Financial development refers to the process of financial innovation and organisational improvements that reduces asymmetric information, increases the completeness of the markets, and reduces transaction costs. When these conditions are satisfied, finance can promote economic growth and serve best the society at large. Indeed, a well developed financial system serves the primary functions of screening and monitoring investment projects, allowing the diversification of risks, facilitating the process of price discovery, and providing the service of liquidity transformation by matching short-term savers with long-term borrowers. Overall, finance helps lifting financial constraints for firms, allowing the realisation of projects with positive net present value, which would have otherwise not been implemented. There are however some forms of financial innovation which may generate perverse incentives, reduce transparency, and overall weaken the stability of the financial system. Let me take securitisation as an example. When correctly implemented, securitisation allows risk to be transferred from the originators of the loans to financial investors willing to hold that risk. This in turn generates a more efficient allocation of risks. The recent financial crisis has, however, highlighted severe weaknesses of such a scheme, related to misaligned incentives, lack of transparency and poor risk management. This form of intermediation has introduced several layers of management between the investor and the investment. Managers had the incentive to place in the market as many instruments as possible, as their compensations were mainly coming from collection of fees.

Still, even when from an individual perspective agents seem to follow a sound behaviour, macro-financial factors, particularly related to the interconnectedness of financial markets and institutions, the interaction between finance and the macro-economy can contribute to the build-up and propagation of aggregate macro-systemic risks. These effects have been at the heart of the recent financial crisis and it has specifically highlighted the need for a macroprudential approach to regulation and supervision, focusing on the financial system as a whole, complementing the existing micro-prudential framework. Macro-prudential policies aim to contain the build up of imbalances and ensure that the financial system is better able to withstand shocks. They will focus on regulatory and supervisory actions aimed at curbing the macro risks of financial market activity. In this regard, it Is, of course, of utmost importance to have a close co-operation and exchange of information between the institutions in charge of macro- and micro-prudential supervision. In the EU, the Ecofin Council has agreed to establish a new independent body responsible for macro-prudential supervision, the European Systemic Risk Board (ESRB). The main task of the ESRB – in which the European System of Central Banks, the Supervisory Agencies of the 27 Member Countries as well as the newly created European authorities will play a key role – is to identify and assess risks to the stability of the EU financial system and issue risk warnings if systemic risks appear to be significant. If deemed appropriate, the ESRB can make explicit policy recommendation.