ceps forum : reconstructing the union emu governance : a reality check address by dr mario vella governor of the central bank of malta brussels, 23 february 2017 the five presidents ’ report on completing europe ’ s economic and monetary union argues that economic and political convergence underpinning emu needs to go deeper if it is to ensure prosperity for all its members and fairer outcome for its citizens. in the first phase, which was meant to be completed in june, the report envisages a number of steps including : − a new boost to convergence, employment and growth, through the creation of a euro area system of competitiveness authorities and stronger implementation of the macroeconomic imbalance procedure ; − the completion of the banking union and the launch of the capital markets union ; − the establishment of a new advisory european fiscal board ; − a reorganisation of the european semester, with greater parliamentary control and accountability. the commission should soon be publishing a related white paper on the future of europe. before moving forward, let ’ s see what ’ s been achieved so far. in the twenty - five years since the maastricht treaty was signed, the euro has been established a successful currency. it is widely accepted as a medium of exchange and store of value, not only within the euro area itself, but also beyond it. it enjoys popular acceptance and support. although the process of financial integration in the euro area was heavily disrupted in the aftermath of the global financial crisis in 2008 and the sovereign debt crisis in the euro area in 2011, the single currency area has held together. these gains should not be lightly discarded. but the double shock of the financial crisis and the subsequent fiscal crisis has hit emu hard. the euro area economy is currently in a moderate, gradual recovery that has been under way since the second quarter of 2013. however, in some member states that were hit the hardest by the sovereign debt crisis, output remains considerably below the levels registered in 2008. unemployment rates diverge considerably across the euro area, ranging from over 20 % in greece to below 4 % in germany. the euro area is facing pressure along four different fault lines. first, there is the tension between euro area member states that are in different cyclical and, in some cases, secular positions and yet face the same nominal interest rate and exchange rate. second, there is the related tension between monetary policy that is determined at the level of the euro area as a whole and fiscal policy which has remained, in effect,

of products and credit ratings were inflated, conveying a false sense of security. a euphoric bubble thus developed, based, in alan greenspan ’ s words, on “ the complexity of the interactions of asset markets and the economy ”, and which concealed a massive global under - pricing of risk. market participants seem to have been aware of the growing risks but were unwilling to retrench. you might recall citibank ’ s chuck prince ’ s memorable words during the onset of the crisis that “ as long as the music is playing, you ’ ve got to get up and dance. we ’ re still dancing ”. market players failed to appreciate the speed at which demand could evaporate and risk aversion could increase. this soon resulted in record - high risk premia, seized - up interbank markets, acute liquidity and credit shortages, bank failures and a widespread loss of confidence. meanwhile the high degree of financial market integration had created the premise for a simultaneous build - up of systemic risk. financial institutions did not internalise the costs arising from the too - big - to - fail and too - interconnected syndrome. central banks had been monitoring these trends, but it turned out that the regulatory tools were not designed to address systemic risk. neither was the strength of the feedback loop between the financial system and the economy fully anticipated. unfortunately, these all proved to be critical weaknesses. in response to the unfolding crisis, governments and central banks adopted aggressive measures, including fiscal stimulus packages, bank recapitalisations and the provision of government guarantees, and injections of huge amounts of liquidity. it was also important to critically review the legislative and regulatory framework in order to pre - empt the recurrence of, or at least better manage, similar situations. the de larosiere report, mandated by the european commission ( ec ) and published in february 2009, set the scenario for reforms at a european level. similar work was undertaken at the global level by the financial stability board ( fsb ) and by the basel committee on banking supervision ( bcbs ). this work has clearly showed that the basel ii capital requirements did not ensure an adequate buffer to sustain an institution on a going concern basis. confidence in regulatory capital waned and the market started to assess bank robustness using other tools. liquidity measurement, for example, had been largely excluded from basel ii. some internal risk models were based on short - term statistical horizons that failed to capture periods of