Banking supervision and resolution: the European dimension

Abstract

Both theory (game theory) and practice (recent financial crisis) indicate that national interests prevail in cross-border resolution. National authorities aim for the least-cost solution for domestic taxpayers. This results in an undersupply of the public good of global financial stability. International banks are increasingly run on national lines, as national supervisors force stand-alone subsidiaries to maintain separate liquidity and capital buffers in each jurisdiction. To preserve the internal market in banking, this paper proposes a supranational approach to banking supervision and resolution in Europe. The large cross-border banks would then be supervised directly by the European Banking Authority, and in case of liquidity and solvency problems, have access to the ECB and the newly proposed European Resolution Authority. The European Resolution Authority needs a fiscal backstop and a strong legal framework to be credible. The access to government funds could be based on ex ante burden sharing between participating countries. The legal regime could be provided by a new special resolution regime embedded in a EU Regulation giving powers to liquidate or resolve ailing banks in a timely and orderly manner on a EU-wide scale.