26 April 2012

Mario Draghi: Speech at the ECB-EC conference, “Financial integration and stability - towards a more resilient single financial market"

In his welcoming remarks, Draghi said that future financial developments will constantly put the institutional framework to the test; the current reform efforts are therefore part of the journey, and not the end of the road.

The Eurosystem has a keen interest in financial integration and in the efficient functioning of the financial system. Financial integration helps to maintain balanced monetary and financial conditions and thereby fosters a smooth transmission of monetary policy throughout the euro area.

Financial integration also plays an important role for financial stability, as financial integration and financial stability can be mutually reinforcing. As evidenced by the years prior to the financial crisis, the stability of the financial system contributes to financial integration. At the same time, a more integrated financial sector typically improves the resilience of the financial system through more competition, better diversification and risk-sharing, as well as through more liquid markets.

Despite differences in speed in different sectors, it was widely assumed that financial integration was a continuous process, that financial integration was a one-way street once all legal barriers were removed. However, the financial crisis has demonstrated that financial integration cannot be taken for granted: the process of financial integration was brought to a halt and even reversed in some market segments.

I see two main reasons for this development. First, some market developments before the crisis were not really signs of increasing integration. What I am referring to is the complete compression of cross-country yield differentials before 2007. While the compression had been interpreted as an indicator of financial integration, it was, in fact, a sign of a systematic underpricing of credit risk.

And second, the pre-crisis institutional set-up had shortcomings and proved unable to support the single market in times of crisis. Regulation, supervision and crisis management had been organised along national lines, with some elements of cross-border cooperation. This approach was incapable of adequately preventing the build-up of risks. Moreover, when the risks finally materialised, the fragmented crisis management arrangements led to policy responses that were rational from a national perspective, but suboptimal from a European point of view. The fragmented arrangements also induced banks to withdraw behind national borders.

Regarding the financial sector, financial supervision underwent a comprehensive reform: three European Supervisory Authorities were established, and the European Systemic Risk Board now adds an EU-wide macro-prudential perspective that was missing before the crisis.

The ongoing reform efforts are important steps towards closer integration. Looking forward, it will be crucial that the current initiatives are completed. Undoubtedly, these reforms are significant and would even have been unlikely without the crisis. However, it is also indisputable that financial integration is a process. Future financial developments will constantly put the institutional framework to the test. The current reform efforts are therefore part of the journey, and not the end of the road.

Press release

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