Banking systems: from regional

to national

3.1. The American banking system

The American commercial banking system is known as a dual banking

system because its main feature is side-by-side federal and state chartering
(and supervision) of commercial banks. There are federal chartered banks,
under the aegis of the Comptroller of the currency, and state-chartered
banks, under the supervision of each of the various states.

A unique feature of the system is that the regulated can choose their
regulator: state banks can shift to national charters and vice versa, state
member banks can shift to non- member status and vice versa 13 .

The justification for the dual banking system is that it is supposed to foster
change and innovation by providing alternative routes so that each bank can
seek charters and do business. It is claimed that a dual banking system is
more responsive to the evolving banking need of the economy than a single
system would be.

Federal Reserve System

The Fed, as the system is commonly called, is an independent governmental

entity created by Congress in 1913 to serve as a central bank of the United
States, comprising 12 regional Reserve Banks and the Board of Governors
in Washington D.C. The Federal Reserve Bank of New York, one of the 12
regional reserve banks is the largest in terms of assets and volume of
activity. The 12 reserve banks supervise and regulate bank holding
companies as well as chartered banks in their District that are members of
the Federal Reserve System. Each reserve bank provides services to

13
Ligia Georgescu Golosoiu, Business of Banking, Editura ASE, 2002
depositary institutions in its respective district and functions as a fiscal agent
of the U.S. government. The regional Federal Reserve Banks, one of each
federal district, are geographically dispersed throughout the country: New
York, Boston, St. Louis, San Francisco, Philadelphia, Atlanta, Chicago,
Kansas City, Richmond, Dallas, Minneapolis, Cleveland.

The Federal Reserve System was designated to ensure its political

independence and its sensitivity to divergent economic concerns. The
chairman and the six other members of the Board of Governors who
oversee the Federal reserve are nominated by the President of the United
States and are confirmed by the Senate. The President is directed by law to
select governors who provide a fair representation of the financial,
agricultural, industrial and geographical divisions of the country. Only one
member of the Board may be selected from any one of the twelve Federal
Reserve Districts. These aspects of selection are intended to ensure
representation of regional interests and the interests of various public
sectors.

The primary responsibility of the Board members is the formulation of

monetary policy. The seven Board members constitute a majority of the 12-
member Federal Open Market Committee (FOMC), the group that makes
the key decisions affecting the cost and availability of money and credit in
the economy. The other five members of the FOMC are Reserve Bank
presidents, one of whom is the president of the Federal Reserve Bank of
New York. The other Bank presidents serve one-year terms on a rotating
basis.

Each Reserve Bank is headed by a president appointed by the Bank’s nine-

member board of directors.

FOMC is the most important monetary policymaking body of the Federal

Reserve System. It is responsible for formulation of a policy designated to
promote growth, full employment, stable prices and sustainable pattern of
international trade and payments. The FOMC makes key decisions
regarding the conduct of open market operations-purchases and sales of US
government and federal agency securities-which affect the provision of
reserves to depository institutions and, in turn the cost and availability of
money and credit in the US economy. The FOMC also directs System
operations in foreign currencies.
Reserve Bank boards of directors are divided into three classes of three
persons each.

Class A directors represent the member commercial banks in the District,

and most are bankers. Class B and class C directors are selected to represent
the public, with due consideration to the interests of agriculture, commerce,
industry, labor and consumers.

Class A and class B directors are elected by member banks in the District,
while class C directors are appointed by the System’s Board of Governors in
Washington.

Similarly, each of the Reserve Banks is supervised by a board of nine

directors who are familiar with conditions in the area encompassed by the
Branch.

The responsibilities of directors are broad, ranging from the supervision of

the Reserve Bank to making recommendations on monetary policy.
Directors review their reserve Bank’s budget and expenditures. They are
also responsible for the internal audit program of the bank. They also have
to set the discount rate every two weeks, subject to approval by the Board of
Governors. The discount rate is the interest rate depository institutions pay
when borrowing from the Reserve Banks. By raising or lowering the rate,
the System can influence the cost and availability of money and credit.

The main functions of the Fed

1. Monetary policy
The Fed creates and executes monetary policy to influence monetary and
credit conditions and thereby contributes to the nation’s economic goal of
non- inflationary growth. Although the Fed uses three major tools to
implement policy, the most important is open market operations.
• Through open market operations, Fed buys and sells US Treasury
securities in the secondary market in order to produce a desired
level of banks reserves. The Fed adds extra credit to the banking
system when it buys Treasury securities from dealers, and drains
credit when it sells to the dealers.
• Discount window operations, a second monetary policy tool of the
Fed provides secured short-term loans to depository institutions
temporarily in need of funds. Each of the twelve district reserve
 banks lends to depository institutions in its district, but only after
borrowers have exhausted their market sources of funds. Banks
borrow from window at the discount rate that is set by each
reserve bank, but requires the approval of the Board of Governors.
The rate is adjusted occasionally to reflect changes in the market
conditions and monetary policy objectives. Discount window
lending is often referred to as “lender of last resort” function of
the central bank.
• Reserve requirements establish the proportions of demand deposit
(checking) accounts and time deposits that must be held as non-
interest bearing reserves at Federal Reserve Banks or as vault
cash. An increase in reserve requirements would be regarded as an
attempt to restrict bank credit and restrain economic activity. A
reduction in the reserve ratio would be viewed as a stimulative
monetary policy move.

2. International operations
The New York Fed, representing the Federal Reserve System and the US
Treasury is responsible for intervening in foreign exchange markets to
achieve dollar exchange rate policy objectives and to counter disorderly
conditions in foreign exchange markets. Such transactions are made in close
coordination with the US Treasury and Board of Governors and most often
are coordinated with the foreign exchange operations of other central banks.
Dollars are sold in exchange for foreign currency if the goal is to counter
upward pressure on the dollar. If the objective is to counter downward
pressure, dollars are purchased through the sale of foreign currency.

The Federal Reserve Bank of New York serves as fiscal agent in the United
States for foreign central banks and official international financial
organizations. It acts as the primary contact with the foreign central banks.
The services provided for these institutions include the receipt and payment
of funds in US dollars, purchase and sale of foreign exchange and Treasury
securities, the custody of almost $800 billion in currency, securities and
gold bullion held for over 200 foreign account holders, and the storage of
over $64 billion in monetary gold for about 60 foreign central banks,
governments and official international agencies (about one-third of the
world’s known monetary gold reserves).

3. Supervision and regulation

One of the reasons for the establishment of the Federal Reserve System was
to forestall a repeat of the liquidity crisis and financial panics that occurred
sporadically in the United States prior to 1913. Consequently, the Federal
Reserve is one of several governmental banking regulators that share
responsibility for supervising and examining depository institutions. The
objective is to ensure the financial strength and stability of the nation’s
banking system.

The Fed’s responsibilities extend to all state-chartered banks that are

members of the Federal Reserve System, all US bank holding companies
and many of the US operations of foreign banking organizations. In
addition, as lender of last resort, the Fed stands ready to provide temporary
or long-term liquidity to any depository institutions that meets its criteria for
discount window borrowing.

The Fed is responsible fo r enforcing laws and establishing rules to protect

customers or depository institutions. It also ensures that banks try to meet
the credit needs of their communities by observing community reinvestment
laws and laws assuring consumer’s fair and unbiased access to credit.

4. Financial services

Government services
The Federal Reserve System performs various services for the US Treasury
and other government, quasi- government and international agencies. Each
year, billions of dollars are deposited to and withdrawn by various
government agencies from operating accounts in the US Treasury held by
the Federal Reserve Banks.

The Fed holds in its vaults, collateral for government agencies to secure
public funds that are on deposit with private depository institutions. In
addition, Reserve Banks receive for deposit to the Treasury’s accounts such
items as federal unemployment taxes, individual income taxes withheld by
payroll deduction, corporate income taxes, and certain federal excise taxes.
The Fed also issue and redeem instruments of the public debt such as bonds
and Treasury securities, make periodic payments of interest on outstanding
obligations of the US Treasury or federal agencies.

Depository institutions services

Fed distributes currency and coin to depository institutions to meet the
public’s need for cash. During periods of heavy cash demand, institutions
obtain larger amounts of cash from the Federal Reserve Banks. When public
demand for cash is light, institutions deposit excess cash with the Reserve
banks for credit to their reserve accounts. Also Fed serves as a central
check-clearing system, handling almost 18 billion checks a year. It process
these checks, route them to the depository institutions on which they are
written and transfer payment for the checks through accounts that depository
institutions maintain with the Federal Reserve Banks.

The Fed and about 7,800 institutions are linked electronically through the
Federal Reserve Communications System, a network through which
depository institutions can transfer funds and securities nationwide in a
matter of minutes. In addition, Federal Reserve Banks and their Branches
operate automated clearinghouses, computerized facilities that allow for the
electronic exchange of payments among participating depository
institutions 14 .

Financial institutions
Commercial banks- are the most widely diversified in terms of both
liabilities and assets.

Ranked in terms of assets size, these are the largest financial institutions.
Traditionally, their main source of funds has been demand deposits. This
situation has changed over the past twenty- five years; savings and time
deposits have become an even more important source of funds for
commercial banks.

Life insurance companies insure people against the financial consequences

of death, receiving their funds in the form of public payments that are based
on mortality statistics. They consequently purchase longer-term assets, such
as long-term corporate bonds and Lon-term commercial mortgages.

Pension and retirement funds are also concerned with the long rather than
short run. Their inflow of money comes from working people concerning to
the retirement’s years. They invest in long-term corporate bonds, high- grade
common stocks, large-denomination time deposits and long-term mortgages.

Mutual funds are frequently stock market related institutions but there are
also mutual funds specializing in bonds of all kinds.

14
The Structure of the Federal Reserve System, www.fed.org
Savings and loan associations have acquired almost all their funds through
savings deposits and used them to make mortgage loans.

Sales and consumer finance companies specialize in lending money for

people to buy cars and take vacations and for business firms to finance their
inventories.

Property and casualty insurance companies insure homeowners against

burglary and fire, car owners against theft and collision, business firms
against negligence lawsuits etc.

Credit unions- are organized as co-operatives for people with some sort of
common interest, such as employees of a particular company or members of
a labor union. Members buy shares that make them eligible to borrow from
the credit union.

Mutual savings banks-are practically identical with savings and loan

associations except that there are only about 500 of them.

3.2. EU banking system

The European System of Central Banks (ESCB) is composed of European

Central Bank (ECB) and the national central banks (NCBs) of all 15 EU
member states. The Eurosystem is the term used to refer to the ECB and the
NCBs of the member states, which have adopted the Euro. The NCBs of the
member states which do not participate in the Euro area, however are
members of the ESCB with a special status-while they are allowed to
conduct their respective national monetary policies, they do not take part in
the decision- making with regard to the single monetary policy for the Euro
area and the implementation of such decisions. In accordance with the
Treaty establishing the European Community and the Statute of the
European System of Central Banks and the European Central Bank, the
primary objective of the Eurosystem is to maintain price stability. The basic
tasks to be carried out by the Eurosystem are: to define and implement the
monetary policy of the Euro area; to conduct foreign exchange operations;
to hold and manage the official foreign reserves of the member states and to
promote the smooth operation of payment systems. In addition, the
Eurosystem contributes to the smooth conduct of policies pursued by the
competent authorities relating to the prudential supervision of credit
institutions and the stability of the financial system. The ECB has an
advisory role vis-à-vis the Community and national authorities on matters,
which fall within its field of competence, particularly where Community or
national legislation is concerned. Finally, in order to undertake the tasks of
the ESCB, the ECB, assisted by the NCBs, shall collect the necessary
statistical information either from the competent authorities or directly form
economic agents.

The process of decision- making in the Eurosystem is centralized through the

decision- making bodies of ECB, namely the Governing Council and the
Executive Board. As long as there are member states, which have not yet
adopted the Euro, a third decision-making body, the General Council shall
also exist.
§ The Governing Council comprises all the members of the Executive
Board and the governors of the NCBs of the member states without
derogation, i.e. those countries, which have adopted the Euro. The main
responsibilities are:
- to adopt the guidelines and take the decisions necessary to ensure the
performance of the tasks entrusted to the Eurosystem.
- to formulate the monetary policy in the Euro area, including, as
appropriate, decisions related to intermediate monetary objectives, key
interest rates and the supply of reserves in the Eurosystem
- to establish the necessary guidelines for their implementation.
§ The Executive Board comprises the President, the Vice-President and
four other members, all chosen from among persons of recognized
standing and professional experience in monetary or banking matters.
They are appointed by common accord of the governments of the
member states at the level of the Heads of State or Government, on a
recommendation from the EU Council after it has consulted the
European Parliament and the Governing Council of the ECB. The main
responsibilities of the Executive Board are: to implement monetary
policy in accordance with the guidelines and decisions laid down by the
Governing Council of the ECB and, in doing so, to give the necessary
instructions to the NCBs; and to execute those powers which have been
delegated to it by the Governing Council of the ECB.
§ The General Council comprises the President and the Vice-President
and the Governors of the NCBs of all 15- member states. The general
Council peforms the tasks which the ECB took over from the EMI
(European Monetary Institute) and which, owing to the derogation of
one or more member states, still have to be performed in stage three of
Economic and Monetary Union (EMU). The General Council also
contributes to the necessary preparations for irrevocably fixing the
 exchange rates of the currencies of the member states with derogation
against the Euro.

The Eurosystem is independent. When performing Eurosystem-related

tasks, neither the ECB, nor an NCB, nor any member of their decision-
bodies may seek to take instructions from any external body. The
Community institutions and bodies and the governments of the member
states may nor seek to influence the members of the decision- making bodies
of the ECB or of the NCBs in the performance of their tasks.

The ECB’s capital amounts to EUR 5 billion15 . The NCBs are the sole
subscribers to and holders of the capital of the ECB. The subscription of the
capital is based on the basis of the EU member states’ respective shares in
the GDP and population of the Community. The Euro area NCBs have been
paid up their respective subscriptions to the ECB capital in full. The NCBs
of the non-participating countries have paid up 5% of their respective
subscriptions to the ECB’s capital as contribution to the operational costs of
the ECB. In addition, the NCBs of the member states participating in the
Euro area have provided the ECB with foreign reserve assets of up to an
amount equivalent to around EUR 40 billion. The contributions of each
NCB were fixed in proportion to its share in the ECB’s subscribed capital,
while in return each NCB was credited by the ECB with a claim in Euro
equivalent to its contribution.

It should be stressed that both Eurosystem and ESCB are not legal
persons 16 . According to the international public law, ECB is the core of the
complex structure of the Eurosystem. According to the national legislation,
each central bank of ESCB is a legal person. So each central bank form
Eurosystem perform the tasks entrusted by the ECB. These central banks
may run any other functions ouside the Eurosystem as long as they are not
interfering with its objectives. Thus, the national cemntral banks perform
financial operations on their name and exercise prudential supervision on
the national credit institutions. The central bank of the EU countries that
have not adopted euro are ESCB members with a special status.

According to the Article 122 of the Treaty, these countries are members
with derogation which implies that their central banks don’t have certain
rights and obligations within the ESCB. The central banks from these

15
www.ecb.int, Organisation of the European System of Central Banks
16
Piata Financiara, No 11/2002
countries (Denmark, Sweden, Great Britain) may conduct their own
monetary policies; they are not part of the unique monetary policy,
concerning its definition and implementation.

Monetary policy instruments

Open market operations- are initiated by the ECB, which decides also on
the instrument to be used and the terms and conditions for the executions of
such operations, With regard of their aim, regularity and procedures, the
ESCB open market operations can be divided into the following four
categories:
- The main refinancing operations are regular liquidity-providing
reverse transactions with a weekly frequency and maturity of two
weeks. They are executed by the national central banks on the basis
of standard tenders and according to a pre-specified calendar;
- The longer-term refinancing operations are liquidity providing
reverse transactions with a monthly frequency and a maturity of
three months. They will be executed by the national central banks on
the basis of standard tenders and according to pre-specified calendar;
- Fine-tuning operations can be executed on ad- hoc basis with the aim
both of managing the liquidity situation in the market and of steering
both interest rates, in particular in order to smooth the effects on
interest rates caused by unexpected liquidity fluctuation;
- In addition, the ESCB may carry out structural operations through
the issuance of debt certificates, reverse transactions and outright
transactions. The operations will be executed whenever the ECB
wishes to adjust the structural position of the ESCB vis-à-vis the
financial sector.

Standing facilities aim to provide and absorb overnight liquidity, signal the
general stance of monetary policy and bound overnight market interest rates.
Two standing facilities, which will be administrated in a decentralized
manner by the national central banks, are available to eligible counterparts
on their initiative:
- counterparts will be able to use the marginal lending facility to
obtain overnight liquidity from the national central banks against
eligible assets. The interest rate on the marginal lending facility will
normally provide a ceiling for the overnight market interest rate;
- Counterparts will be able to use the overnight deposit facility with
the national central banks. The interest rate on the deposit facility
will normally provide a floor for the overnight market interest rate.
Minimum reserves
Any minimum reserve system would be intended to pursue the aims of
stabilizing money market interest rates, creating (or enlarging) a structural
liquidity shortage and possibly contributing to the control of monetary
expansion. The reserve requirement of each institution would be determined
in relation to elements of its balance sheet. Only institutions subject to
minimum reserves may access the standing facilities and participate in open
market operations based on standard tenders 17 .

Economic and monetary union

The first step on the road to European Integration was taken in 1951 with
the signing of theTreaty establishing the Euroepan Coal and Steel
Community. Then, in 1957, Belgium, the Netherlands, Luxembourg,
Germany, France and Italy signed the Treaties of Rome. One Treaty
introduced common economic policies, especially on agriculture and, in
1968, a custom union. The other was the Euratom Treaty on nuclear energy.

The Community gradually branched out into other areas. In 1986 the
European Single Act provided for the free movement of people, goods,
capital and services and established many new policies. In 1993, the Treaty
on European Union ( Maastricht Treaty) entered into force. It intoduced the
pillar structure: the European Community is the first pillar, foreign policy
the second, and justice and home affaires the third.

In 1997, the Treaty establishing the EC was amended once again, this time
at Amsterdam. Consumer policy, employment, growth and free movement
of people were amongst the most important issues dealt with.

Economic and monetary union (EMU) first came to the fore as a primary
objective of the EC in 1969. Each element in the term has a maximalist and
a minimalist meaning. Economic union implies that the member states will,
at most, cease to follow independent economic policies, and at least will
follow co-ordinated policies. Monetary union means, at most the adoption
of a single EU currency, at least the maintenance of fixed exchange rates
between the currencies of the member states.

The history of monetary integration began in 1968 with the Werner report,
which set out a blueprint for the stage-by-stage realisation of economic and

17
Ligia Georgescu-Golosoiu, Business of Banking, Ed. ASE 2002
monetary union. In 1979 the European Monetary System was established:
bilateral rates were determined between all currencies in the system, which
were allowed to fluctuate within pre-set margins around these rates. At the
center of the EMS was the ecu, a basket currency, made up of fixed
percentages of the participating national currencies. In 1989 the Delors
report laid the foundations for the euro and the Maastricht Treaty of 1992
provided a legal basis for EMU and the single currency.

The Maastricht Treaty provides for EMU in three stages: the first, beginning
on July 1, 1990, is mainly about the free movement of capital; the second,
starting on January 1, 1994 is concerned with preparations for the single
currency, including the setting up of the European Monetary Institute, which
is to be dissolved in the third stage, beginning on January 1, 1999. This last
stage will focus on the establishment of the European Central Bank and the
introduction of the single currency.

The European Monetary System (EMS), which began operation in March

1979, had a much less ambitious aim: to create a zone of monetary stability
in Europe. Although it went through several crises, it did eventually prove
to be successful. However, the project for monetary union was revised in the
wake of the success of the single market program, and despite opposition
from the British government, and skepticism in several quarters, a single
European currency, the “Euro” formally came into existence in January
199918 .

18
Stephen George & Ian Bache, Politics in the European Union, Oxford University Press
Inc., New York, 2002
Study-case: EURO replaced ECU, as it was easier to pronounce

Set up in 1978, ECU (European Currency Unit) was an abstract currency, a standard
legal tender used by those ones in Brussels, to calculate the budgetary contributions of
each member state. In fact, it represented a basket of currencies, adjusted periodically to
reflect the relative economic power of each state.
Over the time, ECU became more important in the international market: non-European
institutions joint the ECU game in the ’80. The outcome: ECU was ranged the fifth in
the top of the most used currencies for international transactions with a 6% market
share.
Used first only for European interbanking operations, ECU became one of the main
reserve currencies in the world; the European Central Banks deposited at the European
Cooperation Monetary Fund 20% of their gold and US dollars reserves, in the exchange
of ECU. ECU was easily accepted on international level, even without the help of a
powerful institution as Federal Reserve of USA, Bundesbank or Bank of Japan. Norway
wasn’t member of European Economic Community, but decided to relate the value of
its currency to ECU. Far away from Europe, the Japanese, the Americans, and other
important players of the economic market used ECU as financial instrument to fight
against the fluctuations of the yen and dollar. Great performance for a currency that
really didn’t exist!
ECU was on its way to achieve the status of a real currency. Luxembourg introduced
for a month ECU as a payment instrument and it was accepted by all the traders of the
country that used cards as Visa and Eurocard and eurocheques.
As a peak of this euphoria, Spain issued a gold currency with the ECU symbol, sold
very quickly when Spanish peseta was officially accepted in the mechanism of
exchange rates.
Hotels and restaurants, air companies and even shops started to accept credit cards in
ECU, paving the way for payments in ECU. A pool made by Ernst&Young among 209
European companies and 47 banks showed that ECU would have the chance to become
the principal currency in the world in 1997.
“Although the Community does not agree to set up a common currency, ECU will
become a unique currency”, said John Heimann, the president of Merrill Lynch Europe.
The Maastricht Treaty confirmed the launch of ECU for 1994. It was also a secret
competition for the name of this currency. Some people spoke about “Monnet” in the
honor of Jean Monnet which would have been the homonym of the French and English
terms. Others backed up the term “Francfort”, with powerful remainder of Carolingian
period and would have the merit to connect the France, Belgium, Luxembourg, and
Switzerland, since their currencies were based on franc, with the German city Frankfurt
(in French Francfort), where the Bundesbank and other German private banks are
located.
But ECU, disregarding all this scenario, was liked best by most of the people.
Don’t forget that ECU is the name given by the French to their golden and silver coins
while France was the biggest world power. Finally, as ECU was very difficult to be
pronounced in some languages of the Community, it was replaced by EURO. This
decision was taken in December 1995 at the Madrid European Council.
Convergence criteria
The main convergence criteria laid down by the Maastricht Treaty are as
follows: an inflation rate not more than 1.5% above the average rate of the
three Member States with the lowest inflation; a public budget deficit not
exceeding 3% of GDP; public debt of not more than 60% of GDP; a long-
term interest rate no more than 2 percentage points higher than the average
rate of the three Member States with the lowest inflation; and no currency
fluctuations outside the normal EMS margins for two years and no serious
stains or devaluations.
The secondary convergence criteria are integration of markets, balance of
payments, labour costs, price indices and ecu trends.
Not all the member states will be taking part in EMU from 1 January 1999
but all of them (except Denmark and the United Kingdom) have decided to
join as soon as possible. It was decided at the Brusells Council on May 1998
that Austria, Belgium, Finland, France, Germany, Ireland, Italy,
Luxembourg, the Netherlands, Portugal and Spain would participate. The
bilateral exchange rates between their national currencies were set and the
members of the Executive Board of the ECB were appointed. The “ins”
concluded a Pact for Stability and Growth, while “pre- ins” agreed to work
harder towards convergence.
During the transition period (1 January 1999-31 December 2001) the ECB
started to operate, all new public issues were in euro, the financial markerts
and banks, for internal purposes might use euro, business also. In practice it
was possible to use euro for non-cash transactions only, but anyone might
open a bank account denominated in euro.
The euro was introduced as physical currency on 1 January 2002. The
period from 1 Janury 2002 to 30 June 2002 was a dual-circulation period
(euro and national currencies).
Study-case: The future tasks of National Bank of Romania within the ESCB
The National Bank of Romania will become a member of ESCB at the moment of
accession to the EU. Romania will be in the position to adopt Euro only after it has
complied with the convergence criteria stated in the Treaty. The task of NBR will differ
from one stage to another. There are to be no essential changes in the NBR activity since
the central bank will be an ESCB member with derogation during the period between
accession to EU and acceptance to the Euro area.
Consequently, the NBR governor will not attend the meeting of Governing Council, but
only the General Council, which has a consultative role. The NBR will keep on
maintaining the price stability and will have to look the currency exchange policy as an
issue of general concern. Therefore, Romania will have to participate to the exchange rate
mechanism of EU-MCE II. According to the circumstances, this participation may take
place immediately after accession or later.
National Bank of Romania will become a full member of ESCB only after Euro will
replace ROL. So NBR will no longer define the monetary policy, as our central bank will
implement the unique monetary policy established by the Governing Council. But the NBR
governor will be a member of this Council, thus being part of the decision-making process
related to the monetary policy. NBR will have the same task of prudential supervision,
issuing coins, having and establishing international relations with different institutions and
effecting any financial operations for various entities. NBR will also manage the official
reserves after the transfer of share-quota to the European Central Bank.
Euro-area banking system
General overview
The structural changes brought about by the adoption of a common currency
and a common monetary policy is exerting a profund impact on the area’s
financial sector. Faced with the combined pressures of globalization,
disintermediation, new technologies, and increased competition from non-
bank financial intermediaries, banks are designing strategies to thrive in this
new environment.

Altghout it is difficult to characterize the euro-area banking sector, it has

been identified some common trends in bank performance, balance sheet
structure, recent capital market developments.
§ The euro area’s financial system continues to be bank dominated. The
proportion of financial asstes controlled by the banking systems of the
euro-area countries remain high. Bank loans to to euro-area residents
amount to about 100% of the area’s GDP, twice the ratio in the United
States and similar compared to Japan. While euro-area banks continue to
play a dominant role in intermediating saving through traditional
means of collecting deposits and extending loans, the use of investment
funds as well as pension and insurance products as savings vehicles is
growing. For instance, assets in investment funds have increased at
double-digit rates in the recent years in almost all countries 19 .
§ Unlike other developed countries, virtually all euro-area countries
continue to maintain savings banks, and mutual and/or cooperative
banks that gained considerable weight in the local market, particulary at
the retail level. Altghough in the euro-area sector, the largest institutions
in the banking sector are private commercial banks, other types of banks
with different ownership structures continue to play a substantial role in
the banking sector. These institutions can be characterized along the
following lines: commercial (private-stock companies), savings banks,
cooperative or mutually owned banks, public banks and a mixture of
other types of banks, usually with special purposes. In several cases, the
savings banks are publicly owned, most often by local or municipal
authorities, and there are still cases of state and central government
ownership of big banking institutions.

19
Agnes Belaisch, Laura Kodres, Joaquim Levy and Angel Ubide, Euro Area Banking at
the Crossroads, IMF Working Paper, 2001
§ Germany has the largest system in terms of number of credit
institutions-over 3.000-due to its large population and the diverse nature
of its banking system. France has fewer than half that many, followed by
Austria and Italy (with each containing slightly fewer than 1.000). Spain
ranks sixth after the Netherlands. Each of the remaining countries
contains fewer institutions by far.
§ To date, consolidation in the euro area is taken mostly two forms, (1)
mergers among relatively large private, commercial banks and among
bank and non-bank financial institutions; and (2) mergers within the
savings and cooperative banks, respectively. Consolidation has been
essentially limited, sometimes with implicit government guidance, to
within national borders and within their own type. Some commentators
have interpreted the governments’ guidance as an apparent desire to
limit ownership of some influencial institutions and to create a few
“national champions” in each country to compete in the European or
global market place.
§ Consolidation has accelerated recently at the top: more than half of the
30 biggest euro-area banks are the result of recent mergers and the
average size of the top five has doubled since 1995. Bank of
International Settlements (BIS) data show that some 500 mergers and
acquisitions took place in 1991-1992, valued at $17.5 billion, whereas
in 1997-1999 only 200 took place, at a value of about $100 billion- fewer
but of a much larger scale.
§ The degree of concentration at the top is particularly striking in the
smaller euro-area countries, where now just a handful of banks dominate
these banking sectors. Euro-area countries banking systems are
characterized by relatively few large banks, some of which are
considered global palyers, and an array of medium-sized and small
institutions. In almost all smaller countries, the top of five banks hold
more than 50% of the total banking system whether measured by total
assets, total loans, or total deposits. In a few countries, the concentration
is now even more pronounced. For example, in the Netherlands and
Belgium, two large banking groups have more than half of the banking
sector assets, respectively. The four biggest countries have less
concentrated banking sectors, although in France, the five banking
groups take in nearly 90 percent of all deposits. Notably, Germany has
the lowest level of concentration in the euro area almost regardlessof
how it is measured. France and Spain are relatively more concentrated.
Types of Euro Area Banking Institutions
1. Private commercial banks. Commercial or private banks are owned by
their shareholders. Such private-stock companies usually offer equity to the
public, but may be owned by private equity holders. They can distribute
profits to their shareholders, typycally in the form of dividents. These
owners generally have limited liability and exercise control through various
mechanisms, often through board of directors or supervisory bodies. Voting
rights, though, may be separable from share ownership.

2. Savings banks. Savings banks often supply credit to local or regional

areas. In many cases, their original purpose was to provide credit to
farmers, artisans, or other underprivileged groups who were unable to
obtain credit elsewhere. Even when not required to do so, savings banks
often focus on individuals and small and medium sized businesses. When
partly or entirely owned by state or local governments or municipalities,
these institutions are usually required to allocate part of tehir operating
surplus to a “social fund” for use in the local community and the remaining
profit can be either retained or distributed to the government owner.

3. Cooperative/mutual banks. Thsese banks are typically owned by their

depositors and creditors and the services of these banks may be restricted to
those who own them, although recent liberalization has permitted many of
these institutions to offer their services to others. Ownership shares can be
restricted to ensure broad ownership. In some countries, profits are
distributed as dividents to the mutual owners, sometimes in the form of
highest interest rates on deposits. In other countries, profits are retained,
adding to reserves and the equity base. Governance is often implemented
through boards of directors selected from among the members of the
cooperative or mutual institution.

4. Public banks. Public financial institutions are now less prevalent in

Europe and are typically outside the banking system. However, the most
common type of public banks remaining in Europe are savings banks,
owned or controlled in part by local or municipal authority. Germany and
Austria, with 35 percent and 14 percent of assets in banks either owned or
governed by the public sector, respectively, constitute the largest public
banking sectors of this type.

5. Others types of banks. Often countries have some specialized lending

institutions. For instance, many EU countries contain martgage banks,
Germany has the largest such sector, whose assets are predominantely
mortgages and their liablities come from either household deposits or the
issuance of mortgages-backed securities. In some countries, there are
agricultural lending banks, postal savings banks, and other special banks
servicing specific sectors of the economy.

3.3. Short comparison between Fed and Eurosystem

The term Eurosystem is not to be found in the legal basis, i.e. the Treaties of
Maastricht and Amsterdam including the protocols which are part of the EU
Treaty. The only reference is to the European System of Central banks
(ECSB), which comprises the legally independent national EU central banks
(NCBs) – currently 15 – and the legally independent European Central Bank
(ECB). The ECB was established on June 1st, 1998 as a common subsidiary
of the national central banks located in Frankfurt/Main. The term
Eurosystem was introduced by the decision- making bodies of the ECB at
the beginning of Stage 3 of EMU (January 1st, 1999) in order to designate
those parts of the European System of Central Banks which are responsible
for monetary policy in the Euro area. Therefore, in addition to the ECB, the
Eurosystem only comprises the national central banks of the countries
participating in the monetary union. The Eurosystem bears the exclusive
responsibility for monetary policy in the EMU and the ECB is the heart of
the Eurosystem. It is responsible for carring out all tasks of the Eurosystem
either through its own activity or through the national central banks. This
means that the national central banks are, by function, subordinated to the
ECB „to allow the Eurosystem to operate efficiently as a single entity with a
view to achieving the objectives of the Treaty”. As integral parts of the
Eurosystem, the national central banks act as operative arms of the ECSB,
carring out the tasks conferred upon the Eurosystem in accordance with the
rules established by the ECB. Therefore, the basic principle of the
Eurosystem is „centralized decision- making, decentralized operations”. This
principle of decentralization stipulates that, to the extent deemed possible
and appropriate, the carrying out of the monetary policy operations is the
task of the NCBs. However, decentralization applies to operations only. The
monetary policy decisions and legislative activities remain centralized as
necessary for a common monetary policy. Unlike the ECB, the Eurosystem
and the ECSB have neither legal personality nor competence to pass
decision on their own. Both are governed by the decision- making bodies of
the ECB – the Governing Council, the General Council, and the Executive
Board.
The Federal Reserve System was set up in 1913. It is comprised of the
Board of Governors and the twelve regional Federal Reserve Banks. Until
1935, the decisive role was played by the FRBs. The most important
monetary policy instrument at that time, the discount rate, was decided upon
independently by each FRB. In the 1920s the instrument of open market
operations was „discovered”. It was used with varying intensity by the
individual FRBs. The FOMC was founded in 1933. At that time it could
only give recommendations whareas the individual FRBs had the right to
decide. In order to have a common monetary policy, directed to the whole
economy, a basic reform of the Fed came up in 1935. Open market policy
was now placed into the responsability of the FOMC and the influence of
the FRBs in the FOMC was reduced. Consequently, since then the members
of the Board of Governors have had a majority in the FOMC.

The primary objective of the Eurosystem is to maintain price stability. The

EU Treaty does not specify a precise, quantitative definition of price
stability or a time frame within which this objective should be attained.
Without prejudice to the primary goal of price stability, the Eurosystem
should support the general economic policy in the EU. Insofar, as the
general objective is not to the discretion of the Eurosystem, it is goal
dependent.

On the contrary, the Fed shall pursue several goals. The Federal Reserve Act
states the following: „The Board of Governors of the Federal Reserve
System and the Federal Open Market Committee shall maintain long run
growth of the monetary and credit aggregates commensurate with the
country’s long run potential to increase production, so as to promote
efficiently the goals of maximum employment, stable prices and moderate
long-term interest rates.” Despite this multitude of final objectives, the
monetary policy reaction function of the Fed seems to reveal a kind of
implicit inflation targeting. 20

Compared to other central banks, the Eurosystem has the highest degree of
independence. The EU Treaty and the Statutes of the ESCB are the legal
basis. Since this is international law, it can only be modified with unanimity
by all EU member states. In this respect, the position of the Fed is by far
weaker. The Federal Reserve System is considered to be an independent

20
Gunnar Heinsohn and Otto Steiger, The Eurosystem and the art of central banking,
Center for European Integration Studies, Working Paper, 2002
central bank. It is so, however, only in the sense that its decisions do not
have to be ratified by the president or anyone else in the executive branch of
government. The entire system is subject to oversight by the US Congress
because the Constitution gives to Congress the power to coin money and set
its value – a power that, in the 1913 act, Congress itself delegated to the
federal reserve. The Federal Reserve must work within the framework of the
overall objectives of economic and financial policy established by the
government, and thus the description of the System as „independent within
the government” is more accurate. Consequently, unlike for the Eurosystem,
the danger exists for the Fed that Congress could change the legal basis.
Thus, the ESCB has a more secure institutional foundation than the Fed,
which is a creation of Congress and whose structure can be changed at any
time.

The Eurosystem has three types of instruments at its disposal: minimum

reserves, open market operations and so called „standing facilities”. In the
US, there are minimum reserves, open market operations and so called
„discount windows”. In the Eurosystem, all esential decisions about the use
of instruments are made by the Governing Council of the ECB. In the
Federal Reserve System, the FOMC is only responsible for the open market
operations. Decisions about the use of minimum reserves and the discount
window are made by the Board of Governors.

The design of required reserves is similar in both systems. Credit

institutions are required to hold „minimum reserves” at their central bank
either as deposits on accounts with the central bank or as vault cash. The
Eurosystem only allows the first alternative, whereas credit institutions in
the USA can also fulfil their obligations with vault cash. Credit institutions
are obliged to hold required reserves in relation to specific liabilities of their
balance sheet. The Eurosystem also carries out open market operations,
which are undertaken on the initiative of the Eurosystem. Traditionally, the
term „open market operations” was used for purchase and sale of securities.
The Eurosystem, however, uses this term in an enumerative way. The most
important open market operations of the Eurosystem are the so-called „main
refinancing operations” and the „longer-term refinancing operations”. The
former are loans of a two-week term which are offered every week; the
latter are loans with a term of three months. In contrast to the Eurosystem,
the Fed still uses the term „open market operations” in the traditional way.
Open market operations are only purchases and sales of bonds, which could
take place either as outright operations or as repurchase agreements. Finally,
the Eurosystem has at its disposal so-called „Standing Facilities”. These
operations are carried out on the initiative of the credit institutions. They are
designed simmetrically and provide or absorb liquidity with an overnight
maturity. The marginal lending facility offers the oportunity to credit
institutions to get liquidity overnight. The amounts are not limited if a credit
institution has enough collateral. On the other hand, there is the deposit
facility which enables credit institutions to deposit excess liquidity. The
standing facilities shall facilitate the liquidity management of the credit
institutions.
Within the „discount window”, the Fed offers loans to credit institutions.
The interest rate which is charged for this is traditionally called the
„discount rate”. The discount window is in particular designed for credit
institutions with liquidity problems. The use of the discount credit is
combined with more intensive bank supervision on the part of the Fed.
The central starting point for the instruments of both central banks is the
money market. On the money market, the credit institutions trade funds at
the central bank. Such transactions do not lead to a change of the amount of
existing base money, they only cause a redistribution of the overall volume
between the credit institutions. From the point of view of an individual
bank, operations with the central bank and in the money market fulfil the
same function. Both support the balancing of changing liquidity needs.
Conclusions
The institutional structure of the two central banks is rather similar but the
main tasks and the legal status are different. Whereas the main task of the
Eurosystem is clearly spelled out (price stability), the Fed has several tasks
leading to some ambiguity. In this context, it is also important that the
independent status of the Eurosystem is guaranteed by international law (EU
Treaty), whereas the status of the Fed depends on Congress because the
Constitution gives to Congress the power to coin money and to set its value.
Regarding the instruments and operating procedures of monetary policy,
there are similarities in the design of the minimum reserves and the
operating target. In both cases, the overnight interest rate is the operating
target of monetary policy. Apart from required reserves, the instruments of
monetary policy are different. The differences in institutional and
instrumental respect can be traced back to historical factors, legal problems
of the change of existing arrangements and a different understanding of
monetary policy. In this context, the Eurosystem has had the advantage of
introducing all arrangements according to the knowledge of monetary policy
and theory at the end of the 20th century. In sum, the Eurosystem must be
classified as the superior system under efficiency aspects. 21

Summary

§ Hystory of European integration

- 1951: ECSC
- 1957: Treaties of Rome
- 1986: Single Act
- 1992: Maastricht Treaty
- 1997: Amsterdam Treaty.

§ Hystory of monetary integration

- 1968: Werner Report;
- 1979: EMS established;
- 1989: Delors report lays foundations for euro;
- 1993: Maastricht Treaty.

§ Convergence criteria
- inflation rate: price stability
- public finances: budget discipline
• max. deficit 3% of GDP
• max. debt 60% of GDP
- exchange-rate stability
- convergence of interest rate

§ Stages of integration:
- free trade area
- customs union
- common market
- economic union
- monetary union.

§ Decision-bodies of ECB:
- Governing Council
- Executive Board
- General Council

21
Karlheinz and Franz Seitz, The Euro System and the Federal Reserve System compared:
facts and challenges, Center for European Integration Studies, Working Papers, 2002
§ Microeconomic benefits (euro):
- facilitates cross-border financial transactions
- makes travelling easier for consumers
- no time wasted changing money
- no more exchange charges
- easier to compare prices

§ Macroeconomic benefits (euro):

- eliminates exchange-rate risk
- strengthens the single market
- encourages investment in the euro zone
- promotes convergence of national economies.

Check out questions

1 How is the Federal Reserve System organized?

2 What is the main body of the Fed and how is this elected?

3 What is the FOMC and what is its composition?

4 What is the role of the Federal Reserve?

5 What are the instruments of monetary policy used by the Fed?

6 What kinds of facilities are offered by the Fed to the government

agencies and to the depository institutions?

7 The regulation and supervision function supposes….

8 Lender of last resort means that:

9 State two benefits of the membership of Fed and/or Eurosystem.

10 Mention the convergence criteria of the EMU.

11 State the difference between the ESCB and the Eurosystem

12 Specify two common points between the Fed and the EU banking
system.

13 When was the Euro introduced?

14 State two different points between Fed and EU banking system.

15 Mention the stages of integration prior to monetary and economic

union.

16 What are the main features of the EU banking system?

17 What is understood by public finance discipline in case of EMU

convergence criteria?

Choose the right answer(s).

18 Open market operations:

a. are the main instrument used by the Fed to implement the
monetary policy
b. are foreign exchange operations
c. mean buying and selling US Treasury securities
d. are operations that influence the bank reserves.

19 The role of ECB is:

a. to implement the monetary policy in the Eurosystem
b. to implement the monetary policy throughout the EU
c. to support the general policies of the EU
d. to hold and manage the official foreign reserves of the member
states
e. to maintain price stability and sustainable economic growth.

20 The main bodies of the EU banking system are:

a. The Governing Council, the Executive Board, the General
Council
b. The Board of Governors, the Board of Directors and the General
Council
c. The Board of Governors, the Executive Board, the General
Council
d. The Governing Council, the Executive Board, the Council of
Governors of EU.
21 The countries that have not yet adopted the Euro are:
a. Great Britain, Sweden, Norway
b. Sweden, Denmark, England
c. Denmark, Ireland, Great Britain
d. Sweden, Great Britain, Ireland.

22 Convergence is related to:

a. inflation, price stability, long- interest rate
b. price stability, budgetary discipline, long-interest rate
stability, exchange rate stability
c. public deficit, budgetary deficit, public debt
d. inflation criteria, interest criteria, public criteria.

References

1. “Piata Financiara” magazine, 2000-2002

2. Dumitru Miron, “The Economics of European Integration”, ASE

Bucharest, 2002

3. Ligia Georgescu-Golosoiu, The Business of Banking, ASE Bucharest

2002-12-02

4. www.ecb.org, www.eu.int, www.fed.org

5. Center for European Integration Studies, Working Papers, www.zei.de

6. IMF Working Papers, www.imf.org