The legal basis in the Treaties of the European Union and its amendments (from 1957 and then on) for the creation of the Banking Union

Written by Athanasios I. Patsikas

Lawyer (LLM)

The Banking Union represents an unprecedented transfer of sovereignty from participating Member States to an EU institution for conducting banking supervision and for delegating authority to an EU agency to have responsibility for the preparation, implementation and funding of a European bank resolution regime[1]. The sovereign debt crisis in Europe triggered a domino of legal and political big bangs in the banking sector. The fact that tax payers in almost all Member States were (mandatorily) invited to fund several recapitalizations of failed banks on the one hand and the on the other hand the emergency bell for price stability in Eurosystem inaugurated the notion of banking union in terms of a legal framework with several instruments in order to identify the cause of the problem occurred and to respond instantly to the crisis. In other words, given the inherent flaw of the Eurosystem by “permitting” the Member States to issue joint debt,  the insertion of the so called  “risk mutualization” is concentrated to the aim of protecting deposits,  so that panic can be avoided. As a matter of fact it was decided that the European Central Bank was the most credible EU institution to be given the powers of prudential bank supervision because of its relative success in maintaining price stability in the euro area, its experience in guiding the euro zone banks and sovereigns through the banking crisis of 2008–09 and the sovereign debt crisis of 2010–12, and its strong legal basis in the EU Treaties guaranteeing its independence from external political pressure[2]. Banking Union consists of three pillars; (1) the European Central Bank, with vast new powers to supervise over 6,000 banks in the euro zone; (2) an EU-wide deposit guarantee scheme with above mentioned mutualization of risk across Member; and (3) an EU/euro area bank resolution authority and fund that would restructure banks and investment firms having financial difficulties without direct costs to taxpayers[3].  Its overriding objectives are to ensure safety and soundness of the European banking system and to ensure the unity and integrity of the EU internal market[4]. The present essay deals with the legal basis of the banking Union in the treaty of Rome and all of its amendments.

Back in 1957, the Treaty of Rome contained no certain provision for the establishment of the banking union. The European economies were growing fast to rebuild the ruins of the 2nd World War and accordingly the reconstruction phase was based solely on American dollars through investments prescribed by the Marshal plan which were materialized by using the European banks as subsidiaries. At the time there were no cross border banking transactions, no lending practices, no insolvency rules influenced based on the non-discrimination rule (on the basis of nationality), no harmonization in licensing (minimum  initial capital) and of course the capital controls button was permanently pushed. Money did not move without special administrative permits and licensing, so banking was a in a very low priority. Banking union means that capital comes in and out without restrictions. No one thinks of it back then and no one wants it.  Till the 1st directive in 1977 there was not a slight reference about banking union. The IMF was acting as global police of international banking which was responsible for the reconstruction of national economies in terms of national sovereignty, with national banks providing the capital flow. The problem in Europe in 1957 was to get as many US dollars as possible and invest the dollars in “your” own country.

At the end of the day the law followed real life, in the light of the obvious truth that if banks are national and not cross-border nothing is going to work properly. A part of the 7 year (1987-1994) single banking market plan had been put a priority, having three basic ideas as cornerstone: 1) No country would allow banks from another country to operate if the savings were to be exposed into risks. The single European act of 1987 was adopted to amend the Treaty of Rome introducing a qualified majority for all measures towards the internal market (including no veto possibilities); 2) the Single European passport, the case being that if a bank is licensed in one Member State, it can operate anywhere in EU without another license; 3)Duplicate regulation was avoided so in case of insolvency the place (Member State) of incorporation is held liable to pay the deposits, in order to make sure that the home country pays attention to strict and prudent supervision.

What distinguishes the EU from other international and regional regulatory groupings in terms of banking regulation, supervision and resolution is the EU Treaty (TFEU) principle of the "internal market"[5]. It is from where the banking union derives its legal basis. The internal market principle has its origins in the Treaty of Rome of 1957 and has served as a core building block of European economic and financial integration[6]. The principle consists, in part, of the right of establishment and free movement of persons, services and capital across Member State borders under conditions of competitive equality[7].

Single Supervisory Mechanism-legal basis

The ECB’s role as a supervisor and its participation in the resolution process was questioned by the European policy authorities before the draft of the SSM Regulation in September 2012. On the one hand, there was an urgent need to sever the link between fragile banking institutions and sovereign debtors by enhancing banking supervision to repair the banking sector[8]. The discipline and credibility of theEuropean Central Bank was considered a necessary remedy for the ineffective and weak supervisory practices of many euro zone states that had contributed to causing the European banking and sovereign debt crisis. Indeed, a redesigned banking supervision regime built on the shoulders of the European Central Bank was considered necessary to stem the market panic that was sweeping euro zone sovereign debt markets in early 2012[9].After the EU institutions agreed to provide emergency funding support for Spain from the European Stability Mechanism in May 2012, the European Council issued its Decision in June proposing a European Banking Union for euro area and other participating Member States that would centralize banking supervision with the ECB and concentrate resolution powers and deposit guarantee rules at EU level[10].In respect of banking supervision, this expedited plan of action required activation of the enabling clause of art.127(6) TFEU, while  at the same time, policy-makers were wondering if another and more accurate and sound legal basis for the establishment of banking union could be found in the Treaty. In particular, there was concern that the ECB’s potential treaty powers were limited strictly to micro-prudential supervision of banking and financial institutions based on a unanimous vote of EU Member States, and therefore the ECB could not play a role in broader supervision of financial markets, nor could it play a direct role in a reformed bank resolution regime[11].This viewpoint is in line with the obligatory previous amendment of the EU Treaty before all the superpowers of supervision and resolution confer upon the ECB and other EU authorities so that the banking activity is not jeopardized.  However, amending the Treaty would presuppose unanimity by Member States and would be more time consuming, given the circumstances, to make the sovereign securities markets of the Euro system to return to their normality. What urged the EU policy makers to proceed to the adoption of the existing legal basis for the establishment of the banking union was the back then on-going growing pressure in the sovereign bond markets for Italy and Spain (June 2012) and consequently they supported the recapitalization of the failure-flirting banks with ESM financing (bonds governed by private law).  

Regarding the ECB’s competence to act as a bank supervisor, art.13(2) TFEU provides that EU institutions operate under the doctrine of conferred powers, which states that public institutions are constrained by law, in this case by the Treaties, because they are creatures of law[12].EU institutions only have powers granted to them by the Treaties[13].The rationale behind this is that the exercise of state powerin a liberal society or market economy should be exceptional and require justification and constraint[14].The Treaty itself does not grant the ECB excessive competence to supervise financial institutions given the non-existence of unanimity by all Member States for the opposite position. Accordingly, the adoption of the SSM Regulation was based on the clause of art.127 (6) TFEU as a justification of attributing the above mentioned comptences to the ECB for the credit institutions. According to the language of art.127 (6), however, the ECB can only have supervisory powers conferred on it "concerning policies relating to the prudential supervision of credit institutions and other financial institutions with the exception of insurance undertakings". This means it can only have supervisory powers conferred on it for individual credit and financial institutions, not wider powers involving bank resolution, nor oversight of financial conglomerates or investment firms not defined under EU law as "credit or other financial institutions"[15]. Article 127(6) essentially applies to micro-prudential supervision of "credit institutions and other financial institutions" and not to supervision of other financial firms or areas of the financial markets that are off the balance sheets of credit and financial institutions, such as the shadow banking market[16].The narrow literal interpretation of Art. 127(6) is a clear evidence of why the SSM Regulation concerns solely individual credit institutions.

Notably, according to the above mentioned restrictions of art. 127(6), the ECB would have had no competence to be the supervisor of the wider financial system part of which is the shadow banking system, practically being five times bigger than the actual banking system and at the same time the ultimate cause of the banking crisis of 2007-2009. Furthermore, the ECB would have been less likelyto be able to drag acredit institution into the resolution situation or to proceed to respective actions such as transferring the high-risk assets of a bank to a resolution fund and the low-risk loan book to a healthy “bridge” bank. It would not be able even to conduct the resolution authorities. The narrow supervisory competence allocated to the ECB under art.127(6) suggests that the ECB would be acting ultra vires if it took broader macro-prudential supervisory measures that go beyond the micro-prudential supervision of individual credit institutions and financial institutions, so someone would be of the view that  these narrowly conferred powers significantly limit the ability of ECB to perform effective banking supervision and that the ECB should not be granted banking supervisory powers unless the Treaty is amended to provide it—at a minimum—with enlarged powers to monitor the broader financial system (i.e. macro-prudential supervisory powers) and to take interventionist measures (i.e. prompt corrective action) as part of a bank resolution or restructuring[17].

The debate concerning the legal basis of the banking union is of fundamental importance for the legalization of the instrumentations put forward to achieve both financial and sovereign debt stability for the Euro area. It is a matter of pure law and concrete legal rational. In other words, legal certainty is at stake. On the other hand, law can constitute a de facto situation or an auto-regulation of real life. And in real life, the National Central Bank of Greece from 2007 to 2014 resolved 26 banks using only national tools! It ensured the deposits, it achieved the orderly separation of good from bad assets, it protected the employees and at the end of the day it avoided panic. It only had a weekend for this massive liquidation. The banks closed on Friday and opened on Monday like nothing was happening. The same events took also place in Italy and Belgium. Thus, it is more than evident that although the concrete legal basis for the above superpowers to be conferred upon the ECB may be absent in the Treaty, the reality dictates that the initiatives which followed serve(d) something more than legal certainty, that is social justice. So, by the time that a NCB is able to carry out such a de facto task why not to open the discussion of transfer this national field of responsibility to the ECB so that uniformity and harmonization are achieved?

This huge experience and legal knowledge were unified to create the BRRD Directive[18] , in order to avoid public funds through citizens’ taxes and honor the legal priority of claims in insolvency. If senior creditors are to suffer any losses it means that junior creditors must be completely wiped out. These classes of creditors at the bottom in insolvency must have all the losses and then we may move to the last class of creditors. All the creditors of the same class must be satisfied pro rata-proportionally. The BRRD core principles are the following: 1) Equality of creditor classes. All non-protected deposits are equal (of the same class) in insolvency. The outcome must be better than the outcome in liquidation; 2) before a class of creditors loses any money the losses must be born completely by the inferior classes. We move above the classes of creditors bailing in from the junior to the senior; 3) In practice the BRRD tool is the transfer of assets-entire loan book to another bank (bridge bank).

Single Resolution Mechanism-legal basis

As the case appeared to be, the adoption of art. 114 as the legal basis for the inceptive SRM draft was a day-to-day surveillance orientated justification of the European Commission strategy to patrol banking resolution activities and establish at the same time the Single Resolution Board (SRB). The proposal delegated to the SRB powers to design, oversee and implement bank resolution plans and to ensure that the SRF had adequate financing arrangements in place to support a resolution framework[19].At the time of proposal, there was considerable opposition led by Germany (supported by Sweden and the Czech Republic) to the SRM on the grounds that there was no legal basis in the Treaty to concentrate such broad authority in the Commission to make the final decision on resolution and that any centralization of resolution authority with the Commission and the delegation of discretionary authority to the SRB under art.114 to decide resolution funding arrangements involving Member State contributions to the SRF and associated mutualization of risk between Member States wouldrequire Treaty changes[20].The amendment of the Treaty of the EU was something quite complicated and tricky to be achieved without time consuming sessions.

Germany’s legal position, however, was weakened by a legal opinion from the Council Legal Service (CLS), issued on September 11, 2013[21].This concluded that art.114 may be the legal basis for the establishment of the SRM and the Single Resolution Fund, as long as safeguards are introduced to protect the budgetary sovereignty of Member States[22].Germany’s position, however, drew support from the Court of Justice’s Advocate General’s Opinion on the UK’s legal challenge to the Short Selling Regulation (published on September 12, 2013), arguing that art.114 was not suitable to confer wide resolution powers on the Single Resolution Board and that instead a legal base requiring unanimity in Council was required (art.352 TFEU)[23].As an alternative to the Commission proposal, German officials proposed that an SRF could be established and funded by industry contributions along with mutualization of risks between Member States if these Member States agreed to establish the Fund through an IGA and as a matter of fact under German pressure, the Commission amended the SRM proposal so that art.114 would provide the legal basis for the transfer of powers to the SRB to make recommendations to the Commission regarding the design and implementation of resolution plans and the governance aspects of the SRF, and also would be used to create an IGA that would-outside the EU Treaty-support the transfer and mutualization of funds between resolution authorities of participating SRM Member States in the Single Resolution Fund[24]. In support of the Commission’s approach, the Commission’s legal services found that the resort to an IGA under these circumstances was not contrary to the Treaty so long as it was limited to the transfer and mutualization of funds[25].

The SRM’s legal basis and the Meroni doctrine

The controversy regarding whether the Commission was the appropriate institutional body to exercise such broad powers should be seen in light of the constraints imposed by the Meroni doctrine and art.114 TFEU that restricts the exercise of discretionary authority by EU agencies to the development and interpretation of technical standards that are legally non-binding and which do not involve decision-making of a policy-making nature and that the agency’s authority must be based in a legislative framework that has as an important objective the harmonized implementation of EU laws aimed at improving the conditions for the functioning of the internal market[26].

The Court of Justice of the EU (ECJ) case law provides that art.114 may provide a legal basis for the establishment of EU bodies entrusted with the responsibility to adopt non-binding technical standards and other supporting and framework measures to promote the harmonized implementation of EU laws by Member States[27]. In Smoke Flavourings, the ECJ held that the EU legislative authorities have discretion, especially in complex and technical fields, to use the "harmonization technique most appropriate for achieving the desired result"[28].The desired harmonization technique may include the establishment of an EU agency or body, whose responsibilities must be closely linked to the objectives of the underlying legislation[29].Moreover, the agency’s responsibilities must derive from its founding legislation and demonstrate, as a threshold issue, how the agency aims to improve the conditions for the establishment and functioning of the internal market[30].The ECJ has upheld most EU legislation that relies on art.114 as a legal basis when the legislation expressly states an important objective of improving the conditions for the establishment and functioning of the internal market31]

The ECJ has also rendered narrow interpretation of the possibly powers attributed to EU authorities. In the often-cited 1958 Meroni case, the ECJ held that delegation of powers to EU agencies can only relate to clearly defined executive powers, "the use of which must be entirely subject to the supervision of the Commission[32]".In contrast, the EU legislator cannot delegate discretionary powers of a policy-making nature from the Commission to an EU agency because the ECJ has interpreted the Meroni doctrine as precluding EU agencies from making policy choices in place of the delegating authorities (i.e. the Commission), as this would upset the EU institutional balance established by the Treaty[33] On October 7, 2013, the Council Legal Services (CLS) provided a legal opinion on the delegation of power to the SRB concluding that the Board’s powers in relation to resolvability assessments, implementation of resolution tools such as bail-in and the use of the resolution fund need to be either further specified in order to exclude that a wide margin of discretion is entrusted to the SRB or else these functions should be carried out by an EU institution, such as the Commission[34]

In conclusion, the analysis above outlines a not very solid legal basis in the Treaties of EU for the establishment of a true banking union. In many attempts to interpret the provisions, we end to a “what is permitted” approach whilst what the desirable outcome deriving out of the provisions should have been an emerging and undoubtable competence for the institutions and their agencies to take legally binging decisions and make policy without the potential fear of a court challenge. In that sense there would be no obstacle referring to fiscal sovereignty from a Member State to decline an SRB mandate recommending the ensuring of financial assistance by public funds in case of an SRF inadequacy, or even a bank resolution decision. As the case appears to be, the banking union with its present legal inspiration seems to have very little rectifiable chances of failing given the financial market’s elephant memory. It will take ”ages” to regain market confidence. Given the situation, the EU must move from de lege lata to lege ferenda status quickly through an amendment of the Lisbon Treaty under the ordinary revision procedure. It is all about the politicians’ will to wean off the interference with banking affairs and leave the issue to deal with its inherently legal nature and be treated by its prescribed handlers, the lawyers. In this case, someday we may obtain/create an unbreakable solid basis for our banking union.

[1] Chair for Law and Finance, Faculty of Law, University of Zurich, Member of the Expert Panel on Financial Services, European Parliament (2009–2014) and Specialist Advisor, UK Parliament Joint Select Committee on Financial Services Act 2012.

[2] See discussion in European Council, President, Towards a Genuine Economic and Monetary Union (December 5, 2012), pp.6–9 (Four Presidents’ Report). See http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/134069.pdf

[3] Van Rompuy, Towards a Genuine Economic and Monetary Union (June 26, 2012), EUCO 120/12, pp.6–7.

[4] SSM Regulation art.1.

[5] Treaty on the Functioning of the EU (TFEU) Title IV, "Free movement of persons, services and capital", arts 45–66. See discussion in M. Andenas and J. Snell, "Exploring the Outer Limits: Restrictions on the Free Movement of Goods and Services" in M. Andenas and W.-H. Roth (eds), Services and Free Movement in EU Law (Oxford: Oxford University Press, 2002), pp.69–139.

[6] See J. Dermine, "European Banking: Past, Present and Future" in V. Gaspar, P. Hartmann and O. Skeijpen (eds), The Transformation of the European Financial System, Second European Central Bank Conference (Frankfurt: European Central Bank, 2003), pp.31–96.

[7] TFEU Ch.1, Workers, arts 45–48; Ch.2, Right of establishment, arts 49–55; Ch.3, Services, arts 56–62; Ch.4, Capital and payments, arts 63–66.

[8] Kern Alexander, University of Zurich,  E.L. Rev. 2015, 40(2), p.10

[9] As Spain began to lose access to sovereign debt markets in May 2012, urgent action was considered necessary by EU policy-makers to restore confidence in financial markets so that fragile euro area countries could regain access to debt markets on sustainable terms. See House of Lords, Genuine Economic and Monetary Union and the implications for the UK, 8th Report of Session 2013–14 (February 14, 2014), HL Paper 134, pp.8–9.

[10] See Van Rompuy, Towards a Genuine Economic and Monetary Union (June 26, 2012), EUCO 120/12, p.4.

[11] Ibid; Indeed, it seemed unlikely until just before euro zone sovereign debt crisis re-erupted in May 2012 that the Council (Ecofin) would activate the enabling clause of art.127(6) TFEU. EU Ministers of Finance had rejected formal activation of the clause on a number of previous occasions. See Sir Howard Davies, "Comments on Cross-Border Banking Regulatory Challenges" in G. Caprio, D. D. Evanoff and G. G. Kaufman (eds), Cross-Border Banking: Regulatory Challenges (Singapore: World Scientific, 2006), p.42

[12] Parliament v Council (Safe Countries of Origin) (C-133/06) [2008] ECR I-3189; [2008] 2 C.M.L.R. 54, holding, inter alia, that "each institution is to act within the powers conferred upon it by the Treaty" (at [44]), and that "it has already been held that the rules regarding the manner in which the Community institutions arrive at their decisions are laid down in the Treaty and are not at the disposal of the Member States or of the Institutions themselves" (at [54]).

[13] Parliament v Council (C-133/06) [2008] E.C.R. I-3189 at [55]. TFEU art.13(2) provides that "[e]ach institution shall act within the limits of the powers conferred on it in the Treaties, and in conformity with the procedures, conditions, and objectives set out in them".

[14] See discussion in D. Chalmers, G. Davies and G. Monti, European Union Law: Text and Materials (Cambridge: Cambridge University Press, 2014), p.60.

[15] Kern Alexander, University of Zurich,  E.L. Rev. 2015, 40(2), p.11

[16] The Financial Stability Board has defined "shadow banking as a system of credit intermediation that involves entities and activities outside the regular banking system". Financial Stability Board, "Shadow Banking: Scoping the Issues" (April 12, 2011), p.2.

[17] Kern Alexander, University of Zurich,  E.L. Rev. 2015, 40(2), p.11

[18] DIRECTIVE 2014/59/EU OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL

[19] Ibid; “Policy-makers and lawyers have also debated whether the SRM Regulation delegates power to the Commission based on the doctrine of delegated powers under arts 290 and 291 TFEU to take discretionary decisions about whether and when an institution should be put into resolution or insolvency”.

[20] . See P. Spiegel, "German politics puts sand in cogs of EU machine" (June 28, 2013), Financial Times, http://www.ft.com/intl/cms/s/0/74d2d4a4-e007-11e2-9de6-00144feab7de.html#axzz2ZxyjaCUm

[21] Council, Opinion of the Legal Service, 2013/0253 (COD), 13524/13, LIMITE, JUR 458, ECOFIN 787

[22] Ibid

[23] See the summary of the UK case and arguments in the Opinion of A.G. Jääskinen in United Kingdom v Parliament and Council (C-270/12) EU:C:2013:562 at [6], [54]–[58].

[24] Kern Alexander, University of Zurich,  E.L. Rev. 2015, 40(2), p.19

[25] Opinion of A.G. Jääskinen in United Kingdom v Parliament and Council (C-270/12) EU:C:2013:562 at [6], [54]–[58]. The Advocate General concluded that the "emergency powers granted by Short Selling Regulation article 28 to the European Securities and Markets Authority to intervene in the financial markets of Member States so as to regulate or prohibit short selling go beyond what could be legitimately adopted as a harmonising measure necessary for the establishment or functioning of the internal market".

[26] Kern Alexander, University of Zurich,  E.L. Rev. 2015, 40(2), p.20;  Article 114 TFEU provides that: "The European and Council shall, acting in accordance with ordinary legislative procedure and after consulting the Economic and Social Committee, adopt the measures for the approximation of the provisions laid down by law, regulation or administrative action in Member States which have as their object the establishment and functioning of the internal market."

[27] See United Kingdom v Parliament and Council (C-66/04) [2005] E.C.R. I-10553; [2006] 3 C.M.L.R. 1 at [41]–[50] (Smoke Flavourings); see also United Kingdom v Parliament and Council (C-217/04) [2006] E.C.R. I-3771; [2006] 3 C.M.L.R. 2

[28] Smoke Flavourings (C-66/04) [2005] E.C.R. I-10553

[29] ENISA (C-217/04) [2006] E.C.R. I-3771

[30] Smoke Flavourings (C-66/04) [2005] E.C.R. I-10553

[31] Cf. Germany v Parliament and Council (C-376/98) [2000] E.C.R. I-8419; [2000] 3 C.M.L.R. 1175

[32] Meroni & Co Industrie Metallurgiche SpA v High Authority of the European Coal and Steel Community (9/56) [1958] E.C.R. 133 at 152

[33] Ibid

[34] Council, Opinion of the Legal Service, "Delegation of powers to the Board" 2013/0253 (COD), 14547/13, LIMITE, JUR 523, EF 89, ECOFIN 867.