THE FOUNDATIONS OF REGULATORY CONVERGENCE AND DIVERGENCE BETWEEN THE FEDERAL RESERVE AND EUROPEAN CENTRAL BANK KATHRYN C. LAVELLE* ABSTRACT Neither the U.S. Federal Reserve nor the European Central Bank was created as a bank supervisory institution. Each has evolved into its current role, yet for different reasons. While international institutions such as the Basel Committee and Financial Stability Board have promoted regulatory cooperation from the system level down, the international and internal dynamics that have propelled the expansion of these supervisory roles have put competing and, at times, opposing pressures on transnational regulatory convergence and divergence. In order to explore the foundations of regulatory divergence between the U.S. and Europe, this Article will compare the political origins of the regulatory function of the Federal Reserve with the Single Supervisory Mechanism (SSM) of the European Central Bank (ECB) by considering a vast array of influences that shaped these institutions such as statutory authority, domestic politics, and bureaucratic context. The result will point to future dilemmas in the regulation of foreign banking authorities with respect to formal political institutions at the intersection of national and international politics. I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . II. EXPLAINING TRANSNATIONAL POLITICAL DEVELOPMENT IN THE CONTEXT OF INTERNATIONAL FINANCIAL REGULATION . . . . . . . . A. Academic Approaches to Studying Political Development . . . B. What is Transnational Political Development? . . . . . . . . . . C. Why the Study of Transnational Political Development Sheds Light on Divergence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . III. THE NATIONAL AND INTERNATIONAL POLITICS OF BANKING SUPERVISION IN THE EVOLUTION OF THE FEDERAL RESERVE SYSTEM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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* Ellen and Dixon Long Professor of World Affairs, Case Western Reserve University, Cleveland, Ohio; Ph.D. in Political Science, Northwestern University, Evanston, Illinois; M.A. in Government and Foreign Affairs, the University of Virginia, Charlottesville, Virginia; B.S.F.S. cum laude, in International Economics, Georgetown University, Washington, D.C. © 2014, Kathryn C. Lavelle.

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A. The Context of the Creation of the Federal Reserve and Ambiguity in its Supervisory Powers . . . . . . . . . . . . . . . . . . B. The National and International Context of the Early Federal Reserve System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C. The Federal Reserve as a Supervisor . . . . . . . . . . . . . . . . . . 1. International Negotiations Promote National Regulatory Coordination . . . . . . . . . . . . . . . . . . . . 2. International Market Pressures Erode Glass-Steagall . . . . . . . . . . . . . . . . . . . . . . . . . . . . . IV. THE NATIONAL AND INTERNATIONAL POLITICS OF BANKING SUPERVISION IN THE EVOLUTION OF THE EUROPEAN CENTRAL BANK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A. The Creation of the European Central Bank . . . . . . . . . . . . B. The European Central Bank and the Financial Crisis in Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C. The European Central Bank as a Supervisor . . . . . . . . . . . V. COMPARING THE ORIGINS OF DIVERGENCE IN BANKING SUPERVISION BETWEEN THE FEDERAL RESERVE AND THE ECB . . . VI. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I.

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INTRODUCTION

In the wake of the collapse of the U.S. subprime mortgage market after 2007-2008, the global economy experienced a series of financial crises that prompted calls for dramatic regulatory change of financial markets at both the national and international levels. Because the world’s financial system is so integrated, coordination among states is critical to building a coherent framework of financial regulation. Yet, regulatory practices have subsequently diverged in several crucial areas, even among advanced, industrial countries that would benefit the most from coordinating financial regulation in order to support their substantial volume of trade and financial flows. Divergence is a problem because growing opportunities for regulatory arbitrage among market participants can destabilize the entire system as well as undermine the ability of financial authorities to supervise institutions and promote best practices worldwide, ultimately threatening economic growth and job creation in the industrial core of the world’s economy.1

1. ATLANTIC COUNCIL, THE DANGER OF DIVERGENCE: TRANSATLANTIC FINANCIAL REFORM AND THE G20 AGENDA, 2 (2013); see also Michael Moran & Huw Macartney, Financial Supervision: Internalization, Europeanization, and Power, in CENTRAL BANKS IN THE AGE OF THE EURO: EUROPEANIZATION, CONVERGENCE, AND POWER (Kenneth Dyson & Martin Marcussen eds., 2009).

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Scholarship on regulatory divergence takes many forms. Within the discipline of political science, the subfield of international relations debates the problem of international regulatory financial coordination with an emphasis on international institutions—such as the Financial Stability Board (FSB), Basel Committee on Banking Supervision, International Organization of Securities Commissions (IOSCO), or the International Monetary Fund (IMF)—from the top down.2 The subfield of comparative politics considers regulatory change from the bottom up, or within domestic institutions and their accompanying national political debates.3 Similarly, work in the field of American political development points to the connection between crises and state building with an emphasis on the expansion of domestic administrative capacity and the growth of the welfare state.4 Work on central banks focuses on the nature of their independence from political actors and their role in monetary policy. Such scholarship pays less attention to other policies and functions of these institutions, such as exchange-rate policy, financial regulation and supervision, and negotiating in international forums.5 While this scholarship adds considerably to the discourse, a lack of a broad historical framework often leads to very narrow conclusions. The sources of regulatory convergence and divergence are both national and international in origin. Thus, it is more than a truism to state that national and international financial regulatory systems are complex, or that both national and international politics matter. This Article takes a different tack and considers transnational political development by comparing the internal evolution of two of the world’s major financial institutions as they have responded to competing domestic and international pressures for regulatory coordination and

2. For some examples, see TONY PORTER, STATES, MARKETS AND REGIMES IN GLOBAL FINANCE (1993); Eric Helleiner & Stefano Pagliari, The End of an Era in International Financial Regulation? A Postcrisis Research Agenda, in 1 INTERNATIONAL ORGANIZATION 65 (2011); GLOBAL FINANCE IN CRISIS: THE POLITICS OF INTERNATIONAL REGULATORY CHANGE (Eric Helleiner, Stefano Pagliari & Hubert Zimmermann eds., Routledge (2010); DANIEL W. DREZNER, ALL POLITICS IS GLOBAL: EXPLAINING INTERNATIONAL REGULATORY REGIMES (2007). 3. MARK BLYTH, GREAT TRANSFORMATIONS: ECONOMIC IDEAS AND INSTITUTIONAL CHANGE IN THE TWENTIETH CENTURY (2002); ROSEMARY FOOT & ANDREW WALTER, CHINA, THE UNITED STATES, AND THE GLOBAL ORDER (2011). 4. STEPHEN SKOWRONEK, BUILDING A NEW AMERICAN STATE: THE EXPANSION OF NATIONAL ADMINISTRATIVE CAPACITIES 1877-1920 10 (1982); PAUL PIERSON, POLITICS IN TIME: HISTORY, INSTITUTIONS, AND SOCIAL ANALYSIS 83 (2004). 5. LUCIA QUAGLIA, CENTRAL BANKING GOVERNANCE IN THE EUROPEAN UNION: A COMPARATIVE ANALYSIS 3 (2008).

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divergence.6 Specifically, it compares the growth of the supervisory functions of the Federal Reserve System, in connection with the end of the Glass-Steagall separation of commercial and investment banking functions in 1999, and the European Central Bank (ECB), with the establishment of the Single Supervisory Mechanism (SSM) in 2013. In short, this Article focuses on the dual national and international political configurations that made the growth of the supervisory operations of these two central banks possible. Moreover, it compares the internal institutional configurations that push and pull on convergence and render the process anything but static. The Article will proceed in five parts. Part II considers competing understandings of the role of national and transnational politics in banking supervision. Part III explores the history of bank supervision in the Federal Reserve System and its connection to international developments. Part IV explores the history of bank supervision in the European Central Bank and its relation to national and international affairs. Part V compares the two cases, and Part VI concludes by considering the configuration of political and economic institutions that affect the distribution of power in the polities in which each central bank is embedded—i.e. the United States and the Eurozone.7 II.

EXPLAINING TRANSNATIONAL POLITICAL DEVELOPMENT IN THE CONTEXT OF INTERNATIONAL FINANCIAL REGULATION A.

Academic Approaches to Studying Political Development

Traditional explanations for U.S. policy in the international sphere can be classified as system-centered, society-centered, or state-centered approaches.8 System-centered approaches examine the attributes or capabilities of the United States relative to other countries; societycentered approaches take policy to reflect domestic political struggles among interest groups or parties within the United States. Statecentered approaches view foreign economic policy to be constrained by domestic institutional relationships that have persisted over time. In the area of monetary policy, some analysts assert that U.S. leaders have a relatively free hand in trade policy, because decisions are taken in the

6. For a similar argument concerning the governance of shares issued on emerging stock markets, see KATHRYN C. LAVELLE, THE POLITICS OF EQUITY FINANCE IN EMERGING MARKETS (2004). 7. QUAGLIA, supra note 5, at 17. 8. G. John Ikenberry et al., Introduction: Approaches to Explaining American Economic Policy, in THE STATE AND AMERICAN FOREIGN ECONOMIC POLICY (1988); Jeffrey A. Frieden, Invested Interests: the politics of national economic policies in a world of global finance, 4 INT’L ORG. 45 (1991).

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White House, Treasury, and Federal Reserve, where they are insulated from societal demands.9 Joanne Gowa utilizes a logic of collective action wherein different issues connected to monetary policy determine different incentives for group activity across each of them.10 Other approaches, such as the literature on varieties of capitalism, consider the organization of the market, relations between firms, and interactions between social partners.11 The literature on ideas considers the ideational policy frameworks that inform the actions of policymakers.12 Most authors, such as Lucia Quaglia, take a multi-level institutionalist approach that engages the complexity of history.13 Theorists debate the degree to which the United States or EU sets the pace for transnational regulatory coordination. Most approaches to international relations concur that the Basel Committee is an important site for the coordination of financial regulation in the absence of a true global regulator and that the United States plays a key role.14 For Simmons, the dominant financial center innovates and other regulators then confront incentives to emulate or diverge from new arrangements.15 Drezner argues that the United States and EU prefer to raise financial codes and standards to decrease the level of financial instability, protect domestic investors, and improve the functioning of capital markets.16 They use club intergovernmental organizations to establish global financial regulations like the Basel Committee on Banking Supervision (BCBS) to promulgate common regulatory standards in an effort to avoid the cost of bailing out the private sector in a financial crisis. Singer models the 1988 Basel Accord as an exemplar for other industries wherein unelected regulators, having

9. Stephen D. Krasner, United States Commercial and Monetary Policy: Unravelling the Paradox of External Strength and Internal Weakness, in BETWEEN POWER AND PLENTY: FOREIGN ECONOMIC POLICIES OF ADVANCED INDUSTRIAL STATES (Peter J. Katzenstein ed., 1978); JOHN S. ODELL, US INTERNATIONAL MONETARY POLICY: MARKETS, POWER, AND IDEAS AS SOURCES OF CHANGE (1982). 10. Joanne Gowa, Public Goods and Political Institutions: Trade and Monetary Policy Processes in the United States, 1 INT’L ORG. 42 (1988). 11. VARIETIES OF CAPITALISM: THE INSTITUTIONAL FOUNDATIONS OF COMPARATIVE ADVANTAGE (Peter A. Hall & David Soskice, eds., 2001). 12. Peter A. Hall, The Politics of Keynesian Ideas, in THE POLITICAL POWER OF ECONOMIC IDEAS: KEYNESIANISM ACROSS NATIONS (1989). 13. QUAGLIA, supra note 5, at 17. 14. PORTER, supra note 2; Beth A. Simmons, The International Politics of Harmonization: The Case of Capital Market Regulation, 3 INT’L ORG. 55 (2001); DREZNER, supra note 2; DAVID ANDREW SINGER, REGULATING CAPITAL: SETTING STANDARDS FOR THE INTERNATIONAL FINANCIAL SYSTEM (2007). 15. Simmons, supra note 14. 16. DREZNER, supra note 2.

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authority delegated from legislatures, created a new form of global governance.17 Regulators are caught between the regulated industry’s stability and competitiveness and the international competitive constraints that push against higher levels of regulation. This literature lacks an understanding of how these regulators emerged from individual state political development in the United States or from political development in the EU. B.

What is Transnational Political Development?

While much of the field of American political development has made important contributions in the study of welfare policy and administrative capacities,18 little scholarship has explored the institutions that regulate finance, nor their connection to international developments. Work on the EU has focused on only one institutional aspect of central bank governance— central bank independence and its effects on monetary policy.19 In addition to overlooking important central bank policies, the work overlooks the differences in the nature of the timing problem and its connection to transnational pressures.20 When institutions are built that attempt to address the need to rebuild confidence in the financial intermediaries within the existing regulatory structure, political actors play different roles depending on their connection to domestic and international circumstances. In later phases, the existing bureaucracy itself becomes an actor as agencies compete for influence and politicians pursue electoral goals in the executive branch and legislature.21 The term “political development” has many meanings. “National political development” refers to the historical processes wherein political actors forge administrative capacity in a given area. In Stephen Skowronek’s landmark analysis of this process in the United States, state capacity grew out of institutional struggles rooted in the old regime’s structure and was mediated by shifts in electoral politics.22 Actions taken to meet the challenges posed by a crisis often led to the

17. SINGER, supra note 14. 18. THEDA SKOCPOL & KENNETH FINEGOLD, STATE AND PARTY IN AMERICA’S NEW DEAL (1995); Hall, supra note 12; SKOWRONEK, supra note 4. 19. QUAGLIA, supra note 5, at 3. 20. For an exception in the field of law, see CHRIS BRUMMER, SOFT LAW AND THE GLOBAL FINANCIAL SYSTEM: RULE MAKING IN THE 21ST CENTURY 277 (2012). 21. LEWIS WILLIAM SEIDMAN, FULL FAITH AND CREDIT: THE GREAT S & L DEBACLE AND OTHER WASHINGTON SAGAS (2000). 22. SKOWRONEK, supra note 4, at 13.

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establishment of new institutional forms, powers, and precedents.23 Theorists in this area are not just concerned with what happened, but—to use Paul Pierson’s phraseology—when it happened in the historical sequence.24 Thus, the temporal dimension is well-known to existing theories of American political development.25 Thelen argues that institutions reflect neither the tastes of their creators, nor the distribution of power at their inception:26 their coalitional base is, instead, renegotiated over time. They are transformed through institutional layering, wherein new elements are grafted onto an otherwise stable institutional framework, and through conversion, wherein new goals or groups are brought into the coalitions on which the institutions are founded.27 Path dependence is one of the key temporal concepts associated with institutional change, because at some point in an institution’s history— either at its birth or when actors seek to introduce a new policy initiative—a decision must be made after which time the costs of reversing course escalate. Eventually, some decisions become “locked in” even if actors realize in the future that they did not make the best choice in the past.28 With punctuated equilibrium understandings of institutional change, institutions can persist with long periods of ability until the configuration is upset by some exogenous shock. Such a shock forces new issues on the policy agenda, mobilizes new interests, and raises concerns about the prevailing approach.29 As I use the term here, transnational political development occurs when political institutions have a distinct administrative jurisdiction in one or more states, and yet their work responds to global stimuli and has global implications, intended or not, in the temporal sequence. Thus, transnational political development of this type is not the work of international organizations such as the IMF or IOSCO, per se, as national regulatory agencies or central banks are part of the governance apparatus of distinct states. At the same time, the effects of their

23. Id. at 10. 24. Paul Pierson, Not Just What, but When: Timing and Sequence in Political Processes, in Spring AMERICAN POLITICAL DEVELOPMENT 14 (2000). 25. PIERSON, supra note 4. 26. Kathleen Thelen, HOW INSTITUTIONS EVOLVE: THE POLITICAL ECONOMY OF SKILLS IN GERMANY, BRITAIN, THE UNITED STATES, AND JAPAN 34 (2004). 27. Id. at 36. 28. MARC ALLEN EISNER, THE AMERICAN POLITICAL ECONOMY: INSTITUTIONAL EVOLUTION OF MARKET AND STATE 27 (2011); PIERSON, supra note 4; Simmons, supra note 14. 29. EISNER, supra note 28, at 28.

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policies cross borders, thus prompting calls for international coordination of regulatory activities.30 C. Why the Study of Transnational Political Development Sheds Light on Divergence Nonetheless, I have argued in other work that decision-making for most banking policy remains at the domestic level, where bureaucratic agencies—within which interest groups fuel politics—make the rules that govern actual financial instruments, and thus policy outcomes.31 Given the differences between national and international environments, as well as differences in the historical context, it is not surprising that interest groups in the United States might work to harmonize standards in the international forum and then fight domestic implementation depending on how the rules are translated into U.S. regulations.32 Likewise, in the EU, supranational institutions may make policy, but the implementation is most effective when information production and disclosure is a key part of the agreement.33 III. THE NATIONAL AND INTERNATIONAL POLITICS OF BANKING SUPERVISION IN THE EVOLUTION OF THE FEDERAL RESERVE SYSTEM To understand the current state of the Federal Reserve’s supervisory authority and coordination between the Fed and other international regulatory institutions, it is important to look back at the institution’s development and understand that it was shaped by both domestic and international pressures. The first part of this section considers the context in which the Fed was created, the second part considers the Fed’s early stages and how domestic and international forces shaped its development, and the final part explores the role of the Fed’s supervisory capacity and how it was shaped by both international negotiation and domestic pressures that led to the erosion of Glass-Steagall.

30. See discussion in BRUMMER, supra note 20, at 35. 31. KATHRYN C. LAVELLE, MONEY AND BANKS IN THE AMERICAN POLITICAL SYSTEM (2013). 32. Kathryn C. Lavelle, Implementing the Volcker Rule in National and International Politics, in TRANSNATIONAL FINANCIAL REGULATION AFTER THE CRISIS 115 (Tony Porter ed., 2014). 33. Daniel Farber, Introduction: Legal Guidelines for Cooperation between the EU and American State Governments, in TRANSATLANTIC REGULATORY COOPERATION: THE SHIFTING ROLES OF THE EU, THE US AND CALIFORNIA 3, 4 (David Vogel & Johnan F.M. Swinnen ed., 2011).

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A. The Context of the Creation of the Federal Reserve and Ambiguity in its Supervisory Powers The national and international contexts in which the Federal Reserve operates have shaped its supervisory powers since the time it was created up to the present. By the 1930s, two dominant models had emerged concerning the constitution of central banks and their powers: the American Federal Reserve System and the Bank of England system.34 With the latter, a powerful regulator presided over a highly concentrated, close-knit, exclusive market structure through understandings, conventions, trust, and tradition.35 Conversely, the Federal Reserve regulated a highly decentralized market structure alongside other regulators.36 This system of regulation was more rule-bound, formal, and bureaucratic.37 As other countries developed national banking systems, they generally followed one of these models.38 The Federal Reserve System was created with the passage of the Federal Reserve Act in 1913.39 The preamble to the Act states that its purpose is “[t]o provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.”40 While the Act provided for regulation and supervision, its major provisions addressed bank organization.41 What regulation it did accomplish was to create standards for membership, reserve requirements, regulations governing rediscounting, open market operations, and issuance of currency.42 Once the Federal Reserve System was established, it became the final arbiter of what is acceptable in banking.43 The legislation, however, was not clear as to how bank supervision was to be accomplished.

34. JOHN BRAITHWAITE & PETER DRAHOS, GLOBAL BUSINESS REGULATION 93 (2000). 35. Id. 36. Id. (The Fed shared authority with the Comptroller of the Currency, Federal Deposit Insurance Corporation, Treasury, and state agencies.) 37. Id. 38. Id. 39. Federal Reserve Act, 43, 63rd Congress, Session II, 251. Chapter 6. Accessed at http:// www.constitution.org/uslaw/sal/038_statutes_at_large.pdf (January 9, 2014). 40. Id. at 251. 41. Id. at 254-60, 271-72; see also, AM. INST. OF BANKING, MONEY AND BANKING 399 (1940). 42. AM. INST. OF BANKING, supra note 41; Federal Reserve Act at 273-74. 43. See AM. INST. OF BANKING, supra note 41, at 399. For a discussion of the politics of the creation of the system, see Sarah Binder & Mark Spindel, Monetary Politics: Origins of the Federal Reserve, in American 27 STUD. IN AM. POL. DEV. 1 (2013).

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This ambiguity is not surprising. The American governing apparatus is divided among state and federal governments and consciously avoids concentration of power in either.44 What concentration has occurred has evolved over time in response to crises and layers of legislation.45 Prior to the twentieth century, central banks did not act as examiners.46 The Bank of England—which is the second-oldest central bank in the world and was, at the time, arguably the most important bank in Europe—made monetary policy for a community of brokers that evaluated which banks were individually credit worthy.47 With this policymaking arrangement, the central bank did not seek to learn about conditions in individual banks.48 The earliest bank supervision in the United States occurred in stipulations in individual state charters limiting their activities.49 Over time, state legislation expanded the program of supervision into laws applicable to all banks.50 State law thus determined which investments and accounting systems were permitted for savings-bank use. States also created administrative agencies to make periodic examinations of books, vaults, and portfolios.51 The national banking system was established in 1863, when the Office of the Comptroller of the Currency (OCC) was created as an independent agency within the Treasury Department. The OCC initially served to provide funding for the Civil War,52 but it was later transformed into a regulatory agency.53 In the absence of a true central bank and with a variety of agencies that could charter banks at the state and federal levels, the United States lacked the institutional capacity to supervise all banks.54 The ambiguity would prove to be significant during the Great Depression of the 1930s, when further legislation would clarify some roles and leave others for later eras.

44. LAVELLE, supra note 31. 45. For a discussion of the connection between the early American state as a model for the Europeans, see C. RANDALL HENNING & MARTIN KESSLER, Fiscal Federalism: US History for Architects of Europe’s Fiscal Union, (Working Paper, 2012). 46. MARTIN MAYER, THE FED: THE INSIDE STORY OF HOW THE WORLD’S MOST POWERFUL FINANCIAL INSTITUTION DRIVES THE MARKET 33-34 (2001). 47. Id. 48. Id.; see also QUAGLIA, supra note 5, at 17. 49. AM. INST. OF BANKING, supra note 41, at 399. 50. Id. 51. Id. at 389. 52. LAVELLE, supra note 31, at 40. 53. Id. at 41. 54. Id. at 43-44.

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B.

The National and International Context of the Early Federal Reserve System

The international financial system played a role in the creation of the Federal Reserve system, just as its birth had implications on the global stage. Between 1863 and 1913, the shape of the American economy and sources of finance changed dramatically. The United States was an emerging economy that experienced episodic financial panics.55 Great Britain was the center of the international financial system, and the London market financed most American exports.56 Because exports were mostly agricultural, seasonal needs for credit shifted, with high demand for credit in the fall when interest rates would rise.57 American bankers perceived that the lack of a central bank put them at a disadvantage with London bankers because they did not have a facility to discount export credits.58 Politicians were concerned with the seasonal fluctuation in interest rates.59 Thus, many political constituencies were ripe to support a banking system that could expand credit and adjust seasonal interest rates.60 The compromises that were necessary to satisfy these diverse constituencies meant that some key elements remained to be determined when the new institution would become operational. Chiefly, when the Federal Reserve Act was passed, it was ambiguous on the issue of banking supervision. Thus, its passage created a degree of confusion with the existing regulator of banks operating under a national charter: the OCC.61 Confusion stemmed from the provision in the Federal Reserve Act that amended the National Bank Act to give the Comptroller of the Currency the authority to examine every member bank of the Federal Reserve.62 At the same time, the Federal Reserve Act gave Federal Reserve Banks the authority to examine both national and state member banks with the approval of a Board of Governors that was to be established in Washington to oversee the system.63 The Comptroller

55. ALLAN H. MELTZER, A HISTORY OF THE FEDERAL RESERVE: VOLUME I, 1913-1951 9 (2003). 56. Id. at 8. 57. Id. 58. Id. 59. Id. at 8-9. 60. Id.; see also J. LAWRENCE BROZ, THE INTERNATIONAL ORIGINS OF THE FEDERAL RESERVE SYSTEM (1997). 61. BERNARD SHULL, The Fourth Branch: The Federal Reserve’s Unlikely Rise to Power and Influence 56 (2005). 62. Id. 63. Id.

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and Secretary of the Treasury served, ex officio, on the Federal Reserve Board.64 In 1917, the potential for open conflict between the two on this issue was initially avoided when the Federal Reserve and Comptroller agreed to restrict the latter’s supervision to nationally chartered banks and the former’s to state-chartered banks that were members of the Federal Reserve System.65 The policy focus of the new central banking system was on interest rates and the money supply.66 Conflict emerged within the Federal Reserve over the open market operations that affected these areas, as regional Reserve Banks had independent authority.67 As the supervisor of the Reserve Banks, the Board of Governors had to approve open market operations, which became a source of tension as they became a prominent policy instrument.68 An informal committee among regional Reserve Banks, led by the Federal Reserve Bank of New York, organized to coordinate these actions, although participation was optional.69 The Banking Act of 1935 clarified many of the disagreements between the Board and regional Reserve Banks, particularly with respect to the membership of the body that became the Federal Open Market Committee, and set policy goals for the open market operations of the entire system. In the process, the Federal Reserve System became a true central bank, no longer divided among its Board and regional Reserve Banks.70 However, other proposed changes to clarify ambiguity in the system never occurred during the Depression, chiefly those concerning membership in the Federal Reserve System and examination standards.71 Marriner Eccles, the Chair of the Federal Reserve Board at the time, encouraged Franklin D. Roosevelt to support legislation requiring all banks to join the System when the Depression era reforms were debated.72 He argued that the system could not function properly with some banks in and others out.73 He also made a case that all bank examination and regulation should be under the Federal Reserve’s control so that bank examiners could vary their standards over the

64. 65. 66. 67. 68. 69. 70. 71. 72. 73.

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course of the business cycle to complement monetary policy.74 Although Roosevelt did not initially support these proposals, he did eventually agree to support unification and liberalization of bank examination policies.75 At that time, all of the other banking agencies agreed to a common set of standards along with the National Association of State Bank Examiners and later the American Bankers Association.76 That action, and later preoccupation with the Second World War, pre-empted an immediate need for legislation and examination was never consolidated.77 Nonetheless, government officials have put forward other proposals for agency coordination or consolidation since that time, most recently in the form of those for a Financial Stability Oversight Council when the Dodd-Frank reform bill of 2010 was being debated.78 The result of this institutional evolution is that the Federal Reserve became one bank supervisor among several with competing and, at times, overlapping claims. While the Clayton Act of 1914 gave the Federal Reserve new authority to prevent the merger of national banks, the ability to approve or disapprove national banks from establishing foreign branches, the ability to regulate the interest rates that banks could pay depositors after 1933, and the ability to set margin requirements for all lenders on loans for the purpose of selling stocks after 1934, the Federal Reserve did not have much other authority over nationally chartered banks.79 While it strived to remain outside the political process by design, it emerged as a regulator with its own agenda within competing bureaucratic agencies.80 Most Federal Reserve supervision in the 1950s occurred through the operations of the discount window. Officers of the regional Reserve Banks could evaluate the quality of collateral banks offered when they borrowed there.81 Hence, the Federal Reserve could not close a bank, but it could keep one open by continuing to lend through the discount window.82 Working conditions for bank supervisors appeared to be better in the Federal Reserve than in the Office of the Comptroller of

74. Id. 75. Id. at 487. 76. Id. 77. Id. at 488. 78. Ben Bernanke, Testimony Before the Committee on Financial Services, US House of Representatives, Washington, D.C., FINANCIAL TIMES, July 24, 2009. 79. MAYER, supra note 46, at 34. 80. LAVELLE, supra note 31. 81. MAYER, supra note 46, at 34. 82. Id. at 36.

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the Currency.83 The funds to cover deposits in a failed institution came from a third agency—the Federal Deposit Insurance Corporation (FDIC).84 Thus, tensions among the regulators over a myriad of issues persisted.85 C.

The Federal Reserve as a Supervisor

National and international courses continued to collide with market forces to produce dramatic change in the structure of the U.S. and global banking systems in the 1980s. On the national track, deregulation of the banking sector occurred in response to market pressures to end the regulation of interest rates and to completely remove the crumpling wall between investment banking and commercial banking that had been established by Glass-Steagall.86 On the international track, the expansion of global banking compelled market participants to seek international, as well as national, coordination in the Basel negotiations.87 The culmination of the national process was the passage of the Financial Services Modernization Act of 1999, which notably repealed Glass-Steagall, and the culmination of the international process was the conclusion of the Basel agreements on the division of responsibilities for transnational bank supervision between home and host countries and a series of agreements on capital adequacy standards.88 A less prominent provision in the Financial Services Modernization Act of 1999, but of great consequence for the future of bank supervision, was the reorganization of banking regulation and new powers granted to the Federal Reserve with respect to bank holding companies.89 1.

International Negotiations Promote National Regulatory Coordination

On the international front, the U.S. banking system confronted problems associated with its dramatic postwar expansion.90 Banks

83. Id. 84. Id. 85. Id. 86. FINANCIAL CRISIS INQUIRY COMMISSION, THE FINANCIAL CRISIS INQUIRY REPORT 52 (2011). 87. SINGER, supra note 14. 88. FINANCIAL CRISIS INQUIRY COMMISSION, supra note 86, at 55. 89. Id. 90. HAROLD VAN B. VLEVELAND & THOMS F. HUERTAS, CITIBANK: 1812-1970 (1985); JOHN DONALD WILSON, THE CHASE: THE CHASE MANHATTAN BANK, N.A. 1945-1985 (1986); RICHARD B. MILLER, CITICORP: THE STORY OF A BANK IN CRISIS (1993).

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established new branches and broadened their geographic reach.91 From 1952 to 1985, U.S. banking offices’ liabilities to foreign residents compounded at a rate of almost thirteen percent a year.92 When Mexico defaulted on its sovereign debt in 1982, that event and the later Latin American debt crisis forced banks to reconsider traditional regulatory practices and seek international coordination in forums such as the Basel Committee on Banking Supervision that would minimize future instability.93 The international developments would lead national regulators to coordinate among themselves in order to minimize the differential costs of compliance among U.S. banks. Initially, Congress passed the International Lending Supervision Act (ILSA) on November 30, 1983, which charged regulatory agencies with establishing minimum levels of capital for banking institutions and instructed regulatory authorities to use the Basel committee to establish an international agreement on uniform capital standards.94 The banking sector was willing to seek new methods for monitoring bank safety and establishing capital adequacy standards, such as the “riskweighted” standards that had been developed in Europe.95 ILSA reflected the commonality of banking regulators’ positions despite their frequent conflicts.96 Some analysts argue that the regulators were unified in order to prevent Congress from dismantling the entire regulatory system after its failure to prevent the debt crisis.97 Through the Act, Congress and the private sector put political pressure on the regulators to persuade their counterparts to develop a global framework for the regulation of capital standards through ILSA.98 The result was the first Basel agreement on capital adequacy, concluded in 1988 and otherwise known as Basel I.99 In July 1984, the Federal Reserve Board proposed new standards for

91. MILLER, supra note 90. 92. PETER DOMROWSKI, POLICY RESPONSES TO THE GLOBALIZATION OF AMERICAN BANKING, 10 (1996). 93. Ethan B. Kapstein, Supervising International Banks: Origins and Implications of the Basel Accord, in International Finance, Princeton University, no. 185, 16 (1991). 94. DAN TARULLO, BANKING ON BASEL: THE FUTURE OF INTERNATIONAL FINANCIAL REGULATION (2008). 95. Kapstein, supra note 93, at 16. 96. DOMROWSKI, supra note 92, at 117. 97. For an example, see id. 98. Kapstein, supra note 93, at 14; WOLFGANG H. REINICKE, BANKING, POLITICS AND GLOBAL FINANCE: AMERICAN COMMERCIAL BANKS AND REGULATORY CHANGE, 1980-1990, 148 (1995); WOLFGANG H. REINICKE, GLOBAL PUBLIC POLICY: GOVERNING WITHOUT GOVERNMENT?, 108 (1998). 99. LAVELLE, supra note 31, at 234.

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member banks and holding companies that would have put minimal capital of 5.5% of total assets, or total capital equal to 6% of adjusted assets on reserve.100 The banking community was initially receptive to the idea of risk-weighted rules over capital-to-asset ratios in the wake of the Mexican default.101 Smaller banks could actually hold less capital.102 Therefore, at the same time the Basel Committee attempted to find common ground among countries with varying standards that reflected the diversity of banking structures, regulators in the United States sought to find the same common ground among themselves.103 There was the perception that the approach of the first Basel Accord, with its risk-weights, made “global banking markets more stable and competitively balanced.”104 The American regulators resolved the differences in 1985 when they agreed to adopt a minimum fixed capital-to-asset ratio of 5.5% for banks.105 When studying the issue, investigators at the Bank for International Settlements, where the Basel Committee is located, argued that such static capital-asset measures had the effect of driving bank assets off of the balance sheet.106 That allowed banks to avoid regulations by booking off the balance sheet with instruments that were “contingent liabilities” of the bank.107 The BIS research concluded that regulations must capture both on- and off-balance-sheet risk and should reflect the level of risk associated with the asset. The Federal Reserve Board announced supplementary capital measurements that would incorporate the risk-based concept in 1986.108 The measures were designed to address the growth of off-balance-sheet exposure, to reward banks for holding more liquid assets, and to bring the United States closer to the countries that had already begun to use risk-weighted systems.109 While the agreement may have moved in the direction of international cooperation, U.S. regulators debated how the Basel standards would apply. Changing the domestic standards at that time would have

100. SINGER, supra note 14, at 61. 101. Id. 102. Id. 103. Id. 104. Id. 105. Kapstein, supra note 93, at 17-18. 106. Id. 107. Id. Contingent liabilities are those that may be incurred by a financial organization depending on the unknown outcome of an event such as a court case. 108. Ethan B. Kapstein, Resolving the Regulator’s Dilemma: International Coordination of Banking Regulations, 43 INT’L ORG. 323, 338 (1989); Kapstein, supra note 93, at 17. 109. SEIDMAN, supra note 21, at 133.

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threatened the FDIC’s insurance fund because it would have permitted nine out of ten small banks to hold less capital at a time when banks were failing and the whole system was subject to a higher degree of risk. The OCC wanted to use the Basel standard for sovereign bonds because it wanted the banks it regulated to be able to compete with foreign banks that would be using the lower standards. The Federal Reserve compromised with the FDIC and eventually the OCC agreed with them.110 Thus, some coordination occurred both within the United States and across countries. Nonetheless, ongoing changes led negotiators to propose a new accord to replace the 1988 Basel Accord and remove distortions like the favorable risk weightings assigned to industrial countries’ bonds.111 The United States played an active role in the Basel II negotiations as well.112 For example, researchers from the Federal Reserve contributed to the specification and calibration of the models that underlie the approach.113 The next round was not fully implemented when the financial crisis reshaped the financial services industry in the United States after 2008. Thus, the implementation of Basel II would need to occur in the new landscape, where leaders immediately called for a Basel III. 2.

International Market Pressures Erode Glass-Steagall

As coordination occurred across inter-state American and foreign regulators, the intra-state relationship among U.S. regulators also changed as markets challenged the unique arrangement created among them during the Great Depression.114 The story began on the domestic front as inflation curtailed the ability of the Federal Reserve to maintain controls on interest rates during the 1970s.115 As the controls were phased out, debates about the structure of banking regulation reignited, particularly concerning the divisions between investment banking, insurance, and commercial banking.116 The divisions began to erode prior to any legislative action. Some companies borrowed

110. Id. 111. George Kaufman, Basel II vs. Prompt Corrective Action: Which is Best for Public Policy?, 14 FIN. MKTS., INSTS., AND INSTRUMENTS, 351 (2005). 112. Richard J. Herring, The Rocky Road to Implementation of Basel II in the United States, 35 ATL. ECON. J. 411, 412 (2007). 113. Id. 114. FIN. CRISIS INQUIRY COMM’N., supra note 86, at 52. 115. Id. at 29. 116. Id.

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directly in securities markets where they could receive lower interest rates than they could in the banking system, which put pressure on banks to offer more services to their customers.117 In 1986, the Federal Reserve Board reinterpreted Section 20 of the Glass-Steagall Act and allowed banks to earn up to five percent of their gross revenues from the investment banking business. In January 1989, the Federal Reserve added the ability to underwrite commercial paper and municipal revenue bonds to commercial banks, as well as limited power to float corporate bonds.118 Ongoing mergers and rule changes at the Federal Reserve permitted some firms to get around Glass-Steagall long before it was officially repealed.119 Legislation to repeal the Act was more complicated. The George H. W. Bush administration attempted banking reform in 1991 but did not pass a bill.120 The Clinton administration’s first attempt at banking reform would have created an administrator to coordinate the supervision of state-chartered banks, left the OCC as supervisor of nationally chartered banks, and reduced the examination and rulemaking authority of the Federal Reserve.121 The House Banking Committee passed a reform bill in 1995, but it never reached the floor. Alan Greenspan, who mobilized the state banking commissioners, defeated the effort.122 The industry consolidation that the new environment permitted continued, with the notable merger of Travelers and Citigroup in 1998.123 The new entity pursued the legislation by offering political donations.124 When Lawrence Summers took office as Treasury Secretary, he negotiated directly with Alan Greenspan at the Federal Reserve.125 They then passed their agreement to Congress, which was passed into law.126 The main thrust of the 1999 Financial Services Modernization Act— or Gramm-Leach-Bliley—was to end the Glass-Steagall separation of

117. Id. at 30. 118. Thomas Stratmann, Can Special Interests Buy Congressional Votes? Evidence from Financial Services Legislation, 45 J.L. & ECON. 345, 345-73 (2002). 119. Id. 120. Id. 121. LAVELLE, supra note 31. 122. See id. 123. See The Long Demise of Glass-Steagall, PBS Frontline (May 8, 2003), http:www.pbs.org/wgbh/ pages/frontline/shows/wallstreet/weill/demise.html. 124. In the 1997-98 election cycle, the finance, insurance, and real estate industries spent more than $200 on lobbying and more than $150 million in political donations. See id. 125. For a detailed account, see MAYER, supra note 46, at 48. 126. ALAN GREENSPAN, THE AGE OF TURBULENCE: ADVENTURES IN A NEW WORLD 198 (2007).

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commercial and investment banking.127 The Act, however, also represented a significant advance in the Federal Reserve’s supervisory powers.128 While the Federal Reserve had been designed as the consolidated supervisor of all bank holding companies in the Bank Holding Company Act of 1956 (BHCA), this older legislation restricted what entities bank holding companies could acquire.129 Gramm-LeachBliley repealed portions of the BHCA and designated the Fed as the “umbrella supervisor” of the financial holding companies that had grown at the time.130 Under the new law, the functional regulator regulates each specific activity.131 For example, the Securities and Exchange Commission (SEC) regulates the securities subsidiary; the Federal Reserve would be responsible for the company that owns the subsidiary.132 When critics objected to the combination of regulation, supervision, and monetary policy in one institution, the Federal Reserve nonetheless fought to expand its role in regulation and supervision because it argued that it needed to understand what occurs in banking markets, along with the nature of innovations and risk exposures and controls that are necessary for crisis management.133 The result of the converging national and international plotlines is that the Federal Reserve took on additional supervisory powers—as a result of both a process of national harmonization to meet the demands of international negotiations and the international concentration of banking to include both investment and commercial activities within the same entity, a practice the United States had prohibited from the 1930s to 1990s.134 After the financial crisis, changes in regulation progressed more rapidly at the domestic level in the United States than in Europe and included a greater role for the Federal Reserve as both supervisor and regulator.135 In July 2010, the U.S. Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which changed the bureaucratic structure

127. FIN. CRISIS INQUIRY COMM’N., supra note 86, at 55. 128. Id. 129. Id. 130. Id. 131. Id. 132. MAYER, supra note 46, at 28-29. 133. John T. Woolley, The US Federal Reserve and the Politics of Monetary and Financial Regulatory Policies, in CENTRAL BANKS IN THE AGE OF THE EURO: EUROPEANIZATION, CONVERGENCE, AND POWER 315 (Kenneth Dyson & Martin Marcussen eds., 2009). 134. BRAITHWAITE & DRAHOS, supra note 34, at 93. 135. See ROBERT G. KAISER, ACT OF CONGRESS: HOW AMERICA’S ESSENTIAL INSTITUTION WORKS, AND HOW IT DOESN’T (1st ed. 2013).

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through which the Basel Accord must be implemented by altering the terms of supervisory coordination and the creation of the Consumer Financial Protection Bureau.136 IV.

THE NATIONAL AND INTERNATIONAL POLITICS OF BANKING SUPERVISION IN THE EVOLUTION OF THE EUROPEAN CENTRAL BANK

This section compares the transnational political development of the supervisory powers of the European Central Bank (ECB) through the Single Supervisory Mechanism with what occurred in the context of the Federal Reserve. In each case, the supervisory work of these two central banks responded to global events and likewise has global implications, regardless of whether or not these implications were intended. The first part of this section considers the origins of the ECB with the creation of the euro, and the second part explores the evolution of supervision in the ECB in response to the financial crisis in Europe. The final part considers the new role of the ECB as a supervisor. A.

The Creation of the European Central Bank

On January 1, 1999, eleven continental European states created the European Central Bank and with it a new currency, the euro, to replace their national currencies.137 The new central bank in Frankfurt would set short-term interest rates and seek to establish price stability; it would not, however, play a role in fighting unemployment like the U.S. Federal Reserve. Most classifications would place the ECB as the most independent central bank in the world in terms of political and economic independence.138 When it was established, though, the regulation and supervision of individual banking systems remained with national institutions.139 Great Britain chose to remain outside the Eurozone, and moved regulation and supervision of British banks from the Bank of England to a Financial Services authority.140 This umbrella organization was also responsible for securities houses, mortgage lend-

136. See generally, AMERICAN BANKERS ASSOCIATION, DODD-FRANK AND COMMUNITY BANKS: YOUR GUIDE TO 12 CRITICAL ISSUES (2012). 137. DAVID M. WOOD & BIROL A. YESILADA, THE EMERGING EUROPEAN UNION 125 (2nd ed. 2002). 138. QUAGLIA, supra note 5, at 106. 139. MAYER, supra note 46, at 29. 140. ANDRES F. LOWENFELD, INTERNATIONAL ECONOMIC LAW (2002).

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ers, insurance companies, futures and options markets, and securities exchanges.141 Financial reforms in Europe are complicated by the overlapping, but not identical, membership of the European Union and Eurozone.142 For that reason, financial reforms derive from both national and international sources related to the legal complexity of the EU’s treaties, power-sharing political institutions, and interlocking politics.143 Moreover, important differences in decision-making within the EU’s institutions emerged with the advent of the European Monetary Union that have only become more pronounced since the crisis in 2007-2008.144 Hodson argues that with the more traditional “community method” of European governance, the European Commission proposes policy and legislation, represents the EU in international negotiations, and ultimately executes policy together with national governments.145 The Council of Ministers and the European Parliament adopt legislative and budgetary acts.146 The ECB controls and implements monetary policy,147 participates in international monetary institutions, and represents the euro on matters of international coordination.148 The situation has had an additional layer of complexity since the 1950s when European central bank governors began to hold informal meetings among themselves.149 The group formalized in May of 1964 when it created the Committee of Governors of the Central Banks of European Economic Community (EEC) member states; however, it did not meet in Brussels, but rather at the Bank for International Settlements in Basel.150 The Commission’s observer was excluded from some discussions.151 Despite the complexity, formal coordination among the membership of the European Union can be traced to the formation of a Single Market in several phases, with the most recent being that in 1999, which resulted in the creation of the Financial Services Action Plan

141. 142. 143. 144. 145. 146. 147. 148. 149. 150. 151.

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(FSAP) and Lamfalussy framework.152 While the European System of Central Banks and the ECB had no direct responsibility for banking supervision when created, Article 105.5 of the Treaty on European Union stated that the European System of Central Banks would contribute to the smooth conduct of policies pursued by the competent authorities relating to prudential supervision.153 The ECB also had some initial regulatory power and was involved in a number of working groups in areas through senior representatives of banking supervisory authorities and central banks under the auspices of the Committee of European Banking Supervisors (CEBS) that was set up in 2004 in London as part of the Lamfalussy framework mechanism for coordinating supervision of financial services.154 The Lamfalussy framework was initially developed to apply to securities and then extended to other aspects of the financial sector. The ECB opposed this expansion of tasks at the CEBS (now EBA) in London at first, particularly in banking, arguing instead for an enhancement of the role of national central banks in supervision. Later, the ECB made sure that it would be represented on the relevant committees. One explanation for the ECB’s position is that national central banks became anxious to increase their role in supervision, having lost it in monetary policy.155 When the ECB was eventually created, the Banking Supervision Committee (BSC) of the European System of Central Banks was established in Frankfurt, consisting of banking supervisors from all EU member states. Thus, at the time the Lamfalussy framework was established, the relationship between the BSC in Frankfurt and the CEBS in London was quite unclear.156 In January 2011, the European Banking Authority (EBA) took over the responsibilities of the former CEBS. Still headquartered in London, the regulator and its staff of seventy acts as an umbrella oversight body coordinating national supervisors across the entire EU.157 The task of the new entity is to create a European Single

152. LUCIA QUAGLIA, GOVERNING FINANCIAL SERVICES IN THE EUROPEAN UNION: BANKING SECURIPOST-TRADING, 24, 35 (2010). The Lamfalussy architecture was not a specific directive concerning one or two aspects of financial services regulation and supervision, but a change in how to make and implement rules and to coordinate supervision. It delegated responsibility for fostering convergence in supervisory practices to the European Committee of Banking Supervisors rather than the ECB’s Banking Supervision Committee. See id. 153. See id. at 26. 154. See id. 155. QUAGLIA, supra note 5, at 138. 156. Id. at 139. 157. Patrick Jenkins, EBA Chief Plots Path to Banking Union, FINANCIAL TIMES, July 15, 2012. TIES AND

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Rulebook in banking—a single set of rules for financial institutions throughout the EU.158 B. The European Central Bank and the Financial Crisis in Europe As the financial crisis of 2008 played out in Europe, the weaknesses that were inherent in having separated the functions of a supranational central bank from national supervisory institutions became apparent, and the European Commission was forced to respond.159 Any quick reforms were complicated because the Intergovernmental Conference that established the ECB had opposed efforts proposed by the Commission that would allow an amendment to the European System of Central Bank rules by a simplified procedure.160 Moreover, the many veto points in the EU institutions have also tended to lock in a distinctive paradigm with respect to price stability but not employment.161 Thus, in the short institutional history of the ECB, the status quo was difficult to change despite the severity of the deepening crisis.162 When the crisis reached epic proportions in October of 2008, the president of the European Commission, Jose Manuel Barroso, formed a High Level Group on Financial Supervision in the EU in order to make recommendations on a range of problems— one of which was stronger coordination of bank supervision.163 Among those contained in the Group’s final report was a proposal to establish a new European Systemic Risk Council (ESRC) under the auspices of the ECB, where central bankers would play a more active role in warning about risks to the financial system and try to ensure better transfers of information among supervisors.164 While the ECB had already acquired a few supervisory tasks prior to the financial crisis, national supervisory authorities and governments of member states resisted expansion of ECB authority.165 The relations between the ECB and the Council on this matter were somewhat

158. 159. 160. 161. 162. 163.

QUAGLIA, supra note 5, at 110. Id. Id. Id. Id. LAROSIERE GROUP, REPORT OF THE HIGH LEVEL GROUP OF EXPERTS ON FINANCIAL SUPERVISION IN THE EU (2009). 164. See Nikki Tait, Banker attacks piecemeal oversight, FINANCIAL TIMES, March 18, 2009. 165. See HODSON, supra note 144, at 31; see also QUAGLIA, supra note 5, at 126.

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dependent on the Council’s presidency.166 The dispute over the appropriate role of central banks in supervisory activities was over more than a bureaucratic division of responsibilities: some European central banks act as supervisors at the national level, whereas others perform monetary policy and banking supervision is conducted in a separate institution.167 Nonetheless, following other proposals in other European institutions, the June 29, 2012 Euro-Area Summit Statement argued for a single supervisory mechanism in order to break the link between sovereigns and their banks.168 On September 12, 2012, the European Commission proposed that the supervision of the Eurozone’s banks would be assigned to the ECB under article 127(6) of the Treaty of Lisbon as part of a broader package of reforms constituting a “banking union” that would pool the zone’s deposit guarantee systems and supervisory functions.169 C.

The European Central Bank as a Supervisor

When formal proposals for a Single Supervisory Mechanism (SSM) took shape, it was intended to be the first mechanism among several (including common capital requirements, deposit insurance, a recovery and resolution framework and other aspects of banking) that would comprise a banking union. Participation in the banking union is mandatory for Eurozone members, but optional for non-Eurozone EU states that can choose to enter into “close cooperation” with it.170 Hence, with the formation of the comprehensive banking union, the ECB will eventually take responsibility for the stability of the largest banks in the Eurozone. Nonetheless, the banking union will be created in stages, as sketched in the “Four President’s Report” of December 2012.171 Thus, in order to move toward an integrated financial framework, the SSM requires coordinated deposit guarantees and a single

166. QUAGLIA, supra note 5,at 126. 167. See QUAGLIA, supra note 152, at 27, 50; see also QUAGLIA, supra note 5, at 40, 138. 168. Press Release, European Central Bank (June 29, 2012), available at http://www. consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131359.pdf. 169. Communication from the Commission to the European Parliament and Council: A Roadmap Towards a Banking Union, COM (2012) 510 final (September 2012). 170. Non-euro-zone EU members do not have the same legal rights with respect to the ECB and therefore cannot participate in exactly the same manner as euro-zone members. See Michael Steen, ECB delves into messy world of supervision, FINANCIAL TIMES, Sept. 12, 2012. 171. See Herman Van Rompuy, Towards a Genuine Economic and Monetary Union No. 120/12 (June 26, 2012).

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resolution mechanism, and these additional elements continue to be under negotiation as of April 2014.172 Positions among European leaders on the proposal for a Single Supervisory Mechanism were initially divided. German Chancellor Angela Merkel was skeptical, questioning how the ECB could monitor the large number of banks in the Eurozone.173 Great Britain did not want to participate in the SSM but supported the concept for those countries participating in the Eurozone as long as the integrity of the wider EU was not compromised.174 The scheme was presented to German and French taxpayers in order to strengthen their banking systems and lower high borrowing rates.175 The question of the large number of banks to be monitored could be solved by learning most under the supervision of their national bodies, with the ECB only responsible for supervision as the final regulator in order to prevent the escalation of banking crises.176 In time, the imposition of universal controls appealed to Germany, as they are intended to prevent the kind of banking booms that led to the Irish and Spanish Eurozone bailouts.177 Leaders hoped that the banking union would reestablish a degree of trust in the European banking system, restart the European interbank market, improve credit allocation, and break the relationship between bank and sovereign credit.178 The first step of creating the top supervisor in the form of the SSM was finally approved in 2013, yet the additional steps of creating a comprehensive banking union have been more difficult to negotiate. The second step would create a unified authority to close banks and share the costs. Although an early consensus emerged on the concept of a common resolution fund to be established in the next decade and financed by banks, concerns arose over what to do if its resources were inadequate to meet the need. Moreover, the question of the role of the different European institutions also arose.179 Under EU treaties, the

172. Id. at 3. 173. Peter Spiegel, EU Summit: What, Exactly, Was Agreed Friday?, FINANCIAL TIMES, (Oct. 19 2012). 174. See Alex Barker, EU Ministers Set to Define Banking Union, FINANCIAL TIMES, (Dec. 17, 2013). 175. Id. 176. See id. 177. Id. 178. Nicolas Veron, The European Central Bank’s Big Moment, FINANCIAL WORLD (2013). 179. Peter Spiegel, Coming Banking Union Storm: Leaked Points of Friction, FINANCIAL TIMES (Dec. 17, 2013, 12:48 PM), http://blogs.ft.com/brusselsblog/2013/12/17/coming-banking-unionstorm-leaked-points-of-friction/.

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European Commission is the only institution that can close a bank.180 The plan for a common resolution fund was approved by the European Parliament and EU member states in March 2014.181 The March agreement would establish a central resolution authority using a €55 billion rescue fund.182 The fund would be built up over eight years, as opposed to the ten that were initially proposed.183 Moreover, the agreement would enhance the role of the European Commission in approving the decision to resolve a bank, whereas finance ministers can only reject proposals under certain conditions.184 Nonetheless, the step for creating a common deposit insurance plan within a banking union has not advanced as of early 2014.185 Given the differences in membership between the Eurozone and European Commission, linkages on banking issues are complicated by the competing interests of actors inside each.186 Most parties assume that a fully developed banking union will require new EU treaties before 2017.187 The ongoing banking union negotiations have demonstrated that Germany and the Eurozone seek to avoid giving the British Prime Minister, David Cameron, an opportunity to open the EU’s treaties in order to veto proposals or change other legal bases of the single market. These potential objections explain why the banking union resolution system proposal has been negotiated under Article 114 of the Consolidated Treaty on the Functioning of the European Union, which addresses the coordination of laws within the EU’s common market.188 Reforms to this section generally apply to all twenty-eight member states, but the banking union has been able to use it if the Eurozone states band together on an issue and avoid a UK

180. Id. 181. Alex Barker, Marathon Talks Seals EU Banking Union, FINANCIAL TIMES, (March 20, 2014, 7:34 PM), http://www.ft.com/intl/cms/s/0/adfe7be4-b04e-11e3-8058-00144feab7de.html#axzz32 Nn2bG2u. 182. Id. 183. Id. 184. Id. 185. See Barker, supra note 174. 186. Sam Fleming, UK Opposes Mario Draghi Role at Watchdog, FINANCIAL TIMES (Jan. 27, 2014, 8:04 PM), http://www.ft.com/intl/cms/s/0/7227213c-850d-11e3-a793-00144feab7de.html# axzz32Nn2bG2u. 187. Alex Barker, The Brits and Banking Union: Bad Omens for Cameron’s Referendum, FINANCIAL TIMES (Dec. 18, 2013, 17:15 PM), http://blogs.ft.com/brusselsblog/2013/12/18/the-brits-andbanking-union-bad-omens-for-camerons-referendum/?. 188. Id.

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veto.189 The UK position is ambivalent on the Article 114 issue. While it does not favor using the single market as a legal basis, it does favor a banking union as essential to the future of the Eurozone.190 Alternatives, such as using another clause in the treaty, would require a unanimous vote. That would empower the UK, but also require that the final legislation move to the UK parliament, potentially causing even more complications.191 The new supervisory roles attached to the SSM change the character of the ECB, which has no experience with supervision or immediate staff to take on new supervisory tasks.192 Previously dedicated to price stability in the Eurozone, bank supervision is a different intellectual project.193 The ECB’s existing focus on monetary policy and its new supervisory responsibilities may come into tension.194 To prevent this, the ECB created a supervisory board to oversee the new supervisory activities and ensure separation from its monetary policy.195 Once an agreement on the SSM was reached, its hypothetical problems became a reality.196 Because it is a part of a broader package of proposals from the broader banking union, the SSM must operate without the other proposals coming into effect—that is, proposals for a single resolution mechanism and common deposit insurance. In addition, the time that it will take for the other proposals to come into effect mean that until they do, the ECB must operate as a central supervisor, but one that relies on national bank resolution and enforcement arrangements. That is, the supervisor would lack immediate enforcement and resolution authority, thus tying its hands.197

189. Id. 190. Id. 191. Id. 192. Michael Steen, ECB Delves into the Messy World of Supervision, FINANCIAL TIMES (Sept. 12, 2012, 5:11 PM), http://www.ft.com/intl/cms/s/0/b3369dbc-fcea-11e1-a4f2-00144feabdc0.html# axzz32Nn2bG2u. 193. Id. 194. Id. 195. Id. 196. Patrick Jenkins, City of London Urges ‘Muscular’ Defence Against EU Regulation, FINANCIAL TIMES (March 18, 2014, 10:51 AM), http://www.ft.com/intl/cms/s/0/6c540dd8-ae84-11e3-aaa600144feab7de.html; Wolfgang Munchau, Europe Should Say No to a Flawed Banking Union, FINANCIAL TIMES (March 16, 2014, 3:14 PM), http://www.ft.com/intl/cms/s/0/0e6b4800-ab67-11e3-8cae00144feab7de.html#axzz32Nn2bG2u . 197. Michael Steen, Debate Rages on Eurozone Banks Supervisor, FINANCIAL TIMES (Dec. 9, 2013, 6:30 PM), http://www.ft.com/intl/cms/s/0/6d7c4eaa-41e8-11e2-bb3a-00144feabdc0.html# axzz32Nn2bG2u.

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V.

COMPARING THE ORIGINS OF DIVERGENCE IN BANKING SUPERVISION BETWEEN THE FEDERAL RESERVE AND THE ECB

The previous sections have shown that just as national and international politics converge on banking reform and supervision in the role of central banks, these same central banks also influence each other in international forums such as the FSB and Basel. Differences in the arrangements of political institutions between the United States and the EU can affect the time and content of rules that emerge from international agreements as well.198 Thus, implementation can vary dramatically, even when convergence appeared to be a goal in international negotiations.199 We have seen that the two central banks’ historical paths toward financial supervision have also been quite different. The most obvious distinction between the Federal Reserve and European Central Bank is that the Federal Reserve is a central bank for a federal system in one state, while the European Central Bank is a central bank for a set of sovereign states and is thus an international institution established by treaty among them. It is embedded in an evolving polity—what Quaglia terms a pseudo-federal institution—as opposed to the more unitary Federal Reserve.200 In addition, the Federal Reserve must pursue monetary policy with the twin goals of long-run growth and price stability, unlike the ECB.201 In 1999, when the Federal Reserve’s supervisory role was transformed through the passage of the Financial Services Modernization Act, European banking supervision moved in the opposite direction—away from the newly created European Central Bank and toward national regulators. The essence of transnational political development, however, is in the push and pull of domestic and international causes and effects, as well as the time dimension. The differences in implementation of international regulatory agreements results in situations where the same political institutions can work for convergence in one forum, and at one moment in time, and then diverge at another moment or in a national setting. This section will compare the push and pull of implementation. On one hand, implementation in the EU is more prescriptive than

198. LAVELLE, supra note 31, at 237; BRUMMER, supra note 20, at 222. 199. LAVELLE, supra note 31, at 237. 200. QUAGLIA, supra note 5, at 13. 201. See Woolley, supra note 133, at 312. In this regard, the ECB resembles the German central bank, the Bundesbank. See QUAGLIA, supra note 5, at 108.

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U.S. delegation of power to agencies.202 Independent agencies play more limited roles and leave the bulk of their responsibility in banking to national supervisors. The result is that the Commission retains a role in terms of policy, whereas agencies act in a more supportive capacity by providing technical expertise with little direct authority.203 The Basel II Accord was transposed into binding EU legislation—the Capital Requirement Directive. For this agreement, the Commission, ECB, and EU member states attempted to ensure the suitability of the rules for application to the EU single market.204 Nonetheless, since 2008 the European banking union reforms have progressed in parallel with the overhaul of EU financial laws, including stricter capital standards and new rules for bailouts, resulting in division and competition among agencies similar to that in the United States.205 On the other hand, implementation in the United States has meant that as domestic rules became more uniform within the country, regulators have sought to address concerns that American banks will be less competitive than their foreign counterparts if certain aspects are implemented.206 Thus, international agreements serve as an input into the domestic process,207 but they are far from definitive. Changes in U.S. law not only take precedence over the agreements, but they create the need for further amendments and refinements of the powers of supervisors like the Federal Reserve. Because U.S. laws and regulations constantly change, the conclusion of an agreement does not signify coordination in and of itself. Standards must be turned into actual rules in a given legal environment with a bank supervisor that enforces them. Domestic legal processes constitute, empower, and mobilize different groups that seek different standards for different reasons.208 The law’s role in mobilizing different groups is more profound than merely providing information. Whereas principle-agent conceptions view the state as delegating authority to the agency, such as the Basel Committee, the historical accounts offered here present a much more complicated relationship between

202. BRUMMER, supra note 20, at 222. 203. ATLANTIC COUNCIL, supra note 1, at 15. 204. QUAGLIA, supra note 5, at 132. 205. See Barker, supra note 174. 206. LAVELLE, supra note 31, at 237. 207. Id. 208. Martha Finnemore & Stephen J. Toope, Alternatives to ‘Legalization’: Richer Views of Law and Politics, 55 INT’L ORG. 754 (2001).

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the principal and agent, with the roles of principal and agents themselves changing in response to international circumstances. In the United States, banks are not simply “pro-” or “anti-” efforts at international harmonization. Groups opposed to implementation of agreements may find inspiration for their position in specific policies and pieces of legislation passed by the same governments that negotiated the agreements to begin with. Significant variation in domestic legal systems should provoke caution in claiming generalized effects of domestic ratification on interest group politics.209 This detailed examination of the bureaucratic structure within the United States has shown that the law can shape public debates by providing information and by constituting, empowering, and constraining different kinds of actors within them. In Europe, the purpose of the Basel II negotiations was inherently different.210 The United States sought risk management and financial stability, not lower capital requirements.211 Particularly as the Basel II negotiations progressed, Europeans were more concerned with using the negotiations to promote regional integration and a framework for internationally active European banking groups without burdening regional banks.212 The major financial services firms in the United States prior to the crisis were not banks, as they were in Europe.213 Glass-Steagall needed to be repealed in order for them to grow into their roles.214 Hence, European implementation patterns are quite different.215 European banks are supervised by the home country and operate under principles of mutual recognition.216 A minimum number of supervisory standards were harmonized prior to the changes in 2011 and 2013.217 Basel I established credit and capital standards for European Banks in 1988218 when it was implemented in EU directives in 1989, effective in 1993, and it had the effect of increasing the amount of capital held by banks.219

209. Id. at 755. 210. Edward J. Kane, Basel II: A Contracting Perspective, 32 J. OF FIN. SERV. RESEARCH 7 (2007). 211. Id. 212. Id. 213. Harald Benik & George Benston, The Future of Banking Regulation in Developed Countries: Lessons from and for Europe, 14 FIN. MKTS., INSTS., AND INSTRUMENTS 304 (1995). 214. Id. 215. Id. 216. Id. 217. Id. 218. The directives were implemented in 1989 and effective in 1993. Id. 219. Id.

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VI.

CONCLUSION

In comparing the history of supervision between the Federal Reserve and European Central Bank, this Article has shown that the pressures for regulatory convergence and divergence originate in different quarters in each institution. Both central banks share their supervisory responsibilities with other regulators and supervisors: in the case of the Federal Reserve, responsibility is shared among American agencies in the dual banking system;220 in the case of the ECB it is shared with the sovereign member states of the Eurozone and EU.221 In the United States, pressures to cooperate internationally initially came from the domestic need for convergence in prudential bank supervision. When international agreements needed to be implemented, competition among regulators and supervisors emerged, creating the need for coordination at a later stage. As American banks came to look more like European banks, the Federal Reserve played a greater role in supervision at both the national and international levels. In the European example, pressures to cooperate internationally came from the desire to create a single European market that would be able to compete globally. Nonetheless, countervailing pressures came from nation-states that resisted their loss of supervisory authority. Therefore, discussions of convergence and divergence are not easily categorized as between actors such as banks, states, or regulators that are “for” or “against” international cooperation. These actors’ positions and decisions must be situated within their national and international context, as well as the temporal context of the regulatory process, implementation phase, and supervisory institutions, to uncover opportunities for coordination that will work to stabilize the entire system. Some analysts speculate that Wall Street interests will seek to use regulatory convergence with Europe as a way to circumvent restrictions from the Dodd-Frank law.222 In Europe, tension between London and

220. LAVELLE, supra note 31, at 43. 221. Nicolas Veron & Bruegel, Peterson Institute for International Economics, Statement Presented at the Conference “Banking Union and the Financing of the Portuguese Economy,” Assembleia da Republica/Portuguese Parliament, Lisbon: European Banking Union: Current Outlook and Short-Term Choices (Feb. 26, 2014), (citing to Council Regulation (EU) No. 1024/ 2013, Conferring Specific Tasks on the European Central Bank Concerning Policies Relating to the Prudential Supervision of Credit Institutions, 2013 O.J. (L 287) (EU) available at http:// www.piie.com/publications/testimony/veron20140226.pdf.). 222. Christian Oliver, Brussels Wants Finance Rules Back in US Trade Pact, FINANCIAL TIMES (Jan. 27, 2014, 8:13 PM), http://www.ft.com/intl/cms/s/0/191da83a-8775-11e3-ba87-00144fea b7de.html#axzz32Nn2bG2u.

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the ECB in Frankfurt for influence means that Great Britain and other non-euro countries can use other European institutions, such as the EBA and ESRB to make sure that the single market is not dominated by the members of the Eurozone.223 The future of this system will continue to pull in both directions.

223. Fleming, supra note 186.

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