Addressing the Financial Crisis: The EU’s Incomplete Regulatory Response. Egmont Paper No. 39, December 2010

Verhelst, Stijn. (2010) Addressing the Financial Crisis: The EU’s Incomplete Regulatory Response. Egmont Paper No. 39, December 2010. [Policy Paper]

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Abstract

The financial crisis revealed numerous shortcomings in the financial regulatory framework. In response, regulators worldwide started taking measures to tighten their grip on the financial sector. This paper highlights and evaluates the EU’s efforts to address the shortcomings of financial regulation. The EU committed itself to a significant regulatory reform. Its goal is to achieve a sound and secure financial system that operates in a single market.The author finds that in terms of scope, the European response is rather comprehensive. The EU has agreed on a reform of the supervisory framework, which will lead to the creation of new European supervisors. In addition, the EU is taking measures to restore confidence in the financial sector, improve financial institutions’ risk management and address illicit behaviour in the financial markets. Financial institutions, markets and products will face more comprehensive rules as a consequence of EU measures. Some will even be subjected to substantive EU rules for the very first time. Despite the quite ample scope, EU initiatives stop short of a radical overhaul of financial regulation. They rather pursue more moderate changes. Furthermore, the EU priorities sometimes appear to be guided by popular purposes, rather than genuine needs. A lack of focus, combined with the EU’s lengthy legislative process, could have harmful consequences. Hence, Initiatives addressing the vital failures of the regulatory framework should be brought forth. This notably concerns future crisis management arrangements. The author argues that the current proposals risk being insufficient to prevent the uncoordinated national responses experienced during the financial crisis. Even if future reforms would prove to be modest, it would not alter the fact that the financial crisis is leading to a considerable increase of European financial regulatory integration. Nonetheless, the EU needs the support of both its Member States and the international community. If not, it will prove impossible to obtain the safe and secure European financial system the EU is seeking. It should be clear that the EU’s regulatory reform will not render the financial sector risk free and nor should it aim to do so. Some risk-taking is indispensable, as eliminating it would undermine the financial sector’s growth supporting potential. Yet, regulators must prevent the financial sector from repeating the mistakes of the past. Inevitably, misplaced financial euphoria and the resulting recklessness will reoccur in the future. Policymakers need to be better equipped to prevent, detect and deal with these problems. The lessons of the financial crisis mustn’t go to waste. As is argued in the paper, the time to act is now.

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