1) The financial crisis prompted both short-term responses like fiscal/monetary stimulus as well as long-term structural reforms to financial stability frameworks. 2) The EU implemented new regulations through Basel accords and established the European System of Financial Supervision with institutions like the ECB Single Supervisory Mechanism and European Systemic Risk Board. 3) Coordination of fiscal, monetary, and macroprudential policies remains a challenge within the eurozone where policies are not as integrated, compared to other EU countries which can coordinate more effectively.

1. Single market vs
eurozone: financial
stability and macro-
prudential policies
23 April 2015
The new financial architecture in the eurozone
European University Institute
N.B: The views expressed are the author’s and do not reflect those of the ECB.
Carmelo Salleo
ECB - DG MF/MAF

2. Rubric
www.ecb.europa.eu ©
Never let a good crisis go to waste *
The financial crisis which started in 2007 elicited 2 types
of responses:
•Conjunctural: fiscal, monetary, prudential policies were
put in place to mitigate the impact of the crisis and
rebound – with mixed results.
•Structural: policy makers devised a new analytical and
institutional framework for a comprehensive approach to
financial stability.
* Winston S. Churchill.

3. Rubric
www.ecb.europa.eu ©
Source: ECB, FED
3
Fiscal and monetary policies during the crisis
0%
2%
4%
6%
8%
10%
12%
2006 2007 2008 2009 2010 2011 2012 2013 2014
expected
UK US EA
Source: Bloomberg
Unconventional Monetary Policy: Central bank’s balance sheet / GDP Monetary vs. Fiscal Policy: Government debt bought by central banks
Source: ECB, FED, BoESource: ECB, FED, UK Debt Management Office
Fiscal Policy: Government budget deficit / GDP
0%
10%
20%
30%
40%
50%
2006 2007 2008 2009 2010 2011 2012 2013 2014
UK US EA
0%
40%
80%
120%
2006 2007 2008 2009 2010 2011 2012 2013 2014
UK US EA
-5
-4
-3
-2
-1
0
1
2
3
4
5
2006 2007 2008 2009 2010 2011 2012 2013 2014
UK US EA
Monetary Policy: Real interest rates

4. Rubric
www.ecb.europa.eu ©
Source: BIS
4
Credit and GDP during the crisis
Source: BIS, Eurostat, FED
Real GDP per capita (2006=100)
Source: Eurostat
Macro-Prudential Policy: Private sector credit to GDP Total (private sector+government) debt to GDP (YoY change)
95
96
97
98
99
100
101
102
103
104
105
2006 2007 2008 2009 2010 2011 2012 2013 2014
UK US EA
100%
120%
140%
160%
180%
200%
220%
240%
260%
2006 2007 2008 2009 2010 2011 2012 2013
UK US EA
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
2007 2008 2009 2010 2011 2012 2013 2014
UK US EA

5. Rubric
www.ecb.europa.eu ©
What did we learn from the policy mixes of
the past few years?
•In terms of the business cycle, given the severity of the shock
not surprisingly fiscal and monetary policy worked best when
they were pulling in the same direction.
• if the problem was debt overhang, it wasn’t solved. At most
there was a substitution of public for private sector debt.
•What role could there have been for macro-prudential
policies before and during the crisis?

6. Rubric
www.ecb.europa.eu ©
The new framework in the European Union - I
Much of the new framework was developed in Basel, then
implemented in the EU with the CRD IV/CRR. The main
elements are:
•To address pro-cyclicality: counter-cyclical capital buffers.
•To address too big to fail: SIFI buffers, CoCos, bail-in.
•To address contagion: capital buffers and sectoral
requirements, limits to large exposures.
•To address firesales: capital buffers and liquidity ratios.

7. Rubric
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The new framework in the European Union - II
While the tools are common to all countries, the governance
is different between EA and other countries. EA countries
adhere to a banking union (others can join if they want), which
means:
•Common banking supervision (SSM).
•Common resolution (SRM).
•National central banks and the ECB share powers over
macro-prudential tools (but NCBs keep exclusive control of
tools not mentioned in the CRD IV/CRR, such as LTV and
LTD).
•In the future: common deposit insurance scheme.

8. Rubric
www.ecb.europa.eu ©
The new framework in the European Union - III
Each country in the EU chooses how to organise its financial
stability oversight:
•All responsibilities to the central bank (UK).
•Bank supervisors are also the macro-prudential authority
(Sweden).
•A council with the central bank, financial supervisors and the
Treasury (Denmark).
KEY DIFFERENCE BETWEEN THE EA AND OTHER EU
COUNTRIES: outside the EA policy makers can coordinate
effectively fiscal, monetary and prudential policies, while in the
SSM there is a single monetary policy while fiscal policies
remain at the national level and are difficult to coordinate
among themselves, let alone with the other policies.

9. Rubric
www.ecb.europa.eu ©
Real and financial relationships within the EU
UK
Euro Area
19: BE, DE, EE, IE, GR, ES, FR,
IT, CY, LV, LT, LU, MT, NL, AT, PT,
SI, SK, FI
CEE
Non-EA:
BG, CZ, HR,
HU, PL, RO
1.4%
0.3%
54.5%
4.9%
18.1%
4.0%
75.1%
2.0%
51.2%
11.7%
Notes:
Full lines represent trade to GDP ratio (i.e. bilateral X+M /GDP)
Dashed lines represent claims by banks vis-à-vis other
EU regions as a % of total foreign claims (where available).
Source: UN Comtrade, BIS Consolidated International Banking Statistics.

10. Rubric
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Challenges: the EA and CEE - I
• CEE countries have mostly pegged their currency to the
euro: their monetary policy is thus heavily influenced by
ECB decisions. This means limited possibilities to use
monetary policy as an independent instrument should their
business cycles diverge from the EA’s.
• Banking systems in the CEE are part-owned by EA banks.
This means a limited scope for independent prudential
policies should financial cycles diverge from the EA’s
(essentially, it depends on how banks manage a
consolidated balance sheet across subsidiaries).
• The only degree of freedom left is fiscal policy, which
already has its goals and limitations.

11. Rubric
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Challenges: the EA and CEE - II
How likely is this going to be a problem?
•Business cycles are not too divergent, and the exchange rate
can be adjusted in most cases.
•Some countries are entering in “close cooperation” with the
SSM, i.e. they are joining the banking union and becoming “co-
home supervisors of their own banks”.
•The ESRB provides a forum to discuss and coordinate macro-
prudential policies.
•Being part of the EU ensures participating in the common
development of a Capital Markets Union and of further
integration of financial infrastructures.

12. Rubric
www.ecb.europa.eu ©
Challenges: the EA and the UK
• A flexible exchange rate means a more independent
monetary policy.
• Linkages are mostly due to cross-border flows and common
exposures.
• Coordination of prudential policies: from race to the bottom
to gold plating – both are competitive strategies.
What are the main issues?
• Coordination of macro-prudential policies: ESRB.
• Structural problem: the relationship between banks and
markets is different in the EA and the UK.
• Brexit – how would it change the balance with the EA?

13. Rubric
www.ecb.europa.eu ©
Conclusion: the EA within the single market
a financial stability perspective
• The key role of fiscal policy also for financial stability cannot
be ignored. Within the EA this calls for much greater
cooperation and coordination also in the fiscal dimension.
• Between the EA and CEE: the (semi-)fixed exchange rate
regime and strong presence of EA banks in the CEE make
the 2 regions very interdependent also from a financial
stability perspective. This calls for more integration of
prudential policies.
• Between the EA and the UK (and other EU non-CEE
countries?): the relationship seems sufficiently loose and
with enough degrees of freedom that differences in financial
cycles should have little spillovers.