Financial supervision in Europe: A proposal for a new architecture
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.