INTEGRATING MACRO-­‐PRUDENTIAL POLICY: CENTRAL BANKS AS THE ‘THIRD FORCE’ IN EU FINANCIAL REFORM. SAMUEL MCPHILEMY UNIVERSITY OF WARWICK PAPER PREPARED FOR THE ECPR JOINT SESSIONS WORKSHOP ON ‘NATIONAL VERSUS SUPRANATIONAL BANKING SUPERVISION’, SALAMANCA, APRIL 2014. PLEASE DO NOT CITE ABSTRACT In recent years, policymakers and financial authorities have established an intricate, multi-­‐level, framework for 'macro-­‐prudential' policymaking in the European Union (EU). This paper argues that central banks have acted as a ‘third force’ in this process, determining the balance between national and supranational authority and ensuring their own predominance in the macro-­‐
prudential policy field. The paper demonstrates central banks’ influence during three phases in the creation of the new macro-­‐prudential framework: the negotiations surrounding the establishment of the European Systemic Risk Board in 2008-­‐10; the elaboration of a legal and organisational framework for the use of macro-­‐prudential instruments in the banking sector in 2011-­‐12; and the creation of the Single Supervisory Mechanism in 2012-­‐14. The paper suggests that central banks’ influence has been supported by the confluence of structural, institutional and political factors, which favoured an expansion in central bank power after the financial crisis. INTRODUCTION A widely acknowledged lesson of the global financial crisis was the need to supplement micro-­‐prudential regulation and supervision with policies to mitigate ‘systemic’ risks to financial stability. Reflecting this new conventional wisdom, policymakers and financial authorities in the European Union (EU) have in recent years established an intricate, multi-­‐level, framework for 'macro-­‐
prudential' policymaking. Within this framework, the balance of competencies between national and supranational authorities varies in relation to specific policy instruments, with measures affecting the banking sector subject to the greatest degree of centralised oversight and control. The launch of the Single 1 Supervisory Mechanism (SSM) in late 2014 will add to the complexity of this framework by enabling the European Central Bank (ECB) to share power with new national macro-­‐prudential authorities in setting capital buffers and other instruments to mitigate systemic risks in the euro area banking sector. What can explain the division of labour between national and supranational authorities that is established in this framework? The preeminent theories of European integration suggest different answers to this question. ‘Supranational governance’ theories (and their ‘neo-­‐functionalist’ antecedents) start from the premise that transnational trade and investment generates a societal demand for regulatory harmonisation and administrative integration, which supranational institutions work to supply (Stone Sweet and Sandholtz 1997). European financial markets are generally highly integrated, suggesting a high level of private sector demand for a ‘level playing field’ in European regulation and supervision. Thus, a supranational governance perspective predicts that EU rules and institutions will place strong constraints on member states’ use of macro-­‐
prudential policies in their pursuit of financial stability. It also suggests that the key actors in designing and operating the framework for financial stability are likely to be supranational policymakers and administrators, namely, the European Commission and the ECB. These authorities will operate with the active support of transnational financial firms and industry associations to ensure highly centralised regulation and supervision. By contrast, a liberal intergovernmentalist (LI) perspective (Moravcsik 1998) would suggest the new macro-­‐prudential policy framework was the outcome of substantive bargains between key member states. This perspective sees national governments as the pre-­‐eminent actors in determining the thrust of new European regulations and the shape of institutional reforms at the EU level. A LI perspective would posit that the experience of the financial crisis motivated key member states’ to operationalise macro-­‐prudential policy as a means of safeguarding financial stability. Doing so unilaterally would be ineffective because the free market access enjoyed by firms within the Single Market would allow domestic firms subject to macro-­‐prudential measures to be undercut by foreign firms not subject to the same restrictions. This would result in competitive disadvantages and undermine any financial stability benefits that the measures might otherwise have had. Furthermore, the generally high level of integration of European financial markets would mean that policies adopted by one member state under the rubric of macro-­‐prudential policy could have destabilising spillover effects for other member states, for example, by causing firms to repatriate capital to their ‘home’ jurisdictions. Thus, according to the LI perspective, member states had an interest in agreeing a framework for coordinating their new macro-­‐prudential policy efforts, as a means of constraining each other’s future policy decisions in this policy field. While both the supranational governance and LI perspectives reveal aspects of the process shaping the macro-­‐prudential framework in the EU, this paper 2 suggests that neither provides an adequate explanation. To be sure, transnational firms have argued for consistency in member states’ use of macro-­‐
prudential instruments and supranational policymakers have, on the whole, promoted harmonised solutions. Yet the macro-­‐prudential policy framework provides more room for national divergence and manoeuvre than the supranational governance perspective predicts. Likewise, as the LI perspective foresees, member states have at times engaged in hard bargaining over the terms of coordination in macro-­‐prudential policymaking (see, for instance, Barker 2012a). However, the LI perspective fails to explain key aspects of the negotiations and the resulting policy framework. In particular, this perspective cannot account for the influential role that the central banking community has played in defining the terms of cooperation between national and supranational authorities. This paper argues that central bankers have acted as a ‘third force’1 in the reorganisation of financial supervision in the EU since the onset of the crisis. Specifically, it claims that central banks have exerted a decisive influence over the emerging macro-­‐prudential policy framework and, in so doing, they have ensured their own predominance in the macro-­‐prudential policy field. Notwithstanding the failure of central banks to take action to address the build-­‐
up of systemic risks prior to the crisis, in bureaucratic terms central banks have emerged as the clear ‘winners’ from the macro-­‐prudential shift in financial regulation and supervision. The paper suggests that this outcome can be attributed to the interplay of central bankers’ active advocacy for a leading role in macro-­‐prudential policy on the one hand, and the structural and institutional contexts in which they have operated since the financial crisis on the other. At the ‘macro-­‐level’ of broad economic and societal structures, the financial crisis intensified the public demand for financial stability in financialised capitalist democracies that were already sensitised to financial failures and risk more generally (Giddens, 1991; Beck 1992; Clarke 2000). The reorganisation of supervisory architectures at the national and regional levels was thus a necessary, if not sufficient, step towards satisfying the public outcry for reform. At the meso-­‐level of institutions, the sequencing of change in the role and functions of central banks was important. In the decade prior to the financial crisis, many countries hived-­‐off banking supervision from their central banks, establishing unified supervisory authorities. The resulting disconnect between financial stability analysis, which most central banks continued to carry out, and the power to impose specific prudential restrictions on financial institutions came to be regarded as a key failing of pre-­‐crisis financial stability arrangements. At the ‘micro-­‐level’ of individual agency, central bankers have repeatedly emphasised the comparative advantages of central banks in systemic risk analysis and their readiness to play a leading role in macro-­‐prudential policy in the future. 3 Of course, central bank preferences were not the only factor shaping the emerging macro-­‐prudential policy framework. At certain times, central bankers have found themselves in alliances with key member states; at other times, they have been more closely allied to supranational policy entrepreneurs. Nor is it the case that central bankers have always presented a united front; indeed, the decentralised nature of the macro-­‐prudential framework is in large part attributable to power struggles within the central banking community. Still, at pivotal moments in the formation of the macro-­‐prudential policy regime, central bankers’ interventions have been decisive in shaping the complex division of labour between national and supranational authorities. The remainder of the paper proceeds as follows. The next section reviews the economic and public policy literature on macro-­‐prudential policy, demonstrating that it is by no means axiomatic that central banks should play as dominant a role in macro-­‐prudential policy as they do in the EU. The subsequent empirical section demonstrates central banks’ influence during three distinct (if overlapping) phases in the creation of the macro-­‐prudential framework since the onset of the financial crisis in 2008. These phases are the negotiations surrounding the establishment of a European Systemic Risk Board (ESRB) in 2008-­‐10; the elaboration of a legal and organisational framework for the use of macro-­‐prudential instruments in the banking sector in 2011-­‐12; and the creation of the Single Supervisory Mechanism in 2012-­‐14. The penultimate section discusses the sources of central banks’ influence in these processes. The final section concludes. THE ROLE OF CENTRAL BANKS IN MACRO-­‐PRUDENTIAL POLICY The near consensus that emerged during the financial crisis over the potential benefits of macro-­‐prudential policy has spurred governments and financial authorities around the world to re-­‐examine their organisational architectures for policymaking in relation to financial stability. Institutional designs have differed from one country to the next, as have the pace and scale of reform. This reflects differences in national legal and institutional starting points, different levels of public salience of financial reform and diverse experiences during the financial crisis. On the whole, central banks are playing a leading role in new macro-­‐
prudential policy frameworks (IMF 2011), although some countries have afforded (greater or lesser) roles to other agencies as well, in particular finance ministries and financial supervisory authorities. There are three frequently cited arguments in favour of strong central bank participation in macro-­‐prudential policy. First, central banks are said to possess informational advantages that make them uniquely well suited to the task of identifying systemic risks, either in the financial system at large or at a sectoral level (IMF 2011, Nier et al. 2011, Deutsche Bundesbank 2012). This expertise stems from the macroeconomic analytical capacities associated with the other 4 functions that central banks perform, including monetary policy, oversight of payments systems and the provision of lender of last resort facilities to the commercial banking system. Even before the financial crisis, many central banks routinely conducted analyses of risks and vulnerabilities affecting the financial system as a whole, publishing regular financial stability reports. Thus, many central banks already conducted precisely the same type of analysis that is needed to support macro-­‐prudential policymaking. A second argument in favour of central bank-­‐led macro-­‐prudential policy is the alleged complementarity between macro-­‐prudential policy and monetary policy (BoE 2013; Wheelan 2012). The core objective of most contemporary central banks is price stability. In general terms stable prices ensure that money acts as a reliable store of value, which is important in providing certainty to savers and borrowers about the real value of their investments and debts (BoE 2013). Equally, by preventing financial crises, macro-­‐prudential policy ensures financial markets act as a smooth transmission mechanism for monetary policy decisions, thereby helping central banks meet their price stability objectives. Some authors have questioned the analytical separation between the two policy fields, arguing that the use of macro-­‐prudential instruments by central banks ‘is little more than a return to the traditional scope of monetary policy in caring for aggregate financial stability, a role that had been somewhat overshadowed by the sole emphasis placed on price stability in the definition of monetary policy goals.’ (Carmassi et al. 2011). The third commonly cited reason why central banks should take a leading role in macro-­‐prudential policy is that their operational independence from executive politicians leaves them well placed to take decisions that might be unpopular with particular societal groups or private actors. Counter-­‐cyclical macro-­‐
prudential policies, which affect capital and liquidity through a financial cycle, can raise the cost of credit for society at large or for particular sectors of the economy. Measures such as loan-­‐to-­‐income or loan-­‐to-­‐value ratios restrict borrower’s access to credit. Tools such as these have significant distributional consequences affecting financial industry participants, non-­‐financial corporates and retail consumers of financial services. Since the benefits of financial stability are both diffuse and hard to measure, macro-­‐prudential policy is subject to a ‘logic of collective action' problem (Olsen 1971). That is to say, those who stand to suffer (at least in the short-­‐term) from macro-­‐prudential policies will be better organised and will lobby more fiercely than those who stand to gain. Delegating macro-­‐prudential policy to independent central banks to some extent shields decision-­‐making from the ‘inaction bias’ that this problem engenders. And yet, the case for central bank dominance of macro-­‐prudential policy is by no means indisputable. Each of the three arguments for situating macro-­‐
prudential policy within a central bank advanced here – informational advantages, complementary policy objectives and political independence – has an equally often-­‐cited counterargument. First, while central banks may indeed 5 devote significant resources to macroeconomic and financial sector analyses, the effective identification of systemic risks arguably requires a wider range of information and institutional perspectives than is typically found within central banks. Many officials working in the area of macro-­‐prudential analysis argue that data on the exposures of individual financial institutions, which are normally available only to micro-­‐prudential supervisory authorities, are essential for the effective identification of systemic risks (McPhilemy and Roche 2013; Israel 2013). The organisational separation of (micro-­‐)prudential supervision from central banks that exists in many countries can act as an obstacle to the ‘upward’ flow of supervisory information to macro-­‐prudential decision-­‐makers in a central bank, since supervisors may be reluctant to share information provided by firms under conditions of strict confidentiality. Even in countries where central banks do have responsibility for micro-­‐prudential supervision, independent agencies tend to be responsible for supervising insurance companies and securities markets. At a minimum, this suggests the need for well-­‐developed information sharing arrangements between macro-­‐prudential and micro-­‐prudential supervisory authorities. Given that micro-­‐prudential supervisors have first hand knowledge of firm-­‐level developments, there is also a case for involving them directly in macro-­‐prudential decision-­‐making. The argument that monetary policy and macro-­‐prudential policy complement one another is open to the counterargument that these policy fields are just as likely to be in conflict. Monetary policy can have adverse consequences for financial stability through multiple channels. For example, when a central bank lowers its policy interest rate, it stimulates aggregate demand. Consumers and firms will fund a proportion of their additional consumption or investment through borrowing, which can be a source of systemic risk if these borrowers do not adequately factor-­‐in the costs of servicing their debts when interest rates eventually rise (BoE 2013). Since the onset of the global financial crisis, historically low interest rates have also stimulated investors to shift into riskier assets in the hope of increasing (or simply maintaining) returns on their capital. This ‘search for yield’ can leave investors insufficiently compensated for the risks they are exposed to. Arguably, the multiple interconnections between monetary policy and macro-­‐prudential policy suggest macro-­‐prudential policy decisions should indeed be taken ‘in-­‐house’ within a central bank, such that financial stability considerations can be adequately factored into monetary policy decision-­‐making. Yet there is a danger that entrusting macro-­‐prudential policy to decision-­‐makers who are first and foremost concerned with price stability could lead to financial stability considerations being treated as of secondary importance. Central bankers may be reluctant to concentrate on risks that have arisen from actions they themselves have taken in the pursuit of price stability. Finally, the argument that politically independent central banks’ are well placed to implement potentially unpopular macro-­‐prudential policies also has an obvious flipside: namely, that delegating decision-­‐making authority to an 6 independent central bank raises concerns over legitimacy and accountability. The trade-­‐offs associated with delegation to non-­‐majoritarian institutions are well known (see, for example, Majone 1999). If anything, insulating macro-­‐
prudential policy in a central bank raises greater concerns from a democratic perspective than granting central banks independence over monetary policy. This is because the distributional consequences of macro-­‐prudential instruments tend to be more targeted than those of monetary policy, with more concentrated costs for specific firms, sectors or societal groups. Concerns over accountability and legitimacy are doubly severe in the EU, since the ECB is subject to less effective political oversight and accountability mechanisms than national central banks (Amtenbrink and Duin 2009). This brief review of the arguments for and against central bank control of macro-­‐prudential policy demonstrates that central bank domination of macro-­‐
prudential policy should not be regarded as a fait accompli. Indeed, central banks have not emerged as the leading players in all jurisdictions. In the United States, the Financial Stability Oversight Council is under the chairmanship of the Secretary of the Treasury. Furthermore, the finance ministries of both France and Germany have taken a leading role in their new national macro-­‐prudential frameworks. Yet the multi-­‐level framework for macro-­‐prudential policy in the EU is dominated overwhelmingly by central banks. The following section sets out how this came to be. ESTABLISHING THE MULTI-­‐LEVEL FRAMEWORK CREATING THE EUROPEAN SYSTEMIC RISK BOARD At the height of the first acute phase of the global financial crisis in October 2008, European Commission President, Jose Manuel Barroso, set up a ‘High Level Group’ under the chairmanship of former Banque de France Governor Jacques de Larosière to examine means of strengthening the supervision of the EU financial system. The High Level Group had a mandate to examine the balance of competencies between national and EU-­‐level authorities in all financial sectors, reflecting the Commission’s desire ‘to remove the mismatch between a continental-­‐scale market and national systems of supervision’ (Barroso 2008). The Group was required to examine ways of strengthening ‘European cooperation on financial stability oversight, early warning mechanisms and crisis management, including the management of cross border and cross sectoral risks’ (EC 2008). Without actually mentioning the term ‘macro-­‐prudential’, this mandate clearly reflected the widespread enthusiasm for operationalising macro-­‐prudential policy that was emerging at time (Baker 2013). This set the stage for a reconfiguration of national and supranational frameworks for managing financial stability. 7 The proposal for a new body responsible for macro-­‐prudential oversight of the EU financial system came initially from a submission to the High Level Group by the former chairman of the UK Financial Services Authority (FSA) Howard Davies and former senior FSA official, David Green. Their proposal aimed to bridge the ‘double separation’ between central banks and supervisory authorities on the one hand, and between national and EU-­‐level mechanisms for financial stability management on the other (proposal on file with author). Specifically, they called for the creation of a ‘European Systemic Risk Committee’ to replace the ECB’s existing ‘Banking Supervision Committee’. The latter was a relatively neglected body composed of ECB officials, national supervisors and central bankers. It had previously conducted financial stability analysis but it lacked an ability to influence policy. Davies and Green proposed that the new Committee should be largely independent of the ECB. It would report not to the ECB Governing Council2, as the Banking Supervision Committee had done, but rather to a new ‘European Systemic Risk Council’, composed of members of the ECB General Council3 and heads national banking supervisory authorities. To ensure an equal balance between central banks and supervisory authorities, they also suggested that the new body could be chaired jointly by one central bank governor and one head of a supervisory authority. In its subsequent report and recommendations, the High Level Group followed Davies and Green’s proposal in calling for the establishment of a European Systemic Risk Council (de Larosière et al. 2009). However, whereas Davies and Green had called for the new body to be equally balanced between central banks and supervisory authorities, the High Level Group’s proposal was heavily skewed towards central banks. The proposed body was to be composed of the ECB General Council, plus the chairpersons of the three committees of European supervisors4, as well as a representative of the Commission. The ECB would provide the new body’s secretariat and the ECB President would serve as its chair. The High Level Group foresaw only a limited role for financial supervisors. It suggested that the new Systemic Risk Council should conclude information-­‐sharing agreements with national supervisors and that supervisors could be invited to participate in the Systemic Risk Council’s deliberations on an ad hoc basis. Subsequently, the Commission launched a public consultation in which the position of financial supervisors in the new body was slightly enhanced. One senior supervisor per member state would be able to participate in the meetings of the new body as a non-­‐voting observer. This arrangement was subsequently maintained in the Commission’s legislative proposal for the European Systemic Risk Board (as so renamed by the European Council) and remained unchanged in the final regulation that established the ESRB (see Regulation 1092/2010, Article 6). Even with this revision, however, one prominent commentator concluded, the ESRB is ‘ludicrously lopsided in favour of central banks in general and of the ECB in particular’ (Buiter 2009). 8 What can account for this outcome? Part of the answer lies in the composition of the High Level Group: six of its eight members were former central bankers, while only one was a former supervisor. Perhaps more importantly, central bankers campaigned both publically and privately for a leading role in macro-­‐
prudential policy. Following the convening of the High Level Group, many central bankers gave speeches in which they set out the case for central banks to take a leading role in macro-­‐prudential policymaking (see, for instance, Wellink 2008; Landau 2008; Thomopoulos 2009). Additionally, central banks made representations to the High Level Group behind the scenes, where they stressed their unique informational advantages and their concerns that central bank independence would be compromised were supervisors or other authorities to be included in the formal decision-­‐making procedures (author interview, London March 2014). Claims regarding the informational advantages of central banks in macro-­‐prudential policy were also apparent in national central banks’ submissions to the Commission’s public consultation on the reforms, although unsurprisingly there was somewhat less enthusiasm for the recommendation to give a leading role to the ECB (tensions between national central banks and the ECB are discussed below) (see Czech National Bank 2009; Sveriges Riksbank 2009; Romania 2009). The central banks’ success in capturing control of the ESRB needs also to be understood in the context of two interconnected processes of institutional evolution. The first is the changing role of central banks in banking supervision. The financial crisis struck at a moment when central banks everywhere were under threat of being stripped of their supervisory responsibilities. Norway, Iceland, Denmark and Sweden had each established single supervisory authorities in the late 1980s or early 1990s. After the UK created the FSA in 1998, a wave of similar reforms spread across Europe: Austria, Germany, Belgium, Estonia, Malta, Latvia, Hungary and Poland each establishing some variant of the single supervisor model during 2000s (Masciandaro and Quintyn 2009). Such moves aimed to make supervision more efficient (less costly) for large diversified financial firms, whose activities increasingly cut across the traditional divisions between banking, securities and insurance (Briault 1999). At the same time, moving banking supervision from central banks to single supervisory authorities also reflected efforts by centre-­‐left governments to submit this policy area to greater democratic accountability, against a backdrop of frequent financial scandals and populations increasingly exposed to the vagaries of financial markets (Clarke 2000; Westrup 2007). Central banks resisted such changes with varying degrees of success during the 2000s (Engelen 2002; Quaglia 2008). For those which retained supervision, promoting a leading role in the new macro-­‐prudential framework was an opportune means of guarding against any further threats to their supervisory functions. The second long-­‐term process of institutional evolution relevant to central banks’ success in capturing such a dominant position within the ESRB is the 9 slowly changing role of supranational actors in banking supervision in the years prior to the financial crisis. This process has itself been deeply intertwined with the debate over the role of central banks in banking supervision at the national level. The Maastricht Treaty conferred on the ECB a relatively limited set of responsibilities in the area of banking supervision 5 , but it has periodically pitched for an expansion of its powers in this area. In 2001, the ECB published a paper setting out the case for attributing both macro-­‐ and micro-­‐prudential responsibilities to national central banks, which, by extension, would have enhanced its own role in coordinating supervision at the EU level (ECB 2001). A year later, the ECB’s then-­‐President Wim Duisenburg and his deputy Tomasso Padoa-­‐Schioppa made public their long-­‐standing interest in seeing the ECB itself take on a stronger supervisory role. This move was promptly rebuffed in the European Council under opposition from the UK and Germany, both of which were supporting the single supervisor model at the time. Subsequently, policymakers did agree greater European coordination in banking supervision, although this was to be led by supervisors, not central bankers. Thus, a Committee of European Banking Supervisors (CEBS) was established in London in 2004, in which central bankers and the ECB could participate as non-­‐voting observers only. The convening of the High Level Group offered an opportunity to replay these battles. Representatives of the ECB again stressed their interest in taking on a prominent role in both micro-­‐prudential and macro-­‐prudential banking supervision (de Larosière 2009: 42-­‐43). While the High Level Group rejected these appeals in respect of micro-­‐prudential policy, opting instead to transform the CEBS into a new European Banking Authority, it did concede that the ECB should take on a more prominent role in macro-­‐prudential policy, including by providing the new body’s secretariat and its chair. This decision may be regarded as a natural extension of the primacy afforded to central bankers in the ESRB’s overall governance structure. THE CRD-­‐IV AND NATIONAL MACRO-­‐PRUDENTIAL AUTHORITIES Over the course of 2010, before the entry into force of the founding regulation of the ESRB, policymakers in the EU began working on a fundamental overhaul of the main legislation governing the banking sector. The new rules – which were eventually adopted in 2013 as the Capital Requirements Directive IV (CRD-­‐IV) and the Capital Requirements Regulation (CRR) – would incorporate into EU law the latest iteration of the internationally agreed capital adequacy standards of the Basel Committee on Banking Supervision (Basel III). Reflecting the international consensus on the need for macro-­‐prudential policy, Basel III contained a range of macro-­‐prudential capital buffers that aimed to mitigate systemic risks. These included the ‘countercyclical capital buffer’, which is intended to ensure banks build up capital during periods of credit expansion, 10 which can then be drawn down during a downturn to support lending to the real economy. Basel III also included range of buffers designed to enhance the resilience of systemically important financial institutions (BCBS 2011). One of the most controversial issues during the negotiations over the CRD-­‐
IV/CRR concerned the degree of flexibility that should be afforded to member states in using these (and other) macro-­‐prudential instruments. The existing Capital Requirements Directives, agreed in 2006, had been built on the principle of ‘minimum harmonisation’, meaning that member states were free to impose more stringent, ‘gold-­‐plated’, standards if they so chose. This legislation had also contained a large number of options and discretions, which resulted in a lack of regulatory cohesiveness within the Single Market. This was recognised as a source of competitive distortions between member states and excessive compliance costs for cross-­‐border firms (de Larosière 2009: 27). It also inhibited effective supervision of cross-­‐border banks and made crisis management more challenging than it might otherwise have been (EC 2009). In order to close these loopholes, EU finance ministers called in 2009 for the creation of ‘Single Rulebook’ consisting of ‘a core set of EU-­‐wide rules and standards directly applicable to all financial institutions active in the Single Market, so that key differences in national legislations are identified and removed’ (ECOFIN Council 2009). In line with this invitation, in 2011 the Commission published legislative proposals to revise the 2006 Capital Requirements Directives according to the principle of ‘maximum harmonisation’. Key prudential instruments and their calibrations would be included in a regulation (as opposed to a directive), which meant that they would apply directly to banks and other financial institutions without needing to be transposed into domestic rulebooks. As such, member states would no longer be permitted to impose gold-­‐plated capital requirements on the banks under their jurisdiction. Significantly, the maximum harmonisation approach was even extended to most of the macro-­‐prudential elements of the proposals. While national authorities would have had limited flexibility to vary the countercyclical capital buffer at the national level, the power to vary other buffers, such as those directed at systemically important institutions, would have resided with the Commission (EC 2011). As predicted by a supranational governance perspective on European integration, the maximum harmonisation approach accorded with the preferences of many British and continental banks, which were keen to set limits on the ability of national authorities to impose capital ratios beyond the micro-­‐
prudential minimums established in Basel III (Barker and Masters 2012). However, the maximum harmonisation of macro-­‐prudential tools engendered fierce resistance from a large majority of the central banking community as well as several national governments, notably the UK and Sweden. Central bankers repeatedly expressed their misgivings over the economic rationale for maximum harmonisation and their concerns that the proposed framework deprived 11 member states of the necessary tools to mitigate systemic risks of a regional or country-­‐specific nature. As Mervyn King, then-­‐Governor of the Bank of England, told a UK Parliamentary committee, ‘I am completely baffled as to why they want to do it. There is no logical or economic reason why you would want to have maximum harmonisation, other than a theology of convergence for the sake of it’ (King 2013). The ESRB provided the channel by which the central banking community was able to express its reservations on this legislation. It issued a series of confidential communications to the Commission over the course of 2011 and 2012, urging it to adopt a more decentralised approach, which would allow national authorities more power to apply macro-­‐prudential instruments locally (author interviews Brussels, Frankfurt April 2013; McPhilemy and Roche 2013). The ESRB’s interventions culminated with the publication of an open letter from the ECB President Mario Draghi (in his capacity as Chair of the ESRB) to the Presidents of the Commission, the Council and the European Parliament (ESRB 2012). It called for a system of ‘constrained discretion’, which would guarantee member states had the flexibility to set broad measures, such as variations to aggregate capital and liquidity levels, and more targeted requirements, such as sector-­‐specific capital requirements on real estate or consumer lending, whilst also ensuring certain safeguards were in place to prevent this flexibility being used for anti-­‐competitive or protectionist purposes. This intervention came at an unusually late stage in the legislative process, after the Commission had released its legislative proposals. It led to considerable consternation in the Commission, particularly in the Directorate General for Internal Market and Services, whose Commissioner, Michelle Barnier, had energetically defended the maximum harmonisation approach (WSJ 2011). Ultimately, the final CRD-­‐IV/CRR package provided ample discretion to member states to set macro-­‐prudential instruments, albeit within the constraints of a complex system of oversight involving the ESRB, the Commission and the Council. As this outcome was in line with the preferences of the United Kingdom, a member state of central importance in negotiations over financial services legislation, it is arguably consistent with a LI understanding of the integration process. Having said that, in putting the case for a more decentralised framework, the United Kingdom and its allies frequently cited the support of the central banking community for their position. It is also noteworthy that even as the negotiations over the CRD-­‐IV/CRR remained ongoing, the ESRB was taking action to reinforce the decentralisation of macro-­‐prudential policy by another means. In December 2011, it adopted a recommendation addressed to member state governments, requiring them to establish their own national macro-­‐prudential authorities (ESRB 2011).6 This recommendation did not insist that central banks be exclusively responsible for macro-­‐prudential policymaking at the national level, but it did specify that member states should ‘ensure that the central bank plays a leading role in the 12 macro-­‐prudential policy and that macro-­‐prudential policy does not undermine its independence’. The recommendation also did not specify the precise tools that should be available to these authorities. 7 However, by encouraging the creation of a new national ‘layer’ in the organisational framework for macro-­‐
prudential policymaking in the EU, it prepared the ground for flexibility to be exercised at the national level. MACRO-­‐PRUDENTIAL ASPECTS OF THE SINGLE SUPERVISORY MECHANISM The macro-­‐prudential framework in the EU is undergoing another significant transformation with the establishment of the SSM in the euro area, which is one of the two key pillars of the Banking Union.8 The SSM enables the ECB to take on strong powers for the micro-­‐prudential supervision of euro area banks. For approximately 130 ‘significant’ banks, the ECB will lead ‘Joint Supervisory Teams’, composed of officials from the ECB and several national competent authorities. The ECB will be responsible for all key micro-­‐prudential supervisory tasks, including granting authorisations, ensuring on-­‐going compliance and carrying out the supervisory review process (known as ‘Pillar 2’ in the Basel terminology). Additionally, the ECB will be responsible for issuing regulations, guidelines and general instructions to national supervisory authorities in respect of some 6000 less significant banks that will remain under national supervision (Council Regulation 1024/2013, Articles 4, 6). Decision-­‐making in respect of micro-­‐prudential supervisory issues will be the responsibility of a Supervisory Board, composed of a Chair and a Vice Chair, four ECB appointees and one representative from each country’s national competent authority. While ultimate decision-­‐making authority will reside with the Governing Council, a non-­‐
objection procedure will ensure that the new Supervisory Board will be the de facto decision-­‐maker on most issues. A less commented feature of the SSM is that it also empowers the ECB to apply a range of macro-­‐prudential policy tools. Specifically, the ECB will be able to apply capital buffers and other macro-­‐prudential instruments (at the level of individual countries), as defined in the CRD-­‐IV/CRR banking legislation. The ECB’s powers in this area are not as encompassing as they are in respect of micro-­‐prudential policy. The newly established (or soon to be established) national macro-­‐prudential authorities of participating countries have retained the power to calibrate macro-­‐prudential tools for themselves. Should they choose to impose a capital buffer or other macro-­‐prudential instrument, they are required to inform the ECB within 10 working days. However, the ECB may not veto their decision. The ECB, for its part, may apply higher macro-­‐prudential requirements than those applied by the national authorities. However, it cannot lower a buffer that has already been imposed at the national level. Decision-­‐
making procedures in respect of macro-­‐prudential policies also differ from those relating to micro-­‐prudential policies. Whereas micro-­‐prudential supervisory 13 decisions will be mostly left to the new Supervisory Board, there is no non-­‐
objection principle in respect of macro-­‐prudential decisions. This means that the Governing Council will be required to consider all such decisions itself (ECB 2014). The construction of macro-­‐prudential authority within the SSM clearly bears the hallmarks of central banks’ influence. The Commission’s original legislative proposal for the SSM advocated a strongly centralised regime in which the ECB would have had exclusive powers to set ‘countercyclical buffer rates and any other measures aimed at addressing systemic or macro-­‐prudential risks in the cases specifically set out in Union acts’ (EC 2012). This position is consistent with a supranational governance perspective, in which EU-­‐level policymakers advocate greater centralisation of power and harmonisation of rules within the Single Market. However, during the negotiations, the ECB itself stressed the importance of a more decentralised approach. In its formal ‘opinion’ on the Commission’s legislative proposal, it highlighted the ‘close proximity and knowledge’ of national authorities to their national economies and financial systems, and it advocated a power-­‐sharing arrangement between itself and national authorities in this area (ECB 2012). This intervention reflects the decentralised nature of the Eurosystem itself (Howarth 2009) and the strength of national central bank governors within the ECB’s Governing Council. As with the macro-­‐prudential aspects of the CRD-­‐IV/CRR, it is impossible to weigh precisely central bankers’ influence in defining the balance of competencies between national and supranational authorities in the macro-­‐
prudential aspects of the SSM. In the weeks leading up to the ECB’s formal opinion, the Presidency of the Council identified this issue as an area requiring further political deliberation (ECOFIN Council 2012b). Having said that, within a week of the publication of ECB’s opinion, a compromise text appeared in the Council in which the new power sharing arrangement had been agreed (ECOFIN Council 2012b). EXPLAINING CENTRAL BANKS’ INFLUENCE This paper has argued that the central banking community, acting in shifting alliances with other institutional actors, was able to decisively shape the EU’s new macro-­‐prudential framework. In so doing, it has defined the balance between national and supranational authority in this policy area, and ensured that national central banks will retain significant, albeit constrained, flexibility to determine macro-­‐prudential policy according to national prerogatives. Given the failure of central banks to lean against the build up of systemic risks prior to the financial crisis, it is surprising that the central banking community has been able to play such an influential role in shaping the reorganisation of financial governance in the years since the crisis began. What has been the secret of its success? 14 The answer, I suggest, lies in confluence of structural, institutional and political factors, which have provided a particularly favourable backdrop for central bankers’ interventions. The establishment of a multi-­‐level macro-­‐
prudential framework in the EU is, of course, part of a wider process of regulatory and organisational reform of financial market governance after the financial crisis. At a structural level, this wider process may be considered a response to a pervasive sense after the financial crisis that something needed to be done to prevent or mitigate future such episodes. Increasingly exposed – via pensions, mortgages and declining welfare provision – to the vagaries of financial markets, advanced capitalist societies are sensitive to risk at the best of times (see Giddens 1991; Beck 1992). Against the background of the worst financial crisis since the Great Depression, maintaining the status quo was not an option. To be sure, radical, or ‘path-­‐altering’, change in the actual content of financial regulation and supervision has proved largely elusive (see Moschella and Tsingou (eds.) 2013). Still, the reorganisation of supervisory architectures at the national and regional levels has been an obvious first step towards satisfying the public outcry for reform. The inevitability of organisational reform after the crisis does not by itself explain why central banks have emerged as the victors. To explain why this should have been the case, it is necessary to descend from the macro-­‐level of broad structures to the meso-­‐level of institutions and politics. For more than a decade prior to the crisis, economists had discussed the merits and drawbacks of the single supervisor model as compared to the alternative of central bank-­‐led (micro-­‐prudential) banking supervision. This was not an apolitical debate: it pitched centre-­‐left parties against centre-­‐right and democratically elected politicians against technocratic central bankers (Westrup 2007; Perez and Westrup 2010). The financial crisis severely dented the case for the single supervisor model, as well as the reputations for economic good governance of those who had operated and installed those systems. As the poster child for the single supervisor model, the experience in the UK was especially significant. After the creation of the FSA in 1997, the UK instituted a tripartite arrangement for managing financial stability based on a memorandum of understanding between the FSA, the Bank of England and Treasury. This arrangement was widely perceived to have contributed to the paralysis and confusion exhibited by the British authorities in the early stages of the financial crisis. The experience of what became known as ‘regulatory underlap’ – wherein financial stability fell between these three institutions – provided a propitious backdrop for anyone arguing in favour of central banks resuming their traditional role as the leading authority for managing financial stability. In institutional terms, the role of contingency and sequencing cannot be overlooked. Had some central banks not been stripped of their banking supervisory powers in the decade prior to the crisis, the central banking community as a whole would have been less likely to escape the financial crisis 15 with their reputations relatively unscathed (at least relative to financial supervisory authorities). The fact that central banks retained a mandate for financial stability prior to the crisis, even in countries where supervision had been entrusted to a single supervisory authority, is also significant. This greatly enhanced central banks’ credibly in presenting themselves as the natural home for macro-­‐prudential supervision. Central banks’ neglected and underused financial stability departments became the institutional ‘kernels’ from which new macro-­‐prudential capacities could be grown. CONCLUSION The exercise of authority by ‘non-­‐majoritarian’ institutions in the EU is nothing new, as scholarship on ‘new modes of governance’ has demonstrated (Thatcher and Coen 2008; de Visscher et al 2008; Eberlein and Newman 2008; Quaglia 2008; Thatcher 2011). Until now, however, this phenomenon was thought mainly to affect the ‘downstream’ phases of the regulatory process. In the 2000s, formalised transgovernmental committees of national technocrats were mandated to advise on (and more recently draft) regulatory technical standards and other forms of secondary legislation. This involved ‘filling out’ specific gaps that had been deliberately left open in the primary (or ‘framework’) legislation, as agreed by the Council and the European Parliament. Such bodies were also responsible for producing ‘soft-­‐law’ advice, guidance and recommendations to promote convergence on best practices and cooperation between national authorities when it came to on-­‐the-­‐ground application and enforcement of regulations. By contrast, the interventions discussed in this paper have taken place ‘upstream’ in the regulatory process. Central bankers have provided formal and informal opinions on legislative proposals for primary legislation. More importantly, they have also provided input to the pre-­‐proposal stages of the legislative process. Arguably, both the ECB and the ESRB were acting within their mandates in doing so. The ECB is routinely consulted on primary legislation within its field of competence and its opinion on the SSM regulation, discussed above, came at the request of both the Council and the European Parliament (ECB 2012). For its part, the ESRB’s mandate requires it to ‘provide warnings and, where appropriate, issue recommendations for remedial action, including, where appropriate, for legislative initiatives (ESRB Regulation Article 16, emphasis added). Until now, the ESRB has construed this as providing an adequate legal basis for its legislative interventions, although this has been highlighted as an area requiring clarification in a forthcoming review (ESRB 2013b). Beyond the narrow question of legality, however, the interventions discussed in this paper raise important questions surrounding the legitimacy of central bankers’ new powers. Central banker’s interventions in the construction of the 16 new macroprudential framework have not been confined to ‘purely’ technical advice. Rather, they have been focused on the deeply controversial question of ‘who should govern’ in a policy field that has obvious distributional consequences. To be sure, there are legitimate financial stability arguments to suggest that macro-­‐prudential regulation should indeed be conducted at the national level. In fact, there is now a broad consensus between central bankers, financial supervisors and policymakers, including many in the European Commission, that macro-­‐prudential policy could become a valuable adjustment mechanism for mitigating localised systemic risks in countries otherwise lacking macroeconomic policy tools (interviews Brussels March 2014; Brussels, Frankfurt April 2013). Even so, the success of the central banking community in securing for itself such a dominant position in the new macro-­‐prudential framework is a troubling development from a democratic perspective. Only time will tell whether these non-­‐majoritarian actors will be as bold in actually using these new policy instruments as they have been in securing the right to control them. NOTES 1 This term is borrowed from Thatcher (2005), who discusses independent regulatory agencies as a ‘third force’ in domestic politics. It used here to distinguish central banks from the principal actors identified in the liberal intergovernmentalist and supranational governance theories of European integration, which are member states and supranational policy entrepreneurs, respectively. 2 The Governing Council is composed of the ECB President, the ECB Vice-­‐
President, the four other Executive Board members and euro area central bank governors. 3 The General Council is composed of the ECB President and ECB Vice-­‐President and the governors of the central banks of every EU member state. 4 These were the Committee of European Banking Supervisors (CEBS), the Committee of European Securities Regulators (CESR) and the Committee of European Occupational Pensions and Insurance Supervisors (CEIOPS). The High Level Group Report also called for these micro-­‐prudential supervisory committees to be ‘upgraded’ to European Supervisory Authorities. 5 The Maastricht Treaty also contained a mechanism whereby, under certain circumstances, the ECB could take on ‘specific tasks concerning policies relating to the prudential supervision of credit institutions and other financial institutions with the exception of insurance undertakings’ (Article 105(6) TEU, now Article 127(6) TFEU; emphasis added). The emphasised words indicate that this provision was specifically not intended to enable the ECB to become the pan-­‐
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