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N° 1999 - 12 |
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| September |
| A Lender of Last Resort for Europe |
| Michel Aglietta |
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Prudential policy in Europe has strong national
traditions jealous of their peculiarities. The Maastricht Treaty has enshrined
them, making a comprehensive prudential system for the EMU-wide area all the more
problematic. The multiple and very costly banking crises of the 90’s have
shattered the wisdom of an arrangement whereby the word "subsidiarity"
is a recipe for staying put. Therefore we are left with disparate supervisory
agencies, piecemeal and ad hoc bilateral cooperation between these supervisory
agencies, uncertainty at the identity of the lender of last resort against Euroland-wide
systemic risk. It amounts more to destructive than to constructive ambiguity.
The development of capital markets and the subsequent hazardous restructuring of banks are likely to emphasize the shortcomings in prudential policy and to bring forth macro-prudential issues at the European level. Euro markets will become more alike Dollar markets. They will become vulnerable to types of instability stemming from market finance whereas Continental European countries have shaped their prudential policies to deal with risks proceeding from bank finance. Market finance is prone to multiple equilibria, sudden discontinuities in value, high leverage and extreme dependence of credit risk on market risk, high speed contagious processes spurred by brutal changes in the correlation of market risks. Systemic risk is inherent to market dynamics and can trigger liquidity crises which know no borders and no national sanctuaries.
What that means is the following : the development of financial markets in Europe requires a European lender of last resort. The principle for this requirement is clearcut : overall financial stability pertains to an enlarged view of monetary policy because asset price dynamics drives the business cycle. Furthermore, to keep moral hazard in check, the lender of last resort should be supported by a powerful system of prevention and surveillance with multiple lines of defense. In Europe the lender of last resort must be the ESCB as a whole, the ECB Council the ultimate authority. This design will evolve through the experience of crises and find its ways to fill the ambiguities of the Treaty.
Organizing supervision to meet the challenge of EMU-wide area systemic risk is subtle. On the one hand, national supervisors should work in close contact with market participants. Decentralization is of the essence but under harmonized criteria, including deposit insurance schemes. On the other hand, decentralization should not cristallize in national power centers. National supervisors should work as part of a network headed by the Banking Supervision Committee and in conformity with a single doctrine elaborated by the European lender of last resort. It means that the channel and content of information flows should be multilateral and aggregated in a coordinating unit whose purpose is to prepare the ingredients for the best diagnosis of eventual systemic risk situations. Moreover the lender of last resort in its final decision would greatly benefit from the work of an observatory of systemic risk endowed with the mission of making indepth studies of the channels of contagion and developing early warning signals from the use of market data.
With a strengthened financial safety net, the lender of last resort will be able to concentrate on its own function : thwarting liquidity crises at their most appropriate points and overseeing the resolution of major failures. |
Abstract |
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| Bank supervision, Liquidity crisis, Lender-of-last-resort,
Safety net, System risk |
Keywords |
| E5, F3 |
JEL classification |
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