Euro Area Policies
2011 Article IV Consultation—Lessons from the European Financial Stability Framework Exercise; and Selected Issues Paper

The European Union’s (EU) financial stability framework is being markedly strengthened. This is taking place on the heels of a severe financial crisis owing to weaknesses in the banking system interrelated with sovereign difficulties in the euro area periphery. Important progress has been made in designing an institutional framework to secure microeconomic and macroprudential supervision at the EU level, but this new set-up faces a number of challenges. Developments regarding the financial stability may assist in the continuing evolution of the European financial stability architecture.


The European Union’s (EU) financial stability framework is being markedly strengthened. This is taking place on the heels of a severe financial crisis owing to weaknesses in the banking system interrelated with sovereign difficulties in the euro area periphery. Important progress has been made in designing an institutional framework to secure microeconomic and macroprudential supervision at the EU level, but this new set-up faces a number of challenges. Developments regarding the financial stability may assist in the continuing evolution of the European financial stability architecture.

I. Introduction

1. Since the 2008–9 global economic crises, the EU has intensified its efforts to strengthen its financial stability infrastructure, recognizing that financial stability is a common public good and that national decisions easily transcend borders. The aim is to promote the single market in financial services and to manage the financial system in a way that minimizes the likelihood and potential severity of future financial sector difficulties. Impressive progress has been achieved, as a range of new institutions have been established and started operations

2. The success of EU-wide efforts to secure financial stability is of keen interest to the IMF, reflecting its global mandate. The IMF has long been involved in the debate over the EU’s financial policy framework, notably through its euro area surveillance. Bilateral financial sector surveillance too is being pursued: Financial Sector Assessment Program (FSAP) Updates have recently been completed for five EU members, and more are planned.2 In several areas, similar vulnerabilities or institutional issues in different countries have been investigated in detail (Box 1). Thus, a review at the regional level enables an assessment of the common threads, which in many cases derive from decisions and developments at the EU level, and similarly to identify possible regional policy measures.

3. In light of these considerations, the EU Economic and Finance Committee (EFC) invited the IMF to conduct a limited European Financial Stability Framework Exercise (EFFE) in 2011 as a precursor to a broader FSAP-type exercise in 2012.3 The 2011 exercise is intended to give the opportunity for an early view of the emerging European financial stability infrastructure, and to provide a timely oversight over the outstanding issues from the ongoing national FSAPs.4

4. This report is an outcome of the IMF mission that visited Brussels, Frankfurt, London and Paris between April 26 and May 6, 2011.5 The mission would like to thank all its counterparts for their frank and full discussions, and for the excellent coordination of the arrangements for the mission.

Some Lessons from Recent European FSAP Updates

The recent FSAP Updates for five EU countries have re-emphasized a number of cross-cutting themes. Especially relevant here are the following:

  • The recent global financial crisis was in large measure the product of credit booms and asset price bubbles in the U.S. and various European countries, with its intensity and virulence exacerbated by cross-border linkages and disruption in euro and U.S. dollar funding markets. Financial market strains have been perpetuated by the lack of a common approach to the crisis;

  • National institutional and legal frameworks for financial stability are still incomplete. The autonomy of some of the agencies, and institutional arrangements, are open to enhancement. In several cases supervisors are still struggling to adapt their operations to require more and higher quality capital, and to be more pre-emptive, for example in requiring early action; bank resolution frameworks remain a major gap. Crisis management, and especially the management of cross-border crises, needs to be improved in terms of the legal framework, operational arrangements, and ensuring that adequate resources are available on a timely basis;

  • Some impediments to fully effective cross-border supervision remain, and the resolution of cross-border banks has been unsatisfactory; and

  • Supervisory authorities need to have available more comprehensive and consistent data related to current risk factors, including cross-border developments.

Dealing with these issues may well require EU-level action in terms of both regulation and operational mechanisms.

A more complete discussion of institutional and legal issues deriving from the recent FSAP updates is provided in Annex I.

II. The EU Financial Stability Infrastructure6

A. The European System of Financial Supervisors (ESFS)

5. The establishment of the ESFS represents a large step forward for the single financial market project, but at the same time forms a complicated network of regulatory and supervisory institutions (see Figure 1). It was set up to facilitate cooperation among EU and national supervisors, secure the exchange of relevant information, and ensure effective decision-making with respect to cross-border financial institutions. The ESFS is designed to be an integrated network of national and EU-wide supervisory authorities leaving the day-to-day supervision to the national level. An advantage of this network is that it engages the existing national supervisory authorities. However, it remains to be seen how this network will operate in practice, and whether all relevant information will be shared among participating authorities.

B. The European Supervisory Authorities

Structure and responsibilities

6. On 1 January 2011, the three ESAs were created: the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA), and the European Insurance and Occupational Pensions Authority (EIOPA). Their creation represents a major enhancement of the mechanisms to coordinate cross-border supervision, facilitate cooperation between supervisors, promote convergence of supervisory practices, and implement the planned “Single Rule Book.”

7. The ESAs are regulatory agencies of the Commission accountable to the European Parliament and the Council of the European Union. They have legal personality as well as administrative and financial autonomy. Each ESA is governed by: (i) a Board of Supervisors, which is made up of representatives of the relevant national supervisors and, on a non-voting basis, the main relevant European institutions, (ii) a Management Board, made up of a more limited group of Board of Supervisors members, and (iii) a Chairperson and an Executive Director, vested with the powers to, respectively, represent and manage the ESA.

8. The ESAs have no direct general regulatory powers. Basic acts such as the main sectoral directives and regulations (e.g., CRD, MiFID, and Solvency II) can only be adopted by the EU legislators (i.e., European Parliament and the Council) on the basis of a proposal by the European Commission. While the ESAs are empowered to draft the technical standards, the Commission retains the formal regulatory power: ultimately it is the Commission that endorses and gives them binding legal effect.7

9. Within the limited circumstances specified in EU legislation, the ESAs will be able to temporarily prohibit or restrict certain financial activities that threaten the orderly functioning and integrity of financial markets or the stability of the financial system. In most areas, however, the day-to-day supervision of financial institutions will remain at the national level, and the ESAs have only indirect supervisory powers (settlement of disagreements between competent authorities in cross-border situations and across sectors, participating in colleges of supervisors). At the same time, ESAs may adopt decisions addressed to a financial institution in case of a breach of a directly applicable EU legislation, provided that such decision is in conformity with a formal opinion issued by the Commission.8 ESMA, however, will be the first example of an agency with a pan-European supervisory responsibility, for Credit Rating Agencies (CRAs) starting in June 2011.9 The overall supervisory package is to be reviewed in 2014.

Establishing credibility

10. The new ESAs will need to move quickly to establish their credibility with financial institutions and political weight vis-à-vis national authorities. Otherwise, they risk becoming just an additional layer of supervision and workload with little effect on coordination and targeted harmonization.

11. Credibility can best be established by early and decisive action. The main areas of focus are:

  • The 2011 EU-wide banking stress test will be a first and critical challenge for the EBA. The methodology and the procedures are already determined, and have been commendably disseminated. While the approach to certain aspects of the current exercise may be viewed as too circumspect, the decision to focus on Core Tier I capital sends a strong signal. The EBA will need to be in the lead with a careful communication strategy as the results come out, and to ensure any follow-on requirements, for instance that certain banks replenish their capital, will be understood and prepared. More generally, there will be a need to ensure that stress tests in the future are properly understood and that they are conducted independently and clear in identifying areas of concern.

  • Solvency II implementation is in full swing (see Box 2). For this purpose, EIOPA will have to provide a large volume of detailed guidance and implementing standards, before full implementation at end 2012.10 Moreover, conducting the upcoming European insurance sector stress tests with rigor and efficiency will contribute to consolidating EIOPA’s standing. There is a full agenda of issues affecting the insurance and occupational pensions sector.

  • Recent legislative initiatives in the securities markets reinforce the role of the ESMA on several fronts, including on CRAs, hedge funds (Alternative Investment Fund Managers), Trade Repositories (TR), Central Counterparties (CCPs)11 and the temporary prohibiting or restriction of financial activities that threaten financial stability or the orderly functioning of financial markets.

12. It is important that sufficient resources with commensurate skills be allocated to these functions. In this regard, the initial administrative burden related to the creation of the new operational and administrative framework together with the need to deliver on the responsibilities will present a challenge. Capacity to deliver on existing tasks is already stretched, and the prospective expansion of the tasks of the ESAs will require commensurate enhancements in expertise.

Current Issues in the Supervision of Insurance and Occupational Pensions

Solvency II is in the process of replacing the current regulatory framework (Solvency I) for insurance companies licensed in the EU; the new regime should be in place January 2013. Solvency II is based on three pillars: quantitative requirements; qualitative requirements such as risk management; and supervisory reporting. EIOPA will take over from CEIOPS in providing technical advice on Solvency II Level 2 implementing measures, and related training. The implementation efforts are following a maximal harmonization approach. But, internal model approval, a key component of Solvency II, will probably require strong engagement from EIOPA, as will the effort to reconcile Solvency II rules on liability valuation with the International Financial Reporting Standards.

With regard to pension funds, the Institutional and Occupational Retirement Prevision (IORP) Directive is in the process of review, thus adding to the workload of EIOPA. Issues of valuation of technical provisions, the security of the benefits and the risk supervision are the main topics of discussion of possible harmonization.

EIOPA’s contribution to the assessment of systemic risks is likely to be prominent. The current low interest rate environment could strain the insurance industry even while it benefits other parts of the system.

13. An important function that has been given to the ESAs is to foster a cooperative relationship among national supervisors. The ESAs’ role is to coordinate and monitor the actions of the national authorities; in this connection, they are also represented at supervisory colleges, and play a mediating role in solving disputes. To enable them to fulfill their responsibilities in this area and to ensure that EU-wide concerns are taken into account, the ESAs need to be represented in any “core colleges” that are established. The ESAs should also make active use of their rights (set out in the regulation establishing the ESAs) to participate in onsite supervision.

14. Another significant role for the ESAs is to disseminate best practices in supervisory activities. This needs to be embedded in procedures and in a credible verification process, supported by training. Peer reviews will play an important role in this area. They will need to be intrusive, and be disclosed. The ESAs will also need to put in place procedures for developing, and subsequently verifying consistency of application of the planned “Single Rule Book,” and promoting the exchange of information on the treatment of individual institutions, in order to prevent regulatory arbitrage and financial institutions searching for supervisory gaps (“shopping for a regulator”).


15. The ESAs should act decisively in order to establish their credibility. Their governance framework assigns one vote per member, and provides for a decision making process requiring majority—either simple or qualified, depending on the circumstances—rather than unanimity; these factors should facilitate rapid and forthright decision-making. A shift of “culture” toward a more EU-wide focus of decision-making will be important.

16. The required endorsement by the EC of any binding regulation drafted by an ESA is intended to ensure recognition of the interests of the Union, but limits formal independence. This reliance may however be justified on legal and practical grounds. The procedure for the adoption of technical standards allows the Commission to refuse endorsement only on the basis of certain grounds that have to be based on EU-wide interests. Such procedure may—if applied in a sound manner—lead to a fruitful and transparent dialogue in the adoption of standards, while leaving a predominant role to the ESAs given their technical expertise.12 As greater experience is gained with the process, the concept of “technical standards,” which does not include policy choices, will need to be clarified to avoid possible challenges.

C. European Systemic Risk Board

17. The ESRB, established at the start of 2011, has a broad mandate and is responsible for the macro-prudential oversight of the financial system in the EU. It is to issue risk warnings when risks are deemed significant and, when necessary, provide policy recommendations to mitigate the risks identified.

18. The ESRB is not a separate legal entity. Formally, it is an independent EU body responsible for the macroprudential oversight of the financial system within the EU13 The ECB provides analytical, statistical, logistical and administrative support to the ESRB.14

19. The institutional set-up of the ESRB is relatively complex, and could prove unwieldy. Decisions within the General Board of the ESRB (comprising 37 voting members and 27 non-voting members) will be taken by simple majority, but a majority of two thirds will be needed to adopt recommendations or to make a warning public. The functioning of the ESRB is based on participation involving all key players—national authorities and other EU institutions. This is a pragmatic approach for a new organization. However, there is a risk that such an approach could lead to overly cautious warnings. Moreover, the size of the decision-making group in the ESRB is large, so the timing and the procedures of the decision-making process risk becoming cumbersome. This may be especially costly in time of emerging risks. Moving forward, the General Board should adopt an approach under which puts in place rules that provide broad direction for ESRB activities and ensure accountability but leave ESRB management operational flexibility.

20. The decision-making processes will need to be flexible enough to facilitate the timely identification of emerging risks. Currently, the Steering Committee (a sub-group of the General Board) effectively sets the specific work program. In order to promote the “bottom up” identification of risks, it is suggested that the ESRB staff propose the work program to the Steering Committee and thus the General Board, after consultation with national supervisors, the ESAs, and the Advisory Scientific Committee. The ESRB could also consider how to use the Steering Committee beyond setting the work program in order to be the most effective for decision-making.

21. The ESRB’s enforcement of its recommendations will depend on the effective operation of the “comply or explain” principle. But making warnings and recommendations public may not be a credible threat because doing so could trigger an adverse market reaction. The European Parliament has an explicit role in monitoring actions taken in response to a warning, but such a role can be performed only when recommendations are made public. This limits the potential usefulness of oversight by the Parliament. A possible solution to this concern could be to mandate publication, after a lapse of time, of risk warnings, and recommendations that were not made public, as well as the responses by the addressees, much as central banks do with their market-sensitive decisions. If “comply or explain” does not work well, serious consideration should be given for more direct involvement of the ESRB in ensuring that its recommendations have effect.

22. The credibility of the ESRB will depend crucially on its ability to speak “truth to power,” and to weigh in on policy decisions. To this end, it needs early on to publish clear and well-argued analyses of the main current macro-prudential risks. The key test for the ESRB is whether it will be able to identify major risks, issue risk warnings on these risks, and recommend policy actions that are followed-up.

23. Successful interaction between the ESRB and the ESAs, in particular to ensure a proper coordination of macroprudential and microprudential instruments, will be important. The ESAs are providing microprudential risk assessments, and are working with the ESRB through the Working Groups on systemic risks and data exchanges. In one direction, decisions on temporary bans of financial products (by an ESA) and various bank capitalization ratios, for example, have macroprudential dimensions which necessitate a close coordination with the ESRB. In the other, the ESRB Board envisages that the ESAs will more broadly contribute to systemic risk monitoring through joint submissions of cross-sectoral risk assessments; the ESAs’ contribution would be built into the governance structure through their participation on the ESRB General Board. Eventually and depending on the implementation process, a clarification of the respective mandates may be needed. The ESAs and the ESRB need to establish processes for sharing information and analyses that can feed from, and inform, risk assessments at both the EU and individual college level, for both on and off site examinations.

24. The ESRB is dependent on the ESAs for the provision of microprudential data, which will be crucial for its oversight of the financial system. Under the current regulation the ESRB may only submit a “reasoned” request to the ESAs to receive non-aggregated information on an ad hoc basis. The need for ad hoc and motivated requests may give rise to problems in practice, for example, if it is necessary to compare bank-specific data over time on a systematic basis. The ESAs and the ESRB are working on protocols for information sharing and should be encouraged to develop guidelines and processes for handling such requests.

25. The ESRB is developing the institutional framework, concepts and tools to ensure macro-prudential stability at the EU level. In close cooperation with the ESAs, it will elaborate a color-code system (dashboard) corresponding to situations of different risk levels.

D. Supervisory Colleges

26. One step to achieve effective supervision in the EU of financial groups operating across border has been the establishment of colleges of supervisors. In this setting supervisors competent in the jurisdictions where a financial institution belonging to a certain financial group is established (and now also the respective ESA) meet periodically in order to exchange information about the condition of the group. These colleges will enable supervisors to strengthen their working relationships with their counterparts, and to have a much better understanding of the overall state of the institutions that they are supervising. However, since many of the largest institutions operate in a substantial number of countries, such colleges might be unwieldy: hence “core colleges” have been established, in which participation is limited to those jurisdictions where the institution has its most significant presence. Both full colleges and core colleges are operational for a number of cross border groups.

27. Although a major step forward, these colleges are not a complete answer to the cross border supervision issue:

  • There are challenges involved in ensuring that the representation of host supervisors in the colleges is sufficiently broad: in particular, it may be difficult to include in the core college the authority of a host country where a financial institution’s activity may not be very significant from the group’s viewpoint even though such activity may be significant from the host country’s perspective. To mitigate this concern, it should be ensured that all decisions and information from the core college are circulated among other college members;

  • College meetings are time consuming, and the burden may fall on a limited number of officials. There is already anecdotal evidence of supervisory agencies declining to send representatives to meetings of colleges;

  • The colleges provide a forum for discussion, but may not lead to prompt action, although, in the case of the EBA, banking colleges are required to reach joint decisions in relation to the solvency of a banking group;

  • It is not always clear that the incentives are such as to maximize information sharing. While such sharing is in principle mandatory, there may be scope for information not to be brought to the attention of college colleagues, or not brought on a timely basis. For instance, as long as supervisors maintain a national focus, the authorities may be reluctant to share information about a troubled financial institution if there is concern that this could lead the authority receiving the information to ring-fence the assets of the institution. If, perhaps, a bank is preparing to downsize, it will likely focus its efforts in those places where it has problems, and supervisors may wish to protect their own jurisdictions by not volunteering information about any problems there; and

  • Moreover, there are in some cases legal prohibitions on the sharing of information, so that supervisors from one member state cannot provide more than generalities about the activities of the bank/insurer they are supervising.

28. To some extent these problems can be seen as teething troubles that will likely fade over time as the process becomes established, but a number of specific measures to enhance cross-border supervision can be suggested:

  • Collaboration on risk assessment, and adopting a common template, methodology, and scoring scales has already been developed for EBA colleges and similar approaches should be encouraged elsewhere. The risk assessment would best be carried out at the group level, within the colleges, and be interactive, structured, and detailed. One of the key challenges for the EBA will be to further harmonize the convergence on Pillar 2 (common methodologies for risk assessment);

  • Collaboration in conducting onsite supervision is essential for supervisory effectiveness. It is already the case that many onsite inspections are joint between home and hosts. There could be a presumption that home supervisors would invite subsidiary and branch hosts to participate, and subsidiary hosts would invite parent home supervisors. Moreover, where the cross-border presence is significant, particularly where the supervisory agency is a member of the core college, the supervisory plan would be discussed at the college level. Participation of all relevant supervisors would also be expected. Such an approach would also serve to mitigate the concerns that have been voiced about the limitations on the powers of national supervisors in the face of branching under the European “single passport” policy. Clearly, this is a significant resource issue, but supervising financial institutions with substantial cross border activity has to be seen as resource intensive;

  • Legal restrictions on the sharing of information should be identified and, to the maximum possible extent, removed;

  • Agreement on ex ante “burden sharing” principles should be designed in such a manner that supervisors have an interest in the outcome of the institution as a whole, so that the incentives for sharing information are maximized; and

  • Where there is uncertainty as to the powers of national authorities, for instance to decline giving “no objections” approval on safety and soundness grounds to a cross-border takeover, such uncertainty could be resolved through the actions of the ESAs.

29. Cross-border activity is of course relevant not just within the EU; nearly all major EU financial institutions have substantial activity worldwide. Insofar as institutions have less understanding of non-EU markets than of those in the EU, this increases the vulnerability of the activity. Many of the problems affecting EU institutions in the crisis originated from outside the EU. Many of the suggestions above therefore apply as much to cross border activity outside the EU as they do to activity within the EU. Joint inspections for instance are similarly useful. And convergence of regulatory regimes will help mutual understanding as to what is happening in the respective jurisdictions. MoUs with U.S. authorities, for instance, should include provisions for joint inspections on a regular basis.

30. The establishment of “crisis management colleges” for larger cross-border banking groups is one important, but in itself limited, element of the framework. Already some groups have been established to bring together the various institutions—supervisors, central banks, and finance ministries—that would be involved in dealing with a crisis in such a bank. Such a pre-existing network should facilitate the logistics of intervention and the negotiation of a coherent approach. However, crisis management colleges will tend to be large and therefore unwieldy. More importantly, the existence of a college will not solve the competing interests over burden sharing in cross-border banking resolution, nor does it create strong incentives for individuals to reveal vulnerabilities and failings on a timely basis.

E. The Financial Stability Work of the European Commission

31. The EC plays a central role in proposing prudential and non-prudential regulations for the financial sector, and in overseeing macroeconomic policies that affect the financial sector. The current legislative agenda is unusually full, with forthcoming amendments to the Capital Requirements Directive (CRD), the directive on Deposit Guarantee Schemes (DGS), the banking crisis management framework, a review of the Market in Financial Instruments Directive (MiFID), as well as measures for the implementation of Solvency II. This agenda largely represents an effort to implement lessons from the global crisis and associated internationally-agreed regulatory changes (e.g., G-20 commitments), for example, to raise the level and quality of bank capital.

32. There has been a shift toward greater reliance on EU regulations, which have the force of directly applicable law, and to allow less room for national discretion in the transposition of directives; the aspiration is to achieve a “Single Rule book.” The shift is motivated by the need to equip the EU financial sector with a consistent set of core supervisory rules, so as to further strengthen EU financial stability. Differences that stem from exceptions, derogations, additions made at national level, or ambiguities contained in directives that have a material impact on the market, that are not as stringent as the minimum core standards, or that may induce competition distortions or regulatory arbitrage, will be identified and removed. However, the rules need to be designed to allow flexibility for the sake of proportionality and to deal with differences in economic conditions across the EU: especially where monetary and fiscal policies are constrained, there may be good reasons to differentiate other policies, for example, for macro-prudential purposes, though as noted above, coordination of such policies will remain essential and could be handled by the ESRB (see below).

F. Cross-Institution Coordination

33. Interagency coordination is effected through a Joint Committee. This is composed of the Chairpersons of the ESAs and staff from the ESAs who are responsible for coordinating the work of the three ESAs on cross-sectoral issues and on the supervision of financial conglomerates. As the three ESAs could, in theory, take different positions on the same issues, which could allow room for regulatory arbitrage, the work of the Joint Committee will be important to bridge the gap with the ESRB, and address underlaps and overlaps.

34. In this context, consumer protection concerns will need to be given due attention. All three ESAs have the same consumer protection mandate, which might on the one hand create overlaps and inconsistencies among them and on the other may lead to inaction and weaken the sense of ownership on the part of each ESA. Moreover, the financial crisis has re-emphasized the connection between consumer protection and systemic stability. To ensure that these issues are effectively addressed, the European system needs to accommodate differences across countries in responsibility for consumer protection: some unify prudential and consumer protection responsibilities, others have a “twin peak” model and will require that the ESAs will have to coordinate across agencies.

III. EU Financial Policy Issues

A. Crisis Management and Bank Resolution

35. Establishing a comprehensive EU framework for resolution and crisis management is necessary to fill a remaining gap in the current financial stability framework. To underpin the single financial market, resolve the mismatch between the banking passport and national fiscal responsibilities, and align national interests toward financial stability in the EU, setting up a unified framework would be the preferred approach. Such a framework should involve the establishment of a European Resolution Authority with associated financing and fiscal backstops, encompassing ex ante rules to fund resolution of financial institutions, through contributions from the industry and pooled fiscal resources in the event that temporary public financial support is necessary; this would also avoid distortions of competition policy at the national level, as compliance with state aid rules would have been cleared at the ESA level.

36. There does not appear to be sufficient political support to make the quantum leap to an EU wide unified setup. Working within this constraint, the Commission outlined in a consultation document of October 2010 a more gradual approach toward building a comprehensive EU framework for resolution and crisis management that will apply to all credit institutions and some investment firms. The first phase consists of a legislative proposal aimed at giving national authorities a common minimum set of resolution tools, which is expected to be adopted by the Commission in fall 2011, while adoption by the European Parliament and Council is expected by the end of 2012.15

37. The enhancement of the resolution toolbox envisaged by the Commission broadly goes in the right direction. The aim is to reduce the frequency and severity of banking crises by ensuring that early remedial action is taken, shareholders and other relevant stakeholders have a greater role in burden sharing—thereby reducing the risk of loss for others including governments—and introducing features that facilitate resolution when it is unavoidable. The Commission’s plans would require Member States to ensure that national authorities have an effective range of options for early intervention, attempting to strike a balance between financial stability concerns at the one hand and the need to minimize interference in property rights at the other, and mitigating legal risks deriving from the interference with such rights. Due consideration is also given to the need to coordinate certain elements at the global level, such as on the application of statutory bank debt restructuring or “bail-in.”

38. In a few areas, clarification is still warranted. For instance, the Commission consultation argues that the general rule should be that failing banks should be liquidated under the bankruptcy code through ordinary (or slightly modified) liquidation rules, and that they should be resolved using special resolution tools (such as transfers of assets on a wholesale basis) only as a going concern and only if the public interest of financial stability is at stake; however, there seems a strong case that special resolution tools should be available more broadly, also in the bankruptcy process to allow an orderly liquidation, and for both systemic and non systemic institutions.

39. While the Commission intends to review the EU crisis management framework with a view to possibly establishing an integrated regime in 2014, the authorities must be able to take appropriate measures in the interim if problems arise in cross border institutions. The Commission consultation envisages that group-level resolution plans will be developed by resolution colleges under the leadership of the home country authority and with a strong coordination role for the EBA; such plans would include measures for a coordinated resolution of cross-border group entities, with losses being absorbed by private stakeholders. For EU cross-border banks having a significant presence outside the EU (or for EU sub-groups that are part of global financial conglomerates) such plans should be developed with relevant third countries authorities, to ensure coordination in the resolution process and, ultimately, mutual recognition of resolution measures. It would be useful for the above mentioned resolution plans to be developed soon, well before the 2014 review.

40. A framework for intra-group financial support also deserves consideration, provided that the complex underlying legal and economic challenges are addressed. The Commission envisages in its recent consultation that group financial support agreements be concluded among the various group entities in case of troubles affecting the financial stability of the group as a whole. Such a framework may provide a useful tool to facilitate private funding of troubled groups and may give an early intervention mechanism that stabilizes the financial soundness of the groups. Again, the EBA could play a role in facilitating joint decision.

41. Agreement ex ante on principles for specific burden sharing is necessary for a fully satisfactory resolution regime, given that, due to market failures, temporary funding of a resolution by Member States might be necessary.16 In particular, the resolution plans discussed above should provide for ex ante burden sharing principles, with appropriate participation by national fiscal authorities. Any agreement on burden sharing should cover both the financing of restructuring and the allocation of any net costs. Reaching agreement may be difficult, but if the resolution framework is to reduce the expected cost to government from bank failures, the effort will be well worthwhile.17

42. Two elements of the new regime have an important bearing on the effectiveness of the financial stability framework: bank creditor bail-ins and sovereign risk. While the framework for bank creditor bail-ins is being discussed in a global context (FSB), uncertainty about its parameters and timing is complicating current crisis management. In addition, the explicit recognition of the need for market discipline on sovereign borrowing has important ramifications for the approach to risk weighting of government debt on the books of financial institutions. Clarifying how both will be handled is urgent and seems essential to help resolve current conjunctural strains.

Deposit guarantee scheme

43. There is merit in having an integrated framework for crisis management that would be interlinked with a pan-European deposit insurance scheme. A gradual approach is now being pursued, in which it remains the primary responsibility of the member States to ensure that depositors are duly compensated through the national DGSs. The amendments to the DGS directive, which are currently under negotiation in the Council and the European Parliament, need to be supportive of the overall crisis management framework. To this end, certain features that would strengthen the existing framework (discussed below) are especially important; it is welcome that many of these elements are being covered in the proposed amendments:

  • The DGS should be adequately pre-funded, and have ready recourse to additional funding if needed, so as to be credible and to avoid a pro-cyclical increase in contributions during a time of stress;

  • The DGS should be structured to work seamlessly with resolution funds. DGS resources should be available to finance the resolution of banks, for example, through a purchase and assumption (P&A) operation, on condition that insured depositors and the DGS itself are not thereby made worse off;

  • In case of bank failure, depositors should be paid out very quickly.18 Depositors should be aware of this and other key features of the scheme;

  • Private ownership of DGS raises conflict of interest issues that may give rise to constraints on the flow of confidential information in a way that ultimately may hinder resolution efforts;

  • Depositor preference could be considered, so as to reduce potential costs to the taxpayer;

  • DGS coverage should be sufficiently high but limited so as to cover most depositors and not weaken market discipline unnecessarily. Also, the level of coverage should be uniform in order to avoid competitive distortions within the single market; and

  • The DGS and the resolution funds are complementary, and so establishing a single decision making structure will be helpful in achieving a least cost resolution.

B. Financial Stability, State Aid, and Competition

44. The EU has had to adapt its rules on state aid to take into account the exceptional conditions generated by the global financial crisis. The Treaty on the Functioning of the European Union contains strict limitations on state aid being used to distort competition and the internal market, but also allows some derogation when a country’s economy is subject to a serious disturbance. With this justification in mind, the European Commission has issued a series of Communications19 defining how it will assess state aid to the financial sector in the context of the current financial crisis. These communications emphasize the temporary nature of the crisis; the objective of ensuring that institutions receiving aid are viable and are quickly restored to a condition where they can safely operate without aid; the need to take into account systemic stability and the maintenance of credit flows; and the desirability of containing moral hazard by ensuring that shareholders assume a large share of the costs associated with the restructuring of the troubled institution and do not unduly benefit from the aid received. Against this background, the Commission has issued rulings on numerous cases of state aid to individual financial institutions and sectoral support schemes.

45. The European authorities are working to formulate a more permanent special framework for state aid in the financial sector, in recognition of certain special features of the financial services industry: the financial sector plays a unique systemic role in the economy, but it is also subject to systemic vulnerabilities and very sudden crises.20 The financial sector is heavily regulated for prudential purposes, and is protected by certain safety nets, such as a DGS, the availability of Emergency Liquidity Assistance, and, in some countries, a Financial Stability Fund or a resolution fund.

46. More specifically, a dedicated regime for state aid to the financial sector should acknowledge systemic stability concerns, which recognize that:

  • Risk is reduced by diversification of sectoral and country exposures. A business line or subsidiary that is “non-core” can contribute to stability if its returns are not strongly correlated with those of other business lines;

  • The effect on a bank’s margin of support received by an institution is ambiguous. A stigma may attach to receiving state aid, such that the recipient’s marginal funding and capital costs are high; on the other hand, a bank may benefit from the public’s perception of state support;

  • Support for one institution could sometimes have positive spill-over effects on others, for example, by underpinning investor confidence; and

  • Moral hazard factors are already pervasive in the financial sector, even in the absence of an institution requiring state aid; prudential regulations and mechanisms already go some way to limit this effect. For example, a systemically important financial institution (SIFI) may be subject to a capital surcharge or a higher levy in part because it may well be rescued if it gets into difficulty. Such a measure serves to achieve a similar objective to that of the state aid regime, and indeed a degree of burden sharing with shareholders is achieved in advance.

47. The speed with which financial crises can develop suggests that the operational procedures for assessing state aid need to be implementable under very tight deadlines. In some cases it may be necessary to provide assistance in a matter of days, and a delay to review acceptability under state aid rules could be very costly.21 So far, the European Commission has always managed to decide on assistance within the market constraints on timelines since existing procedures are already made sufficiently flexible in this respect. However, also during normal times, and not just during a crisis, it will be useful to validate in advance the pricing of assistance that is available from various standing facilities, such as a bank resolution fund. In the absence of such standing facilities, emergency state aid to a financial institution could be presumed to be acceptable, but subject to ex post review and possible correction in line with the predetermined principles.

48. The new bank resolution regime, by facilitating earlier and more market-based restructuring of problem banks, should reduce but not eliminate the need for a regime for state aid to the financial sector. The two regimes should be consistent with each other, so that, for example, principles applied to divest activities under early intervention should not contradict the principles of bank restructuring under the state aid regime. State aid has been interpreted widely, to encompass also temporary government financing or guarantees to facilitate restructuring. Moreover, such assistance may turn into losses for government if the restructuring does not succeed and/or an appropriate remuneration for the State funds has not been paid. Lastly, the circumstances under which the financing from a compulsory DGS or a bank resolution fund would count as state aid should be clarified. The Commission will need to ensure that the effectiveness of its crisis management framework is not undermined by other EU rules and directives that were largely developed before the recent financial crisis and may not fully recognize the implications of the crisis for effective resolution. This could include the Financial Collateral Directive, in respect of termination rights.

49. A dialogue with prudential regulators and supervisors is advisable. Competition and prudential authorities may have parallel responsibilities in areas such as the vetting of major acquisitions and changes in ownership. They may also have complementary information, for example, on competition between banks and nonbanks and the scope for cross-border entry. Competition authorities need to take prudential regulations into account in assessing what is a “normal” balance sheet structure and what action is needed for a weak bank to become securely viable, because meeting prudential norms is one element of viability.

C. Macroprudential Instruments

50. The institutional structure for the implementation of macroprudential instruments remains decentralized at the Member State level. Macroprudential policies should be calibrated mostly based on country-level macro-financial conditions. In some countries work is advanced in developing a macroprudential framework, although in others this is still at an early stage of development. Nonetheless, there is a strong case within the EU for coordination through an EU institution (e.g., the ESRB) to deal with single passport and home-host concerns.

51. One area in which the ESRB’s powers could be usefully expanded is that of the coordination of macroprudential tools and ensuring their consistent application across borders, so as to limit the scope for regulatory arbitrage as well as for leakage, and ensure that similar products are treated similarly for all institutions. The ESRB could take a more proactive role in issuing recommendations to the Commission, as part of the harmonization of national regulatory frameworks, regarding the set of available instruments to be used for macroprudential purposes by the national authorities; similar considerations apply to the imposition of loss absorbency requirements for globally systemic financial institutions. ESRB guidelines would then help operationalize these macroprudential instruments. The tool-box of macroprudential instruments available to the authorities should be easy to implement and to enforce, be effective in mitigating macroprudential risks, have limited distortionary effects, and not result in regulatory arbitrage. Given that systemic crises can originate from various segments of the financial sector (banks, non-banks such as hedge funds, insurance companies), a range of macroprudential instruments should be available for each of these segments. Since possible challenges to financial stability are diverse, one can imagine that instruments might need to be applied to specific institutions, to sectors of the financial system, to regions within a country, regions cross-border, nationally or more widely. A broad range of macroprudential instruments (such as was earlier prepared by the ESRB) should be available to the authorities. If a Member State wishes to apply a macroprudential tool and wants to secure reciprocity from an institution operating in its territory but not subject to its national supervisory oversight, it could submit a proposal to this end for approval to the ESRB.

52. Recommendations on the design of the macroprudential instruments and their calibration should ideally be binding on the Member State. The role of the ESRB could be substantially enhanced, potentially as part of 2014 review that the Commission intends to conduct in 2014 on the new EU financial stability framework, to define the set of instruments and the range over which they may normally be applied, or to review macroprudential measures introduced at a national level with a view to ensuring reciprocity (similar treatment for all institutions performing a particular activity). Nonetheless, careful consideration will need to be given whether it will be possible under the existing EU legal framework to confer upon the ESRB such binding powers toward Member States. A “comply or explain” regime in this regard, analogous to that in place concerning its warnings, would be a weaker alternative.

53. For banks, the set of instruments to be included in a macroprudential legal framework should encompass a broad range of tool. addressing both the demand and supply of credit. Work is ongoing to identify and put in place a comprehensive set of instruments. Amongst the instruments that might be included are:22

  • A countercyclical capital buffer, where the overall buffer for internationally active banks should be a weighted average of capital add-ons set by national jurisdictions, with weights based on the geographic composition of a bank’s portfolio of exposures, as under the Basel III approach. The EU Capital Requirements Directive (CRD4) implementing Basel III should set an ambitiously high common bar that enhances the safety of the European financial system. At the same time, it should allow sufficient scope for the calibration of macroprudential instruments such as countercyclical capital buffers to cope with asynchronous credit cycles, and recognize that there may be still a need for the ESRB to issue recommendations and endorse the introduction of other macroprudential tools. The countercyclical capital buffer has some limitations: (a) there will be long lags in implementation (banks are likely to have one year to adjust their countercyclical buffers); (b) it is a fairly complex instrument; (c) its effectiveness remains untested.

  • Limits on loan-to-value ratios could form part of the policy toolkits of national macro-prudential authorities to allow a swift reaction to emerging risks in real estate markets. Existing experience with limits on LTVs suggests that this measure can be effective in dampening mortgage credit growth and in slowing house price appreciation. As with the limit-to-debt ratio below, to prevent regulatory arbitrage, such limits should be applied not only to banks but to non-banks as well. To avoid circumvention through cross-border lending, such limits could be reviewed by the ESRB, which could have the power to ensure reciprocity.

  • Limits on debt-to-income ratios could be considered as a macro-prudential instrument. They would help ensure that borrowers have the ability to repay their mortgages. The experience of some countries that have relied upon such limits on DTI for a long time (e.g., France) should prove useful in designing and calibrating this instrument.

  • Measures to address the cross-sectional dimension of systemic risk could also be included, such as capital or liquidity surcharges, risk-weighted instruments, or levies on SIFIs.

54. For non-banks such as hedge funds, possible additional macroprudential measures include:

  • Margins or valuation haircuts on securities used as collateral in the securitized lending markets (such as repo markets). This instrument would be used to regulate the supply of secured funding. It could also mitigate the pro-cyclicality of the shadow banking system by affecting their funding conditions given that most source their funding in the wholesale markets.

  • Leverage limits. A leverage ratio in the hedge funds sector could help dampen lending exuberance. The EU directive on Alternative Investment Fund Management already gives an advisory role in this regard to the ESRB. However, the draft regulation on a ban of short selling and naked CDS currently does not include any role for the ESRB, which instead is given to ESMA.

55. For insurance companies and pension funds, there may be a need to identify more specialized measures, for instance in relation to the low long term interest rates and longevity risk, and risks associated with derivative products.

D. Data Adequacy

56. An important aspect of the new European supervisory architecture regards its ability to eliminate data gaps and foster an efficient flow of information between its various components. Compiling and disseminating appropriate information on risk exposures and interconnections among institutions is a precondition for the establishment of an effective framework targeted to achieve stability in the financial system. The framework should ensure vertical (across the three layers) as well as horizontal (within members in each layer) distribution of data and information in general. While an effective framework that protects the confidentiality of information needs to be put in place, maximum data sharing should be the goal: lack of data or lack of data sharing should be eliminated as a potential cause of the next crisis.

European Supervisory Authorities

57. The regulation establishing the ESAs entitles them to obtain access, via European and national counterparties, to all the information necessary to conduct their activities. While it is clear that information having a micro-supervisory purpose may be obtained by ESAs, there is more uncertainty over the possibility of the ESAs gaining access to supervisory data that could be used for risk assessment purposes.23 For example, whereas the EBA has indicated it will have access to all confidential data available to national supervisors on a regular basis, EIOPA is facing opposition in its efforts to obtain all detailed data necessary for the implementation of Solvency II. Reportedly, national securities market regulators are, citing a range of obstacles, reluctant to share data on individual financial transactions with ESMA.24 In addition, it is still unclear whether ESMA will be able to use its supervisory data on CRAs internally for the purposes of risk assessment. This may in turn have implications for the information that can be shared with the ESRB.

58. Achieving comparability of financial data across all Member States is important for micro and, a fortiori, macro-prudential supervision. ESAs will play a central role in this process, since they will be responsible for creating and updating common reporting templates for their respective sectors. As an example, the EBA is to prepare harmonized data reporting systems for implementation by end of 2012 which will be applied by national supervisors to banking companies.25 Similarly, EIOPA is developing a fully harmonized reporting framework to meet requirements under Solvency II which would enhance the availability of supervisory information on insurance firms. Finally, ESMA is developing a centralized system to collect data on CRAs.26

59. In order for common reporting to be effectively applied:

  • The ESAs should implement such systems through binding technical standards (in the form of regulations), enforcing their consistent application across all national supervisors;

  • The ESAs will likely need to conduct periodic revisions of the reporting templates to ensure they are kept updated and sufficiently flexible to rapidly incorporate information on evolving financial products and risk factors; and

  • The ESAs should ensure a high degree of coordination in the design and implementation of reporting systems, so as to reduce the reporting burden and avoid duplication of efforts. 27

European Systemic Risk Board

60. The ESRB will not have direct access to all the data necessary to conduct its activities. It will depend heavily on the collaboration of the ECB, which has the resources and capabilities to provide analytical as well as statistical support. Notwithstanding, there are legal constraints preventing full sharing of confidential information between the two institutions, particularly on information that is not in summary or in aggregate form. The ESRB is also expected to rely on the ESAs and Member States for data derived from supervisory sources and also for “soft” information for its macroprudential analyses. This type of information will normally be aggregated.28

61. There is concern that the relevant authorities may not be willing to share institution-specific data with the ESRB. As noted above, the ESRB regulation stipulates that requests from the ESAs for confidential data on individual institutions may only be made on an ad hoc basis and must be justified on the basis on prevailing market conditions; this may limit access to sensitive microprudential data. Besides these legal constraints, the broad range of parties involved in the ESRB’s governance structure increases the risk of leakages of confidential information.

62. The ESRB will need to build its reputation and develop solid relationships with other institutions to gain trust and thus increase its access to information. By giving stakeholders a higher degree of participation in its activities, it can be expected to build up the initial reputational capital necessary to facilitate its future engagement with the national bodies. For example, the ESRB will attempt—through its Advisory Technical Committee—to capture through a so-called “bottom-up” approach, evidence on risks and vulnerabilities, also to complement the analytical input from the ECB, which is based on a “top-down” approach.

E. Direct Regional Supervision: The Rating Agencies

63. On 1 July 2011, CRAs will be the first cross-border financial institutions in the EU licensed and supervised by a supranational agency—ESMA—and to this end, ESMA has been endowed with a comprehensive mix of supervisory tools. If ESMA manages to instill a supervisory culture and implement supervisory tools tailored to cross border entities, it could pave the way to possible future centralized supervision of financial markets and/or institutions in the future.

64. ESMA will have the right to request a broad set of reports and returns, and also conduct on-site inspections. Hence, it is developing reporting templates and systems on CRAs that will facilitate the processing, monitoring and analysis of the prudential information received. A central repository (CEREP) will gather all the information for prudential purposes. Part of the information will be made public, on an aggregated and bi-annual basis (as from summer 2011); published information will include CRAs’ performance indicators, including rating actions (downgrades/upgrades), defaults, and transition matrices. ESMA can also access staff and management, and can conduct on-site inspections, which may help enhance its credibility as well as its effectiveness.

65. ESMA can impose stringent fines, according to a comprehensive list of breaches attached to the regulation. It can also require corrective measures, including suspending the use of credit ratings for regulatory purposes, issuing a public notice, temporarily prohibiting the credit rating agency from issuing credit ratings and, as a last resort, withdrawing the registration when the credit rating agency has seriously or repeatedly infringed the regulation. With regard to accountability, ESMA will present its annual report on fines and corrective measures to the EU Commission, Parliament and Council.

66. ESMA will possess its own budget for the supervision of CRAs. While the calibration of the fee is still under discussion (secondary legislation on fees is to be adopted by the EU Commission), the Commission should only set a minimum and a maximum percentage, to give some leeway to the Authority and at the same time establish criteria that ensure a degree of predictability.

67. The accumulated delays in hiring staff and preparing tools and methods for supervision at ESMA’ may hinder its efforts to establish credibility for its supervisory function quickly. By the end of 2011 ESMA is expected to have 15 staff working on CRAs. While supervision legally starts in July 2011, it will initially apply to a narrow set of entities; only four rating agencies—including none of the three largest ones—had been registered as of May 2011. The delay was due mainly to the complexity of the license applications, and the continued functioning of a collegial procedure (where ESMA was an observer and not the licensing authority) on a transitional basis. The largest CRAs are now expected to be registered by the summer. Meanwhile, ESMA is undertaking an intensive recruitment process.29 A balance between supervisors and former private sector practitioners should be an objective in order to ensure the build-up of a supervisory culture and independence from the industry.

Appendix I: Details of Current Institutional Arrangements

The European System of Financial Supervisors

68. The main objective of the ESFS is to ensure that the rules applicable to the financial sector are adequately implemented to preserve financial stability and to ensure confidence in the financial system as a whole and protection for the customers of the financial services. The ESFS comprises the ESRB, the three new supervisory authorities (EBA, EIOPA, and ESMA), the Joint Committee of these supervisory authorities, and the national supervisory authorities.

European Supervisory Authorities

69. The ESAs are entrusted with the following main tasks:

  • To contribute to the establishment of high-quality common regulatory and supervisory standards and practices, in particular by providing opinions to the Union institutions and by developing guidelines, recommendations, and draft regulatory and implementing technical standards;

  • To contribute to the consistent application of legally binding Union acts, in particular by contributing to a common supervisory culture, ensuring consistent, efficient and effective application of the Union acts, preventing regulatory arbitrage, mediating and settling disagreements between competent authorities, ensuring effective and consistent supervision of financial institutions;

  • To promote a coordinated European Union supervisory response and contribute to the stability of the financial system of the European Union in close cooperation with all other ESAs and the ESRB;

  • To organize and conduct peer review analyses of competent authorities, including issuing guidelines and recommendations and identifying best practices, in order to strengthen consistency in supervisory outcomes;

  • To ensure the coherent functioning of colleges of supervisors and taking actions, inter alia, in emergency situations; and

  • To contribute to providing a high level of protection to consumers and beneficiaries of financial services and products in its area of competence.

70. Basic acts such as the main sectoral directives and regulations (e.g., CRD, MiFID, Solvency II) can only be adopted by the EU legislators (i.e., the European Parliament and the Council) on the basis of a proposal by the European Commission. In areas specified in these acts, the ESAs and the Commission are delegated the power to adopt rules that either further develop (regulatory technical standards) or implement (implementing technical standards) the basis acts. As regulatory agencies, the ESAs’ powers are limited to drafting these standards; while European case law requires that the Commission retains the formal regulatory power, and that it ultimately endorses them to give them binding legal effect.

71. Each ESA is governed by its Board of Supervisors, which integrates the relevant national authorities in the field of its competence in each Member State. The Management Board, a subgroup of the Board of Supervisors, ensures that the ESA carries out its mission and performs the tasks assigned to it. The ESA is represented by a Chairperson, elected for a five years term that can be extended once by the Board of Supervisors following a pre-selection by the European Commission and confirmation by the European Parliament in public hearing. The Chairperson is responsible for preparing the work of the Board of Supervisors and chairs its meetings as well as the meetings of the Management Board. The Executive Director appointed by the Board of Supervisors for a similar term as the Chairperson is in charge of the management of the ESA and is responsible for the implementation of the annual work program under the guidance of the Board of Supervisors and the control of the Management Board. At the moment, national authorities predominate amongst the Board of Supervisors members, and have all the votes, which may under-weight EU-wide interests and considerations that are not favored by member-states authorities.

72. When carrying out the tasks conferred upon it by the Regulation, the Chairperson and the voting members of the Board of Supervisors are to act independently and objectively in the sole interest of the Union as a whole and shall neither seek nor take instructions from Union institutions or bodies, from any government of a Member State or from any other public or private body

73. Peer Reviews are mandated to help monitoring the implementation of supervisory provisions set out in Community Legislation and in the ESAs’ measures, as well as to monitor convergence in supervisory practices. The Review Panel aims at encouraging a timely and consistent day to day application of all the above and at enhancing supervisory convergence within the European Economic Area (EEA).

74. Stakeholder groups are established to facilitate the ESAs’ consultation with stakeholders in Europe. The stakeholder groups, each comprising of 30 people, include representatives of the industry, consumers and beneficiaries as well as academics. 30

75. The ESAs have an autonomous budget, with revenues coming from national supervisory authorities and the General Budget of the Union. The Union budgetary procedure is applicable and the auditing of accounts is undertaken by the Union’s Court of Auditors.

76. The fact that ESAs have legal personality, autonomy and binding powers makes it essential that they are accountable to the European Parliament and the Council. Decisions taken by the ESAs may be appealed by the addressee or any natural or legal person directly and individually concerned by that decision, by filing an appeal to the competent ESA. The Board of Appeal, which is a joint body of ESAs, independent from their administrative and regulatory structures, shall decide within two months, which decision can be contested before the Court of Justice of the EU.

77. To prepare their statements and documents and to carry out their technical work, the ESAs have set up a number of Working Groups consisting of experts from the national supervisory authorities, and to which other stakeholders contribute from their expertise and insight. These Working Groups relate closely to the respective ESAs’ work programs.

78. The ESAs are successor institutions of the “Level 3 Lamfalussy Committees” of supervisors. The formation of the ESAs was thus a continuation and enhancement of the pre-existing committees. The ESAs’ regulations provide for continuity of the Committees’ work including the transfer of their existing staff. For both EBA and EIOPA the total assigned number of staff will be around 60 experts in 2011 increasing to around 100 in 2013; and around 70 in 2011 rising to 130 for ESMA.

The European Systemic Risk Board

79. On January 1, 2011, the ESRB was established as the new EU independent macro-prudential entity.31 The structure of the ESRB comprises a General Board, a Steering Committee, a Secretariat, an Advisory Scientific Committee (ASC) and an Advisory Technical Committee (ATC). Members of the Board with voting rights (with one vote each) include the President (Chair), the Vice-President of the ECB, the Governors of the national central banks, a member of the Commission, the Chairs of the European Supervisory Authorities (ESAs), the Chair and two Vice Chairs of the ASC, and the Chair of the ATC (37 voting members and 27 non-voting members32).

80. The ESRB’s oversight includes all financial institutions, shadow banks, markets, products and infrastructures. It is tasked with the mitigation of system-wide risks of financial instability. The ESRB shall monitor the financial system, and identify and assess risks of instability that may affect the financial system as a whole. The ESRB is to issue risk warnings when risks are deemed significant, and when necessary, provide policy recommendations to mitigate or address the risks identified. Warnings and Recommendations can be of a general or of a specific nature, and be addressed to the European Commission, to specific Member States, to the ESAs, or to one or several national supervisory authorities. The ESRB is also responsible for the implementation in the EU of the recommendations of the IMF, the BIS and the FSB to the G20, and of the coordination of its actions with International Financial Institutions and with relevant institutions in non-EU countries on macro-prudential oversight matters.

81. The ESRB reports at least annually to the European Parliament and the Council, marking the publication of its annual report, and more frequently in the event of widespread financial distress. Where appropriate, the European Parliament and the Council invite the ESRB to examine specific issues to financial stability. The European Parliament may request the Chair of the ESRB to attend a hearing of the competent Committees of the European Parliament and the Chair of the ESRB shall hold confidential oral discussions at least twice a year behind closed doors with the Chair and the Vice-Chairs of the Economic and Monetary Affairs Committee of the European Parliament.

82. The ESRB does not have a legal personality. It has no binding powers, and enforcement of recommendations will depend on the good functioning of a “comply or explain” concept. To enhance its influence and legitimacy, warnings and recommendations addressed to national authorities will be transmitted, subject to confidentiality, to the Council, the Commission, and the ESAs. Moreover, the ESRB may make warnings and recommendations public where appropriate. Policy recommendations will specify a timeline for the relevant policy response by the body to which the warning is addressed, and it will be the responsibility of the authority to which the ESRB sends a warning to act on it, or to provide a justification in case of inaction. If a recommendation has not been followed or the addressees fail to appropriately explain their inaction, the ESRB shall inform the Council and when relevant, the ESAs. The regulation foresees an explicit role for the European Parliament in the follow-up of ESRB recommendations when they are made public.

83. The headcount of the ESRB Secretariat as of May 2011 is approximately 25 staff members, about half ECB staff and half from national central banks. The ECB has recruited 35 staff from NCBs to deal with ESRB-related issues. The EBA has provided resources to working groups. More broadly, the ECB provides analytical, statistical, administrative and logistical support to the ESRB. As a center of knowledge in the euro area, the ECB analytical power is crucial for the ESRB. The ESRB can also count on its stakeholders’ contributions through its related sub-structures, such as working groups with the ESAs, and Committees such as the ATC and the ASC providing for crucial analytical tasks and independent reviews of strategies by distinguished academics.

The financial stability work of the European Commission

84. The EC plays a central role in setting prudential and non-prudential regulations for the financial sector, and in overseeing macroeconomic policies that deeply affect the financial sector. The Commission has the ‘right of initiative’, i.e., the Commission alone is responsible for drawing up proposals for new European legislation, which it presents to Parliament and the Council. Thus, the Directorate General (DG) for the Internal Market and Services manages the process of formulating and issuing new financial sector directives and regulations, in consultation with the ESAs, national authorities and market participants. 33

85. The current agenda is unusually full, with forthcoming amendments to the Capital Requirements Directive (CRD), the directive on Deposit Guarantee Schemes (DGS), the banking crisis management framework, a review of the Market in Financial Instruments Directive (MiFID), and implementation of Solvency II. This agenda largely represents an effort to implement lessons from the global crisis and associated internationally-agreed regulatory changes, for example, to raise the level and quality of bank capital. Moreover, to strengthen the reforms of the European supervisory architecture, initiatives have been launched to work toward a “common rulebook.” This should provide a common legal basis for supervisory action in the EU - ensuring strengthened stability, equal treatment, lower compliance costs for companies as well as removing opportunities for regulatory arbitrage. Such efforts do not require full harmonization of all aspects of EU legislation, but rather focus on one harmonized core set of key standards. Indeed, some flexibility needs to be maintained for the sake of proportionality and to deal with differences in economic conditions across the EU: especially where monetary and fiscal policies are constrained, there may be good reasons to differentiate other policies, for example, for macro-prudential purposes.

86. The EC’s responsibility to safeguard the internal market implies that it oversees state aid to the financial sector, and also mergers. The DG for Competition has had to pay increasing attention to the financial sector as governments reacted to the global crisis by introducing facilities to support the financial sector.

87. The DG for Economic and Financial Affairs oversees macroeconomic conditions and policies—such as the maintenance of the Stability and Growth Pact—but is also involved in financial stability work, such as the recent stress testing exercises. An area of increasing attention has been that of macro-financial linkages: on the one hand, fiscal and current account balances, and the balance sheet positions of the government and nonfinancial private sector translate into important risk factors in the financial sector; on the other, the functioning of the financial sector influences, for example, savings and investment rates, and contingent claims on government.

Appendix II: Supervising the Insurance and Pensions Industries

88. Solvency II is in the process of replacing the current regulatory framework Solvency I in the EU and the new regime should be in place January 2013. The process started already in 2009 with the adoption of the Solvency II Framework Directive by the European Parliament. Solvency II is based on a three pillar approach, which is similar to the banking sector (Basel II) but adapted for insurance. The first pillar contains the quantitative requirements. The second pillar contains qualitative requirements on undertakings such as risk management, as well as supervisory activities, and the third pillar covers supervisory reporting and disclosure. Solvency II will also streamline the way that insurance groups are supervised, and recognizes the economic reality of how groups operate.

89. CEIOPS, the forerunner of EIOPA, was requested by the European Commission since the beginning of the process to provide technical advice on the vast majority of Solvency II Level 2 implementing measures. This role has put EIOPA in the position of being a natural source for reference, standard setting and consultant authority, as is intended in the new regulatory architecture. The implementation efforts are following an approach that requires detailed regulatory and implementing standards to ensure the consistent application of the regime throughout the EU to avoid regulatory arbitrage and an uneven playing field. Training provided by CEIOPS on Solvency II will continue, enhancing the supervisory quality and harmonization. The need for cooperation among member authorities to gain understanding of the complexity of Solvency II will enhance the work of EIOPA in the coordination area.

90. Expectations regarding EIOPA are extremely high. Solvency II is in the final stages of becoming the official solvency regime, creating an immediate need for guidance and implementing standards. Further, the internal model approval, a challenging and crucial step for ensuring solvency will probably require strong engagement from EIOPA to ensure best practice and proper understanding by all supervisory authorities. In addition, the mandate to participation by EIOPA in the Supervisory Colleges will add expectations regarding guidance in this new field of group supervision.

91. Proper staffing will be a critical component for the success of EIOPA and ultimately for the EU insurance and occupational pensions supervision. The urgent need to gain credibility calls for effective and influential participation in the Colleges of Supervision and will require an adequate level of seniority in staffing, thus constraining EIOPA’s ability to hire young promising talent at this stage. In addition, the high demand for actuarial and internal model resources created by Solvency II has significantly raised compensation to levels that could hit EIOPA’s budgeted salary structure boundaries.

92. EIOPA’s role promoting a coordinated European Union supervisory response and contributing to the stability of the financial system of the European Union, working in close cooperation with the other ESAs and the ESRB, will be not free from challenges. The low interest rate environment, together with costs associated with the introduction of Solvency II, could trigger a change in the demand for the products of the insurance industry. Also, the low interest rate environment, while beneficial for other institutions in the financial sector, could accentuate a search for yield to the detriment of credit quality in the pension and long term life products.

93. EIOPA’s contribution to the evaluation of the type of systemic risk posed by the insurance industry, as well as monitoring, providing early warnings and if necessary coordinating responses in emergency situations, will be critical. With around 30 of the largest global insurance groups domiciled in the EU, the engagement and timely evaluation of the prudential situation of these groups by EIOPA will be essential for fulfilling its mandate. Access to detailed, timely data on these groups will be required as well as strong coordination with the national authorities. Information sharing will require strong protection of confidentiality and data security, but also a cultural change in the national authorities and the willingness to share granular data on a timely basis.

94. The Institutional and Occupational Retirement Prevision (IORP) Directive is in the process of review thus adding an important and resource- intensive task to the workload of EIOPA. The EC has approached EIOPA with a Call for Advice on the new IORP Directive due by December 2011. The purpose of the Directive is to remove impediments to the cross border establishment of occupational pension funds. Currently around 78 of 150,000 occupational pension funds operate cross border. Valuation of technical provisions, the security of benefits, risk-based supervision, and modernizing the prudential regulation of defined contribution (DC) schemes are the main topics of discussion and possible harmonization. The fact that the design of occupational pensions remains a national decision is likely to dampen harmonization at EU level.

95. There is a risk that the consumer protection mandate assigned to EIOPA may be relegated in the priorities. While the mandate requires EIOPA to take a leading role in promoting transparency, simplicity and fairness in the market for consumer financial products or services across the internal market, the assigned powers appear disproportionate, for instance giving EIOPA only the option to adopt guidelines and recommendations with a view to promoting the safety and soundness of markets and convergence of regulatory practice but not regulatory standards. EIOPA may also issue warnings in the event that a financial activity poses a serious threat to the stability and effectiveness of the system; however, it is not clear what implications and actions will follow. EIOPA is also to engage in achieving a coordinated approach to the regulatory and supervisory treatment of new or innovative financial activities. This will require a close engagement with the market and access to detailed information at the individual institutions’ level.

  • Proper valuation of assets and liabilities will be necessary for the successful introduction of Solvency II, but current IFRS work in insurance is delayed and there are important differences, particularly as regards the valuation of the liabilities. Solvency II valuation standards have two major areas of divergence with respect to the currently discussed IFRS. The ultimate adopted valuation will impact the application of Solvency II and could compromise the soundness of the system if too much freedom is granted.

96. Training plans are important for the enhancement of supervision. EIOPA has a wide range of training activities. Topics include Solvency II, accounting, consumer protection, and risk supervision. The training on Solvency II traditionally offered to supervisors in the policy departments has now moved to address operational staff needs. The development of online courses and their availability in the various EU languages is recommended.

Annex I: Institutional and Legal Issues from FSAPs in EU Member States

Executive Summary

  • The global financial crisis has led to reform efforts in many countries to improve institutional and legal aspects of financial stability frameworks. Within the European Union (EU), these efforts are taking place both at the regional level and in many member countries. This annex focuses on the evolving financial stability frameworks in five EU countries that have recently engaged in FSAPs and are on the list of the 25 most interconnected economies. This annex is intended to complement the European Financial Stability Framework Exercise (EFFE) that focuses on the emerging financial stability framework at the EU level.

  • The five FSAPs indicate a trend for Ministries of Finance (MoFs) to take on a more prominent role in financial crisis prevention and management, inter alia through increased oversight of autonomous agencies. Such oversight can be appropriate, but should not curtail the operational autonomy of supervisory agencies. While there is no simple solution here, the operational autonomy of supervisory agencies is essential and should remain in the forefront of any institutional reform. The FSAPs call for appropriate coordination mechanisms among supervisory agencies, as well as between the agencies and the Government.

  • There is a tendency in the assessed countries to strengthen the institutional framework for macro-prudential oversight, including clear delineations of responsibilities for macro-prudential surveillance. In this regard, there is a strong case for strengthening the financial stability mandate of central banks, by specifying a clearly defined and well integrated set of objectives, as well as the functions and macro-prudential tools to achieve these objectives.

  • With regard to micro-prudential supervision, the FSAPs have revealed weaknesses in the gathering of supervisory information obtained via formal regulatory reporting. Moreover, further progress can be made in enhancing home-host cooperation.

  • The FSAPs revealed that bank resolution frameworks vary considerably among the five countries. Major weaknesses exist in several countries, especially as their frameworks lack robust resolution tools. Furthermore, coordination mechanisms between supervisory agencies and MoFs, as well as between the courts, resolution authorities and supervisory agencies, need to be strengthened. Some countries have recently introduced legal reforms to improve their bank resolution framework. Problems related to cross-border resolution would likely need to be handled largely at the EU level, but the lack of ex ante burden sharing arrangements within the EU remains a major impediment. Particularly given the present absence of a regional framework, steps should be taken at the national levels to reinforce coordination between national authorities regarding cross-border bank resolution.

  • Finally, the FSAPs have shown a clear need to improve various aspects of national Deposit Guarantee Schemes (DGS). Weaknesses include inability to finance bank resolution, a lack of ex ante funding, and absence of depositor preference, which, taken all together, may make it cumbersome and time consuming for national DGSs to play an active role in bank resolution and ensure that tax payer expenses are minimized.

I. Introduction

97. The global financial crisis has led to widespread reform efforts aimed at improving the institutional and legal aspects of financial stability frameworks; within the European Union (EU) these efforts are evident both at the regional level and in many member countries. The interrelationship between the national and regional structures, and the ongoing moves towards fostering a single market within the EU, has generated additional dimensions to this work. The European Financial Stability Framework Exercise (EFFE) has analyzed the developments in the institutional and legal structure at the regional level. This annex complements the EFFE paper with lessons from recent bilateral exercises.34

98. Over the past year, Fund staff has conducted FSAP updates for various European Union (EU) member countries.35 Five of these covered countries are on the list of members with systemically important financial systems for whom mandatory FSAP stability assessments, conducted every five years, have become an integral part of Article IV surveillance36. With the increasing convergence of the institutional structures and rules in Europe, a number of issues arising in these national FSAPs are similar across countries; some of these derive directly from decisions made at an EU level, while others relate to national responsibilities in an increasingly common external environment.

99. This paper covers three broad areas. The next section looks at the institutional and legal frameworks for financial stability. Section III covers issues arising in the area of micro-prudential supervision. Section IV contains a discussion of crisis management and bank resolution issues at the national level. Finally, Section V offers some conclusions.

II. National Institutional and Legal Frameworks for Financial Stability

100. The FSAPs with the EU members have demonstrated that countries are reconsidering institutional arrangements and legal frameworks aimed at promoting financial stability in light of the crisis. Before the crisis, the institutional debate in the field of financial stability focused mainly on providing appropriate levels of autonomy and adequate toolkits for central banks and micro-prudential supervisors. The financial crisis has signaled a need s for a more comprehensive review of the mandates of central banks and supervisory agencies as well as of the coordination mechanisms between them. In the EU, this requires analysis and action at both EU and member state level. While efforts have been made to address the issue of cross-border coordination in the field of financial stability at the EU level (e.g., supervisory colleges, Winding Up Directive), individual member states continue to retain considerable responsibility for national financial stability. Accordingly, they will need to develop more robust national institutional and legal frameworks to fulfill those responsibilities.

A. Autonomy of Supervisory Agencies

101. The “standards and codes” assessments with the EU members highlighted tensions associated with the autonomous status of supervisory agencies, and particularly their objectives, independence, and powers. From an institutional perspective, a key lesson from the crisis is that financial stability is ultimately the responsibility of the government and that, for this reason, the government will inevitably have a leading role to play in addressing financial stability issues. The government’s central role has a bearing on the design of institutional frameworks for crisis prevention—i.e., macro- and micro-prudential supervision—and crisis management, that may curtail the autonomy of supervisory agencies. At the same time, however, a balance needs to be maintained to ensure a sufficient level of autonomy for regulatory agencies at the operational level. In the recent FSAPs with EU members, a number of jurisdictions were rated “largely compliant,” rather than compliant, on Core Principle 1 (“Objectives, independence, powers, transparency, and cooperation”) and its sub principles (also see Figure 1). These FSAPs identified constraints on the autonomy of regulatory agencies in the areas of the rule-making process, the reporting lines vis-à-vis the political authorities, the procedure for appointment and removal of the governing bodies, the lack of clear mandates and/or insufficient independence in priority setting and insufficient resources. The recommendations from the FSAPs highlight a number of important lessons.

Figure 1.
Figure 1.

Observance of Core Principle 1 across five EU countries

Citation: IMF Staff Country Reports 2011, 186; 10.5089/9781462338542.002.A001

  • The mandates and supporting objectives of supervisory agencies should be sufficiently clear and coherent, and individual objectives should be sufficiently balanced vis-à-vis each other (for instance, prudential objectives vs. consumer protection objectives) (Sweden, United Kingdom).

  • Where rules are set exclusively by the MoF the supervisory agency has autonomy only as regards implementing those rules. Under such circumstances, the rule-making powers of the MoF should focus on the broad components of the prudential framework, allowing the prudential supervisor to determine quantitative thresholds, minimum ratios et cetera (Netherlands).

  • There is a need to safeguard the operational autonomy of supervisory agencies, ensuring that they can effectively withstand any undue industry and/or government interference (Luxembourg, Sweden).

  • Rules for the appointment and removal of the members of the governing bodies must be set in a way that avoids undue influence in daily management (Luxembourg). Moreover, supervisory agencies should have sufficient autonomy in setting supervisory priorities and allocating resources accordingly (Sweden). There should be mandatory disclosure of the reasons for the dismissal of a supervisory agency’s board member (Germany, Luxembourg).

  • The internal governance framework of the agencies must allow for an efficient decision-making process to ensure that remedial actions can be taken in a timely manner. Weaknesses identified in members’ frameworks do not typically relate to the range of available instruments (although the assessments highlighted some notable exceptions (Netherlands, United Kingdom)) but to their application in practice; in some cases supervisory authorities fail to apply a “ladder” of actions, ensuring that timely and appropriate supervisory actions are taken, commensurate with the nature and seriousness of the identified issues (Germany, Luxembourg, Sweden).

  • The framework for establishing the budget and setting priorities for the agency should be transparent. Priorities should be set on the basis of sound risk assessments performed by the supervisory authority, encompassing both micro- and macro risks. Frequent changes to the budget or to the priorities of the agency should be avoided (Sweden).

  • The framework should provide robust legal protection for supervisors. In several countries, existing protections need to be strengthened (Germany, Netherlands, and Sweden).

102. The strengthened role of MoFs in crisis prevention and management is likely to have an impact on the autonomy of micro-prudential supervisors. In several of the FSAPs, officials from the relevant MoF expressed the view that regulators did not perform particularly well in the period leading up the crisis, and that there is a need for increased oversight over the autonomous supervisory agencies. (This was particularly the case in those of the assessed countries where the MoF is politically responsible before Parliament for the actions of the central bank and financial regulators.) Accordingly, MoFs will likely continue to assert a more prominent role in crisis prevention and management even into the post-crisis period in ways that may potentially undermine the autonomy of regulators.

103. There is no simple solution to resolve the tension between the needs for government involvement and supervisory autonomy; rather it will require a delicately balanced approach. On the one hand, institutional arrangements will have to recognize that, as is the case in the assessed countries, the minister of finance is politically responsible to Parliament for the action of supervisory agencies and for the expenditure of taxpayer money as part of interventions aimed at buttressing financial stability. On the other hand, operational autonomy for supervisory agencies is essential for the performance of their tasks, and political interference with daily management and supervisory decisions must be avoided. Moreover, supervisory agencies, as any public agency, benefit from the powers that have been conferred upon them in legislation: their authority must therefore be framed in a manner that ensures their democratic legitimacy, with related accountability and transparency requirements. Going forward, this balance may most effectively be struck through a framework consisting of the following four pillars:

  • Each supervisory agency operates with functional autonomy and a well calibrated, realistic and, the extent possible, verifiable mandate;

  • Those mandates are complemented by clear transparency and accountability mechanisms vis-à-vis the political authorities and the public at large,37 as well as sufficient budgets to adequately perform its tasks and responsibilities;

  • The supervisory agencies are subject to strong inter-agency coordination mechanisms (see below); and

  • The MoF ensures policy coordination while respecting the autonomy of each agency in its respective field of competencies.

B. Institutional Framework for Macro-prudential Oversight

104. In the assessed countries, the design of institutional arrangements for macro-prudential oversight is still a work in progress. Conceptually, such arrangements should include a clear delineation of responsibilities for macro-prudential surveillance, decision making, and enforcement.38 The FSAPs suggest that, in the assessed countries, the central bank is best placed to perform the surveillance function.39 Similarly, most countries of the countries under review seem to converge towards an approach where the micro-prudential supervisor is charged with most of the enforcement of macro-prudential rules, although the financial consumer protection agency might also play a role. However, the allocation of macro-prudential decision-making powers varies from country to country. In some countries, the political authorities seem hesitant to entrust autonomous agencies with decision-making powers that go beyond their original mandate. This is particularly so in the context of loan-to-value (LTV) ratios for home mortgages, where micro-prudential and consumer protection concerns intersect with housing policies and taxation. (See Box 1).

105. Given the involvement of multiple stakeholders, effective macro-prudential oversight requires close and continuous cooperation. An important precondition of such cooperation relates to the possibility of timely information-sharing between micro- and macro-prudential authorities, which is in some cases hampered by confidentiality obligations. Interestingly, most of the assessed countries seem to be little attracted by the idea of addressing the need to close and continuous cooperation between all stakeholders involved via the establishment of a (U.S.-inspired) “Council”-type of structure, wherein the MoF and the various agencies coordinate policies under the political leadership of the minister of finance; in most cases, countries seem to prefer a Memorandum of Understanding- (MoU) based approach.

Who Should Set LTV Ratios?

Prudential regulation, with its focus on individual firms, may not be sufficient to prevent system risks caused by the failures of individual financial institutions. Progress is being made to enhance macro-prudential framework by expanding the macro-prudential tool box, although more work needs to be done in clarifying the key concepts and developing the institutional framework for macro prudential supervision.

One related question that emerged from the FSAP discussions in Netherlands and Sweden is who should set (LTV ratios. The housing sector played a critical role in recent financial crises and empirical studies tentatively support the effectiveness of using LTV ratios in taming housing booms. The agency in charge of setting LTV ratios varies from the supervisor responsible for consumer protection (Sweden) to the MoF (Netherlands). Another possibility would be the central bank.

  • In the Netherlands, the high LTV ratio of household mortgage loans (well above 100 percent and still rising until recently) is seen as a key vulnerability, which led the MoF, w to propose capping them. They are now at a maximum of 110 percent. The staff recommended assigning additional powers to the supervisors (DNB and the Authority for Financial Markets (AFM)) to facilitate timely actions, specifically by allowing them to modify LTV ratios within a range that could be set by the MoF.

  • In Sweden, the Finansinspektionen, which is in charge of both prudential and conduct-of-business supervision, imposed an 85 percent maximum LTV cap in October 2010—combined with a 125 basis points hike of the policy rate by the Swedish central bank—in response to rapidly rising house prices, which has apparently helped slow down mortgage lending in recent months.

106. This discussion raises the question whether, and how, the financial stability mandate of central banks should be strengthened. Before the crisis, policy makers broadly agreed that price stability should be the main objective of central banks, and the overall mandate of central banks was geared toward pursuing that objective. After the crisis, policy makers have been debating whether central banks should receive a more explicit and stronger financial stability mandate and, if so, how such mandate should be crafted. The FSAPs found that designing adequate financial stability mandates is not a clear-cut exercise. For instance, in the Netherlands, the central bank already had a financial stability mandate before the crisis, but that mandate was arguably too limited, because it included a financial stability objective that was tied exclusively to the micro-prudential function of the central bank and not to its activities more broadly. Going forward, if policy makers aim at strengthening the financial stability mandate of central banks, care should be given to define and elaborate a cohesive set of objectives, functions and instruments, that would be closely tied with the central bank’s other statutory tasks (e.g., monetary stability, micro-prudential supervision).

C. Institutional Models for Micro-Prudential Supervision

107. The FSAPs suggest that there is no perfect institutional model for micro-prudential supervision: each model can work, or fail. The assessments detected, however, a trend to move micro-prudential supervision from a “stand alone” regulatory agency to either vest these responsibilities in the central bank (Netherlands and United Kingdom) or strengthen the interactions between the macro prudential (typically the central bank) and the micro prudential supervisor (Germany). As discussed in Box 2, the arguments for charging the central bank with micro-prudential supervision are compelling, but there is no guarantee that reliance upon such a model will be successful. A strong supervisory culture (with minimal regulatory capture) and the avoidance of intra-central bank “silo” mentalities are instrumental in making the model work.

108. The challenges for micro-prudential supervision do not lie only in the institutional model, but also relate to other elements. In many assessed countries, in addition to a more forceful supervision (as discussed in Section III), the mandates of micro-prudential supervisors leave room for improvement. In addition to the supervisory autonomy, which will be separately discussed below, the most pressing issues calling for discussion are the following:

  • Mandates—Prior to the crisis, prudential supervision tended too often to promote the competiveness of national financial systems (including by supporting “national champions”) either formally or simply in practice. The financial crisis has emphasized the need to shift toward protecting the safety and soundness of the financial systems, rather than the competiveness of individual institutions. (Also, the impact of regulation should be analyzed in light of the former rather than the latter.) Particularly in the EU context, such an approach is also inconsistent with the objectives of the single market.

  • Regulatory Powers—Another important lesson from the FSAPs (see. e.g., Netherlands) is that the regulatory instruments of supervisors may be limited and in need of strengthening.. In this regard, the distinction between enforcement powers and rule-making authority comes into play. The FSAPs have revealed that often political authorities (such as the Minister), rather than the supervisors, may be vested with rule-making powers. This is explained by democratic legitimacy and the ministerial accountability toward the Parliament (e.g., Netherlands). The challenge is to combine such approach to rule-making with the operational autonomy of the agencies. One avenue could be to involve supervisory agencies in the exercise of Ministerial regulatory powers by way of a transparent and open consultation procedure with a view to balance political, policy and technical arguments.

The “Twin Peaks” Model of Supervision

The “twin peaks” model refers to a supervisory framework that separate the prudential and conduct-of-business supervision under different agencies. This model of supervision was adopted in the Netherlands in 2002, under which the Dutch Central Bank (DNB) became a single prudential supervisor for all financial institutions (banks, insurance companies, investment firms, pension funds, and securities firms), and the Authority for Financial Markets (AFM) was created as supervisor responsible for conduct-of-business supervision including supervision of security market activities, with a strong focus on market behavior and consumer/investor protection. The “twin peaks” model has been or is being adapted by several Euro area countries, including the United Kingdom (Table 1). Specifically, in the aftermath of recent financial crisis, the U.K. government has announced that the existing unified supervisory regime (“one peak” model) will be replaced by a “twin peak” model, under which a new prudential regulator, the Prudential Regulation Authority (PRA), will be created, as a subsidiary of the Bank of England, to carry out prudential supervision of financial firms; and a new Financial Conduct Authority (FCA) will be set up for the conduct-of-business supervision.

The preference for a unified prudential supervisor has been driven by changes in the financial industry structure. More specifically, financial systems had become dominated by a few very large financial conglomerates operating across bank/insurance/pension lines, and offering increasingly complex financial products that blurred the conventional credit/insurance/securities boundaries.

The preference for objective-based supervision has led to the separation of prudential and conduct-of-business supervision under different agencies, or “twin peaks.” The preference seems to be based on the view that the objective of prudential supervision is to safeguard financial stability, while the objective of conduct-of-business supervision is to protect consumers. Despite synergies between them, they require different skill sets and different tools to achieve their individual objective. That said, problems in conduct-of-business are often precursors of prudential difficulties, so focus on appropriate conduct-of-business practices should assist financial stability.

The decision to locate the unified prudential supervisor within the central bank has been based on several factors. These include (i) the close link between macroeconomic stability and financial stability; (ii) the expectation that prudential supervisors could benefit from the central bank’s macroeconomic analysis, as well as from the central bank’s long standing credibility; and (iii) for the Netherlands, the intention to enhance DNB’s role with new responsibilities at the time when monetary policies became the responsibility of the European Central bank (ECB), which would also limit the potential conflict of interest between monetary policy and financial stability objectives.

The crisis demonstrated that the effectiveness of supervision goes beyond which institutional model it is based on. Both the United Kingdom’s “one peak” and the Dutch “twin peaks” model were seriously tested during the recent financial crisis. A strong supervisory culture and close coordination between the agencies will be needed to make any model work. .

Table 1.

Selected Supervisory Models40

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109. Above all, there is a need to improve the effectiveness of supervisory agencies. A theme common to all the FSAPs in the study is the significant reliance in the past on moral suasion and the increasing focus now being put on intrusive supervision. While the supervisory culture in Europe is typically less “enforcement driven” than in, for example, the United States, supervisory agencies should acknowledge that while moral suasion and informal pressure may, under normal circumstances, be sufficient to influence supervisory institutions’ senior management, they also need to stand ready to demand progressively stronger remedial action. This will typically require a decisive “will to act,” supported by effective decision-making procedures that do not suffer from stakeholder interference and a legal framework that is not susceptible to arbitrary suspension of supervisory sanctions and decisions.

III. Issues Related to Micro-Prudential Supervision

A. Data Reporting Requirements

110. In all instances, the granularity of the information obtained via formal regulatory reporting was assessed as insufficient. The reporting requirements often respect the minimum harmonization dictated under the Capital Requirements Directive. The financial crisis has emphasized the need for rich data being readily available for supervisory agencies, for instance on nonperforming assets or sectoral and geographical concentrations.41

111. Because of the paucity of data collected through normal central reporting to the agencies, the relevant authorities tend to rely on ad hoc arrangements that are based on financial institutions’ own internal systems. In Sweden, Germany and the United Kingdom, there has been a strong reliance on individual bank management information for the systemic banks. For the purposes of off-site supervision, DNB also makes substantial use of banks’ internal management reports.

112. Given the differences that exist between the banks’ internal management reporting systems, inconsistencies exist in the manner in which the data is collected and reported. This has implications for the building of supervisory tools such as Early Warning Systems (EWS) and stress tests, as it makes it difficult to conduct comparative or aggregate analysis. The FSAPs clearly demonstrated a need to enhance existing regulatory reporting frameworks and implement more standardized, comprehensive approaches that ensure timely reporting or all material risks and developments on a sufficiently granular basis. However, they also highlighted that domestic authorities are already undertaking initiatives aimed at overhauling existing frameworks (e.g., Germany).

B. Cross Border Supervision

113. The guiding principle of the EU’s existing framework for cross-border supervision of the banking system is that of home country control. The responsibility for prudential supervision of a banking group as a whole lies with the “consolidated supervisor,” in the country where the group has its head office (“home country”). The consolidated supervisor is required to coordinate and disseminate all relevant or essential information in going concern and emergency situations.

114. Home country control is also the prudential basis for the “single passport” system, which grants EU-wide freedom of establishment and operation to any bank licensed in any Member State.42 When a bank that has received a license operates a branch in another Member State, prudential responsibility, authority, and accountability for the branch are all vested in the home country authorities, for all elements of the prudential framework with the sole exception of liquidity.

115. The single passport system raises several concerns:

  • As a consequence of the “single passport,” host supervisors cannot prevent the establishment of a branch of an EU institution in their country, as the Capital Requirements Directive (CRD) does not provide them with the authority to make an independent assessment of the incoming institution’s plans. Instead, host supervisors are wholly reliant on the assessment by the home supervisor of the “adequacy of the administrative structure or the financial situation of the credit institution, taking into account the activities envisaged.” The CRD does not, in other words, provide host supervisors with formal powers to review and/or challenge the substantive assessment to be conducted by the home supervisors.43

  • Moreover, host supervisors have limited supervisory powers vis-à-vis branches, hampering their ability to take appropriate measures under deteriorating circumstances.44 Under the CRD, the host supervisor is solely responsible for liquidity supervision and for the implementation of monetary policies in the context of the Euro system (as well as the prevention of financial crime and consumer protection). In contrast, responsibility for supervising the financial soundness and solvency of a credit institution as a whole (including all of its foreign activities) resides with the home supervisor.45 This limited role for host supervisors has important implications for countries whose banking systems have a large foreign presence—for example, Luxembourg—as their supervisors are heavily dependent on supervision conducted by the home countries.46 The developments with regard to Icesave during the course of 2008 provide ample illustration of the need for changes in this area (Netherlands).

  • In several instances, host supervisors have not strictly enforced the limited supervisory powers they have. Host supervisors47 have granted “concessions”48 to cross border banking groups located within the EU, lifting solo liquidity requirements. Moreover, host supervisors have placed undue reliance upon home supervisors in ways that have compromised their ability to take effective and timely (if necessary, preemptive) action vis-à-vis branches.

116. The importance of branches in some EU countries has emphasized the need for closer cooperation between the host and the home country supervisor. Moreover, operational differences between subsidiaries and branches are waning (Luxembourg), as increasingly important functions of banks such as liquidity and risk management as well as technical systems are centralized at the group level, which makes it hard to disentangle assets and liabilities of the various entities, also characterized by a high level of intra-group exposure.

117. While EU directives49 impose mandatory rules for cooperation, coordination, and information exchange for supervisory purposes, the FSAPs have highlighted problems in this regard. In some instances, information sharing was inadequate (United Kingdom), and in others the supervisor appears to have relied to a large extent on the supervision exercised by the host supervisor (Netherlands).

118. Recent enhancements to the EU legislative framework on the home-host cooperation are a positive step forward in helping to address issues identified in the FSAPs. The European Union has enhanced supervisory co-operation through mandatory Colleges of Supervisors. Since the CRD II amendment,50 branches can be designated as ‘significant’, mandating the establishment of a College of Supervisors—if such a forum does not already exist—in which the relevant host state supervisor of such a branch will participate. Through such a College, the supervisory authorities will, inter alia, exchange information, determine supervisory programs on the basis of a risk assessment and trying to come to joint decisions on Pillar 2 additional capital. The establishment of Colleges of Supervisors has enhanced the effectiveness of cross-border supervision in several ways. The Colleges meet (at least) twice per year and provide a useful forum to coordinate supervisory activities and exchange information; moreover, the Colleges are beginning to serve as a forum for joint decision-making.51

119. At the same time, the operational framework for the Colleges could be strengthened. While the legal framework for information sharing within the supervisory perimeter within the EU is well established, the exchange of information can be sluggish in practice. The CRD explicitly permits and, in some cases, requires information sharing for specified purposes between the supervisory authorities of Member States, even if memoranda of understanding are not in place.52 In practice, however, College participants do not share information proactively and have been slow to reach agreements on the sharing of information for particular purposes. Moreover, the CRD, as amended, allows the participation of third countries’ supervisory authorities in Colleges of supervisors, but only if they are subject to confidentiality requirements that are equivalent to the relevant CRD requirements. In practice, some key third countries are still missing at EU Colleges.

120. The effectiveness of the colleges of supervisors would be substantially enhanced through the implementation of several key measures. These include greater emphasis on peer reviews, and on onsite as well as offsite supervision. According to the Peer Review on the Functioning of Supervisory Colleges, conducted by CEBS in 2010,53 important next steps to strengthen the role of the Colleges will be (i) to extend and deepen cross-border cooperation, inter alia through more joint activities, (ii) to extend the perimeter of the Colleges by expanding the membership toward (additional) non-EU countries; and (iii) to establish efficient and secure channels for information sharing, ensuring a swift information delivery on a ‘real time’ basis.

Table 2.

Main Observations of EBA’s Supervisory Colleges Peer Review 2010

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IV. Issues Related to Crisis Management and Bank Resolution

A. Recognizing the Role of the Ministry of Finance

121. The FSAPs point to the need to explicitly recognize and support the central role of the MoF in crisis management frameworks. In particular, three areas could be improved.

  • Flow of Information from Agencies to the MoF—While MoFs should not ordinarily have access to confidential supervisory information concerning individual financial institutions in normal times, the MoF does need access to such information when there is a crisis (e.g., to inform adequate decision making including with regard to solvency support), albeit under appropriate safeguards. At present, legal frameworks within the EU (including EU directives) do not sufficiently make provision for such information sharing. The FSAPs, therefore, recommended that confidentiality rules be modified accordingly.54

  • Budgetary Frameworks for Official Support—MoFs should have the legal authority to enter swiftly into support transactions with financial institutions (recapitalization, acquisition of shares, extension of guarantees) and execute those through the transfer of financial resources. The FSAPs have demonstrated that sufficient provision is made for the former but not the latter. More specifically, authorities have been forced to enter into support transactions without necessarily having budgetary authorization to fund those transactions. Staff has therefore recommended that MoFs benefit from a standing budgetary authorization to provide official support, albeit with safeguards (such as adequate resolution frameworks) to mitigate moral hazard.

  • Role of MoF in Bank Resolution—Given that the effective resolution of ailing banks is likely to require temporary official financing,55 the decision-making process of resolution agencies should provide for adequate coordination with the MoF. In particular with regard to the resolution of large or systemically important financial institutions, the MoF is likely to be involved in the design of resolution and crisis containment strategies. Legal frameworks should recognize this reality explicitly, and establish a clear and effective division of labor between the MoF, the central bank, and the resolution authorities, subject to appropriate confidentially arrangements. (Netherlands, Sweden and United Kingdom).


From the perspective of home-host cooperation within Europe, the Icesave case is interesting for two reasons. First of all, it highlights the importance of effective cooperation and information-sharing. Secondly, the case highlights the importance of full and timely information-sharing between relevant authorities, as this would typically be a prerequisite for effective intervention at an early stage, thus preventing the occurrence of bigger and more costly problems at a later stage. Icesave was an online savings account brand owned and operated by Landsbanki from 2006–2008. It operated in two countries - the United Kingdom (since October 2006) and the Netherlands (since May 2008).

Landsbanki was placed into receivership by the Icelandic Financial Supervisory Authority (FME) on October 7, 2008, following numerous comments in the international media on weaknesses in the Icelandic banking system and a subsequent deposit run in its U.K. operations. At the time, a press release from the FME stated that all of Landsbanki’s Icelandic branches, call centers, ATMs and internet operations would be open for business as usual, and that all “domestic deposits” were fully guaranteed; the press release did not refer to deposits abroad. Shortly after issuance of the press release, on October 9, 2008, the Icelandic assets and liabilities of Landsbanki were transferred to a new government-owned bank, Nýi Landsbanki. As Landsbanki had been acquiring assets in Iceland with foreign loans and deposits, the assets of Nýi Landsbanki exceeded its liabilities significantly, even after it had made provisions for over half its loans to customers. .

It was immediately after Landsbanki has been placed into receivership by FME that both the U.K. and the Dutch authorities attempted to ring-fence assets and using their deposit insurance schemes to compensate depositors up to the insured maximum. In this context, both countries took it upon themselves to compensate their depositors and subsequently tried to recoup the paid-out amounts from Iceland. Iceland has disputed that it has a sovereign obligation to repay the United Kingdom and Dutch governments. Since then the three governments have spent over two years trying to reach an agreement on the Icesave deposit payouts. To date, the governments involved have not reached agreement on the way forward, with the population of Iceland voting against two consecutive repayment schemes via two referenda. The Netherlands and the United Kingdom instituted legal proceedings against Iceland at the Court of Justice of the European Free Trade Association States. The Court has not taken any decision against Iceland, although the ESA issued a reasoned opinion in June, finding that Iceland has breached the EU directive on deposit insurance.

B. Emergency Liquidity Assistance

122. The principles underlying the provision of emergency liquidity assistance (ELA) to banks are well-established.56 Such assistance should only be provided to banks that are illiquid but not insolvent. Moreover, such lending should be provided against high-quality collateral although, in a crisis, this requirement can be relaxed, and a central bank can accept any asset of the bank in question, in principle with a haircut to ensure that it is not at financial risk. In addition, such lending is not traditionally reported to the public at the time, on the assumption that such reporting would undermine the standing of the bank.

123. In the recent financial crisis, European central banks made extensive use of emergency liquidity assistance. On 2 October 2008, the European Union announced that guarantees from the German government, consistent with EC principles on state aid, enabled Hypo Real Estate Holding AG to “tap additional emergency liquidity lines” from the Bundesbank. As another example, RBS and HBOS received more than GBP 60 billion in emergency loans in the autumn of 2008, repaying the last of these loans in January 2009.57 More recently, reports from the Central Bank of Ireland indicate substantial emergency liquidity is being provided to Irish banks.

124. In the Euro-Area, under current arrangements, ELA is provided by, and at the risk of, the National Central Banks (NCBs), and not by the ECB. In the Euro Area, the NCBs provide monetary policy credits to their local banks pursuant to a policy and legal framework established by the (Governing Council of the) ECB. Even though the NCBs are legally the counterparty of the borrowing banks, the risks and revenues from those credits are pooled within the Eurosystem. The framework for ELA is fundamentally different: such assistance is provided by individual NCBs and the risks are not pooled within the Eurosystem. (Losses thus accrue to the NCB and ultimately the Member State’s Treasury.) NCBs are required to inform the ECB of such operations. In cases involving large amounts of support above an agreed threshold, the NCB involved has to seek the approval of the ECB, in order to avoid interfering with the single monetary policy.

125. While the FSAPs found the relevant countries’ frameworks for ELA to be adequate, they also revealed that the crucial distinction between ECB monetary policy credit and NCB emergency liquidity assistance is not always well understood by market participants. This became evident when NCBs (as part of the ESCB) occasionally closed out local banks from access to monetary policy operations and shifted them toward ELA. In such cases, market participants did not understand that, given the greater risks associated with ELA, the haircuts imposed on collateral in this context are generally much higher than they are for monetary policy credits.

C. Bank Resolution

126. It is generally recognized that a sound bank resolution regime is a key component of a country’s crisis management framework. Without such a regime in place, policy-makers will be faced with the difficult choice between letting a financial institution fail with a potential risk to financial stability or bailing out the institution with taxpayer money and serious moral hazard consequences. Many countries have therefore enacted special insolvency frameworks that apply to banks and that differ in several important respects from the general corporate insolvency regime. These frameworks typically give the banking authorities the central role in the conduct of insolvency proceedings and often minimize the involvement of the courts. In addition, sound bank resolution frameworks typically include mechanisms to resolve banks under official control as a going concern (“official administration”) as well as liquidation mechanisms that strike a balance between financial stability, the protection of depositors, and creditor rights.58 Special resolution tools (such as “purchase and assumption” transactions and, increasingly, mandatory debt restructuring) that can be triggered both before and after actual insolvency constitute key components of the regime.

Official administration

127. The assessed countries’ regimes for going concern resolution under official control (“official administration”) vary considerably. Some countries (such as the United Kingdom) have no such framework in place, and rely on mechanisms to resolve an ailing bank while it is under private control. Other countries (such as the Netherlands and Luxembourg) have a form of official administration, albeit with some design features that may impede effective bank resolution. Typical weaknesses include (i) a lack of robust bank resolution tools such as a mechanism for the authorities to transfers of assets and liabilities of the failing institution without the consent of the counterparties, and (ii) a requirement that a full moratorium over bank liabilities be automatically imposed upon the initiation of official administration even where it may hinder the resolution of the bank as a going concern.

Resolution tools

128. In response to the crisis, progress has been made at the national level to introduce more effective resolution tools. The recent global financial crisis has exposed inadequacies in national bank insolvency frameworks, specifically with regard to the resolution of systemic financial institutions. More specifically, under highly volatile and uncertain market conditions, lengthy and uncertain court proceedings to wind-down a distressed bank—mainly owing to the complexity and cross-border nature of a distressed institution—could undermine market confidence and risk destabilizing the financial system. The assessed countries have addressed such inadequacies in particular by introducing the following elements in their frameworks:59

  • Early Triggers- Several countries have introduced new triggers for the commencement of insolvency proceedings that allow their authorities to intervene at an earlier stage of the bank’s difficulties. While the Dutch framework already included early triggers before the crisis, Germany and the United Kingdom have recently introduced legislation allowing the resolution authorities to intervene in banks before actual insolvency. In Luxembourg and Sweden, bank insolvency frameworks do not establish triggers for early intervention and this issue remains to be addressed.

  • Purchase and Assumption Transactions—Germany and the United Kingdom have recently introduced legislation for purchase and assumption (P&A) transactions. Under these mechanisms, the authorities are empowered to restructure ailing banks by transferring assets and liabilities to another institution without the consent of the relevant counterparties, thus preserving their going-concern value. The Netherlands already had a framework for P&As while Luxembourg and Sweden still have no such framework.

  • Bridge Banks—Post crisis, Germany and the United Kingdom have enacted rules underpinning the use of “bridge banks” under which the viable parts of a troubled bank’s business is spun off to a publicly-held bridge institution on a temporary basis, pending transfer to a private sector purchaser. The Netherlands is considering legislation in the same direction. Luxembourg and Sweden have no framework for bridge banks.

  • Mandatory Debt Restructuring—Germany is the only of the assessed countries which has already enacted a bank-specific framework for mandatory debt restructuring of banks – that is, under which the authorities may unilaterally restructure the balance sheet of a troubled bank without the consent of the counterparties.

Administrative versus judicial resolution procedures

129. The FSAPs present compelling arguments for strengthening the balance between judicial review and the effectiveness of resolution procedures. In many assessed countries (Germany, Netherlands, and Sweden), the judiciary plays a prominent role in bank resolution. While this is understandable in light of the legal traditions of those countries, there is a tension between the protection of stakeholder interests through judicial involvement and the need for speed of those resolution proceedings. To achieve a better balance between the various public policy objectives, the FSAPs have recommended strengthening the administrative nature of bank resolution proceedings by shifting decision-making power to bank resolution agencies wherever possible, while enhancing the ex post review powers of the judiciary so as to ensure that stakeholder rights are protected and that the resolution authorities act consistently with the legal framework.

D. Institutional Set-Up of Deposit Guarantee Schemes (DGSs)

130. Another lesson from the FSAPs is that their governance structures may undermine the ability of DGSs to contribute to resolution. The EU’s harmonization of national DGSs (see below) does not address their governance, and as a consequence, the governance frameworks of DGSs in EU Member States continue to differ significantly.

  • In the Netherlands and the United Kingdom, the DGS does not have separate legal personality and is directly managed and operated by respectively the central bank and micro-prudential supervisor. Such a structure favors the sharing of confidential information regarding weak banks and strong coordination between resolution and deposit insurance.

  • In Germany and Luxembourg, the DGS is managed by the contributing banks and accountable to its members but not to the public authorities. Private ownership of the DGS raises conflict of interest issues and can hinder the sharing of confidential information and coordination in resolution.

131. The DGSs in many of the assessed countries are not well-equipped to support effective bank resolution. While deposit insurance is organized at member state level, the European Union has issued a directive to harmonize to some extent the rules underpinning the national DGSs.. However, this directive follows the strict “pay-box” approach that has been implemented by a number of Member States and that suffers from a number of weaknesses:

  • No Authorization to Finance Bank Resolution- As “pay box” systems, several of the assessed DGSs do not have the power to provide financing in support of a resolution of a troubled bank. They are either inadequately pre-funded or unavailable to finance the resolution of banks, for example, through “purchase and assumption” transactions.60 Those DGSs typically also lack regulatory obligations regarding the availability of information on insured depositors, operational manuals, contractual frameworks and due diligence tools to prepare and perfect the necessary transfers within a rapid timeframe, and are prohibited from establishing “bridge banks” structures.

  • Lack of Depositor Preference—Several DGSs do not have a system of deposit preference in place. Consequently, the DGS ranks as an unsecured creditor of the insolvent estate. Depositor preference would strengthen the ability of the DGS to recover its claim by preference over the ordinary unsecured creditors, thus reducing potential costs to the taxpayer.

E. Inter-Agency Coordination for Crisis Management and Bank Resolution

132. Another finding of the FSAPs is that, while inter-agency MoUs may be useful in the context of crisis management, their effectiveness in facilitating a quick crisis response varied among countries. All of the assessed countries have domestic interagency MoUs, which in several instances contributed to an appropriate policy response. For instance, in the Netherlands, the actions of the authorities have been buttressed by a well-designed MoU between the MoF and the central bank that provides guidance on how the central bank will provide emergency liquidity assistance. In some countries, the FSAPs have identified a need to expand the coverage of MoUs, in particular where the supervisory and resolution authorities are separate agencies (such as Germany); an additional concern arises as to the coordination between those two agencies in resolving banks. This being said, the U.K. experience has illustrated the inherent limitations of MoUs: while the Tripartite MoU was relatively well designed in function of the respective responsibilities of the relevant agencies (including MoF), the crisis response was hampered by inter-agency coordination problems.

133. The limitations of MoUs should ideally be addressed by legislative reforms. In addition to fine-tuning the individual mandates of the respective agencies, there is room for enshrining explicit legal coordination duties and mechanisms in legislation (as is, for instance, the case in Luxembourg). One type of crisis management coordination mechanism could consist of a multiparty inter-agency committee in which MoF and various agencies are represented. The design of such a committee should be well aligned with the institutional arrangements for macro-prudential oversight. While there are some similarities between the two, there are also significant differences. For instance, the deposit insurance fund might not necessarily be involved in macro-prudential oversight, but should be a key member of crisis management committees.

F. Cross-Border Resolution

134. In addition to progressing with international and EU reforms, the FSAPs suggested that steps should be taken at the national levels to reinforce coordination between national authorities and foreign authorities regarding cross-border bank resolution. Resolution within the EU is dealt with by EU directives, which are broadly appropriate, albeit with some room for improvement (mainly regarding intra-group coordination). In contrast, with regard to coordination with non-EU Member States, the assessed countries would benefit from taking more forceful action authorizing their resolution authorities to coordinate action with foreign authorities. Such reforms likely will have to be combined with parallel strengthening of cross-border supervisory arrangements, and are likely to require some minimum harmonization and burden sharing to be fully effective.61

V. Conclusions

135. The FSAPs indicate a trend that MoFs are likely to have a more prominent role in financial crisis prevention and management that is likely to have an impact on the autonomy of central banks and prudential supervisors. While increased oversight of autonomous agencies of the State is appropriate, the operational autonomy of these agencies should nevertheless be safeguarded. While there is no simple solution here, the operational autonomy of supervisory agencies is essential and should remain in the forefront of any institutional reform. Moreover, there is a need for strong coordination mechanisms among those agencies as well as between the agencies and the Government.

136. There is a clear tendency in the assessed countries to strengthen the financial stability mandates of central banks, but those mandates should be carefully designed. In this context, greater precision should be given to the design of a well integrated set of central bank objectives, functions and instruments. Especially, those central banks that are also micro-prudential supervisors will have to calibrate a delicate balance between their monetary stability and their financial stability mandates.

137. The FSAPs demonstrated a need to enhance existing regulatory reporting frameworks by implementing more standardized and comprehensive approaches. The FSAPs reveal weaknesses in the gathering of supervisory information obtained via formal regulatory reporting and too much dependency on the internal reporting systems of financial institutions. Remaining legal impediments that hinder an efficient exchange of information between the supervisory agencies to fulfill their tasks should be abolished.

138. The FSAPs indicate that, as a consequence of the EU home country control principle, the limited supervisory powers of host supervisors vis-à-vis branches of foreign banks can cause problems. Enhancement of home-host cooperation is under way in most jurisdictions, for instance through the colleges of supervisors, but such cooperation can be intensified..

139. The bank resolution frameworks vary considerably among the assessed countries. Major weaknesses exist in several countries, especially as their frameworks lack robust resolution tools. Adequate coordination mechanisms with MoFs should be provided in case temporary official financing is required. Also, coordination mechanisms between courts, resolution authorities and supervisory agencies can be strengthened by increasing reliance on administrative procedures wherever possible while enhancing the ex-post review powers of the courts. Some other countries have recently introduced law reform measures to overcome the identified weaknesses. With regard to cross-border banks the lack of ex ante burden sharing arrangements within the European Union continues to be an impediment.

140. Many national DGSs still require improvement in a number of important areas. These include the absence of authorization to finance bank resolution, the lack of ex ante funding, and the lack of depositor preference, which, taken all together, may make it cumbersome and time consuming for national DGSs to play an active role in bank resolution and ensure that tax payer expenses are kept as low as possible.

141. Especially with regard to cross-border financial institutions, some of the weaknesses are beyond control of the assessed countries. Thus impediments to fully effective cross-border supervision remain, and the resolution of cross-border banks to date has been unsatisfactory. Comprehensive solutions are likely to be reached at the EU-level or beyond.


Given that the banking passport applies also to EEA countries, it is preferable to include also these countries in such regime.


FSAP Updates have been completed for Germany, Luxembourg, Netherlands, Sweden and the United Kingdom, and a more limited exercise has been held for Poland. FSAP Updates for France and the Czech Republic are forthcoming. A discussion of the institutional and legal issues arising from the five completed EU member FSAPs is provided as an annex to this paper.


An FSAP has a number of formal requirements, some of which may not be relevant at a regional level. It therefore needs to be determined whether the exercise in 2012 would technically constitute an FSAP or a parallel exercise with similar characteristics.


The mandate of the EFFE includes the institutional architecture of the EU financial stability framework. Other conjunctural issues, such as the role of the ECB in the current crisis, and alternative mechanisms to deal urgently with ailing financial institutions, form part of the Euro Area Article IV consultation.


The mission comprised Messrs. Enoch (head) and Hardy, Ms. Jassaud, and Messrs. Severo and Wehrhahn (all MCM), Messrs. Everaert and Tressel (both EUR), and Messrs. Gullo and Jansen (both LEG).


A detailed description is contained in Appendix 1.


It should be noted that the European Parliament and the Council have the power to object these standards and, where necessary, block their adoption.


Individual decisions addressed to financial institutions may also be issued in case of an emergency situation, triggered by the Council, and if a financial institution is required to comply with its obligations under EU law where competent authorities have not resolved disagreements in cross-border situations.


It is understood that the responsibility will be delegated to national authorities as the ESMA builds up its implementation capacity.


Appendix II provides more details on outstanding supervisory issues in the insurance and occupational pension sectors.


In the upcoming European Market Infrastructure Regulation (EMIR) regulation, the ESMA is likely to be given a central role in the colleges of competent authorities facilitating the reach of joint opinions necessary for the authorization.


However, the Parliament or the Council may reject a regulatory technical standard before its adoption.


In contrast to the ESAs, the ESRB is not overseeing the enforcement of EU laws, and it does not have the status of a regulatory agency.


Other central banks also provide assistance.


Further steps will include a study and, if appropriate, a legislative proposal for full harmonization of bank resolution and insolvency regimes and, in 2014, an integrated framework, possibly centered on a European Resolution Authority.


See IMF, “Resolution of Cross-Border Banks—A Proposed Framework for Enhanced Coordination,” 2010.


There is a need also to improve the framework for managing crises in global banks. Within the EU, however, there is more scope for making progress because the Member States are committed to cooperate with each other indefinitely and on a wide range of issues.


With perhaps an exception for deposits that are in dispute. The Commission earlier proposed payout within seven days of a failure.


The Commission is preparing a policy paper (due by end-2011) on the permanent framework for state aid in the financial sector, which would apply from 2014 after a transitional period.


There is a parallel with rules for bank intervention: normally, intervention is not subject to a stay of execution, and ex post judicial recourse may lead to compensation rather than reversal of the action.


Some of these measures could apply to non-bank lenders.


The legal ambiguity derives from the fact that existing provisions require that supervisory data cannot be used for purposes other than strict supervision. ESAs, however, are mandated to perform risk assessment exercises beyond pure supervision.


These data are currently available in the Transaction Reporting Exchange Mechanism (TREM), which was created in 2007 by CESR–ESMA’s predecessor.


In order to achieve full consistency in the application of current Common Reporting (COREP), the EBA is working on the definition of uniform reporting formats according to Art. 74 of Directive 2010/78/EU of November 24, 2010. This common reporting system will become effective on December 31, 2012. In order to ensure uniform conditions of application of this Directive, the EBA is required to develop implementing technical standards to introduce, within the Union, uniform formats, frequencies and dates of reporting before January 1, 2012.


This central repository (CEREP) requests CRAs to make available public information on their historical performance including the ratings transition frequency and information about credit ratings issue in the past.


Even small differences in the reporting format and timing can add significantly to regulatory burden.


For example, the EBA must provide information on Key Risk Indicators to the ESRB on a regular basis.


Staffing and preparation are currently speeding up. While 3 experts were working on CRAs in 2009, the team reached 5 experts in May 2011. The unit should reach 15 staff members by the end of 2011, and 35 by end-2012.


The ESAs will need to consult with a narrower circle of respective industry representatives on technical issues.


Regulation No. 1092/2010 of the European Parliament and of the Council of November 24 of 2010 and Council Regulation No.1096/2010 of November 17 of 2010.


The voting members of the General Board are the President and the Vice-President of the ECB, the Governors of the national central banks, a member of the EU Commission, the Chairs of the ESAs, the Chair and two Vice Chairs of the ASC, and the Chair of the ATC. The non-voting members are the high level representatives of the national supervisory authorities, and the president of the EFC.


One implication is that the ESAs do not themselves have full power to set regulations in their respective areas of competence.


This Annex was prepared by a team led by Messrs. Enoch (MCM) and Jansen (LEG) and comprising also Ms. Jassaud, Mr. Verkoren and Ms. Zhou (all MCM), and Messrs. Bossu and Gullo (both LEG).


Germany, Luxembourg, Netherlands, Sweden, and the United Kingdom. All the FSAP teams also included staff from the Fund’s European and Legal Departments.


Integrating Stability Assessments Under the Financial Sector Assessment Program into Article IV Surveillance, August 27, 2010,


Parliamentary committees can play a role in overseeing the effective exercise of powers delegated to the agencies. However, all of the assessed countries have parliamentary systems wherein the Minister of Finance is politically responsible for the agencies before parliament, and the accountability arrangement should reflect this central role of the minister.


Work is in train on MCM and LEG papers on this topic.


In the United States the Dodd-Frank Act (see Section 153 et.seq.) established the Office of Financial Research in the Treasury Department and charged this Office with supporting the Financial Stability Oversight Council including through the collection of data and the design of tools for risk monitoring.


Based on (1) ECB, 2010, “Recent Developments in Supervisory Structures in the EU Member States (2007–10); (2) Donato Mascinadaro and Marc Quintyn, 2010 “Regulating the Regulators: The Changing Face of Financial Supervision Architectures Before and After the Crisis,” and (3) a review by MCM experts.


This paper does not discuss Pillar 3 issues as it looks only at issues covered in the FSAP discussions.


The EU provisions on the single passport relate to EU Member States, plus the countries that are a member of the EEA, i.e., Norway, Iceland, and Liechtenstein. For simplicity’s sake, the analysis focuses on the EU Member States, but would in principle also apply to afore-mentioned EEA countries.


Although the Guidelines for Passport Notifications, issued by CEBS on 27 August 2009 ( stress that there should be co-operation between the relevant Authorities, leading to “genuine dialogue” and that Authorities should “provide each other with the fullest mutual assistance” in any matters falling within the scope of this Guideline, it does not obligate home state supervisors to provide host state supervisors with any substantive argumentation evidencing their approval of the envisaged branch establishment. However, the CRD provides for a general cooperation requirement among supervisor with respect to branches, including on information sharing.


As also highlighted in the developments with regard to Icesave, as discussed in Box 3.


The CRD explicitly states that host state supervisors (Article 16) “may not require authorization or endowment capital for branches of credit institutions authorities in other Member States” and (Article 23)” “shall provide that the activities listed in Annex 1 [of the CRD] may be carried out within their territories (…) either by the establishment of a branch of by way of the provision of services, by any credit institution authorized and supervised by the competent authorities of another Member State, provides that such activities are covered by the authorization.”


For instance, in the event of breaches of domestic legislation, host authorities can only intervene by asking the home supervisor to take measures aimed at correcting the irregular situation.


Three supervisory authorities (Germany, Netherlands and United Kingdom) have granted liquidity concessions to third country branches.


Liquidity concessions were used to hand off responsibilities to the home supervisors (Germany, United Kingdom, the Netherlands as well as two other EU countries). They imply waiving quantitative requirements with respect to liquidity, in return home supervisors assume certain reporting obligations to the host supervisor. This “cooperation” involved the home supervisory authority carrying out liquidity supervision on a centralized basis for the whole group, including branches in other EU Member States.


CRD, Articles 129 and 132.


This is the case even though full implementation of EBA’s Guidelines for the joint assessment and joint decision regarding the capital adequacy of cross-border groups51 is only expected as of the end of March 2011.


Certain concerns are persisting as to possible impediments which may prevent a national authority to provide firm-specific information that is not relevant for direct supervisory purposes, but for other goals such as systemic risk assessment.


Once the legislation has been modified to allow better information flows from the specialized agencies to the MoF, a MoU between them could further specify the type and timing of information sharing.


On the role of temporary public financing in orderly resolution see IMF: Resolution of Cross Border bank—A Proposed Framework for Enhanced Coordination, June 2010, pp 23–25.


See Bagehot (1872). ELA is sometimes also referred to Lender of Last Resort (LOLR) funding.


See the Bank of England’s submission to the Treasury Committee, dated 24 November 2009.


On the concept of “official administration” see IMF/World Bank, “An Overview of the Legal, Institutional, and Regulatory Framework for Bank Insolvency,” 2009, pp 26–35, and IMF, “Resolution of Cross Border Banks—A Proposed Framework for Enhanced Coordination,” June 2010, para 35.


As discussed in the EFFE companion paper, the EC is also preparing an EU-wide Directive with the aim to harmonize resolution tools.


To avoid moral hazard, such power should be well circumscribed: the DGS should only provide financial support up to the amount of insured deposits, and under the condition that the transferor bank is subsequently put into liquidation (thus avoiding open bank assistance inappropriately benefitting to the pre-insolvency stakeholders).


See IMF, “Resolution of Cross Border Banks—A Proposed Framework for Enhanced Coordination,” June 2010.

Euro Area Policies: 2011 Article IV Consultation—Lessons from the European Financial Stability Framework Exercise; and Selected Issues Paper
Author: International Monetary Fund