which opt in cannot be represented on the Governing Council, they would not be on an equal footing with Euro Area Member States participating in the SSM.

As for Member States which choose not to participate (in particular the UK), a major consideration is to avoid fragmentation of the internal market and the creation of a two-speed Europe. The EBA, which is responsible for regulatory and supervisory convergence across the entire Union could play a significant role. However, the emergence of the ECB as a powerful coordinating force in supervision could still have disturbing long-term implications for the EBA’s regulatory and supervisory role. Voting modalities within the EBA are a particularly thorny issue. On the one hand, there is the risk of participating member states “caucusing” around common policies coordinated by the ECB. On the other hand, structures intended to act as safeguards against this risk could turn a potentially small number of non-participating member states into a blocking minority.

The article concludes by attempting a first evaluation of the emerging SSM. The emergence of the ECB as a powerful supervisory force could lead more generally to an institutional shake-up, raising questions about the role of the EBA and also of the ESRB in the future EU supervisory scene. The short term challenge for the SSM will be to build up its institutional capacity. In the longer term, the SSM’s performance could be affected by its own institutional design (forged under legal constraints and political compromise) and by the arduous process of completing the single regulatory rulebook for the European Union.

The full article is available for download here.