Macroprudential Policy in a Monetary Union
SUERF conference „Monetary and economic policies on both sides of the
Atlantic"
01.10.2019 | Frankfurt am Main | Claudia Buch

1 Motivation

2 Public and Private Debt in the Long-Run

a) Leveraging Up

b) Financial Crises and Deleveraging

3 Links between Private and Public Debt

a) Crisis-Related Support to Financial Institutions

b) The Bank-Sovereign Nexus

c) Implicit Subsidies and Systemic Risk

The Role of Macroprudential Policy in a Monetary Union

5 Summing Up

6 References

7 Figures and Tables

Figure 1: Long-Run Trends in Private and Public Debt

a) Aggregate Data

b) Country-by-Country

Figure 2: Public and Private Debt Before and After Financial Crises

Figure 3: Effect of Financial Sector Assistance on Public Debt
Corresponding author: Claudia M. Buch, Deut​sche Bun​des​bank, Postfach 10 06 02,
60006 Frankfurt, Germany. This text is based on joint work with Manuel Buchholz and
Katharina Knoll, both Deut​sche Bun​des​bank. An earlier version of this text has been
prepared for the conference "High Public Debt: Theoretical and Historical Perspectives"
held at Goethe University Frankfurt on May 17, 2019. We are grateful to Puriya Abbassi,
Fabian Bichlmeier, Magnus Brechtken, Robert Düll, Albrecht Ritschl, and Edgar Vogel for
most helpful inputs as well as to Janina Berner for excellent editorial assistance. The
paper reflects the views of the authors and not necessarily those of the Deut​sche
Bun​des​bank. All errors and inconsistencies are our own.
1 Motivation
Central banks rely on and play a key role in ensuring the stability of the financial system.
Yet, the definition of "financial stability" as an explicit policy objective and the
assignment of a role for central banks has been a relatively recent development.
Financial stability is defined as a situation in which the financial system neither
contributes to a pronounced amplification of an economic downturn nor is a source of
instability itself.
The specific tasks assigned to central banks have been evolving over time. According to
the Bun​des​bank Law of 1957, the Bun​des​bank's mandate was rather broadly defined as

to "safeguarding the currency". [1] Forty years later, in the wake of the evolving
European economic and monetary union, the mandate became focused
Bun​des​bank's
on "maintaining price stability". After the financial crisis, the Financial Stability Act of
2013 prominently provided for the Bundesbank to contribute to safeguarding financial
stability.
While central banks play an important role in ensuring financial stability through
macroprudential policies, they do not act independently. The Bun​des​bank and the
Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht,
Bafin) are members of the Financial Stability Committee (Ausschuss für Finanzstabilität),
the main policy body responsible for macroprudential surveillance. The committee is

chaired by the Ministry of Finance. [2] The Committee evaluates the stability of the
German financial system, submits an annual report to the German Bundestag, and it can
issue warnings and recommendations. The provides analytical inputs for the
Bun​des​bank
discussions.
Macroprudential policy is particularly important in a monetary union where joint
responsibility for monetary policy coincides with national responsibility for key policy
areas affecting financial stability. Hence, mechanisms are needed which prevent the
build-up of excessive levels of private or public debt.
Recognizing the importance of sound fiscal positions for a monetary union, the Stability
and Growth Pact focuses on mechanisms to contain the build-up of excessive levels of
public debt at the level of individual member states. The European sovereign debt crisis
has been a painful reminder of how important incentives to maintain sound public
finances are. But it has also shown that looking at the current levels of public debt might
be insufficient. In the wake of banking crises, and without credible mechanisms to
restructure excessive private debt, governments might be forced to intervene. Private
debt may then turn into public debt.
Financial stability has thus been established as a new policy field in order to address the
build-up of excessive levels of private debt. Macroprudential policy aims at increasing the
resilience of the financial system, making systemic financial crisis that may, ultimately,
result from excessive surges in debt less likely and severe. In addition, credible resolution
regimes for banks are needed to reduce implicit government guarantees and to prevent
risks from being shifted from the private to the public sector in times of crisis.
Against this background, this paper makes three key points:
First, monitoring the build-up of unsustainable debt levels requires taking the real
economy into account. Weaker economic growth impairs the ability to repay debt, and
negative shocks can lead to a self-enforcing downward spiral as has happened during
the European debt crisis (German Council of Economic Experts 2011; Shambaugh 2012).
Sound financial systems contribute to economic growth, and financial instabilities have
negative implications for the real economy (Levine 1997, Pagano 1993, Rajan and
Zingales 1998). Debt per se is not the issue, but debt levels which are excessive relative
to the underlying strength of the real economy. Understanding the channels through
which the build-up of financial stability risks affect the real economy and may cause
resource misallocation is important. Expectations are key in this regard: Expectations
that are overly optimistic with regard to future fundamentals and the evolution of the
real economy can put the repayment of debt at risk.
Second, the dividing line between private and public debt is not always clear-cut.
Through the conversion of implicit into explicit subsidies for the financial sector,
unsustainable levels of private debt can spill over into governments' balance sheets. A
highly leveraged financial system may breed systemic risks and threaten the functioning
of the financial system. If buffers against risks in the private sector are insufficient, the
government might be forced to intervene in times of crisis. Implicit public guarantees for
financial institutions can contribute to excessive risk taking and high leverage. Such
implicit subsidies not only reflect that some institutions can become too large or too
complex to fail. Instead, common exposure to aggregate or macroeconomic risks can
lead to "collective moral hazard" if too many institutions are exposed to the same type
of shock (Farhi and Tirole 2012).
Third, macroprudential policy is the first line of defence against such spill overs of risk
from the private to the public sector. Macroprudential policy aims at enhancing the
resilience of the financial system with regard to adverse shocks and addressing the build-
up of unsustainable financing choices. Macroprudential policy plays a particularly
important role in the European monetary union which lacks a single sovereign and
where many policies that can affect the stability of financial markets are under the
domestic responsibility for policy (Buch and Weigert 2019).
2 Public and Private Debt in the Long-Run
a) Leveraging Up
The 20th century has seen a substantial increase in overall debt levels. Figure 1 (Panel a)
plots the aggregate private and public debt over time for 17 advanced economies since
the late 19th century. Relative to GDP, total debt has more than doubled. Around the
year 1900, the total debt of households, non-financial businesses, and governments
amounted to a little less than 100% of GDP. In 2016, total debt was just about to cross
the 200% mark. Advanced economies have levered up considerably during the past
century, and a large share of the increase in total debt happened in the decades after
1970. Figure 1 (Panel b) also shows that there is considerable heterogeneity across
advanced economies, reflecting different institutional structures, financial sector
regulation, social security systems, and preferences.
Figure 1 (Panel a) shows that the public debt ratio has been broadly stable at around
50% between 1870 and World War I. But two world wars and the Great Depression
created substantial demand for public spending and drove up public debt levels
significantly in advanced economies. In the middle of the 20th century, public debt
amounted to nearly 100 percent of national income on average. After a consolidation
period of about three decades, the increase came to a halt around 1990. In the
aftermath of the Global Financial Crisis, fiscal imbalances once more increased
considerably. By the year 2016, the mean public debt-to-GDP ratio had nearly reached its
mid-20th-century peak (Eichengreen, El-Ganainy, Esteves and Mitchener 2019; Jordà,
Schularick and Taylor 2016b).
The trajectory of private debt to GDP looks somewhat different. Relative to national
income, borrowing of households and non-financial businesses rose more than threefold
prior to World War I. While public debt surged, bank lending declined during the World
Wars and the Depression-era of the 1930s. Around 1950, private credit amounted to
less than a third of annual GDP on average. By the early 1970s, it had doubled and
reached its pre-World War I level. Since then, the private debt ratio has nearly doubled
again, arriving at more than 110% of annual GDP in 2016 (Jordà, Schularick and Taylor
2016b; Schularick and Taylor 2012). The spectacular rise in total debt relative to GDP
since the 1970s depicted in Figure 1 (Panel a) has thus mainly been the result of an
unprecedented growth of private sector debt.
Which factors can account for the leveraging up of public and private balance sheets?
The determinants of trends and fluctuations in public debt ratios are rather well-
documented. Historically, spikes in public borrowing often followed armed conflicts,
recessions, and financial crises. On a more general level, the role of the state for the
macro-economy has changed. Particularly in the second half of the 20th century popular
demands on governments, for health care, or pensions became an important driver of
public debt ratios across the Western world (Eichengreen, El-Ganainy, Esteves and
Mitchener 2019).
This increase in private leverage has been driven by several factors. First, financial
development and financial integration have proceeded rapidly over the past century.
Financial innovations have allowed financial institutions to better manage risks, to
increase their tolerance to risk, and to take on higher leverage. In the post-war period,
banking markets were largely protected by capital controls and restrictions on the
activities of domestic financial institutions. Banking crises were rare (Kaminsky and
Reinhart 1999), and banking was considered to be "boring" (Krugman 2009). Yet,
deregulation of banking markets started in the 1980s, both in the US and Europe,
leading to a significant expansion of financial intermediation, including expansion of
cross-border finance. Second, the widespread introduction of deposit insurance and of
lender of last resort functions has, arguably, changed risk tolerance and the extent of
moral hazard (Taylor 2014). Third, policies targeted at specific credit market segments
have increased the demand for credit. For example, policies aimed at increasing
homeownership may have contributed to an increase in mortgage credit given that the
vast majority of households borrow to buy a house (Rajan 2011). This aspect is
particularly important since mortgage debt is the main financial liability of the household
sector, and mortgage loans are the main asset of the financial system (Jordà, Schularick
and Taylor 2016a).
b) Financial Crises and Deleveraging
High leverage may be problematic as it increases the vulnerabilities of debtors (and thus
creditors) to macroeconomic volatility and heightened uncertainty. This is the reason
why, historically, financial crises have often been private credit booms gone bust. High
levels of debt can signal a debt overhang. A debt overhang exists if the current debt
burden is deemed "unacceptably" high by market participants and misaligned with
fundamentals. The level that is perceived to be "acceptable" varies with economic
conditions - it may be higher when times are good and lower in economic downturns.
In fact, financial crises are often associated with a downward revision of acceptable debt
levels resulting from a sudden awareness that assets have become overvalued and that
collateral requirements have been too lax.
In response to adjustments of expectations, debtors will deleverage to clean up their
balance sheets. And this deleveraging may lead to a self-enforcing debt deflationary
spiral that reinforces the initial shock (Fisher 1933). Once debt is perceived as being
excessive, credit markets tighten. Debtors are forced to liquidate assets in order to
reduce the stock of debt. Asset prices fall and increase the value of debt in real terms,
leading to a vicious cycle of distress selling and a debt-deflationary spiral. The existing
evidence suggests that such deleveraging spells can be both severe and long-lasting (IMF
2016, Lang and Welz 2018, Mbaye, Badia and Chae 2018). Average deleveraging
episode in advanced economies since the mid-20th century took roughly four years, and

private debt was reduced by about 15-19% of GDP. [3] The shock triggering an
adjustment of expectations may be a demand or a supply shock - i.e. (that is)
households or firms may deleverage. Recent research based on historical evidence points
to the importance of demand shocks (Benguria and Taylor 2019).
Deleveraging of households and deleveraging of firms may act as a drag on economic
growth. High and persistent levels of household debt were a main factor holding back

economic recovery after the Global Financial Crisis, [4] just as it played an important

role in explaining the consumption collapse during the 1930s. [5] In both cases, a shock
to household balance sheets resulted in a reduction in consumption with significant
macroeconomic effects. As indebted households tend to have a relatively higher
propensity to consume out of wealth compared to creditors, their effort to deleverage
can translate into a decline in aggregate demand (Tobin 1980). Indeed, evidence
suggests that an increase in the household debt-to-GDP ratio predicts lower GDP growth

and higher unemployment in the medium run (Mian, Sufi, and Verner 2017). [6] Debt
overhang in the non-financial firm sector can trigger similar adjustment patterns
(Ceccheti, Mohanty, and Zampolli 2011). Facing the need to "repair" their balance sheet
following an adverse shock, firms reduce investment with negative effects for economic
growth.
In both cases, the financial sector may act as an amplifier. In light of a debt overhang of
firms and households, banks' may face a surge in nonperforming loans. In a benign
scenario, this may cause a reduction in credit availability, additionally dragging on the
macroeconomy. In the most extreme case, a surge in nonperforming loans may even
threaten the solvency of banks. Banks foregoing profitable lending activities may
aggravate the initial shock (Philippon and Schnabl 2013). Such feedback loops are more
likely if many sectors of an economy are affected at the same time. For example,
declining household demand will force firms to reduce wage costs or to lay off workers,
which further depresses demand (Bornhorst and Ruiz-Arranz 2013).
3 Links between Private and Public Debt
a) Crisis-Related Support to Financial Institutions
While households and firms lever up their balance sheets when times are good and
when optimism is high, governments tend to reduce their debt burden relative to GDP.
Private borrowing thus tends to be strongly procyclical. Public borrowing displays at
least some countercyclical elements as it tends to grow faster in recessions than in
expansions. These different cyclical trajectories tend to be most pronounced in the
runup to and the aftermath of financial crises (Jordà, Schularick and Taylor 2016b). Based
on data for the group of advanced economies discussed above, Figure 2 confirms that
private and public debt are likely to move in opposite directions around these episodes.
Bank lending typically strongly increases in the years before a financial crisis. By contrast,
governments tend to be able to reduce their debt burden relative to GDP. Once the crisis
is in full swing, trajectories reverse. Public debt increases significantly, by about 20
percentage points within the 5-year window on average. Bank lending to the private
sector stagnates or even declines during this period.
This pattern is not very surprising. After all, once vulnerabilities in private balance sheets
are exposed, interventions of the public sector are often the only option in the
shortterm to prevent a further fall in output and deflationary pressure. Romer and Romer
(2019, p. 39) review the narrative evidence of post-crisis fiscal expansions and conclude
that there appears to be "[...] remarkable agreement across policymakers from different
countries that financial rescue is valuable and appropriate in times of high financial
distress." Clearly, the response to a financial crisis depends on the fiscal space
governments had ex ante: The larger the fiscal space, the more aggressive governments'
response to financial crises, and the less severe the post-crisis output losses (Romer and
Romer 2019; Jordà, Schularick, and Taylor 2016b).
As an example, the right panel of Figure 3 sheds light on the effect on public finances
measures based on the recent German experience. When the financial crisis hit,
Germany had a comparably balanced budget. In 2008 and 2009, the government
introduced measures aimed at stimulating economic growth in the form of three main

stimulus packages. [7] Between 2007 and 2010, the German public debt ratio had
increased by nearly 20 percentage points. As the European national debt crisis began to
unfold, the German government took a U-turn and passed the so-called Future Package
aimed at reducing public spending and increasing taxes.
Public support after crises often targets troubled debtors or creditors directly. The
rationale is to help overcoming coordination problems, market failures, or the inability of
distressed banks to absorb losses (Laeven and Laryea 2009; Laryea 2010). Providing
relief for debtors, e.g. (for example) by providing subsidies to creditors for lengthening
maturities, providing credit guarantees, creating asset management companies, or even
engaging in direct lending to companies that are unable to access financial markets.
Measures may also focus on creditors, e.g. (for example) in the form of financial sector
rescues.
In the wake of the Global Financial Crisis, governments also supported banks within
their jurisdictions through capital injections or explicit guarantees. The extent of this risk
transfer from the private to the public sector is reflected in public debt ratios. Figure 3
compares the evolution of public debt levels with and without assistance of the public
sector for financial institutions. In the counterfactual case without any crisis-related
support to the financial sector, general government debt relative to GDP would have
been more than 4 percentage points lower in 2017 in the euro area (left panel). In
Germany, this gap amounted to nearly 12 percentage points in 2010 (right panel).
Almost ten years after the crisis, in 2017, the gap still stood at 6 percentage points.
Rescue measures such as capital injections or explicit government guarantees can have a
pronounced and persistent effect on government finances. The long-term net effect
depends on the specific form of intervention and the recovery of markets. If, for
instance, governments have acquired equity stakes in banks and the market recovers,
net cost of interventions decline over time and may even turn into net benefits. If,
however, the public sector issues guarantees only and does not participate in the upsides

of this investment, costs for the taxpayer might be substantial. [8]
b) The Bank-Sovereign Nexus
If risk is transferred from the private to the public sector through some form of bail out,
this leaves its trace on balance sheets of governments. Indeed, sovereign spreads tend to
increase after bailout announcements. As a result, governments themselves might come
under financial pressure after a bailout. A self-reinforcing feedback loop harbouring risks
to financial stability and macroeconomic growth may ensue: Doubts about government
solvency induce a decline in sovereign bond prices and may lead to a deterioration in the
credit quality of banks; bank distress may become more widespread and trigger
additional government support measures, calling into question the sustainability of
public finances even more (Deut​sche Bun​des​bank 2015a). This bank- sovereign nexus,
which has been exposed not least during the European sovereign debt crisis, has been
extensively described in recent literature (Acharya, Drechsler and Schnabl 2014, Alter
and Schüler 2012).
The mutual dependence of banks and government has a long history. Historically,
governments often needed a financier to enable warfare and trade. During the 16th
century, the role of banks became more important as Europe evolved from decentralized
feudalism to a more centralized system of a few dominant nation-states (Calomiris and
Haber 2014). But banks were not only important financiers, they also helped the
sovereign placing its debt on the market.
One indication for the close financial relationship between banks and sovereign is that
banks tend to overinvest into bonds issued by the home government compared to a
well-diversified international bond portfolio (De Marco and Macchiavelli 2016, Horváth,
Huizinga, and Ioannidou 2015). To what extent this pattern reflects a "home bias" in
banks' investment portfolios is hard to assess, given that investment patterns depend on
preferences, incentives, regulations, and transaction costs.
The regulatory treatment of sovereign debt certainly affects portfolio choices of banks
(Deut​sche Bun​des​bank 2014, 2017; Kirschenmann, Korte and Steffen 2017). Under
current bank capital regulations, exposures of banks to sovereign debtors in the
country's own currency are assigned a risk weight of zero. In addition, these claims are
exempted from limits on large exposures that would otherwise apply to large exposures
to non-sovereign entities. Similar exemptions apply to liquidity regulations. Yet, claims
on governments are not immune to the risk of default or of illiquidity.
c) Implicit Subsidies and Systemic Risk
Implicit guarantees for liabilities of financial institutions are a key channel through which
private and public debt are linked. They are contingent liabilities for the government
which can turn into explicit payment obligations in times of crisis. Quantifying this
implicit subsidy and thus the expected bailout that debt holders expect to receive is not
an easy task. Funding costs advantages of banks which are deemed "too big to fail"
(TBTF) may serve as a proxy (Siegert and Willison 2015). The size of the funding cost
advantage for a bank depends on the expected probability of default, the loss given that
a default has occurred, and the expected recapitalization through the government. The
probability of being bailed out, in turn, is influenced by factors such as the resolution
regime and the fiscal capacity necessary to make the implicit guarantee credible.
Financial institutions that are deemed "too-big-to-fail" are indeed a recurrent theme in
the history of financial crises. Individual banks can become too big, too interconnected
with the rest of the financial system, or too complex to disorderly exit the market. In
2011, G20 members thus agreed on reforms addressing the "systemic and moral hazard
risks associated with systemically important financial institutions" (FSB 2011). Three sets
of policies have been implemented to achieve this objective: (i) improved loss
absorbency and resilience, (ii) improved recovery and resolution, and (iii) improved
supervision.
Assessing the effects of reforms requires a distinction between private as well as social
costs and benefits. The internalization of systemic externalities and the withdrawal of
implicit TBTF subsidies results, ceteris paribus, in an increase in funding costs. Like the
introduction of a pollution emission tax, an increase in funding costs will be perceived as
a cost of reforms by private market participants while, at the same time, contributing to
lower "emissions" - hence lowering the costs of financial crises to the taxpayer.
The withdrawal of subsidies also has implications for the risk-taking of banks. The
optimal level of risk taken by TBTF banks from a private perspective can be higher than
the socially efficient level of risk: Owners of banks fully reap potential profits but only
partially bear potential risks due to the expected government bailout in case of distress.
Excessive risk-taking implies costs for society: If risks materialize, taxpayers may face
additional costs related to the need to rescue the bank. Regulatory reforms aimed at
internalizing the external costs through, for example, higher loss absorbing capacity and
provisions to facilitate the orderly resolution of TBTF banks thus have the potential to
increase social welfare. But these reforms may come at a net private cost for the
affected banks as they will incur costs to comply with the new regulation and are likely
to face higher funding costs.
In an ongoing evaluation conducted in 2019 and 2020, the Financial Stability Board
assesses whether the implemented reforms are reducing the systemic and moral hazard

risks associated with systemically important banks (SIBs). [9] The evaluation will also
examine the broader effects of the reforms to address TBTF for SIBs on the overall
functioning of the financial system.
This project focuses on a core objective of the G20 financial reforms: To address the
systemic and moral hazard risks associated with systemically important financial
institutions (SIFIs) (FSB 2011). Beyond resolution regimes, policy measures to address the
"too-big-to-fail (TBTF)" problem include a more intense supervision of SIFIs and higher
requirements for their loss absorbing capacity. The project will assess whether perceived
implicit funding subsidies have changed; how much progress has been made regarding
the resolvability of systemically important banks; whether this has affected bank
behavior; and whether there have been broader effects of the reforms on the real
economy.
The FSB published its work plan, invited feedback on it, and solicited supporting
evidence of reform effects from respondents. This is in line with the FSB's aim to be
open and transparent and engage in a dialogue with a broad range of stakeholders. To
put the evaluation on a firm methodological foundation, the project is conducted with
input from academic advisors. There are further opportunities for interaction with the
FSB evaluation teams: External stakeholders will engage with the team in workshops
and roundtables, and a consultation report will be published in June 2020.
The Role of Macroprudential Policy in a Monetary Union
Credit booms and a potentially resulting debt overhang are crucial determinants of the
likelihood of financial crises, their severity, and the strength of the recovery that follows.
This is why monitoring debt levels and macroprudential policy are particularly important
in a monetary union with a joint responsibility for monetary policy but national
responsibilities for key policy areas potentially affecting financial stability.
Most central banks relate the stability of the financial system to its ability to cushion
shocks so as to mitigate the costs of financial distress for the real economy. The Bun​des​-
bank's definition is in line with this notion. It follows the idea that the financial system
should constantly be able to fulfil its key macroeconomic functions: Financing
investment, providing savings opportunities, allocating risks, and maintaining the
payments system. A stable and resilient financial system fulfils these functions and does
neither amplify nor trigger an economic downturn. It should consistently be in a position
to absorb losses from both financial and real economic shocks.
Consider a negative shock to the economy and to the net worth of firms. This may
trigger a negative spiral, causing credit defaults, and a reduction in banks' capital.
Capital ratios will decline, potentially leading to the breach of regulatory capital
requirements. At the same time, market participants will revise expectations and require
higher levels of capital over and above the regulatory minimum. How can banks react?
In theory, they could accumulate additional equity capital internally through retained
earnings or by raising fresh capital on markets. In practice, however, this route will be
blocked in a crisis. Hence, banks can restore required levels of capital only by divesting
assets and deleveraging. This adjustment, in turn, has effects on other market
participants: Direct contagion through contractual linkages or indirect contagion
through fire sales of assets affect market prices and thus all other institutions that are
exposed to the same types of risk. The result can be a credit crunch, which amplifies the
initial shock and has negative repercussions on the real economy. Bank capital is thus the
most important determinant of a banks' loss absorption capacity. Sufficient equity
buffers of banks can be a "circuit breaker".
Microprudential supervision is thus the backbone of a stable financial system. But
safeguarding financial stability requires a complementary, macroprudential perspective.
The financial system is highly interconnected, shocks to large financial institutions may
affect the stability of the system, and common exposures to macroeconomic risks
matter. All of this creates systemic risk externalities. Even if all financial institutions
properly manage their risks and behave prudently, amplification and contagion effects
may threaten the stability of the system as a whole. This is why one should not fall
victim to the "fallacy of composition": The resilience of individual institutions is a
necessary, but not a sufficient condition to ensure the resilience of the financial system.
It was the Global Financial Crisis that prompted the re-think in terms of legal mandates,
in terms of regulation and policymaking. Macroprudential policy was introduced as a
new policy area. In Europe, it is a shared responsibility between the national and the
European level. Almost every member state has a national Financial Stability Council,
which is responsible for the implementation of macroprudential policy domestically.
While institutional arrangements differ across countries, central banks often play an
explicit role in macroprudential policy and surveillance of risks to financial stability.
Financial stability begins at home and is a national mandate. Yet, it calls for close
collaboration within Europe, given the close integration of markets and the potential of
spillovers. This is why, at the European level, the European Systemic Risk Board (ESRB)
has been monitoring financial stability in the EU since early 2011. The ESRB can issue
warnings and recommendations addressed to the EU as a whole or to Member States,
the European Commission, the European supervisory authorities or national authorities.
Moreover, building on the financial market reforms agreed upon at the international
level by the G20, the European institutional structure has been adjusted to make crises
less likely and less costly. The European Stability Mechanism (ESM) and a resolution
regime for distressed banks are key components of the post-crisis institutional
architecture.
In 2014, the institutional setup of the European supervision changed fundamentally with
the establishment of the Banking Union: Banking supervision of euro area banks was
assigned to the Single Supervisory Mechanism (SSM) within the ECB which directly
supervises systemically important banks of all member states. The Single Resolution
Board was established as the central resolution authority. Together with the national
resolution authorities, it forms the Single Resolution Mechanism (SRM).
With the formation of the Banking Union, the ECB has assumed macroprudential
responsibilities in the banking sector alongside national authorities. The ECB has the
power to top-up national