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Domestic reforms are important, but we also have work to do at the level of the euro area and the European Union. Much has already been done by way of strengthening fiscal and macro-economic governance of the euro area. In EU jargon we talk about the “six-pack” and the “two-pack”, of which the former entered into force already in December 2011, and on the latter a final agreement was reached just last week (“trilogue agreement” on 20 February). These packages of legislation included the reform of both the preventive and corrective arms of the Stability and Growth Pact (SGP), the new minimum requirements for national budgetary frameworks, the new Macroeconomic Imbalance Procedure (MIP), and a stronger enforcement mechanism through new financial sanctions, under both the SGP and the MIP. The two additional regulations that are just about to be adopted will further strengthen surveillance of euro area countries.
Rather than talk about what has already been achieved, I would like to sketch out the further improvements that are in the pipeline, in particular in the area of financial regulation and supervision.
One of the structural flaws that exacerbated the crisis was that supervisory policies often failed to prevent excessive risk-taking in the financial sector. Supervisory decisions at the national level did not always take their potential effect across national borders into account. More fundamentally, supervisory decisions were “micro-economic” in nature, concentrating on the financial health of individual institutions rather than on systemic impact at the “macro-economic” level.
The recognition of these fault lines led to the creation of two institutional bodies that are or will be closely associated with the European Central Bank in Frankfurt: the European Systemic Risk Board (ESRB), and the Single Supervisory Mechanism (SSM). The ESRB addresses shortcomings in the macro-prudential policies, while the SSM will ensure a uniform and consistent supervision of all banks in the euro area.
Better supervision will benefit the conduct of monetary policy, because a stable financial system is a prerequisite for the proper transmission of monetary policy signals across the euro area. Effective bank supervision is conducive to a stable macroeconomic environment with a stable price level. And strong supervision will minimise moral hazard concerns when it comes to crisis intervention.
The SSM is an important first step towards a genuine banking union. But more must follow. Another indispensable element is a Single Resolution Mechanism (SRM) that will be able to ensure swift and orderly resolution – and, if need be, the closure – of non-viable banks with minimum recourse to taxpayers’ money. In addition to the SRM it would be highly desirable to establish a deposit insurance framework built on common EU standards.