The Economist

Banking on a crisis?

WHILE the ECB will have more power over monetary policy than perhaps any other central bank, it has been all but shut out of another common role of central banks: bank supervision. As a result, the euro area could be ill-equipped to handle a financial crisis. Bank supervision is to be left in the hands of existing national authorities—in some cases central banks, in others a supervisory body or the finance ministry.

This decentralised structure may be a source of weakness as banks merge and become more pan-European. The integration of financial markets will make it more difficult for national supervisors to monitor and assess banks’ overall risks—and hence make it hard for anybody accurately to assess the health of the banking system.

An even bigger concern is: who will be the lender of last resort? This question would immediately arise if a big European bank—or, even worse, a group of European banks—encountered serious liquidity problems. The division of responsibility between the ECB and national central banks is left unclear in the Maastricht treaty. In future, however, national central banks will be unable, without the ECB’s authority, to provide liquidity on an unlimited basis.

The International Monetary Fund recently gave warning that in the early years of monetary union there may be a tendency for systemic financial risks to increase temporarily. As new pan-European markets emerge, the growth of cross-border unsecured interbank lending could increase the risk of international as opposed to domestic financial crises. And given that European banks have been by far the heaviest lenders to the emerging economies in Asia, Latin America and Russia, it may not be that long before the banking system is put to the test.

The current set-up looks unsatisfactory. The ECB should be recognised as lender of last resort. It could also be given central responsibility for financial-sector supervision—or else an independent euro-wide bank regulator may be needed.