These two findings militate in favour of a more comprehensive policy framework for governing financial stability in Europe, which should comprise in my view the following. First, the full implementation of the economic governance reform, which is presently under discussion. It is unquestionable that a sound and credible framework of economic governance is fundamental for financial stability, as, for example, public debt developments have demonstrated. Second, a strengthening of financial supervision in the euro area. This should be understood as an essential component for the overall effectiveness economic governance alongside the strengthening of the fiscal pillar, the surveillance of macro-economic imbalances, co-ordination of economic policies, and the European Stability Mechanism. I will organise my remarks today as follows. I will begin by examining how the crisis unveiled the shortcomings of economic governance in what regards in particular the channels through which financial instability can propagate in the euro area. I will then propose what should be, in my view, the five key components of financial stability governance, highlighting in particular the necessary euro area dimension of such governance. Economic governance and financial stability The crisis provided some important lessons for economic governance in the euro area – lessons that were not fully understood at the inception of EMU. BIS central bankers’ speeches  1  The first lesson refers to the sources of financial instability in the euro area. Euro area economic governance had been constructed primarily to prevent negative spillovers via the public finance unbalances and we learned that this was not enough.

As a response, the economic governance in the euro area is being reformed. The Stability and Growth Pact is being strengthened to focus more on fiscal sustainability and reducing government debt levels, with a clearly defined debt reduction rule and sanctions. A surveillance procedure for macroeconomic imbalances is being instituted which will include a new “Excessive Imbalances Procedure” and a special focus on the euro area. This is complemented by the European Semester and Euro Plus Pact, which aim to improve ex ante policy co-ordination. If crises are still relevant, a permanent mechanism, the ESM, is being put in place to provide bridge funding while countries with liquidity challenges implement a deep adjustment programme, correct imbalances and regain market access. These measures represent an important step forward towards providing a more comprehensive economic governance framework in the EU and the euro area. But there is also a second lesson revealed by the crisis, which I would like to highlight. It falls outside what I might call the “conventional” economic governance debate and refers to the channels through which financial instability can spread in the euro area. Monetary union was associated with a structural increase in financial integration in the euro area. The resulting interconnectedness, coupled with the balance sheet structure of the financial sector, constitutes a powerful mechanism to propagate economic shocks between sovereigns and the financial sector. Negative feedback loops are the key transmission mechanism.