23.12.2009   

EN

Official Journal of the European Union

C 318/57

1.3.1

The de Larosière Group recommends introducing higher capital requirements for banks in ‘good times’ and lower requirements in ‘bad times’. In view of the difficulty of forecasting fluctuations in the economic cycle, this might be a risky proposal. At the same time, the example of Spain shows that a system based on variable capital requirements can work. Therefore the EESC believes that such a measure needs to be studied with regard to timing before it can be implemented.

1.3.2

The EESC thinks that higher capital requirements and greater transparency for off-balance sheet operations are absolutely essential. The Spanish authorities had the most stringent rules governing off-balance sheet items and the Spanish banks were the least affected by the crisis.

1.3.3

‘Off-balance sheet items’ and ‘Special purpose vehicles’ have sometimes been abused. Risky assets have been removed from banks’ balance sheets in order to avoid capital requirements and sometimes in order to avoid taxation. Against this background, the EESC thinks that stricter rules are required.

1.3.4

The EESC believes that making the riskiness of bank assets more transparent ought to be one of the main demands in the follow-up to the report. The EESC, like the Group, thinks that banks and financial institutions should always retain a part of the underlying risk on their books when risky assets are sold on. The risks inherent in financial products must be clearly evident. Transparency of financial products is necessary in order to restore confidence in the financial markets. Here the EESC would again refer to the case of Spain. New instruments should not be used in the financial markets before they have been vetted by a monetary authority. The introduction of such checks should be discussed. It has to be decided whether they should be national checks or whether a common EU-wide system is required. The degree to which financial activities are cross-border in nature argues in favour of a common system.

1.3.5

The ‘parallel banking system’ consists of various forms of unregulated lending. These new forms of financial activity have been able to develop outside the scope of regulation, not even being subject to reserve requirements. The EESC agrees that they should also be brought within the ambit of regulation. The report also calls for common rules for investment funds, definitions of the various products used and stricter supervisory control. It is easy to concur with these recommendations.

1.3.6

Stricter requirements concerning bank management and auditing are essential. The EESC does not believe that the solutions put forward by the de Larosière Group pay enough attention to the role of auditors. With effective auditing it would have been possible to reduce the spread of risky instruments. Management of financial firms must be able to rely on auditing in the valuation of assets. The role of auditors and accounting methods should be included in the revision of Basel II.

1.3.7

The report makes good recommendations on bonus schemes. They should be set in a multi-year framework and reflect actual performance rather than just being guaranteed in advance. The EESC believes that there is need for a transition from a short-term to a long-term horizon, with bonuses not linked to speculative activities. In this spirit, the EESC supports the idea of a tax on financial transactions, the proceeds from which could be allocated to development aid. Moreover, an additional requirement is that bonuses should not be based on general developments but on whether the bank manages to turn in a performance which is better than the overall trend. It would also be good to establish a ceiling for bonuses in order to avoid excesses and ill-considered risk-taking. An ‘exit strategy’ for the financial crisis should provide for repayment of the vast sums disbursed to financial institutions from government budgets rather than reverting to high profits and bonuses.

1.4.1

The de Larosière Group notes that there is a need for a European body to carry out macro-prudential supervision of the financial system and issue macro-prudential risk warnings. It recommends that the ECB/ESCB be given this responsibility and that a special council be entrusted with this task. Whilst linking the council administratively link to the ECB makes sense per se, it is the ESCB which must be formally responsible for conducting supervision. Supervision must definitely cover financial systems in all of the Member States and the ESCH must also appoint the senior management of the new council/board.

1.4.2

The report recommends that the new system of micro-prudential supervision be created in two phases, with different authorities for the supervision of banks, investment funds and securities markets. The second phase would consist of establishing common ground rules for supervision and eliminating differences in national application. During this phase, sanction regimes would also be harmonised. The EESC sees no reason to delay this process and therefore welcomes the fact that in its communication the Commission now recommends that immediate steps be taken to prepare the whole system for micro-level supervision.

1.4.3

The EESC believes that colleges made up of supervisors from the relevant national supervisory authorities could be difficult to manage unless accompanied by the necessary harmonisation. Otherwise differences in the rules governing national supervisory authorities would make it necessary in practice for the three new authorities to assume responsibility for part of the supervision of cross-border financial firms.

1.4.4

The boards of the three new authorities should not be composed of only bankers. Trade union organisations, consumers of bank services as well as the EESC, as the representative of civil society, should also be given places on the boards.

1.5.1

In discussions on financial markets use is now made of the term ‘stress test’ – an examination of how a country's banking system would cope in the event of a financial market crisis. Viewed against the background of the current financial crisis, it is easy to understand how important such tests could be. At the same time this raises the crucial question as to whether the results should be made public. If the IMF were to publish the results of such a test showing that the banking system in a particular country would not be able to survive a crisis, the crisis could then become a reality.

2.1

The extent of the current financial and economic crisis is unprecedented in peacetime. The Depression of the 1930s took place at a time when the world's economies were not as integrated as they are now. It was mainly the US and Europe which were hit. What we are experiencing today is, to a large degree, a global crisis.

2.2

What started as a financial crisis has turned into an economic crisis accompanied by recession in large parts of the world. It is likely to be followed by a social crisis with high unemployment. How extensive it becomes will be determined by what kind of policy is adopted to address the crisis. It has been accompanied by a political crisis which has led to the fall of governments.

2.3

However, the present opinion focuses exclusively on the financial crisis and what can be done to prevent it recurring in the future. Seen against the background of the overall crisis, the subject matter is limited: it does not deal with the economic crisis or with measures for countering the current financial crisis, such as providing the financial sector with public funds. Rather, it is simply about the future and in particular the supervision of the financial sector.

2.4

This was the brief entrusted to the de Larosière Group, whose report is the subject of the present EESC opinion. The de Larosière Group saw fit to widen its brief. This was necessary in order to provide a comprehensive picture enabling more constructive proposals to be put forward.

2.5

The current crisis started in the financial sector. Before the de Larosière Group had published its report, the crisis had assumed such serious proportions that the European Commission had already put forward proposals for changes to EU legislation. The most important of these is probably the proposal on credit rating agencies. A proposal has been put forward for a directive on particular forms of financial activity. A communication presented on 27 May discusses the section of the de Larosière report dealing with supervision of the financial sector. According to Annex 1 of the Commission staff working document accompanying the Commission communication, there are five differences between the de Larosière report and the communication. These differences are commented on briefly in points 6.2.4, 6.3.1 and 6.3.5. The EESC will deliver a separate opinion on the forthcoming practical legislative proposals. Although the Commission does not touch upon the other parts of the de Larosière report in the communication, the EESC believes that they are also of the utmost importance for the future of the financial sector.

2.6

The de Larosière report was written by bankers for bankers and those who will have to take the proposals on board are primarily banking experts in the Commission and finance ministers in the Member States. The EESC supports the Group's 31 recommendations but the focus must be widened. Those who, in practice, brought about the financial crisis cannot solely be responsible for solving the current problems. Consumers of financial services are private individuals and firms who deposit their savings and borrow to finance their investments. The task of the financial markets is to serve these groups, i.e. civil society, in the best possible way. So, whilst generally endorsing the report, we would like to make some comments on it and put forward some additional proposals.

3.1

Excess liquidity in the financial sector did not prompt any measures by central banks. The focus was exclusively on the level of prices, and this did not justify raising interest rates. The availability of cheap liquidity led to a rise in security prices. Just as there can be no doubt that the level of liquidity was too high when the crisis started, so a consequence of the crisis is that it has now fallen to a level which is too low. On the other hand, it is difficult to say what is an adequate level of liquidity and money supply under normal circumstances. The EESC would also highlight the dilemma of simultaneously using inflation and some measure of money supply as monetary policy indicators. An excessive money supply should lead central banks to raise interest rates. If, at the same time, inflation is low, this should, on the contrary, lead to a fall in interest rates. The EESC therefore believes that if, even in such complex situations, the money supply is used as an indicator, the potential effects on the real economy must be taken into consideration.

3.2

Political decisions supporting home ownership regardless of people's ability to pay, the low cost of borrowing and new products created by financial institutions by bundling up different securities had the effect of concealing the underlying risky loans (subprimes). These securities spread throughout the world's financial markets as private saving in the US was even negative in the period 2005-2006. The EESC commented on this in July 2008 (1) as follows: ‘The recent sub-prime mortgage crisis in the United States has revealed how the volatility of property prices combined with poor client-risk assessment practices with respect to non-payment of instalments that are out of proportion with the actual value of the mortgaged property itself, can generate a financial crisis serious enough to destabilise the entire system. For this reason, any EU action should draw on this experience …’

3.3

At the same time, imbalances in world trade led to the emergence of large surpluses in some countries (above all China), which were used to buy US Treasury bonds. New, complex combinations of securities (including subprimes) yielded high returns and the whole financial market searched for ever-higher returns. The additional securities served as a basis for new lending so that the volume of financial transactions expanded – an expansion which was based on securities which were more risky. The understanding was that one of the purposes of the new, complex financial products was to spread risks. The increase in the volume of transactions on financial markets created the impression of ever-increasing profits.

3.4

Risky mortgage-backed assets, which were difficult to sell in the banking system, were incorporated into new securities (through securitisation), which made it possible to sell them on. This practice was brought to an end and the crisis triggered when the United States entered recession in 2008 and unemployment climbed. Many homeowners could not afford to pay the new interest rates. Banks had to mark down the value of their securities and sell them. The value of the assets underlying these securities fell further and the downward slide accelerated. Confidence collapsed.

3.5

The de Larosière report mentions several factors which contributed to the sequence of events described above:

3.6

Implicit in the de Larosière report is the criticism that central banks did not take measures to deal with the dramatic increase in liquidity.

3.7

However, the EESC would like to take the analysis a few steps further. Rising liquidity was partly due to imbalances in the world economy. This is most clearly evident in relations between the US and China: a trade surplus in China and a saving ratio equivalent to 30-40 percent of income, as a buffer against illness and old age; a trade deficit in the US associated with non-existent saving. Another possible explanation, which is not touched upon by the de Larosière Group, is the shift in income distribution away from labour income to capital income. The distribution of income has become more uneven. Both the ILO and the OECD have stated that this trend must be stopped.

3.8

The wealthiest needed to find an investment outlet for their increased assets. As the opportunities for real investment had not grown at the same pace, this put upward pressure on security prices. A new regulatory framework for financial markets cannot solve these causes of the current problems, as political decisions are needed to address them. The de Larosière report provides an in-depth account of the financial ‘bubble’ but further analysis is also needed to determine what political decisions are required in the future.

3.9

The financial context described undeniably encouraged the proliferation of speculative deals that bore little relation to developments in the real economy, with no use being made of international fiscal and monetary policy instruments that could have reined in their growth. The financial institutions and international bodies ignored the many social movements that have repeatedly called for regulatory measures to be adopted, one of the most important of which is the Tobin Tax.

4.1

According to the report, the present crisis is due to market failures, global imbalances, poor regulation and weak supervision. Not all these problems can be resolved by regulation but effective regulation is a precondition. The report goes on to state that all these problems must be addressed but it is questionable whether the proposed regulation goes far enough. Moreover, it could be argued that there is a danger that more regulation could reduce financial innovation. Here the EESC would recall that subprime loans and securitisation are just such financial innovations. Abuse of some of these innovations is at the root of the current financial problems. Regulation can sometimes also contribute to financial innovation, such as the SEPA (Single European Payments Area).

4.2

The Group recommends better coordination between central banks and the political bodies responsible for supervising financial markets. Central banks must devote more time to macroeconomic considerations in the form of better supervision of financial markets. The EESC believes that this recommendation and the requirement that the IMF play a more effective role in surveillance are necessary proposals.

4.3

The report states that public regulation and self-regulation in the financial sector must complement each other. As internal control has not worked, it is asserted that there is a need to oversee self-regulation. This effectively eliminates the boundary between public regulation and self-regulation.

4.4

In reality, there is no such boundary. In practice, the banking sector lays down rules for self-regulation of the financial sector through the Basel 1 and 2 frameworks. It is up to banks and other financial institutions themselves, or the state in cases where the rules are introduced by law, to ensure compliance with the rules. (Basel II entered into force in the EU on 1 January 2008 and will only become applicable in the US on 1 April 2010.) The report does not give serious consideration to the organisational and democratic deficiencies in financial markets which self-regulation gives rise to. Given a globalised market, a key question should be: do political bodies have enough influence?

5.3.1

When banks undertake off-balance sheet operations they do so in most cases by making use of one of the financial innovations, namely ‘special purpose vehicles’. Here the purpose is often to remove risky assets from the bank's balance sheet so that the bank itself is not exposed to risk. Another reason may be to avoid taxes. Bearing in mind the way in which these instruments have been abused, the EESC believes there is a need for stricter rules both with regard to off-balance sheet items and special purpose vehicles. Essential from the point of view of regulation is that banks and financial firms must not be able to use these methods to conceal their activities.

5.4.1

The report discusses securitisation, derivatives markets, investment funds and the ‘parallel banking system’. The EESC would like to see a comprehensive solution where no problem associated with these risky securities is left unresolved outside the scope of individual proposals. The parallel banking system consists of various forms of unregulated lending. The report recommends that the Basel 2 framework be extended to cover these activities (hedge funds, investment banks, etc.). This seems self-evident and a decision to this effect should be taken immediately. These new forms of financial activity, which often take place alongside the banking system, have been able to develop outside the scope of regulation, not even being subject to reserve requirements. The report also calls for common rules for investment funds, definitions of the various products used and stricter supervisory control. It is easy to concur with these recommendations. Banks and financial institutions should always retain a part of the underlying risk on their books when risky assets are sold on.

5.7.1

Here again the EESC would refer to the case of Spain. New instruments should not be used in the financial markets before they have been vetted by a monetary authority. In its review the Commission should examine the differences between the instruments used in Spain and in other EU Member States. In addition, the introduction of such checks should be discussed and a decision taken as to whether they should be national checks or whether a common EU-wide system is required. The degree to which financial activities are cross-border in nature argues in favour of a common system.

5.10.1

A bonus scheme which rewards investment in short-term, risky assets is a major factor shaping the behaviour of bank management. The report makes good recommendations on bonus schemes, namely that assessment of bonuses should be set in a multi-year framework and reflect actual performance rather than just being guaranteed in advance. The EESC believes that there is need for a transition from a short-term to a long-term horizon, with bonuses not linked to speculative activities. In this spirit, the EESC supports the idea of a tax on financial transactions, the proceeds from which could be allocated to development aid. An additional requirement is that bonuses should not be based on general developments but on whether the bank manages to turn in a performance which is better than the overall trend. It would also be good to establish a ceiling for bonuses in order to avoid excesses and ill-considered risk-taking.

6.2.1

The report criticises the present supervisory arrangements for placing too much emphasis on the supervision of individual firms and recommends, instead, that supervision should encompass the entire financial system. It recommends that the ECB/ESCB (European System of Central Banks) be charged with this responsibility. Where cross-border supervision is necessary (for financial institutions with branches in other countries), the Group considers that a binding mediation mechanism is required.

6.2.2

The de Larosière Group notes that there is a need to formally charge a European body with the task of macro-prudential supervision of the financial system and of issuing macro-prudential risk warnings where required. An independent council/board (European System Risk Board should be set up within the ECB/ESCB and entrusted with this task. In addition to the central banks, the council would comprise representatives from the three authorities it is proposed should be responsible for micro-prudential supervision. The EESC would note that, at present, there probably does not exist any body with the knowledge necessary for macro-prudential supervision. Therefore such knowledge needs to be built up as support for the council. The Larosière report also makes the point that the Commission should be called in where overarching risks arise in the financial system.

6.2.3

The EESC endorses ECOFIN'S and the European Council's additions to the Commission's proposal in the communication of 27 May, according to which the ECB General Council should be represented on the European Systemic Risk Council (ESRC), with national supervisory authorities as observers, every country should have a vote and any recommendations from the ESRC should be made through the ECOFIN Council. The European Council has also proposed that the chairperson of the ESRC be chosen by the ECB General Council. The EESC thinks that this is appropriate given that all 27 Member States are represented on this body. The European Council recommends that the new European Supervisory Authorities should also have supervisory powers for credit rating agencies. The EESC supports this proposal, which is the outcome of the discussions on the proposal for a directive on credit rating agencies, but points out that only one of these three authorities should have this task.

6.3.6.1

The EESC believes that colleges made up of supervisors from the relevant national supervisory authorities could be difficult to manage unless accompanied by the necessary harmonisation. Owing to fundamental differences in the rules governing national supervisory authorities, the three new authorities would, in practice, have to assume responsibility for part of the supervision of cross-border financial firms.

6.3.6.2

The EESC fully supports the European Council invitation to the European Commission to specify how the European System of Financial Supervisors could play a strong coordinating role among supervisors in crisis situations, while fully respecting the responsibilities of national authorities in relation to potential fiscal consequences and fully respecting central banks’ responsibilities, in particular relating to the provision of emergency liquidity assistance.

7.1

The de Larosière Group also feels there is a need at global level to address regulation of the financial sector, supervision and crisis management and that an appropriate framework for this purpose is lacking. The Group calls for a strengthening of the Basel II framework and international accounting standards, for global regulation of credit rating agencies, for new governance practices in the financial sector and for a stronger role for the IMF. It would like to put an end to the possibility whereby financial firms are attracted to a particular jurisdiction because of weak regulation of the financial sector. Colleges of bank supervisors are particularly important for banks which operate globally.

7.2

Bringing about changes at global level can be expected to be difficult. Several of the Group's recommendations were, however, already addressed at the G-20 summit in London. The Financial Stability Forum, set up in 1999, was transformed into the Financial Stability Board, with an increased membership comprising all the G-20 countries plus Spain and the European Commission, a wider remit and closer links to the IMF. These changes are fully in line with the de Larosière Group's recommendation. During the current crisis, the Forum has not, to date, been capable of giving early warnings of the risks existing in the financial system. The EESC expresses the hope that the changes will make this body more transparent and that it be endowed with increased resources, knowledge and the power to act. It also needs to be stressed that the majority of the decisions made in London have yet to be implemented.

7.3

In discussions on financial markets use is now made of the term ‘stress test’ – an examination of how a country's banking system would cope in the event of a financial market crisis. Viewed against the background of the current financial crisis, it is easy to understand how important such tests could be. At the same time this raises the crucial question as to whether the results should be made public. If the IMF were to publish the results of such a test showing that the banking system in a particular country would not be able to survive a crisis, the crisis would then become a reality. Nevertheless, such tests should be as transparent as possible and could become a key instrument for supervision of national financial systems.

7.4

The London summit also took on board the recommendation to give the IMF more resources to help countries facing acute problems. The EESC welcomes this but would criticise the demands laid down by the IMF, which bring into question social issues which are important components of the European social model. It provides all the more reason why it is essential for the EU to speak with a single voice within the IMF.