European Banking Integration: Don't put the Cart before the Horse

Abstract

This paper reviews the progress in European banking integration over the last twenty years, and evaluates the current system of banking supervision and deposit insurance based on home country control. The public policy implications to draw from the paper are threefold: First, after a relatively slow start, European banking integration is gaining momentum, in terms of cross-border flows, market share of foreign banks in several domestic markets, and cross-border M&As of significant size. If this trend continues, the issue of adequate supervision and safety nets in an integrated European banking market will become even more pressing. Second, although until recently banks have relied mostly on subsidiary structures to go cross-border, this is changing with the recent creation of the European company statute, which facilitates cross-border branch banking. A review of the case of the Scandinavian bank, Nordea Bank AB, helps to understand some remaining barriers to integration, and the supervisory issues raised by branch banking. Third, it is argued that the principle of home country supervision is unlikely to be adequate in the future for large international banks. Because the closure of an international bank would be likely to have cross-border spillovers, and because some small European countries might be unable to finance the bail-out of their very large banks, centralization, or at least Europe-wide coordination, of the decision to close or bail-out international banks is needed. This raises the issue of European funding of bail-out costs, European banking supervision, and European deposit insurance.