Friday, August 17, 2012

Banking union fallacies 4 - Draghi on capital controls: fact of fiction?

Wolfgang Münchau tells us that because we can't impose capital controls by Treaty, the only way to fight bank runs is through an EU-wide pooling of deposit insurance, one of the pillars of the banking union.

Mari Draghi, OTHO, tells us that 'national supervisors' are imposing capital controls on the banks in their jurisdictions to underscore 'national bias' in financial regulation. A similar scenario was imagined by Daniel Gros from CEPS—'who developed original plans for EMU—in promoting a banking union.

Are national supervisors breaking the law, or are Gros and Draghi bending the truth to make the case for  the ECB to take over banking supervision?

Wolfgang Münchau tells us that the only viable policy to fight bank runs in failing country is EU banking union (FT). He refers, here, to an EU-wide pooling of deposit insurance. Why, according to him? Because freedom of capital movement can be suspended only in relation to non-Euro countries (Art. 66 of TFEU). By this logic, if capital controls could be imposed, the proposed remedy might be different. But it can't, he says, because it's not in the treaty. Yet, amending the treaty is possible, to put a banking union in it. Double standard.

Daniel Gros presents the case "a bank headquartered in Italy, but with an important subsidiary in Germany" (NakedCap). He assumes that if "the German operations generate a surplus of funds since Germany saves more than it invests at home.", this may happen: "The German supervisory authorities consider Italy at risk and thus oppose any transfer of funds from the German subsidiary to the Italian headquarters.".

Draghi tells us a scenario similar to Gros' is in fact happening (FT):
National supervisors have asked their banks to [keep] activities within [borders].
The second point is in a sense a collective action problem: because national supervisors, looking at the crisis, have asked their banks, the banks under their supervision, to withdraw their activities within national boundaries. And they ring fenced liquidity positions so liquidity can’t flow, even across the same holding group because the financial sector supervisors are saying “no”.

So even though each one of them may be right, collectively they have been wrong. And this situation will have to be overcome of course.
Well coordinated tango between Gros and Draghi, but out of sync with Münchau's music. If the treaty can so easily be breached in practice at the bank level, then that opens to the door to also imposing national capital controls on customer deposits, contrary to what Münchau claims, and his case for deposit insurance pooled at the EU level is weakened. Alternatively, it is Münchau who is right and the Draghi + Gros tandem is bending the truth to make the case of ECB supervision.

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