Is the Larosière Proposal on European

Financial Regulation on the Right Path?

Marco Onado

The financial crisis has prompted an extensive debate on the lessons to be learned,
particularly from a regulatory point of view, and especially in the European Union,
where the crisis could mean a serious setback for financial integration. The
Larosière Report issued in February 20091 has set out guidelines for improving
the European regulatory framework and was substantially endorsed by a
Communication from the Commission and a detailed proposal for European
legislation.2 Although the Report has generally been praised for its effort to over-
haul European regulation, many details – where the devil loves to hide – are still
vague and have not been discussed enough.
This article takes a look at the main points on which the Larosière proposals
should be more detailed or stronger. In particular, there are seven points – they can
be considered the seven ‘‘sins of omission’’ – in the macro-level of prudential
supervision on which clearer and tougher solutions seem to be needed.
Furthermore, as a result of the need to reach a workable compromise between
different national interests, there are two unresolved problems in the proposals
for micro-supervision. Although it is true that, as Voltaire said, ‘‘the perfect is
the enemy of the good’’ (mind that he didn’t say ‘‘the better’’ as often misquoted),
the European experience has shown beyond any reasonable doubt that compro-
mises (and the committees that are expected to make them work) have not deliv-
ered the results optimistically hoped for. The last striking example was the
Lamfalussy procedure,3 whose results are negatively commented upon in the

Marco Onado is Professor of Financial Institutions at the Bocconi University, Milan, Italy.
Email: marco.onado@unibocconi.it
1
EU, High-Level Group on Financial Supervision (‘‘de Larosière Group’’), Report, 2009.
2
EC, Communication from the Commission; EC, Community Macro Prudential Oversight of the Financial
System; EC, Establishing a European Banking Authority; EC, European Securities and Markets Authority.
3
The Lamfalussy procedure, proposed by a committee chaired by Alexander Lamfalussy, was adopted by
the European Commission to enhance convergence in the regulation of financial services. The aim was to
simplify and speed up the complex and lengthy EU legislative process related to financial services by means
of a four-level approach. According to the procedure, the EU institutions adopt framework legislation
under the auspices of the Commission (level one). The Commission prepares the detailed technical
implementing measures with the help of four specialist committees (level two) composed of representatives
of the national finance ministries (the European Banking Committee (EBC), the European Securities

The International Spectator, Vol. 45, No. 1, March 2010, 59–73 ISSN 0393-2729 print/ISSN 1751-9721 online
ß 2010 Istituto Affari Internazionali DOI: 10.1080/03932720903562528
60 M. Onado

same Larosière Report. So it is debatable whether the Larosière compromise can be

expected to work any better than the Lamfalussy compromise.

The financial crisis and the weaknesses of the European regulatory

structure
The crisis revealed many weaknesses in the global financial system. Financial insti-
tutions proved to be much more fragile than expected and the overall regulatory
framework was not commensurate with the size and complexity of modern banks.
The Financial Stability Forum (FSF) (now Financial Stability Board – FSB) pro-
posed important measures in April 2008,4 most of which still have to be imple-
mented. In particular, it pointed to the problem of supervision of global banks
that fall under multiple jurisdictions. For this cluster of banks, the FSF proposed
enhancing cooperation among supervisors and, in particular, improving the func-
tioning of the so-called ‘‘colleges of supervisors’’. The Group of Thirty Report
issued in January 2009 also makes this proposal.5
Europe has a further problem to face. The crisis upset the fragile common
supervisory structure built through the so-called ‘‘Lamfalussy level-3
Committees’’. In the bleakest days of the crisis, the situation of the ailing banks
was assessed only by national regulators and remedial action was left almost exclu-
sively to national governments. This contrast between Europe’s achievement
of a common currency and goal of financial integration on the one hand and
a regulatory framework strictly designed at the national level on the other is intol-
erable. According to many commentators, the process of European integration
has suffered a serious setback. Banks that had become pan-European found them-
selves penalised. A paper by Unicredit6 argues that the fragmented European
regulatory and supervisory framework results in a higher and unnecessary level
of regulatory costs and prevents pan-European banks from functioning efficiently.
Therefore, as Lord Turner said, we must choose between more national powers or
more Europe.7

(footnote continued)
Committee (ESC), the European Insurance and Occupational Pensions Committee (EIOPC) and the
Financial Conglomerates Committee (FCC) for supervisory issues relating to cross-sector groups).
In developing the implementing measures (level three), the Commission is advised by three committees
of experts (the Committee of European Banking Supervisors (CEBS), the Committee of European
Securities Regulators (CESR) and the Committee of European Insurance and Occupational Pensions
Supervisors (CEIOPS)). Finally (level four), the Commission – in close cooperation with the member
states, the regulatory authorities involved in level three and the private sector – checks that Community law
is applied consistently.
4
FSF, Enhancing Market and Institutional Resilience.
5
Group of Thirty, Financial Reform.
6
Unicredit Group, ‘‘Cross-border banking in Europe’’.
7
FSA, The Turner Review.
 Is the Larosière Proposal on the Right Path? 61

To tackle this problem, the European Commission appointed a high level

Committee chaired by Jacques de Larosière with a mandate ‘‘to make proposals
to strengthen European supervisory arrangements covering all financial sectors,
with the objective to establish a more efficient, integrated and sustainable
European system of supervision’’. The Larosière Report makes a distinction between
the macro and micro level of supervision: it suggests establishing a European
Systemic Risk Board (ESRB)8 in charge of macro-prudential supervision and over-
hauling the level-3 Committees of regulators to form a European System of Financial
Supervisors in charge of micro-prudential supervision.
The big question is whether this solution is the right answer to the problems
raised by the financial crisis and in particular by the cluster of global banks,
the so-called ‘‘large and complex financial institutions’’ (LCFI) that were the
epicentre of the crisis because of their systemic relevance.

The group of large complex financial institutions

Research on the large and complex financial institutions had been promoted by
the central banks well before the crisis9 and pointed out that what characterises
them is not only their size (measured either by total assets or geographic spread)
but also other important features. In particular:
 complexity (difficulty even for supervisors to have a reasonable view of the
actual level of risk);
 interconnectedness (high probability of starting the classic chain reaction
prompted by one financial failure);
 common exposure to common factors (amplification of the reactions, making
risk more and more endogenous).10
This cluster of banks raises regulatory problems that are largely unprecedented,
at least to this extent. The debate prompted by regulators and various reports is
unanimous in stressing the following points for the supervisory agenda.

LCFI must be jointly supervised

The banks that belong to this group are not only very large by total assets (often far
exceeding the GDP of their home country) but also operate on a global scale, beyond
the jurisdiction and means of intervention of any national regulator. For them,
neither the home country principle, nor the host country principle can provide
efficient supervision. Agreements at a supra-national level must be sought.
8
Defined as ‘‘Council’’ in the Larosière Report. The word Board has been adopted by the European
Commission and is used throughout this article.
9
Meyer, Challenges of Global Financial Institution Supervision; Marsh, Large Complex Financial Institutions.
See also the Financial Stability Reports published by the Bank of England and the ECB of the last years.
10
Haldane, Rethinking the Financial Network.
62 M. Onado

There is, however, a silver lining to this cloud: given the level of bank concen-
tration, the main source of systemic risk can be controlled by focussing
macro-supervision on this group of banks. In Europe, the Financial Stability
Reports of the European Central Bank have identified a cluster of 35 ‘‘large and
complex banking groups’’. The vice-president of the ECB reports that at the end
of 2007 the 43 largest cross-border banking groups in the EU accounted for 76
percent of total EU bank assets, while in the euro area, the 30 largest cross-border
banking groups accounted for 73 percent of total bank assets.11

Supervision must take account of interconnections and

endogeneity of risk
The evolution of the financial system in the last twenty years has made risk more
and more endogenous, thus opening a wide gap between the individual institu-
tion’s perception of risk (micro level) and the actual risk incurred by that institu-
tion, taking into account its connections with other agents, which are more and
more likely to react in the same way to the same stimulus, generating systemic
destabilising effects (macro level).
What is needed, therefore, is a higher level of supervision that links the micro
and the macro aspects. But the latter are related not only to the general conditions
of the economic system, but also to the systemic effects of individual behaviours,
particularly those of large complex financial institutions, that make risk more and
more endogenous.

Supervision must be more discretionary at both the macro

and micro level
The long list of proposals for financial reform has not been implemented because
governments and regulators were too busy rescuing banks, at least until
March 2009. But we now know that bank regulation must be overhauled.
This does not necessarily mean that a corset of tight rules has to be stitched
together. As is clearly set out in the Financial Stability Forum Report, the financial
system can be fixed with a reasonable number of new rules to correct the past
misjudgements as regards capital adequacy, bank liquidity, market risk, etc.
The point is that in the past, the pendulum swung too far from discretion
(the traditional modus operandi of central banks) to rules and the system relied
too heavily on the efficiency of automatic mechanisms, such as the Basel provi-
sions.12 In other words, it relied too much on market discipline (the Basel Pillar 3)
11
Papademos, ‘‘Strengthening Macro-prudential Supervision’’.
12
The Basel Agreements (or Accords) refer to a common set of rules for the prudential supervision of
banks, agreed by major countries, with particular reference to capital adequacy, i.e. minimum capital
requirements. The first set of rules (Basel I) was published in 1988 by the Basel Committee (BCBS),
while the second (Basel II) was published in 2004 and came into effect in 2008–09.
 Is the Larosière Proposal on the Right Path? 63

and not enough on the regulatory application and interpretation of the rules
(Pillar 2). Regulators refrained from asking their banks to increase their level of
capital, sometimes as a consequence of a form of regulatory capture, but also
because they did not want (or did not dare) to correct the market.
The excess towards automatic rules was one of the determinants of the
pro-cyclicality of the Basel requirements, which are now being amended. But it is
almost impossible to correct flaws generated by automatic rules with other automatic
rules.
In other words, future supervisory action must be based on a discretionary
assessment of the riskiness of individual banks and must take a more ‘‘hands
on’’ approach. The years of praise for the ‘‘light touch’’ are gone. This also
means that regulators need powers and instruments to translate their judgements
into action. As ECB President Jean-Claude Trichet said, ‘‘at the level of the finan-
cial system, we need to be more resolute in preventing the build-up of risks. We
must strengthen financial stability assessments and develop mechanisms for trans-
lating them into concrete measures.’’13

Information
The crisis has also shown that regulators lacked fundamental information on the
global financial system: the formation of the shadow banking system and the
opacity of the over-the-counter (OTC) markets for structured products and deri-
vatives are significant examples. The regulators’ radar screens were blind to sub-
stantial portions of today’s financial system. Therefore, an efficient database
reflecting the modern global financial system must be set up, which means
taking the interconnections between banks into account. Regulators have to
know not only who owns what, but also who owes what to whom. They must
therefore have the powers and the authority to get the necessary information from
individual institutions. The next step will be to find ways and means to share the
data among the supervisors, particularly for large complex financial institutions.

The critical points of the Larosière Report

The Larosière Report has been highly appreciated for its effort to improve the
European regulatory architecture and enhance future regulatory convergence. But
to understand whether it gives the right response to the financial crisis in general
and the setback in European integration in particular, two fundamental questions
have to be answered: 1) Are these proposals up to the challenge of regulating
the European group of large complex financial institutions? 2) Did the Report
draw the right conclusions from the dismal results of so many years of alleged
13
Trichet, ‘‘Remarks on the Future of European Financial Regulation’’.
64 M. Onado

regulatory harmonisation in Europe? The two levels of regulatory bodies suggested

by the Report will be dealt with separately.

The macro level of prudential supervision

The Larosière Report identifies the weakness of macro-supervision as a major cause
of the crisis. In particular: ‘‘regulators and supervisors focused on the micro-
prudential supervision of individual financial institutions and not sufficiently on
the macro-economic risks of a contagion of correlated shocks’’.14 This judgement
is shared by other important reports, such as the Group of Thirty’s and the
Financial Stability Reports issued in these years by the Bank of England and
the European Central Bank, as well as by major international bodies such as the
International Monetary Fund and the Bank of International Settlements, just to
mention the most important. The need to strengthen the macro level of supervision
in Europe and elsewhere is therefore beyond doubt. The real problem is whether
the specific proposals made for the European Systemic Risk Council are adequate
or not.
In several points, the Larosière Report seems to be too vague or not forceful
enough to allow for a clear-cut answer to this fundamental question. These points
can be seen as the seven ‘‘sins of omission’’.
1. A broad vs a narrow interpretation of macro-prudential supervision
The Larosière proposal seems to reflect a narrow interpretation of macro-prudential
supervision and therefore gives the ESRB a rather general and high-level role with
limited powers. The European Commission has further reduced the possible
actions that the ESRB can take. Therefore, the main task of the ESRB is now to
assess the stability of the EU financial system in the context of macro-economic
developments and general trends in financial markets. If significant stability risks
are foreseen, the ESRB provides early warnings and, where appropriate, issues
recommendations for remedial action.
The Commission explicitly states that
warnings and recommendations issued by the ESRB could be of a general nature
or could concern individual Member States and there would be a specified timeline
for the relevant policy response. These warnings and/or recommendations would be
channelled through the Ecofin Council and/or the new European Supervisory
Authorities. The ESRB would also be responsible for monitoring compliance with
its recommendations, based on reports from the addressees. The ESRB would not
have any legally binding powers.15

To sum up, the Larosière Report seems to assign the ESRB the role of analysing
macro economic conditions and their implications for systemic risk and issuing
14
Par. 29, 11.
15
EC, Communication from the Commission, 5.
 Is the Larosière Proposal on the Right Path? 65

warnings and making recommendations that the authorities in charge of

micro-prudential supervision should follow.
Yet, in an important paper published in 2003, well before the crisis,
Claudio Borio, a leading economist at the Bank for International Settlements,
interpreted macro-prudential supervision much more broadly.16 In particular,
Borio stressed two points: that systemic risk comes mainly from the common
exposure of global banks to the same risk factors and that this makes financial
risk more and more endogenous (exactly as happened during the crisis).
Borio clearly understood that the mainstream theory of systemic risk (embedded
in the present regulation) looks primarily at the possible failure of a single financial
institution as the primary cause which then spreads, through a variety of contagion
mechanisms, to the financial system as a whole. In this perspective, to avoid
financial instability it is enough to avoid the failure of one financial institution,
that is, the first link in the chain reaction. But Borio stressed that a broader
interpretation is needed because
. . . the significance of such instances pales in comparison with that of the cases
where systemic risk arises primarily through common exposures to macroeconomic
risk factors across institutions. It is this type of financial distress that carries the more
significant and longer-lasting real costs. And it is this type that underlies most of the
major crises experienced around the globe. By comparison with the canonical model
of systemic risk, these processes are still poorly understood.

The consequence of this broad interpretation of macro supervision should be to

give the competent authority a wide mandate and very detailed powers of inter-
vention. Moreover, the macro and micro supervisors should work together closely:
from Borio’s perspective the macro and micro levels of supervision are just two
sides of the same coin.
Thus, macro-prudential supervision should be strictly linked to micro super-
vision and in a sense can be viewed as the new form of supervision required by the
characteristics of the modern financial system. Borio concluded:
Strengthening the macro-prudential orientation would, in some respects, bring
the framework closer to its origin, when the main concern was the disruption to
the economic life of a country brought about by generalised financial distress.
It would take it somewhat away from the pursuit of narrowly interpreted depositor
protection objectives while at the same time helping to achieve them in a more
meaningful way. And it holds the promise of bringing realistic objectives into
closer alignment with the means to attain them.17

16
Borio, Towards a Macroprudential Framework.
17
Ibid.
66 M. Onado

2. No responsibilities in matters of macro-prudential relevance

The Larosière analysis fails to identify problems that are systemic by nature.
The consequence is that the Commission document wrongly assigns some of
these issues to the micro-level of supervision: for instance, clearing and central
arrangements, the heart of the financial system’s infrastructure. From a theoretical
point of view, this is unfounded. This is a typical responsibility of central banks
(for the same reasons that central banks have supervisory responsibilities for the
payment system); it follows that in Europe this should be a fundamental task of the
European Central Bank.18 Moreover, the debate on the clearing and settlement
issues of the European financial markets has clearly shown the intrinsic European
and macro dimension of the problem and the need to give the ECB full
responsibility.19
This point has been clearly stressed from a technical point of view in a recent
ECB paper20 and officially underlined in the response to the consultation of the
European Commission on possible initiatives to enhance the resilience of OTC
derivative markets.21
3. The relationship between the different authorities involved
One very delicate matter on which the Larosière Report is vague is the relationship
between the different regulators which in the European case involves two dimen-
sions: the vertical, between the macro and micro European level, and the horizon-
tal, among the various national regulators.
Looking at the first dimension, it is important to remember that there are already
many examples of problems between the micro and macro levels of regulation,
for example in the UK and in general in countries in which central banks do not
have supervisory power at the micro level. The British experience revealed many
weaknesses that deserve to be taken into account. In particular, the Turner Review
pointed out that the Bank of England tended to focus on monetary policy analysis,
while the Financial Services Authority focused too much on the supervision of
individual institutions. Therefore, the vital activity of macro-prudential analysis
and the definition and use of macro-prudential instruments ‘‘fell between two
stools’’.
It is likely that the most delicate matters of the Larosière proposal related to
macro-prudential supervision will also ‘‘fall between two stools’’. Solving this
problem depends on two things. First, a very clear definition of the responsibility
of the various bodies. Second, the effectiveness of the powers given to the body
in charge of macro-prudential supervision (which will be dealt with in the
following point). So far, neither is clear enough.
18
Onado, ‘‘European Integration and Financial Regulation’’.
19
Alemanni et al., The European Securities Industry.
20
ECB, OTC Derivatives.
21
ECB, ‘‘Possible Initiatives to Enhance OTC Derivatives Markets’’.
 Is the Larosière Proposal on the Right Path? 67

As for the problem of coordination among national authorities, an efficient

outcome depends on the effective powers that will be entrusted to the ESRB
(see below) and the new European Supervisory Authorities (ESA).
4. Warnings and interventions (voice vs teeth)
The Larosière Report seems to believe that warnings issued by the ESRB will be
sufficient to foster action at the micro-level and therefore to correct possible threats
to financial stability. So voice is the main weapon given to the ESRB.
This solution is not considered efficient even in a national environment.
As Mervyn King, Governor of the Bank of England, has put it:
The Bank finds itself in a position rather like that of a church whose congregation
attends weddings and burials but ignores the sermons in between.[. . .] Warnings are
unlikely to be effective when people are being asked to change behaviour which
seems to them highly profitable. So it is not entirely clear how the Bank will be able
to discharge its new statutory responsibility if we can do no more than issue sermons
or organise burials.22

European proposals are extremely vague on this issue. The Larosière Report states
that when a warning is issued, it must be clear who must do what and suggests
different scenarios in which the ESRB could enforce supervisory instruments
(countercyclical provisioning, etc) to limit systemic risks. The European
Commission document says nothing on this.
Moreover, there is convincing evidence that warnings are not sufficient in the
European environment either. The ECB Stability Reports issued warnings in the
past, but as Lorenzo Bini Smaghi has said, ‘‘[I]t is clear that the warnings contained
in these reports were not heeded by the relevant authorities’’.23
In other words, the macro regulator needs not only voice, but also teeth.
5. The role of the European Central Bank
From a theoretical point of view, it is clear that the central bank should play
a leading role in the macro-prudential level of supervision. But in addition to
giving the ECB a fundamental position in the ESRB, it seems even more important
to amend the ECB’s present mandate to put monetary and financial stability on the
same footing.
For the ESRB to function efficiently, a precise procedure for handling possible
differences of opinion has to be established. To avoid stalemates (the more likely
the more delicate the problems involved) the person or entity that has the authority
to work out a solution has to be clearly identified. A solution could be to give
the ECB a casting vote (that is, the vote that decides in case of a split decision).
Moreover, it is clear that the ESRB and the ECB in particular must also have
a leading role vis-à-vis national regulators, should they fail to comply with the
22
King, ‘‘Speech at the Lord Mayor’s Banquet’’.
23
Bini Smaghi, ‘‘Regulation and Supervisory Architecture’’, 4.
68 M. Onado

warnings and recommendations issued by the ESRB. Such a solution has now been
proposed for the future British framework: the Bank of England would have the
final say in case of any divergence of opinion. Instead, both the Larosière Report
and the European Commission are extremely vague on these points.
6. The independence of the ESRB
A European body in charge of macro-prudential supervision must be fully inde-
pendent. This is an important condition not only per se but also because the ESRB
can put at risk, at least indirectly, the independence of the ECB.24 Nevertheless,
the European Commission has chosen to give a Commission representative a seat
(with voting power) in the Council (ESRB) and to allow the finance ministries
to be represented indirectly. Both these provisions entail substantial threats to the
ESRB’s independence and, above all, seem unnecessary, given the provisions on the
disclosure and accountability of the body’s decisions.
Moreover, the effectiveness of a supervisory body is strictly determined by its
endowment in terms of dedicated and high-skilled resources. The ESRB must
therefore have its own budget to hire the human resources needed to build the
database and conduct the research promoted by its Board, in cooperation with the
ECB. The staff can be temporarily seconded by the ECB or national central
banks, but in the medium term the ESRB should have a staff of its own.
Instead, the European Commission document proposes a simple ‘‘advisory tech-
nical committee [. . .] to support the ESRB, including preparing detailed technical
analysis of financial stability issues’’.25
7. The information necessary for macro-prudential supervision
Last but not least, information is crucial if macro-prudential supervision is to be
effective. The crisis has shown that systemic analysis must be based on both macro
data and a very specific knowledge of the risks inherent in the tangled web of large
complex financial institutions. As seen, in a broad interpretation like Borio’s,
macro-prudential supervision requires adequate information on the interlinkages
through which instability can spread. At the same time, for this kind of supervision
to work, the authority must be protected from falling victim to the many
information asymmetries typical of modern finance.
Instead, the European Commission deals with the problem of information only
at the level of micro-prudential supervision, when it states:
The European supervisory authorities should be responsible for the aggregation of all
relevant micro-prudential information emanating from national supervisors [. . .]

24
Should the ESRB be subject to political pressures, inevitably the ECB (and its chairman in particular)
would be in a very delicate position and the independence of the central bank could be threatened.
25
EC, Communication from the Commission, 7.
 Is the Larosière Proposal on the Right Path? 69

The information would be available for the relevant authorities in colleges of super-
visors and may be forwarded in aggregate and/or anonymous format to the ESRB.26

As a result, the ESRB not only has no information power, but depends on the three
future European authorities for getting it, and then only in a format that is
absolutely useless from the point of view of analysing the interconnections.
In other words, the radar screen of the macro-prudential supervisors could be
blinded.
Jean-Claude Trichet, president of the ECB, has clearly stated: ‘‘effective macro-
prudential supervision depends on access to data and its translation into concrete
measures. Access to relevant data is essential for the assessment of risks and vulner-
abilities in the financial system. This is why such access must be part and parcel
of a well-functioning arrangement for macro-prudential supervision.’’ The ECB
Vice-President Lucas Papademos has added that ‘‘the development of the appro-
priate structure and the procedures for bringing together all types of pertinent
information, also in a manner that ensures strict confidentiality in the use of
micro data, will represent a major challenge, which will require analytical
sophistication, market knowledge and supervisory expertise’’.27
The creation of a European database for macro-prudential analysis requires,
first of all, close cooperation between the ESRB and national supervisors, as well
as with the relevant European Supervisory Authorities. As a consequence, the
ESRB should be given specific responsibility in this field as well as the power to
set down the reporting requirements for the group of large and complex financial
institutions.
Only if these points are solved, will a proper level of macro-prudential super-
vision be established – one that takes into account the lessons which must be
learned from the present crisis and that follows Borio’s guidelines.

The micro level of prudential supervision

In Europe, the segmentation of regulation and supervision along national lines
conflicts increasingly with the common currency and the objective of fostering
financial integration.
It goes without saying that supervision has to be carried out on a ‘‘federal’’ basis
because day to day relationships with individual institutions can only be imple-
mented, in practical terms, by authorities that are ‘‘close to the field and know
the institutions well’’.28 By the same token, the common monetary policy relies
on a system based on national central banks and an autonomous body, the ECB,
which has the main responsibility for coordinating and implementing the decisions
linked to monetary policy and lending of last resort.
26
EC, Communication from the Commission, 11.
27
Papademos, ‘‘Strengthening Macro-prudential Supervision’’.
28
Bini Smaghi, ‘‘Regulation and Supervisory Architecture’’, 3.
70 M. Onado

So, the problem is not to abolish national supervisors, but to decide what kind
of body should be in charge of coordinating the decisions that are most important
from the point of view of micro-prudential supervision, in particular for European
LCFIs.
The Larosière Report and the European Commission discarded both the option
of creating a true system of European supervisors on a federal basis, similar to the
Eurosystem, and the option of giving the ECB responsibilities in this field, using
Article 105(6) of the Treaty of European Union. The second not only seems much
easier to implement under the present conditions, but is also more founded
theoretically.
Having discarded these two extreme but theoretically robust solutions, the
Larosière Report chose a compromise in an attempt to minimise the political
opposition from the main European countries. It is important to remember that
in the worst days of the crisis, notwithstanding the lip service paid to mutual
understanding and cooperation, all major countries worked out national – not
European – solutions for their banks. As a consequence, micro supervision will
be assigned to three European Supervisory Authorities (ESA), resulting from
an upgrading of the three committees in charge of coordinating supervision in
the fields of banking, securities markets and insurance.
The ESA will issue binding interpretations of European legislation and will be
the only counterpart for European banks with cross-border activity. The former
provision can make an important contribution to the harmonisation of European
legislation, but not to the harmonisation of supervision as such. The latter is
definitely an important achievement, but effective results will depend crucially
on three things: the definition of the banks to be supervised at this level; the
information that will be provided by national regulators to the colleges and there-
fore to the ESA; and the legal powers that will be given to the ESA. These
important points have not been detailed so far, particularly (and worryingly) in
the European Commission document. The problem is the same as the one already
discussed for the macro level of supervision: without clear rules concerning effective
powers and the decision-making process, it will be very difficult for ESA to reach
a decision, particularly during a crisis. The European Commission uses a very
vague word to define the position of the colleges: ‘‘lynchpin of the supervisory
system and [important players] in ensuring a balanced flow of information between
home and host authorities’’.29
Furthermore, the Larosière Report raises two important issues without providing
adequate responses. First, according to the Report, the so-called Lamfalussy
Procedure for fostering harmonisation of the regulatory framework has
produced very dismal results and the present regulatory framework in Europe
lacks cohesiveness. A very troubling example offered is that even the definition
29
EC, Communication from the Commission, 9.
 Is the Larosière Proposal on the Right Path? 71

of credit institution and bank capital varies from one European country to another.
Bini Smaghi shares this negative assessment of the Lamfalussy procedure and finds
that ‘‘the Lamfalussy framework, which was supposed to promote the convergence
of regulatory and supervisory practices, has been insufficient’’.30 When the
Lamfalussy Report was published, many commentators were rather sceptical
about the efficacy of the proposed procedure. They were told that it was the
best possible solution as only a compromise outcome would be workable, given
the strong differences between European countries. The question therefore is: why
should the ‘‘Larosière compromise’’ work any better than the ‘‘Lamfalussy com-
promise’’? In other words, the ESA should be given very binding powers, otherwise
the current lack of cohesiveness in regulation will be replicated in micro
supervision.
The second problem is that the Report states that there is a disturbing ‘‘lack
of frankness and cooperation between supervisors’’. In particular, ‘‘as the crisis
developed, in too many instances supervisors in Member States were not prepared
to discuss with appropriate frankness and at an early stage the vulnerabilities of
financial institutions which they supervised. Information flow among supervisors
was far from optimal, especially in the build-up to the crisis.’’31 On this matter,
Bini-Smaghi adds that ‘‘in some countries, like Germany or Austria, where the
supervisory authorities are not part of the central bank, the supervisors consider
that they cannot deliver information on their own institutions to European
authorities for reasons of confidentiality’’.32
Neither the Report nor the Commission make any specific recommendation to
remove these obstacles. This could prove to be a major flaw for the efficient
working of the future European authorities. The rather byzantine structure of
the micro level of supervision could make effective decision-making very difficult,
particularly during a financial crisis.33

Conclusions
The crisis has shown that we need to strengthen prudential regulation, particularly
for the core group of large complex financial institutions. This need is particularly
felt in the European area, at both the macro and micro level, as a necessary step
towards financial integration.
The Larosière Report contains interesting proposals which however appear to
reflect the typical compromise between national interests. The solutions appear
politically workable, but show numerous weaknesses and have raised many
30
Bini Smaghi, ‘‘Regulation and Supervisory Architecture’’.
31
Larosière Report, 41.
32
Bini Smaghi, ‘‘Regulation and Supervisory Architecture’’.
33
The Chairman of the Italian Securities regulator seems to share this doubt. See Cardia, Audizione del
Presidente della Consob.
72 M. Onado

unanswered questions. From this point of view, they risk replicating the dismal
results of the Lamfalussy procedure, which is fiercely criticised in the report itself.
These issues should be taken into account when the proposals for legislation
inspired by the Larosière Report will be discussed by the European Parliament,
presumably in early 2010.
It is certainly important to set up committees for discussing supervisory matters
at the supra-national level, but as one of Europe’s founding fathers, Jean Monnet,
said: ‘‘I have too often observed the limits of coordination. It is a method which
promotes discussion, but it does not lead to a decision.’’34

References
Alemanni, B., G. Lusignani and M. Onado. ‘‘The European Securities Industry: Further evidence
on the roadmap to integration’’. In Investor Protection in Europe. London: Oxford University
Press, 2006.
Bini Smaghi, L. ‘‘Regulation and Supervisory Architecture: Is the EU on the Right Path?’’ Speech,
2009 ECON meeting with national parliaments on financial crisis, Brussels, 12 February 2009.
Borio, C. Towards a Macro-prudential Framework for Financial Supervision and Regulation?
BIS Working Papers No. 128. Basel: Bank for International Settlements, February 2003.
Cardia, L. Audizione del Presidente della Consob. Camera dei Deputati VI Commissione Permanente,
Rome, 16 September 2009.
Commission to the EC. Proposal for a Regulation of the European Parliament and of the Council on a
European Securities and Markets Authority. COM (2009) 503, Brussels, 23 September 2009.
Commission to the EC. Proposal for a Regulation of the European Parliament and of the Council on
Community Macro Prudential Oversight of the Financial System an Establishing a European
Systemic Risk Board, COM (2009) 499/3, Brussels, 23 September 2009.
Commission to the EC. Proposal for a Regulation of the European Parliament and of the Council on
Establishing a European Banking Authority, European Insurance and Occupational Pensions
Authority, COM (2009) 502, Brussels, 23 September 2009.
Commission to the EC. Communication from the Commission, European Financial Supervision.
COM (2009) 252 final, Brussels, 27 May 2009.
EU, High-Level Group on Financial Supervision. Report, chaired by Jacques de Larosière, Brussels,
25 February 2009.
European Central Bank (ECB). OTC Derivatives and Post-Trading Infrastructure. Frankfurt: ECB,
September 2009.
European Central Bank. ‘‘Possible Initiatives to Enhance the Resilience of OTC Derivatives
Markets’’. Consultation of the European Commission, Eurosystem Contribution, Frankfurt:
ECB, September 2009.
Financial Services Authority (FSA). The Turner Review: A Regulatory Response to the Global Banking
Crisis. London: FSA, March 2009.
Financial Stability Forum (FSF). Report on Enhancing Market and Institutional Resilience. Basel:
Bank for International Settlements, 7 April 2008.
Group of Thirty. Financial Reform: A Framework for Financial Stability. Washington DC,
January 2009.

34
Quoted by Bini Smaghi, 3.
 Is the Larosière Proposal on the Right Path? 73
Haldane, A. G. ‘‘Rethinking the Financial Network’’. Speech, Financial Student Association,
Amsterdam, April 2009.
King, M. ‘‘Speech at the Lord Mayor’s Banquet for Bankers and Merchants of the City of London’’,
London, 17 June 2009.
Marsh, I. W. and I Stevens. ‘‘Large Complex Financial Institutions: Common Influences on Asset
Price Behaviour?’’ Bank of England Quarterly Bulletin 15 (December 2003).
Meyer, L. H. ‘‘The Challenges of Global Financial Institution Supervision’’. Remarks at the
Federal Financial Institutions Examination Council, International Banking Conference,
Arlington, VA, 31 May 2000.
Onado, M. ‘‘European Integration and Financial Regulation. Towards a European Authority’’.
Paper presented at the European Central Bank, Frankfurt, 19 January 2001.
Papademos, L. ‘‘Strengthening Macro-prudential Supervision in Europe’’. Paper presented at
the Conference on ‘‘After the Storm: The Future Face of Europe’s Financial System’’,
National Bank of Belgium and the IMF, Brussels, 24 March 2009.
Trichet, J.-C. ‘‘Remarks on the Future of European Financial Regulation and Supervision’’.
Keynote address, Committee of European Securities Regulators (CESR), Paris,
23 February 2009.
Unicredit Group. ‘‘Cross-border Banking in Europe: What Regulation and Supervision?’’.
Discussion Paper presented at the Forum on Financial Cross-Border Groups, London,
11–12 March 2009.