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 ‚[pic]Crйdit Lyonnais.

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