Monday, December 3, 2012
Do not trust politicians to supervise Europe’s banks
December 3, 2012
When the Bank of England was made independent in 1997 it had to surrender its power to supervise the banking system. Parliament used two main arguments to justify this. The first was that there is a conflict of interest between monetary policy and the conduct of banking supervision. The second was that banking supervision cannot be as independent as monetary policy, and therefore needs to be much more accountable to the political authorities.
Both arguments proved wrong, not only in theory but also in practice. And not only in England.
Rather than a conflict of interest between monetary policy and bank supervision, the opposite has turned out to be true in recent years. The lack of information on the solvency of the banking system made it much more difficult for central banks, such as the BoE, to interpret market developments and to provide liquidity to sound institutions only. National supervisors had the tendency to paint a rosy picture of their financial system, which enabled banks to easily qualify as counterparties for central bank operations.
It is also unlikely that independent central banks that are accountable for their monetary policy objective, in terms of price stability, would seek to use monetary instruments for other reasons. Trying to address banks’ solvency problems by extending central bank liquidity support is not very effective over time. Furthermore any attempt to manipulate monetary policy for other purposes would become apparent if there were sufficient transparency of central banks’ operations.