Monetary and financial issues

Economic Survey of the Euro Area 2009: Financial market stability: enhancing regulation and supervision


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The following OECD assessment and recommendations summarise chapter 3 of the Economic Survey of the Euro Area published on 14 January 2009.




More integrated and developed financial markets in Europe need to be accompanied by enhanced regulatory and supervisory frameworks.

More integrated and developed financial markets in Europe have contributed to economic growth and fostered resilience as larger and more diversified financial systems are better placed to absorb economic shocks. However, it may also open up additional channels for the transmission of financial shocks, including across borders. Moreover, several new financial products have contributed to more risk taking. The appropriate design of regulation is a complex issue, which requires the balancing of stability, innovation and growth considerations. It is unlikely that future episodes of instability can be avoided altogether. It will always be challenging for regulators and supervisors to stay informed, because of information asymmetries, about the institutions they supervise and to keep pace with innovations and their potential impact on the stability of financial markets. The European single capital market continues to be heavily reliant on co-operation between national regulators working within differing supervisory structures, having different responsibilities, instruments and powers. Against this background, it is necessary to continue efforts to ensure a level playing field, to enhance the sharing of information between regulators and supervisors and to align the incentives of national authorities with the cross-border impact of their institutions.

The European authorities are participating in a number of international initiatives to respond to  weaknesses revealed by the financial instability and should continue to follow these closely.

The on-going global financial market turmoil has raised a number of issues about how institutions should be regulated and supervised. European authorities are participating in a number of international initiatives to respond to the weaknesses revealed by the financial instability. In October 2007, the Economic and Financial Affairs Council (ECOFIN) agreed a specific roadmap of policy actions in the wake of the onset of financial turmoil, consistent with recommendations made at the international level, i.e. notably the Financial Stability Forum and the G7. EU authorities should continue to follow international initiatives closely.

The main policy priorities are:

  • Improving transparency through enhanced disclosure of risk, improved valuation methods and a more comprehensive picture of off-balance sheet entities.

  • Changing the role of credit rating agencies and improving their functioning.

  • Strengthening risk management standards and procedures, and providing better incentives to hold appropriate levels of capital. Liquidity risk management should be improved.

  • Regulators and supervisors should become more responsive to risks. This requires: better information about financial developments; a well-defined framework for liquidity provision in conjunction with the monetary authorities; enhanced mechanisms for identifying and dealing with failing banks at an early stage; more effective and specific bankruptcy procedures for banks; and better cross-border supervisory arrangements.

  • Ensuring that adequate deposit-insurance schemes are in place and that payouts are swift and predictable.

  • Developing policies to reduce the pro-cyclicality of financial regulations and policies that can be used to “lean against the wind” such as smoothing capital and provisioning requirements.

  • Concrete steps have been taken by the EU authorities in these areas. The European Commission has already put forward a revision of EU rules on deposit guarantee schemes.

The intensification of the financial turmoil in September 2008 prompted a co-ordinated rescue plan for the EU banking system that was adopted by the European Council in mid-October.

In response to the intensification of the financial turmoil in September and early October 2008, individual countries initially pursed a wide variety of responses, including comprehensive packages to recapitalise the banking system, ad hoc measures to recapitalise or provide emergency funding to individual financial institutions, providing blanket guarantees of all retail deposits, and guaranteeing that no financial institutions would be allowed to fail. These initiatives were followed by a co-ordinated rescue plan for the EU banking system adopted by the European Council in mid-October. This committed governments to:

  • Ensuring appropriate liquidity conditions for financial institutions.

  • Providing financial institutions with additional capital resources and allow for efficient recapitalisation of banks.

  • Adopting changes to accounting standards to mitigate the consequences of the exceptional recent turbulence in financial markets.

  • Enhancing co-operation procedures among European countries.

Policy interventions in financial markets need to be designed carefully. Countries should keep externalities for other European countries to a minimum, and policies should not make future crises more likely.

Policy interventions in financial markets need to be designed carefully. For instance, allowing institutions to deviate from strict application of marking their assets to market may give them some breathing room during the current crisis, but it may also undermine price discovery. It is also unclear whether guarantees to prevent banking failures are appropriate when some institutions, which are not systemically important, may prove insolvent. However, in real time it can be difficult to distinguish between insolvency and illiquidity. As agreed by the European authorities, interventions should be timely and temporary, mindful of tax payers’ interests, and ensure that existing shareholders bear the consequences of the intervention and that management does not receive undue benefit. Detailed consideration will also have to be given to how countries exit from the commitments they have made when the turmoil eventually dissipates. Finally, while differences in liquidity and solvency concerns mean that it is appropriate for countries’ responses to the crisis to differ, countries should keep externalities for other European countries to a minimum, and competition should not be distorted.

The main challenge is to manage systemic and cross-border risks in order to ensure financial stability in an integrated financial market.

The main challenge is to manage systemic and cross-border risks in order to ensure financial stability in an integrated financial market. The Capital Requirements Directive establishes the key standards for banking solvency. Banking supervision, however, has primarily remained the responsibility of national supervisors. The single EU banking passport sets out many areas where home country supervisors are responsible for branches of cross-border banks, while subsidiaries are supervised by host country supervisors. The Lamfalussy structure provides a framework for updating EU financial regulations as well as converging supervisory practices. Co-ordination between national supervisory authorities is encouraged both through the Lamfalussy level 3 committees (covering banking, insurance and securities markets) and the Banking Supervision Committee.

The current regulatory regime in the EU has advantages, but also has potential costs.

This current regulatory regime in the EU has a number of advantages. It aligns regulatory and legal responsibility for firms with political and fiscal responsibility, should things go wrong, and with the operation of national insolvency law and the operation of national deposit guarantee schemes. However, the EU’s current regime and the patchwork of different instruments, institutions and responsibilities does carry some disadvantages, especially as large complex financial institutions have extensive cross-border activities and the potential to have a significant impact on the wider economy. There is a risk that differences in regulation between countries lead to regulatory arbitrage, undermining the objectives of the regulation and distorting the operation of the European single market in capital services. The existing system relies heavily on close co-ordination and information sharing between different regulators with a variety of responsibilities and approaches. It also imposes a considerable burden on cross-border firms that have to report to an array of different authorities. National supervisors are closer to the institutions they supervise, but a more centralised and uniform system for supervising large complex financial institutions would also have advantages by pooling information, regulating in a consistent way, enhancing preparedness for a crisis and reducing regulatory costs. Although the ECB carries out macro-prudential supervision in the euro area, there is a need for better linkages between macro and micro-prudential supervision. The envisaged co-operation between the Committee of European Banking Supervisors and the ESCB Banking Supervision Committee regarding a semi-annual risk assessment in the EU is a useful step in this direction. Moreover, further convergence of regulatory and supervisory practices would be desirable.

Progress is being made to improve financial regulation in the European Union.

Progress is being made to improve EU regulation: ECOFIN adopted a roadmap on improving the Lamfalussy framework in December 2007. This improves and streamlines the processes for developing financial regulations and enhances the role of the level 3 committees. The Commission is working on a revision of the Commission Decisions establishing these Committees. By the end of 2008, they will be assigned specific tasks, such as mediation, drafting recommendations and guidelines and having an explicit role to strengthen the analysis and responsiveness to risks to the stability of the EU financial system. In October 2007, the Council adopted conclusions setting out further steps at both EU and national levels for the development of financial stability arrangements. The conclusions included common principles, a new Memorandum of Understanding for crisis management, and a roadmap for the enhancement of co-operation and preparedness and for reviews of the tools available for crisis prevention, management and resolution. Proposals are currently being formulated or considered to deal with a number of issues, including the cross-border transfer for assets and other questions within the review of the Winding Up Directive and amendments to the EU regulations relating to Deposit Guarantee Schemes.

Action has been taken to enhance cross-border co-operation between supervisors.

Moreover, in October 2008 the Commission adopted a proposal for a revision of the Capital Requirements Directive. Elements of this proposal relate to the establishment of Colleges of Supervisors to enhance cross-border co-operation between supervisors, the mandatory exchange of information between supervisors to help detect signs of financial stress, reducing banks’ exposure to interbank lending markets, and requiring firms issuing asset-backed securities to hold a portion of the securities on their balance sheets. In this context, a coherent group-wide supervision could be supported by strengthening the role of the “consolidating supervisor”. In the meantime, guidelines concerning the public support for banks have been issued.

Achieving a coherent system of financial supervision as well as managing cross-border risks calls for a more centralised and integrated approach.

Achieving a coherent system of financial supervision as well as managing cross-border risks calls for a more centralised and integrated approach. Possible options might include the establishment of a single EU financial supervisor or a European system of supervisors, with a central agency working in tandem with national supervisors. Either option has the potential to improve the monitoring and containment of systemic risks within the rapidly growing and increasingly integrated European financial market. A European system would probably be easier to integrate with the existing framework and might be able to ensure cultural and geographic proximity of supervision. In principle it should be possible to balance the interests of both home and host countries. However, if such a system was unable to overcome national biases and the externalities that arise from them, a single supervisor should be considered. As a matter of urgency the principles and procedures for burden sharing should be specified in greater detail, a European dimension should be added to the mandates of national supervisors to align their incentives, regulations should be more closely harmonised to limit compliance costs and EU-wide reporting forms introduced. Colleges of supervisors should also have enhanced powers to foster effective supervision, and the role of level 3 committees should be expanded to ensure that the colleges work effectively. Recent events have made it clear that it is essential to reflect on how to elaborate a longer term and shared vision of the EU supervisory architecture, combining the need to safeguard EU financial stability with legitimate national interests.


How to obtain this publication


The complete edition of the Economic survey of the Euro Area 2009 is available from:

The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.


Additional information

For further information please contact the Euro Area Desk at the OECD Economics Department at

The OECD Secretariat's report was prepared by Nigel Pain, Jeremy Lawson, Sebastian Barnes and Marte Sollie under the supervision of Peter Hoeller. Research assistance was provided by Isabelle Duong.




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