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Discussion Paper

“Cross-border banking in Europe: what regulation and supervision?”

Draft Comment by: Kumar Pallav1

Banking Regulation and Supervision Seminar

Prof. Hertig

1 Candidate for LLM, class of 2010, NYU School of Law.

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Synopsis

I. Introduction.....................................................................................................1-3

II. European Supervisory Architecture- A Revised Framework

A. Present European Supervisory Architecture (ESA) and need of proposal........5-8

B. Proposed European Supervisory Architecture (ESA)...........................................9

III. Potential solutions

A. European System of Banking Supervisors (ESBS).........................................9-13

B. New Regulation for Financial Groups ..........................................................13-17

C. Early Intervention Mechanism and Burden Sharing Issues...........................18-21

IV. Conclusion .......................................................................................................22

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I. Introduction

Most financial institutions in the European Union (EU) are still based in one

country, but a number of large financial institutions have systemic cross-border

exposures. Specially, Cross-border banks are a European and global reality and

they are crucial in maintaining and developing financial and economic integration.

The recent crisis has shown that it is urgent to reform the European supervisory

architecture to recognize the international dimension of financial markets.2 It is

important to achieve a prudential level playing field for European banks, while

helping to remedy more rapidly problems presented by the national segmentation

of Europe’s financial stability framework. This segmentation stands in the way of

better supervision and optimization across borders of banks’ operations. The EBA

therefore aims at leveling the playing field for cross-border banking business –

which is essential to boost competition and productivity in Europe’s financial

services sector – and improving the cross-border supervision of large, complex

cross-border banking institutions.3

In October 2008, de Larosiere Group submitted its report4 on

implementation of a new European supervisory architecture, particularly with the

2See Peter Praet, Overview of recent policy initiatives in response to the crisis, Journal of

Financial Stability 4, 368–375 (2008).

3See Praet, P., Herzberg, V., Market liquidity and banking liquidity: linkages, vulnerabilities and

the role of disclosure, Banque de France. Fin. Sta. Rev. 11, 95–109 (2008).

4See generally the High-Level Group on supervision on financial supervision in the EU,

http://ec.europa.eu/internal_market/finances/docs/de_larosiere_report_en.pdf

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view that there is an urgent need to reform and harmonize the European financial

regulatory and supervisory framework. The cross- border banking perspective

adopted in this report brings useful insights into the broader and comprehensive

approach taken by the de Larosiere Group, whose mandate was to analyze financial

markets overall. This report includes various proposals to reform the European

supervisory architecture.5

In times of stressed financial conditions, the current banking institutional

framework in EU does not give due consideration to the cross-border externalities

and negative spillovers resulting from individual supervisory decisions. This paper

examines the implications that alternative regulatory structures may have for

resolving failed banking institutions. This report gives emphasis on the European

Union (EU), which is both economically and financially large and has several

features relating to cross-border banking. The present paper makes a first step

towards providing proposals for a new regulation for Multi National Banks

(MNBs) to define the responsibilities and powers of the parent company and

establish neutrality with respect to the organizational structure of the cross-border

group (branches vs. subsidiaries).

In this comment I intend to focus on the discussion paper by UniCreditGroup

and how their proposals advanced by the High Level Group chaired by Mr. de

Larosiere to move towards a European System of Banking Supervision which

would operate along the same lines, in terms of independence, governance and

mechanisms, as the present Eurosystem model. The goal of this comment will be to

5 See Penning Och. Valutapolitik, “Cross-border financial supervision in Europe: Goals and

transition paths,” 2, 58-89(2006).

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support and contrast the views of the UniCreditGroup, specifically in the issue of

rapid creation of a European supervisory architecture.

II. European Supervisory Architecture- A Revised Framework

This paper analyze the emergence of an increasingly integrated financial market

in the EU which is indeed a major challenge for financial supervision – a challenge

which goes to the heart of the objective of supervision: integration increases

contagion risks, and thereby jeopardizes financial stability; integration makes it

more difficult to ensure a level playing-field if rules and supervisory practices

differ; integration means the development of large cross-border groups, which will

require more streamlined and cost-effective supervisory organization.6

A. Present European Supervisory Architecture (ESA) and need of proposal

At the current juncture, report reveal that the supervision of EU firms

remains largely based on national, home state supervision – but where cross border

firms have set up subsidiaries under local law. These subsidiaries are regulated

finally at host state level.7 Cross border branches of firms are regulated by the

home country, but safeguards have been provided in EU law for host state

6 See Giannetti, M., and S. Ongena, Financial Integration and Firm Performance: Evidence from

Foreign Bank Entry in Emerging Markets, Rev. Fin. 13, 181-223(2009).

7See Garcia, Gillian G. H., and María J. Nieto, “Banking crisis management in the European

Union: Multiple regulators and resolution authorities,” J. Banking Reg., Vol. 6, No. 3, 206-

226(2005).

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supervisors to act for example in emergency situations to protect depositors

(Article 33 CRD).8

In the case of investment services, host state supervisors have significant

areas of control - including the right to examine branch arrangements. Host

supervisors retain control of liquidity in branches as well and should be informed

of all relevant information about the group (Article 42 CRD and its recent

strengthening).

This organization is a very complex one, leading to multiple reporting lines

between supervisors and supervised entities and to complex mechanisms of

cooperation between home and host supervisors. Some argue that the present

arrangements should be preserved because, in certain cases, it could be better to

handle complex banking institutions with different supervisors holding different

views on a number of issues. However, such a view would have to be backed by a

precise and convincing analysis.9

Given the above, report suggests that the current supervisory arrangements

are not optimal to contribute to a high degree of financial stability in the Single

Market. Host Member States, in particular, largely depend on the effectiveness of

supervision carried-out in the home Member States. And one supervisory mistake

can have major consequences throughout the Single Market. The appropriateness

8 The Capital Requirement Directive 2006/48/EC (CRD).

9 Reviews of the benefits appear in Caprio et al. (2006), Committee on the Global Financial

System (2004), Goldberg (2007) and Soussa (2004). Brief previous warnings about the unsettled

state of affairs in cross-border banking appear in Goodhart (2005), Eisenbeis (2005), and Mayes

(2005). See in particular the analysis of the Nordea Bank, which is headquartered in Sweden but

operates in a number of other countries in the appendix to Mayes (2005).

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of current arrangements also fails from an efficiency standpoint. In 2003, the

Sveriges Riksbank took the same observation and stated the affect due to failure of

the current arrangement that:

“… if a cross-border [branch bank] were to fail, it is improbable that

either politicians or authorities in the respective countries would be willing

to risk taxpayers’ money to guarantee stability in countries other than their

own. This could prompt the concerned countries to try to ring-fence the

bank’s assets in their own country with a view to minimizing the costs to the

domestic economy, or not to intervene at all in the hope that other countries

in which the bank has a bigger presence feel forced to act. The result could

be a suboptimal resolution of the crisis that proves more costly or that

produces greater adverse effects for all the countries involved.”

Currently, banking institutions operating in different markets have to cope with

different national supervisory rules and practices. They have to commit extensive

resources to deal with numerous supervisors and differing supervisory

requirements, for example in the area of reporting. This entails administrative costs

without any added value and mitigates the cross- border banking failures.10

Finally, one can question whether the current arrangements provide for a

level playing-field between banking institutions.11 Cross-border banking

10 See Cerutti, Dell’ Ariccia, and Peria, “How banks go abroad: Branches or Subsidiaries?” J.

Banking & Fin., vol.31, Issue 6, 1669 (2007); George Kaufman, “Banking Regulation &

Foreign-Owned Banks” (2004).

11 For the following discussion of the EBC see Cihak, M. and Decressin, J., ‘The case for a

European Banking Charter’ IMF Working Paper, 2007.

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institutions have different home supervisors, depending on the Member State

where they have established their headquarters. These various supervisors may

have different views on major supervisory issues.

B. Proposed European Supervisory Architecture (ESA)

There are a range of views on how EU banking regulation and supervisory

structures should face up to the challenges of the 21st century. What’s more, these

opinions are not static, which makes for a complex situation. The de Larosiere

Group identified the relevant Basel Committee12 standards for microfinance

activities and develop additional guidance for micro prudential supervision.13 The

proposals advanced by the de Larosiere group provides a guidance, which is the

result of an analysis of the key issues and challenges faced by supervisors of

deposit taking EU banking institutions engaged in microfinance. The guidance is

not a summary of best practices, nor does it constitute new principles or revisions

to the core principles. However, it is intended to highlight the key differences

between the application of each core principle to traditional retail banking and

microfinance, pointing out areas that may require tailoring. Similarly, the Guidance

does not seek to reduce or supersede the discretion of national supervisors to act in

a manner that is consistent with their unique regulatory approach and their broader

12 See Generally Basel Committee on Banking Supervision (BCBS), 2008. “Principles for Sound

Liquidity Risk Management and Supervision”, See http://www.bis.org/publ/bcbs138.htm

13 See L. Papademos, “Financial stability and macro-prudential supervision: objectives,

instruments and the role of the ECB”, Speech of 4 September 2009.

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policy goals. The analyses conducted to develop the guidance greatly benefited

from the findings of the range of practice described in this proposal, which

provides background information on supervisory issues, practices and trends for

the regulation and supervision of microfinance.14 However, micro-prudential

supervision might conflict with the European Central Bank's role in monetary

policy or expose it to excessive political pressures. Additionally, creation of two

different authorities could result in a loss of information for both macro-

and micro-

supervision. In contrast as an advantage, providing the European Authority with

direct micro-prudential supervisory powers would solve co-ordination problems

and contribute to the effectiveness of macro-prudential supervision.

On the other hand of the spectrum, proposals deals with the potential

solutions, within the ambit of European System of Banking Supervisors (ESBS).

Additionally the de Larosiere group report suggest a new Regulation for Financial

Groups and also deal with Early Intervention Mechanism and Burden Sharing

Issues.

III. Potential solutions

A. European System of Banking Supervisors (ESBS)

The de Larosiere group’s recommendation proposes a new European System

of Banking Supervisors which suggests a voluntary agreement between member

14 See Jones, David S., and Kathleen Kuester King, “The implementation of prompt corrective

action: An assessment,” J. Banking & Fin. 19, 491–510 (1995).

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states. This includes that states should establish the ESBS coordinated by the EBA.

Additionally this report opines that ESBS should make up of national banking

supervisors for nationally operating banks. These national supervisors will form

colleges of supervisors for cross-border banks. Further the EBA shall coordinate

national supervisors and colleges of supervisors. However, the ESBS will operate

as independent, and follow the same governance and mechanisms, as the present

Eurosystem model.15

This report also suggests a significant step to provide open participation to

non-EU countries in the ESBS. The report classifies the supervision of cross-

border banks in three tiers. First to the day-to-day supervision, which requires

supervisors to be close to a business, will remain to national supervisors. Second,

for the decision level aspect, it suggest that strategic decisions affecting the entire

group will be supervised by colleges of supervisors. Third, a noteworthy one, that

it provide a legally binding supervisory powers for each cross-border institution.

Additionally report enhance the role of EBA by enhancing its coordination in

supervision and information sharing. Report also provides a further function of

EBA, that EBA should participate within each college of supervisors and define

the issues. It shall have the final legally binding decision in the college. It also

gives the duty on EBA to coordinate early intervention mechanisms.16

Report also mandates a need for new regulation for MNBs. This is required

in order to define the responsibilities and powers of the parent company,

15 Detragiache, E., P. G. Garella, and L. Guiso, “Multiple versus Single Banking Relationships:

Theory and Evidence,” J. Fin. 55, 1133-1161(2000).

16 Commission Decision 2004/10/EC of 5 November 2003, “Establishing the European Banking

Committee”, O.J. L 003 of 7 January 2004, p. 0036-0037.

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subsidiaries/branches. It is also required for institutional mechanisms for early

intervention. This will allow neutrality towards the organizational structure of a

banking group (branches vs. subsidiaries) and better and clearer allocation of

responsibilities between national supervisors, colleges and the EBS.17 The main

policy objective of the proposal is to enhance cross-border supervisory co-

operation for supervisory action to be perceived as unified by virtue of the

corresponding function of EBA within the ESBS regime. The present discussion of

the report identifies some of the key issues that provide a potential solution by the

role of ESBS and EBA in managing crises involving cross-border banks.

The de Larosiere group report makes each national supervisor jointly

accountable for the supervision of the cross-border groups operating in their own

territory. It suggests them to participate in the appropriate colleges of supervisors.

This would make all parties (participant) internalize the external effect caused by

(the lack of) supervision, thus avoiding regulatory arbitrage. By virtue of that the

risk of home country bias will be reduced and it will also provide the right

incentives to fully cooperate in and exchange all relevant information. As

independent, the ESBS (including the EBA) will be accountable to political

authorities for financial stability and crisis prevention and management.

According to the proposal, all powers not delegated to the EBA will remain

in the hands of national authorities. However it will be exercised within the college

of supervisors. College of supervisors shall take the relevant decisions relating to

17 See art. 105 of the Treaty establishing the European Community, Consolidated Version O.J.C

325 of 24 December 2002, p. 0001-0184 and art. 25 of the Protocol on the Statute of the

European System of Central Banks and of the European Central Bank, O.J.C 191 of 29 July

1992, p. 0068-0079.

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strategic, consolidated supervision of the group, under the coordination of the

EBA. The EBA will retain legally binding final powers in the case of a dispute

between national supervisory authorities within the college.18 Regular meetings of

the college of supervisors would take place in the Member State of the parent

institution of the cross-border banking group (home Member State). Colleges of

supervisors will have binding supervisory powers, performed by the national

supervisors within the college. In the case of dispute between national supervisors,

the relevant decisions will be taken by the representatives from the EBA. Banks

operating domestically will remain under the supervision of national authorities.19

In all cases, report impose the compliance law based on the European

System and suggest that European System of Banking Supervisors20 should act

according to existing EU and national legislation and within the EU institutional

framework. This report also gives various alternative routes and options as a

solution in case of a lack of European political consensus, proposes to the

European Commission for an enhanced cooperation.

18 The Transformation of the European Financial System, European Central Bank, Frankfurt,

2003, See http://www.ecb.int/pub/pdf/other/transformationeuropeanfinancialsystemen.pdf

19 Wymeersch, E. (2005), The future of financial regulation and supervision in Europe, See

SSRN: http://ssrn.com/abstract=728183.

20 See Dirk Schoenmaker and Sander Oosterloo, “Cross-Border Issues in European Financial

Supervision”, See nt. 4, p. 11 referring to J. Dermine, “Banking in Europe: Past, Present and

Future” in Vitor Gaspar, Philipp Hartmann and Olaf Sleijpen (eds.), The Transformation of the

European Financial System, European Central Bank, Frankfurt, 2003, See

http://www.ecb.int/pub/pdf/other/transformationeuropeanfinancialsystemen.pdf.

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B. New Regulation for Financial Groups

In order to achieve full harmonization this report supports that European

Commission should propose a harmonized regulation for MNBs. This regulation

will harmonize risk management rules and define the responsibilities and powers

of the parent company and the branches\subsidiaries within the specific context of

the banking sector and of a more efficient centralized supervision. It will also grant

a sector-specific form of protection to minorities and creditors. In addition, it will

set out the mechanisms for early intervention and crisis management. 21However

this new regulation on financial groups will set conditions for the recognition of the

parent company's management powers over the whole group and it will include

asset transferability. As a result of this change, branch and subsidiary structures

will become relatively fungible. Furthermore new regulation will also define ex

ante rules on deposit insurance and lender of last resort. This will provide a

clear

allocation of responsibilities, thus avoiding regulatory arbitrage and reducing

systemic risk.

An integrated European supervisory model will support for a European

Banking Group as it will set out the core regulatory framework for cross-border

banking groups in Europe. Further rules should be adopted by the EC, which is a

second level regulation within the Lamfalussy regulatory architecture (as in the

21 See Niemeyer, Jonas, “The Regulatory Framework for Banks in the EU: An

Introduction,”Eco. Rev. 2(2006).

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cases of the Market Abuse Directive and Markets in Financial Instruments

Directive {MiFID}).22

The need of new regulation also supported as part of an effort to encourage

the development of a single economic market. Earlier in this same line the Second

Banking Directive (1988) as modified in 1995 established three principles –

harmonization, mutual recognition and home country control. These principle

states as “Harmonization requires that a minimum set of uniform banking

regulations be adopted across the Union. Mutual recognition means that during the

transition to a single market, member countries would honor the regulations and

policies of the other member states. Finally, regulation and supervision by the

“home country” (country of charter) would have precedent over regulation and

supervision by a “host country.”23 Together with the concept of a single license,

these three principles mean that, once a banking institution receives a charter from

an EU member state, it would be permitted to establish branches anywhere within

the EU without the necessity of review by the regulators in the host countries into

which it expanded.” 24 On the other hand, the proposed regulation will impose an

additional regulatory cost on subsidiary structure. This will hinder the most

22 Schoenmaker, D. and Oosterloo, S., “Financial Supervision in Europe: Do we need a New

Architecture”, ELEC, (2006).

23 See David Mayes & Jukka Vesala, “On the Problems of Home Country Control” at 19–21,

Bank of Finland, Studies in Economics and Finance 20/98 (1998).

24 Regardless, of the form of entry, however, the Core Principles for Effective Banking

Supervision (Basle Committee on Banking Supervision (1997)) clearly indicates that supervision

is to be “effective” within the EU, regardless of whether it is provided under the auspices of the

home or host county.

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efficient allocation of resources through the internal capital market of the banking

groups. Report proposed that new substantive regulations should be applicable to

cross-border banks on a voluntary basis. But it can also be argued that a mandatory

regulation would be better suited for the purposes of leveling the playing field and

avoiding regulatory arbitrage.

There are also certain arguments which provide grounds for the proposed

European Commission. First argument suggests that the legal instrument of a

directive is not appropriate for this purpose, as discretion is left to Member States

in implementation. This argument further suggests that a regulation would be

better suited, if the relevant rules would be directly applicable and uniform in all

Member States. The ESBS will clearly benefit from regulatory uniformity and the

EBA could further enhance it by adopting common policies, standards and

interpretations of harmonized supervisory rules which would be binding for all

members of the supervisory network. In order to achieve full harmonization,

common implementing measures could be provided by an EC regulation (in line

with what occurred in the cases of the Market Abuse Directive and MiFID).25

As per the recommendation in the report, European Banking Groups

Regulation (EBGR) should apply to banks with at least one branch or subsidiary26

in a Member State different from the home Member State. No distinction should be

made between branches or subsidiaries in order to achieve neutrality with respect

25 Majaha-Jartby, Julia, and Thordur Olafsson, “Regional Financial Conglomerates: A Case for

Improved Supervision,” 05,124(2005) (IMF).

26 See Cerutti, Dell’ Ariccia, and Peria, “How banks go abroad: Branches or Subsidiaries?”, J.

Banking & Fin., vol. 31, Issue 6, 1669 (2007); George Kaufman,“Banking Regulation &

Foreign-Owned Banks” (2004).

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to the legal structure of the group. This regulation will guarantee an enhanced role

of coordination for the parent company towards its subsidiaries/branches. This

means that the group as a whole must make up a logical and economic unit.

However, individual companies must retain a certain degree of independence, i.e.

the parent company may not treat its subsidiaries merely as “departments”, thereby

completely, or even significantly, ignoring the interests of the subsidiaries.27

The management of the parent company should be at the centre of group

planning and decision-making. However, there is no need for exact and immediate

compensation for the unequal burdening of an individual subsidiary. Compensation

might even occur years later and indirectly, through the benefits to the group as a

whole with the individually burdened subsidiary being a part of it. The relevant

interests, in fact, shall always be assessed on a mid to long-term basis. However,

even in the pursuit of the group interest as a whole, individual subsidiaries may not

be either unreasonably burdened or arbitrarily advantaged at the expense of other

group members. In any case, the burden of individual subsidiaries may never

exceed its capacity to pay or jeopardize its soundness.28

Within this framework the parent company shall be free to enact its role of

direction and coordination of the group as a whole, thereby enabling the effective

27 Global Bank Insolvency Initiative, “Legal, Institutional, and Regulatory Framework to Deal

with Insolvent Banks”; Financial Stability Forum, “Guidance for Developing Effective Deposit

Insurance Systems” at 8–11 (September 2001); IMF Legal Department, “Orderly & Effective

Insolvency Procedures” (1999).

28 Degryse, H., and S. Ongena, The Impact of Competition on Bank Orientation, J. Financial

Intermediation 16, 399-424(2007).

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functioning of the ICM within the MNB. This would allow group-wide, centralized

risk management and compliance with capital requirements.29

The regulation would allow a uniform set of rules creating a level playing

field, ensuring the effective functioning of the ICM and achieving neutrality with

respect of the legal structure of an MNB. On the other hand, harmonization

proposed for the bank includes the information sharing requirement. However

proposed report lack the uniform application of this information sharing issue due

to the privacy laws in different countries. This report fails to provide that how to

resolve this issue. As concerned by the regulators, secrecy legislation remains an

impediment in certain circumstances and jurisdictions. In this case, while

recognizing the legitimate issues and reasons for protecting consumer privacy will

affect the mechanism of information sharing requirement for harmonization,

because such secrecy laws should not impede the ability of supervisors to ensure

the safety and soundness in the international banking system.

Additionally, report fails to address that how will the new regulation face the

challenge of diverse regulations in different EU countries. For an example, in

England and Wales, Financial Services Authority30 regulates and supervises all the

financial services including banking. Likewise other EU territories have different

set of regulations. This report fails to disclose that how the uniform regulation shall

take place in this diverse regulatory region.

29 See Henk Brouwer, Gerbert Hebbink & SandraWesseling, “A European Approach to Banking

Crises,” in David Mayes & Aarno Liuksila, eds., Who Pays for Bank Insolvency? at 211 (2004);

30 FSA, available at http://www.fsa.gov.uk/

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C. Early Intervention Mechanism and Burden Sharing Issues

The UniCreditGroup report gives stronger emphasis to trigger mechanisms

for automatic adjustment and early intervention mechanisms in order to minimize

the need to resort to public money. A reform of Deposit Guarantee Schemes

facilitates this approach.31 The current financial turmoil has shown the importance

of defining a consistent regulatory framework for crisis prevention, management

and resolution. A macro-supervision scheme, such as the one proposed by the de

Larosière Group, represents from this point of view a crucial element that with

respect to micro-level, a uniform framework should be applied across countries

and developed on the assumption of an MNB being a single undertaking. This

framework generally addresses, inter alia, the crucial issue of negative spillovers

arising in the event of a branch of a foreign institution going bankrupt and the

Deposit Guarantee Scheme (DGS)32 of the host country. However, it is inadequate

to fulfill its obligation towards foreign depositors (the small country issue). Any

proposal relating to crisis prevention generally implies an a priori consideration on

how to deal with the trade-off between moral hazard for banks and effectiveness

in crisis management.

In the same line a ‘Prompt Corrective Action’ (PCA) scheme as suggested,

will reduces the risk of bank failure by requiring action to be taken in the early

stages of financial distress to try to stop the problem from escalating. In the case of

31 Evidence from Foreign Bank Entry in Emerging Markets, Review of Finance 13, 181-223.

32 See Michael Krimminger, “Deposit Insurance and Bank Insolvency in a Changing World:

Synergies & Challenges,” Current Developments in Monetary and Financial Law, IMF (2004)

available at www.imf.org.

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an ailing MNB, the EBA is empowered with the authority to nominate a task force

for corrective action.33

The task force will be formed and function to propose a plan for the

reorganization and the winding-up of the banks belonging to a cross-border group

mobilizing private resources and deposit guarantee funds. This will be

implemented in order to minimize the eventual need for public money. Deposit

guarantee funds will have to balance the costs of early intervention with the risk of

higher costs in the case of bankruptcy. The task force shall have powers to trace

asset transfers within subsidiaries.34 The

de Larosiere Report partially address

the

problems like the Obstacles to asset transferability between group entities , because

it do not allow for fully consolidated supervision, centralized compliance and risk

management of cross-border banking groups. However, asset transfers still face

several obstacles in the company, insolvency and banking

laws of several Member

States, as harmonization is still lacking. Moreover, differences are found between

the subsidiary and the branch structures that will affect the compliance

requirement. For more effective and timely early intervention in crisis

management, clear-cut trigger events should be established, which should

focus not

only on solvency but also on liquidity. Indeed, recent bank failures have shown that

the borders between liquidity and solvency crisis are often blurred,

as liquidity

crises might rapidly turn into solvency crisis, especially in listed

banks. In order to

avoid moral hazard, however, no clear ex ante rules should address the bail-out of

33 See Cihàk, M. and Decressin, J. (2007), “The Case for a European Banking Charter”, IMF

Working Paper, WP/07/173.

34 Nguyen, G., National Bank of Belgium, Fin. Stability Rev., 89–102(2008).

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an insolvent bank with public funding, which shall remain a political issue to

be

dealt with at national level.

Centralized supervisory system, such as the one proposed here in the report,

is in itself a fundamental improvement on the status quo. However, a joint reform

of national DGSs would make it more effective and credible. The debate on the

reform of banking supervision generally falls short of also discussing a reform in

DGSs. The possible reforms that have been investigated so far mainly concern the

harmonization of DGSs across Europe.35

It should also be clear that, regardless of the type of reform, a DGS may not

be sufficient in facing systemic events, such as diffuse episodes of financial

distress or the failure of a large banking group. Both banking supervision and

DGSs have implicit costs and benefits. Banking supervision helps maintain

financial stability but it can be relatively more costly, both for banks and taxpayers.

DGSs can help prevent and contain the overall costs of a crisis but they have the

downside of engendering moral hazard in normal times.

A well-designed and comprehensive DGS reform in the banking sector has

not yet been proposed, probably due the complexity of the issue. In this case, what

concerns is the definition of clear rules of burden sharing between countries. Some

burden sharing rules should have been proposed in the literature.36A feasible

35 See Dr. Alan Bollard, Governor, Reserve Bank of New Zealand, in address to Trans-Tasman

Business Circle in Sydney, Australia, August 11, 2004; See also Basel Concordat (1983); The

Supervision of Cross-Border Banking (1996); and Supervision of Financial Conglomerates

(1999).

36 Ongena, S., and D. C. Smith, The Duration of Bank Relationships, J. Fin. Eco. 61, 449-

475(2001).

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alternative is, rather, to leave the determination of burden sharing, when fiscal

resources are involved, to the negotiation of national authorities. If there is no

government agreement on burden sharing or the common decision of the EBA and

relevant national governments is to let the group fail, national bankruptcy rules

should be applied and the EBA should also provide information to national judicial

courts.37 Due to remarkable differences in domestic bankruptcy laws, it is highly

unlikely, at least at this stage, that harmonization in bankruptcy regulations across

Europe will occur. Moreover, Davide Alfonsi discussed38 the various issues and

problems of this report in European parliament on Oct. 7, 2009 as:

“Once more, we come back to a problem of institutional architecture, which

in this case can involve also the creation of uneven playing fields between

Europe and the rest of the world. Our obvious recommendation is that all

international institutions entitled with designing the new financial

architecture work closely together and that impact and spill-over effects of

the whole set of new rules be carefully assessed before implementation.”

On December 1, 2009 on the same lines, European Banking Federation gives

support with the key features39 to the European Commission proposals on the

reform of the European supervisory architecture.

37 Hardy, D.C. and Nieto, M.J., “Cross-Border Coordination of Prudential Supervision and

Deposit Guarantees”, IMF WP/08/283.

38 Davide Alfonsi, EPFSF Lunch Discussion, European Parliament, Brussels “Financial

supervisory architecture”, Oct 7, 2009.

39 EBF position on the EC proposals on the reform of the ESA, Nov. 2009, available at

http://www.ebffbe.eu/uploads/documents/positions/FinMark/D1839C2009%20_CESR_Consulta

tion_on_Trade_Repositories_in_the_European_Union.pdf

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V. Conclusion:

The focus of UniCreditGroup report has been on the structure of supervisory

and regulation for banking groups in cross-border banking through branching with

particular emphasis on the EU and the related aspects of failure resolution and

coordination when financial problems arise. The present issues reforming cross-

border banking is important and deserves attention because the impact of resulting

crisis. This report has identified a number of issues and concerns about the present

system design that are likely to result in higher than necessary mechanism for

cross-border banking. At present date, substantial progress appears to have been

made in the EU in dealing with them. Indeed, as both cross-border branches and

subsidiaries increase in importance in host EU countries. Implementing these

proposals would go a long way towards mitigating or possibly even eliminating

many rules of the EU regulation and related supervisory problems inherent in the

current multiple and confusing EU banking regime and across countries.

Finally, UniCreditGroup report propose a mechanism to put such a scheme

into place quickly in the case where a cross-border banking organization seeks to

take advantage of the liberal cross-border branching provisions in the single

banking plate-form available to banks in the EU.