Making Theory Applicable: Observable Implications for the Combined Approach

operationalize them. The goal is to find out whether the combined functional-political approach suggested in this paper can actually account for the creation and design of the Banking Union. This can only be tested, if it is defined what needs to be observed according to the combined approach in the empirical case to eventually confirm the hypotheses.

Functional Observations: Regulatory Deficits and Core Advantages of Regulatory Bodies At first, we would have to observe that the creation of the SSM and the SRM was due to functional reasons. Hypothesis H1 indicates that a functional reason for creation would be given, if a functional gap existed. For example, a regulatory deficit could account for such a gap: If regulatory supervision or resolution rules are missing, this can lead to upheavals in the banking sector of the Eurozone. After all, no or incomplete regulation would result in the authorities in charge not knowing how to supervise or wind up a bank. This in turn can aggravate the situation for the bank and possibly even the overall situation on EU financial markets due to contagious effects within the banking sector. It is furthermore not enough if supervision and resolution rules only exist on the national level because many banks in the euro area are big cross-border banks which operate on the EU level. Consequently, NRAs have to be aware of how to handle transnationally working banks. Additionally, a regulatory deficit would also be present if regulation existed but implementation of it was not efficient and thus failed because the member states had missed to establish a strong regulatory authority to ensure compliance. If regulation exists but member states do not comply a regulatory deficit emerges and this, too, can lead to problems with ailing or even collapsing banks. Summarizing, a regulatory deficit exists if crucial banking regulation is missing, if there is uncertainty about how to supervise or wind up banks or if an efficient regulatory authority is missing which is able to make sure that member states comply with the rules.

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Such a regulatory deficit would eventually lead to the failing of banks or even to the aggravation of the banking sector’s crisis.

Furthermore, a functional gap could be observed if there was an operational deficit. In this case, supervision and resolution rules would have existed while implementation had obviously failed. Implementation would have to fail because of insufficient or deficient regulatory standards which do not work out in practice. If implementation of banking rules failed, this also would have led to ailing banks and a worsening of the banking crisis.

Eventually a capacity deficit would represent a functional gap, too: Maybe the EU level was lacking the tools to tackle a specific banking governance problem. For example, on the national level as a countermeasure to quickly prevent the failure of a bank, governments, central banks or other lenders of last resort often directly recapitalize banks. However, this is hardly possible on the EU level since the ECB is officially not allowed to act as a lender of last resort. In summary, if policy makers simply lack the tools and thereby the capacity to guarantee proper banking governance and if this has negative impacts on supervision or resolution, a capacity deficit exists.

Of course, the functional gap must also have been the trigger for EU policy makers to take action and start discussions about the creation of the Banking Union. Therefore, it would be necessary to observe EU policy makers directly referring to banking governance deficits and using these deficits as arguments to advocate for the creation of the SSM or SRM.

Beyond that, hypothesis H1 also suggests that EU actors decide on an institutional set up which is best able to solve the particular functional problem. That means when policy makers decide to create the SSM within an institution like the ECB or within a new agency like the SRB, they do so out of particular functional advantages of such an institution or agency. That means: an institution would have to be best suited to solve the functional problem in supervision and an agency would have to provide advantages for banking resolution. As explained above, networks, agencies and institutions have different qualities. For example a network has the advantage of informality, an agency can guarantee a higher level of integration but at the same time the inclusion of various actors and an institution has more power to enforce rules or to exert pressure on the member states. Such functional advantages would have to be present in the argumentation of EU actors when deciding for the creation of the SSM and SRM. Or if we look at it the other way round: The reason for delegating regulatory authority to the ECB and the SRB must not be the result of political power struggles but of functional considerations. An overview of the observable implications for H1 can be found in Figure 2 on the next page.

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Figure 2: Observable Implications for the Functional Part (H1) of the Causal Chain (own illustration) Functional parameters What needs to be observed

Functional gap in banking governance exists; it

aggravates the banking crisis and causes costs

 Regulatory deficit leads to failing banks; common EU rules for supervision and resolution are missing and result in uncertainty; or there is a lack of a regulatory authority which creates rules and ensures their implementation

 Operational deficit leads to failing banks; common implementation fails because of deficient and not implementable regulatory standards

 Capacity deficit leads to failing banks; EU actors lack the capacity to guarantee proper supervision or resolution, they do not have the

possibility to provide certain necessary functions (e.g. lender of last resort)

Functional gap triggers the SSM / SRM creation process

 EU actors become aware of at least one functional deficit and constantly refer to this gap when making suggestions for the SSM / SRM

 EU policy makers offer the creation of the SSM / SRM as an solution to the specific functional deficits

Regulatory authority (ECB / SRB) is chosen according to functional advantages to close the functional gap

 ECB is chosen as SSM institution because only an institution has enough power to (if necessary) enforce common supervision and ensure compliance with supervisory rules across member states

 SRB is created as SRM agency because only an agency can guarantee a common level of resolution standards as well as the involvement of all relevant actors and their particular know-how on bank resolution

Political Observations: Distributional Conflicts and Asymmetrical Burdens

After having researched the first hypothesis, the political and power-based hypothesis (H2) will be examined. H2 claims that if there was a distributional conflict in the areas of banking supervision and resolution, this would have led to fights between the EU actors about how to exactly implement the SSM and SRM. For the most part, a distributional conflict arises between different EU member states. This is because a distributional conflict is usually about who pays how much for a certain policy measure and about how things – for example financial aids for banks – are distributed among member states. Such a conflict could be observed in the case of the Banking Union if – after having agreed on creating the SSM and SRM in general – especially the member states were fighting over how to exactly organize supervision and resolution on an EU level. After all, every member state has the political preference to reduce costs for him by pushing for certain design proposals. An observation for H2 could for example be that member states argue about when to start the implementation at all, how many banks to include into EU supervision or resolution or how to distribute financial burdens (for example financial aid for banks) within the Banking Union.

According to H2, these disagreements become even worse, if it is not just a distributional conflict but an asymmetrical distributional conflict. That means it is not just about who pays

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how much for example for failing banks, but that one or a few member states are burdened more than others. For example, they have higher adaption costs to the SSM or SRM because of special national features of their banking systems. Or they fear that they generally will have to pay more for a policy measure than others, for instance because they have a very stable banking sector and are not dependent on EU aid whereas other member states desperately need such financial support. Since it is about their costs, they will be highly reluctant to give up control over banking supervision or resolution. If they have to bear these costs, they at least will try to keep power over the SSM or SRM by wanting control rights, veto powers or quite generally a final say in supervision and resolution issues. By pushing through these political interests, they extensively influence the design of the SSM and SRM, inter alia by establishing specific decision making procedures or by determining what kind of actors get involved in EU level supervision and resolution. However, to confirm H2, it must not be observed that member states refuse to delegate supervision or resolution authority altogether.

It rather means that they delegate authority to a regulatory body but at the same time they at any rate try to weaken these agents by applying tight control mechanisms via management boards or the like, by claiming veto powers or a final word in decision-making procedures.

The observable implications of H2 are summarized below in Figure 3.

Figure 3: Observable Implications for the Political Part (H2) of the Causal Chain (own illustration) Political parameters What needs to be observed

Distributional conflict exists  High costs for member states to create Banking Union (e.g. adaption costs due to specific features of their national banking sectors)

 Negotiations about who pays how much for SSM or SRM or in particular for failing banks or the wind up of such banks

 Giving up sovereign powers and thereby losing control over national financial issues (e.g. funds for bank rescues)

Leads to disputes about exact implementation of supervision / resolution mechanisms

EU actors disagree about …

 Decision-making procedures and involvement of different actors in the SSM / SRM

 The Scope of the SSM or SRM

 Veto powers and control mechanisms of the SSM or SRM

Asymmetrical distributional conflicts makes the member states want to keep a high level of control over supervision / resolution

 At least one member state is more burdened by the SSM or SRM than the others or the member state at least fears to be more burdened in the future

 The asymmetrically burdened member states advocate for tight control mechanisms, for example through management boards, decision-making procedures and veto rights

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