An agreement on a single supervisory mechanism is scheduled to be agreed by the end of this year with legislation due to be put in place before the European Parliament breaks up for elections next year, according to Frank Smets, director general of research at the ECB.
However, there is still differences between EU leaders on who ultimately bears the responsibility for winding down a bank. The ECB and Commission as well as France, Italy and Spain, want a common resolution fund in order to backstop the losses of a failing bank.
However, Germany is insisting that national governments should take responsibility for banks within their borders.
Mr Smets was in Dublin speaking at the Institute of International and European Affairs (IIEA).
Under the Maastricht Treaty criteria, the focus of monetary union was too narrow, he said.
In the period up to 2006, there was a huge credit boom, which saw spreads between member states narrow to historically low levels. This, in turn, caused countries, mainly in the eurozone periphery, to lose competitiveness.
The resulting financial meltdown led to banking fragmentation. Only a functioning banking union with a single supervisory mechanism, a single resolution fund and a harmonised deposit insurance scheme can reverse this fragmentation, said Mr Smets.
The biggest challenges facing a banking union was to break the “doom loop” between sovereigns and banking and remove the national bias in bank supervision which results in the under-provisioning for bad loans, attempts to ring-fence liquidity and an overinvestment in government debt.
The most systemically important 130 of the eurozone’s 6,000 banks will have to undergo rigorous stress tests before the ECB takes over responsibility for supervision in Nov 2014.
This comprehensive review of the banking system will take place in three parts. Firstly, there will be a risk assessment of liquidity, leverage and funding. Then, there will be an asset quality review, which will look at collateral values, non-performing loans, asset valuations and market exposures. The stress tests will then look at shock absorption capacities.
Banks with balance sheets over €30bn and/or the three most systemically important banks in any country will be directly supervised by Frankfurt. This means that Bank of Ireland, AIB and Bank of Ireland will be supervised by the ECB.
But some macro-prudential competencies will stay with national supervisors, including loan to value ratios and counter cyclical capital buffers.
However, central banks will have to get agreement from the ECB before they can finalise counter-cyclical capital buffers, said Mr Smets.
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