Nicolas Véron

Breaking the Deadlock: A Single Supervisor for Europe's Capital Markets Union

Bruegel today published Breaking the Deadlock: A Single Supervisor to Unshackle Europe's Capital Markets Union, a book-length essay in which I argue that supervisory integration is the key to progress towards the now decade-old vision of a capital markets union for the EU. Beyond making the case for capital market supervisory integration as a priority project, I contribute a detailed analysis of current supervisory structures and how they could be unified into a single entity based on the existing European Securities and Markets Authority (ESMA). 

Download the publication here if the above link does not work. 

EU Banking Sector & Competitiveness: Framing the Policy Debate

The European Parliament today published a study in which Juan Mejino-López and I contribute to the debate on EU competitiveness and the role of the banking sector. Among other things, we highlight the extent to which undercapitalization in the early 2000s hurt the European banking sector's global competitive position in the following decade. The same mistake should not be repeated now. We also compare capital requirements and actual capital levels between the largest EU and US banks, and find that they are not currently less demanding in the US - contrary to what is often heard in Europe. 

Click here to downlad the study in case the above link is broken.

Updated assessment: Memo to the commissioner responsible for financial services

Bruegel recently published this short memo in which I update the slightly longer piece co-authored last year with Silvia Merler, intended for the new European Commissioner in charge of financial services policy. This update takes into account the initial announcements of the new von der Leyen Commission as well as the election of Donald Trump in the United States. It is part of a broader holistic look at the European Commission's policy platform coordinated by Heather Grabbe and Jeromin Zettelmeyer at Bruegel. 

The European Union’s major achievements in the past decade include the successful implementation of European banking supervision and the recent establishment of a new EU agency that promises to greatly increase the effectiveness of anti-money laundering supervision (1). But the goal of a single market in financial services, identified by Letta (2024) and Draghi (2024) as a critical component of their broader ambitions for the EU, remains distant. Banking union is unfinished in the absence of an integrated crisis-response framework, which itself cannot happen without changes to the regulatory treatment of banks’ sovereign exposures. The separate project of a capital markets union, trumpeted a decade ago by then European Commission president Jean-Claude Juncker, has failed to deliver anything big so far.

What changes as a result of Trump? Trump is likely to push financial deregulation in the United States, leading to lobbying from European banks to lower capital requirements and from multiple stakeholders to reduce the burden of sustainability-related reporting.

The European Commission’s approach. The objective for Maria Luís Albuquerque, the Commissioner for Financial Services and the Savings and Investments Union for 2024-2029, is to make genuine progress towards a better EU financial system, relabelled the Savings and Investment Union. She has leeway to choose her reform priorities. She comes to the job with solid experience of her portfolio, and therefore more personal agency than arguably any of her recent predecessors.

Assessment and updated recommendations. Calls to lower capital requirements should be resisted: the EU has paid an extremely high price for its past lapses in banking regulation. Some of the ideas being debated – such as the harmonisation of corporate insolvency law or taxation of investments, not to mention pension regimes or mortgage frameworks – are seductive but provide limited prospects of transformational EU legislation in the short or even medium terms.

Reform potential is greatest in terms of reducing the mind-numbing complexity of the current supervisory environment, which in turn will allow regulatory complexity to be reduced. Over a hundred different bodies in the EU carry out banking, insurance, pensions, audit, AML and macroprudential supervision, as well as mandatory deposit guarantee schemes and resolution authorities, each with their own requirements and idiosyncrasies. That is far too many. Greater capital markets policy integration at EU level is the only credible way to structurally alleviate the regulatory burden over the medium term without increasing systemic risk.

Reform impetus should therefore be concentrated first on an overhaul of capital markets supervision. The best design would be to restructure the Paris-based European Securities and Markets Authority (ESMA) by streamlining its governance and creating ESMA offices in EU countries. These offices would not be separate decision-making entities but would provide bridges to local market participants and their environments, in place of the current national authorities, after an inevitable transition period. Moreover, some of the numerous supervisory mandates in capital markets supervision could be led from an office other than Paris without jeopardising consistency of implementation and enforcement. That could facilitate national buy-in without sacrificing supervisory consistency.

This ‘multicentric ESMA’ concept was hinted at in July 2024 by the French Council of Economic Analysis and the German Council of Economic Experts (Landais, Schnitzer et al, 2024). European Central Bank president Christine Lagarde (2024) has also spoken about it. A reform of this kind is not easy but would be achievable if there were enough pressure from heads of state and government. If adopted quickly, it could in turn open space for a renewed push to complete the banking union in the second half of the Commission’s five-year term.

Notes and references

(1) The EU Anti-Money Laundering Authority (AMLA); see https://www.amla.europa.eu/index_en.

Draghi, M. (2024) The future of European competitiveness, European Commission, available at https://commission.europa.eu/document/download/97e481fd-2dc3-412d-be4c-f152a8232961_en

Lagarde, C. (2024) ‘Follow the money: channelling savings into investment and innovation in Europe’, speech at the 34th European Banking Congress, 22 November, available at https://www.ecb.europa.eu/press/key/date/2024/html/ecb.sp241122~fb84170883.en.htm

Landais, C., D. Sraer, M. Schnitzer, V. Grimm, U. Malmendier, A. Truger and M. Werding (2024) ‘Enhancing EU capital markets’, joint statement of the French Council of Economic Analysis and the German Council of Economic Experts, available at https://www.bmwk.de/Redaktion/DE/Downloads/C-D/cae-svg-joint-statement-enhancing-eu-capital-markets.pdf

Letta, E. (2024) Much More Than a Market, available at  https://www.consilium.europa.eu/media/ny3j24sm/much-more-than-a-market-report-by-enrico-letta.pdf 

Financial Statements - Episode #100: The Trump administration's policies and global financial risk

Today was the 100th and - as it happens - last episode of the Financial Statements series, which started in June 2020 during Covid-19 lockdown. It will be replaced with a new PIIE series, in which we will experiment a different format and theme.

In this session, I hosted the London School of Economics's legendary Charles Goodhart and Agathe Demarais of ECFR to reflect on the potential global financial risks associated with the Trump administration's policies.

Financial Statements: Is "Twin Peaks" the future of financial supervision?

In 1995, Michael Taylor authored a landmark essay on the so-called Twin Peaks model, in which prudential supervision and conduct-of-business supervision are carried out by separate authorities. In today's session, I hosted him and former Bank of Japan Executive Board member Shimizu Tokiko to discuss the Twin Peaks idea and experience with it so far. 

Financial Statements: The present and future of fast payment systems

In yesterday's session, I hosted Harish Natarajan of the World Bank and Othon Moreno of the Bank of Mexico to review the development of fast payment systems, particularly in developing and emerging economies.

Financial Statements: Should we care about who owns audit firms?

In the episode on Thursday 16 January, I hosted Maria Borysoff of George Mason University and Liza McAndrew Moberg (formerly at the U.S. Public Company Accounting Oversight Board), to look at the emerging trend of accounting firms accepting capital injections by private equity firms, mostly for now in the United States. 

PIIE Tracker: China's share of companies in private sector saw small uptick in second half of 2024 after years of decline

This is the latest update of the semi-annual PIIE tracker jointly prepared with Tianlei Huang, published on January 9. 

The share of the private sector among China's largest listed companies declined continuously for three years, from 55 percent in mid-2021 to 33 percent in mid-2024. In the second half of 2024, however, PIIE's half-yearly tracker for this metric showed a slight uptick, with the private sector’s share rising to 34 percent by the end of December.

The tracker is based on the methodology defined in a PIIE Working Paper published in 2022. The private sector is defined restrictively as firms with less than 10 percent state ownership. The state sector includes both mixed-ownership enterprises (MOEs), in which the state owns between 10 and 50 percent, and majority-owned state-owned enterprises (SOEs). The tracker shows relative shares of aggregate market capitalization of the top 100 listed mainland Chinese companies ranked by market capitalization, irrespective of whether they are listed domestically or overseas. It thus filters out any general market movements that affect the private and public sectors identically.

In the above-mentioned Working Paper, we had cautioned when observing the initial dip in 2021 that it was “conceivable that the 2021 decline we observed in private-sector market caps could mark the start of a more long-lasting trend reversal. Taking that as a baseline scenario would be adventurous, however, given the longstanding vigor of China’s private sector despite a policy environment that has not been tilted in its favor.”

As it turned out, the end-2021 decline was more than a fluke. However, we also advise against over-interpreting our most recent observation, despite its positive direction. What remains most striking in the 2020s so far is the uninterrupted decline for three years (at our half-yearly pace of observation) of an indicator that had risen tremendously and almost continuously throughout the previous decade. If the private sector’s share continues to rise through mid-2025, that may signal a trend reversal from the slump of the past three years. But for now, it is too early to interpret the latest data with confidence.

Note: We spotted minor errors in our earlier dataset in mid-2023 and mid-2024, which have now been corrected. They are too small to affect the chart in a visible way.

This is the latest update of the semi-annual PIIE tracker jointly prepared with Tianlei Huang, published on January 9. 

The share of the private sector among China's largest listed companies declined continuously for three years, from 55 percent in mid-2021 to 33 percent in mid-2024. In the second half of 2024, however, PIIE's half-yearly tracker for this metric showed a slight uptick, with the private sector’s share rising to 34 percent by the end of December.

The tracker is based on the methodology defined in a PIIE Working Paper published in 2022. The private sector is defined restrictively as firms with less than 10 percent state ownership. The state sector includes both mixed-ownership enterprises (MOEs), in which the state owns between 10 and 50 percent, and majority-owned state-owned enterprises (SOEs). The tracker shows relative shares of aggregate market capitalization of the top 100 listed mainland Chinese companies ranked by market capitalization, irrespective of whether they are listed domestically or overseas. It thus filters out any general market movements that affect the private and public sectors identically.

In the above-mentioned Working Paper, we had cautioned when observing the initial dip in 2021 that it was “conceivable that the 2021 decline we observed in private-sector market caps could mark the start of a more long-lasting trend reversal. Taking that as a baseline scenario would be adventurous, however, given the longstanding vigor of China’s private sector despite a policy environment that has not been tilted in its favor.”

As it turned out, the end-2021 decline was more than a fluke. However, we also advise against over-interpreting our most recent observation, despite its positive direction. What remains most striking in the 2020s so far is the uninterrupted decline for three years (at our half-yearly pace of observation) of an indicator that had risen tremendously and almost continuously throughout the previous decade. If the private sector’s share continues to rise through mid-2025, that may signal a trend reversal from the slump of the past three years. But for now, it is too early to interpret the latest data with confidence.

Note: We spotted minor errors in our earlier dataset in mid-2023 and mid-2024, which have now been corrected. They are too small to affect the chart in a visible way.

Financial Statements: Bpifrance's experience of promoting high-growth firms

In yesterday's session, I hosted Arnaud Caudoux of Bpifrance, and Josh Lerner of Harbard Business School to discuss this idiosyncratic case of a national government-owned business-promotion bank. 

Financial Statements: Lessons from the Basel Committee's assessments of individual jurisdictions

In this week's session (November 25), I hosted Stefan Ingves and Patrick Honohan, the former central bank governors of Sweden and Ireland respectively, for a deep dive on the Regulatory Consistency Assessment Program of the Basel Committee on Banking Supervision.

Financial Statements: Will China's most dynamic companies keep listing outside the mainland?

In today's episode, I hosted Guiying Laura Wu of Nanyang Technological University and Wendy Liu of J.P. Morgan to discuss the prospects for Chinese corporate listings outside of the mainland in the evolving regulatory and geopolitical context. 

Main financial services themes for European Commissioner designate Maria Luís Albuquerque

This blog post was published by Bruegel on 31 October, ahead of Ms Albuquerque's hearing at the European Parliament on 6 November.

Just as it was five and ten years ago (1), the dominant challenge for the European Union’s new financial services commissioner – or to give the full title, commissioner for financial services and the savings and investments union – will be to advance the ongoing transition from 27 national financial systems towards a single European financial system (Merler and Véron, 2024). That is desirable on grounds of economic efficiency, investment capability and, as the euro-area crisis demonstrated, financial stability in the euro area and by implication in the EU as a whole. 

Recent EU parlance refers to this ambition as the Savings and Investments Union (2), encompassing both the completion of the banking union – defined as breaking the bank-sovereign vicious circle, initiated a decade ago, already transformative but still unfinished (Véron, 2024a) – and the establishment of a capital markets union (CMU), a loosely defined expression coined by then Commission president Jean-Claude Juncker in 2014. 

Capital markets supervisory integration

CMU is arguably the most immediate issue on the commissioner’s agenda. The associated legislative projects so far have been either of limited impact or overly ambitious, such as attempts to harmonise policies that member states have not yet opted to pool at European level, including taxation, insolvency law, pension finance and housing finance, not to mention steps towards fiscal union.

As suggested a year ago by European Central Bank President Christine Lagarde, capital markets supervision is the one area of CMU in which transformative reform is achievable and should be prioritised (Lagarde, 2023). A reform of the European Securities and Markets Authority (ESMA) was unsuccessfully attempted by the Juncker Commission, but a renewed effort now would be more promising (Véron, 2024b). It should be focused on ESMA and not its sister agencies for banking and insurance, to prevent a coalition of opponents driven by concerns not directly related to CMU. Lagarde summarised that vision as a “European SEC” with reference to the US Securities and Exchange Commission, a broadly effective supervisor that has shaped American capital markets since its establishment in the 1930s.

Implementing that vision of capital markets supervisory integration should combine the broadening of ESMA’s scope of authority with root-and-branch reform to transform ESMA into an independent, effective and market-conscious supervisor, which it currently is not to a sufficient extent. This should include governance and financing arrangements broadly aligned with those adopted for the new EU Anti-Money Laundering Authority (AMLA) (3), currently in build-up phase. It should also include a new supervisory concept which, given the wholesale nature of most areas of capital markets supervision, must be less dependent on national authorities than those adopted for AMLA or for European banking supervision.

In line with the new Commission’s aim of reducing complexity and better serving the day-to-day needs of business, the best design would be one in which the reformed ESMA is the only supervisor of the areas of capital markets for which it is empowered, avoiding the pitfalls of over-centralisation by operating through a network of offices in the relevant member states. Given the multiplicity of supervisory mandates that ESMA would gradually assume, some of these offices could take an EU-wide lead for a given mandate.

This unitary but decentralised design has been recommended in July in a joint report by the French Council of Economic Analysis and German Council of Economic Experts (Landais, Schnitzer et al, 2024). It would combine the best of both worlds: consistency and predictability of practice, in contrast to the present divergence of national approaches that perpetuates market fragmentation; and appropriate familiarity and proximity with local market realities, legacies and practices. 

Because supervision shapes markets, its streamlining and integration into a single organisation could have a catalytic impact on the dynamics of market integration at a European scale, in line with the EU agenda of open strategic autonomy. It would also represent major simplification compared to the current jumble of competing centres of decision-making, once the inevitably complex transition from the current regime is completed. 

Completing the banking union

Given the dominant role of banks in the EU’s financial system, completing the banking union may be viewed as even more important than capital markets supervisory integration, but progress towards its completion also appears more difficult to achieve rapidly. The legislative proposal known as Crisis Management and Deposit Insurance (CMDI), an attempt at incremental improvement, has been bogged down in crippling compromises among member states. 

The Council position on CMDI, adopted in June, appears worse than the status quo (4). It would reverse the Commission’s proposed streamlining of deposit seniority, introduce further incentives to handle bank failures under national rather than EU law and undermine the governance of the EU Single Resolution Board (SRB). CMDI did not address many of the banking-union incompleteness challenges to start with and may now be beyond repair. If so, the new commissioner should withdraw it. 

Instead, the Commission should reframe the agenda for banking union completion by explicitly acknowledging the twin challenges of concentrated domestic sovereign exposures and of an ill-designed crisis intervention framework, both of which perpetuate the bank-sovereign nexus within the monetary union (5). 

Concretely, this means promoting regulatory treatment of sovereign exposures such as concentration charges (Véron, 2017) on banks’ capital (set at zero if the exposures are sufficiently diversified), together with a fully integrated framework for crisis intervention to replace the present halfway house (including mandatory deposit insurance that would be managed by a single European organisation, presumably a reconfigured SRB). The shift from an exclusive focus on the crisis intervention theme towards acknowledging the necessity of also tackling concentrated sovereign exposures is politically challenging for the Commission, but indispensable to unlock this crucial reform. 

The revealed preference of member states in past negotiating rounds is that they are unwilling to concede key items – such as European deposit insurance for Germany, or regulatory treatment of sovereign exposures for Italy – if they only obtain a halfway house in return. This observation suggests that the banking union will be completed via a grand bargain that addresses the key issues together, rather than by a succession of incremental steps. 

Unless events intrude, a key milestone could be the Commission’s forthcoming report on the framework for bank prudential requirements, which the capital requirements legislation adopted earlier this year (Regulation (EU) 2024/1623) requires before end-2028. The Commission could opt to deliver that report earlier, say in late 2026, to leave time for subsequent consultations and negotiations to bear fruit before the end of the current term. 

Other issues

Following the successful adoption earlier this year of a comprehensive legislative package that enabled the ongoing establishment of AMLA in Frankfurt, the Commission should devote sufficient resources to its successful implementation, which will require significant technical work on relevant technical standards. The existential challenges associated with the war in Ukraine and the related need to improve the enforcement of EU financial sanctions add urgency to these tasks. 

The EU has been a generally constructive champion of global financial standards, a vision that is made even more pertinent by the degradation of the global geopolitical environment and also by the realities of Brexit. It should work, in particular, on better alignment of its sustainability reporting standards with those set at global level and, on a medium-term basis, on full alignment with the Basel Committee’s framework for banking regulation, including the so-called Basel III accord. 

In particular, the painful experience of the euro-area crisis, together with the observation of developments in the US and other jurisdictions, should enable the EU to resist misguided pleas from the banking industry for relaxation of bank capital standards. The competitiveness of the banking sector is positively associated with demanding capital requirements, whereas watering these down generates fragility that is detrimental to the banking sector as a whole. In line with both its commitment to global standards and its need for a sound and dynamic banking sector, the EU should thus act to remediate its current areas of lingering non-compliance with Basel III. 

Sustainable finance was a major area of activity for the 2019-2024 Commission. Effort should be made to maintain momentum on the more impactful aspects of the agenda, while acknowledging that the initial legislative phase may not have got everything right. In particular, the EU should not shy away from an honest assessment of relevance of the EU taxonomy for sustainable activities and refinement of critical definitions, such as those of sustainable investment and of transition finance. In other words, the objectives of optimising the compliance burden and of aligning the EU’s financial sector policy with its climate policy, should and can be pursued simultaneously.

Notes

1. See Véron (2019) and Véron (2014).
2. See Mission Letter from Ursula von der Leyen to Maria Luís Albuquerque, Commissioner-designate for Financial Services and the Savings and Investments Union, 17 September 2024, https://commission.europa.eu/document/ac06a896-2645-4857-9958-467d2ce6f221_en.
3. See https://www.amla.europa.eu/index_en.
4. See Spitzer and Magnus (2024) and McGuinness (2024).
5. Joachim Nagel and Nicolas Véron, ‘Opinion: Breaking the vicious circle between banks and sovereigns for good’, Politico, 22 October 2024, https://www.politico.eu/article/eu-banking-union-project-banks-sovereignseurozone-crisis/.

References

Lagarde, C. (2023) ‘A Kantian shift for the capital markets union’, speech at the European Banking Congress, Frankfurt am Main, 17 November, available at https://www.ecb.europa.eu/press/key/date/2023/html/ecb.sp231117~88389f194b.en.html

Landais, C., D. Sraer, M. Schnitzer, V. Grimm, U. Malmendier, A. Truger and M. Werding (2024) ‘Enhancing EU capital markets’, joint statement of the French Council of Economic Analysis and the German Council of Economic Experts, July, available at https://www.bmwk.de/Redaktion/DE/Downloads/C-D/cae-svg-joint-statement-enhancing-eu-capital-markets.pdf

McGuinness, M. (2024) ‘Speech by Commissioner McGuinness at Bruegel event, “Europe's banking union at 10: unfinished yet transformative”’, 25 June, available at https://ec.europa.eu/commission/presscorner/detail/en/speech_24_3467

Merler, S. and N. Véron (2024) ‘Memo to the commissioner responsible for financial services’, in M. Demertzis, A. Sapir and J. Zettelmeyer (eds) Unite, defend, grow: Memos to the European Union leadership 2024-2029, Bruegel, available at https://www.bruegel.org/book/unite-defend-grow-memos-european-union-leadership-2024-2029

Spitzer, K.G. and M. Magnus (2024) ‘Council position on the CMDI reform: An initial analysis regarding key aspects of the proposed bank crisis management framework’, Briefing, Economic Governance and EMU Scrutiny Unit, European Parliament, available at https://www.europarl.europa.eu/RegData/etudes/BRIE/2025/755737/IPOL_BRI(2025)755737_EN.pdf

Véron, N. (2014) ‘Flash Cards for European Commissioner-designate Jonathan Hill’, Bruegel Blog, 3 October, available at https://www.bruegel.org/blog-post/flash-cards-european-commissioner-designate-jonathan-hill

Véron, N. (2017) Sovereign Concentration Charges: A New Regime for Banks’ Sovereign Exposures, Study for the European Parliament, available at https://www.europarl.europa.eu/thinktank/en/document/IPOL_STU(2017)602111

Véron, N. (2019) ‘Questions on financial services policy for Valdis Dombrovskis, Executive Vice-President-designate of the European Commission’, Bruegel Blog, 30 September, available at https://www.bruegel.org/blog-post/questions-financial-services-policy-valdis-dombrovskis-executive-vice-president-designate

Véron, N. (2024a) Europe’s Banking union at ten: unfinished yet transformative, Bruegel, available at https://www.bruegel.org/book/europes-banking-union-ten-unfinished-yet-transformative

Véron, N. (2024b) ‘Capital Markets Union: Ten Years Later’, In-Depth Analysis requested by the ECON Committee, European Parliament, available at https://www.europarl.europa.eu/thinktank/en/document/IPOL_IDA(2024)747839

Financial Statements: Basel III implementation status and prospects

In yesterday's session, I hosted independent analyst and author Daniel Davies and Pervenche Berès, chair of Paris-based Association Europe-Finances-Regulations, to discuss the current state of compliance with the Basel Committee's standards especially in the European Union and United States. 

Korea Herald column (April): Latest financial supervisory reform diverts China from the path towards a market-based financial system

This column was published in The Korea Herald six months ago, my first column for that newspaper. I had omitted to repost it on this website at the time.

In May last year, China inaugurated a new system of financial sector supervision, which had been announced two months earlier during the twin plenary sessions of the National People‘s Congress and Chinese People’s Political Consultative Conference. One year on, it is time to take stock. Sadly, all indications suggest that the supervisory overhaul will make it more difficult, rather than easier, for China to make progress in the direction of a market-based financial system that could efficiently allocate capital in its increasingly large and complex economy.

The reform has two main components. First, the former China Banking and Insurance Regulatory Commission, renamed National Financial Regulatory Administration (NFRA), got an expanded supervisory mandate covering the entire scope of financial firms in China except stock exchanges and securities firms that remain under the China Securities Regulatory Commission (CSRC). The NFRA‘s role includes financial customer protection and the supervision of financial holding companies, previously carried out by the People’s Bank of China (PBC), as well as investor protection duties transferred from the CSRC. As a partial offset, the CSRC received bond market oversight responsibilities previously held by the National Development and Reform Commission in a belated legacy of the days of top-down “credit planning” before the market-oriented reforms of the 1980s and 1990s. Correlatively, the NFRA took over the bulk of the supervisory capacity previously under the PBC, namely more than 1,600 county-level branches according to a Financial Times report. As China‘s central bank, the PBC retains responsibility for macroprudential oversight, but it has essentially lost its once all-encompassing role as financial supervisor, a process that had started in 1992 when the CSRC was spun off from the PBC.

Second, a new structure is overlaid above the NFRA in the form of the Central Financial Commission (CFC) which is given a general role of oversight of the financial sector, replacing a lighter Financial Stability and Development Committee that had been set up in 2017 but never quite found a role. Unlike the NFRA, which like the CSRC and PBC formally reports to China‘s State Council, the CFC is a body of the Chinese Communist Party. It is also a substantial central agency, not just a small coordination office, with significant specialized personnel and a permanent office close to those of the NFRA, CSRC and PBC in Beijing’s “Financial Street” neighborhood. Veteran officials with experience of state-owned bank management have been appointed to head the two bodies, namely Li Yunze for the NFRA and Wang Jiang for the CFC, the latter formally as deputy to He Lifeng, China‘s economic affairs Vice Premier who doubles as Director of the CFC’s Office. Meanwhile Wu Qing, another politically savvy official with financial experience, was appointed in February as the new head of the CSRC.

As so often in China, the authorities gave no clear explanation of their motivations underpinning these major changes. There were no discussion papers, no public hearings, no observable debates. In fact, the semblance of policy deliberation that had accompanied previous changes in that space was not only abandoned, but even ironically inverted. Previous major changes in the financial sector policy framework had been preceded by a “national financial work conference” that set the stage for forthcoming reforms and were at least a performative expression of deliberative process. These conferences had regularly occurred every five years since the first one in 1997, which paved the ground for China‘s first major state-directed financial sector restructuring. On that established basis, a financial work conference should have been held in 2022, but the year came and went with no announcement. Instead, the new supervisory structure was publicized seemingly out of the blue in March 2023, and the new bodies promptly inaugurated in May. Only in November 2023 was a “central financial work conference” held in Beijing ― ostensibly a formality, with the adjective “central” replacing “national” as a clear indication of the shift from state to party emphasis.

At the time of the initial announcement last year, some analysts attempted to rationalize the reform by portraying it as what financial supervisory experts refer to as a “twin peaks” architecture. The twin-peaks concept was coined in the 1990s and adopted since then by countries including Australia, Belgium, the Netherlands, South Africa, and the United Kingdom (UK). As its name suggests, it entails a division of labor between two main financial regulatory authorities: one in charge of prudential supervision, working against systemic risk, and the other in charge of conduct-of-business supervision, defending market participants against abuses of information asymmetries and fraud and ensuring market integrity. In the UK, for example, the names of the two authorities directly reflect their respective mandates, namely the Prudential Regulation Authority (which is part of the Bank of England) and the Financial Conduct Authority. But the new Chinese architecture clearly does not conform to the Twin Peaks template. The NFRA cumulates both mandates, prudential and conduct-of-business, while the CSRC is left with a diminished scope of conduct supervision compared with its pre-reform status.

On the face of it, the new Chinese framework is functionally comparable to that adopted in Korea in the late 1990s, which entails a sector-wide Financial Services Commission making policy and the Financial Supervisory Service implementing it, echoing the respective roles of the CFC and NFRA. But the cost-benefit balance of an all-encompassing sector-wide supervisor is very different in a massive financial sector like China‘s, the world’s second-largest by most measures (or even first, e.g. by size of banking assets ― see chart), versus a medium-sized one like Korea‘s, where it makes more sense to centralize all policy mandates in a single institution. In that respect, the CFC/NFRA architecture rather resembles that adopted by the UK also in the late 1990s, with an all-powerful Financial Services Authority (FSA) supervising all financial firms and markets. Even though the UK financial sector at the time was considerably smaller than China’s now, this setup turned out to be too unwieldy and ended in disastrous failure with the great financial crisis of 2007-2009, after which the UK switched to the Twin Peaks concept. The UK FSA tried to exercise all financial supervisory mandates at once, and ultimately failed to deliver on them simultaneously, with particularly unforgiveable lapses of its prudential duties leading to the costly collapse of Royal Bank of Scotland and other major British lenders. This definitely does not look like the right template for China to emulate.

Rather than a more effective or efficient allocation of supervisory roles, the real motivation of China‘s reform appears all too obvious: a blunt reassertion of Communist Party control. This is, of course, embodied in the NFRA’s evident subordinate status to the Party-labeled CFC, and also to the parallel revival of a Central Financial Work Commission whose proclaimed task is “to strengthen the ideological and political role of the Party in China‘s financial system”. This may be related to a perception of mounting risk in China’s financial system, with particularly alarming developments in the property market and local government financing, or simply with a general tendency towards reinforcing the “vertical of power” in Xi Jinping‘s third term. Be that as it may, the appearance of a demotion of supervisory independence and expertise is reinforced by the steep pay cut imposed on NFRA and PBC staff, and by the sidelining of the PBC which had perhaps come closest to an autonomous, technocratically driven institution within the hyper-politicized Chinese system. Indeed, the upshot of this reform may be simply that under the present circumstances, the Chinese party-state can simply not countenance anything that might resemble an independent administrative body.

But there lies precisely the challenge for China. Public bodies with well-defined mandates and authority to act independently, including central banks and financial supervisors, are critical to the operation of complex market-based financial systems. Formally, China dismantled its centrally-planned credit system during the two decades between 1978 and 1998, but old habits die hard. The shareholding structure of the dominant Chinese commercial banks, brokerages and institutional investors makes them state-owned or state-controlled. Experiments to introduce more private ownership in the financial sector since the 1990s have largely failed, as too many of the new entrants turned out to abuse their customers or be outright frauds. The predecessors of today‘s CFC and NFRA were never fully capable of properly policing a complex market-based financial system. The present structures appear even less prepared to become effective supervisors of decentralized, market-based actors. To be sure, financial supervisors everywhere are ultimately accountable to political authorities, but the best ones are sufficiently insulated from direct political interference to create a favorable environment for market activities. Even Napoleon, who was not driven to relinquishing control, memorably stated in 1806 after creating the Bank of France that he “want[ed] that the Bank be sufficiently in the hands of the government, but not too much so”. The Chinese Communist Party seems to know no such restraint these days.

The long-term impact of the complex changes brought last year to China‘s financial supervisory system remains to be seen. The new structure has barely been put in place and has not yet been tested in crisis. But the omens are not good. By sidelining its central bank, creating an all-encompassing supervisory behemoth, and placing it under the pernickety oversight of a top-heavy Party commission, it is likely that China has structurally degraded the effectiveness of its financial supervision.

Korea Herald column: Relaxing capital requirements would plant the seeds of the next banking crisis

This article was published in Korean by The Korea Herald newspaper on 25 October. It is also available, together with the version in Korean, on The Korea Herald website.

Banking regulation goes in cycles that are punctuated by crises. Typically, a crisis results in regulatory tightening. Then after an extended period of time, memories of the crisis fade away, and policymakers end up yielding to bank lobbyists‘ constant push for loosen the rules. Then banks take more risk as allowed by the weaker new rules, and more often than not, a banking crisis erupts. Then everyone asks why nobody saw it coming.

There is a paradox at play here. Demanding and well-enforced capital requirements actually tend to benefit the banking sector as a whole, as they buttress confidence in the entire system. Even so, however, at least in countries where banks are mostly joint-stock companies owned by private shareholders, bank lobbyists always ask for relaxing the rules, irrespective of the circumstances. In the short term, such lobbying is rational. All things equal, more leverage allows the banks to increase their return on equity and thus to give greater immediate satisfaction to their shareholders and, in most cases given the structure of their compensation incentives, to increase the bankers‘ own remuneration. But in so doing, bankers don’t lobby in their employers‘ long-term interest. (Of course, there could theoretically be such a thing as excessive capital requirements, but analysts who are not somehow beholden to the banks near-unanimously concur that the current levels are far from that mark.)

This cycle has been observed time and again. The great financial crises of the 1930s in Europe and America (the 1920s in Japan) led to a tightening of prudential frameworks that ensured widespread financial stability until the 1970s. From then, a deregulatory cycle started that brought increasingly frequent crises, including that of 1997 in Korea and the major financial crisis of the late 2000s in Europe and the United States which saw the collapse of major institutions such as Bear Stearns and Lehman Brothers in America, Royal Bank of Scotland in the United Kingdom, or Westdeutsche Landesbank in Germany. In response, a new consensus on tighter requirements formed among the world‘s prudential authorities assembled in the Basel Committee on Banking Supervision, which meets regularly in the Swiss city of Basel. The result was a set of rules collectively known as Basel III, issued by the Basel Committee in several batches, the first in late 2010 and the last, nicknamed the Basel III Endgame, in late 2017.

Since the climax of the great North Atlantic crisis only happened 16 years ago in 2008, one would expect that the memories thereof are still fresh enough to avoid a harmful swing of the pendulum in the deregulatory direction. Deplorably, that expectation would be wrong. The indications are multiplying that policymakers are rapidly forgetting the painful lessons that were inflicted on them or their predecessors less than a generation ago.

In the United States, Federal Reserve Vice Chair Michael Barr announced in September that the standards to implement the Basel III Endgame would end up being significantly less strict than earlier proposed. Even though the detailed text has not been published, this announcement has been widely understood as a lack of capacity of the U.S. prudential authorities to resist fierce bank lobbying, in the country‘s present context of extreme political polarization.

The European Union, whose banks collectively hold even more assets than those in the U.S., has recently adopted legislation that is far from fully compliant with Basel III. Even so, there are calls to water it down further. No less an authoritative figure than Mario Draghi, the former president of the European Central Bank, wrote in a recent report that the EU should “assess whether current prudential regulation, also in light of the possible upcoming implementation of Basel III, is adequate to have a strong and international competitive banking system in the EU”. In late September, the heads of the Treasury Departments of France, Germany and Italy have sent a joint letter to the European Commission in which they call for putting “stronger emphasis on the competitiveness of the financial sector, particularly banking, and its capacity to finance the economy”. In both cases, the reference to competitiveness of the banking sector has been understood by commentators as a call to relax capital requirements.

In line with the above-mentioned paradox, the largest U.S. banks are in a much stronger competitive position than their European counterparts ― as Draghi acknowledged in his report ― after a decade during which they were subject to generally higher capital requirements. The latest assessments by the Basel Committee, issued in 2014, had found the U.S. “largely compliant” with the first batch of Basel III rules, while the EU was “materially non-compliant”. (Korea was deemed largely compliant in 2016.) A tweak is that the EU imposes its version of Basel standards on all banks irrespective of size, whereas the U.S. does so only on the very largest. (The Basel Committee only says that its rules are intended for large internationally active banks, without setting quantitative thresholds to define the category.) Predictably, this creates financial stability vulnerability among medium-sized U.S. banks, as the short but highly unfortunate crisis around Silicon Valley Bank and peers disastrously illustrated last year. But local banks are so politically influential in the U.S. that prudential authorities have never been able to expand the scope of Basel application even to banks with total assets well above a hundred billion dollars.

For the European Union, the non-compliance with Basel III is particularly embarrassing. It is overrepresented in the membership of the Basel Committee, which includes no fewer than eight EU countries (Belgium, France, Germany, Italy, Luxembourg, the Netherlands, Spain and Sweden) as well as the EU itself among its 28 member jurisdictions. Of these, seven (all but Sweden) are part of the euro area and thus of the banking union, a framework that has now been in place for a decade and implies that individual euro-area countries no longer have an independent supervisory policy. Furthermore, the EU describes itself as uniquely committed to global standards and the international rules-based economic and financial order. In such a context, the combination of such stark overrepresentation with poor compliance is galling.

In the United States, the adherence to that order is at risk of being further weakened in the years to come, depending of course on the outcome of the forthcoming presidential election. But at the end of the day, jurisdictions such as the U.S. and the EU should not just adhere to Basel standards for the sake of robust global governance. They should do so out of a lucid but also narrow definition of their own self-interest, namely avoiding the devastation of future banking crises. For that, the U.S. should expand the scope of application of Basel III to its medium-sized banks, and the EU should move towards full compliance. Sadly, in the near future at least, there is scarce chance of either doing so.

Joint opinion article with Joachim Nagel: Breaking the vicious circle between banks and sovereigns for good

On Tuesday 22 October, Politico published an opinion article coauthored with Joachim Nagel, in which we advocate completion of the banking union and outline what it would involve. 

Study for the European Parliament: Banking union and the long wait for cross-border integration

In this study published by the European Parliament last Friday, my Bruegel colleagues Giulia Gotti, Conor McCaffrey and I document the continued fragmented condition of the euro-area banking system despite a decade of implementation of the (admittedly incomplete) banking union framework. This study provides an empirical complement to my recent book on Europe's banking union. 

Financial Statements: A holistic perspective on climate and financial policies

In this week's session, I hosted Pierre Wunsch of the National Bank of Belgium and Irene Monasterolo of University of Utrecht, for a spirited conversation on the consistency of the EU's climate and financial regulatory policies. 

Financial Statements: Do EU regulations unduly penalize securitization?

In today's session, I hosted the Bank of France's Emmanuelle Assouan and Sebastian Mack of the Jacques Delors Centre in Berlin, to discuss the trade-offs of EU policy regarding securitization in the context of the Capital Markets Union project.

Bruegel Memos for the new EU leadership 2024: Unite, defend, grow

As every five years since 2009, Bruegel this week published a compendium of memos to the new EU leadership covering many areas of policy. Silvia Merler and I contributed the memo to the new Commissioner for financial services. The memo was discussed at one of the panels of the Bruegel Annual Meetings on Wednesday 4 September. 

Click here for a PDF version of the Financial Services memo.