See also Anjan V. Thakor, “Bank Capital and Financial Stability: An Economic Trade-off or a Faustian Bargain?,” Annual Review of Financial Economics, 2014, 6:185–223 for a review of theoretical and empirical findings. 4 In the early 1980s, for example, there is some evidence that a shorter exam cycle contributed to an increase in  the number of bank failures in FDIC, History of the Eighties – Lessons for the Future, 1997. See Bank for International Settlement, 2010 on costs and benefits of higher capital requirements. 5 Kevin J. Stiroh, A Perspective on Supervisory Objectives, and Trade-offs, February 23, 2017. 6 For example, Thakor, 2014, reports that higher capital levels are associated with higher lending, higher liquidity  creation, higher bank values, and higher probabilities of surviving crises and Beverly Hirtle, Anna Kovner, and Matthew Plosser, The Impact of Supervision on Bank Performance, Federal Reserve Bank of New York, Staff Report No. 768, September 2018, find that increased supervisory attention results in lower risk without significantly reduced performance. 7 There may be certain states of the world where the frontier is not upward-sloping, e.g., in a downturn or crisis  period, restricting intermediation might increase financial stability risk. 8 Board of Governors of the Federal Reserve System, Supervision and Regulation Report, November 2018; Vice  Chair Randall Quarles, Semiannual Supervision and Regulation Testimony, April 17, 2018; and Vice Chair Randall Quarles, Supervision and Regulation Report, November 14, 2018.

The existence of fiscal rules at the EU level, codified in the Stability and Growth Pact and in the  4  BIS central bankers’ speeches  Treaty Excessive Deficit Procedure, was motivated by the need to ensure fiscal discipline, preserve fiscal space and hence allow automatic stabilisers to play out in full during downturns. More fundamentally, the fiscal rules were supposed to prevent countries from pursuing irresponsible fiscal policies with negative externalities on the rest of the monetary union. However, the previously existing framework did not have sufficient “teeth” and its implementation by Member States within the Eurogroup remain insufficiently strict. As a result, EU fiscal rules did not constrain budgetary policies sufficiently.5 At the beginning of the crisis, it became painfully evident that the euro area was also lacking effective crisis management tools. First, the design of the euro area assumed that stabilisation would take place at the national level and to a large extent automatically. The crisis has shown us, however, that shock absorbers at the national level are insufficient in case of a major financial and economic crisis. Indeed, the scale of the shock after the 2008 financial crisis was unprecedented in a number of countries and it far exceeded their national shock absorption capacity. The euro area had no mechanisms to provide financial support for countries in difficulty, ensure efficient risk sharing and prevent cross-border contagion; notably, there were no area-level institutions to prevent fiscal sustainability from being jeopardised by severe problems in their domestic banking systems.