As the first reports start to leak about how the Commission intends to organise European bank supervision, it is worthwhile offering some remarks on the questions of governance of banking supervision. As Peter Spiegel in today's FT reports, the Commission intends to propose that 17 national representatives plus six independent members would form a "supervisory board", which would hold ultimate supervisory responsibility. This board will be separate from the governing council of the Eurosystem so that there is a Chinese wall between monetary policymaking and banking supervision.
Three immediate remarks on this structure appear warranted.
1) Strong bank supervision requires swift decision making. It also requires the individuals on the decision-making committee to have the right incentives to search for banking problems to support their decision-making process. Anne Sibert, among others, has studied the effects of committee size on performance of the Committee. She concludes that a committee size of five or less is ideal.
2) Sibert's research on the European Systemic Risk Board (ESRB) argued that the detection of systemic risk requires a certain diversity of the skills of Committee members, notwithstanding the small committee size. She concluded that the set up of the ESRB, consisting mostly of national central bank representatives, is not conducive to effective systemic risk assessment.
3) Chinese walls are often introduced in banks or other large financial institutions to separate conflicts of interest between different departments. Yet, in practice, the effectiveness of Chinese walls has often been questioned.
These remarks suggest that the Commission should carefully consider whether a different governance of banking supervision in the euro area might be warranted. A small, yet heterogeneous committee, able to take swift decisions based on a wide variety of views, appears central to effective bank supervision. Moreover, the Committee should be as free as possible from entrenched national interests but instead be solely accountable to a common European interest. The purpose of the common European supervisor is to mitigate the failure of national supervision and its tendency for forebearance, in particular in circumstances in which costs could be mutualised. To achieve this goal, the euro-area supervisory board should have as few national representatives as possible, and it should have a small and strong decision-making structure.