Курсовая: European Monetary System

Курсовая: European Monetary System

was disconnected from the quantity of gold. Thus, a double revolution in the

technology of the payment system, the advent of banknotes and that of cheques

or giros, has shaped the functions that most central banks performed over

this century: monetary policy and prudential supervision. Man-made money made

monetary policy possible. The fact that a large, now a predominant, component

of the money stock was in the form of commercial bank money made banking

supervision necessary.

Ensuring confidence in the paper currency and, later, in the stability of the

relationship, one could say the exchange rate, between central bank and

commercial bank money, were twin public functions, and, in general, they were

entrusted to the same institution. Just as money has three well-known

economic functions - means of payment, unit of account and store of value -

so there are three public functions related to each of them. Operating and

supervising the payment system refers to money as a means of payment;

ensuring price stability relates to money as a unit of account and a store of

value; and pursuing the stability of banks relates to money as a means of

payment and a store of value. In each of the three functions commercial banks

have played, and still largely play, a crucial role.

In an increasing number of countries the original triadic task entrusted to

the central bank has now been abandoned in favour of a "separation approach",

according to which banking supervision has been assigned to a separate

institution. Following the recent adoption by the United Kingdom and

Luxembourg of the separation approach, only two of the 12 countries

represented in the Basle Committee on Banking Supervision (Italy and the

Netherlands) have the central bank as the only authority responsible for

banking supervision. In all systems, however, whether or not it has the task

of supervising the banks, the central bank is deeply involved with the

banking system precisely because the banks are primary creators of money,

providers of payment services, managers of the stock of savings and

counterparties of central bank operations. No central bank can ignore the

need to have a concrete and direct knowledge of "its" banking system, i.e.

the banking system that operates in the area of its monetary jurisdiction.

Personally, I have an intellectual attachment to, as well as a professional

inclination for, the central bank approach to banking supervision, due partly

to the fact that I spent most of my professional life in a central bank which

is also to this day the banking supervisor. Yet I can see, I think, the

arguments that have led a growing number of industrialised countries to

prefer the separation approach. Such arguments basically point to the

potential conflict between controlling money creation for the purpose of

price stability and for the purpose of bank stability. On the whole, I do not

think that one model is right and the other wrong. Both can function, and do

function, effectively; if inappropriately managed, both may fail to satisfy

the public interest for which banks are supervised.

5. Against this background, let me now describe the institutional framework

currently adopted by the Treaty. As my description will refer to the area in

which both the single market and the single currency are established, it will

not specially focus on the problems of the so-called "pre-in" countries,

including the United Kingdom.

The current institutional framework of EMU (i.e. the single market plus the

single currency) is a construct composed of two building blocks: national

competence and co-operation. Let me first briefly review the main aspects of

these two building blocks and then see how the Eurosystem relates to them.

First, national competence. In a market based on the minimum harmonisation

and the mutual recognition of national regulatory standards and practices,

the principle of "home country control" applies. According to this principle

every bank has the right to do business in the whole area using a single

licence, under the supervision, and following the rules, of the authority

that has issued the licence. The full supervisory responsibility thus belongs

to the "home country". This allows, inter alia, the certain identification of

the supervisor responsible for each institution acting as a counterparty to

the monetary policy operations of the Eurosystem. The only exception to this

principle - the "host country" competence for the supervision of liquidity of

foreign branches - is no longer justified now that the euro is in place;

hence it should soon be removed.

Second, co-operation. In a highly regulated industry such as banking, a

single market that retains a plurality of "local" (national) supervisors

requires close co-operation among supervisors to safeguard the public good:

namely, openness, competition, safety and soundness of the banking industry.

EU directives (the 1st and 2nd Banking Directives and the so-called BCCI

Directive) lay the foundations for such co-operation, but they do not contain

specific provisions or institutional arrangements to this end. They limit

themselves to stating the principle of co-operation among national

authorities and to removing obstacles to the exchange of information among

them.

6. How does the Eurosystem relate to this construction? Essentially in two

ways. First, the Treaty assigns to the Eurosystem the task to "contribute to

the smooth conduct of policies pursued by competent authorities relating to

the prudential supervision of credit institutions and the stability of the

financial system" (Article 105 (5)). Given the separation between monetary

and supervisory jurisdictions, this provision is clearly intended to ensure a

smooth interplay between the two. Second, the Treaty gives the Eurosystem a

twofold (consultative and advisory) role in the rule-making process.

According to Article 105 (4), the ECB must be consulted on any draft

Community and national legislation in the fields of banking supervision and

financial stability; and, according to Article 25 (1) of its Statute, the ECB

can provide, on its own initiative, advice on the scope and implementation of

the Community legislation in these fields. It should be borne in mind that

central banks are normally involved in the process of drawing up legislation

relating to, for example, regulatory standards, safety net arrangements and

supervision since this legislation contributes crucially to the attainment of

financial stability.

7. Two observations should be made about the institutional framework just

described. First, such an arrangement establishes a double separation between

central banking and banking supervision: not only a geographical, but also a

functional one. This is the case because for the euro area as a whole banking

supervision is now entrusted to institutions that have no independent

monetary policy functions. The separation approach that was chosen for EMU

has effectively been applied not only to the euro area as a whole, but to its

components as well. Indeed, even in countries where the competent authority

for banking supervision is the central bank, by definition this authority is,

functionally speaking, no longer a central bank, as it lacks the key central

banking task of autonomously controlling money creation.

The second observation is that the Treaty itself establishes (in Article 105

(6)) a simplified procedure that makes it possible, without amending the

Treaty, to entrust specific supervisory tasks to the ECB. If such a provision

were to be activated, both the geographical and the functional separation

would be abandoned at once. The fact that the Maastricht Treaty allows the

present institutional framework to be reconsidered without recourse to the

very heavy amendment procedure (remember that such procedure requires an

intergovernmental conference, ratification by national parliaments, sometimes

even a national referendum) is a highly significant indication that the

drafters of the Treaty clearly understood the anomaly of the double

separation and saw the potential difficulties arising from it. The simplified

procedure they established could be interpreted as a "last resort clause",

which might become necessary if the interaction between the Eurosystem and

national supervisory authorities turned out not to work effectively.

III. INDUSTRY SCENARIO

8. When evaluating the functioning of, and the challenges to, banking

supervision in the current institutional framework, two aspects should be

borne in mind. First, the advent of the euro increases the likelihood of the

propagation of financial stability problems across national borders. For this

reason a co-ordinated supervisory response is important at an early stage.

Second, the sources of banks' risks and stability problems depend on ongoing

trends that are not necessarily caused by the euro, but may be significantly

accelerated by it. On the whole, we are interested not so much in the effects

of EMU or the euro per se, as in the foreseeable developments due to all

factors influencing banking in the years to come.

9. It should be noted at the outset that most banking activity, particularly

in retail banking, remains confined to national markets. In many Member

States the number, and the market share, of banks that operate in a truly

nationwide fashion is rather small. Although banks' international operations

have increased, credit risks are still predominantly related to domestic

clients, and the repercussions of bank failures would be predominantly felt

by domestic borrowers and depositors.

10. Assessing the internationalisation of euro area banks is a complex task

because internationalisation can take a number of forms. One is via cross-

border branches and subsidiaries. Although large-scale entry into foreign

banking markets in Europe is still scarce, reflecting persisting legal,

cultural and conduct-of-business barriers (less than 10% on average in terms

of banking assets in the euro area; Table 1), there are significant

exceptions. The assets of the foreign branches and subsidiaries of German and

French banks account for roughly a third of the assets of their respective

domestic banking systems (Table 2). The Dutch banking system is also strongly

diversified internationally.

Another way to spread banking activity beyond national borders is

consolidation. Cross-border mergers or acquisitions still seem to be the

exception, although things have started to change. The recent wave of

"offensive" and "defensive" banking consolidation has mainly developed within

national industries, thus significantly increasing concentration,

particularly in the smaller countries (Table 3); it may be related not so

much to the direct impact of EMU as to globally intensified competition and

the need to increase efficiency.

In the coming years internationalisation is likely to increase, because, with

the euro, foreign entrants can now fund lending from their domestic retail

deposit base or from euro-denominated money and capital markets. The

relatively large number of foreign branches and subsidiaries already

established could be a sufficient base for an expansion of international

banking activity (Table 4) since a single branch, or a small number of

branches, may be sufficient to attract customers, especially when they are

served through direct banking techniques, such as telephone and Internet

banking. Also, the cross-border supply of services on a remote basis is

likely to spread as direct banking techniques develop. As to cross-border

mergers and acquisitions aimed either at achieving a "critical mass" for

wholesale financial markets, or at rapidly acquiring local expertise and

customers in the retail sector, they may remain scarce because the cost

savings from eliminating overlaps in the retail network are likely to be

limited and the managerial costs of integrating different structures and

corporate cultures are substantial.

11. However, banks' internationalisation does not provide the full picture of

the interconnections of banking systems. As "multi-product" firms, banks

operate simultaneously in many markets which have different dimensions:

local, national, continental (or European) and global. The advent of the euro

is likely to enlarge the market for many banking products and services to the

continental dimension; this will "internationalise" even those banks that

remain "national" in their branch networks and organisation.

The formation of the single money market in the euro area has largely taken

place already. The dispersion in the euro overnight rate across countries, as

reported by 57 so-called EONIA banks, fell in January from around 15 to 5

basis points. The variation between banks has been significantly greater than

between countries. The TARGET system has rapidly reached the dimension of

Fedwire, with a daily average value of payments of E1,000 billion, of which

between E300 and E400 are cross-border. The ever stronger interbank and

payment system links clearly increase the possibility of financial

instability spreading from one country to another. Through these links the

failure of a major bank could affect the standing of its counterparties in

the entire euro area. On the other hand, the deeper money market could absorb

any specific problem more easily than before.

As regards the capital markets, the effects of the euro will take more time

to manifest themselves, but are likely to be substantial. The single currency

offers substantial opportunities for both debt and equity issuers and

investors. The increase in the number of market participants operating in the

same currency increases the liquidity of the capital markets and reduces the

cost of capital. The low level of inflation and nominal interest rates and

diminishing public sector deficits are additional supporting factors of

capital market activity, especially private bond market activity which has so

far been relatively limited (Table 5). Banks will thus operate in

increasingly integrated capital markets and will be exposed to shocks

originating beyond their national borders.

As to corporations, they may concentrate their operations (treasury, capital

market and payment management) in a single or few "euro banks", while the

disappearance of national currencies may break links between firms and their

home country "house bank". This dissociation would make the domestic economy

indirectly sensitive to foreign banks' soundness, thus creating another

propagation channel of banking problems across countries.

12. When considering the industry scenario for the coming years, the

viewpoint has to be broadened beyond the impact of the euro. Rather than the

exclusive, or even primary, force for change, the euro is expected to be a

catalyst for pre-existing trends driven by other forces. The recent ECB

report prepared by the Banking Supervision Committee on "Possible effects of

EMU on the EU banking systems in the medium to long term" gives a

comprehensive analysis of such trends, which can be summarised as follows.

First, regulation: the industry has yet to feel the full impact of such

fundamental, but relatively recent, regulatory changes as those related to

the single market legislation. Second, disintermediation: other financial

intermediaries and institutional investors will grow relative to banks,

pushed by demographic and social changes, as well as by the increasing depth

and liquidity of the emerging euro area-wide capital market.

Disintermediation is expected to take the form of increasing recourse to

capital market instruments relative to bank loans by firms, and diminishing

investment in deposits by households relative to mutual funds and related

products. Third, information technology: bank products, operations and

processes are changing rapidly, while technology offers increasing

possibilities for dissociating the supply of a large number of services from

branches and face-to-face contact with customers. The current tendency in the

EU banking systems to reduce over-branching and over-staffing will grow

stronger.

These factors will increase competition, exert pressure on profitability and

oblige banks to reconsider their strategies. Such effects are already visible

throughout the EU. They produce changes in organisation, new products and

services, mergers, strategic alliances, co-operation agreements, etc. They

also involve strategic risks, because the pressure for profitability and some

losses of revenue due to the euro, for example from foreign exchange, may

push some banks to seek more revenue from unfamiliar business or highly risky

geographical areas. Inadequate implementation of new technologies or failure

to reduce excess capacity may also affect banks' long-term viability. In the

short term, the structural adaptation process could be made more difficult by

the combination of factors like the protracted financial difficulties of Asia

and Russia, or the preparations for the year 2000.

IV. CURRENT SUPERVISION

13. Against the background of the institutional framework and the industry

scenario I have outlined, let me now turn to the functioning of banking

supervision in the euro area. Two preliminary observations. First, the

objective of financial stability pursued by banking supervisors is only one

in a range of public interests, which also includes competition policy and

depositor and investor protection policy. Second, current supervision and

crisis management involve different situations and procedures and will

therefore be examined in sequence.

14. Starting with current supervision, let me consider banking regulation

first. As observed earlier, the regulatory platform for the euro area banking

industry combines harmonised rules with country-specific (non-harmonised, but

mutually recognised and hence potentially competing) rules.

The harmonised part of the platform includes most of the key prudential

provisions that have been developed in national systems over the years. More

than 20 years ago (1977), the 1st Banking Co-ordination Directive adopted a

definition of a credit institution and prescribed objective criteria for the

granting of a banking licence. In 1983 the first Directive on carrying out

supervision on a consolidated basis was approved, and in 1986 the rules

relating to the preparation of the annual accounts and the consolidated

accounts of banks were harmonised. In 1989 the 2nd Banking Co-ordination

Directive (which became effective on 1 January 1993) marked the transition

from piecemeal to comprehensive legislation, introducing, inter alia, the

principle of "home country control". A number of other specific directives

have subsequently addressed the main aspects of the regulatory framework -

notably, own funds, solvency ratios and large exposures. A Directive imposing

deposit guarantee schemes supplemented the legislation in support of

financial stability. All in all, the European Union, including the euro area,

now has a rather comprehensive "banking law" consistent with the Basle

Committee's rules and with the 1997 Core Principles of Banking Supervision.

The country-specific, non-harmonised, part of the platform is also quite

relevant and very diversified. It includes, among other things, the different

organisational arrangements for the conduct of banking supervision (central

bank, separate agency or a mixed arrangement); the tools used by banking

supervisors (e.g. supervisory reporting, on-site inspections); provisions for

the liquidation and restructuring of banks; and the definition and legal

protection of financial instruments and contracts. Even the key notion of a

regulated market is harmonised only to a very limited extent.

15. Such "neutrality" and "incompleteness" on the part of the EU legislator

with respect to key aspects that are normally incorporated in the regulatory

framework is a unique feature of EU banking regulations and is likely to

trigger a deregulatory process, pushed by competition among the national

systems and the different financial centres in the euro area, and beyond that

in the EU. Against the background of the increasing competition and other

changes in the banking industry, one can expect that the regulatory platform

will evolve in the years to come. Additional EU legislation may prove

necessary to complete and strengthen the harmonised part. One important part

of common legislation, namely the draft Directive on liquidation and re-

organisation measures for credit institutions, has not yet been adopted and,

indeed, has been stalled for years. This Directive is needed to bring legal

certainty to the framework for banking crisis management. In this regard, it

would be useful for the Eurosystem, if necessary, to be able to exclude

counterparties from the single monetary policy on prudential grounds. Also,

the non-harmonised part of the platform will come under pressure to converge,

as I have just mentioned, through the process of "regulatory competition".

Like any other rapidly changing industry, the banking sector will require

careful attention by regulators. As indicated earlier, the ECB will have the

possibility of contributing to the rule-making process through its advisory

tasks under Article 105 (4) of the Treaty and Article 25.1 of the Statute of

the ESCB.

16. On the whole, and taking a euro area perspective, the legislative-cum-

regulatory platform of the banking industry, although rather unusual and very

diversified in comparison with those of most currency jurisdictions, does not

seem to present loopholes or inconsistencies that may hamper the pursuit of

systemic stability. Seen from the point of view of the regulatory burden, it

is a light system. It will become even more so if competition among national

banking systems and financial centres encourages national regulators to free

their banks from regulatory burdens that are not required by the EU

Directives. Conversely, seen from the point of view of its flexibility, i.e.

how quickly it can adapt to new situations, it is, on the contrary, a heavy

system. This is the case both because the EU legislative process is slow

(three years or even longer may be needed to pass Directives) and, perhaps

more importantly, because many provisions are embodied in the Community

primary legislation (i.e. Directives) rather than in Community secondary

legislation (amendable through simpler comitology procedures).

The establishment of EMU does not seem to determine a need for revising the

pillars of the current legal framework. What seems to be necessary, however,

is a more flexible legislative procedure which allows for a faster and more

effective revision of Community legislation, whenever needed in relation to

market developments.

17. Let me now turn to the execution of banking supervision. It should

immediately be recalled that supervision, contrary to regulation, is a

national task, exercised by what the jargon of the Directives calls the

"competent authority". Since the euro area has adopted a separation approach

between supervisory and central banking functions, it is natural to examine

first the functioning of the "euro area supervisor" (i.e. the co-operative

system of national supervisors) and then turn to the tasks and needs of the

"euro area central banker" (i.e. the Eurosystem).

18. The euro area supervisor can be regarded as a rather peculiar entity

composed of national agencies working in three modes: stand-alone, bilateral

and multilateral. Let us briefly examine each of them.

The stand-alone mode is the one in which the supervisor exclusively operates

in the national (or even local) context. Today it is by far the most

predominant mode. In most cases, this approach is sufficient to achieve the

objectives of banking supervision because most banks in Europe are operating

in a context that does not even reach the nationwide market of the country of

origin. Such a decentralised model is even more effective because it allows

the efficient use of information that may not be available far from the

market in which the bank operates. That is why it is actually applied even

within countries. In Italy, for example, over 600 of the 900 licensed credit

institutions at end-1998 were entirely supervised by the Banca d'Italia

branch of the town in which the bank is licensed.

The bilateral mode involves co-operation between two supervisory agencies. It

is used for cross-border supervision of the same type of financial

institutions, such as credit institutions, or the supervision of different

types of financial institutions operating in the same market, such as credit

institutions and securities firms. The instrument that has been devised to

organise bilateral co-operation between banking supervisors is the Memorandum

of Understanding (MoU). With the implementation of the 2nd Banking Co-

ordination Directive, the Member States began to negotiate extensively MoUs

in order to establish the necessary co-operation between "home" and "host

country" authorities to supervise efficiently institutions that have cross-

border activities or foreign country establishments.

By the end of 1997, 78 bilateral MoUs had been signed between the EEA banking

supervisory authorities. The key aims of MoUs are to establish a regular

exchange of information between national supervisory authorities. While the

"gateways" for the exchange of information have been laid down in Community

legislation, MoUs provide a practical framework for communication to be

carried out between supervisors. Moreover, MoUs define procedures and

reciprocal commitments between pairs of EU supervisors related to the various

parts of the supervisory process, such as establishment procedures and on-

site examinations.

Finally, the multilateral mode is the one in which a group of supervisors

works collectively as, say, a single consolidated supervisor. Such a mode is

required when the problems involved are area-wide. They may be area-wide for

a number of reasons with regard to the institutions, or groups, involved:

their dimension; their linkages with a number of different markets in various

countries; the role they play in the payment system or in other "systemic"

components of the market, etc. Multilateral co-operation can also enhance the

quality of supervision by examining common macroeconomic influences on the

banking system and common trends in the financial system that may not be

revealed from the national perspective only.

Today, the Banking Supervision Committee is the key forum for multilateral

co-operation. It is composed of representatives of the banking supervisory

authorities of the EU countries, either forming part of the respective NCB or

separate bodies. The Banking Supervision Committee's main functions are the

promotion of a smooth exchange of information between the Eurosystem and

national supervisory authorities and co-operation among EU supervisory

authorities. Another forum for dealing with the requirements of the

multilateral mode is the Groupe de Contact, a group of EU banking supervisory

authorities which, for many years, has discussed individual banking cases in

a multilateral way, but at a lower organisational level than the high-level

Banking Supervision Committee.

19. So far, the need to develop the multilateral mode has been relatively

limited, as the emergence of a single banking market in the European Union

has been slow and the euro was not yet in place. Thus, the fact that the

multilateral mode has not gone, for the moment, beyond periodic discussions

among supervisors and occasional industry-wide analyses should not be a cause

for concern.

I am convinced, however, that in the future the needs will change and the

multilateral mode will have to deepen substantially. Over time such a mode

will have to be structured to the point of providing the banking industry

with a true and effective collective euro area supervisor. It will have to be

enhanced to the full extent required for banking supervision in the euro area

to be as prompt and effective as it is within a single nation.

There are no legal impediments to that. The existing legislation, whether

Community or national, permits all the necessary steps to be made.

Information can be pooled; reporting requirements and examination practices

can be developed and standardised; common databases can be created; joint

teams can be formed; and analyses of developments across the whole banking

system can be conducted. The Community legislation providing for the

unconstrained exchange of confidential information between supervisors does

not distinguish between bilateral and multilateral co-operation, but the

common interpretation is that it covers both modes. It will be the task of

the Banking Supervision Committee, for its part, to develop the multilateral

mode among EU banking supervisors.

20. If the above concerns primarily the euro area supervisor, what about the

euro area central banker, i.e. the Eurosystem? The euro area central banker

has neither direct responsibility for supervising banks nor for bank

stability. It is, however, no stranger in this land. It has a vital interest

in a stable and efficient banking industry; it is, therefore, keen to see its

action complemented with an effective conduct of the supervisory functions by

the competent authorities; it needs a clear and precise knowledge of the

state of the euro area's banking industry as a whole and of its major

individual players; and it may have a role to play, as we shall see, in the

management of crises.

For the Eurosystem, natural reference models are provided by the central

banks of countries that apply the separation approach, for example: Germany

before the euro; the United Kingdom after the creation of the Financial

Services Authority; or Japan. In all these cases the central bank has a well-

developed expertise in the micro and macro-prudential field; each

distinctively plays a role in the macro-prudential field by addressing

threats to the stability of the banking system and analysing the soundness of

the structural features of the system. For their own purposes, these central

banks also have precise and comprehensive information about the banks in

their respective country. This is obtained either from performing practical

supervisory duties, as in the case of the Bank of Japan or the Bundesbank; or

from the national supervisory authority; or through direct contacts with the

banking industry, as in the case of the Bank of England.

The Banking Supervision Committee is in a good position to co-operate with

the Eurosystem in the collection of information. Indeed, the so-called BCCI

Directive has removed the legal obstacles to the transmission of confidential

information from competent supervisory authorities to "central banks and

other bodies with a similar function in their capacity as monetary

authorities". This includes national central banks and the ECB. Of course,

the provision of supervisory information is voluntary and its development

will have to be based on an agreed view of the central banking requirements

the Eurosystem will have in this field.

V. CRISIS MANAGEMENT

21. In normal circumstances central banking and prudential supervision have

an arm's length distance between them. In crisis situations, however, they

need to act closely together, often in co-operation with other authorities as

well. Charles Goodhart and Dirk Schoenmaker have made here at the London

School of Economics a valuable contribution to analysing the handling of

major banking problems in the history of industrial countries. One of their

conclusions is that, in most instances, central banks have indeed been

involved. Banking problems are so close to monetary stability, payment system

integrity and liquidity management that this finding hardly comes as a

surprise. The advent of the euro will not, by itself, change this state of

affairs.

22. When discussing crisis management, it should not be forgotten that, while

central banks have a direct and unique role to play when the creation of

central bank money is involved, this represents just one category of

emergency action. Another category refers to the injection - by politically

liable Finance Ministries - of taxpayers' money into ailing or insolvent

credit institutions. There is also a third, market-based, category,

consisting of the injection of private money by banks or other market

participants. These three typologies of emergency action all require the

involvement of policy-makers, but they must not be mixed up when evaluating

the existing arrangements. Therefore, before discussing the much debated

question of the lender-of-last-resort, let me briefly comment on the two,

probably less controversial cases where central bankers are not the providers

of extra funds.

23. First, the "private money solution". This market-based approach is

clearly the preferable option, not just to save public funds and avoid

imbalances in public finances, but also to reduce the moral hazard problem

generated by public assistance to ailing institutions. Indeed, policy-makers

are increasingly aware that the expectations of a helping hand can increase

financial institutions' risk appetite in the first place. However, even when

a market-based solution is possible, on the grounds of private interest,

private parties may not be able to reach a solution for lack of information

or co-ordination. Public authorities have therefore an active role to play

for the market solution to materialise. The recent rescue package co-

ordinated by the Federal Reserve Bank of New York to prevent the LTCM hedge

fund from collapsing is a good example of public intervention being used to

achieve a private solution.

Acting as a "midwife" in brokering a private sector deal is not the only

example of managing crises without injecting public funds. Banking

supervisors have at their disposal a number of tools to intervene at the

national level to limit losses and prevent insolvency when a bank faces

difficulties. These tools include special audits, business restrictions and

various reorganisation measures.

In the euro area, national supervisors and central banks will continue to be

the key actors in the pursuit of market-based solutions to crises. The

Eurosystem, or the Banking Supervision Committee, would become naturally

involved whenever the relevance of the crisis required it.

24. Second, the "taxpayers' money solution". Taxpayers have been forced to

shoulder banks' losses in the past, when public authorities felt that otherwise

the failure of a large portion of a country's banking system or of a single

significant institution would have disrupted financial stability and caused

negative macroeconomic consequences. In such instances banks have been taken

over by the state, or their bad assets have been transferred to a separate

public entity to attract new private investment in the sound part of the

otherwise failed banks. The US savings & loans crisis of the 1980s, the

banking crises in Scandinavia in the early 1990s and the current banking crises

in Japan and some East-Asian countries are examples of system-wide insolvency

problems that have triggered taxpayers' support. Crйdit Lyonnais and Banco di

Napoli are recent examples of public support to individual insolvency problems.

The introduction of the euro leaves crisis management actions involving

taxpayers' money practically unaffected. The option of injecting equity or

other funds remains available for the Member States, since these operations

are not forbidden by the Treaty. Nevertheless, the European Commission will

be directly involved in scrutinising and authorising such actions, since any

state aid must be compatible with the Community's competition legislation.

This happened, for example, in the cases of Banco di Napoli and Crйdit

Lyonnais.

The handling of solvency crises is not within the competence of the national

central banks nor that of the ECB, although national central banks are likely

to be consulted, as they have been in the past.

25. Third, the "central bank money solution". This is the lender-of-last-

resort issue that has brought the Eurosystem under vigorous criticism by

distinguished academics and the IMF's Capital Markets Division of the

Research Department. The criticism has been that the alleged absence of a

clear and transparent mechanism to act in an emergency raises doubts in the

markets about the ability of the Eurosystem to handle crisis situations. It

is said that the uncertainty generated by the present arrangements would

entail new risks, including the possibility of investors requiring an

additional risk premium at times of financial market volatility and,

ultimately, of the credibility of EMU being damaged. Two examples of these

concerns deserve an explicit mention. The IMF "Report on Capital Markets",

September 1998, stated that "it is unclear how a bank crisis would be handled

under the current institutional framework .which is not likely to be

sustainable". Similarly, the first report of the CEPR (Centre for Economic

Policy Research) on monitoring the ECB entitled "The ECB: Safe at Any Speed?"

expressly suggested that the Eurosystem lacks crisis management capacity and

is too rigid to pass the A-Class test to keep the vehicle on the road at the

first steep turn in financial market conditions in Europe.

26. My response to this criticism is threefold. To my mind, the criticism

reflects a notion of lender-of-last-resort operations that is largely

outdated; it underestimates the Eurosystem's capacity to act; and, finally,

it represents too mechanistic a view of how a crisis is, and should be,

managed in practice.

27. The notion of a central bank's lender-of-last-resort function dates back

more than 120 years, to the time of Bagehot. This notion refers to emergency

lending to institutions that, although solvent, suffer a rapid liquidity

outflow due to a sudden collapse in depositors' confidence, i.e. a classic

bank run. A bank could be exposed to depositors' panic even if solvent

because of the limited amount of bank liquidity and an information asymmetry

between the depositors and the bank concerning the quality of bank's assets

that do not have a secondary market value.

Nowadays and in our industrial economies, runs may occur mainly in textbooks.

They have little relevance in reality because, since Bagehot, many antidotes

have been adopted: deposit insurance, the regulation of capital adequacy and

large exposures, improved licensing and supervisory standards all contribute

to the preservation of depositors' confidence and minimise the threat of a

contagion from insolvent to solvent institutions.

A less unlikely case is a rapid outflow of uninsured interbank liabilities.

However, since interbank counterparties are much better informed than

depositors, this event would typically require the market to have a strong

suspicion that the bank is actually insolvent. If such a suspicion were to be

unfounded and not generalised, the width and depth of today's interbank

market is such that other institutions would probably replace (possibly with

the encouragement of the public authorities as described above) those which

withdraw their funds. It should be noted, in this respect, that the emergence

of the single euro money market lowers banks' liquidity risk, because the

number of possible sources of funds is now considerably larger than in the

past.

Given all of these contingencies, the probability that a modern bank is

solvent, but illiquid, and at the same time lacks sufficient collateral to

obtain regular central bank funding, is, in my view, quite small. The

textbook case for emergency liquidity assistance to individual solvent

institutions has, as a matter of fact, been a most rare event in industrial

countries over the past decades.

28. What if this rare event were nevertheless to occur and cause a systemic

threat? The clear answer is that the euro area authorities would have the

necessary capacity to act. This is not only my judgement, but also that of

the Eurosystem, whose decision-making bodies have, as you can imagine,

carefully discussed the matter. I am not saying that we are, or shall be,

infallible; no one can claim such a divine quality. I am saying that there

are neither legal-cum-institutional, nor organisational, nor intellectual

impediments to acting when needed. In stating this, I am aware that central

banks may be the only source of immediate and adequate funds when a crisis

requires swift action, while solvency remains an issue and failure to act

could threaten the stability of the financial system.

In these circumstances the various national arrangements would continue to

apply, including those concerning the access of central banks to supervisors'

confidential information. As is well known, such arrangements differ somewhat

from country to country.

29. The criticism I have referred to also underestimates the Eurosystem's

capacity to act. To the extent that there would be an overall liquidity

effect that is relevant for monetary policy or a financial stability

implication for the euro area, the Eurosystem itself would be actively

involved.

The Eurosystem is, of course, well equipped for its two collective decision-

making bodies (the Board and the Council) to take decisions quickly whenever

needed, whether for financial stability or for other reasons. This readiness

is needed for a variety of typical central bank decisions, such as the

execution of concerted interventions or the handling of payment system

problems. Indeed, it has already been put to work during the changeover

weekend and in the first few weeks of this year.

A clear reassurance about the capacity to act when really needed should be

sufficient for the markets. Indeed, it may even be advisable not to spell out

beforehand the procedural and practical details of emergency actions. As

Gerry Corrigan once put it, maintaining "constructive ambiguity" in these

matters may help to reduce the moral hazard associated with a safety net. I

know of no central bank law within which the lender-of-last-resort function

is explicitly defined.

The question of who acts within the Eurosystem should also be irrelevant for

the markets, given that any supervised institution has an unambiguously

identified supervisor and national central bank. As to the access to

supervisory information, the lack of direct access by the Eurosystem should

not be regarded as a specific flaw of the euro area's institutional

framework, as has been frequently argued, since this situation also exists at

the national level wherever a central bank does not carry out day-to-day

supervision.

30. Finally, the criticism reflects an overly mechanistic view of how a

crisis is, and should be, managed in practice. Arguing in favour of fully

disclosed, rule-based policies in order to manage crises successfully and,

hence, maintain market confidence, is almost self-contradictory. Emergency

situations always contain unforeseen events and novel features, and

emergency, by its very nature, is something that allows and even requires a

departure from the rules and procedures adopted for normal times or even in

the previous crisis. Who cares so much about the red light when there is two

metres of snow on the road? As for transparency and accountability, these two

sacrosanct requirements should not be pushed to the point of being

detrimental to the very objective for which a policy instrument is created.

Full explanations of the actions taken and procedures followed may be

appropriate ex post, but unnecessary and undesirable ex ante.

31. So far, I have focused on the provision of emergency liquidity to a bank.

This is not the only case, however, in which central bank money may have to

be created to avoid a systemic crisis. A general liquidity "dry-up" may

reflect, for example, a gridlock in the payment system or a sudden drop in

stock market prices. The actions of the Federal Reserve in response to the

stock market crash of 1987 is an often cited example of a successful central

bank operation used to prevent a dangerous market-wide liquidity shortfall.

This kind of action is close to the monetary policy function and has been

called the "market operations approach" to lending of last resort. In such

cases, liquidity shortfalls could be covered through collateralised intraday

or overnight credit, or auctioning extra liquidity to the market. The

Eurosystem is prepared to handle this kind of market disturbance.

VI. CONCLUSION

32. In my remarks this evening, I have looked at the euro area as one that

has a central bank which does not carry out banking supervision. This would

be normal, because in many countries banking supervision is not a task of the

central bank. What is unique is that the areas of jurisdiction of monetary

policy and of banking supervision do not coincide. This situation requires,

first of all, the establishment of smooth co-operation between the Eurosystem

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