Lucas Papademos: Banking supervision and financial stability in Europe
Speech by Mr Lucas Papademos, Vice President of the European Central Bank, at a conference
organised by the European Banking Federation, "Supervision of international banks: Is a bank crisis
still possible in Europe?", Brussels, 28 October 2005.
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Ladies and gentlemen,
Thank you for inviting me to this conference. I am very pleased to participate in this panel discussion.
Our subject today - the future of banking supervision in Europe - is topical and important. It is and will
remain a key area of financial services policy in the EU over the coming years. Effective and efficient
banking supervision is essential both to promote financial integration and to safeguard financial
stability. From a financial integration perspective, the main priority is to remove any supervisory
obstacles to cross-border finance, notably via enhanced supervisory cooperation and convergence.
Other panellists will certainly address these issues in some detail. In my speech, I will focus on
potential challenges for EU banking supervision from a financial stability perspective and assess the
existing institutional arrangements in this regard.
I. Challenges to banking supervision and financial stability
Let me start by pointing to some developments in the banking sector which may pose challenges to
current financial stability arrangements. As we are all aware, the financial integration process - in the
EU as well as on a global level - has involved a substantial increase in cross-border banking. Four
developments can be mentioned in this respect. First, banks have considerably expanded their
crossborder banking activities in Europe, especially in the wholesale and capital markets. For example, in
2005 cross-border interbank loans account for 30% of total interbank loans and the share of
crossborder bank holdings of non-bank securities in the total holdings of such securities by banks is more
than 45%; in 1997, however, both figures stood at around 20%. Second, a number of large and
complex institutions spanning several jurisdictions have emerged. Some of them are akin to
panEuropean players. The 14 largest of these cross-border banking groups already account for almost
one-third of total banking assets in the EU. Third, large foreign establishments with a significant
market share in host countries have become more prevalent, especially, but not exclusively, in the
new Member States. Finally, cross-border banking groups are increasingly centralising key business
functions such as credit risk and liquidity management, often cutting across separate legal entities in
different countries.
The growing prominence of cross-border banking has important financial stability implications. On the
one hand, cross-border banking broadens and deepens banking markets, increases liquidity and risk
sharing and thus strengthens the overall resilience of the European financial system. On the other
hand, national financial systems may be increasingly exposed to common risks, and financial
disturbances may be transmitted more easily across borders. Against this background, it is essential to
ensure that the EU framework for financial stability is fully prepared to respond to the greater
possibility that risks may be cross-border in nature or in origin. This calls for (i) enhanced interplay
between home and host authorities, especially with regard to significant foreign entities in host
countries, and (ii) the development of effective arrangements for dealing with large and complex EU
banking groups.
II. Policy initiatives
What has been done so far to strengthen the EU financial stability framework in order to achieve these
objectives? Such a framework comprises arrangements for banking supervision, financial stability
monitoring, crisis management and deposit insurance. In the area of banking supervision, two
important policy initiatives have recently been taken to enhance home-host cooperation between
supervisors and to strengthen cross-border arrangements for the supervision of large and complex
banking groups. The first policy measure is the improved legal framework for supervisory cooperation
regarding banking groups with foreign subsidiaries, introduced by the recently adopted Capital
Requirements Directive (CRD). In particular, the CRD entrusts the consolidating supervisor with
coordination responsibilities. It also strengthens and clarifies the requirements for information sharing
and cooperation between all authorities responsible for the supervision of group entities. This
improved framework should promote and facilitate effective supervisory cooperation, especially for
large groups that are active in several countries. The second important policy measure is the
extension of the Lamfalussy framework to include the banking sector and the related activities of the
Committee of European Banking Supervisors (CEBS) to promote supervisory cooperation. The
forthcoming CEBS guidelines for supervisory cooperation will provide concrete guidance for the
effective and consistent implementation of the revised legal framework for cross-border banking
groups. This will also increase the effectiveness of the arrangements for supervisory cooperation with
regard to cross-border banks that have a significant number of foreign branches in host countries.
I would also like to remind you briefly that important initiatives have been taken to enhance the other
public policies safeguarding financial stability. For example, in the area of financial stability monitoring,
the Economic and Financial Committee's recently established Financial Stability Table has played an
important role in forming a comprehensive assessment of risks to financial stability in the EU. This
work has been strongly supported by the Eurosystem, notably via the ESCB Banking Supervision
Committee's annual report on EU banking sector stability and the biannual ECB Financial Stability
Review of the euro area financial system. With regard to crisis management, the adoption of the
Memoranda of Understanding on cooperation between central banks, banking supervisors and, more
recently, ministries of finance, has been a major accomplishment. Work to carry out simulation
exercises to test these arrangements is already underway.
III. Alternative approaches
While the progress achieved is widely acknowledged, some market participants have nevertheless
called for a more integrated institutional approach, particularly in the area of banking supervision.
Specifically, the introduction of a "lead supervisor" for cross-border banking groups has been
proposed. This lead supervisor would not only be responsible for the prudential supervision of all
group entities during normal times, but would also coordinate and take the final decision on possible
emergency and crisis management measures concerning the group. While the panel discussion this
afternoon will offer us the opportunity to debate the possibility of a more integrated supervisory
framework in detail, I would like to share with you at this stage some thoughts on this matter.
The development of European financial markets is manifestly a highly dynamic process. The
supervision and management of this process requires close monitoring and careful analysis of the
current trends. It also requires all responsible authorities to assess, on an ongoing basis, whether the
existing institutional arrangements remain appropriate and whether they are likely to cope well with
future challenges. Keeping an open mind certainly complements our attitude of considering with
caution some of the ideas that call for fundamental institutional changes. Several reasons underlie our
position.
First, we consider that the arrangements for supervisory cooperation have been considerably
enhanced by the strengthened legal framework for supervisory cooperation and the introduction of the
Lamfalussy approach. If fully exploited by all stakeholders, the new arrangements, by promoting
supervisory convergence and cooperation, should enable us to effectively address the financial
stability challenges lying ahead. The present institutional set-up should therefore be given adequate
time to show its effectiveness before alternatives are considered.
Second, any fundamental revisions of the existing supervisory arrangements which challenged the
basic principle of national responsibility and accountability would have a number of political, legal and
practical implications. Moreover, such changes would affect not only banking supervision, but also
other public policies safeguarding financial stability, notably crisis management and deposit insurance.
In order to deal with these complex matters effectively, it would be necessary to analyse all these
aspects very carefully so as to ensure the consistency, credibility, legal certainty and political
legitimacy of the EU framework for financial stability. It is vital that the overall effectiveness and
efficiency of the EU institutional arrangements are not endangered and that no concerns arise from a
financial stability perspective. Therefore, the ECB favours an evolutionary, rather than a revolutionary,
approach to the further development of the EU framework for banking supervision. Nevertheless, if the
existing arrangements prove in practice to be insufficiently effective in addressing the challenges
associated with the changing financial landscape, consideration should be given to new ideas that
would help us to develop the EU supervisory framework further.