Brussels famously shuts down completely in August. There are no Commission meetings, no Parliament sessions and no backroom dealings between national diplomats in the Council. There are no press conferences, no announcements and even the ranks of Brussels’ 15,000 lobbyists appear to have thinned out. In other words, it is the perfect time to either take a holiday or spend an hour or two leafing through the latest International Monetary Fund report on the Eurozone. I chose the latter option, and having waded through almost 70 pages of colourful little graphs and bone-dry economical analysis I thought I might as well share some of the highlights.

Perhaps the most interesting issue raised by the Washington-based institution concerns the threat to financial stability in the Eurozone. The IMF’s experts point out that the Eurozone (the same might just as well be said about the EU as a whole) is prone to a very peculiar risk deriving from the gap between market integration on the one hand and the lack of supervisory integration on the other hand.

Put more simply, the worry is that banks and other financial institutions are merging and co-operating across borders, raising the risk that negative events will spill over from one banking market to another, while financial supervisors remain stuck within their national borders.

The IMF writes: "The potential for extreme events to spill over from one bank to another appears to have increased, both among domestic banks and across the border. The number of significant cross-border links is already larger than the number of significant links among domestic banks, adding another piece of empirical evidence supporting the need for greater cross-border supervisory co-operation in the EU."

Alas, supervisory co-operation is moving forward at a glacial pace only. Though the EU’s recent Solvency II proposal aims to strengthen the powers of an insurer’s home country supervisor, there is no similar initiative in other financial services sectors. In fact, many member states remain deeply opposed to any move that would curb the powers of their national regulator - a necessary step for establishing greater cross-border oversight.

For banks and other service providers, the Balkanised nature of financial supervision in the EU has been a long-standing disappointment. They complain above all about the cost of having to comply with so many different regulators and jurisdictions. The IMF has now served a timely reminder that the current state of affairs may pose an altogether more serious threat - by increasing the risk that a local problem will spread quickly, and unchecked, across the Union’s entire financial system.

August 1st, 2007 in Economic policy | Permalink