Professor Patrick Honohan:

I thank the Chairman and members for the invitation to appear before the joint committee and contribute to its work on the future of economic and monetary union. It is important work for a number of reasons, namely, the scale of the challenge to restore stability and create sustainable growth and jobs, and also because of the role of the joint committee in ensuring democratic participation and accountability on EU issues.

The euro area in particular has been battered by the fallout from the great financial crisis that broke out in 2007. When the flood of financial globalisation receded it exposed interrelated banking, fiscal and competitiveness weaknesses in many euro area countries. Cross-border banking claims threatened to transmit weakness from stressed countries such as Greece, Portugal and ourselves to banks elsewhere in the monetary union. The high indebtedness of some countries no longer seemed as easily supportable as had previously appeared, and even the stronger countries experienced sizable banking losses.

As we come out of that, accelerated balance sheet repair, associated with aggregate macroeconomic demand weakness, has meant that recovery has been slow and tentative. This combination of pressures, primarily related to banking and wider financial sectors, as well as to macroeconomic and fiscal imbalances and divergences in competitiveness, has represented a significant challenge to the cohesion of the union. Both borrowing countries and lenders became apprehensive and protective of their interests. At certain moments in 2011-12 the combination of problems seemed to market participants to threaten the very sustainability of the institutional arrangements supporting the common currency.

While such fears have been allayed by the credibility of subsequent action, most notably the announcement of the outright monetary transactions, OMT, programme of the ECB, the wider need to rebuild trust and to strengthen the institutional architecture of the system is evident and confirmed in a general recognition that progress needs to be made on four dimensions, namely, banking, fiscal, economic, and political, as has been adumbrated in the report of the four Presidents of the European Council, the European Commission, the Eurogroup and the ECB last June.

I could range far and wide but it would be most appropriate for me to focus my remarks today chiefly on the banking pillar, a banking union. We need banking union to transform the financial system from a source of risk and instability to a source of growth and support to the real economy. We have made considerable progress in the euro area in recent months, especially under the Irish Presidency, in the construction of a banking union, but much remains to be done.

Announcement of action to build a banking union combined with the firm commitment of the ECB has contributed greatly over the past several months to the gradual but clear restoration of confidence in euro area financial markets. I should stress that while it is not appropriate for me to touch on monetary policy issues today ahead of the ECB governing council meeting which will be held on Thursday, as this is a closed period for those immediate monetary policy issues, it is evident that, with some exceptions, sovereign spreads have generally declined in the stressed economies, not least in Ireland, and this trend has held even through the Cyprus situation. The financial markets are counting on the completion of a banking union. We must avoid any easing of tensions in the markets leading to a slackening in the pace of reform.

Banking Union, which involves shifting supervision of banks to the European level, combined with a single resolution regime and a common system for deposit protection, will reassure citizens and markets that a common, high level of prudential regulation is being consistently applied. Together with greater fiscal and economic co-ordination, it will help build the necessary trust between member states which is a pre-condition for the introduction of common financial arrangements.

The Irish Presidency has given top priority to the banking union files. At the Central Bank we have been heavily involved and a large number of my colleagues in the bank have been assisting in the discussions and the technical negotiations that have been happening around the large body of legislative reform that is required for banking union. I should first mention that the Irish Presidency brokered final agreement on the capital requirements directive and regulation, CRDIV as it is called. It is very complex and comprehensive legislation that is intended to strengthen capital and liquidity provisioning of Europe's banks and to improve governance and remuneration practices. Because of this achievement it is expected to apply from January 2014. Agreement has been also reached, following the informal ECOFIN held in Dublin a few weeks ago, on the single supervisory mechanism for banks in the euro area. This will transfer bank supervisory tasks to the European level and will provide strong and consistent supervision. Preparations are well advanced within the ECB to take on this task; it is one that will be performed by the ECB, for which active preparations are already under way, and this could happen as early as July 2014, depending on the formal implementation date. It has been a remarkable success to obtain agreement on this proposal, for which credit is due to all concerned, within just seven months of its publication.

Attention is now focused on negotiations to agree a bank recovery and resolution directive. This would ensure that authorities throughout Europe would have the means to intervene decisively when problems occur and that the costs of dealing with failing banks fall in a clearly defined rank order on the owners and creditors. If we had only had some of that in the past, we would have been in a better position to handle the problems that hit us several years ago. Ministers will discuss this text on 14 May and there is a target to reach agreement by the end of the Irish Presidency.

Considerable progress has been also made on other items of legislation in the financial area and I will highlight those that are key to the banking union. Linked to this is the need to get agreement on a common scheme of deposit guarantee funds throughout Europe, and it is also an objective of the Presidency. However, the combination of a European supervisor of banks with responsibility for the resolution of bank failures remaining at the national level might not be a stable equilibrium. We have got agreement so far on a common supervisor and we have very nearly got agreement on a recovery and resolution directive but it is a directive for national resolution authorities. Having that imbalance between a European supervisor and a national resolving agency might not be a stable equilibrium in political economy terms, as individual member state governments might question and resent the imposition from the single supervisor of bank resolution requirements potentially including recapitalisation costs. Clearly, supervision and resolution should be placed at the same level. The need for this has been acknowledged at successive European Councils which affirmed that it is imperative to break the vicious circle between banks and sovereigns. Now that there is agreement on a single supervisory mechanism it is especially important to press ahead with establishing a single resolution mechanism authority and a single deposit guarantee scheme. I could continue at length about that, but I have laid out some of the elements and I would be pleased to hear members' questions.