The European Union is now the proud owner of a NobelPeace Prize. When the choice alighted onBarack Obama three years ago, the Norwegian Nobel Committee was criticized forhonoring someone whose achievements were still to come. The Committee took thatcriticism to heart, and this time decorated an institution with a proud past,but a clouded future.

The eurozone is distinct from the EU of course, but it is the Union’s most ambitious undertaking to date, and it isstill struggling to equip itself with the structures needed to bolster a currency union. A common fiscal policyremains a distant dream, as does a genuine political union.

But Europe’s policymakers claim to bemaking progress toward a so-called “banking union,” which means collectivebanking supervision, rather than a merger ofbanks themselves. In September, the European Commission announced a plan tomake the European Central Bank the supervisor of all 6,000 of Europe’sbanks.

The reaction among national politicians, central banks, and banksthemselves was not universally favorable. The Germans want the ECB to focusonly on large systemic banks, and leave smaller savings banks (like those thatinvested heavily in subprime mortgages) to national authorities. The United Kingdom and Sweden argue that they cannot bemade subservient to a central bank of whichthey are, at best, semi-detached members.

The case for a pan-European supervisor is widely accepted, especially asthe European Banking Authority (the EU’s banking regulator) proved feeble in carrying out financial stress tests: thefirst tests were so weak that even Spain’s now-bankrupt savings bankscould pass with

flying colors. Europe must break the vicious circle linking distressedsovereign borrowers with banks that are obliged, or at least encouraged, to buytheir bonds, which in turn provide the funding for bank rescues.

But the method chosen by the Commission to implement a banking union isfatally flawed.  Moreover, according to a leaked opinion from the EUCouncil’s chief legal adviser, the proposed reform is illegal, because, accordingto the Financial Times (which received the leak), it goes “beyondthe powers permitted under law to change governance rules at the European CentralBank.”

Throughout the crisis, European leaders have tried to respond to the gapsin the monetary union without proposing a new treaty, because they fear thatany new treaty proposing more centralization of authority in Brussels would be rejected, either bynational parliaments or by voters in a referendum. So they have tried to proceed by intergovernmental agreement, or by usingexisting treaty provisions.

In the case of the banking union, they plan to use Article127(6) of the Lisbon Treaty which allows the European Council to grantauthority to the ECB to perform specific tasks concerning “policies relating tothe prudential supervision” of certainfinancial institutions in the Union. That is athin legal basis for establishing a pan-European supervisor with directresponsibility for individual institutions, and it was clearly not intended forthat purpose. Indeed, Germanyagreed to the wording only on the understanding that the ECB could not be adirect supervisor.

The consequences of choosing this inadequate, if expedient,route are serious. For starters, the existing treaty cannot be used to create asingle European resolution authority, leaving an awkward interface between the ECB and nationalauthorities. Nor can it be used to establish a European deposit protectionscheme, which is arguably the most urgent requirement, to stem the outflow of deposits from southern European banks.

There will also be potentially dangerous consequences for the ECB itself.The use of the Lisbon Treaty clause means that the ECB must be given theseadditional responsibilities. But it is impossible to create a separatebank-supervision entity within the ECB, as has been done in France, for example, with the Prudential Control Authority, or in the UKwith the new Prudential Regulatory Authority, which has its own board andaccountability arrangements within the Bank of England.

The importance of these structures is that they insulatethe central bank’s monetary-policy independence from corruption by the tighteraccountability requirements that inevitably come with banking supervision.Because supervisors’ decisions affect individuals’ property rights – and theiractions or omissions can put taxpayers onthe hook to bail out banks – governments, parliaments, and the courts are boundto hold the watchdogs on a tight leash.

That is why Germany’s Bundesbank, which always guarded its monetary-policyindependence so assiduously, has once againfound itself in the rejectionist camp,expressing severe doubts about the route that the Commission plans to take.This time, they are right.

There are other serious issues, too. According to the Commission’s model,the European Banking Authority will remain in place, and is charged withproducing a single rulebook for all 27 EU member states. But, while its work iscarried out under the normal qualified majority voting system, the 17 eurozonecountries will have a single supervisor, so will have a block vote. The Commissionis trying to find ways to protect the rights of the non-eurozone countries. Butthe very complexity of what is proposed shows just how inadequate the schemeis.

Non-Europeans, in particular, may find the entire topic impenetrably abstruse.But it illustrates a simple point: Europe istrying to achieve a stronger federal model that responds to the weaknessesrevealed by the eurozone crisis. But it is doing so without addressing thecrucial need to bring its citizens along. Indeed, the devices that the EU isadopting are designed specifically to avoid having to consult them.

The proposed construction of a banking union reveals this fundamental flawat the heart of the European project today. It is difficult to be optimisticabout the success of an initiative built on such flimsylegal foundations, and lacking democraticlegitimacy. Europe’s banks and their customersdeserve better.