One Size Fits Most: How appropriate is an EU-wide response to the Economic Crisis?

Civitas, 8 July 2009

Yesterday, European Union finance ministers decided that in periods of economic growth, bank loans will be tightened, writes Nicola Di Luzio. This is in order to make sure that funds are available when recession hits.

The new agreement aims to create a bank liquidity buffer to guarantee a “survival period of at least one month”. In order to ensure that this rapid liquidisation will not disrupt the broader market, the committee also specified that the buffers must be composed of money or assets that are quickly convertible into cash with a predictable value.

This is not the first EU-coordinated measure targeted at protecting European economies from recession. In this vein, EU leaders have also agreed to set up two financial institutions: the European Systemic Risk Board (ESRB) and the European Supervisory Authorities (ESAs), to oversee EU economies and warn of potential problems.

In response to the more pressing problem of the current economic crisis, an EU stimulus package of 5% of member states’ GDP (€600 billion in 2009-2010) has already been agreed, however it is the shadowy fear of hypothetical future crises which is causing the disputes in Brussels. This problem has a basis similar to the UK’s main objection to the euro: economic conditions in the EU may not be homogenous enough to justify EU-wide economic policy.

Nor is the UK the only country affected by this issue. In an example of a particularised problem, at the meeting of EU finance ministers Germany had hoped to relax the Basel II international Accord which requires banks to put aside capital proportional to the risk they expose themselves to through lending and investment. This would be particularly useful for Germany because this year its economy, which relies heavily on exports, has suffered its worst performance since 1990 and saw GDP fall by 3.8% in a quarter – the biggest decline since records began in 1970. German industry has repeatedly warned that companies risk running short of funds, and that banks’ lending needs to be loosened. However, the proposal to relax the Basel II arrangements was rejected by other member states.

In contrast, Britain’s objection to the new supervision rests on the importance of its financial markets compared to the relative size of this sector in other EU countries. Another aspect is the potential power of the European Central Bank and the Eurogroup (eurozone countries) in future economic decisions –despite the fact that the UK and others still retain their own currencies.

In practice, the influence of the EU’s new measures on the UK financial industry might not lead to anything radically different from the UK government’s reaction thus far. In negotiations, Britain complained that a supervisor with legally-binding powers could order a national government to spend billions bailing out a major bank. It has also battled for years against EU attempts to tighten regulation. However, Britain has been one of the first countries to tighten its rules after the recent financial crisis, and even used huge sums of public aid to rescue the first major bank in the EU to face collapse: Northern Rock. Nonetheless, the UK remains opposed to an assault on its sovereignty over financial services and taxpayers’ money; it believes that only national regulators are close enough to the issue to supervise individual financial firms. Furthermore, it is feared that some regulation might force the migration of profitable companies, such as hedge funds and private equity firms, away from the UK. According to Harvey Pitt, ex-director of the US Securities and Exchange Commission, an exodus of hedge fund managers from Europe would lead to job losses and a flight of capital. Worryingly, if this capital does leave, it could make detecting financial risk in future more difficult.

The solution to this conflict of national and EU interests is unclear: EU-wide policies risk ignoring the more particular needs of individual members, but recognising all member states’ interests can create problems of its own. The EU’s planned financial supervision scheme has been greatly criticised for lacking real credible ‘threat power’; this is the result of the compromises that were needed to reach the deal, such as the modification of the proposal that the ESAs should be allowed to make binding emergency decisions in a crisis – instead, they will only be allowed to “coordinate” national supervisors. Similarly, EU leaders weakened the decision to give ESAs a casting vote over national supervisors in cross-border disputes by depriving it of the right to force governments to spend money. According to Daniel Gros, the director of the Centre for European Policy Studies, the final product is “not the revolution you might expect after such a crisis”. The chair of the monthly meetings of the Eurogroup (European central banks and eurozone finance meetings) was right to state that: “We could have been more ambitious, but we cannot be more ambitious than the willingness of the member states.”

Gordon Brown, previously opposed to tighter regulation at European level, has since changed his position, but the question is, if EU directives are watered down to the point that they lack the necessary bite, are they worth implementing at all? It is a question which the new Swedish EU presidency will no doubt have to address.