Financial stability plays a crucial role in the financial system and the economy as a whole, as the current crisis shows. And with an increasing number of financial institutions now active in two or more countries or continents, global financial stability has become even more important.
The financial system consists of:
In order to protect the financial system and ensure financial stability, the main sources of risk and vulnerability must be identified, and all relevant parties (such as financial institutions and supervisors) must be made aware of risks.
Banks, insurance companies and other financial institutions form the first line of defence against financial crises. It is their responsibility to remain viable and solvent, checking the creditworthiness of borrowers and thereby managing the risks that they take on.
Measures adopted by public authorities in order to prevent or mitigate financial crises constitute a second line of defence. These measures include:
If, despite all of these measures, financial institutions run into trouble, public authorities may need to intervene.
The ECB/Eurosystem has four tasks in the field of financial stability.
The ECB, together with the other central banks of the Eurosystem and the European System of Central Banks, systematically monitors cyclical and structural developments in the banking sectors of the euro area and the EU as a whole, as well as other financial sectors. It does so in order to identify any vulnerabilities and check the resilience of the financial system.
This assessment is carried out in cooperation with the NCBs of the EU through the Financial Stability Committee. At the ECB itself, the monitoring and assessment of financial stability is performed in cooperation with several directorates general: Financial Stability (which coordinates activities), Economics, Market Operations, International and European Relations, and Payments and Market Infrastructure.
Analysis of developments in the area of financial stability is published on a regular basis in various reports – for example the ECB’s Financial Stability Review and Annual Report, as well as regular publications entitled "EU banking sector stability" and "EU banking structures".
On account of its technical expertise, the ECB is frequently asked by both EU and national authorities to help design and draft the financial rules and supervisory requirements applicable to financial institutions. The ECB occasionally contributes to discussions on its own initiative. Whether its advice is sought or not, it nevertheless ensures that financial stability is taken into account.
The ECB is consulted on draft EU and national legislation relating to financial stability and supervision (see ECB opinions on financial system stability).
It also participates in relevant international and European fora, such as:
Since the establishment of the ECB, the central banks and supervisory authorities of the EU have worked to enhance cooperation within the framework of the Banking Supervision Committee. In 2011, following institutional changes brought about by the EU regulation establishing the European Systemic Risk Board, a new ESCB committee was created: the Financial Stability Committee. This comprises high-level representatives from the ECB and the other central banks of the euro area (and occasionally the EU as a whole). The Financial Stability Committee assists the decision-making bodies of the ESCB in the fulfilment of their tasks in the field of financial stability.
Good cooperation and frequent exchanges of information are essential to the maintenance of financial stability, both in normal circumstances and in times of crisis. Ministries of finance are also involved in such exchanges where a crisis needs to be managed and resolved. In order to place this cooperation on the proper footing, all relevant authorities have signed a memorandum of understanding. The agreed procedures are reviewed and tested on a regular basis by means of exercises simulating financial crises and other activities.
In addition to the tasks described above, the Eurosystem is directly responsible for overseeing financial market infrastructures. These facilitate flows of funds, securities and other financial instruments between buyers and sellers, and between borrowers and lenders. They constitute a key component of the financial system and are essential to its overall stability. Oversight activities aim to ensure that these infrastructures function smoothly and that any disruption does not give rise to systemic risks affecting the financial system and the economy as a whole.
The tasks of the ECB/Eurosystem in the field of financial stability are laid down in Articles 127(4), 127(5) and 282(5) of the Treaty on the Functioning of the European Union, as well as Articles 3.3, 4 and 25.1 of the Statute of the ESCB. Oversight forms part of the ECB’s task of promoting the smooth operation of payment systems and ensuring efficient and sound clearing and payment systems within the European Union and with other countries (Article 127(2) of the Treaty on the Functioning of the European Union and Articles 3.1 and 22 of the Statute of the ESCB).
The institutional framework for financial stability in the EU is based on two components: (i) crisis prevention; and (ii) crisis management and resolution. The ECB, together with the NCBs of the euro area, contributes to both.
The institutional framework has been revised and now explicitly addresses both macro- and micro-prudential supervision. The new European System of Financial Supervision consists of:
Financial crises can inflict enormous damage on society, extending far beyond the costs incurred by individual banks. In the European Union, banks and other financial institutions have the right to provide services outside their home countries, either directly across borders or by establishing branches or subsidiaries. This cross-border business needs to be taken into account in the pursuit of financial stability, so the relevant national authorities have to work closely with their foreign counterparts.
Safeguarding financial stability and averting such crises comprises two elements: prudential regulation (i.e. the rules that financial institutions have to comply with); and prudential supervision (i.e. checking that financial institutions obey these rules).
Prudential regulation is based on a largely harmonised EU-wide regulatory framework, for which the European Commission, the EU Council and the European Parliament have primary responsibility.
National supervisors have responsibility for prudential supervision at the national level. Coordination and cooperation between supervisors takes place through the new European Supervisory Authorities established on 1 January 2011. (The ECB and NCBs that do not have supervisory responsibilities participate in the EBA as non-voting members.)
Regular monitoring and assessment of systemic risks at the EU level is performed by the recently established European Systemic Risk Board, which is responsible for macro-prudential oversight in the EU.
If the activities of financial markets, intermediaries or infrastructures are disrupted for any reason, public authorities may have to intervene.
Authorities can take various steps to manage a crisis and tackle disruption. For instance:
The EU’s crisis management arrangements aim to ensure that the EU’s supervisory authorities, central banks and ministries of finance share information and cooperate on the basis of established procedures. In June 2008 these parties concluded a memorandum of understanding on cooperation in financial crises. Further legislative proposals will follow in due course.
This concerns the handling of an insolvent bank or other financial institution, as well as the protection of creditors (notably depositors). However, "crisis resolution" does not mean bailing out banks. It includes:
The effectiveness of crisis management and resolution arrangements at the EU level is regularly tested by means of simulation exercises. National arrangements in the form of financial stability committees, memoranda of understanding, and other formal or informal coordination instruments complement the EU’s financial stability framework.
The Eurosystem contributes in several ways to the smooth conduct of policies by competent national authorities as regards the prudential supervision of credit institutions and the stability of the financial system. Specifically, the Eurosystem:
What started out as turbulence in particular parts of the financial system in August 2007 has since become a global economic and financial crisis, with businesses failing, unemployment rising, investors losing money and governments having to commit large sums of money in order to prevent the banking system from collapsing. This has also had an adverse impact on government finances. These tensions have culminated in requests for EU/IMF support from some euro area countries and the implementation of concrete policy measures at the EU level with a view to strengthening backstop mechanisms and mitigating financial vulnerabilities.
The world’s financial systems remain under pressure.
For more information, see the ECB’s latest Financial Stability Review.