Elderfield warns on bank oversight

European leaders must put the funds and tools in place to rescue ailing lenders before they transfer oversight to the region's central bank or they risk worsening the sovereign-debt crisis, Central Bank deputy governor Matthew Elderfield has said.

Policy makers need to ensure rules for capital injections and the orderly winding down of failed lenders are "fully operational" by the time the European Central Bank takes charge under plans for banking union, he said in a speech at Bloomberg's London office today.

Without the right structures, governments may be forced to inject additional capital into banks, putting more pressure on their budget deficits, he said.

"It is a distinctly unpleasant situation to be asked to put out a fire and to find your fire extinguisher is half-full and that the only way to get a reload is to increase debt and austerity," Mr Elderfield said.

European Union leaders, trying to stop the cost of failing lenders driving up the price of borrowing for governments, aim to hammer out details of the agreement by January, when the ECB is set to take over supervision of the euro zone's lenders.

A common supervisor would open the door for the euro area's firewall-fund to offer direct aid to banks, spreading the cost of bailing out lenders across member states.

The voting structure governance of the European Banking Authority, which coordinates financial rule-making across all 27 EU nations, needs to be altered to address the concerns of countries such as the UK that are outside the euro zone, Mr Elderfield said.

"It would be unfortunate if the 'ins caucus' sought to agree a common position on matters before engaging in debate around the EBA table," he said. "I would not see the caucus leading to a block vote, as individual supervisors will still retain their responsibility for policy-making."

Draft proposals give the ECB power to order banks to raise capital, cut the riskiness of their activities and provide information on how liquid their assets are, according to measures drawn up by Cyprus, which holds the EU's rotating presidency.

Much of the detail on banking union, including which firms would be covered by the new regulator, has yet to be fleshed out. ECB president Mario Draghi is pushing for a regulator that oversees all Europe's banks, while German Chancellor Angela Merkel has lobbied to limit oversight to systemically important lenders.

A banking supervisor limited to Europe's top 30 banks wouldn't have "caught" either Anglo Irish Bank or Bankia SA, which contributed to Ireland and Spain seeking bailouts, Minister for Finance Michael Noonan said on Friday.

Mr Noonan said the Irish Government favours the ECB having oversight of all lenders in member states that are part of the banking union. Transitional arrangements could be put in place as the ECB's role expands, Mr Elderfield said.

The ECB could be given power to examine banks outside its core group that are "flashing red on its radar".

The ECB could choose to bring particular banks directly under its control, he said.

"This would allow it to gradually expand its remit during the transitional period and have the absolute right to troubleshoot problems beyond the system group, which is surely what recent experience has proved necessary," he said.

Mr Elderfield said regulators are grappling with how to make banks safer by bolstering capital without jeopardising growth by making them restrict lending.  "It certainly makes sense to take off the table any thought about attempting to impose an additional counter- cyclical buffer for the foreseeable future," he said. "With the end point" clear, banks should set out their plans to comply with the Basel rules.