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THE EU should establish two new pan-European bodies to oversee and co-ordinate supervision of the financial system to ensure that the current crisis can never be repeated.

It also needs to regulate more effectively by setting tough new rules on executive pay, credit ratings agencies and hedge funds, according to an influential report published yesterday.

The High-Level Group on Financial Supervision in the EU, which was chaired by former Bank of France governor Jacques de Larosiere, makes 31 recommendations on how to strengthen supervision of financial institutions and markets.

It pinpoints the need for more co-operation between Europe’s patchwork of national financial supervisors, although it stops short of recommending a single pan-EU banking and financial regulator.

“The regulatory response to this worsening situation was weakened by an inadequate crisis management infrastructure in the EU, both in terms of the co-operation between national supervisors and between public authorities,” says the report, which concludes the current crisis is the worst the world has faced since 1929.

The report recommends setting up a new body called the European Systemic Risk Council under the aegis of the European Central Bank (ECB) to monitor risks to the financial system. EU central bank governors and national supervisors from the financial sectors would sit on its board. It would issue risk warnings, which if they are judged serious to disturb the economy as a whole or the financial system, would have to be followed up by national supervisors.

The ECB had lobbied for a role in supervising financial institutions such as banks and insurance firms to create a single pan-EU supervisor. But the report rejects this proposal because devolving such power to the bank could leave it open to political pressure and impinge on the ECB’s crucial role of ensuring monetary stability.

Instead, the report recommends beefing up three existing financial supervisory bodies (the “level-three committees” composed of national supervisors in the banking, insurance and securities sectors) to create a European system of financial supervisors.

Under this model, national supervisors would continue to undertake day-to-day supervisory work, but they would have to attend regular EU-wide meetings, known as colleges of supervisors, to ensure proper scrutiny of cross-border institutions.

The new EU body would act as a form of decentralised network that ensures common high-level supervisory standards are followed by national regulators to ensure a level playing field.

The report pinpoints a failure of national regulation as a contributory factor to the current crisis.

“Strong international competition among financial centres also contributed to national regulators and supervisors being reluctant to take unilateral action,” it says, noting that a lack of resources and inadequate skills also hampered regulators.

Many EU states such as Britain have opposed plans to devolve supervisory power over its financial sector to Brussels, fearing it could hurt their banks or undermine financial centres such as the City of London.

But Mr de Larosiere said yesterday he didn’t propose any “unrealistic options” to ensure his report did not sit on a bookcase gathering dust.

European Commission president Jose Manuel Barroso said the report confirmed his belief that a European system of financial supervision was now indispensable. “If we do not take these steps now in this crisis, the decisions will never be taken,” he added.

The report pins the blame for the global crisis on a number of actors: the US for fuelling a housing bubble and credit boom by keeping interest rates very low; China for pegging its currency to the dollar and contributing to global imbalances; financial institutions for designing ever more complex and risky products to pursue higher returns, management for incentivising greater risk-taking through poorly designed remuneration schemes and regulators for failing to properly assess risk or being willing to take counter measures.

It strongly criticises managers and directors of banks for not understanding the complex financial products that they were dealing with or being aware of the exposure of their firms.

It also concludes remuneration and incentive schemes at banks and other financial institutions “contributed to excessive risk-taking by rewarding short-term expansion of the volume of risky trades rather than the long term profitability of investments”.