Chapter

Chapter 7 Banking in the European Community After 1992

Author(s):
Robert Effros
Published Date:
June 1994
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I. Introduction: The General Context

The realization of a global banking market is one of the elements of the program provided by the oft-cited White Paper entitled Completing the Internal Market, adopted in 1985 by the European Council and confirmed by the conference that negotiated the Single European Act of 1986 (SEA). As is well known, the SEA includes a revision of the EEC Treaty. This revision appears modest in its content, at least as compared with the draft European Union Treaty prepared by the European Parliament in 1984. But it has proved to be a potent catalyst of European integration.

The SEA has assigned some important objectives to the Community:

  • the completion of a single market by the end of 1992, that is, an area without frontiers where goods, persons, services, and capital will move freely;

  • the prospect of a European and Monetary Union;

  • new policies on regional and structural matters, research and development, environment protection, and social concerns.

These objectives were not entirely new, but they have been enshrined in the Treaty. In addition, the decision-making process has been improved by the introduction of majority rule for a greater number of decisions to be taken by the Council. Finally, a new procedure for harmonization of legislation has been provided.

The main objective of the SEA is the building of the internal market. This objective follows the program laid down in the White Paper for the adoption of some 300 measures in all the sectors concerned. The White Paper promotes a new method based on two complementary principles: essential harmonization and mutual recognition. The mutual recognition principle of this new method is founded on case law of the European Court of Justice1 that was first developed in the field of free movement of goods. It is the doctrine known as “Cassis de Dijon,” after a case concerning a French alcoholic beverage, the importation of which into Germany had been impeded. The Court of Justice ruled that a product legally commercialized in one country can be exported to the others without restrictions except for those based on considerations related to the protection of public good or general interest (public health, public order, security, tax fraud or avoidance, protection of the consumer, and so forth).

Following this line of reasoning, the White Paper proposed to renounce the detailed harmonization process then in use, which had proved time-consuming and unsatisfactory. As a result, harmonization was limited to the essential: common rules will be defined in order to replace any national regulation that constitutes legitimate obstacles. This is pursuant to the Court of Justice’s “Cassis de Dijon” decision as to the free movement of goods and services. Accordingly, this harmonization must achieve reasonable standards of protection of the interests that the national rules were enacted to protect.

Therefore, no obstacle to the free movement of services or goods can be admitted if those goods or services respect the Community’s basic specifications. As a result, essential harmonization is the condition for mutual recognition of the whole complex of national rules. (These national rules do not need to be harmonized because they cannot legitimately be invoked to oppose the free movement of goods and services.)

In the financial sector, considerations based on public good are important (e.g., stability of financial institutions, consumer protection, effectiveness of monetary and fiscal policy). Essential harmonization has to intervene. “Essential” in this context means that harmonization has to be limited to what is necessary to achieve the realization of a unified market for financial services. Particularly, prudential rules are to be harmonized in order to avoid a multiplicity of controls and the fragmentation of the market. This harmonization is the condition for the application of the principle of “home country control,” which has been considered vital in this respect in the absence of a central authority and which symbolizes the unity of the Community’s area.

Before going into more detail concerning the harmonization of banking legislation, it seems necessary to give some attention to the realization of the free movement of capital. This essential achievement of the Community can act as a catalyst for the creation of an internal market of banking and other financial services. The discussion on the free movement of capital will be followed by a close look at the Second Directive on Banking, and finally, the third section will address the possible evolution of a supervisory framework.

II. Free Movement of Capital

  • A. EEC Treaty Article 67, which provides for the realization of free movement of capital, is less peremptorily drafted than the parallel provisions related to the other main liberties, despite the fact that Article 3 of the Treaty provides for the liberation of capital movements as it does for goods, persons, and services.

    Specifically, Article 67 calls on member states to undertake a progressive liberalization of capital movements during the transition period “to the extent necessary in order to ensure the proper functioning of the Common Market.” This means that Article 67 did not have direct effect from the end of the transition period (December 31, 1969): directives had to be adopted by the Council, which had the responsibility of judging, under the control of the Court of Justice, the level of liberalization required. Until very recently, only a few directives—in 1960, 1962, and 1986—had been adopted; they liberalized some capital movements, essentially those most directly connected with the exercise of the other freedoms (personal capital movements, direct investments) but not, for example, short-term money deposits.

  • B. The Directive of June 24, 1988 provides for the full liberalization of capital movements.

    • All restrictions have to be abolished. A nomenclature of capital movements is annexed to the directive. It is not an exhaustive list; it has been provided only to facilitate the application of the directive, especially in the case of the implementation of safeguard measures (Art. 1, §1).

      Multiple exchange rate practices are prohibited. This provision concerns especially the dual exchange market applicable until the beginning of March 1990 to the Belgian and Luxembourg francs (Art. 1(2)).

    • The liberalization has been given, in principle a erga omnes effect. Article 7, Section 2, provides that “[i]n their treatment of transfers in respect of movements of capital to or from third countries, the Member States shall endeavour to attain the same degree of liberalization as that which applies to operations with residents of other Member States, subject to the other provisions of this Directive.”

      The erga omnes effect is a logical consequence of the intention of suppressing every restriction to capital movements in the Community. Nevertheless, it has been drafted in the directive as a “best endeavor” clause, that is, a principle that does not create enforceable rights for private persons. The reason for such a loose provision is founded in economic as well as political considerations. The freedom of capital movements achieved by the directive has been complemented, and will have to be complemented, by collateral rules in the fields of prudential, fiscal, and monetary policies. Third countries, however, are not participating in the harmonization process. As a result, they cannot benefit from one isolated element that is included in a whole complex of integration measures. One also has to mention the fact that a stringent rule would have implied a weakening of the negotiating position of the Community, which would have unilaterally conceded a favorable regime without seeking any compensation. Furthermore, the drafting of the clause permits the adoption of national restrictive measures, without the necessity of relying upon a safeguard provision.

    • A temporary derogation has been provided for existing national measures bearing on the acquisition of secondary residences (Art. 6, §4).

  • C. Some exceptions and limits to the principle of complete suppression of the obstacles to the free movement of capital have been established:

    • Article 2 of the directive provides for the immunization of measures regulating bank liquidity. The member states will have to keep abreast of these measures, and limit them to what is necessary for the implementation of their domestic monetary policy.

    • Article 3 contains a specific safeguard clause in order to avoid the perturbation caused by anarchic and speculative money movements. It applies only to short-term capital movements of exceptional magnitude. The measures have to be authorized by the Commission, although on grounds of urgency, they can be taken by the member state itself. The duration of the measures is limited to six months. Article 3 does not provide a limitation of time for the existence of the clause. The specific safeguard clauses can be relied upon in addition to the various safeguard clauses provided by the Treaty itself: Article 70 in relation to capital coming from third countries, Article 73 concerning perturbations in capital markets, and Articles 108 and 109 relating to balance of payment problems.

    • Article 4 of the directive permits the enactment of national control procedures in order to prevent infringements of the law and regulations concerning, inter alia, taxation, prudential control, and statistics. Application of these measures and procedures may not have the effect of impeding capital movements carried out in accordance with Community law (Art. 4, §2).

    • The directive entered into force on July 1, 1990. Special restrictions can subsist for four countries: Spain, Portugal, Greece, and Ireland (which have balance of payment difficulties). These measures can be in force until December 31, 1992. For Portugal and Greece, an extension of the time limit is possible for some capital movements, with a maximum set at three years.

  • D. The Commission has mentioned in its communications on the subject,2 not as prerequisites for the liberalization but as necessary accompanying steps, measures to harmonize the taxation of some income to achieve equality of competitive opportunities, to strengthen monetary cooperation in order to avoid the destabilizing effect of very short-term speculative movements, and to harmonize prudential supervision even further.

    Fiscal harmonization in the Community requires a unanimous vote in the Council (Art. 99). Up until now, however, it has been impossible to reach an agreement on this matter, for example, through the creation of a generally applicable withholding tax on saved income. Notwithstanding, some limited progress is in view in the field of cooperation between taxation administrations. Also, monetary cooperation has been somewhat improved in the framework of the preparation of the first stage of the realization of the Economic and Monetary Union on July 1, 1990. The following section will address the Second Banking Directive, which, since its adoption, has provided substantial progress in the harmonization of prudential controls.

III. The European Banking Act

René Smits, in his important article “Banking Regulation in a European Perspective,” recalls that EC regulatory convergence has “not only to patch up blind spots in supervision and improve the bank’s resistance to shocks but especially … to facilitate business expansion across the internal boundaries of the Community.”3 One of the first important directives in the banking sector was adopted in 1977.4

  • A. The First Banking Directive:

    The First Banking Directive provided the principle of mandatory licensing of credit institutions and common basic licensing criteria. These credit institutions are defined as undertakings whose business is to receive deposits or other repayable funds from the public and to grant credits for their own account (Art. 1, 1st clause). A separate licensing procedure, however, is required for every branch of a foreign credit institution.

    The application for authorization cannot, in principle, be examined in terms of the economic needs of the market (Art. 3, §3(a)).

    The directive sets up minimum licensing requirements: two day-today managers are required (the “four eyes” principle); they must have sufficient experience and be of sufficiently good repute. The institution itself must have “sufficient” separate funds (i.e., bank capital) and a program of operations. The directive does not provide for harmonizing methods of monitoring liquidity and solvency of the institutions. It promotes cooperation among authorities. To the existing “groupe de contact” of banking supervisors, created in 1973, it adds the influential Banking Advisory Committee, which includes high-ranking officials from supervisory agencies and finance departments.

    As underlined by René Smits in his previously quoted article, any description of the harmonization process of banking regulation in the Community has to take into account the existence and work of the Basle Committee on Banking Regulations and Supervisory Practices created in the framework of the G-10 (called the Cooke or Muller Committee after two of its chairmen). The result of this work includes the Basle Concordat of 1975 on the supervision of banks’ foreign establishments, which laid down the principle of specific responsibility for solvency for the country of incorporation (“home country control”); the revision and expansion of the Concordat in 1983, after the Banco Ambrosiano crisis, which introduced the principle of consolidated supervision, enshrined in the Community Directive of 1983;5 and the rules on capital adequacy adopted in 1988, which have influenced the directive on a solvency ratio for credit institutions.6 Through legally binding instruments, the Community is able to give a true legal impact to the non-legally-binding recommendations adopted in the G-10 Committee.

  • B. The objectives of the Second Banking Directive:

    Formally adopted by the Council on December 15, 1989, the so-called Second Banking Directive constitutes the most important piece of legislation in this sector adopted up to now by the Community.7 It has nevertheless to be considered in connection with other instruments of harmonization, of which we have mentioned two or three: the Directive of 1983 on the supervision of credit institutions on a consolidated basis,8 the Directive of 1989 on a solvency ratio for credit institutions,9 the related Directive of 1989 on the own funds of credit institutions,10 and the Directive of 1986 on the annual and consolidated accounts of banks and other financial institutions.11 Other relevant texts are in the pipeline: a proposed directive on investment services, which is under consideration by the Council, a proposed directive on harmonization of the conditions relating to the reorganization and winding up of credit institutions, and two recommendations of the Commission, one on large exposures of credit institutions12 and another concerning the introduction of deposit guarantee schemes.13

The Second Directive was intended to “join the body of Community Law already enacted”14 and to be completed by the texts mentioned above. The legislation has several purposes and goals.

  • It seeks to achieve, jointly with these other instruments, the harmonization of the banking supervisory system, essential for the application of the principles of a single banking license and of home country control.

  • It aims at strengthening the cooperation among the supervisory authorities of the member states.

  • It replaces the national vision of clauses of reciprocity in relations with third countries, specifically, clauses that the creation of a single market renders unworkable, by a Community-wide approach that is both flexible and effective.

  • The single banking license:

    An institution authorized in one member state can exercise its activities in the whole Community. Neither additional authorization nor additional separate capital endowment is needed for branches. Freedom to provide services is ensured. This principle is one of the most important rulings of the Second Directive. Pursuant to Article 18, §1:

    • The Member States shall provide that the activities listed in the Annex may be carried on within their territories, in accordance with Articles 19 to 21, either by the establishment of a branch or by way of the provision of services, by any credit institution authorized and supervised by the competent authorities of another Member State, in accordance with this Directive, provided that such activities are covered by the authorization.

    In order to achieve this objective, the harmonization of the following authorization conditions and other supervisory rules has been considered essential:

    • The initial funds of the credit institution have to be “adequate,” that is, of not less than ECU 5 million (Art. 4, §1).

    • The competent authorities have to exercise certain controls concerning major shareholders. The credit institution has to give notice and control has to be exercised before authorization is granted (Art. 5). Notification of the authorities has to be given in the event of acquisition, increase, or disposal of a qualifying holding in a credit institution (Art. 11).

    • Credit institutions’ qualified holdings in the nonbanking and non-financial sector are limited to no more than 15 percent of their own funds in one single institution and 60 percent for the total amount of such participations (Art. 12).

  • The role of competent authorities and the cooperation between them:

    • (a) The directive provides for the principle of home country control (Art. 13, §1) but this principle is not absolute. Important exceptions include:

      • the role ascribed to the host country authorities in cooperation with the home country authorities in the supervision of the liquidity of the branches of credit institutions (Art. 14, §2, 1st sent.);

      • the complete responsibility of the host member states for the measures resulting from the implementation of their monetary policies without prejudice to the measures necessary for the reinforcement of monetary cooperation (Art. 14, §2, 2d sent.);

      • the cooperation of the authorities of the host member states to ensure the supervision of risks resulting from transactions carried out on the financial markets (Art. 14, §3), pending further harmonization;

      • the obligation for the credit institution to provide the authorities of the host member state with statistical data (Art. 21) and so forth.

    • (b) Competent authorities of the member states are called upon to collaborate in various ways:

      • Competent authorities must consult each other before granting an authorization to a subsidiary of a credit institution or of a parent company or of an institution controlled by the same persons who control a credit institution authorized in another member state (Art. 7).

      • Authorities of the home country are to be allowed to carry out on-the-spot verification of branches carrying their activities into another country (Art. 15).

      • Authorities are granted professional secrecy in order to promote communication among themselves (Art. 16). (Important provisions to this effect amend Article 12 of the First Directive.)

      • Competent authorities of the home country must notify host country authorities of the intention of a credit institution to establish a branch in another member state (Art. 19).

      • A simplified procedure of notification is provided in the case of a credit institution wishing to exercise its freedom to provide services within the territory of another member state (Art. 20).

      • Competent authorities must collaborate in the case of noncompliance by a credit institution with the provisions adopted in the host member state pursuant to the directive (Art. 21).

      The Contact Committee mentioned above has been granted a specific role in the mutual exchange of information (compare Art. 7, Directive of 1977). The Banking Advisory Committee intervenes as an auxiliary committee so that the Commission can exercise its implementing powers (Art. 22).

  • The reciprocity issue:

    Title III of the directive concerns relations with third (i.e., non-EC) countries. It consists of Articles 8 and 9. These provisions reflect the intention of the Community not only “to keep its financial markets open to the world” (see Preamble, 4th recital from the end) but also to preserve the Community’s negotiation position for the sake of increasing the liberalization of financial markets globally.

    The accent on a Community-wide vision of global reciprocity is due also to the need to replace national systems of reciprocity that, as we have mentioned, will lose their effectiveness after the establishment of the single license regime. The solutions laid down in Articles 8 and 9 have been softened in comparison with the original proposal, which provoked some concern in and out of the Community. Recall, for example, the speech of U.S. Acting Treasury Secretary Peter McPherson in August 1988, in which he objected to what he described as a “mirror image reciprocity,” that is, the requirement that third countries grant the same treatment to Community credit institutions as that offered to third-country credit institutions within the Community. The system adopted in the Second Directive seems to have reassured at least some sectors of the U.S. Administration. Mr. David Mulford, Under Secretary of the Treasury, said in testimony before a House of Representatives banking subcommittee on February 28, 1990: “The EC now has adopted a reciprocal national treatment/effective market access standard in its second Banking directive. What the EC actually seeks from others seems similar to the U.S. objective of equality of competitive opportunity in foreign markets.”

    The provisions of Articles 8 and 9 include a systematic and ad hoc notification of the Commission about authorizations granted (Art. 8) and the general difficulties met by credit institutions abroad (Art. 9, §1). In addition, the Commission has to present periodic reports together with appropriate proposals to the Council.

    Under Article 9, Section 3, if effective market access comparable to that granted by the Community to credit institutions from a third country is not granted by that country to Community institutions, the Commission may propose negotiations with the country involved “with a view to obtaining comparable competitive opportunities for Community credit institutions.” In this provision, the “mirror image” is established as a negotiating goal and not as an obligation that non-EC countries may be required to fulfill.

    Pursuant to Article 9, Section 4, if it appears that Community credit institutions in a third country do not receive national treatment offering the same competitive opportunities as are available to domestic credit institutions and the conditions of effective market access are not fulfilled, the Commission may initiate negotiations to remedy the situation. A suspension or a limitation of the granting of authorization may be asked of the national competent authorities by the Commission for a period not exceeding three months. Before the end of that period, the Council may decide, by a qualified majority, in light of the results of the negotiations, “whether the measures shall be continued.” The mechanism does not apply to credit institutions or subsidiaries duly authorized in the Community (§4, 4th par.).

    One could ask why the text of Article 9 includes both the concept of “effective access to the market” and the notion of “national treatment.” It is not possible here to enter fully into the controversies concerning those concepts. The insertion of the notion of “effective access” seems to mean that the Community expects not only analogous treatment but also protection against administrative practices that could in fact be discriminatory. What is requested is practical access to the local market. When difficulties mentioned in Section 3 or 4 occur, in order to be able to assess the situation, the Commission may ask to be informed of any pending request for authorization.

    Section 6 includes an interesting provision concerning the respect by the Community of international agreements both bilateral and multilateral: “Measures taken pursuant to this Article shall comply with the Community’s obligations under any international agreements, bilateral or multilateral, governing the taking-up and pursuit of the business of credit institutions.” We take the view that this provision applies to international agreements concluded prior to the entry into force of the EEC Treaty, or the accession of a member state to the Treaty, and to international agreements concluded by the Community itself. For the reasons expressed in the preamble of the directive, the adoption of common rules at Community level has transferred to the Community the treaty-making power in the field, and only a Community-wide position is conceivable for the Community in every international negotiation, forum, or organization concerned with financial institutions and banking markets, such as the G-10, OECD, GATT, and so forth. To open the possibility of member states negotiating separately with third countries would be contrary to the principles governing the treaty-making power of the Community15 and would jeopardize the system established by the directive and the negotiation position of the Community. It is possible that the regime provided in Article 9 provokes some discrimination in the treatment reserved by the Community for OECD members, for example, but the system, as a whole, has the advantages of making obsolete bilateral restrictions in the relations between individual member states and some third countries, and of adding pressure for negotiation in order to lead to further liberalization.

    The directive was drafted expressly to enter into force at the latest on January 1, 1993.

IV. The Prospect of a European System of Central Banking

The purpose of this section is not to analyze the different aspects of the creation of a European System of Central Banks (ESCB) and a European Central Bank. The objective is more limited; it is to determine what role the ESCB could play for the credit institutions and the financial system in general.

First of all, we must remember the status questionis. In April 1989, the Committee, consisting of Mr. Jacques Delors, President of the European Commission, the presidents of the central banks of the member states of the EC, three experts, and Mr. Frans Andriessen, a vice-president of the Commission, concluded in its Report on Economic and Monetary Union16 that the management of a Monetary Union for the Community requires the creation of a European System of Central Banks. The European Council, meeting in Madrid in June 1989 and in Strasbourg in December 1989, considered the Delors Report a good basis on which to proceed and called for an intergovernmental conference to meet in December 1990. There is a general consensus, although not shared by the U.K. Government, on the need for the system to be “federally structured and democratically accountable,” even though conceptions on the precise meaning of these terms vary a lot from one member state to another.

The new monetary institution would manage the single monetary policy of the Union. There would be either permanently fixed parities of the currencies or a single currency, the ECU. The Commission and some member states are definitely in favor of the second alternative. As far as relations with national central banks and relations with the financial sector are concerned, views diverge. There is no common view on the responsibilities of the system as a lender of last resort or on its role in the management of the systems of payment and in banking supervision. The Delors Report took the view that the following functions had to be granted to the system: (1) it would be responsible for the formulation and implementation of monetary policy, exchange rate and reserve management, and the maintenance of a properly functioning payment system; and (2) the system would participate in the coordination of banking supervision policies of the supervisory authorities. The careful formulation of the three main functions of the new monetary authority reflects the preoccupation with avoiding unnecessary interference in banking supervision, which would remain essentially a national responsibility.

Yet, the “maintenance of a properly functioning payment system” has long been considered a basic function of the new authority on the same level as the “formulation and implementation of monetary policy.” In the reports of both the Monetary Committee of March 12, 1990 and of the Committee of the Governors of Central Banks of March 26, 1990, the role of the system in banking supervision has been seen as one of coordination, as it was viewed in the Delors Report. At least “for some time” (report of the Monetary Committee), banking supervision will remain a primary responsibility of the national competent authorities. But neither document excludes a gradual development of the role of the system in line with the progress of monetary integration.

The report prepared by the Commission in March 1990 for the informal meeting of finance ministers in Ashford Castle on March 31 adopted a somewhat timid stance as far as the functions of the system are concerned. This orientation seems to have resulted from a narrow interpretation of the “subsidiarity” principle.17 In conformity with this interpretation, national central banks would remain responsible for the smooth functioning of national payment systems, for relations with national financial institutions and the business world, for market analysis, and so forth. The same preference for decentralization appears regarding the implementation of the common monetary policy.

This part of the Commission’s report leaves some questions unanswered. If there are “national payment systems,” will the responsibility for the “international” or “European” aspects nevertheless lie with the system? Do the relations with financial institutions include the function of lender of last resort? What about deposit guarantee schemes? Clearly, matters are not fully settled. Different standpoints are competing.18 Moreover, it seems that many decision makers have yet to reach a conclusion.

In draft organic provisions for the system,19 a proposal was made to include in the mandate of the European Central Bank, in addition to its monetary competencies, responsibility for the smooth functioning of the payment systems and to some extent of financial markets. Article 6 of the draft on banking supervision, reflects a more comprehensive view of what could be the attributes of the European Central Bank in this regard, more or less following the same trend as, but with more details than, the abovementioned reports of the Monetary Committee and the Committee of Governors.

COMMENT

CYNTHIA LICHTENSTEIN

In my opinion, the European Community, in trying to meet a tight deadline for the Second Banking Directive and also feeling pressure to issue a proposal for a council directive on investment services in the securities field, simply left aside a number of points on which it was going to be impossible to get political agreement. That is why there is little clarity about who will supervise what. I have recently written a substantial part of the Interim Report1 of the International Law Association International Securities Regulation Committee in which I come to exactly the same conclusion as Mr. Louis: the Community has ducked when it comes to questions of supervision.

Specifically, the Community has ducked a particular form of supervision. When we refer to supervision—either the British term “prudential supervision” or the U.S. term “safety and soundness regulation”—we need to distinguish between supervision that is necessary for safety and soundness of the markets and what is called “conduct of business” rules, that is, supervision to ensure that private actors dealing with the public act in accordance with legal rules. In my report I reviewed both the Second Banking Directive and the proposed Directive on Investment Services.2 Article 18 of the Second Banking Directive states that there shall be home country control. But both directives permit host countries to supervise investment firms or credit institutions originating from other member states when the supervision is necessary for the public good. The problem is, nowhere does either directive define the public good.

There has been some guidance on this question in the jurisprudence of the European Community. In the so-called German insurance case, the Commission brought Germany before the European Court of Justice on the theory that Germany’s insurance regulation—essentially its conduct of business rule—did in fact set up barriers to the entry of U.K. insurers. In another case, the Court seemed to draw a line between wholesale and retail business, indicating that regulation at the consumer level would be proper. The Court, however, went on to say that it could not distinguish between what is a commercial insurance operation and what might be a consumer operation—really saying, in effect, “Commission, the ball is in your court to distinguish between types of financial services, whether they are wholesale or retail, and to propose such a distinction to the Council.” The original discussion draft of the Investment Services Directive did try to make the distinction between wholesale and retail financial services and, interestingly, would have provided that neither home state nor host state could subject wholesale business to conduct of business rules. The discussion draft evoked such controversy, however, that those distinctions do not now appear in the present form of the proposal for an Investment Services Directive.

Thus, one does not really know the extent to which a host state may regulate at the consumer level the conduct of business of either investment firms or credit institutions. The directives have failed to adopt even the approach of the European Court of Justice specifying that host state regulation in the public good does not include supervision of wholesale business. When the Economic and Social Committee was asked to comment by the Council on the proposed Investment Services Directive, they stated quite explicitly that the Commission should have made these distinctions and clarified to what extent host states may regulate for the public good. In fact, the Economic and Social Committee took the position that to the extent that any business is listed on the annexes, the host state may not regulate for the public good; the home state’s regulation, even though it is consumer regulation, should be given recognition.

The final point I want to make about supervision is on quite a different topic from conduct of business rules. I do not think there is any confusion, at least for credit institutions, about the core of prudential supervision. Although I am a professor, not a central banker, I believe that what the Basle Committee on Banking Supervision really determined was that ensuring stability in the banking system was going to be accomplished primarily through harmonized capital adequacy requirements. I understand that as many as 20 countries have agreed to join the Basle framework, that is, the 1988 International Convergence of Capital Measurement and Capital Standards, and all the major industrialized countries have adopted it. Moreover, I understand that there is ongoing review in Basle by this committee of relevant questions, such as whether particular capital instruments correspond to the definition of capital in the framework. Thus, there is a genuine form of supranational regulation for capital adequacy requirements with respect to credit institutions. The Community’s Own Funds and Solvency Ratio Directives3 were very carefully harmonized to resemble Basle; the Community’s Banking Advisory Committee also meets at the Bank for International Settlements (BIS), and I cannot imagine that any differences will arise between what the European Community’s Committee decides is the proper capital instrument under its Own Funds Directive and what the Basle Committee decides is the proper capital instrument under the Basle framework.

Where, however, there is currently a great deal of political division is on a similar system of capital adequacy requirements for both credit institutions and investment firms in relation to their position risk. One of the things that is holding up the Directive for Investment Services in the Community is the lack of a directive on position risk, establishing how much capital must be held against the securities portfolios and the underwriting risks incurred by both credit institutions and investment firms. Clearly, this matter does not constitute consumer regulation. The concern with position risk is not that if one of these firms goes under, funds are available to pay off the account holders; that eventuality is covered by guarantee schemes. Instead, the concern once again is about the stability of the system. It is just like the Basle requirements. One ensures that each competing economic actor has an adequate capital base.

Unfortunately, there is intense disagreement on what is an adequate capital base for position risk. The British Securities and Investment Board (SIB) has its own form with which British investment services firms must comply, and the Bank of England also uses this form for the position risk of the institutions it monitors. The U.S. Securities and Exchange Commission has a similar scheme, albeit with some distinctions that loom large in the eyes of the SEC. The Japanese have adopted a scheme that looks very much like the British and American versions. Reportedly, though, the Germans strongly oppose these schemes. There is an international association, which somewhat resembles the Basle group, called the International Organization of Securities Commissions (IOSCO). IOSCO has a Technical Committee with a number of working groups. Working Group 3 has produced an outline of position risk requirements, but IOSCO as a whole has not yet adopted it because it is still controversial. On the question of systematic risk due to the interconnection of international securities markets, we will just have to await some resolution of the extreme disagreement at the moment as to what is an appropriate requirement for holdings against position risk.

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