Lorenzo Bini Smaghi: The economic governance of the European Union
in the light of the Treaty of Lisbon - harmonisation or competition
between countries?
Speech by Mr Lorenzo Bini Smaghi, Member of the Executive Board of the European Central
Bank, at the conference on "The European Central Bank: a new actor on the international
scene", Milan, 24 January 2008.
* * *
Introduction1
It is a great pleasure for me to speak at this conference, which gives us the opportunity to
take stock - some ten years since the start of the Economic and Monetary Union - of the
institutional framework for the governance of the European economy.
The book entitled "The Law of the European Central Bank" by Chiara Zilioli and Martin
Selmayr, which looks at the legal framework of the European Central Bank, is a good place
to start. Ten years on, it is possible to question whether this framework is still valid.
I should specifically like to focus on an area of particular interest, especially in the light of
recent events. The new Treaty of Lisbon, which was signed by the Heads of State or
Government and the Finance Ministers of the 27 European Union Member States last
December, did not make any substantial changes to the governance structure of the
European economy. There continues to be a contrast between a fully-integrated monetary
system, with a single monetary policy decided by the European Central Bank, and a financial
market that is only partially integrated, since regulatory and supervisory policies are
implemented at national level. This issue, which is quite complex, has been studied by
various commentators, academics and officials.2 The question is whether the current
institutional framework is adequate given the accelerating process of market integration and
the market turmoil experienced in recent months, or whether it should instead be
strengthened in order to ensure an effective regulation of the markets.
I intend to address these issues mainly from an economic perspective, leaving to the legal
experts the task of outlining their legal-institutional vision in this regard.
1. The new Treaty: innovation and continuity
I do not intend to discuss either the controversy or the difficulties encountered during the
process of revising the Treaty, which took seven years: from the Presidency Conclusions of
the Nice European Council at the end of 2000, through the draft European Constitution
outlined in 2004 and the negative referenda on the Constitution in France and the
Netherlands in 2005, to the signing of the Treaty of Lisbon in December 2008. I should only
like to point out that, despite the discussions which took place in various quarters in parallel
to the institutional debate and the positions taken by academics, commentators and
politicians, all the official documentation drawn up during that time, from the Constitution to
the Treaty of Lisbon, underlines the political will to grant a strong independent status to the
ECB and the national central banks (NCBs).
The Treaty of Lisbon strengthens the ECB's position in several ways: i) it establishes the
principle according to which the ECB is independent in the exercise of its powers; ii) explicit
reference is made to the financial independence of the ECB; iii) the primacy of the objective
of price stability for the Eurosystem, which is included as one of the Union's objectives, is
confirmed, together with the (new) objective for an "economic and monetary union, whose
currency is the euro"; iv) the ECB is recognised as an institution of the European Union,
joining the Council of the European Union, the European Commission and the European
Parliament, even though it has legal personality.
It can sometimes seem as through central banks are obsessed with the question of
independence, which, now that it has been laid down in the Treaty, would appear to have
been achieved. Yet, it is surprising how often, ten years after the start of Economic and
Monetary Union, measures continue to be proposed at national level that in some way or
another threaten the independence of the central banks, in particular, with respect to their
functional, institutional, personal and financial independence.3
I refer to two very recent examples, concerning two countries - Italy and Germany - where
draft legislation introduces measures that risk contravening the principle of independence
established in the Treaty.
In Italy, the 2008 Financial Law, which was approved by the Parliament on 24 December
2007, provides for measures to reform the Banca d'Italia aimed at reviewing "in a general
manner [its] means of financing, expenditure control, and payment of salaries and
emoluments". These provisions do not take into account the (functional, institutional and
legal) specificities of the Banca d'Italia, in particular, as a member of the Eurosystem, and
therefore risk being contrary to the principle of independence.
In Germany, the draft law amending the Law on public employees, which would also apply to
the Deutsche Bundesbank, risks undermining the functional independence of the German
central bank, denying it the capacity to manage independently its legal and professional
relations with its own employees.
The ECB will finalise its response to these two laws in the coming days.
The governance of the European economy is another aspect which has not been modified by
the Treaty of Lisbon. Despite the ongoing debate and calls from several quarters to the
contrary, economic policy remains substantially a national competence. However, it is true
that the Treaty has introduced some changes to the economic governance of the euro area.
Firstly, the roles played by the European Commission and the euro area countries have been
strengthened in two ways. It provides for the capacity of euro area countries to adopt laws
which reinforce the coordination and monitoring of budgetary discipline and which lay down
specific economic policy guidelines. Furthermore, it falls to the euro area countries to adopt
the Recommendation for another Member State to join the euro (until now this power was
exercised by the European Council meeting comprising all of the Member States, rather than
just the euro area countries). Moreover, the recognition of the Eurogroup as an informal
group, and the extension of the mandate of its President to two and a half years both
strengthen the governance of the euro.
However, the political will has not developed to achieve a high level of harmonisation or
coordination of the economic policies, even if a few improvements have been made to the
procedures for increased cooperation. In short, despite the occasional calls by some
governments for the creation of a real and genuine "European governance" of the economy,
economic policy (with the exception of monetary policy) has remained the preserve of
national governments or, at the most, a task that is performed by the Member States
concurrently.
The Treaty of Lisbon recognises the principle of subsidiarity as a founding principle of the
European Union, even though it does so as a counterweight to the principle of superiority of
European law over national legislation. In essence, the principle of subsidiarity leads to a
situation whereby legislative and regulatory autonomy are deemed "normal". A high degree
of coordination or complete harmonisation is only allowed if this leads to better results. The
burden of proof weighs heavily on the side of harmonisation and centralisation.
2. Financial regulation and supervision
The European system of supervision and regulation is characterised by a combination of
regulatory harmonisation and autonomy - and to some degree also of competition. No single
Community body bears overall responsibility. The legal instruments typically used in this
regard take the form of Directives rather than Regulations. This gives the national authorities
considerable room for manoeuvre when transposing the Directives into national law.
The system of cooperation and coordination among the national authorities is based on a
four-level approach known as the "Lamfalussy process". To summarise, this consists of:
1. a few framework principles laid down in Community legislation (Level 1);
2. a series of technical implementing measures defined by the European Commission
(Level 2);
3. a system of committees through which cooperation takes place among the national
authorities for implementation of the legislation and convergence of supervisory
practices (Level 3);
4. under Level 4, the European Commission is given the task of monitoring the
application of European Law, with the help of the national authorities and the private
sector.
Although this system has borne some fruit over recent years, the question remains whether
financial market developments necessitate substantial improvements in the quality of the
European regulatory set-up. There are at least four arguments that support this hypothesis.
First, there is no doubt that the banking and financial systems of the various countries
continue to be diverse. However, the recent market turmoil has highlighted the vulnerability
of various national systems to shocks originating elsewhere, underlining how, today, banking
and financial activity knows no boundaries.
Second, until a few years ago, cross-border financial activity was somewhat limited, above all
as far as retail banking services were concerned. The distortionary effects of the various
national regulations did not seem to be overly pronounced. Recently, the process of financial
integration within Europe, and in particular within the euro area, has accelerated significantly.
We have seen a large number of cross-border mergers and acquisitions and today in Europe
there is a group of large banks that operate in various countries of the EU.4 Moreover, the
recent market turmoil has shown that, in an integrated monetary system such as the euro,
the monetary market can constitute a conduit for the transmission of financial shocks
originating elsewhere. There is no longer any need for a cross-border structure for a country
to be infected by an external shock.5
Third, although it is not in principle an optimal model of financial regulation, the recent market
turbulence has revealed structural weaknesses in some supervisory systems. In particular, it
has shown the need to ensure that the central banks, which are responsible for supplying the
markets with liquidity, especially in emergency situations, have all the necessary information
at their disposal in order to assess the capital adequacy and sound balance sheets of their
counterparties. The ECB had drawn attention to this in the past.6
Finally, the supervisory authorities appear less protected than the central banks from
external pressures, which aim to reduce their decision-making autonomy. The concept of
independence, which has been developed for monetary policy, is however not easily
extendable, merely via regulations, to the supervisory authorities. This, however, also applies
to the problem of accountability.7 In a financial market in which there is room for a certain
degree of regulatory competition and in which the supervisory authorities have a mandate
and a predominantly national system of accountability, there may be incentives to utilise the
margins for manoeuvre that European legislation leaves for protectionist purposes. There
may also be disincentives for a proper exchange of information, necessary in order to
guarantee the stability of the market. The risk of harming the financial institutions of one's
own country and of exposing them to possible acquisitions may discourage a timely
transmission of the information to other authorities, especially in periods of financial turmoil.
In brief, the developments under way in the financial markets are causing two types of
problem to emerge. First, the continual integration of markets increases the inefficiencies
resulting from a variety of laws, or applied in different ways in different countries. Second, the
possibility of applying the laws in various ways reduces the incentives for proper coordination
between national supervisory authorities in respect of the prevention and resolution of crises.
The approach taken up to now to tackle these problems has been to strengthen the current
institutional system (the Lamfalussy system). But much remains to be done. The ECB has
recently published its proposals for improving the system, notably:
i) strengthening the role of the Committee of European Banking Supervisors (CEBS, a
level 3 committee that brings together the banking supervisory authorities) in order
to improve convergence and cooperation in supervisory activities. In particular, it is
deemed necessary to reinforce the legal basis of the CEBS (that at present is a
network of national authorities) and both its accountability and that of its members,
in relation to cooperation and convergence in supervisory practices.
ii) a greater convergence of the laws, by means of a clearer distinction between level 1
principles and the implementing measures by the Commission at level 2 (to which
more attention should have been paid in the "Capital Requirements Directive") and
the elimination of those laws in the said directive that leave options and
discretionary assessments to the national authorities.8
In my opinion, the reasons for justifying differences in legislation, and differences in the
applications of European laws, are getting weaker by the day. Rapid progress is needed
towards a single regulatory approach, applied in the same way throughout the single
European market. This is what the market wants, what the banking and financial institutions
want and what their customers want. This is also necessary in order to remove the
disincentives to closer cooperation between the national supervisory authorities.
3. Two examples
I would like to illustrate two examples of fields where it is necessary to progress quickly, also
in the light of the recent financial turbulence: deposit insurance and management of liquidity
risk.
Banks are typically among the financial intermediaries which, on the one hand, have liquid
liabilities and, on the other hand, illiquid assets. Transformation of liquidity is part of their
raison d'être. However, it is also the basis of their vulnerability. Doubts felt by creditors,
particularly by depositors, about the quality of the bank's assets (whether justified or not),
can lead to a hasty withdrawal of the liquid liabilities of the bank and therefore to its
insolvency (bank run). In order to prevent this scenario, the authorities have provided for
liquidity requirements (ex ante) and deposit insurance schemes (ex post). The latter also
have, if not above all, a consumer protection function.
In Europe deposit insurance schemes are still very diverse. The relevant Directive only calls
for minimal harmonisation.9 Such diversity can complicate the resolution of crises. It has to
be noted, however, that there are no harmonised procedures to follow in the case of a
banking crisis. In some countries the general law is applied to insolvency and there are no
specific procedures for the failure of a banking enterprise as such; while in others countries
(such as ours) there are appropriate procedures. The European Commission is studying a
review of the Directive on the reorganisation and winding up of credit institutions.10
It is interesting to note how the funding difficulties of the British bank Northern Rock have
forced the UK Treasury, the Bank of England and the Financial Services Authority to review
some fundamental aspects of the regulatory framework for managing banking crises. As
Mervyn King, Governor of the Bank of England, has also observed, the Northern Rock crisis
has highlighted the need to reform the system of banking supervision in order to include (i) a
special insolvency regime for banks, (ii) a credible deposit insurance scheme with sufficient
cover able to refund depositors quickly. These remarks may be useful for reflection at
community level.
Another example of the impact of the legislative divergence on financial stability concerns
legislation on liquidity risks, which is not harmonised at European level and is applied
nonuniformly to cross-border bank groups internally, at the very time when banking activity, in
terms of stability and profitability, depends increasingly on the flow of liquid financial
instruments between the various countries. The legislative discrepancy prevents an efficient
cross-border use of collateral. This applies in particular to securitised credits and bank loans
in general, which are not covered by the specific Directive.11 Even though problems of this
kind have not yet emerged, these conflicts could hinder the good functioning of the money
markets and interventions by the central banks to restore appropriate liquidity conditions.
Faster progress is needed towards a single law at European level, at least as far as deposits
insurance and liquidity management are concerned.
Conclusions
In conclusion, the European institutional framework continues to be based on a fundamental
asymmetry, with a single monetary policy and decentralised systems of supervision and
financial regulation, subject to coordination that has increased over time but must be
strengthened. If full advantage is to be taken of the economies of scale of the Single Market,
also in the banking and financial sector, of which it forms the backbone, it is necessary to
reinforce the common bases of European legislation, in order to ensure at the same time the
development and stability of the market.
The progress achieved so far in this field is undeniable. But it is also undeniable that this
progress is still insufficient to meet the demands for stability and efficiency in Europe's
financial market. Experience shows that in times of relative stability it is very difficult to put
into effect regulatory reforms of supervisory systems. Institutional changes often take place
after turbulence and financial crises. However, experience also shows that hasty changes
made under the pressure of an emergency are not always the best.
In my opinion, it is possible and necessary to work inside the current system to adopt, in
reasonable times, a common rulebook at European level which constitutes a clear point of
reference for financial institutions when performing cross-border services and which is
applied uniformly by the national authorities. If sufficient progress were not to be made within
the current system, the trends under way in the markets could determine a situation in which
the only alternative, in order to safeguard the integration and stability of the market, would be
a radical review of the European institutional framework in favour of a greater concentration
of powers.
It is in the interest of those who prefer a decentralised - but coordinated - approach to
supervision that rapid progress is made towards the harmonisation of European legislation
on financial affairs.