On a first reading, there is an elephant in Jacques de Larosiere’s kitchen. The report recommends a new architecture for pan-European supervision, falling short of a single pan-European regulator as Kevin O’Rourke notes. It also recommends revisions to Basel II, without much in the way of specifics. The report has been welcomed by the Commission and is to be considered by EU Finance ministers next month.
The elephant is moral hazard. European governments have instituted wide-ranging guarantees of bank liabilities, amounting to de facto (and potentially free in some cases) unfunded deposit insurance for commercial banks. The report rattles on about the possibility of a limited and pre-funded deposit insurance scheme, with the option of national variations on a European template. But it seems to me that the genie is out of the bottle, and that, if and when business-as-usual returns, the public will not believe that there are deposit insurance limits. If there is a systemic crisis, Governments will be expected to step in. Even if there is just one distressed commercial bank, it is difficult to see how the clamour for retrospective liability guarantees can be resisted. These expectations could be with us for generations.
Clearly there are categories of near-banks (hedgies, prop-trading units) which could credibly (in the eyes of the public) be placed outside the pale, and denied guarantee. But how to prevent banks, believed to be guaranteed, from lending to these entities at inadequate rates, endowed with too-cheap funds from the public deposited on the basis of an assumed guarantee?
The net question is this. What are the implications for regulation and supervision of a European banking system in which liabilities of all the main commercial banks are perceived to be guaranteed? Can it be less than Glass/Steagel, plus high capital and liquidity ratios, plus intensive supervision and risk monitoring beyond anything thus far contemplated?
Margaret Thatcher lamented, at the end of the Cold War, that nuclear weapons could not be de-invented. Can the perception of perpetual availability of retrospective and ‘costless’ bank liability guarantees be de-invented?