Firm Investment and Banking Union
The banking system of the euro area countries is known to be highly leveraged. In fact, it is the single most highly leveraged banking system in the world with assets equivalent to almost 90 percent of GDP of the respective countries. This huge amount of leverage is used by the banks to secure their funding and infuse it into further investments. The banks are also able to support the governments of these countries with a substantial portion of their respective currency. The result is that the euro area as a whole appears to be highly dependent on credit from the banking system.
It is this high degree of reliance on bank financing that makes it difficult for governments in the euro area countries to control their firm investment portfolios. The inability of the governments to control their firm portfolio directly through the banks results in the failure of their macroeconomic policies. A very worrying factor here is the potential for “deflationary spiral” to emerge. If the state of the banks were to lose credibility, this would have a negative effect on other sectors of the economy that are supported by fiscal policy such as investment, durable goods and tourism.
The European Central Bank may be able to address these issues more effectively through the establishment of a supervisory board, which would provide a more effective oversight over bank supervision in Europe. The proposal put forward by the European Central Bank to introduce a supervisory board that would consist of prominent bankers was rejected by the German government. The reason cited for this rejection was that the German government did not feel that the introduction of such a board would strengthen the supervision of the banks. In addition to this, the German government indicated that it would not support a Banking Union, even if it was introduced as a means to reform the banking sector. The working paper on which the European Central Bank is based suggests that there are some positive aspects that can be expected from the establishment of such a board.
The most important element associated with introducing centralised bank supervision is the creation of a supervisory body that would have the power and authority to undertake independent supervision of the banks. It is envisaged that the supervision of the banks should include not only the bank supervisors but also the Board of Directors and the Managing directors. This independent supervision will provide an additional layer of protection for the financial stability of the financial system of the country. If the supervisory body is weak in terms of capacity, the impact will be felt in the level of firm investment. Since the introduction of a supervisory body, there have been significant improvements in the supervision of the banks.
One of the important recommendations made by the European Central Bank was that the supervisory arrangements for savings and loan associations should be extended to the regionally and nationally administered banks. The introduction of a national supervisor for banks and other monetary institutions might reduce conflicts of interest between the regional managers and the national supervisors. Another aspect that is believed to be of considerable importance is the development of a local supervision of financial activities in peripheral areas. The role of the local supervisors is increasingly being taken over by the centralised supervisors. Supervision at the level of the national level can sometimes conflict with the proper functioning of the regional management system. This is one of the reasons why it is proposed that the supervisory arrangements for banks be extended to the peripherals.
The introduction of a single supervisory mechanism is proposed to solve the problems associated with the failure of the different local banks to co-operate. If this new provision had been in force from the start, then the situation would have been prevented. Many people think that a single supervisory mechanism will not be effective because the banks are likely to refuse to co-operate. There is an argument that the introduction of a single supervisory mechanism is bound to bring about a concentration of banking resources at the centre of the European Union. It is argued that the concentration of banking resources will lead to higher interest rates and to a fall in the real value of the currencies of the European Union countries.