manoeuvre is in fact very constrained by the two dimensions of the negative feedback loop problem. the central dilemma is that for microprudential regulators more capital is a good thing – but that from a macroprudential perspective there is a concern about how fast to get that and at what cost. perhaps the safest course of action, then, is for a breathing space in terms of further initiatives on the capital front. the eba ’ s decision to postpone its next stress test exercise into 2013 is therefore a sensible development. there is also an argument for breathing space to let the political decisions on the sovereign debt crisis be fully implemented, both with respect to fiscal discipline and to building a firewall with adequate resources and sufficient operational flexibility. indeed, if this does happen, and has a sustained positive impact, it could eventually give scope to the eba to revisit the necessity for the full scale of the current capital buffer. i would like to see that we use this breathing space wisely to consider the future design of stress tests and the operational flexibility of firewall structures. it seems that the role of the stress test as a diagnostic tool needs to be reasserted. recent eu stress tests have evolved into what might be described as a “ capital shortfall ” calculation : setting a single scenario and a specially created threshold to effectively prescribe additional capital even where not required by eu law or basel rules. interestingly, the us stress tests are now focused on dividend and share repurchase approval rather than closing a capital gap in a prescribed timeline. the eu stress test approach therefore is in addition to – and potentially cuts across – the new basel 3 minimum capital requirements which are coming in anyway. also, i fear that trying to satisfy insatiable market expectations of conservatism in a stress test risks being very procyclical. stress tests were originally conceived as diagnostic tools, considering a range of scenarios and providing the basis for management and supervisory judgement, rather than as an automatic capital formula. given that the introduction of basel 3 already requires increased capital and in light of the changing balance of risks of procyclical regulatory action, it would be sensible to recalibrate the european approach to stress testing in the next period. what about the second negative feedback problem that i mentioned, which might be described as “ backstop burdens ”. the problem here is if countries with sovereign debt concerns need to borrow more to recapitalise their banks, which

matthew elderfield : european banking regulation and the eurozone crisis address by mr matthew elderfield, deputy governor of the central bank of ireland and alternate chairman of the european banking authority, to the 4th cdu / csu congress in the bundestag, berlin, 26 march 2012. * * * these remarks are the authors personal views and do not necessarily reflect those of the eba or of the esrb, of which mr elderfield is a member of the general council. thank you for the invitation to join you today to discuss european banking regulation. in my brief time for opening remarks i would like to do three things : explain the actions the european banking authority ( eba ) has taken to address the eurozone financial crisis ; discuss the limits of regulatory action due to the feedback loop characteristics of the crisis and suggest two or three areas to explore to improve the current policy response to the crisis. the formation of the eba at the start of 2011 was a very significant milestone in the development of european regulation and the single market in banking. the eba is different from its predecessors in three important ways. first, its actions as policy - maker will mean that a single european rule book will become a reality and be directly binding on all eu banks. second, its remit for supervisory convergence and direct operational responsibilities – such as its role in colleges of supervisors – will make it increasingly influential in how supervision works on the ground in national authorities. and third, its responsibilities for crisis management mean that it will be at the forefront of the most important regulatory challenges of the day. this has, of course, been the case with the current eurozone financial crisis, first through a series of stress tests and, more recently, with its recommendation to create a temporary capital buffer to strengthen the european banking system. it is important to remember that the eba ’ s actions on capital were taken in response to not only market concerns but also calls for strengthening of capital from leading international and european policy makers. last autumn both the new managing director of the imf and the european systemic risk board, comprising the eu ’ s central banks and regulators, made strong calls for increased capital levels at europe ’ s banks. eba ’ s chairman, andrea enria, showed strong leadership to respond to those concerns by crafting a new initiative on capital which was adopted by the eba ’ s members. constructing correctly calibrated regulatory measures involving bank capital is extremely challenging in the current financial crisis. this is principally because of