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September 18, 2017

Sabine Lautenschläger, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, at a conference hosted by the Financial Stability Institute spoke about striking a balance between regulation, supervision, and market discipline. She highlighted that the financial crisis made clear that the three pillars—regulation, supervision, and market discipline—that support a stable banking sector were in need of some repairs.

Ms. Lautenschläger noted that the crisis clearly demonstrated that banking is a global business and the first step is to finalize the global rulebook, Basel III, as quickly as possible. The second step is to implement and apply the rules in a broadly consistent manner at regional and national level. However, rules are just one of the pillars that support a stable banking sector. The second pillar is supervision. There is a need to strike a delicate balance because these two pillars interact in a subtle way. She further highlighted that the world is complex and uncertain, particularly when it comes to finance and banking. Either we come up with more rules to try to cover every potential situation or we allow supervisors some discretion within a set framework and let them judge specific situations on their merits. In the end, these two options need to be in balance and we must be careful not to disturb this balance.


The third pillar of a stable banking sector is the market discipline, as banks operate in a market economy. Market forces can be used to keep risks in check. There is nothing like the prospect of failure and financial loss to keep a lid on risk-taking; this, as a general rule, is the essence of market discipline. Investors who stand to lose their own money will be more cautious than investors who can offload losses onto someone else. Governments often stepped in and propped up failing banks with public funds. She noted, "There was no chance for the market to impose discipline. This has changed. In Europe, we now have a single resolution mechanism for banks. It was designed to ensure that banks can fail in an orderly mahnner without damaging the financial system. This new mechanism has recently passed its first series of tests. Generally speaking, it was successful, although some adjustments are still needed. In any case, we have taken a big step toward more market discipline in the European banking sector." She concluded her speech by reinforcing that these three pillars have become stronger since the crisis and we must ensure that they remain in good shape and share the load in a balanced way. Otherwise, we will not reap all the benefits of the transformation that has taken place in banking supervision.


Related Link: Speech

Keywords: Europe, Banking, Regulation, Supervision, Market Discipline, Basel III, ECB

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