The current financial crisis introduced a sense of urgency to the debate on the desirable structure of financial supervision in the EU, but the adopted new framework does not resolve all the tensions in the coordination/centralisation debate. In October 2008, the European Commission mandated a group of experts, under the chairmanship of Jacques de Larosière to formulate recommendations on the future of European financial regulation and supervision (de Larosière Group, 2009). On 27 May 2009, the European Commission published its proposal for the future structure of European financial supervision (based on the de Larosiere recommendations) which was adopted by the European Council on 18-19 June 2009 (Council of the EU, 2009). The adopted framework consists of a macro-prudential supervisory framework centered around the European Systemic Risk Council (ESRC) under the aegis of the European System of Central Banks and a micro-prudential supervisory framework, the European System of Financial Supervisors (ESFS), consisting of a steering committee, three sectoral European Supervisory Authorities (ESA), and the network of national supervisors.
Analysed against the theoretical framework established in the recent literature on reform of supervisory architectures, this reform could be considered another example of the central bank fragmentation effect (Masciandaro, 2007 and Masciandaro and Quintyn, 2009), although in an original shape. In both cases, settings with multiple authorities are proposed with an increasing involvement of the central bank using the “new” formula of the macro supervision. I examine this in greater detail in CEPR Policy Insight No. 37.
Let us qualify this assessment. First, the experience with the current crisis has stressed the importance of monitoring systemic risks arising from macro-developments within the economy, as well as the financial system as a whole (macro-supervision). There is a growing consensus that central banks are in the best position to collect and analyse this type of information, given their role in managing monetary policy and acting as the lender of last resort.
Therefore, from the policymakers’ point of view, the involvement of the central bank in macro-supervision entails potential benefits in terms of information gathering and analysis. At the same time, they can postulate that the potential costs of the involvement are smaller, compared with micro-supervision. In other words, the separation between micro- and macro-supervision can be used to reduce the arguments against the central bank involvement.
The separation between macro- and micro-supervision can produce one more effect – it is possible to have consolidation in micro-supervision without any reduction in the central bank’s involvement in macro supervision. However, this has not been the approach taken by the EU. The EU policymakers have chosen to maintain supervisory regimes where the authorities are multiple, confirming the silos approach. There is a possible political economy explanation of the conservative behaviour of the politicians: notwithstanding the crisis, in both cases they evaluated the expected benefits in reducing the fragmentation to be smaller than the expected gains of political and bureaucratic consensus in maintaining the status quo.
The relatively complex three-layered framework for micro-prudential supervision (ESFS) is composed, at the bottom layer, of a large group of a very heterogeneous set of national supervisory architectures (47 agencies for 27 countries), with a wide variety of governance arrangements, supervisory cultures and regulatory frameworks. This supervisory structure is characterised by a multiple principals–multiple agents framework, implying that all players involved need to have an incentive-compatible governance framework in order to make this supervisory network operational, particularly in times of crisis. Although the ESFS falls short of a centralisation of microprudential regulation in the EU, it will contribute to internalising some of the existing externalities of national supervisors´ actions via, for example, reducing information asymmetries and strengthening the “ex ante” commitment of EU supervisors to abide by their decisions thanks to the "comply or explain" principle to be applied on the decisions taken by the ESAs. However, this internalisation is only partial and for this reason, it is most relevant to understand the potential implications of heterogeneous supervisory architectures and governance arrangements for the quality of future EU financial regulation and supervision.
The network of national supervisors is characterised by two dimensions—their architecture and their governance arrangements—that have an impact on their incentives to cooperate cross-border. These two dimensions also interact with each other to the extent that different supervisory architectures are associated with different patterns of governance arrangements. A systematic comparison of both across the EU members and an analysis of their potential impact on future cooperation has thus far not been undertaken.
On supervisory architecture, the EU is polarised with, at the one extreme a number of unified supervisors, and at the other a number of fragmented systems (sector-specific supervisors), with a few countries not belonging to either of these groups. Typically in the fragmented systems, the central banks are in charge of banking supervision (hence, the central bank-fragmentation effect). Building on the Lamfalussy-framework, the politically-endorsed plan for the EU also establishes a sector-specific system at the supranational level. While there is no such thing as best practice in terms of supervisory architecture, it is clear that inter-agency coordination issues could arise from this heterogeneous supervisory landscape, particularly when we take into account the diverse supervisory governance arrangements that are associated with these diverse architectures. It also remains to be seen what the reactions to this heterogeneity will be, both at the supranational and the national levels, once frictions and coordination failures surface. Will there be another (spontaneous) round of reforms at the national level (a process that should be interesting to observe, given that several national architectures have emerged from country-specific political-economic considerations)? Or will there eventually be some pressure for harmonisation coming from the European level?
On governance arrangements, the degree of independence is relatively high among EU members, while accountability arrangements are less elaborated and less homogeneous. From this, we deduct that independence and accountability are not perceived as two sides of the same coin, which certainly hampers the solidity of the agencies’ governance. We argue that supervisory architecture matters: supervisors housed in central banks are more independent than others, while their accountability arrangements are less developed (or to a lesser extent geared towards the supervisory tasks). Unlike for the architectures, a set of best governance practices is emerging in the literature and we defend that, given the complexities involved in establishing coordination and cooperation in the emerging European supervisory framework, intra-European harmonisation towards best practices in independence and accountability is highly desirable, including for the ESAs. Such upward harmonisation would align the incentive structures by (i) reducing incentives of national supervisors to forbear –particularly conspicuous in a cross border setting- and increasing incentives to cooperate among them; (ii) limiting self capture and industry capture by strengthening the principle-agent relation between the tax payer and the supervisor; (iii) promoting independence from the political branch of power; and (iv) fostering a level playing field among supervisors.
While not all aspects of independence and accountability need to be fully harmonised, we argue that some crucial issues need to be addressed, such as the need for (i) legal protection for supervisors acting in good faith; (ii) budgetary independence; (iii) eliminating the presence of politicians on supervisors´ decision-making bodies; (iv) supervisory autonomy in matters of licensing and withdrawing licenses; and lastly, (v) mechanisms for judicial accountability. Upward harmonisation of governance arrangements will be most relevant in order to have incentive-compatible structures aimed at achieving the pan-European goal of financial stability.
Against this background, we suggest two policy recommendations; First, policy makers could consider the harmonisation of supervisors´ governance arrangements. In this regard, the comparison with the creation of the ECB and the ESCB could be relevant. Their establishment was preceded by a number of mandatory changes in the governance structure of the prospective members’ central banks under the Maastricht Treaty. Some similar process—through recommendations or mandatorily—could be envisaged now for the ESFS. In the case of the central banks, convergence was facilitated by the fact that central banks have always been more similar than supervisory agencies in terms of governance and mandates. Also, the main task of the national central banks was centralised in the ECB, whereas in the case of the ESFS the national authorities retain (at least in the foreseeable future) most of their powers. Second, consideration should be given to the introduction of a European mandate for national supervisors (Hardy, 2009) in order to better align incentives in the EU supervisory framework for micro-prudential supervision. While conceptually attractive, the promulgation of a European mandate would raise another set of governance issues. Its effectiveness would heavily rely on adopting lines of accountability from national supervisors to certain European institutions such as the ESA. Otherwise, it would not guarantee proper compliance with the European mandate because national legislative and executive branches may be tempted to look at their national interests in the first place, or fail to grasp the European dimension of financial stability.
The views expressed herein are those of the authors and should not be attributed to the Banco de España or the IMF, its Executive Board, or its management.
Council of the European Union, 2009, “Council conclusions on strengthening EU financial supervision,” 2948th Economic and Financial Affairs, Luxembourg, June 9, 2009, 7 pp.
de Larosière Group, 2009, “Report of the High Level Group on Supervision.”
Hardy, D., 2009, “A European Mandate for Financial Sector Supervisors in the EU,” IMF Working Paper WP/09/5 (Washington D. C., International Monetary Fund).
Masciandaro 2007, “Divide et Impera: Financial Supervision Unification and the Central Bank Fragmentation Effect,” European Journal of Political Economy, pp. 285–315.
Masciandaro, D. and M. Quintyn, 2009, “Reforming supervision and the role of central banks: a review of global trends, causes and effects (1998- 2008)” CEPR Policy Insight No. 30, January