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Public hearing on "After Enron: financial supervision in Europe" at theCommittee on Economic and Monetary Affairs of the European Parliament

Statement on "EU structures for financial regulation, supervision and stability"by Tommaso Padoa-Schioppa, Member of the Executive Board of the European Central BankBrussels, 10 July 2002

1. These hearings organised by the European Parliament are particularly timely. The ECOFIN Council, with the assistance of the Economic and Financial Committee and the European Commission, is currently reviewing the structures for co­ operation at the EU level in the fields of financial regulation, supervision and stability. In the light of the relevance and the complexity of this review, and in consideration of the central role of the European Parliament in the regulatory process, I shall concentrate this introductory statement on financial regulation and supervision, leaving the Enron case to the subsequent debate.

2. A debate on three issues. The debate on the institutional arrangements for prudential supervision and financial stability encompasses three issues.

The first relates to the optimal organisation of supervisory tasks at the national level in view of the blurring of distinctions between the traditional sectors of financial activity (banking, securities and insurance). There is some agreement that the old arrangements, based on a rigid compartmentalisation of responsibilities in three sectoral agencies, require adjustments. This has brought about a wave of reforms in various Member States, some of which are currently being considered by national parliaments. However, no clear convergence towards a common model is emerging. Three models coexist. One of these relies on committee structures to liaise between the sectoral authorities. A second one is based on the consolidation of supervisory responsibilities across the whole financial sector into a single agency. A third envisages the (partial or complete) consolidation of responsibilities across financial sectors, but distinguishes between prudential tasks, aimed at safeguarding the stability of financial institutions, and conduct of business tasks, aimed at ensuring transparency.

The second issue - also referring to the national level - concerns the role of central banks in prudential supervision, in particular in the banking sector. Here also there are various arguments and approaches. The ECB has recently argued that in the institutional and market environment created by the introduction of the euro, the arguments against central bank involvement lose much of their weight, while those in favour acquire greater prominence. [1] In most Member States central banks are either directly entrusted with supervisory responsibilities in banking or operationally involved in the conduct of supervisory tasks. Where this is not the case, the central bank is responsible for the stability of the financial system as a whole, and co-operation mechanisms are established with the responsible supervisory authority.

The third issue is whether arrangements should be national or European. The question was raised very forcefully in academic circles and international institutions when the introduction of the euro started to exercise a powerful influence on the integration of wholesale financial markets and payment and settlement systems infrastructures. After an extensive debate based on the work of the Economic and Financial Committee and, in the securities field, of the Committee of Wise Men chaired by Alexandre Lamfalussy, there is now broad agreement that a Treaty change should not be considered at present. In accordance with the subsidiarity principle, the ability of national authorities to establish a close network through co-operation and to deliver a unified functioning of the present institutional arrangements has to be fully tested.

3. A twofold challenge. The present discussions on the EU framework for financial regulation, supervision and stability will be set against the background of two elements:

  • the national competence in the implementation and enforcement of regulation;

  • the fast-changing and rapidly integrating financial industry.

Both elements are very important and intertwined. A financial industry which changes and integrates rapidly on a cross-border basis calls for a flexible and consistent implementation and enforcement of regulation across countries. The latter objective needs to be pursued in a context in which responsibility for implementing and enforcing regulation remains at the national level. This unprecedented situation presents an inherent degree of tension and will constitute a severe challenge for the regulatory and supervisory framework. The pursuit of new arrangements for financial regulation, supervision and stability is further complicated by the different national answers to the first two dimensions of the debate, which translate into different preferences as to the structures for co-operation at the EU level. It is then essential that these different views find an equilibrium that is satisfactory to all the parties with responsibilities in this area.

4. Multiple objectives. The new arrangements must meet a number of different objectives. First, the arrangements should effectively safeguard systemic stability in increasingly integrated financial markets. The single currency is changing the nature and scope of systemic risk. The amalgamation of infrastructures for large-value payments, the restructuring of interbank activities and the increase in cross-border provision of capital market-related services to large corporates have already altered the traditional channels for contagion, making the notion of systemic risk a euro area concept rather than a nation-wide one. This calls for increased co-operation in the monitoring of risks to financial stability.

Secondly, the arrangements should contribute to the removal of cross-border obstacles to a single EU financial industry. As argued by financial industry sources, [2] these obstacles stem from inconsistencies in national rulebooks, reporting requirements and supervisory practices. But they also include obstacles created by remaining protectionist attitudes of national authorities, seeking to promote their national champions and financial market-places.

Thirdly, the arrangements should provide efficient and flexible rules to meet the demands of fast-changing markets. The legislative procedures for adopting, implementing and updating regulatory initiatives through Directives are lengthy and cumbersome. As pointed out by the Committee of Wise Men on securities regulation, a different balance between framework principles, to be adopted through Directives, and technical implementing measures, to be left to comitology procedures, could enhance the ability of the EU regulatory framework to cope with financial innovation. In this respect, the co-operative stance taken by the European Parliament, which enabled an agreement preserving the institutional balance to be found, is to be praised.

Fourthly, the arrangements will have to provide for effective implementation and enforcement of those rules in all Member States. This means promoting substantial convergence in supervisory practices, which is needed both for level playing-field considerations and to reduce the dead-weight costs of a still complex supervisory structure.

All elements are important. In the present debate, the dominant focus on just the single aspect of regulation is a source of distortion. More active co-operation in ensuring convergence in supervisory practices and safeguarding financial stability, together with a more effective competition policy, are also called for.

5. Clarifying the notion of "Lamfalussy framework". The present debate often refers to the need to extend the so-called "Lamfalussy" framework adopted for securities to other sectors. This is an ambiguous notion, because that framework has several components, which should be considered one by one. It includes, among other things: i) wider reliance on comitology procedures and secondary legislation; ii) separate committees of regulators and supervisors at different levels; and iii) an agreed interinstitutional formula with respect to the roles of the Council, Commission and Parliament. It does not, however, state that iv) central banks should be excluded from either supervisory or regulatory tasks in the banking sector, as is sometimes argued.

There is a strong case for wider use of secondary legislation under comitology arrangements in all sectors of finance, since this would make regulation more flexible and easily adaptable to changes in the industry. However, when designing the structures for regulatory co-operation, attention should be paid to efficiency considerations. Particularly in sectors where regulation has a strong technical content, regulatory committees (so-called level 2) should have sufficient direct expertise to be able to take independent decisions. This could lead to the participation of authorities endowed with the technical skills to contribute to shaping effective rules. Restricting the membership of regulatory committees to finance ministries could have the consequence that /) the issuance of regulation will become too dependent on technical advice and ii) the supervisory committees (so-called level 3) will be distracted from their key functions (information exchange, supervisory convergence, best practices, etc).

When speaking of "adopting the Lamfalussy framework", it should also be borne in mind that the proposal of the Committee of Wise Men was intended to favour enhanced harmonisation of Community legislation in the field of securities, where the Single Market had started on the basis of very limited common regulation, thus lending a major role to the regulations issued in the host country where the financial services are offered. This is not the case in banking, where substantial harmonisation has been achieved and any intermediary can provide services in the whole EU under the supervision of the authority that has issued its licence. The key activity of the supervisory committee (level 3), particularly in the field of banking, should therefore be supervision, not regulation. Supervision involves continuous work to monitor developments in the banking industry and institutions and to ensure effective and consistent implementation and enforcement of regulation. This is now lacking and will be increasingly needed as the industry integrates on an EU- wide basis.

6. Central bank involvement. In banking supervision synergies between central banking and separate agencies must be fully ensured at the EU level. This need for synergy stems from the specific potential for systemic risk intrinsic to banking, which has a direct implication for the viability of payment infrastructures and the management of liquidity. This is recognised by almost all Member States, including those, like Germany , where the separation between supervisory and central banking functions was first introduced. It is also recognised by the Basel Committee on Banking Supervision, which includes central banks and banking supervisory agencies and is the major standard-setting body at the global level. Equally, the ESCB Banking Supervision Committee, which supports the Eurosystem in the conduct of its tasks in the field of prudential supervision of credit institutions and financial stability (see Article 105 (5) of the Treaty), encompasses all EU central banks and separate banking supervisory authorities.

Central banks can and do bring to supervisory co-operation their direct knowledge of, and operational participation in, the banking and securities markets, from which they derive technical expertise on risk management issues. If one considers the major tasks which will have to be performed via supervisory co­ operation in the near future, it appears that most of them are linked to the new tools for measuring credit risk in the new framework for capital adequacy. Both at the global and the EU level central banks are playing a major role in this area, since many of them have developed their own internal system for measuring credit risk in the exercise of their lending functions or in the management of credit registers. This experience is valuable to the process of reviewing the measurement systems adopted by commercial banks, as acknowledged at the national level in countries like Germany and Austria , where the central banks actively participate in this process. Central banks are also contributing to banking regulation and supervision with research assessing the impact of the new proposed framework on macroeconomic fluctuations and the availability of credit to small and medium-sized enterprises, two issues that are at the core of the present debate. Furthermore, a great deal of useful information, also company-specific, which should not be lost from the supervisory system, is available only via the central banking functions.

In conclusion, the exclusion of central banks from regulatory and supervisory committees would run counter to a well-established national and international tradition and could seriously undermine the effectiveness with which the public interest is pursued in circumstances that are already quite challenging. It would be difficult to understand why what is considered an asset both at the national level and in international co-operation should be lost in the new EU structures. The appropriate way to achieve these synergies is by granting membership to both supervisors and central banks, as the Governing Council of the ECB has recently proposed in its contribution to the Economic and Financial Committee.

7. Exchange of information. An argument sometimes raised against the involvement of central banks without supervisory responsibilities in the structures for co­ operation at the EU level is that this would violate the statutory protection of confidential information. Such an argument clashes with the understanding that the arrangements need to effectively safeguard financial stability in an increasingly integrated financial market. It is acknowledged that an open exchange of information should take place in the event of a crisis, where central banks and banking supervisors must co-operate closely to limit the impact of the crisis and avoid its social costs. In this respect, the EFC report on financial crisis management (the so-called Brouwer II report) explicitly calls for the removal of any remaining legal obstacles to information sharing between all the parties potentially involved in the management of a crisis. But exactly the same argument is valid in ordinary times, i.e. for the prevention of a crisis, since the exchange of information is needed to monitor the potential for systemic risk and the threats to financial stability in a continuously changing environment.

In view of this, all national supervisors and central banks should receive a clear mandate from European institutions to share information. Where national laws or regulations create barriers to such an information exchange, they should be amended.

8. A multiparty forum. In increasingly integrated financial markets, co-operation between all the authorities involved in regulation and supervision of the different sectors (banking, securities, insurance) of the financial system is warranted: a strong case exists to establish a new forum bringing together all the interested authorities: central banks, finance ministries, supervisors, etc. This new forum cannot replace sectoral fora, which should remain responsible for regulation and supervision at the sectors' level, but could contribute to the co-ordination of their activities and help build a unified perspective on financial stability issues. As already experienced in a G7 setting, this gathering of relevant authorities could help identify incipient vulnerabilities in the European financial system, favour the development and implementation of standards and best practices and ensure that consistent European rules and arrangements apply across all types of financial institutions. For the new forum to work effectively, the number of participants should be limited, while ensuring adequate representation of countries and sectors.

9. Time horizon. The framework which will result from the present discussion could last for many years. It will imply a redrafting of relevant directives, a new design of the respective competences of primary and secondary legislation in all fields of financial regulation, the revision of implementing measures, changes in national rules reflecting the new Community framework and co-ordinated efforts to achieve more consistent rulebooks and supervisory practices across Member States. All this will take a considerable amount of time, in the order of three to four years. Hence, it is vital to be sufficiently convinced that the new arrangements are appropriate for dealing with a fast-changing, highly integrated EU financial sector, which will not wait until the new arrangements are fully operational. In spite of this, the timetable set for the work of the EFC and the Commission is exceptionally tight and is aimed at agreeing on a solution already by early September 2002. There is here a striking difference with the work pursued by the Committee of Wise Men on securities regulation. On that occasion, the Committee had much more time available and was able to conduct online consultation with all the parties potentially interested, to receive input via hearings of high-level experts, to discuss preliminary conclusions with all European institutions and to submit to the attention of the general public an initial report before coming to its conclusions. By contrast, in the present debate on EU arrangements for financial regulation, supervision and stability, there is a risk that there will not be sufficient time to conduct the work in a thorough way. The decisions to be taken are very relevant and this might require a more considered review of the different options available, benefiting also from the insights of persons and institutions that have not been involved so far in the debate. The issue is urgent but urgency should not override the need to proceed in a fully considered manner.

  1. [1] See ECB, The role of central banks in prudential supervision, April 2001

  2. [2] See F. Heinemann and M. Jopp, The Benefits of a Working European Retail Market for Financial Services, Report to the European Financial Services Roundtable (so-called Gyllenhammer report). Europa Union Verlag, 2002.


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