In a speech by Lorenzo Bini Smaghi, Member of the Executive Board of the European Central Bank (ECB) last Thursday, he emphasized the idea of a single EU regulator.
This has been mooted since the Financial Services Action Plan (FSAP) was created in 2000, and is a regular discussion. It is now even more discussed as a result of the financial crisis.
Unsurprisingly, Mr. Smaghi argues that the new central EU Regulator should be the ECB. Here are a few choice excerpts from his speech:
"Today, I would like to focus on the enhancements to the European regulatory and supervisory architecture which need to be implemented in order to restore confidence. The financial crisis has affected all European countries. In some, the financial landscape has dramatically changed.
"The EU regulatory and supervisory framework, which is based on a set of EU directives and some mechanisms for cooperation designed several years ago, does not seem to have worked as expected. Let me mention three shortcomings.
"First, even though we have a single market in Europe, there remains substantial room for discretion in the transposition of EU directives into national legislation. This latitude can be used by national legislators to improve the competitiveness of the institutions and infrastructures in their own countries.
"The Lamfalussy framework, which was supposed to promote the convergence of regulatory and supervisory practices, has been insufficient. High costs are being imposed on banks, especially those that have to comply with more than one rulebook and interact with more than one supervisor because of their cross-border activity. Furthermore, regulatory competition tends to reduce prudential standards and make the whole system more fragile. The current financial crisis seems to suggest that financial institutions have been more resilient in those countries where EU directives have been transposed in a more prudent way.
"Second, competition between national financial centres and between institutions is an obstacle to effective cooperation between national supervisors. In particular, it reduces the incentive to exchange information on individual institutions. This hampers the effectiveness of any cooperative mechanism for crisis prevention. It is even more problematic in the event of crisis resolution, especially for cross-border institutions, as has been seen in the specific case of a large and complex banking group. This particular case also showed that the resolution of a crisis of a cross border nature is further complicated by a mis-match between the supra-national nature of some financial institutions and the national nature of solvency aid.
"Colleges of supervisors have been created recently, but whether they can overcome these disincentives to cooperate is a moot point. Although the recent amendments to the Capital Requirements Directive (CRD) strengthen the legal underpinning of the colleges, they do not reduce or eliminate the disincentives to exchange information. In addition, all these colleges create level-playing-field and coordination problems. Moreover, the CRD does not introduce clear rules as regards decision-making, which may make it very difficult for colleges to come to a joint decision, especially in a crisis situation.
"Third, the financial turbulence has shown that in respect of both crisis prevention and crisis resolution the supervisory and central banking functions have to be closely linked, even within individual countries. When these functions are allocated to different authorities, exchanges of information are more complex and action tends to be slower and less effective. Moreover, the smooth management of crisis situations may be undermined by different views of the central banks and the supervisory authority about actions to be taken, as it happened in a well documented case.
"A stronger role for the ECB?
"Strengthening the role of the ECB in the field of supervision has some important advantages which, in my view, outweigh the disadvantages.
"First, there is no need to follow the normal procedures for changing the Treaty. Article 105.6 can be applied if unanimously agreed by the Member States and with the assent of the European Parliament. This article could also be used to address governance issues that are of concern to those who would like to safeguard the independence of the ECB in monetary policy, and keep some degree of separation between the prudential and monetary policy function. If responsibility for prudential supervision were to be entrusted to a body other than the ECB, a change in the Treaty would be needed, and this might take years, as we all know. In the light of the current financial crisis, it would be irresponsible to wait for a Treaty change via the normal revision procedures to achieve a stronger supervisory framework if the same result could be achieved without it.
"Second, bringing prudential supervision under the roof the ESCB would ensure that the information-related synergies between central banking and supervision are exploited to the maximum extent.
"Third, it would ensure that supervision is put in the hands of an institution, which has a proven track record, has relevant technical expertise in the house, and has an independent status. The latter point should not be underestimated.
"Fourth, the current crisis has shown the need to strengthen macro-prudential supervision, which concentrates on the systemic components of financial markets. It was the lack of a comprehensive perspective which led to the contagious nature of the crisis being underestimated, even in countries where financial institutions were thought to be sound. Macro-prudential supervision can obviously not be conducted at national level, certainly not within the euro area. It has to be conducted at a level close to the central bank, where analyses of monetary and financial developments are undertaken. This is consistent with the recommendations made by the FSF and other bodies in response to the current crisis. It has been suggested also by various members of the European Parliament. Furthermore, it is in line with the proposal in the US to assign macro-prudential responsibilities to the Federal Reserve. The ECB has in fact laid the necessary basis for taking on such a task, notably through the preparation of its Financial Stability Reports. Yet it is clear that the warnings contained in these reports were not heeded by the relevant authorities. This shows the authority for macro-prudential supervision should be equipped with the necessary powers.
"The macro-prudential supervisory tasks to be assigned to the ECB should include: the development of early warning systems about the emergence of risks and vulnerabilities in the financial system; the conduct of macro-stress testing exercises aiming at verifying the degree of resilience of the financial sector to specific shocks and propagation mechanisms with cross-border and cross-sector dimensions; the definition of reporting and disclosure requirements; macro-prudential regulation related to pro-cyclicality, leverage, risk concentration and liquidity mismatch.
"Fifth, in order to conduct macro-prudential supervision, it is necessary to have access to all the relevant information, including from systemically relevant institutions. This requires the EC
B to participate in the relevant colleges of supervisors of major banking groups. There also needs to be a full and proper exchange of information between national and European supervisors. The decentralised structure of the Eurosystem permits strong coordination between the national central banks and the ECB. Any European supervisory structure will have to rely on a combination of centralised decision-making and de-centralised implementation. The Eurosystem’s experience can be very useful in this respect."