vitor constancio : the establishment of the european systemic risk board – challenges and opportunities introductory remarks by mr vitor constancio, vice - president of the european central bank, at the eurofi financial forum plenary session 14 on “ implementing the de larosiere agenda ”, brussels, 29 september 2010. * * * the european systemic risk board ( esrb ) will be established in january 2011 as the body responsible for the macro - prudential oversight of the eu financial system. it is mandated to actively monitor the various sources of risk to financial stability in the eu – across member states and financial sectors – with due consideration of also global developments. it should identify the risks and assess how they could impact the financial system so as to prioritise them. in this context, systemic risk is defined in legislation on the esrb as “ a risk of disruption in the financial system with the potential to have negative consequences for the internal market and the real economy. ” the esrb should issue warnings on significant systemic risks and issue recommendations for policy action to address such risks. the creation of the esrb is a response to one of the key lessons of the financial crisis regarding the need for an enhanced macro - prudential oversight of the financial system as a new policy function. the value added of a macro - prudential function to safeguard financial stability is its focus on detecting, assessing and addressing vulnerabilities that arise from the interconnections between financial institutions and markets, as well as from macroeconomic and structural developments, including financial innovation. it will thus take a system - wide perspective, which will complement micro - prudential supervision, whose purpose is to assess the soundness of individual financial institutions. the design of a framework for the conduct of macro - prudential oversight as new policy function involves significant challenges, but also represents a unique opportunity for reinforcing the arrangements to safeguard financial stability. in particular, the following three main components should underpin a macro - prudential framework : first, the necessary conditions for an enhanced monitoring of the financial system as a whole, in order to identify potential threats to financial stability ; second, the instruments for translating financial stability assessments into concrete policy action aimed at enhancing the resilience of the financial system ; and third, appropriate governance structures, including mechanisms for ensuring an effective interplay between, and coordination of, macro and micro - prudential responsibilities. as regards the first, one of the basic prerequisite

were most likely to fail. the wave of losses, consumer foreclosures and business failures infected every element of the economy. the deleveraging process commenced as highly - leveraged financial institutions, working with highly - leveraged consumers and business, had insufficient capital to withstand the financial blows. increasing numbers of homeowners were unable to keep up with their mortgage payments, leading to higher defaults. mortgage defaults, in turn, sharply lowered the values of mortgage securities held by financial institutions. these losses led banks to attempt to reduce their leverage, which required rebuilding tangible capital and reducing total assets – thus reducing loans. this placed downward pressure on asset values, losses worsened and the vicious cycle of deleveraging worsened. homes and businesses were lost to foreclosure and liquidation, while unemployment climbed. the large increases in leverage over the past decade have wrecked havoc on our economy and are responsible for the sluggishness of our recovery. strong economic growth simply cannot occur if consumers and businesses must focus on rebuilding balance sheets instead of on increasing spending, production and hiring of new workers. once again we have learned that the double edged sword of leverage is a pro - cyclical weapon. constraining leverage today, the largest financial firms are showing a solid recovery. regional and community banks continue to show stress but problems may have peaked as they have worked to reestablish stable capital and leverage levels. the market appears to be correcting and leverage based on high quality capital is returning to more historic norms. in time credit will once again expand and the economy will improve. but it won ’ t be quick or easy. therefore, we must now turn to actions that will prevent the impulses of consumers, businesses, and financial institutions from assuming ever more leverage as the expansion becomes a boom. if we take action now, then when the next economic correction occurs there will be less devastation to our economy. if we don ’ t change policy now, then this crisis will be remembered only in text books and leverage will rise again and lead to another crisis. i strongly support establishing hard leverage rules that are simple, understandable and enforceable and that apply equally to all banks and bank holding companies that operate in the united states. as we saw in the years leading up to the current crisis, leverage tends to rise during economic expansions as investors and lenders forget their past mistakes and believe that prosperity will continue with no end in sight. straightforward leverage and underwriting rules are not procycl