Nationally Fragmented Supervision Over Multinational Banks as a Source of Global Systemic Risk: A Critical Analysis of Recent EU Reforms

Abstract

The European single market supported the creation of multinational banking groups. However, the European banking directives and the single license system were built along the model of the stand-alone bank and cannot keep pace with recent market developments. The national character of prudential supervision determines at least three sets of negative consequences for cross-border banking groups: higher compliance and enforcement costs; national solutions rather than cross-border cooperation between supervisors; greater systemic risks as a consequence of coordination failures. In this paper we argue that there is a strong case for further centralization of supervision and crisis management. Recent reforms in Europe, including the creation of a European Banking Authority, move in the right direction, but they still rely too heavily on cooperation between national authorities. While (enhanced) coordination may be effective in normal times, in emergency situations national authorities tend to behave strategically and exploit information asymmetries. As shown by the recent crisis, misalignment of incentives can lead them to national bias and non-cooperative dominant strategies. We argue that early intervention measures and crisis resolution tools should be reserved to a pan-European authority. Also ongoing supervision should be centralized, so as to avoid an inefficient transfer of powers to a single resolution authority at the outset of a crisis.