chapter  15
18 Pages

Financial supervision in Europe: A proposal for a new architecture

ByDIRK SCHOENMAKER, SANDER OOSTERLOO

After the successful establishment of the EMU, the debate on the need for a ‘European System of Financial Supervisors’ is intensifying in the literature (e.g. Vives 2001; Schoenmaker and Oosterloo 2005) as well as in the policy arena (e.g. Economic and Financial Committee 2002; Committee of European Securities Regulators 2004; Financial Services Committee 2005). The basic argument in favour of moving to a European structure is that it might be

difficult to achieve simultaneously a single financial market and stability in the financial system, while preserving a high degree of nationally based supervision and crisis management with only decentralized efforts at harmonization (Thygesen 2003). This is an application of the classical trilemma in macroeconomic policy. Policy-makers are confronted with three desirable, yet contradictory, objectives: fixed exchange rates, capital mobility and independent national monetary policy. Only two out of the three objectives can be pursued at the same time, leaving policy-makers with the decision of which one they wish to give up: the ‘trilemma’ (Rose 1996). Figure 15.1 illustrates the three incompatible objectives in our case: (1) a stable financial system; (2) an integrated financial market; and (3) independent national financial supervision and crisis management. An argument against moving to a European solution for financial supervision at the present time could be that the degree of integration in financial markets does not yet justify such a move. The integration of financial markets is thus the key driver for possible changes. In parti-

cular, the capacity of the financial services groups to span different EU financial markets fosters integration. Emerging pan-European banks and insurers give rise to cross-border externalities arising from the potential failure of these banks (and insurers). The increasing presence of financial groups from other EU countries undermines the capacity of host authorities to manage effectively the stability of their financial system. Host authorities are thus dependent on the action, or lack of it, of home authorities. Moreover, increased linkages between banks, insurers and pension funds may raise the potential vulnerabilities of the wider European financial system. If these trends continue, it may become necessary to give up the third objective of the trilemma: national financial supervision and crisis management. To maintain the stability of an integrated EU financial system, arrangements for financial supervision and stability may have to be anchored at the EU level. This chapter identifies the trends in the European financial landscape. The first trend is

centralization of risk management functions at the headquarters of financial groups. This reinforces the role of the home supervisor as the consolidating supervisor. The second trend is increasing cross-border penetration of banks and insurers. New evidence on emerging pan-European banks and insurers is provided. We are moving from a landscape with primarily

domestically operating financial firms to a small group of large European-wide operating financial firms. Some of these large firms even operate on a global scale. To create an internal market for financial services, regulations are based on a European

footing to ensure their effectiveness as well as a European level playing field. However, supervisory authorities, who enforce these regulations, are still nationally rooted with some elements of European coordination. The national base of supervisors is related to political sovereignty (Herring and Litan 1994). In a more practical sense, it also related to the issue of jurisdiction. One needs a jurisdiction for enforcement of regulations, liquidation and winding-up procedures and taxation. As a European jurisdiction is (or can be made) available, policy-makers have the choice to organize financial supervision and crisis management on a national or a European basis. We review the different policy options. Coordination arrangements between national

supervisors will cultivate duplication of supervisory efforts by home and host supervisors and multiple reporting by financial groups (Schüler and Heinemann 2005). In this chapter, we propose a prospective European System of Financial Supervisors to be created by a European Financial Agency working in tandem with the national financial supervisors. Key elements are decentralized day-to-day supervision close to financial institutions and centralized policy-making to foster a uniform execution of supervision. Such a European System could combine the advantage of a European framework (to incorporate crossborder effects in the decision-making) with the expertise of national supervisors.