FRANKFURT (Reuters) - A European Commission proposal to limit the European Central Bank's power to supervise banks is "much too tight" and risks hampering ECB efforts to make the sector safer, Frankfurt's top supervisor said on Tuesday.
Speaking at the European Parliament, Daniele Nouy questioned part of the Commission's package setting out rules for deciding how much Pillar 2 capital banks must hold to absorb losses -- effectively the ECB's most powerful tool as a supervisor of euro zone lenders.
This was likely to rekindle a simmering conflict between the ECB's Single Supervisory Mechanism, which has been trying to establish itself as a tough watchdog since 2014, and other policymakers in Frankfurt and Brussels, who worry about the risk of choking off bank lending and growth.
"The proposed legislation on Pillar 2, while rightly seeking to further supervisory convergence, seeks to put a frame around supervisory actions that is much too tight in essential aspects," said Nouy, who chairs the ECB's supervisory board.
Nouy argued supervisors should be allowed to demand that banks meet their Pillar 2 requirements using the most restrictive definition of capital, known as Core Equity Tier 1.
Erik Thedeen, director general of the FSA, Sweden's financial watchdog, told the same parliament session that he had "considerable problems" with limitations on "supervisory flexibility" in the European Commission proposals.
Sweden, not part of the euro zone, has a large banking sector and Thedeen said flexibility in supervising lenders does not mean regulators would go soft on their own banks in a "race to the bottom".
"Diverse implementation of Pillar 2 is not maybe a bad thing, but a reflection of how reality looks like," Thedeen said.
Nouy also said Additional Tier 1 instruments -- a form of convertible bonds that banks have extensively used since the crisis to raise funds -- posed "significantly supervisory issues" and are mainly useful when a firm is already bust.
Nouy added the Commision did not go far enough in certain areas, such as non-performing loans, and that she was not in favour of a proposed reduction of the frequency of regulatory reporting by small banks.
She did however welcome other aspects of the proposal, such as closer prudential supervision of financial holding companies and of significant foreign banking groups located in the European Union.
Britain has been lobbying against the measure as it could affect UK lenders who want to serve EU customers after Brexit.
Additional reporting by Huw Jones in London; Editing by Keith Weir