Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

Typical street scene in Santa Ana, El Salvador. (Photo: iStock)

IMF Survey: Overhauling Europe's Financial System

April 14, 2009

  • Plans for EU single financial market at critical juncture
  • IMF, others urge quick implementation of de Larosière proposals
  • Cross-border banking requires EU-level safety nets

Although the rationale for a single financial market in the European Union (EU) remains compelling, there are genuine risks that the global financial crisis will derail the project, according to Marek Belka, head of the IMF’s European Department.

Overhauling Europe's Financial System

The global crisis has given new impetus to the debate on how best to secure financial stability within and across borders (photo: Newscom)

Europe and the financial crisis

Belka, a former Prime Minister of Poland, called on European policymakers to secure a better outcome and achieve the EU’s 52-year-old quest to establish such a market. “For all its costs, this crisis presents a historic opportunity to put in place a sound financial stability framework for Europe that will foster the kind of high-performing integrated financial system that Europe’s citizens and businesses deserve,” Belka said in prepared remarks for a conference in Brussels that took place on March 23-24.

Focus on financial stability

The IMF has long been a champion of the EU’s efforts to integrate its financial markets. Financial integration is the necessary complement to the free flow of goods, services, and labor within the EU. But because financial systems are shaped by regulatory and supervisory frameworks, financial integration is only possible if financial stability arrangements are adapted to enable and facilitate it.

At the same time, tighter integration makes the cross-border dimension of financial stability all the more important. The global financial crisis has given new impetus to the policy debate on how best to secure financial stability both within and across borders, adding significance to this conference, which focused on policies to achieve a better performing and stable financial system in Europe. The conference was organized jointly by the IMF, the think tank Bruegel, and the National Bank of Belgium.

Taking European cooperation to the next level

Much of the discussions focused on proposals put forward by a high-level expert group headed by former IMF Managing Director Jacques de Larosière. In its recently published report, this Group proposed establishing two supra-national structures to deal with cross-border aspects of financial stability:

• a European System of Financial Supervisors (ESFS), which would bring together existing national supervisors with three new sectoral EU-level authorities (for banking, insurance, and securities markets respectively), and

• a European Systemic Risk Council (ESRC), which would monitor systemic risks and address them through coordinated policy responses from EU member states.

De Larosière Group members Leszek Balcerowicz and Rainer Masera, and Group rapporteur David Wright, explained that the Group had focused on recommendations that were likely to garner political support, be implemented quickly, and help restore confidence.

The Group’s proposals were met with broad support at the conference. Many participants urged quick follow-up action, but there were also calls to design the proposed bodies carefully to ensure their effectiveness and, more generally, to be more ambitious about reform.

More Europe

In his speech, Belka strongly supported the establishment of the ESFS and ESRC. But, to be effective, he said, they must be given enough resources, independence, and binding powers over national supervisors. Belka also called for a more ambitious overhaul of the EU’s cross-border framework for crisis management and resolution. Otherwise, host countries would increase their control over foreign banks, and this would undermine the single market.

Euroclear Chairman Nigel Wicks feared that the report’s emphasis on decentralized supervision would contribute to a fragmented European financial market, and advised exploring the “more Europe” options alluded to in the Turner Review of the U.K.’s Financial Services Authority.

Deutsche Bank Vice Chairman Malcolm Knight underlined the need to establish a single rulebook for the EU’s financial market, as also advocated by the Turner Review. David Wright said that the European Commission had not yet taken a firm view on the optimal architecture of the proposed bodies, but that independence and cross-sectoral coordination would be essential.

Better ways to resolve banking crises

Jan Brockmeijer, Deputy Director of the IMF’s Monetary and Capital Markets Department, joined Belka, Wicks, Knight and others in calling for complementing the de Larosière proposals with better cross-border mechanisms for crisis resolution.

Such mechanisms were seen as essential to safeguard cross-border banking and reduce the tension between desirable EU-level financial oversight and the reality that crisis resolution has to rely on national fiscal resources. Brockmeijer argued that special resolution regimes for financial institutions and a European Deposit Insurance Fund to insure cross-border deposits could be part of the solution.

Managing systemic risks

Managing systemic risks was a major point of discussion. Rainer Masera, an Expert Board Member of the European Investment Bank and former CEO of San Paolo IMI, said that systemic risks needed to be met with a tripartite response: monetary, regulatory and supervisory.

The country dimension must not be forgotten, Bruegel Chairman Balcerowicz said. EU member states should retain tools to effectively address systemic risks. IMF senior economist Wim Fonteyne agreed, but said that supranational bodies such as the ESFS and ESCR offered the best chance of safeguarding individual countries’ interests within a single market. A twin-peaks European oversight structure would help bridge macro- and micro- prudential supervision, Brockmeijer said.

Independent analysis will be key

The ESRC’s effectiveness in managing systemic risk will depend on its work being supported by effective pooling of information and scrupulously independent analysis by a highly competent team of specialists, Alexandre Lamfalussy said.

Lucas Papademos, Vice President of the European Central Bank (ECB), said that the ECB and the European System of Central Banks (ESCB) stood ready to carry out such supporting work. He added that it will be important to establish appropriate links between the EFSF and the ESCB.

Fortis Chief Economist Freddy Van den Spiegel pointed out that the sustainability or unsustainability of financial trends could always be debated, and this risked making ESCR assessments and recommendations controversial.

Role of competition

Discussing the EU’s financial services policies more generally, Jan-Pieter Krahnen, Director of the Center for Financial Studies in Frankfurt, argued that cross-border consolidation could help accomplish the necessary downsizing of the financial system in a competition-friendly way.

KBC Group CEO André Bergen cautioned that competition also has downsides. In his view, excessive competition and peer pressure among banks had contributed to the crisis. For the future, he thought that the financial system would have to revert to offering a reduced range of simpler products. Krahnen, however, was optimistic that many problems could be prevented with greater transparency and better information systems. Drawing lessons from the crisis in the Baltics, EBRD Chief Economist Erik Berglof called for state aid provided to banking groups to be extended to their foreign subsidiaries.

Read the presentation titled “Impact of the Crisis on European Banks” by Matthew Sebag-Montefiore from Oliver Wyman Financial Services.

Read the presentation titled “Looking for the Right Lessons” by Mojmir Hampl from the Czech National Bank.

Read the presentation titled “Where Do We Stand?” by Nicolas Véron from the Bruegel think tank.

Read the presentation titled “What Impact has the Crisis Had So Far?” by Philipp Hartmann from the European Central Bank.

Read the presentation titled “EU as a Framework for Action by Member States” by Vitor Gaspar from the European Commission.

Read the presentation titled “Consolidation Versus Financial Crisis and Competition Policies” by Hans-Joachim Dübel from Finpolconsult.

Read the presentation titled “Crisis Management and Resolution in the EU” by Wim Fonteyne from the International Monetary Fund.

Read the presentation titled “Crisis Resolution: Where We Stand and How to Improve It” by Eva Hüpkes from FINMA Switzerland.

Comments on this article should be sent to imfsurvey@imf.org