Journal Issue

Euro Area Policies: Selected Issues

International Monetary Fund
Published Date:
July 2009
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III. A New EU Cross-Border Financial Stability Framework1

A. Introduction

1. The EU has embarked on a comprehensive overhaul of its cross-border financial stability framework. This overhaul aims to more effectively monitor, assess, and manage systemic risks through a formal system for macro-prudential oversight, and enhance trust, efficiency, accountability, and consistency in cross-border micro-prudential supervision, consistent with the objective of a single financial market.2 The outlines of the overhaul have been agreed (see organigram in Figure 1), concrete legislative proposals are due by the early autumn, and full implementation is envisaged in the course of 2010. The new framework will be reviewed no later than three years after its establishment.

Figure 1.The EU’s New Financial Stability Framework

Source: European Commission, IMF Staff

B. Main Elements of the Reforms

Macro-Prudential Oversight

2. A European Systemic Risk Board (ESRB) will be established to monitor and assess macro-financial risks and issue warnings and recommendations to address them.

3. Set-up and composition. The ESRB will be organizationally closely tied to the ECB and ESCB,3 including for logistical and analytical support, and will not have separate legal personality or binding powers. It will be composed of the President of the ECB, the Governors of the EU’s central banks, the heads of the European Supervisory Authorities (ESAs, see below), and a representative of the European Commission. The president of the Economic and Financial Committee (EFC)4 and one representative per country of the national supervisory agencies will participate as observers, the latter alongside their central bank Governors in a 1+1 formula. The Chairman will be a central bank Governor or the ECB President (in the latter case, the ECB will be represented by its Vice-President) and will be elected by the members of the General Council of the ECB,5 essentially the central bank Governors. The Vice Chairman will be elected by the ESRB members.

4. Mandate. The ESRB will focus on analyzing risks that arise from macroeconomic developments and developments within the financial system as a whole. It will issue risk warnings and, where necessary, recommendations and advice on measures to address these risks, including possible legislative ones. The risk warnings and recommendations can be either of a general nature or concern individual member states or groups of member states. Accountability will be vis-à-vis the European Parliament and the EU Council.

5. Functioning. A small Steering Committee will set the work agenda and prepare decisions.6 The ESRB will meet at least quarterly and decide based on simple unweighted majority voting. It is expected that most of the analytical and preparatory work will be conducted by the ECB, in coordination with the other central banks within the ESCB. The existing Banking Supervision Committee will be transformed into a broader technical advisory body to the ESRB that will bring together all national supervisory agencies. The ESRB will also be able to draw on the advice of other parties and is expected to liaise closely with the Financial Stability Board, the IMF, and other international bodies.

6. Risk warnings and recommendations will generally be addressed to the ECOFIN and, as appropriate, to the ESAs. They will normally be kept confidential, but could be made public on a case-by-case basis after consultation with the ECOFIN. The ESRB will be required to follow up on its risk warnings and monitor the implementation of its recommendations. While these recommendations will be non-binding, non-implementation will have to be explained (“act or explain”).7 The option of publication should also help to encourage action.

Micro-Prudential Supervision

7. Set-up. A European System of Financial Supervisors (ESFS) will be established, bringing together the EU’s national supervisory agencies with three new independent, sectoral, supranational European Supervisory Authorities (ESAs): the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA), and the European Insurance and Occupational Pensions Authority (EIOPA). The ESAs will be formed out of the existing Level-3 committees in the Lamfalussy structure, and have the same sectoral coverage.8 They will have legal personality. A Steering Committee will be established to coordinate and ensure consistent approaches among the three ESAs, seeking in particular effective supervision of conglomerates and a level playing field between sectors.9

8. The ESAs will have significantly strengthened governance systems, powers, and operational autonomy compared to the Level-3 Committees. They will have full-time, independent chairpersons and secretary-generals, a Supervisory Board composed of the highest-level representatives of the corresponding national supervisory authorities, and a Management Board composed of representatives of the same national authorities. It is envisaged that decisions will be made on the basis of qualified majority voting, using the Treaty weights of the member states. The ESAs will have increased resources and staff levels compared to the secretariats of the current Level-3 committees.

9. Mandate. The ESAs will be tasked with building a common supervisory culture, ensuring consistent supervisory practices, and establishing uniform procedures and consistent approaches across supervisory colleges. Specifically, they will seek to establish a single rule book (see below), ensure consistency in the interpretation of these rules, collect feedback on practical issues that arise in the implementation of these rules, issue guidelines on practical supervisory issues, coordinate supervisory analyses, conduct peer analysis with a view to achieving consistency in supervisory outcomes, develop common training programs, and provide input into international issues. The ESAs will be directly accountable to the EU Council, the European Parliament, and the European Commission.

10. Functioning. While the ESAs will have direct supervisory powers over rating agencies (and possibly central counterparty clearing houses), other institutions will continue to be supervised by the national supervisory authorities, this is, the national level of the ESFS. For cross-border groups, supervisors will set up colleges, in which the ESAs will be able to participate as observers.

11. Enforcement and conflict resolution. The ESAs will fulfill an important role in enforcement and conflict resolution within the ESFS. Two important tools are envisaged. First, in case of a manifest breach of EU Law or the ESAs’ binding technical standards, the ESAs will be able to address recommendations to the relevant national supervisor. If noncompliance nonetheless persists, the ESAs can refer the case to the European Commission so that the latter can use its enforcement powers to resolve the matter.10 Second, in case of disagreement between national supervisors or within a college of supervisors, the ESAs will be able to initiate a binding process of mediation, in which they facilitate a dialogue and assist the supervisors in coming to a joint agreement. If no agreement can be reached after a phase of reconciliation, the ESAs will have the power to settle the matter with a binding decision. However, the areas in which such binding decisions can be taken remain to be clarified at the time of writing, as the June 19 European Council agreed that such binding decisions can not impinge on the fiscal responsibilities of the member states. Binding decisions will be subject to judicial review in the EU’s Community Courts.


12. The ESFS is expected to establish a “single rule book applicable to all financial institutions in the Single Market.” A three-pronged approach is envisaged to achieve this goal:

  • a review of existing Directives to remove national exceptions and achieve greater harmonization;

  • a new mechanism that would turn the ESAs into rule-setting bodies: within areas specified in EU legislation, the ESAs will be able to set binding harmonized technical standards that come into effect from a fixed date, provided the European Commission endorses them;11

  • the ESAs will also draw up non-binding standards, recommendations and interpretative guidelines, which would be applied by the national authorities in taking individual decisions. While non-binding, application will be on a “comply or explain” basis, which has proven to be effective in achieving compliance.

Information Gathering and Sharing

13. An integrated system for collecting, managing, and sharing prudential information is envisaged. It will comprise the following elements:

  • the ESAs will be responsible for the definition, collection and aggregation of all relevant micro-prudential information emanating from national supervisors (who will remain the point of contact for the prudential reporting of financial institutions);

  • a central European database will be established and managed by the ESAs;

  • the information in the central European database will be made available to the relevant authorities in the colleges of supervisors;

  • the ESFS Steering Committee will organize the sharing of this information with the ESRB, subject to specific confidentiality arrangements; and

  • the European Commission has been asked to review existing legislation in order to facilitate the functioning of this system.

C. Challenges and Unresolved Issues

14. The reform package leaves crisis management and resolution largely untouched. However, the European Council has asked the European Commission to accelerate its work under the existing crisis management roadmap, with a view to establishing a comprehensive cross-border crisis management framework for the EU. In this context, it has asked for proposals to give the ESAs a strong coordinating role in crisis management.

15. In the absence of comprehensive solutions for cross-border crisis resolution and the related question of fiscal burden sharing, the envisaged binding powers for the ESAs have been controversial. The argument against is that these binding powers could lead to fiscal (crisis management and resolution) costs in member states and that this would impinge on member states’ responsibilities for fiscal policy. The European Council took a middle road, deciding that binding powers are needed but that these should not impinge in any way on the fiscal responsibilities of member states. It asked the European Commission to come up with detailed legislative proposals to achieve this balance.

16. The extent to which the ESFS will be able to succeed in producing a single rulebook will depend on the design and quality of the legislative framework, and the scope that the legislator will provide in individual Directives for rule-setting by the ESAs. In addition, a long-standing challenge is that of ensuring rapid transposition of the common rules at the national level, where rule-setting mechanism still vary greatly.

17. Establishing the single EU prudential database will likely require significant legal reforms in member states in order to alter the current country-based confidentiality regimes.


Prepared by Wim Fonteyne.

The prososed reforms were endorsed by the European Council on June 19 (Council of the European Union, 2009b). They are based on the recommendations of the De Larosière Group (De Larosière Group, 2009), a set of Commission proposals on the basis of these recommendations (European Commission, 2009), and the conclusions of the June 9, 2009 ECOFIN meeting (Council of the European Union, 2009a).

The European System of Central Banks (ESCB) reunites all EU central banks, regardless of whether their country has adopted the euro. Central banks of euro area member states also form the Eurosystem, whose membership therefore constitutes a subgroup of the ESCB.

The Economic and Financial Committee brings together senior officials of the EU’s Ministries of Finance. Its main task is to prepare the meetings of the Ministers of Finance in the ECOFIN Council. A subgroup of the EFC, the Euro Working Group (EWG) prepares the meetings of the Eurogroup.

The ECB’s General Council is composed of the President and Vice-President of the ECB, as well as the Governors of the central banks of all EU member states.

Comprising the Chairman, Vice-Chairman, and two additional central bank members of the ESRB, the Chairs of the ESAs, the representative of the European Commission, and the EFC president.

A similar “comply or explain” mechanism was recently introduced by the Level-3 Committees of supervisors, and has reportedly proven to be effective.

The Committee of European Banking Supervisors (CEBS) will become the European Banking Authority (EBA), the Committee of European Securities Regulators (CESR) will become the European Securities and Markets Authority (ESMA), and the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) will be turned into the European Insurance and Occupational Pensions Authority (EIOPA).

The Steering Committee will comprise representatives of the three ESAs and the European Commission.

Under the Lamfalussy process, enforcement (Level 4) was the task of the European Commission. This new arrangement shifts the task essentially to the ESAs, using the (threat of the) European Commission’s existing enforcement powers to give the ESA recommendations teeth.

Compared to the existing Lamfalussy process, this implies that the rulemaking functions of Levels 2 (detailed technical rules) and 3 (technical advice and industry consultations on such rules) are largely merged in the ESAs.

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