Banking on the ECB?

There is a new sheriff in town! The European Parliament voted to put the European Central Bank (ECB) in charge of eurozone banks on Thursday. Some say this will prevent failing banks from causing financial crises, though in our view, this seems a touch premature. Panaceas don’t exist. The ECB isn’t guaranteed to be any more effective than national supervisors—who weren’t responsible for recent bank failures in the first place. Still, having a single supervisor in place might shore up confidence in eurozone banking in the near term—likely a positive for investor sentiment.

With the successful vote (and pending member-state approval), European leaders got one step closer to their long-desired banking union with “a single bank supervisor, a single resolution authority and a single deposit guarantee scheme” to wind down insolvent banks. Since bank bailouts were what broke Ireland’s, Spain’s and Cyprus’s state budgets, officials believe this will prevent banks from catalyzing future sovereign bailouts.

Currently, we know who the supervisor will be (the ECB), where it has authority (the eurozone) and when it will take charge (2014). We also know its powers—at least in very broad terms. The ECB will be the sole grantor of eurozone banking licenses and will set and enforce all macro-prudential regulations—those designed to head off potential financial market bubbles or excesses—including capital buffers and other risk-weighting requirements. It will directly oversee the 150 or so largest banks, and it will work with national regulators to monitor the remaining 6,000—though it can also petition to oversee other banks directly on an ad hoc basis. For the banks under its immediate purview, it will have the power to order capital raises above the required ratios as it deems necessary to “protect financial stability.”

The ECB’s new powers have limits, too. The supervisory committee will remain accountable to the European Parliament—it must provide meeting minutes to lawmakers, and the chairperson must testify to Parliament regularly. Lawmakers will also have power to confirm—and remove—the committee chair. And member states have the final say on whether a failing bank will be shut down, restructured or rescued. Thus its scope of power—particularly to prevent bailouts—are open to interpretation and potentially quite limited.

Limited isn’t necessarily a problem—what matters more than the amount of oversight is the efficiency and transparency of the system. But efficiency and transparency aren’t guaranteed, and investors won’t gain clear insight until more specific rules and powers are codified. The new system also might not do much to decrease uncertainty over time, depending on how things take shape. With so many cooks in the kitchen and multiple get-out clauses—all in the benign name of democratic accountability—the potential for inconsistent responses in the event of future bank failures remains. (An important thing to consider five years after US officials’ erratic response to Lehman and other failures touched off the US’s financial crisis.)

Uncertainty remains on a broader scope, too. For one, some countries are resistant to too much centralized power over banks, leaving potential for the ECB’s role to change. And, though it’s largely seen as a formality, the measure still needs approval from EU governments, adding more time (and a slight pinch of extra uncertainty) to the process. Germany also maintains the European Commission’s proposal for centralized bank resolution violates EU treaties. The European Court of Justice disagreed in a preliminary ruling also issued Thursday, but the potential for further challenges and politicking remains. As does the possibility treaties will have to be amended, a slow process requiring all member states—each with their own interests and goals—to agree to all changes. In short, October 2014 seems like a rather aggressive timeline for the ECB to take over. But this isn't such a bad thing—slower progress typically reduces the likelihood of unintended consequences downstream.

What matters for now isinvestors likely see the eurozone is still moving forward, even though the urgency of immediate crisis is gone—one reasing folks are increasingly gaining conficende in the region. So while regulators and leaders still have some homework to do, between improving sentiment and economic stabilization, things are perhaps looking a bit brighter in Europe.