Financial supervision: Strange priorities

October 26, 2009

The parties set to form the new German government have agreed to concentrate banking supervision (which hitherto has been a task shared by Germany’s financial supervisor, BaFin, and the Bundesbank) in the hands of the central bank. Even though such plans had been part of the three parties’ electoral platforms, the pace and form of their approach to this matter still comes as a surprise. No less of a surprise is the exclusive focus on national supervisory arrangements, while the currently discussed re-design of the European financial supervisory architecture has not been mentioned at all.

It is noteworthy that the proposal is being presented without having been preceded by an analysis as to whether the current supervisory structure aggravated the impact of the financial crisis in Germany. Even a cursory glance at this issue would seem to suggest that such an analysis is unlikely to yield an unequivocal result. On the one hand, it can be noted that, up until now, both BaFin and the Bundesbank have been active in day-to-day supervision and, prima facie, it is not evident that possible failures have been concentrated at BaFin. On the other hand, a look at the experience of other countries does not suggest unequivocally that allocating the task of banking supervision to the central bank yields superior results: Positive case studies such as Italy and Spain can be juxtaposed to negative ones such as the Netherlands and the Fed. This seems to confirm the emerging consensus in the academic literature that it is not so much the institutional structure of financial supervision that counts, but the actual execution.

Beside these considerations, surveys amongst the institutions supervised and studies on the issue, conducted before the outbreak of the crisis, do not provide sufficient justification for the intended reform. While these studies – amongst them the evaluation by the IW Institute in February 2009 – have identified a need for closer coordination between BaFin and the Bundesbank they have not stressed the need for radical institutional reform.

It is no less remarkable that the protagonists of institutional change have, so far, not provided any answers to the basic questions that need to be raised when thinking about transferring supervisory responsibilities to the central banks. Even leaving aside the perennial, but by no means trivial issue of a potential conflict of interest between monetary policy and supervisory responsibility, at least four questions need to be answered:

• First: How can the execution of sovereign powers be made compatible with the autonomy that a central bank enjoys as regards the conduct of monetary policy? The solution apparently favoured by the advocates of change – to have the Ministry of Finance endorse critical supervisory decisions on a case-by-case basis, is hardly convincing. Not only does it erroneously suggest that only critical decisions would raise the question of compatibility of sovereign power and autonomy; the proposed solution also looks strikingly similar to current arrangements in which BaFin, as an authority acting on behalf of the Ministry, issues orders prepared by the Bundesbank.
• Second: In case of a transfer of supervisory powers to the central bank it needs to be ensured that there is full transparency and control of the budget for supervisory work. It would certainly not be acceptable if the Bundesbank, to the extent that supervisory work is concerned, maintained its long-held stance that its budget is off-limits to control by a court of auditors. Such a stance would neither be compatible with the fiscal prerogative of parliament not with the legitimate interests of those paying for the budget, i.e. the institutions supervised.
• Third: as the example of the Fed underlines vividly at the moment, the risk that mistakes in supervision – which are hard to avoid – can damage the reputation of a central bank is not a merely a theoretical one.
• Fourth: The proposed reform would kill the sensible approach of a comprehensive, integrated supervisory structure, which was the philosophy underlying the creation of BaFin – and this in spite of the fact that the crisis has underlined the close interconnection between banking, insurance and securities markets. It is hard to see how comprehensive monitoring  of the risks in all financial market segments can be organised more effectively in the new structure than within BaFin.

To avoid any misunderstanding: No objective observer would suggest that BaFin was immune to making mistakes prior and during the crisis. At BaFin, too, much could be improved. In particular, the potential of an integrated supervisor has been far from exhausted and BaFin also provided too little input for the international supervisory discussions. But it is a fact that most of the weaknesses of BaFin simply reflect birth defects, which left the institution with too few competences and resources. 

Be that as it may: The spirit of reform has been let out of the bottle and the debate is therefore unavoidable. Irrespective of its outcome one thing is clear: The debate will paralyse the supervisory agencies with changes to organisation and personnel – and all of this in a situation that is still fragile. And, as resources are tied up, it will also guarantee that Germany will continue to have little to contribute to supervisory reform in the EU. It is strange to see that just as Europe finally seems to make some progress on this issue, Germany concentrates its energy on parochial issues. It can only be hoped that Germany’s politicians  will discover the importance of EU level issues at least as a complement to national reforms.

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Bernhard Speyer (+49) 69 910-31835

 

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