EU financial regulation

Thu, May 28, 2009, 01:00

ONE FEATURE of the global economic crisis has been the failure by national financial regulators to detect an expanding financial bubble – in the form of soaring asset prices – and to deflate that bubble in time. Governments everywhere have now recognised this failure of oversight by the regulatory authorities and are taking steps to prevent a repetition.

However, for national regulation to be effective in a global economy, much greater co-operation is necessary at both European Union and international level. And yesterday, the European Commission published outline proposals for Europe-wide reform that will help ensure more effective regulation.

This involves the creation of a European Systemic Risk Council (ESRC) which would identify risks to financial stability in the EU and issue recommendations and early warnings to member states. The ESRC – which would include the 27 governors of the central banks of member states – would not have the legal power to direct governments to follow its orders. Nevertheless, ESRC advice could not be discounted very easily: governments that ignored its strictures could be called to public account.

The commission’s proposals, which are based on a report in February by former French central bank governor Jacques de Larosiere, envisage a second structure, the European System of Financial Supervisors (ESFS) that would supervise banks and insurers on a Europe-wide basis. This agency would complement the work of national regulators and – in certain circumstances – have the power to overrule them. This plan will be discussed by EU leaders at a summit next month and, if approved by EU governments and the European Parliament, could come into effect by 2011.

No country is in greater or more urgent need of regulatory reform than Ireland. The failure of “light touch” or principles-based regulation is all too evident in the indebtedness of the banks which serves as a monument to national regulatory failure. Given that experience, what the European Commission is proposing should be strongly welcomed here. It should complement the major reforms in this area that Minister for Finance Brian Lenihan has promised to introduce shortly.

However, Britain may well oppose the measures outlined by Brussels because it regards the proposals as a threat to London as Europe’s main financial centre. In particular, and in the run-up to a British general election, a Labour government may be reluctant to give EU regulators a right to overrule national regulators.

For the EU, the financial crisis presents the best opportunity to achieve regulatory reform that all member states accept is both necessary and overdue. The real difficulty may be ensuring that the essence of these reforms is retained as public debate about them intensifies. Any excessive dilution of the measures proposed in order to win general political acceptance risks making them an ineffective and inadequate response to the challenge of supra-national regulation at this time of economic crisis.