Foreword: International Monetary Stability (OUP, 2006), I Very Much Doubt Whether She Then Expected

Foreword
From: International Financial and Monetary Law (2nd Edition)

Rosa Lastra
Content type: Book content

Product: Financial Law [FBL]
Published in print: 22 January 2015
ISBN: 9780199671090
When Professor Rosa Lastra completed her earlier book on Legal Foundations of
International Monetary Stability (OUP, 2006), I very much doubt whether she then expected
that so much would change in the subsequent eight, or so, years that a major rewrite, a re-
assessment, would be necessary, as indeed it is. It is, perhaps, symptomatic that the word
Stability has been dropped from the title of the new book. It was not, however, as if
everything had been totally stable and constant prior to 2006. As I wrote in my Foreword
then, ‘Over the past fifty years [1960–2006] this simpler structure [of national and
international financial systems] has dissolved and been reformulated in a much fuzzier and
more complicated system.’ But that reformulation into a more liberal, global and market-
oriented system seemed complete by 2006. In 2006 the ‘Great Moderation’ was still
working, and Central Bankers, who were deemed to have made it work, were widely
applauded. New financial innovations were supposed to have made the system safer. In
efficient markets, bankers should control risk for themselves, so only ‘light touch’
regulation should be necessary; the golden eggs laid by such bankers were so widely
rewarding that the increasing share appropriated by top management was barely noticed,
or even treated as a condign incentive. The euro had seamlessly replaced the prior national
currencies, and the ‘nay-sayers’ disconcerted. The IMF’s role was narrowing to looking
after emerging economies, and, as these regained strength after the 1997/98 South East
Asian crisis, there were concerns whether the IMF would be making enough loans to earn
the money to pay its staff!
One only has thus to recall the financial circumstances of 2005/6 to realize what an
enormous amount has changed since the onset of the Great Financial Crisis in 2007/8, plus
the subsequent travails in the eurozone. Concepts and ideas have changed; institutional
roles have been altered at a breathtaking speed, for banks, investment banks, central banks
and the IMF (who could have foreseen the Troika ten years ago?), and also for market
structures. This has necessarily been driven and accompanied by a whirlwind of new
financial regulations, the Dodd-Frank Act, more EC financial Directives than I can count, or
remember, and a complete recasting of the regulatory structure in the UK, involving
From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2015. All Rights Reserved.
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centralisation of regulation in the Bank of England at the same time as partial separation
(ring-fencing) of the major commercial banks.
This process of institutional and regulatory change remains ongoing. Nevertheless its pace
may now slow. In the US the political face-off between Republicans and Democrats will
prevent most legal initiatives over the next few years. Elsewhere fading memories of the
Great Financial Crisis, and the need to underpin a sluggish European recovery with
additional bank credit expansion, may lessen the enthusiasm for further tougher bank
regulations; there will be a need to digest what has been force-fed to the financial system in
recent years. Having embarked on the most extraordinary practices of unconventional
monetary policies (UMP), central banks, or at least those where recovery has become
established, are looking forward to clawing their way back to normality, or perhaps to the
‘new normal’, (p. vi) whatever that may be. So there may now be something of an inflection,
a hiatus, in the pace of institutional and regulatory change.
In short, the present is a good moment to take stock of the recent momentous changes to
International Financial and Monetary Law, and there is no one better qualified and able to
do so than Rosa Lastra. She is primarily an (excellent) lawyer, and this is primarily a legal
tome. But no one could do justice to this broad subject without a wide range of
interdisciplinary skills, especially economics, international relations, politics, and current
history, and a thorough knowledge of the context in the Eurozone, the USA and the UK, plus
the relevant international bodies in Basel (eg, BIS, FSB) and Washington (IMF). Rosa has all
these skills and knowledge in abundance. Indeed, I do not know of anyone else with an
equivalent, and so necessary, skill set.
In additional to sheer ability, Rosa has drive, dedication and great management skills. I
marvel that anyone could bring up four lovely teenage children, run a happy home,
undertake a full professorial teaching and administrative load, and still find the time and
space to do as much excellent research and writing as she has done.
Charles Goodhart
London School of Economics
Foreword

Rosa Lastra

ISBN: 9780199671090
More than 15 years ago, Rosa María Lastra demonstrated to me her expertise about central
banking and her clear-eyed analysis in a rather dramatic fashion. She was testifying as an
expert on behalf of the Federal Reserve Bank of New York before the Iran–United States
Claims Tribunal in The Hague, and the Tribunal was considering whether the New York Fed
acted independently of the United States Government in implementing the Algiers Accords.
The Algiers Accords are the legal agreements that resulted in a kind of trade between Iran
and the United States. But this was no ordinary trade—it was a trade that affected countries
and the lives of individuals. I should probably also mention that I was no ordinary observer.
I was there in my capacity as the general counsel of the Federal Reserve Bank of New York.
In this trade, Iran received assets that had been frozen as the result of an Executive Order
issued by President Carter, and the United States received 51 Americans who had been held
hostage in Iran. The case concerned interest that the Iranians claimed to be owed on their
frozen assets during the pendency of the freeze order. To discredit Professor Lastra’s direct
testimony, a series of lawyers representing Iran stood up and attempted to cross-examine
the diminutive, youthful expert who appeared on behalf of the Federal Reserve Bank. She
spoke perfect English with a beautiful Spanish accent. Her demeanor in her direct
testimony was courtroom perfect, and she answered every question clearly, concisely, and
confidently.
On cross-examination, each lawyer for Iran took a turn, no doubt expecting to elicit some
type of concession that would be useful to the claimant, the Central Bank of the Islamic
Republic of Iran. As I recall the scene, there were six lawyers and each one failed in a
wonderful sequence. I remember wishing there were more lawyers to represent Iran, and
even considered ceding the Federal Reserve’s time to Iran. Professor Lastra, even before
her global reputation had become established as a monetary lawyer, showed her
characteristic capability. She never became rattled or upset, and she established a clear
rapport with the international legal experts who sat on the Tribunal. The Italian judge
seemed especially taken with Professor Lastra, and at times even seemed somewhat
protective (although Professor Lastra needed no protection). She seemed almost to relish
being questioned about a topic on which she was clearly the master. Her core topic—central
bank independence—was a topic that Professor Lastra owned.
Since that time, Professor Lastra has become the world’s foremost authority on central
bank independence. In addition, she has studied and written about so many other legal
issues that affect central banks and monetary lawyers. Of course, events and circumstances
have created an enormous opportunity for Professor Lastra. During the last 15 years,
central banks throughout the world have become so much more significant from a public
policy perspective. For example, the Great Recession has made the Federal Reserve much
more prominent and recognizable to the public, underscoring the organization’s exceptional
crisis management capabilities and also highlighting some things that were not done as well
in (p. viii) the prelude to the crisis. Similarly, in the Eurozone, the emergent European
Central Bank has achieved incredible success with the introduction of the Euro, seamlessly
and flawlessly replacing a plethora of legacy currencies. But a sound and stable Euro was
not enough to avoid the financial crisis that afflicted the Eurozone, a crisis so challenging
that it nearly led one member state, Greece, to consider returning to the Drachma.
Like many in academia, Professor Lastra observes the successes and failures of central
banks, the ups and downs of those who participate in the financial services industry, and the
global struggle to restore and maintain financial stability. But she is so much more than just
an observer. With respect to a number of discrete issues, Professor Lastra has offered her
advice and counsel to some of the crisis protagonists and to the Parliament. Accordingly,
her perspective is not that of someone who sits in an ivory tower. It is the perspective of
someone who is deeply thoughtful and independent, to be sure, but not so detached as to
lose perspective on the practical considerations that make policy executable.
This reference to the practical prompts my recollection of the occasion when I first met
Professor Lastra. It was at Harvard Law School and Professor Lastra was interviewing with
the New York Fed for a possible position in our Legal Group. While I have a somewhat hazy
recollection of the interview itself, Professor Lastra occasionally reminds me of one
important practical detail that arose during our interview. Professor Lastra was bound and
determined to work at a central bank in her first job since graduating law school, and she
was as focused and determined in the interview as she was in answering cross-examination
questions from Iranian lawyers at The Hague. At some point in the interview, I innocently
inquired whether Professor Lastra was a U.S. citizen. At that time, citizenship was a
requirement for all of our legal positions. Professor Lastra remembers that the interview
took a downhill turn when she candidly admitted she was not a U.S. citizen. Yet the story
has a happy ending because Professor Lastra’s Federal Reserve interview gave rise to
another interview with an organization that did hire non-U.S. citizens. Through an amiable
personal style and a hyperintensive focus, Professor Lastra was able to parlay her Federal
Reserve interview into a legal position at the International Monetary Fund (IMF) in
Washington. The Fund experience enriches Professor Lastra’s manuscript in many places.
Professor Lastra’s experience at the IMF also helped to season her analysis of how this
international organization has affected various events, including the crisis in the Eurozone.
And, once again, her scholarship shows a blending of the theoretical and the practical.
Nowhere is this more manifest than in the discussion about the new-found emphasis on
financial stability. This concept, financial stability, brings together microprudential
supervision and macroprudential supervision, and emphasizes again the importance of
central banks. As the IMF has documented, there are the potential dangers of conflict, but
the more important hazard is where micro and macro policy makers proceed in blissful
ignorance of each other.
Vision is a word that is tossed about with some frequency. Professor Lastra is not only well
grounded in financial events that have occurred in recent history. She also has her eyes on
an emerging future, especially within Europe. Her analysis of the single supervisory
mechanism, an innovation that promises to reform banking supervision in Europe in the
same manner as the ECB has reformed Eurozone monetary policy, is exceptional in
identifying the potential promises and likely pitfalls. It could not be more timely and draws
on all of Professor Lastra’s strengths.
(p. ix) I am sure that central bankers, supervisors, international monetary organizations,
and the people affected by them (ie, all of us) will benefit from the wisdom that appears on
the pages that follow of the second edition of Legal Foundations of International Monetary
Stability, International Financial and Monetary Law. I know that I have.
Thomas C. Baxter, Jr.
General Counsel
Federal Reserve Bank of New York
New York, New York(p. x)
Preface

Rosa Lastra

ISBN: 9780199671090
The genesis of the first edition, entitled Legal Foundations of International Monetary
Stability, can be traced back to the early 1990s, for the reasons outlined below. The need
for a second edition, renamed International Financial and Monetary Law, became apparent
in the context of the Global Financial Crisis and its aftermath, given the major changes at
the national, European, and international level in the fields of central banking, monetary
law and financial regulation. This second edition is not merely an update (though, of course,
the volume has been substantially updated); it is a fundamental revision of the architecture
that safeguards monetary stability and financial stability domestically, at the EU level and
globally.
Writing a preface is something an author both dreams about and fears. One aspires to
encapsulate in a few introductory paragraphs the essence of one’s research, the thrust of
one’s argumentation, acknowledging the people, works, and events one should remember.
One worries about failing in that task.
To begin, let me explain the rationale for the new title. On the one hand, it reflects the
revised contents of this second edition and, on the other hand, it addresses the issue of the
intended audience, the readership for this volume. This is a book for lawyers and
economists, for experts and students in banking and financial law, and for specialists in
international monetary law (a rapidly evolving branch of international economic law), but it
is also a book for the central banking fraternity and for regulators and supervisors
nationally and internationally.
The definition of money, as I explain in the first chapter, can be narrowly understood
(currency in circulation or monetary base) or broadly understood (other monetary
aggregates that include a broader range of financial assets). Monetary law can also be
construed in narrow terms (the discipline covering money, exchange rates and related
issues) or in broader terms (extending also to the study of the law and regulation of
financial markets and institutions). From an institutional perspective, my study
encompasses both the analysis of the ‘international monetary system’ (the official
arrangements relating to the balance of payments—exchange rates, reserves, and
regulation of current payments and capital flows) and of the ‘international financial
system’ (comprising the international financial institutions—formal and informal—and the
various public and private actors in the so-called ‘global financial market’ which is not a
huge global homogenous market, but rather more like a spider’s web or a radial web with
multiple interconnections and linkages, in which national markets permeate each other and
in which a few of the players tend to dominate the scene). Though a restricted focus can be
at times advantageous, I generally favour a wider interpretation of monetary law/
international monetary law to comprehend the fundamental changes that have taken place
in the last decades. Institutions such as the International Monetary Fund appear to be
struggling somehow to try to sort out how the international financial system relates to the
international monetary system (as well as differentiating between what is public and what is
private). Central banks, on the other hand, appear more (p. xii) comfortable dealing with
the interaction between the monetary system and the financial system. The second edition
of International Financial and Monetary Law encompasses both the ‘monetary architecture’
and the related ‘financial architecture’.
Following an analysis of money and monetary sovereignty, this book commences with the
study of central banks. Logically and chronologically this is a sensible choice, since central
banks are key actors in the international monetary and financial system. The twin mandate
of central banking is safe money and sound banking (in the words of Vera Lutz Smith), or, in
modern terminology, monetary stability and financial stability. These two goals, which are
fundamental for any contemporary nation, also have a European (regional) dimension—
hence the need to re-assess the role of the European Central Bank in the context of Banking
Union—and an international dimension, thus leading us to the analysis of the role and
mandate of the IMF and the evolving international financial architecture. We need to
remove the dust from our old ideas in the field of central banking.
This book examines the role of public authorities at different levels (multi-level governance
or inter-jurisdictional approach) and also considers the role of financial markets, in
particular the interaction between regulators and regulatees. Markets, much derided by
some commentators, are always part of the solution. Though certainly not untainted by the
crisis, the trouble with markets is not markets per se, but the expectations and behaviour of
market participants (and their regulators).
These problems are not new though. In the first edition of the Financial Times of 13
February 1888 (reprinted on the occasion of its 150th anniversary on 13 February 2013), a
piece of news entitled ‘Russia and Finance’ beautifully summarizes the fickleness
associated with markets, plus ça change?:
We are all waiting on the tip-toe of uneasy expectation for the next move. Markets,
as sensitive as the magnetic needle, turn now this way, now that, and there is, no
rest; speculators hesitate, investors wait for the golden moment which means to
them buying in at war prices, and certain manufacturers rub their hands
complacently and mentally, saying with Iago, not no matter which suffer, they gain.
But pause a little, are we—can they be so certain that they profit and we escape?
Back to the origins of this book: In the early 1990s, I was fortunate enough to work at the
Legal Department of the International Monetary Fund in Washington DC at a time of
momentous changes. The break-up of the Soviet Union in December 1991 and the collapse
of communism had given rise to a wave of monetary legal reforms, with the establishment
of central banks, new currencies and a commercial banking system based upon the
principles of a market economy; the Maastricht Treaty on European Union, signed in 1992,
had laid out the legal framework for the creation of a single currency and of a European
Central Bank. These historic events re-kindled the interest in the study of the legal
framework of money and finance, and encouraged me to analyse the rather novel subject of
central banking law.
Monetary and financial law is characterized by the existence of overlapping jurisdictions.
This is particularly clear in the European Union, where national developments in monetary
and financial law overlap with developments at the EU level and with international
developments and obligations imposed by membership in international organizations. A
recurrent topic in my study is the juxtaposition of areas of jurisdiction: national law (p. xiii)
versus international financial markets, national fiscal policies versus supranational
monetary policy, etc.
This book analyses in a systematic and comprehensive manner how national, European, and
international developments in monetary law and related aspects of financial regulation have
dramatically changed this dynamic field of law over the last decades. At the national level
(Part I of the book), the central bank is typically the key monetary institution in a country.
At the European level (Part II of the book), the European System of Central Banks is the
central monetary institution for the Member States that have adopted the euro as their
single currency. At the international level (Part III), the International Monetary Fund is the
central international monetary institution. There is a certain symmetry among the three
parts of the book (which has been preserved in the second edition) each one of them
commencing with a historical chapter, analysing then the framework of the ‘monetary
architecture’ and ending up with a consideration of the ‘financial architecture’ with regard
to the functions of financial supervision (micro and macro) and surveillance, regulation, and
crisis management, including lender of last resort and resolution.
In examining the legal foundations of international monetary stability, it is important to
emphasize that the law typically reflects a notion of monetary stability that focuses
primarily on its internal dimension (ie, price stability, keeping inflation under control), while
it tends to refer to the external dimension of monetary stability (ie, the stability of the
currency vis-à-vis other currencies, which is, in turn, influenced by the choice of exchange
regime) in rather ambiguous terms. Exchange rate issues have always haunted the
economics profession. The pendulum has swung between fixed and floating, and continues
to do so.
To some extent, the ‘stability culture’ itself is a relatively modern phenomenon. The
emphasis on price stability (inflation control) is a development that needs to be understood
in a historical context: that provided by the country experiences, economic policies, and
economic thinking that prevailed in the second half of the twentieth century. The renewed
emphasis on financial stability, increasingly seen as a public good nationally and
internationally, is one of the responses to the financial crisis. Indeed, in the aftermath of the
global financial crisis, the monetary authorities—the central banks—have altered the
‘stability regime’: no longer stability (in the sense of strict focus on inflation control) but
flexibility (a dual or multiple mandate with greater attention to growth and employment) is
the new creed. Of course, this current trend may change again once inflation and
inflationary expectations return (perhaps with a vengeance).
From a methodological point of view, my approach is a combination of public international
law, commercial law, regulatory law, and the inter-disciplinary dialogue between law and
economics. The legal approach provides order, clarity and rationalization to the study of
money and finance, as well as attention to detail. However, I am deeply aware of the
difficulties of any multi-dimensional study. Stigler wrote in his Memoirs of an Unregulated
Economist: ‘One cannot communicate effectively with other people unless one uses the
language to which they are accustomed.’ The challenge remains, in my opinion, to establish
such an effective inter-disciplinary communication in the field of social sciences.
Two main developments affecting the legal framework of central banks are analysed in
depth in the first part of the book: the issue of independence and corresponding (p. xiv)
accountability of central banks and other financial authorities, and the institutional
framework for the conduct of supervision (macro and micro), regulation and crisis
management (lender of last resort, deposit insurance, resolution, and insolvency). Since the
near-collapse of the financial system in 2008, the status of central independence and the
institutional balance in the pursuit of financial stability have been revisited. ‘Architectural’
reforms have granted a more relevant role to systemic risk control through the
embracement of the concept of macro prudential supervision and through the
establishments of committees or councils for financial stability. My study aims to provide a
source of reference for national developments in monetary and financial law in both
developed and developing countries.
The European Central Bank is the institution at the centre of the European System of
Central Banks in charge of the management of the single currency. It is an independent
institution enshrined in the framework of EU law. Despite the oneness of monetary policy in
the European Union, this exclusive competence remains geographically limited to a part of
the Union: the Member States that have adopted the euro. The asymmetries between
monetary policy and fiscal policy and between monetary policy and financial regulation and
supervision proved to be an inherent source of strain on EMU during the twin financial and
sovereign debt crises in the euro area. The advent of banking union—addressing the
inconsistency between a centralized monetary policy and decentralized banking supervision
and crisis management—has fundamentally changed the European financial architecture in
the direction of greater centralization, with the ECB firmly at the helm of the Single
Supervisory Mechanism. However, the supervision of capital markets and insurance
undertakings remains decentralized, while economic governance reforms post-crisis,
important as they are, still fall short of a true fiscal union.
The differentiated integration and the bewildering complexity that characterize the EMU
structure are a key theme in Part II of the book. The European project of integration was
born out of hopes and fears: the fear of France for Germany and the fear of Germany for
itself (in the words of the editor of Die Zeit, Josef Joffe: ‘It is tough to be Germany, the
country in the middle that has always been too strong for Europe but too weak to dominate
it’, Financial Times, 22 March 2013), the fears of wars and divisions, and the hopes of peace
and prosperity, bringing forces together to build a better future. And those hopes and fears
remain at the heart of any further integration.
There are two contrasting views that will determine the future of the EU: one regards
integration as a political project which may require economic sacrifices, while the other
considers the process of integration from the perspective of its economic benefits. In the
United Kingdom, where the latter view is clearly dominant (the economic benefits of the
single market and free trade are generally welcome, while political integration and the
expanding regulatory framework are not) the long shadow of a referendum not only casts
uncertainty, but also puts into question the very commitment of the UK to the Union. I for
one firmly believe that the future of the UK lies at the heart of Europe. And the EU, of
course, benefits greatly from the tradition of liberalism, openness, accountability,
transparency, and a global outlook that an engaged UK brings to the table of European
negotiations.
The third part of this book analyses the law governing international monetary relations. The
challenges that the international monetary and financial system faces in the twenty-first
century are very different from the challenges the Bretton Woods institutions—the (p. xv)
International Monetary Fund and the World Bank—confronted when they started operations
in Washington DC in 1946. These challenges, particularly the ones encountered by the
International Monetary Fund, are examined in Part III.
The unique nature of the responsibilities of the Fund, the economic character of most of its
functions and operations, the idiosyncratic and rather opaque terminology that applies to
its activities and financial structure (derided by Keynes as ‘Cherokee’ language), and the
specific knowledge required to understand the legal aspects of those activities (a
knowledge that is traditionally the reserve of Fund lawyers and of a few academics who
venture into its study) explain the relatively thin body of doctrine dealing with the complex
issues of public international monetary law.
The worldwide change from fixed to floating exchange rates, following the collapse of the
par value regime, also meant a more profound change in the nature of the IMF. It signified
the shift in emphasis from being primarily a rule-based international monetary institution
focusing on issues such as exchange rate stability and convertibility, to becoming an
international financial institution with a broader array of responsibilities (and greater
degree of discretion), encompassing not only monetary issues, but also other financial
issues, such as the regulation and supervision of banking and capital markets, financial
reform, debt restructuring and others. The evolution of the Fund over the last three
decades has affected the exercise of surveillance, the practice of conditionality and its
crucial role as international lender of last resort.
An analogy can be made between the role of the central bank at the national level and the
role of the IMF at the international level. A central bank is typically entrusted by national
law to maintain monetary stability in the domestic jurisdiction. The IMF is the international
institution entrusted by an international treaty (the IMF Articles of Agreement) to promote
stability in the international monetary order. The evolution of national central banks in
recent years is characterized by the increasing importance and attention given to the goal
of financial stability, as part of the mandate of the central bank (with or without supervisory
responsibilities). By analogy, the interpretation of the mandate of the IMF (according to the
broad enumeration of goals in Article I of the Articles of Agreement) has been expanded
over the last years, and the pursuit of international financial stability has become an
important objective in the international financial architecture.
The IMF is not only the international monetary institution par excellence; the IMF is also at
the centre of the international financial system. This central role is key to understand the
legal framework for the prevention and resolution of international financial and sovereign
debt crises.
The process of international financial standard setting (the growth of soft law) that I
critically examine in the last chapter of the book is a key feature of the evolving
‘international financial architecture’. The IMF, however, is not the only international
financial standard-setter, nor is it the most relevant one. This regulatory function is shared
by a number of formal international organizations, informal groupings and fora of an
international character (with the Financial Stability Board, the Basel Committee on Banking
Supervision and other Committees that have grown under the auspices of the Bank for
International Settlements, playing a significant role), professional associations and other (p.
xvi) entities. However, the IMF is uniquely placed to monitor the compliance with standards
through its function of surveillance and through its assessment of the health of the financial
sector (via the Financial Sector Assessment Program (FSAP), and the Reports on the
Observance of Standards and Codes (ROSCs)) and to provide countries with the incentive to
observe those standards through the design of conditionality.
The final revisions of this manuscript were completed on 19 June 2014, though it was
possible to include a few relevant subsequent developments during production.
The process of writing a book is characterized by a certain solitude. Hence, it is with
heartfelt gratitude that I acknowledge the feedback, advice, and support received from
colleagues and friends in the course of its preparation. To all those that I thanked in the
first edition, Charles Goodhart and Gaspar Ariño (my intellectual fathers), Lee Buchheit,
Thomas Baxter, René Smits, Antonio Sainz de Vicuña, Sean Hagan, Geoffrey Miller, Joseph
Norton, Charles Proctor, Hal Scott, Howell Jackson, Stephen Breyer, Jordi Canals, Forrest
Capie, Sam Cross, François Gianviti, Karel Lannoo, María Nieto, Pierre Panchaud, Charles
Proctor, Dirk Schoenmaker, Geoffrey Wood, Chiara Zilioli, Harald Benink, and the other
member of the European Shadow Financial Regulatory Committee, and my CCLS
colleagues and friends, I must also add now my thanks to John Jackson, Thomas Cottier,
Diego Devos, Philip Wood, Charles Randell, Claus Zimmermann, Nusret Cetin, Anamaria
Viterbo, Luis Garicano, David Bholat, Costanza Russo, Gabriel Gari, Jeremy Pam, Graham
Nicholson, Jean-Victor Louis, Mark Jewett, Stefan Gannon, Ross Cranston, William Blair, and
MOCOMILA (Monetary Committee of the International Law Association) colleagues. A
special mention to René Smits for all his suggestions concerning Chapters 6 to 11, and to
the staff of the IMF Legal Department under the direction of Sean Hagan (in particular
Katharine Christopherson, Yan Liu, Nadia Rendak, Gabriela Rosenberg, Eric Robert and
Amanda Robin Kosonen) for their careful reading and insightful comments regarding
Chapters 12 to 14.
We have a saying (‘refrán’) in Spain that states: ‘Dime con quien andas y te diré quien
eres’ (tell me who you hang out with and I will tell you who you are), commending good
friendships and warning about less desirable ones. This ‘refrán’ comes to mind when I
acknowledge the influence of all those who have inspired and informed my views over the
years. I feel truly privileged to have come across and befriended so many wonderful and
influential thinkers and experts. Needless to say, errors and limitations remain mine alone.
My editors and publishers at Oxford University Press encouraged my writing with courtesy
and patience. Apostolos Gkoutzinis and Rodrigo Olivares Caminal were excellent research
assistants in the first edition (and the two have done remarkably well since then: Apostolos
is today a partner at Shearman & Sterling, while Rodrigo is now a Law Professor and one of
the leading scholars in sovereign debt law). For this second edition I have counted with the
competent research assistance of Samuel Dahan, Tatjana Nikitina, Lucia Satragno,
Enmanuel Cedeño-Brea, and Andrea Miglionico.
Over the years, my students in Columbia University in the City of New York and at the
Centre for Commercial Law Studies, Queen Mary University of London—a rainbow of
nationalities and cultures—have been a constant source of inspiration. The future belongs
to them and I thank them all.
(p. xvii) A debt is always owed to one’s parents, and here I must thank my own for their
dedication to me and to my siblings throughout the years. As they grow older, I treasure
their very presence ever more. And last, but not least, very special thanks to my husband,
Mats Kummelstedt, and to our four children, Alejandro, Eric, Roberto and Anna (they have
grown so much in the last eight years!), since it is their enthusiasm, their wit and their joy
that keep me going. To them I dedicate my work.
Rosa María Lastra
London, 19 June 2014(p. xviii)
Contents

Rosa Lastra

ISBN: 9780199671090
Table of Cases xxiii
Table of Legislation xxv
List of Abbreviations xliii
I Developments at the National Level
1. Monetary Sovereignty
A. Introduction 1.01

B. Definition of Sovereignty 1.06
C. History of Sovereignty 1.11
D. Money and Monetary Sovereignty under International Law: Lex
Monetae 1.29
E. The Attributes of Monetary Sovereignty 1.51
F. The Erosion of Monetary Sovereignty 1.56
G. Concluding Observations 1.76
2. Central Banking Law

B. Rationale and Functions of Central Banks 2.07
C. Monetary Stability and Other Central Bank Objectives 2.85
D. Independent Central Banks: Theory and Practice 2.104
E. Central Bank Accountability and Democratic Legitimacy 2.159
F. Supervisory Independence and Accountability 2.187
G. Central Bank Reserves and Central Bank Immunity 2.195
H. Currency Boards 2.221
3. Supervision, Regulation, and Financial Stability

B. Definition of Supervision and Regulation 3.06
C. Separation between Monetary and Supervisory Functions 3.51
D. Financial Stability 3.58
E. The Optimal Number of Supervisory Authorities 3.85
F. Public versus Private Supervision 3.94
G. Independence versus Politically Directed Process 3.101
H. Institution versus Business Function 3.110
I. Institution versus Supervisory Function 3.114
J. Structural Reforms 3.116 (p. xx)
4. Crisis Management

B. The ‘Anatomy of a Crisis’ 4.05
C. Lender of Last Resort 4.08
D. Deposit Insurance 4.37
E. Bank Resolution and Insolvency 4.59
F. Systemic Risk and Systemic Crises 4.113
5. Law Reform in Emerging Economies

B. The Importance of the Legal Framework 5.06
C. Reform Agenda: The ‘Washington Consensus’ 5.10
D. Beyond the ‘Washington Consensus’ 5.17
E. The Law Reform Process 5.28
II Developments at the EU Level
6. History of Monetary Integration in Europe

B. Progress Towards Monetary Union in Europe 6.06
C. The Maastricht Treaty on European Union 6.50
D. Degrees of Integration 6.80
E. Optimum Currency Areas 6.106
F. Impact of EMU upon Other Regional Groupings 6.111
7. The Law of the European Central Bank

B. The European System of Central Banks 7.03
C. Objectives of the ESCB 7.24
D. Tasks of the ESCB 7.33
E. The Status of the European Central Bank 7.68
F. Legal Provisions Regulating the Euro 7.92
G. The Future of the Euro 7.137
8. Economic Governance

B. Asymmetry of EMU 8.15
C. Primary Law Regarding ‘Economic Union’: From Maastricht to
Lisbon 8.19
D. Pre-crisis Secondary Law: The Stability and Growth Pact 8.63
E. The Fiscal Crisis and Lessons Thereof 8.95
F. Strengthening Economic Governance Post Crisis 8.115 (p. xxi)
G. Architecture to Deal with Sovereign Debt Problems in the
Eurozone 8.167
H. Genuine Economic and Monetary Union 8.193
I. Regional Adjustment 8.198
J. Concluding Observations 8.207
9. External Aspects of EMU

B. Exchange Rate Policy 9.07
C. Detailed Analysis of Articles 219 and 138 TFEU 9.30
D. International Relations 9.45
E. Concluding Observations 9.70
10. Banking Union

B. The Rationale of Banking Union 10.07
C. The Three Pillars of Banking Union 10.16
D. The ‘Missing Pillar’: Lender of Last Resort 10.69
11. European Financial Architecture
B. Models of Integration 11.07
C. History of the Legislative Processes to Adopt Financial
Regulation in the EU 11.13
D. The European System of Financial Supervision 11.28
III Developments at the International Level
12. History of International Monetary Cooperation

B. The International Gold Standard 12.06
C. The Inter-war Period 12.09
D. The Keynes and White Plans 12.15
E. The Bretton Woods Conference 12.22
F. The Bretton Woods Regime 12.26
G. The Second Amendment to the IMF Articles of Agreement 12.55
H. Concluding Observations 12.69
13. The Law of the International Monetary Fund
A. Introduction 13.01 (p. xxii)

B. The Role and Purposes of the IMF 13.05
C. Organizational Issues 13.11
D. Financial Issues 13.22
E. Special Drawing Rights 13.54
F. Current Account Convertibility and the Control of Capital
Movements 13.63
G. IMF Functions 13.79
H. The Evolution of IMF Financial Facilities and Policies 13.194
I. Concluding Observations 13.240
14. International Financial Architecture

B. ‘Soft Law’ and International Financial Standard Setting 14.07
C. The Role of the IMF in Crisis Management 14.100
D. The Actors in the International Financial Architecture 14.183
E. A New Architecture: Do We Need a World Financial
Organization? 14.195
F. Concluding Observations 14.216
Bibliography 555
Index 607
Table of Cases

Rosa Lastra

ISBN: 9780199671090
Algera v Common Assembly of the European Coal and Steel Community (7/56 & 3/57–
7/57) [1957] ECR 81 9.47
Bank Markazi Iran v Federal Reserve Bank of New York, Case No 823, Award No
595-823-3 (Iran–US Claims Tribunal) 2.108, 7.21
BVerfG, 2 BvR 1390/12 (12 September 2012) German Constitutional Ct 7.50
BVerfG, 2 BvR 1390/12 (17 December 2013) German Federal Constitutional Ct 7.50,
8.182
BVerfG, 2 BvR 2728/13 (14 January 2014) German Constitutional Ct (OMT case) 7.50
Casati, Re (203/80) [1981] ECR 2595 6.12
Case Concerning the Payment in Gold of Brazilian Federal Loans Contracted in

France (France v Brazil), Judgment, 12 July 1929, PCIJ Ser A No 21, 44–5 1.36
Case Concerning the Payment of Various Serbian Loans Issued in France (France v
Kingdom of the Serbs, Croats and Slovenes), Judgment, 12 July 1929, PCIJ Ser A No
21, 122 1.36
Case of Certain Norwegian Loans (France v Norway) [1957] ICJ Rep 9 1.55
CIBC Bank & Trust Co (Cayman) Ltd v Banco Central do Brasil, 886 F Supp 1105
(SDNY 1995) 14.108
Commission of the European Communities v Council of the European Communities

(‘ERTA’) (22/70) [1971] ECR 263 9.27
Commission of the European Communities v Council of the European Union (C-27/04)
[2004] ECR I–06649 8.01, 8.58, 8.92, 8.211
Commission of the European Communities v European Central Bank (OLAF case)

(C-11/00) [2003] ECR I–7147 2.109, 2.129, 2.131, 7.69, 7.74, 7.78–7.80, 7.83, 7.88,
8.211, 9.50
Costa v Enel (6/64) [1964] ECR 585 1.59
Elliott Associates, LP v Banco de la Nacion, 194 F3d 363 (2d Cir 1999) 14.108
Estager SA v Receveur principal de la recette des douanes de Brive (C-359/05)

unreported, Judgment of 18 January 2007 8.211
First National City Bank v Banco Para el Comercio Exterior de Cuba (Bancec), 462 US
611 2.217
Gaston Schul Douane Expediteur BV v Inspecteur der Invoerrechten en Accijnzen

(15/81) [1982] ECR 1409 6.93
Hispano Americana Mercantil, SA v Central Bank of Nigeria [1979] 64 ILR 221 2.216
Meroni v High Authority (9/56 & 10/56) [1957–8] ECR 133 10.42, 10.51
NML Capital, Ltd v Banco Central de la Republica Argentina, 652 F 3d 172, 175 (2d
Cir 2011) 2.12, 2.13, 2.215, 2.218–2.220
Peter Gauweiler (C-62/14) pending 7.50
Peter Paul v Bundesrepublik Deutschland (C-222/02) [2004] ECR I–09425 2.193,

3.105
Pravin Bankers Assocs Ltd v Banco Popular del Peru, 109 F3d 850, 853 (2d Cir 1997)
14.108(p. xxiv)
Romano v Institut National d’Assurance Maladie Invalidité (98/80) [1981] ECR 1241
10.42
Schlüter v HZA Lörrach (9/73) [1973] ECR 1135 6.12
SS ‘Lotus’ (France v Turkey), Judgment, 7 September 1927, PCIJ, Ser A, No 10 14.08
Thesing and Bloomberg Finance v ECB (C-28/13 P) 7.87
Thomas Pringle v Government of Ireland, Ireland and the Attorney General (C-370/12)
Judgment, 27 November 2012 8.13, 8.183–8.186, 8.188–8.192, 8.196, 8.211
Three Rivers DC v Governor and Company of the Bank of England (No 3) [2000] 2
WLR 1220; [2000] 3 All ER 1; [2000] Lloyd’s Rep Bank 235, HL 2.192, 3.105
Trendtex Trading Corp v Central Bank Nigeria [1977] 1 All ER 881 2.216
Trinh v Citibank, 850 F 2d 1164 (6th Cir 1988) 4.95
Tyson v United States 285 F 2d 19 (1960) 1.48
United Kingdom v Parliament and Council (C-270/12) unreported, 22 January 2014
10.42, 11.55
Wade case [1601] 77 ER 232 1.48
Wells Fargo Ltd v Citibank, 936 F 2d 723 (2d Cir 1991) 4.95
Züchner v Bayerische Vereinsbank (172/80) [1981] ECR 2021 4.26, 10.85
Table of Legislation

Rosa Lastra

ISBN: 9780199671090
International Legislation
Charter of the United Nations (signed 26 June 1945, entered into force 24 October
1945), 1 UNTS 16 1.51, 13.12
Art 2(7) 1.45
Convention establishing the Organisation for Economic Co-operation and

Development (OECD) (signed 14 December 1961) 6.09
Convention respecting the Bank for International Settlements (20 January 1930)
14.189
Economic Community of West African States (ECOWAS) Treaty 1975 14.99
Economic Community of West African States (ECOWAS) Treaty 1993 14.99
European Convention for the Protection of Human Rights and Fundamental Freedoms
(European Convention on Human Rights) (ECHR) (Rome, 4 November 1950, entered
into force 3 November 1953) 213 UNTS 222
Art 6 4.83
Protocol 1 4.83
European Convention on State Immunity (ECSI) 2.200

Art 15 2.200
General Agreement on Tariffs and Trade (adopted 15 April 1994, entered into force 1
January 1995) 1867 UNTS 187, 33 ILM 1153 (GATT) 12.02, 12.05, 13.68
Art XV 2.35, 14.202
General Agreement on Trade in Services (GATS) 13.68, 14.34
Hague Convention 1930 2.209
Monetary Agreement between Andorra and the European Union (signed in 2011,
entered into force 1 April 2012) 7.134, 9.40
Monetary Agreement between the European Union and the Principality of Monaco
[2012] OJ C310/01 9.40, 9.47
Monetary Agreement between the European Union and the Republic of San Marino
[2012] OJ C121/5 9.47, 9.58
Monetary Agreement between the European Union and the Vatican City State [2010]
OJ C28/05 9.47
Monetary Agreement between the Government of the French Republic, on behalf of

the European Community, and the Government of His Serene Highness the Prince of
Monaco [2002] OJ L142/59 7.135, 9.40
Monetary Agreement between the Italian Republic, on behalf of the European

Community, and the Republic of San Marino [2001] OJ C209/1 7.134, 9.40
Monetary Agreement between the State of the Vatican City, represented by the Holy
See, and the Italian Republic on behalf of the European Community [2001] OJ C299/1
7.135, 9.40
Montevideo Treaty 1889 4.100
Montevideo Treaty 1940 4.100
Statute of the International Court of Justice

Art 34(1) 13.12
Art 36(2) 1.54
Art 38 14.90
Treaty of Versailles 1919 2.149, 12.09, 12.11, 14.189
United Nations Convention on Jurisdictional Immunities of States and their Property

(UNCJIS) (adopted 2 December 2004, UNGA Res A/RES/59/38) 2.200–2.202
Art 21(c) 2.201
Vienna Convention on the Law of Treaties (VCLT) (adopted 22 May 1969, entered into
force on 27 January 1980) 596 UNTS 261 14.90
Art 31 14.213
Arts 31–33 13.10
Art 32 14.213
EU Legislation
Agreement of 1 September 1998 between the European Central Bank and the national
central banks of the Member States outside the euro area laying down the operating
procedures for an exchange rate mechanism in stage three of Economic and Monetary
Union [1998] OJ C345/05 6.40(p. xxvi)
Agreement of 14 September 2000 between the European Central Bank and the
national central banks of the Member States outside the euro area amending the
Agreement of 1 September 1998 laying down the operating procedures for an
exchange rate mechanism in stage three of economic and monetary union [2000] OJ
C362/10 6.40
Agreement of 29 April 2004 between the European Central Bank and the national
central banks of the Member States outside the euro area on 1 May 2004 amending
the Agreement of 1 September 1998 laying down the operating procedures for an
exchange rate mechanism in stage three of economic and monetary union [2004] OJ
C135/3 6.40
Decision 64/300/EEC of the Council of 8 May 1964 on cooperation between the

Central Banks of the Member States of the EEC [1964] OJ 77 6.14
Decision 71/142/EEC of the Council of 22 March 1971 on the strengthening of

cooperation between the central banks of the Member States of the EEC [1973] OJ
L73/14 6.21
Decision 74/120/EEC of the Council of 18 February 1974 on the attainment of a high

degree of convergence of the economic policies of the Member States of the European
Economic Community [1974] OJ L63 8.64
Decision 90/141/EEC of the Council of 12 March 1990 on the attainment of

progressive convergence of economic policies and performance during stage one of
economic and monetary union [1990] OJ L78/23 8.64
Art 1 8.64
Art 3 8.64
Decision 98/415 of the Council 29 June 1998 on the consultation of the European
Central Bank by national authorities regarding draft legislative provisions [1998] OJ
L189/42 7.07
Decision 1999/95/EC of the Council of 31 December 1998 concerning the monetary

arrangements in the French territorial communities of Saint-Pierre-et-Miquelon and
Mayotte [1999] OJ L30/29 7.132
Decision 1999/98/EC of the Council of 31 December 1998 on the position to be taken

by the Community regarding an agreement concerning the monetary relations with
Vatican City [1999] OJ L30/35 7.135
Decision 2001/913/EC of the European Central Bank (ECB/2001/15) of 6 December

2001 on the issue of euro banknotes [2001] OJ L337/52 7.102
Decision 2003/89/EC of the Council of 21 January 2003 on the existence of a
government deficit in Germany—Application of Article 104(6) of the EC Treaty [2003]
OJ L34/16 8.88
Decision 2003/205/EC of the European Central Bank (ECB/2003/4) of 20 March 2003

on the denominations, specifications, reproduction, exchange and withdrawal of euro
banknotes [2003] OJ L78/16 7.130
Recital 3 7.129
Art 5 7.130
Decision 2003/223/EC of the Council of 21 March 2003 on an amendment to Art 10(2)

of the ESCB Statute based on ECB Recommendation ECB/2003/1 [2003] OJ L83/66
7.14
Decision 2004/49/EC of the European Central Bank (ECB/2003/23) of 18 December

2003 [2003] OJ L 9/40 7.102
Decision 2004/506/EC of the European Central Bank (ECB/2004/9) of 22 April 2004

amending Decision ECB/2001/15 of 6 December 2001 on the issue of euro banknotes
[2004] OJ L 05/17 7.102
Decision 2009/5 of the European Central Bank (ECB/2008/29) of 7 January 2009

[2009] OJ L3/4 7.14
Decision 2009/522/EC of the European Central Bank (ECB/2009/16) of 4 July 2009

[2009] OJ L175/18 7.41
Decision 2010/268/EU of the European Central Bank (ECB/2010/3) [2010] OJ

L117/102 7.41
Decision 2010/281/EU of the European Central Bank (ECB/2010/5) of 14 May 2010

establishing a Securities Markets Programme [2010] OJ L124/8 4.30, 7.41, 8.47, 8.99
Recital 2 7.45
Recital 3 7.45(p. xxvii)
Decision 2010/597/EU of the European Central Bank (ECB/2010/14) of 16 September

2010 on the authenticity and fitness checking and recirculation of euro banknotes
[2010] OJ L267/1 7.128
Decision 2011/67/EU of the European Central Bank (ECB/2010/29) of 13 December

2010 on the issue of euro banknotes [2011] OJ L 5/26 7.63
Decision of the European Systemic Risk Board of 20 January 2011 on the procedures
and requirements for the selection, appointment and replacement of the members of
the Advisory Scientific Committee of the European Systemic Risk Board (ESRB/
2011/2) [2011] OJ C39/10 11.39
Decision 2011/199 of the Council of 25 March 2011 amending Art 136 TFEU [2011]
OJ L91/1 8.177, 8.184, 8.185, 8.187, 8.192
Decision 2011/734/EU of the Council of July 2011 addressed to Greece with a view to
reinforcing and deepening fiscal surveillance and giving notice to Greece to take
measures for the deficit reduction judged necessary to remedy the situation of
excessive deficit [2011] OJ L295/38 8.175
Decision of the European Systemic Risk Board of 21 September 2011 on the provision
and collection of information for the macro-prudential oversight of the financial
system within the Union (ESRB/2011/6) [2011] OJ C302/3 11.33
Decision 2011/870/EU of the European Central Bank (ECB 2011/25) of 14 December

2011 [2011] OJ L341/65 7.46
Decision of the European Central Bank (ECB/2013/10) of 19 April 2013 on the

denominations, specifications, reproduction, exchange and withdrawal of euro
banknotes [2013] OJ L118/37 7.130
Recital 4 7.130
Recital 12 7.130
Art 3 7.130
Art 6 7.130
Decision of the European Systemic Risk Board of 27 January 2014 on a coordination

framework regarding the notification of national macro-prudential policy measures by
competent or designated authorities and the provision of opinions and the issuing of
recommendations by the ESRB (ESRB/2014/2) 11.33
Decision of the European Central Bank (ECB/2014/39) of 17 September 2014 on the

implementation of separation between the monetary policy and supervision functions
of the European Central Bank 10.31
Decision of the Council of 6 May 2014 on guidelines for the employment policies of
the Member States for 2014 [2014] OJ L 165/49 8.27
Declaration concerning the legal personality of the European Union [2007] OJ

C306/258 9.46
Directive 74/121/EEC of the Council of 18 February 1974 on stability, growth, and full
employment in the Community [1974] OJ L63/16 8.64
Directive 88/361/EEC of 24 June 1988 for the implementation of Art 67 of the Treaty
[1988] OJ L178 6.44, 6.49
Directive 94/19 of the European Parliament and of the Council of 30 May 1994 on
deposit-guarantee schemes [1994] OJ L135/5 4.42, 10.67, 10.90
Directive 2001/17/EC of the European Parliament and of the Council of 19 March

2001 on the reorganisation and winding-up of insurance undertakings [2001] OJ
L110/28 4.101
Directive 2001/24/EC of the European Parliament and of the Council of 4 April 2001
on the reorganisation and winding-up of credit institutions [2001] OJ L125/15 4.101
Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006
relating to the taking up and pursuit of the business of credit institutions [2006] OJ
L177 3.33
Directive 2011/85/EU of the Council on requirements for budgetary frameworks of the

Member States [2011] OJ L306/41 8.115
Recital 3 8.138
Art 1 8.137
Art 3(2) 8.138
Art 4(1) 8.138
Art 6(1)(b) 8.138
Art 14(1) 8.138
Directive 2013/36/EU of the European Parliament and of the Council on access to the
activity of credit institutions and the prudential supervision of credit institutions and
investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/
EC and 2006/49/EC (CRD IV) [2013] OJ L176/338 10.03, 11.42
Art 133 11.33(p. xxviii)
Directive 2014/49/EU of the European Parliament and of the Council of 16 April 2014
on deposit guarantee schemes (SDGS) [2014] OJ L173/49 4.42, 10.67
Recital 4 10.68
Recital 22 10.67
Art 4(1) 10.68
Art 4(7) 10.68
Art 6 10.67
Art 8 10.67
Art 11 10.68
Art 12 10.68
Art 14 10.68
Art 16 10.68
Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014
establishing a framework for the recovery and resolution of credit institutions and
investment firms (Bank Recovery and Resolution Directive) (BRRD) [2014] OJ L173/90
4.83, 4.90, 4.91, 4.111, 4.112, 10.02, 10.37, 10.48, 10.57, 10.61, 10.64, 11.01, 14.196
Art 31 10.61
Art 38 10.61
Art 39 10.61
Art 40 10.61
Art 41 10.61
Art 42 10.61
Arts 43–58 10.61
Art 93(1) 10.64
Interinstitutional Agreement between the European Parliament and the European

Central Bank on the practical modalities of the exercise of democratic accountability
and oversight over the exercise of the tasks conferred on the ECB within the
framework of the Single Supervisory Mechanism [2013] OJ L320/1 10.32
Protocol on the Statute of the European System of Central Banks and the European
Central Bank (ECSB Protocol) [2010] OJ C83 2.150, 2.202
Art 2 2.150
Recommendation 2008/390/EC of the Council of 14 May 2008 on the broad guidelines

of the economic policies of the Member States and the Community (for the 2008–2010
period) [2008] OJ L137/13 8.27, 8.31
Recommendation 2010/410/EU of the Council of 13 July 2010 on broad guidelines for

the economic policies of the Member States and of the Union [2010] OJ L191/28 8.27
Recommendation of the European Systemic Risk Board of 4 April 2013 on

Intermediate Objectives and Instruments of Macroprudential Policy (ESRB/2013/1)
[2013] OJ C170/01 3.17, 4.120
Regulation (EEC) 907/73 of the Council of 3 April 1973 establishing a European

Monetary Cooperation Fund [1973] OJ L89/2 6.27
Art 2 6.28
Regulation (EC) 3603/93 of the Council of 13 December 1993 specifying definitions

for the application of the prohibitions referred to in Articles 104 and 104b(1) of the
Treaty [1993] OJ L332/1 8.65
Art 1(a) 8.65
Art 3 8.65
Regulation (EC) 3604/93 of the Council of 13 December 1993 specifying definitions

for the application of the prohibition of privileged access referred to in Article 104a of
the Treaty [1993] OJ L332/4 8.65
Art 1 8.65
Regulation (EC) 3605/93 of the Council of 22 November 1993 on the application of

the Protocol on the excessive deficit procedure annexed to the Treaty establishing the
European Community [1993] OJ L332/7 8.65
Art 4 8.65
Regulation (EC) 1103/97 of the Council of 17 June 1997 on certain provisions relating
to the introduction of the euro [1997] OJ L162/1 6.69, 7.105–7.107
Preamble 7.96
Recital 8 7.107
Regulation (EC) 1466/1997 of the Council of 7 July 1997 on the strengthening of the
surveillance of budgetary positions and the surveillance and coordination of economic
policies [1997] OJ L209/1 6.69, 8.69, 8.74, 8.78–8.80, 8.87, 8.123
Art 6(2) 8.80
Regulation (EC) 1467/97 of the Council of 7 July 1997 on the speeding up and
clarifying the implementation of the excessive deficit procedure [1997] OJ L209/6
6.69, 8.69, 8.81–8.84, 8.93, 8.133
Art 1(1) 8.81
Art 2(3) 8.83
Art 3(4) 8.88
Art 5 8.84(p. xxix)
Regulation (EC) 974/98 of the Council of 3 May 1998 on the introduction of the euro
[1998] OJ L139/1 6.72, 7.96, 7.108–7.119
Recital 1 7.108
Recital 8 7.110
Recital 13 7.110
Art 2 7.111
Art 3 7.112
Art 4 7.113
Art 7 7.114
Art 8(1) 7.114
Art 8(2) 7.114
Art 8(3) 7.115
Art 8(4) 7.116
Art 10 7.100, 7.117
Art 11 7.100, 7.117
Art 12 7.117, 7.123
Art 15(1) 7.118
Art 15(2) 7.118
Art 16 7.118
Regulation (EC) 975/98 of the Council of 3 May 1998 on denominations and technical
specifications of euro coins intended for circulation [1998] OJ L139/6 6.73, 7.101,
7.121
Recital 5 7.121
Recital 10 7.121
Regulation (EC) 1688/98 of the Council of 20 July 1998 amending Commission

Regulation (EC) 1749/96 concerning the geographic and population coverage of the
harmonised index of consumer prices [1998] OJ L214/23 2.90
Regulation (EC) 2866/98 of the Council of 31 December 1998 on the conversion rates
between the euro and the currencies of the Member States adopting the euro [1998]
OJ L359/1 6.73, 7.122
Regulation (EC) 1260/1999 of the Council of 21 June 1999 laying down general
provisions on the structural funds and Council Regulation (EC) 1083/2006 of 11 July
2006 laying down general provisions on the European Regional Development Fund,
the European Social Fund and the Cohesion Fund and repealing Regulation (EC)
1260/1999 [1999] OJ L210/25 8.201
Regulation (EC) 1267/1999 of the Council of 21 June 1999 establishing an instrument

for structural policies for pre-accession [1999] OJ L161/73 8.202
Regulation (EC) 1268/1999 of the Council of 21 June 1999 on Community support for
pre-accession measures for agriculture and rural development in the applicant
countries of central and eastern Europe in the pre-accession period [1999] OJ
L161/87 8.202
Regulation (EC) 1346/2000 of the Council of 29 May 2000 on insolvency proceedings

[2000] OJ L160/1 4.101
Regulation (EC) 2595/2000 of the Council of 27 November 2000 amending Regulation

(EC) 1103/97 on certain provisions relating to the introduction of the euro [2000] OJ
L300/1 7.111
Regulation (EC) 2602/2000 of the Commission of 17 November 2000 laying down

detailed rules for the implementation of Council Regulation (EC) 2494/95 as regards
minimum standards for the treatment of price reductions in the harmonised index of
consumer prices [2000] OJ L300/16 2.90
Regulation (EC) 985/2001 of the ECB of 10 May 2001 amending Regulation ECB/
1999/4 on the powers of the ECB to impose sanctions (ECB/2001/4) [2001] OJ
L137/24 7.07
Art 127(6) 11.36
Regulation 1338/2001 of 28 June 2001 laying down measures necessary for the
protection of the euro against counterfeiting [2001] OJ L181/6 7.124, 7.127
Recital 4 7.125
Art 1(1) 7.125
Art 1(2) 7.126
Art 2(a) 7.126
Art 3(1) 7.127
Art 3(3) 7.127
Art 6 7.128
Regulation (EC) 351/2002 of the Commission of 25 February 2002 amending Council

Regulation (EC) 3605/93as regards references to ESA 95 [2002] OJ L55/23 8.65
Regulation (EC) 1055/2005 of the Council amending Regulation (EC) 1466/1997 on

the strengthening of the surveillance of the budgetary positions and the surveillance
and coordination of economic policies [2005] OJ L174/1 8.73, 8.78–8.80, 8.84
Recital 2 8.76
Recital 5 8.76
Recital 8 8.76
Art 2(a) 8.76
Art 5 8.76(p. xxx)
Regulation (EC) 1056/2005 of the Council amending Regulation (EC) 1467/97 on

speeding up and clarifying the implementation of the excessive deficit procedure
[2005] OJ L174/5 8.73, 8.83
Art 2(3)–(5) 8.76
Regulation (EC) 1085/2006 of the Council of 17 July 2006 establishing an Instrument

for Pre-Accession Assistance (IPA) [2006] OJ L210/82 8.202
Regulation (EC) 44/2009 of 18 December 2008 amending Regulation (EC) 1338/2001

laying down measures necessary for the protection of the euro against counterfeiting
[2009] OJ L17/131 7.124
Regulation (EC) 1060/2009 of 16 September 2009 on credit rating agencies [2009] OJ

L302/1
Art 21 11.54
Regulation 407/2010 of the Council establishing a European financial stabilization

mechanism [2010] OJ L118/1 8.170
Regulation (EU) 540/2010 of the European Parliament and of the Council of 16 June
2010 amending Council Regulation (EC) 1085/2006 establishing an Instrument for
Pre-Accession Assistance [2010] OJ L158/7 8.202
Regulation (EU) 1092/2010 of the European Parliament and of the Council of 24

November 2010 on European Union macro-prudential oversight of the financial
system and establishing a European Systemic Risk Board (ESRB Regulation) [2010]
OJ L331/1 11.29
Art 2 11.36
Art 2(b) 11.31
Art 2(c) 11.31
Art 3(1) 11.30
Art 3(1)(g) 11.43
Art 3(2)(c)–(d) 11.35
Art 3(2)(e) 11.35
Art 4 11.36
Art 4(3) 11.37
Art 5(1) 11.36
Art 6 11.36
Art 9(1) 11.36
Art 12(1) 11.39
Art 13 11.39
Art 15(1) 11.32
Art 15(6) 11.32
Art 16 11.34
Art 18(3) 11.35
Art 19 11.40
Art 20 11.39, 11.42

November 2010 establishing a European Supervisory Authority (European Banking
Authority), amending Decision 716/2009/EC and repealing Commission Decision
2009/78/EC (EBA Regulation) [2010] OJ L331/12 11.29, 11.70, 11.72
Art 1(5) 11.46
Art 44(1) 11.72

November 2010 establishing a European Supervisory Authority (European Insurance
and Occupational Pensions Authority), amending Decision 716/2009/EC and repealing
Commission Decision 2009/79/EC (EIOPA Regulation) [2010] OJ L331/48 11.29
Art 1(5) 11.46

November 2010 establishing a European Supervisory Authority (European Securities
and Markets Authority), amending Decision 716/2009/EC and repealing Commission
Decision 2009/77/EC (ESMA Regulation) [2010] OJ L331/84 11.29
Art 1(6) 11.46
Art 45 11.57
Regulation (EU) 1096/2010 of the Council of 17 November 2010 conferring specific

tasks upon the European Central Bank concerning the functioning of the European
Systemic Risk Board [2010] OJ L331/162 11.29
Art 2 11.38
Art 3 11.38

December 2010 concerning authentication of euro coins and handling of euro coins
unfit for circulation [2010] OJ L339/1 7.128
Regulation (EU) 513/2011 of the European Parliament and of the Council of 11 May
2011 [2011] OJ L145/30 11.54(p. xxxi)
Regulation 1173/2011 on the effective enforcement of budgetary surveillance in the

euro area [2011] OJ L306/1 8.115, 8.143, 8.144
Art 4(2) 8.142, 8.143
Art 4(3) 8.143
Art 5(2) 8.142
Art 6(2) 8.142
Regulation 1174/2011 on enforcement measures to correct excessive macroeconomic

imbalances in the euro area [2011] OJ L306/8 8.115, 8.147
Art 3(1) 8.154
Regulation 1175/2011 amending Council Regulation (EC) 1466/97 on the

strengthening of the surveillance of budgetary positions and the surveillance and
coordination of economic policies [2011] OJ L306/12 8.115, 8.123, 8.143
Art 6(2) 8.143
Regulation 1176/2011 of the European Parliament and of the Council of 16 November

2011 on the prevention and correction of macroeconomic imbalances [2011] OJ
L306/25 8.115, 8.147
Art 2 8.150
Art 4(3) 8.150
Art 7 8.152
Regulation 1177/2011 of the Council amending Regulation (EC) 1467/97 on speeding

up and clarifying the implementation of the excessive deficit procedure [2011] OJ
L306/33 8.115, 8.133
February 2012 amending Council Regulation (EC) 1085/2006 establishing an
Instrument for Pre-Accession Assistance (IPA) [2012] OJ L58/1 8.202
Regulation (EU) 236/2012 of the European Parliament and of the Council of 14 March
2012 on short selling and certain aspects of credit default swaps [2012] OJ L86/1
11.55
Art 28 11.55
Regulation (EU) 260/2012 of 14 March 2012 establishing technical requirements for

credit transfers and direct debits in euro and amending Regulation (EC) 924/2009
(SEPA Regulation) [2012] OJ L94/22 7.60
Regulation (EU) 648/2012 of the European Parliament and of the Council of 4 July
2012 on OTC derivatives, central counterparties and trade repositories (EMIR) [2012]
OJ L201/1
Title VI 11.54
2013 on the strengthening of economic and budgetary surveillance of Member States
in the euro area experiencing or threatened with serious difficulties with respect to
their financial stability [2013] OJ L140 8.116, 8.126, 8.130, 8.160
Art 2 8.160
Art 3 8.160
2013 on common provisions for monitoring and assessing draft budgetary plans and
ensuring the correction of excessive deficit of the Member States in the euro area
[2013] OJ L140 8.116, 8.125, 8.130, 8.160
Art 6(6) 8.131
Art 7 8.160
Regulation (EU) 575/2013 of the European Parliament and of the Council of 26 June
2013 on prudential requirements for credit institutions and investment firms and
amending Regulation (EU) 648/2012 (CRR) [2013] OJ L176/1 10.03
Art 458 11.33

October 2013 amending Regulation (EU) 1093/2010 establishing a European
Supervisory Authority (European Banking Authority) as regards the conferral of
specific tasks on the European Central Bank pursuant to Council Regulation (EU)
1024/2013 (EBA Amending Regulation) [2013] OJ L287/5 10.03, 11.29, 11.70–11.72
Art 1(1) 11.70
Art 1(7) 11.72
Regulation (EU) 1024/2013 of the Council of 15 October 2013 conferring specific

tasks on the European Central Bank concerning policies relating to the prudential
supervision of credit institutions (Single Supervisory Mechanism (SSM) Regulation)
[2013] OJ L287/63 1.61, 3.16, 3.57, 3.81, 7.07, 7.64, 7.91, 10.04, 10.07, 10.20–10.33,
10.44, 10.60, 11.08, 11.44
Recital 8 10.18
Recital 11 11.62
Recital 31 11.64
Recital 75 7.84(p. xxxii)
Arts 3–6 10.28
Art 4 10.24, 10.25
Art 4(1)(a) 10.22, 10.23
Art 4(1)(b)–(h) 10.22
Art 4(1)(c) 10.23
Art 4(1)(g) 10.26
Art 4(1)(h) 10.26
Art 4(1)(i) 10.22
Art 4(2) 10.25
Art 5 10.22, 10.27, 11.44
Art 6(1) 10.20
Art 6(4) 10.23, 10.26
Art 6(7) 10.26
Art 7 10.21, 10.24
Art 7(2) 10.21
Art 7(5) 10.21
Art 7(6) 10.21
Arts 7–10 10.28
Art 8 10.24
Arts 9–16 10.22
Art 17(1) 10.25
Art 17(2) 10.26
Art 17(3) 10.26
Art 18 10.22
Art 19 7.85
Art 20 7.91
Art 21 7.91
Art 24(1) 10.33
Art 25 10.32
Art 25(5) 10.30
Art 26 10.29
Art 26(6) 10.29
Art 26(8) 10.29, 10.30
Art 33(2) 10.04
Art 49 10.28

December 2013 laying down common provisions on the European Regional
Development Fund, the European Social Fund, the Cohesion Fund, the European
Agricultural Fund for Rural Development and the European Maritime and Fisheries
Fund and laying down general provisions on the European Regional Development
Fund, the European Social Fund, the Cohesion Fund and the European Maritime and
Fisheries Fund and repealing Council Regulation (EC) 1083/2006 [2006] OJ L347/320
8.201, 8.205
Regulation (EU) 468/2014 of the European Central Bank of 16 April 2014,

establishing the framework for cooperation within the Single Supervisory Mechanism
between the European Central Bank and national competent authorities and with
national designated authorities (SSM Framework Regulation) [2014] OJ L141/1 10.04,
10.21, 10.24, 10.27
Arts 11–18 10.23
Arts 43–44 10.23
Regulation (EU) 469/2014 of the European Central Bank of 16 April 2014 amending
Regulation (EC) 2157/1999 on the powers of the European Central Bank to impose
sanctions (ECB/1999/4) (ECB/2014/18) [2014] OJ L141/51 10.22
Regulation (EU) 806/2014 of the European Parliament and of the Council of 15 July
2014 establishing uniform rules and a uniform procedure for the resolution of credit
institutions and certain investment firms in the framework of a single resolution
mechanism and a single resolution fund and amending Regulation 1093/2010 (SRM
Regulation) [2014] OJ L225/1 4.112, 10.02, 10.37–10.39, 10.41–10.64, 11.01
Recital 2 4.86
Recital 6 4.87
Recital 11 4.112
Recital 31 10.54
Art 2(b) 10.45
Art 4(2) 10.44
Art 5(1) 10.61
Art 7(1) 10.48
Art 7(2) 10.60
Art 7(4) 10.60
Art 8(6) 10.60
Art 8(9)(m) 10.60
Art 10(7) 10.48
Art 18 10.50
Art 18(6) 10.50
Art 18(6)(c) 10.50
Art 18(7)(b) 10.51
Art 18(9) 10.63
Art 19 4.28
Art 19(1) 10.63
Art 22 4.81
Art 24(3) 10.56
Art 27 4.83
Art 28 10.62
Art 28(2) 10.62
Art 32 10.64
Art 32(1) 10.64
Art 33(1) 10.64
Art 34(1)(c) 10.60
Art 36(1) 10.60(p. xxxiii)
Art 38 10.60
Art 39 10.60
Art 42(1) 10.48
Art 43(1)(c) 10.49
Art 43(2) 10.50
Art 43(3) 10.49
Art 45(1) 10.59
Art 46(1) 10.59
Art 48 10.48
Art 52(3) 10.54
Art 53(1) 10.54
Art 53(4) 10.54
Art 55(3) 10.54
Art 56(2) 10.49
Art 56(6) 10.49
Art 56(7) 10.49
Art 60(1)(c) 10.57
Art 65(1) 10.55
Art 65(3) 10.55
Art 65(5) 10.55, 10.57
Art 65(5)(c) 10.57
Art 66(3) 10.57
Art 67(2) 10.55
Art 70(1) 10.57
Art 70(2) 10.57
Art 70(2)(b) 10.57
Art 71 10.57
Art 71(1) 10.55
Art 79 10.67
Art 88 10.38
Art 94(1) 10.59
Resolution of the Council and of the Representatives of the Governments of the
Member States of 22 March 1971 on the attainment by stages of economic and
monetary union in the Community (1971 EMU Resolution) [1972] OJ C28/1 6.21
Resolution of the Council and of the Representatives of the Governments of the

Member States of 21 March 1972 on the application of the Resolution of 22 March
1971 on the attainment by stages of economic and monetary union in the Community
[1972] OJ C38/3 6.22–6.24
Resolution of the European Council on the Stability and Growth Pact of 17 June 1997
[1997] OJ C 236/1 6.69, 8.68, 8.69, 8.77
Resolution of the European Council on economic policy coordination in Stage three of

EMU and on Articles 109 and 109b of the EC Treaty of 2 February 1998 [1998] OJ
C35/1 9.36
Single European Act (SEA) (signed 17 February 1986, entered into force 1 July 1987)
[1987] OJ L169/1 2.81, 6.41, 6.45, 6.90, 6.91, 6.94, 6.96, 11.14, 11.15
Art 8A 2.81
Art 20 6.42
Statute of the European System of Central Banks and of the European Central Bank
(ESCB Statute) (TFEU Protocol No 4) 7.05, 7.24, 7.37, 7.64, 7.75, 7.78, 9.50, 10.91
Art 3 9.18
Art 3(1) 7.33, 7.35, 7.37
Art 3(3) 7.31
Art 4 7.66
Art 5 7.66
Art 6 7.67, 9.51
Art 6(1) 9.51
Art 6(2) 9.51, 9.57
Art 9 2.109
Art 9(1) 7.18
Art 10 7.82
Art 10(2) 7.14
Art 11(2) 7.82
Art 11(4) 7.82
Art 12(1) 2.110, 7.23, 7.37, 7.38, 9.56
Art 12(5) 9.51
Art 14 2.109
Art 14(1) 7.75
Art 14(3) 7.07, 7.11, 7.38, 9.56
Art 14(4) 2.110, 4.09, 7.41, 9.56, 9.67, 10.70, 10.76, 11.44
Art 16 7.63, 7.99, 7.102
Art 18 4.09, 7.41, 10.74, 10.76, 10.77, 10.92
Art 18(1) 7.41, 7.48
Art 20 7.41
Art 21 8.35, 9.27
Art 21(1) 7.83
Art 22 7.60, 9.54
Art 23 7.67, 9.53, 9.54, 9.57
Art 24 9.55
Art 25 7.64, 10.08
Art 29(1) 7.102
Art 30 7.59, 9.19, 9.65
Art 30(1) 2.74
Art 30(5) 2.74, 7.59, 9.66
Art 31 7.59, 9.19, 9.65
Art 31(1) 2.74, 9.57
Art 31(2) 7.37
Art 34 7.07, 7.66
Art 35(6) 7.19
Art 39 (ex-Art 40) 2.202
Art 42(2) 9.57
Art 43 7.17(p. xxxiv)
Art 44 7.13
Art 44(2) 7.17
Arts 44–46 7.16
Art 46 7.17, 9.68
Treaty establishing a Constitution for Europe (Rome, signed 29 October 2004) [2004]
OJ C310 6.02, 6.97, 7.04, 7.70, 7.96, 7.140
Art I-8 6.97, 7.92
Art I-13 6.97, 9.22
Art I-19 7.69
Art I-30 7.04
Art I-30(3) 7.69
Art III-185(2) 9.22
Art III-191 7.104
Art III-196 9.42
Art III-196(3) 9.48
Art III-325 9.38
Treaty establishing the European Atomic Energy Community (EURATOM Treaty) 1957
6.02
Treaty establishing the European Economic Community (EEC/EC Treaty) (Treaty of

Rome) (as amended) 1957 2.81, 2.132, 2.154, 2.155, 6.02, 6.10, 6.11, 6.13, 6.61, 6.87–
6.89, 7.05, 7.06, 7.14, 7.75, 7.78, 8.199, 9.50
Ch 3 6.10
Title VII Ch 2 9.23, 9.25
Art 2 6.11, 6.92
Art 3 6.11
Art 3(1)(c) 6.88
Art 3(1)(h) 6.94
Art 8A 6.90
Art 14(2) 6.88
Art 23 6.83
Art 25 6.84
Art 26 6.84
Art 32(4) 6.94
Art 56 6.62
Arts 56–60 6.62
Art 57 6.62
Art 58 6.62
Art 59 6.62
Art 60 6.62
Art 67 6.11
Arts 67–71 6.13
Arts 67–73 6.11
Art 69 6.12
Arts 81–89 6.94
Art 94 6.94
Art 95 6.94, 11.12
Art 98 6.58
Art 99 6.58, 8.78
Art 100 11.14
Art 101 6.57
Art 102 6.57
Art 102(2) 8.65
Art 102A 6.42, 6.96
Art 104(1) 8.50
Art 104(5) 8.58
Art 104(6) 8.58, 8.59
Art 104(7) 8.59
Art 104(8) 8.59, 8.91
Art 104(9) 8.59, 8.91
Art 104(11) 8.59
Art 104(12) 8.59
Arts 104–109 6.10
Art 105 6.15, 7.60, 7.64, 10.08
Art 105(1) 7.74
Art 105(2) 6.14, 7.37, 9.22
Art 105(6) 7.64
Arts 105–111 9.23
Arts 105–124 7.05
Art 106 6.11, 7.63
Art 108 2.129, 7.76, 7.78
Art 109 6.71, 7.75, 9.33
Art 111 7.55, 9.03, 9.25, 9.30, 9.33
Art 111(1) 9.30
Art 111(1)–(3) 9.03
Art 111(2) 9.30
Art 111(3) 9.30
Art 111(4) 9.03, 9.13, 9.30
Art 111(5) 9.30
Art 112(2) 7.14
Art 116 6.57
Art 118 6.35
Art 121 6.39, 6.71
Art 121(1) 6.40
Art 121(3) 8.28
Arts 121–124 7.97
Art 122 6.40
Art 122(2) 7.98
Art 122(3) 8.59
Art 123(4) 7.106, 7.108
Art 126(3) 8.54
Art 131 6.84
Arts 131–134 6.85
Art 135 6.84
Art 300 9.38
Art 308 (ex-Art 235) 7.106–7.108, 11.12
Protocol 24 7.140
Protocol 25 Opt-Out Protocol 8.59

para 5 8.59
Treaty establishing the European Stability Mechanism (ESMT) (2 February 2012)

[2011] OJ L91/1 8.10, 8.178, 8.179, 8.182, 8.183, 8.186, 8.188–8.191, 8.196, 10.14,
14.135, 14.143, 14.182
Recital 13 14.143(p. xxxv)
Art 12 8.180
Art 13(3) 8.180
Art 41(2) 8.178
Art 48 8.182
Annex I 8.179
Annex II 8.178
Treaty of Amsterdam (2 October 1997, entered into force 1 May 1999) [1997] OJ
C340/115 6.02, 11.12
Art 6 11.15
Treaty of Lisbon amending the Treaty on European Union and the Treaty Establishing
the European Community (signed 13 December 2007, entered into force 1 December
2009) [2007] OJ C306/1 6.02, 7.04, 7.05, 7.70, 7.97, 8.13, 8.15, 8.21, 8.59, 9.05, 9.23,
9.30
Art 50 1.62, 7.140
Art 139(4)(1)(b) 8.59
Treaty of Maastricht. See Treaty on European Union
Treaty of Nice, 11 December 2000 [2001] OJ C80/1 6.02
Treaty on European Union (TEU) (Maastricht Treaty) (signed 7 February 1992) [2002]
OJ C325/5 1.63, 2.81, 2.91, 2.97, 2.105, 2.120, 2.150, 2.154, 2.155, 3.60, 6.02, 6.35,
6.39, 6.50–6.79, 6.96, 7.04, 7.05, 7.30, 7.37, 7.97, 7.106, 8.02, 8.66, 9.33
Art A 6.02
Art G 6.02
Art 3 7.73, 8.200
Art 3(1) 7.92
Art 3(1)(c) 7.92
Art 3(3) 7.73
Art 5 10.92
Art 5(3) 10.77
Art 13 2.109, 9.47
Art 13(2) 7.73
Art 47 9.46
Art 48(6) 8.177, 8.185
Art 99 9.42
Art 105 9.42
Art 218 9.47
Protocol 13 7.133
Treaty on Stability, Coordination and Governance in the Economic and Monetary

Union (TSCG) 2012 8.10, 8.117, 8.121, 8.163, 8.164, 8.196
Title III 8.117
Title IV 8.163
Art 1 8.163
Art 1(1) 8.117
Art 3(2) 8.128
Art 6 8.129
Art 10 8.163
Art 11 8.163
Art 14(2) 8.117
Treaty on the Functioning of the European Union 2012 [2012] OJ C326/47 2.89,
2.100, 2.105, 2.171, 6.02, 6.104, 7.04, 7.05, 7.52, 7.65, 7.92, 7.96, 8.16, 8.20, 9.01,
9.17, 10.39
Pt III 8.186
Title V 9.05, 9.25
Title VII Ch 4 9.03
Title VIII 6.10, 8.04, 9.23
Title VIII Ch 1 8.20
Title VIII Ch 4 9.05
Art 2 8.22, 9.23
Art 2(1) 8.22
Art 2(2) 8.22, 8.171
Art 2(3) 8.22, 8.188
Art 3 9.20, 9.22–9.24
Art 3(1)(c) 7.37
Art 4 8.21
Art 4(2) 6.104
Art 5 8.21
Art 13 2.109
Art 14(2) 6.90
Art 21 8.35
Art 26 (ex-Art 14 EC) 6.88
Art 28 (ex-Art 23 EEC) 6.83
Art 30 (ex-Art 25 EC) 6.84
Art 31 (ex-Art 26 EC) 6.84
Art 33 (ex-Art 135 EC) 6.84
Art 38 (ex-Art 32 EC) 6.94
Art 59 6.03
Art 63 2.81
Arts 63–66 (ex-Arts 56–60 EC) 6.62
Art 75 6.62
Arts 82–89 (ex-Art 69 EEC) 6.12
Arts 82–93 (ex-Arts 67–73 EEC) 6.11
Arts 101–109 (ex-Arts 81–89 EC) 6.94
Art 102 (ex-Art 102A EEC) 6.42
Art 107(1) (ex-Art 87(1) EC) 4.27, 10.63
Art 107(3)(b) 4.27, 4.28, 10.86
Arts 107–109 10.63
Art 114 (ex-Art 94 EC) 6.94, 7.103, 10.41, 10.42, 11.12
Art 115 (ex-Art 95 EC) 6.94
Art 119 7.32, 7.56, 8.13, 8.19
Art 119(1) 6.97
Art 119(2) 6.96, 6.97, 7.27, 9.04
Art 119(3) 6.96, 7.27
Arts 119–121 8.188
Arts 119–126 8.20
Art 120 (ex-Art 98 EC) 6.58, 7.32(p. xxxvi)
Art 121 (ex-Art 99 EC) 6.58, 8.23, 8.24, 8.78, 8.123, 8.149, 8.157, 9.42
Art 121(1) 8.26
Art 121(2) 8.26, 8.27, 8.152
Art 121(3) 8.26, 8.29, 8.147
Art 121(4) 8.29, 8.143, 8.147
Art 122 8.170, 8.189
Art 122(2) 8.43, 8.44, 8.170, 8.177, 8.186, 8.188, 8.189
Art 123 (ex-Art 101 EC) 4.19, 6.57, 7.43, 7.50, 8.32, 8.189, 10.82, 10.84, 14.182
Art 123(1) 8.33
Art 124 (ex-Art 102 EC) 6.57, 8.36
Art 125 7.50, 8.32, 8.38, 8.177, 8.189, 8.190, 10.84, 14.182
Art 125(1) 8.37
Art 126 (ex-Art 104 EC) 8.23, 8.25, 8.55, 8.58, 8.188
Art 126(1) 8.50
Art 126(2) 8.51, 8.52, 8.58
Art 126(2)(b) 8.133
Art 126(3) 8.58
Art 126(4) 8.58
Art 126(5) 8.58
Art 126(6) 8.58, 8.59, 8.62
Art 126(7) 8.58, 8.59
Art 126(8) 8.58, 8.59, 8.144
Art 126(9) 8.58, 8.144
Art 126(11) 8.58, 8.144
Art 126(12) 8.61, 8.59
Art 126(13) 8.59
Art 126(13)(2) 8.62
Art 126(14) 8.57
Arts 126–151 6.10
Art 127 (ex-Art 105 EEC) 2.150, 6.14, 6.15, 7.24, 7.64, 9.42, 10.08, 10.76
Art 127(1) 7.25, 7.26, 7.32, 7.73, 7.83
Art 127(2) 7.33–7.35, 7.37, 7.51, 7.59, 7.60, 9.18, 9.19, 9.22, 9.25, 9.27, 9.37,
10.73, 10.92
Art 127(3) 9.58
Art 127(4) 3.60, 7.08, 7.66
Art 127(5) 7.30, 7.31, 7.34, 10.92
Art 127(6) 2.34, 7.64, 7.65, 10.08, 10.09, 10.19, 10.91, 10.92, 11.07
Arts 127–133 7.72, 9.23
Arts 127–144 (ex-Arts 105–124 EC) 7.05
Art 128 (ex-Art 106 EEC) 2.16, 6.11, 7.63, 7.100, 7.119
Art 128(1) 7.63, 7.99
Art 128(2) 7.63, 7.101
Art 129 2.109, 7.13
Art 129(1) 9.51
Art 130 (ex-Art 108 EC) 2.129, 7.76–7.78, 7.83, 7.84
Art 131 (ex-Art 109 EC) 6.71, 7.11, 7.75
Art 132 2.132, 7.07
Art 133 7.09, 7.104
Art 136 8.130, 8.160, 8.163, 8.177, 8.184
Art 136(1) 8.30
Art 136(2) 8.30
Art 136(3) 8.186, 8.187, 8.192
Arts 136–138 7.10, 7.97
Art 137 7.53, 9.15
Art 138 (ex-Art 111(4) EC) 2.95, 7.52, 7.55, 7.59, 7.67, 9.03, 9.05, 9.13, 9.23,
9.27, 9.30–9.44, 9.70
Art 138(1) 7.59, 9.13
Art 138(2) 7.52, 7.59, 9.13, 9.42
Art 139 (ex-Art 99 EC) 6.57, 7.97
Art 139(1) 8.59
Arts 139–144 7.10, 7.97
Art 140 (ex-Art 121 EC) 6.39, 6.40, 6.71, 7.108, 7.138
Art 140(1) 7.98
Art 140(2) 7.98
Art 140(3) 7.09
Art 141 7.16
Art 141(1) 7.16, 9.67
Art 142 9.67
Art 143 8.41, 8.167
Art 143(1) 8.41
Art 143(2) 8.41
Art 148 8.157
Arts 174–178 8.200
Art 206 (ex-Art 131 EC) 6.84, 6.85
Art 207 6.85
Art 218 9.47
Art 218(1) 9.27
Art 218(3) 9.27
Art 219 (ex-Art 111(1)–(3) EC) 2.95, 7.35, 7.51, 7.55, 7.57, 7.67, 9.03, 9.05,
9.07, 9.19, 9.23, 9.25, 9.30–9.44, 9.46, 9.47, 9.70–9.72
Art 219(1) 9.26, 9.31, 9.33–9.35, 9.40, 9.41
Art 219(2) 9.26, 9.33, 9.35
Art 219(3) 9.32, 9.34, 9.38–9.41
Art 219(4) 9.41, 9.43, 9.58
Art 258 7.19, 8.60
Art 259 8.60
Art 282 6.97, 7.06, 7.18, 7.37, 7.70, 7.72, 7.81
Art 282(1) 7.04
Art 282(3) 2.109, 2.131, 7.83, 9.47
Arts 282–284 7.05
Art 288 7.07
Art 290 11.48
Art 291(2) 11.48
Art 311 8.16
Art 343 2.202(p. xxxvii)
Art 352 (ex-Art 308 EC) 1.62, 7.103, 7.105, 7.106, 7.108, 7.141, 11.12
Protocol 12 on the Excessive Deficit Procedure 8.52, 8.65, 8.67

Art 1 8.52
Art 2 8.55
Art 3 8.56
Art 4 8.56
Protocol 14 on the European Group 7.54, 9.15

Art 1 7.54
Art 2 7.54
National Legislation
Argentina
Carta Organica del Banco Central de la Republica Argentina, Law No 24.244 (22
October 1992) 2.238
Convertibility Law (Ley de Convertibilidad del Austral) No 23.928 (28 March 1991)
2.238
Public Emergency and Exchange Regulations Reform Law No 25.561 (as amended by
Law No 25.820) (6 January 2002) 2.238
Belgium
Companies Code, Art 472 2.209
Law of 2 January 1991, Art 10 2.209
Law of 28 April 1999 implementing the 1998 Settlement Finality Directive as

amended by the Law of 19 November 2004, Art 9 2.209
Royal Decree no 62 of 10 November 1967, Art 11 2.209
China
Law of the People’s Republic of China on the People’s Bank of China (PBC)
(promulgated 27 December 2003, into force 1 February 2004) 2.124
Art 7 2.124
France
Constitution, Art 34 1.42
Germany
Act concerning the Deutsche Bundesbank (Gesetz über die Deutsche Bundesbank)
1957 (Federal Law Gazette I, 2959) 2.149, 2.150, 2.151, 2.154
Art 3 2.150
Art 12 2.150, 7.26
Act to Optimise the Prevention of Money Laundering (Gesetz zur Optimierung der
Geldwäscheprävention) 22 December 2011
Art 9 2.149
Banking Act (Gesetz über das Kreditwesen, KWG) 3.112
Constitution (Basic Law) (Grundgesetz) 7.50

Art 73(4) 1.42
Art 88 2.155
Insurance Supervision Law (Versicherungsaufsichtsgesetz, VAG) 3.112
Law on Integrated Financial Services Supervision (Gesetz über die integrierte

Finanzaufsicht, FinDAG) 22 April 2002 3.86
Securities Trading Act (Gesetz über den Wertpapierhandel, WpHG) 3.112
Greece
Constitution, Art 80(2) 1.42
Hong Kong
Basic Law, Art 111 2.227
Exchange Fund Ordinance, s 3(1) 2.227
Ireland
Constitution 8.183
Italy
Constitution, Art 117(2)(e) 1.42
Netherlands
Act for Financial Supervision (Wet op het Financieel Toezicht) 2007 3.113
New Zealand
Reserve Bank of New Zealand Act 1989 2.102
s 9(4) 2.171
Spain
Constitution, Art 149(1)(11) 1.42
Switzerland
Civil Code, Art 60 14.32
United Kingdom
Bank of England Act 1998 2.181, 3.114
s 2A 3.78
s 4 2.181
s 12(1) 2.102
s 15 2.181
s 18 2.181
s 19 2.181
Banking Act 2009 (c 1) 3.78, 4.63, 4.111
Banking Supervision Act 1979 2.55(p. xxxviii)
Financial Services Act 2012 (c 21) 2.55, 2.182, 3.40, 3.76, 3.78, 3.83
Financial Services and Markets Act 2000 3.114
Financial Services (Banking Reform) Act 2013 (c 33) 3.83, 3.120, 4.52
Magna Carta 1.21
Peel’s Act 1844 2.18
State Immunity Act 1978 (c 33) 2.200–2.202, 2.215, 2.216, 2.218

s 13(4) 2.201
s 13(5) 2.201
United States
12 USC 221 4.11
28 USCs 1611(b)(1) 2.13, 2.220
Act of 16 November 1977 (91 Stat 1387) 2.86
Act of 27 October 1978 (92 Stat 1897) 2.86
Act of 23 August 1988 (102 Stat 1375) 2.86
Act of 27 December 2000 (114 Stat 3028) 2.86
Bank Holding Company Act (enacted 9 May 1956, Pub L 84-511, 70 Stat 133) s 13
3.93
Bankruptcy Code
Ch 9 14.118, 14.120
Ch 11 4.61, 14.118, 14.120
Code of Federal Regulations (CFR) 2.132

Title 12 2.132
Title 12 ch II 2.132, 4.11
Constitution 1.22, 2.167

Art I s 5 paras 5–6 1.42
Art I s 8 cl 3 2.119
Art I s 8 cl 5 2.119
Art I s 8 cl 18 2.119
Declaration of Independence 1.22
Dodd–Frank Wall Street Reform and Consumer Protection Act (enacted 21 July 2010,
Pub L No 111-203, 124 Stat 1376, HR 4173) 2.06, 2.12, 2.62, 2.96, 2.161, 3.52, 3.80,
3.92, 3.93, 3.122, 4.13, 4.14, 4.33, 4.62, 4.111, 4.161, 11.66
Title II 2.62, 4.62, 4.161
s 113(a)(1) 2.62, 4.161
s 165 2.62, 4.161
s 619 3.93
Emergency and Economic Stabilization Act (EESA) (enacted 3 October 2008, Pub L
110-343, 22 Stat 3765) 4.13
Employee Retirement Income Security Act (ERISA) 1974 3.92
Federal Deposit Insurance Act (enacted 21 September 1950, Pub L 81-797, 64 Stat
873) 4.12
Federal Deposit Insurance Corporation Improvement Act (FDICIA) (enacted 19

December 1991, Pub L 102-242, 105 Stat 2236–2393, 12 USC 1823(c)(4)) 4.12, 4.80,
4.117
Federal Reserve Act (enacted 23 December 1913, 38 Stat 251, 12 USC 226) 2.06,
2.27, 2.85, 2.86, 2.96, 2.119, 2.132, 3.52, 3.56, 4.95, 11.66
Preamble 2.06, 2.85, 3.56
s 2(a) 2.86
s 10a 4.11
s 10b 4.11
s 13 4.14
s 13(3) 4.13, 4.14, 4.33
s 13(14) 4.11
s 23(a) 3.33
s 23(b) 3.33
Foreign Sovereign Immunities Act (enacted 21 October 1976, Pub L 94-583, 90 Stat
2891) (FSIA) 2.200, 2.201, 2.215, 2.220
s 1611(b)(1) 2.201
Full Employment and Balanced Growth Act 1978 2.180
Gramm–Leach–Bliley Act (enacted 12 November 1999, Pub L 106-102, Stat 113 Stat
1338) 3.92
Investment Advisers Act 1940 (15 USC 80b-10) 3.92
Investment Company Act 1940 3.92
McCarran–Ferguson Act 1945 3.92
Sarbanes–Oxley Act 2002 3.37, 3.92
Securities Act (enacted 27 May 1933, Pub L 73-22, 48 Stat 74) s 27B 3.93
Rules, Statutes, Decisions, and Resolutions of International
Organizations and Other International Fora
Articles of Agreement of the International Monetary Fund (Bretton Woods, NH,
adopted 22 July 1944, entered into force 27 December 1945) 1.51, 1.63–1.65, 6.11,
6.37, 9.35, 9.60, 9.66, 12.04, 12.22, 12.26–12.38, 12.43, 12.45, 12.55–12.68, 13.02,
13.03, 13.10, 13.59, 13.61–13.64, 13.67, 13.72, 13.84, 13.100, 13.109, 13.115,
13.125, 13.140, 13.141, 13.147, 13.148, 13.151, 13.152, 13.184, 13.241, 13.245,
14.07, 14.95, 14.103, 14.115, 14.123, 14.208, 14.213, 14.219(p. xxxix)
Art I 12.68, 13.05, 13.54, 13.80, 13.124, 13.150, 14.213
Art I (v) 13.150, 13.153, 14.103
Art II 13.11
Art II s 1 13.11, 13.23
Art II s 2 9.60, 9.74, 13.12
Art III s 2(a) 13.30
Art III s 2(ba) 13.31
Art III s 3(a) 13.24
Art IV 1.64, 2.35, 9.63, 12.57, 13.63, 13.78–13.80, 13.89, 13.92, 13.98–13.100,
13.102, 13.168, 13.175, 13.241, 14.103, 14.152, 14.173, 14.202, 14.211, 14.213
Art IV s 1 6.37, 12.58, 13.86, 13.94, 13.95, 13.99–13.101
Art IV s 1(i) 13.95, 13.96, 13.98
Art IV s 1(ii) 13.95, 13.96, 13.98
Art IV s 1(iii) 12.58, 13.95, 13.96, 13.98
Art IV s 1(iv) 13.95, 13.96, 13.98
Art IV s 1(a) 12.30
Art IV s 2 6.37
Art IV s 2(b) 12.57
Art IV s 3 13.86, 13.100
Art IV s 3(a) 12.60, 13.87
Art IV s 3(b) 12.61, 13.88, 13.97
Art IV s 5 12.45
Art IV s 5(a) 12.31
Art IV s 5(b)–(f) 12.45
Art IV s 7 12.32, 12.37
Art V 13.124
Art V s 1 13.83
Art V s 2 13.241
Art V s 2(b) 13.53, 13.79–13.81, 13.189
Art V s 3 13.79, 13.80, 13.140, 13.241
Art V s 3(a) 13.133, 13.136, 13.143, 13.149, 13.150, 13.165, 13.185, 13.198,
13.224, 14.163
Art V s 3(b) 13.115, 13.116, 13.133, 13.165
Art V s 3(c) 13.133, 13.165
Art V s 4 13.115, 13.153
Art V s 7(d) 13.198
Art V s 8(d) 13.198
Art V s 11 13.38
Art V s 11(a) 13.38
Art VI s 3 13.72
Art VII 13.46
Art VIII 1.64, 6.09, 12.39, 12.47, 13.63, 13.70, 13.71, 13.102, 13.188
Art VIII s 2 13.63–13.65, 13.69, 13.80, 13.241
Art VIII s 2(a) 13.66, 14.123
Art VIII s 2(b) 13.04, 13.67, 14.123
Art VIII s 3 13.69
Art VIII s 4 13.69
Art VIII s 5 13.97, 13.180, 13.181
Art VIII s 5(b) 14.82
Art XII 13.14
Art XII s 1 13.14
Art XII s 2 13.14
Art XII s 2(b) 13.17, 14.213
Art XII s 2(j) 13.16
Art XII s 3 13.14
Art XII s 3(a) 13.17
Art XII s 3(b) 13.17
Art XII s 3(g) 13.17
Art XII s 4 13.14
Art XII s 4(a) 13.19
Art XII s 4(c) 13.19
Art XII s 5 13.17
Art XIV 13.69–13.71, 13.102, 13.188
Art XV s 1 13.40, 13.55
Arts XV–XXV 2.212
Art XVI 13.32, 13.43
Art XVI s 2 13.33
Art XVII 13.58
Art XVII s 3 13.40
Art XVIII 13.58
Art XVIII s 1(a) 13.55
Art XIX s 5 13.41
Art XX(4)(a) 12.29
Art XXI 13.32
Art XXVI 13.13, 13.181
Art XXVI s 1 13.13
Art XXVI s 2 13.13
Art XXVI s 2(a) 13.70
Art XXVIII(a) 13.03
Art XXIX(a) 13.21
Art XXX(b) 13.128, 13.143
Art XXX(c) 13.25, 13.42
Art XXX(d) 6.11, 13.68
Art XXX(f) 12.52, 13.26
Sch M 13.62
Basel Capital Accords of 1988 (Basel I) 3.30, 3.32, 14.28
Basel Capital Accords of 2004 (Basel II) 3.32, 14.28, 14.60
Basel Capital Accords of 2010 (Basel III) 3.31, 3.96, 3.118, 4.23, 14.28, 14.77
Basel Committee on Banking Supervision (BCBS) Charter (Bank for International

Settlements) (January 2013) 14.25, 14.26, 14.30, 14.31, 14.42
Board of Governors of the Federal Reserve System Regulations 4.11
Bylaws of the Federal Reserve Bank of New York (FRBNY)

Art 4 2.108
Bylaws of the International Monetary Fund 13.02

s 15 13.17, 14.213(p. xl)
Charter for the International Trade Organization 1948 12.02
Constituent Charter of the Bank for International Settlements (of 20 January 1930)
14.189
Decision of the Executive Board of the IMF No 284-4 of 10 March 1948 13.142
Decision of the Executive Board of the IMF No 446-4 of 10 June 1949 13.67
Decision of the Executive Board of the IMF No 102-(52/11) of 13 February 1952

13.125, 13.142
Decision of the Executive Board of the IMF No 144-(52/51) of 14 August 1952 13.66
Decision of the Executive Board of the IMF No 270-(53/ 95) of 23 December 1953
13.125
Decision of the Executive Board of the IMF No 1289-(62/1) of 5 January 1962 with
effect from 24 October 1962 13.47
Decision of the Executive Board of the IMF No 2603-(68/132) of 20 September 1968

13.144
Decision of the Executive Board of the IMF No 4233-(74/67)S of 13 June 1974 13.57

13.230
Decision of the Executive Board of the IMF No 5392-(77/63) of 29 April 1977 13.89,
13.103
Decision of the Executive Board of the IMF No 6056-(79/38) of 2 March 1979 13.144
Decision of the Executive Board of the IMF No 6631-(80/145)G/S of 17 September

1980 13.57
Decision of the Executive Board of the IMF No 7337-(83/37) of 24 February 1983,
para 21(b) 13.49
Decision of the Executive Board of the IMF No 7403-(83/73) of 20 May 1983 13.48
Decision of the Executive Board of the IMF No 7842-(84/165) of 16 November 1984

13.182
Decision of the Executive Board of the IMF No 8757-(87/176) SAF/ESAF of 18

December 1987 13.53
Decision of the Executive Board of the IMF No 8759-(87/176) of 18 December 1987

13.53, 13.207, 13.217
Decision of the Executive Board of the IMF No 10348-(93/61) of 23 April 1993 13.236
Decision of the Executive Board of the IMF No 11428-(97/60) of 27 January 1997

13.50

13.236
Decision of the Executive Board of the IMF No 11492-(99/48) of 23 April 1999 13.236
Decision of the Executive Board of the IMF No 12087-(99/118) of 21 October 1999

13.209
Decision of the Executive Board of the IMF No 12249-(00/77) of 27 July 2000 13.182

13.236

13.227

13.130

13.133
Decision of the Executive Board of the IMF No 13183-(04/0) of 30 January 2004

13.181

‘Guidelines on Conditionality’ (Decision I) 13.130, 13.133, 13.139, 13.145, 13.153,
13.155, 13.160, 13.164, 13.165, 13.175, 13.176, 13.181
Section A 13.166
Section B 13.166
Section C 13.166
paras 1–8 13.166
para 9 13.130, 13.170
paras 9–13 13.166
para 10 13.167
para 11 13.171
para 14 13.176
principle 1 13.139, 13.150
principle 2 13.139
principle 4 13.153
principle 7 13.153
principle 7(c) 13.139
principle 8 13.178(p. xli)

13.181, 13.182
Decision of the Executive Board of the IMF of 15 June 2007 13.89
Decision of the Executive Board of the IMF No 14064-(08/18) of 22 February 2008

13.238
Decision of the Executive Board of the IMF No 14107-(08/38) of 2 May 2008 13.181
Decision of the Executive Board of the IMF No 14282-(09/29) of 24 March 2009

13.237
Decision of the Executive Board of the IMF No 14283-(09/29) of 24 March 2009,

‘Stand-by Arrangements’ (Decision II) 13.133, 13.145
Decision of the Interim Committee of the IMF No EBS/99/193 of 14 October 1999 and
Supplement 1 of 22 November 1999 13.53
European Bank for Reconstruction and Development Model Law on Secured

Transactions 1994 5.53, 5.54
Financial Stability Board Articles of Association 14.32
Financial Stability Board Charter 2009 14.32
Financial Stability Board Charter 2012 14.35, 14.36

Art 2 14.36
Art 6(1) 14.71
Art 9 14.35
Art 10(1) 14.34
Art 12 14.35
Art 22 14.35
Resolution No 23–5 of the Board of Governors of the International Monetary Fund

(First Amendment) (adopted on 31 May 1968, effective 28 July 1969) 13.03, 13.40,
13.54, 13.141

(Second Amendment) (adopted on 30 April 1976, effective 1 April 1978) 1.64, 2.35,
13.03, 13.24, 13.54, 13.89, 13.90, 13.128, 13.185, 14.202

(Third Amendment) (adopted on 28 June 1990, effective 11 November 1992) 13.03

(Fourth Amendment) (adopted on 23 September 1997, effective 10 August 2009)
13.03

(Sixth Amendment) (adopted on 28 April 2008, effective 3 March 2011) 13.03

(Fifth Amendment) (adopted on 5 May 2008, effective 18 February 2011) 13.03

(effective 15 December 2012) 13.30
Rules of Organization of the Board of Governors of the Federal Reserve Bank

s 4 2.108
Rules of the International Monetary Fund 13.02
Statutes of the Bank for International Settlements (20 January 1930, as amended 27
June 2005) 14.189
Art 3 12.11
Art 54 14.189
Art 55 2.209
UN General Assembly Resolution 2625 (XXV) Declaration of Principles of

International Law Concerning Friendly Relations and Cooperation among States in
Accordance with the Charter of the United Nations, 24 October 1970 1.07
UNCITRAL Arbitration Rules 5.52
UNCITRAL Model Law on Cross-Border Insolvency, Vienna May 1997 4.96, 14.38
UNCITRAL Model Law on Electronic Commerce and Electronic Signatures 5.52
UNCITRAL Model Law on International Commercial Arbitration, 24 ILM 1302 (1985)
4.96
Art 1(2) 4.96
(p. xlii)
List of Abbreviations

Rosa Lastra

ISBN: 9780199671090
ABS
asset-backed securities
AfDF
African Development Fund
AFM
Autoriteit Financiële Markten [Authority on Financial Markets] (The Netherlands)
AFRD
European Agricultural Fund for Rural Development
AML/CFT
anti-money laundering and countering the financing of terrorism
AQR
asset quality review
ASC
Advisory Scientific Committee
ATC
Advisory Technical Committee
BaFin
Bundesanstalt für Finanzdienstleistungsaufsicht [Federal Financial Supervisory
Authority] (Germany)
BAKred
Bundesaufsichtsamt für das Kreditwesen [banking supervision] (Germany)
BAV
Bundesaufsichtsamt für das Versicherungswesen [insurance supervision] (Germany)
BAWe
Bundesaufsichtsamt für den Wertpapierhandel [securities supervision] (Germany)
BCBS
Basel Committee on Bank Supervision
BCCI
Bank of Credit and Commerce International
BCRA
Banco Central de la Republica Argentina
BEPG
broad economic policy guidelines
BIS
Bank for International Settlements
BOPM6
IMF Balance of Payments Manual, 6th edn
BRICs
Brazil, Russia, India, and China
BRRD
Bank Recovery and Resolution Directive
BTS
binding technical standards
CAC
Counterfeit Analysis Centre
CACs
Collective Action Clauses
CAMEL
capital adequacy, asset quality, management, earnings, and liquidity
CAP
Common Agricultural Policy
CBI
central bank independence
CBN
Central Bank of Nigeria
CBPP
Covered Bonds Purchase Programme
CCF
Compensatory Financing Facility
CCFF
Compensatory and Contingency Financing Facility
CCL
Contingent Credit Line
CCLS
Centre for Commercial Law Studies
CCP
central counterparty
CCT
Common Customs Tariff
CD
certificate of deposit
CDS
credit default swaps
CEBS
Committee of European Banking Supervisors(p. xliv)
CEIOPS
Committee of European Insurance and Occupational Pensions Supervisors
CEPS
Centre for European Policy Studies
CESR
Committee of European Securities Regulators
CFF
Compensatory Financing Facility
CFIM
Coordination Framework for Implementation Monitoring
CFP
Communauté Financière du Pacifique [Pacific Financial Community]
CFR
Code of Federal Regulations (USA)
CFTC
Commodities Future Trading Commission (USA)
CHIPS
Clearing House Inter-bank Payments System
CIBC
Canadian Imperial Bank of Commerce
CLP
Commission on Commercial Law and Practice
CMG
crisis management group
CoCo
contingent convertible [bond]
COREP
Common Reporting
CPI
Consumer Price Index
CPSS
Committee on Payment and Settlement Systems
CRA
credit rating agency
CRD IV
Directive 2013/36/EU of the European Parliament and of the Council on access to the
activity of credit institutions and the prudential supervision of credit institutions and
investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/
EC and 2006/49/EC, OJ L 176/338 (27 June 2013)
CRR
Regulation (EU) No 575/2013 of the European Parliament and the Council of 26 June
2013 on prudential requirements for credit institutions and investment firms and
amending Regulation (EU) No 648/2012, OJ L 176/1 (27 June 2013)
CSD
central securities depository
CSF
Currency Stabilisation Fund
D-SIBs
domestic systemically important banks
DDSR
Debt and Debt Service Reduction
DGS
Deposit Guarantee Schemes
DMO
Debt Management Office
DNB
De Nederlandsche Bank [Dutch central bank]
DSA
debt sustainability analysis
DTI
debt service to income [ratio]
DVP
delivery versus payment
DWL
discount window lending
EAGGF
European Agricultural Guidance and Guarantee Fund
EBA
European Banking Authority
EBRD
European Bank of Reconstruction and Development
EC
European Community
ECA
Economic Cooperation Administration (USA)
ECB
European Central Bank
ECF
Extended Credit Facility
ECOFIN
Economic and Financial Affairs Council
ECOWAS
Economic Community of West African States(p. xlv)
ECSC
European Coal and Steel Community
ECSI
European Convention on State Immunity
ECU
European Currency Unit
EDP
excessive deficit procedure
EEA
European Economic Area
EEC
European Economic Community
EESA
Emergency and Economic Stabilization Act (USA)
EFC
Economic and Financial Committee
EFF
Extended Fund Facility
EFSA
European Financial Services Authority
EFSF
European Financial Stability Facility
EFSM
European Financial Stabilisation Mechanism
EIOPA
European Insurance and Occupational Pensions Authority
ELA
emergency liquidity assistance
EMAC
Committee on Economic and Monetary Affairs
EMCF
European Monetary Cooperation Fund
EMFF
European Maritime and Fisheries Fund
EMI
European Monetary Institute
EMIR
Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July
2012 on OTC derivatives, central counterparties and trade repositories, OJ L 201/1
(27 July 2011)
EMS
European Monetary System
EMU
Economic and Monetary Union
EPA
Environmental Protection Agency
EPC
Economic Policy Committee
EPU
European Payments Union
ERBD
European Bank for Reconstruction and Development
ERDF
European Regional Development Fund
ERISA
Employee Retirement Income Security Act (USA)
ERM
exchange rate and intervention mechanism (EU)
ESAs
European supervisory authorities
ESAF
Enhanced Structural Adjustment Facility
ESC
European Securities Committee
ESCB
European System of Central Banks
ESF
Exchange Stabilization Fund
ESFRC
European Shadow Financial Regulatory Committee
ESFS
European System of Financial Supervision
ESM
European Stability Mechanism
ESMA
European Securities Market Authority
ESMT
Treaty establishing the European Stability Mechanism
ESRB
European Systemic Risk Board
EU
European Union
EURATOM
European Atomic Energy Community
FAT
Financial Activities Tax
FATF
Financial Action Task Force on Money Laundering
FCA
Financial Conduct Authority (UK)(p. xlvi)
FCL
Flexible Credit Line
FCS
Financial Stability Contribution
FDIC
Federal Deposit Insurance Corporation (USA)
FDICIA
Federal Deposit Insurance Corporation Improvement Act (USA)
Fed
Federal Reserve System (USA)
FIFG
Financial Instruments for Fisheries Guidance
FinDAG
Gesetz über die integrierte Finanzaufsicht [Law on Integrated Financial Services
Supervision] (Germany)
FINRA
Financial Industry Regulatory Authority
FINREP
Financial Reporting
FIRREA
Financial Institutions Reform, Recovery and Enforcement Act
FOMC
Federal Open Market Committee
FOSC
Financial Stability Oversight Council
FPC
Financial Policy Committee
FRBNY
Federal Reserve Bank of New York
FSA
Financial Services Authority
FSAP
Financial Sector Assessment Program
FSB
Financial Stability Board
FSC
Financial Stability Contribution
FSF
Financial Stability Forum
FSIA
Foreign Sovereign Immunities Act (USA)
FSOC
Financial Stability Oversight Council (USA)
FSSA
Financial System Stability Assessment (IMF)
G-20 MAP
G-20 Mutual Assessment Program
G-SIBs
global systemically important banks
GAB
General Agreement to Borrow
GATS
General Agreement on Trade in Services
GATT
General Agreement on Tariffs and Trade
GDDS
General Data Dissemination System
GDP
Gross Domestic Product
GEMU
genuine economic and monetary union
GLF
Greek Loan Facility
GNI
gross national income
GNP
gross national product
GRA
General Resources Account (IMF)
GSIB
global systemically important banks
HICP
harmonized index of consumer prices
HIPC
heavily indebted poor countries
IaDB
Inter-American Development Bank
IADI
International Association of Deposit Insurers
IAIS
International Association of Insurance Supervisors
IBA
International Bar Association
IBRD
International Bank for Reconstruction and Development
ICC
International Chamber of Commerce(p. xlvii)
ICJ
International Court of Justice
ICR
insolvency and creditor rights
IDA
International Development Association
IEO
Independent Evaluation Office (IMF)
IFI
international financial institution
IGA
Intergovernmental Agreement
ILOLR
international lender of last resort
IMF
International Monetary Fund
IMFC
International Monetary Financial Committee
INSOL
International Association of Restructuring, Insolvency & Bankruptcy Professionals
IOSCO
International Organization of Securities Commissions
IPA
Instrument for Pre-Accession Assistance
ISD
Integrated Surveillance Decision
ISDA
International Swaps and Derivatives Association
ISPA
Instrument for Structural Policies for Pre-Accession
ITO
International Trade Organization
ITS
implementing technical standards
JASMINE
Joint Action to Support Micro-finance Institutions in Europe
JASPERS
Joint Assistance to Support Projects in European Regions
JEREMIE
Joint European Resources for Micro to Medium Enterprises
JESSICA
Joint European Support for Sustainable Investment in City Areas
KWG
Gesetz über das Kreditwesen [German Banking Act]
LCR
liquidity coverage ratio
LCTM
long-term capital management
LDC
less developed countries
LIA
lending into arrears
LIC
low-income countries
LLVS
Legal and Finance theory, aka Legal Origins Theory (La Porta, Lopez-de-Silanes,
Vishny, and Shleifer)
LOI
letters of intent
LOLR
lender of last resort
LTF
Legal Theory of Finance
LTRO
long-term refinancing operation
LTV
loan to value [ratio]
MDG
Millennium Development Goals
MDRI
Multilateral Debt Relief Initiative
MEFP
memorandum on economic and financial policies
MiFID
Markets in Financial Instruments Directive
MIGA
Multilateral Investment Guarantee Agency
MIT
Massachusetts Institute of Technology
MOCOMILA
Committee on International Monetary Law of the International Law Association
MOF
Minister of Finance(p. xlviii)
MoU
Memorandum of Understanding
MPC
Monetary Policy Committee (UK)
MRO
main refinancing operation
MTBoPA
medium term balance of payment
MTO
medium-term objective
NAB
New Arrangement to Borrow
NASD
National Association of Securities Dealers
NASDAQ
National Association of Securities Dealers Automated Quotation System
NATO
North Atlantic
NCA
National Competent Authority
NCB
national central bank
NRP
National Reform Programme
NSFR
net stable funding ratio
OCA
optimum currency area
OECD
Organisation for Economic Co-operation and Development
OEEC
Organisation for European Economic Cooperation
OJ
Official Journal of the European Communities
OLA
orderly liquidation authority
OLAF
European Anti-Fraud Office
OMO
open market operation
OMT
Outright Monetary Transactions
OPEC
Organization of Petroleum Exporting Countries
OTC
over-the-counter
OTS
Office of Thrift Supervision
PBC
People’s Bank of China
PCA
prompt corrective action
PCDR
Post-Catastrophe Debt Relief
PCL
Precautionary Credit Line
PDM
Public Debt Management
PFMIs
Principles for Financial Market Infrastructures
PFP
policy-framework paper
PIN
Public Information Notice (IMF)
PLL
Precautionary and Liquidity Line
PRA
Prudential Regulation Authority (UK)
PRC
People’s Republic of China
PRGF
Poverty Reduction and Growth Facility
PRGT
Poverty Reduction and Growth Trust
PRSP
Poverty Reduction Strategy Papers
PSI
Policy Support Instrument
PVK
Pensioen- en Verzekeringskamer (The Netherlands)
QE
quantitative easing(p. xlix)
RCAP
regulatory consistency assessment programme
RCF
Rapid Credit Facility
RFI
Rapid Financing Instrument
ROSCs
Reports on Observance of Standards and Codes (IMF)
RRP
recovery and resolution plan
RTC
Resolution Trust Corporation
RTGS
real-time gross settlement systems
RTP
reserve tranche position
RTS
regulatory technical standards
SAF
Structural Adjustment Facility
SAPARD
Special Accession Programme for Agriculture and Rural Development
SBA
stand-by arrangement
SCA
Special Contingent Account (IMF)
SCF
Standby Credit Facility
SCP
Stability and Convergene Programme
SCSI
Standing Committee on Standards Implementation
SDDS
Special Data Dissemination System
SDGS
Single Deposit Guarantee Scheme
SDR
Special Drawing Right
SDRM
Sovereign Debt Restructuring Mechanism
SEA
Single European Act
SEC
Securities and Exchange Commission (USA)
SEIR
structured early intervention and resolution
SEPA
Single European Payments Area
SGP
Stability and Growth Pact
SIA
State Immunity Act (UK)
SIFI
systemically important financial institution
SLS
Special Liquidity Scheme
SMEs
small and medium enterprises
SMP
Securities Markets Programme
SRB
Single Resolution Board
SRF
Supplemental Reserve Facility
SRM
Single Resolution Mechanism
SRO
Self-Regulatory Organization
SRP
simplified revision procedure
SRR
special resolution regime (UK)
SSB
standard-setting body
SSM
Single Supervisory Mechanism
STF
Systemic Transformation Facility
SUERF
Société Universitaire Européenne de Recherches Financières
TAF
Term Auction Facility
TALF
Term Asset-Backed Securities Lending Facility
TARGET
Trans-European Automated Real-time Gross-settlement Express Transfer(p. l)
TARP
Troubled Asset Relief Program (USA)
TBTF
too big to fail
TEU
Treaty on European Union
TFEU
Treaty on the Functioning of the European Union
TIM
Trade Integration Mechanism
TLTRO
targeted longer-term refinancing operation
TMU
technical memorandum of understanding
TSCG
Treaty on Stability, Coordination and Governance in the Economic and Monetary
Union
UMP
unconventional monetary policy
UN
United Nations
UNCITRAL
United Nations Commission on International Trade Law
UNCJIS
United Nations Convention on Jurisdictional Immunities of States and Their Property
UNCTAD
United Nations Conference on Trade and Development
UNECE
United Nations Economic Commission for Europe
UNECLAC
United Nations Economic Commission for Latin America and the Caribbean
UNIDROIT
International Institute for the Unification of Private Law
USA
United States of America
VAG
Versicherungsaufsichtsgesetz [Insurance Supervision Law] (Germany)
WFO
World Financial Organization
WpHG
Gesetz über den Wertpapierhandel [Securities Trading Act] (Germany)
WTO
World Trade Organization
Part I Developments at the National Level, 1
Monetary Sovereignty
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
International monetary conduct — Monetary system — Monetary obligations — European Central Bank
(p. 3) 1 Monetary Sovereignty
B. Definition of Sovereignty 1.06
Sovereignty in public international law 1.07
Monetary sovereignty 1.09
C. History of Sovereignty 1.11

Sovereignty of the monarch 1.12
Bodin 1.12
Machiavelli 1.13
Hobbes 1.14
Sovereignty of the people 1.16

Locke 1.17
Montesquieu 1.18
Hamilton 1.22
Madison 1.24
Alexis de Tocqueville 1.26
D. Money and Monetary Sovereignty under International Law: Lex Monetae 1.29
The concept of money 1.29
The functions of money 1.30
Money and the law 1.32
Monetary sovereignty under public international law 1.36

Lex monetae and legal theories of money 1.40
E. The Attributes of Monetary Sovereignty 1.51

F. The Erosion of Monetary Sovereignty 1.56
Voluntary or consensual limitations of monetary sovereignty 1.59
The advent of European Monetary Union 1.59
International obligations: The IMF Articles of Agreement 1.64
Other limitations of national monetary sovereignty 1.66
G. Concluding Observations 1.76
The use of words is to express ideas. Perspicuity, therefore, requires not only that
the ideas should be distinctly formed, but that they should be expressed by words
distinctly and exclusively appropriate to them. But no language is so copious as to
supply words and phrases for every complex idea, or so correct as not to include
many equivocally denoting different ideas. Hence it must happen that however
accurately objects may be discriminated in themselves, and however accurately the
discrimination may be considered, the definition of them may be rendered
inaccurate by the inaccuracy of the terms in which it is delivered. And this
unavoidable inaccuracy must be greater or less, according to the complexity and
novelty of the objects defined.
Alexander Hamilton, The Federalist Papers, 17881
A. Introduction
1.01 The power to issue currency is a sovereign power, one of the attributes of sovereignty
as classically defined. This chapter explores first the notion of sovereignty and its history, a
history which is linked to the evolution of the nation State. In this respect, I provide an (p.
4) analysis of the philosophical and political roots of sovereignty, with references to the
work of Bodin, Machiavelli, and Hobbes, and of the evolution of this concept over the
centuries, with the advent of democracy and the rule of law. While the debate in the
eighteenth and nineteenth centuries focused upon the evolution of this concept with regard
to the locus of that supreme power (ie, from the sovereignty of the king—hereditary
monarch—to the sovereignty of the people), the debate in recent decades has been centred
on what is referred to as the ‘erosion’ of sovereignty. The receding power of the nation
State in recent years has been accompanied by a redefinition of the notion of sovereignty.
Power today is no longer the exclusive domain of the nation State. Centripetal and
centrifugal forces have diffused the power of the nation State, and today a variety of actors,
including international organizations, multinational corporations, regions, local
communities, and the civil society also exercise power.
1.02 The process of European integration has redefined the jurisdictional boundaries of
the powers of the European States. The advent of Economic and Monetary Union (EMU)
signifies a voluntary surrender of the traditional monopoly power enjoyed by the State—in
the case of EMU, the participating Member States—with regard to the issue of currency.
The globalization of financial markets and the powers vested upon the International
Monetary Fund and other international financial institutions, as well as economic
considerations such as the choice of exchange regime, have also limited and altered the
traditional contours of the domain of monetary sovereignty.
1.03 The development of alternative currencies (local currencies such as the Bristol
pound2 or virtual currencies such as Bitcoin), together with the increasing use of
alternative payments (initiatives in digital transactions and mobile payments such as
Kenya’s M-Pesa) and alternative finance provides (such as peer-to-peer lending and
crowdfunding), are some of the latest manifestations of the changing powers of the State in
the monetary arena.
1.04 Notwithstanding these limitations, States remain the key actors in the international
community. Indeed, following the global financial crisis that commenced in 2007 and
reached its zenith in 2008,3 there has been a certain retrenchment to national boundaries
with the de-globalization (or re-nationalization) of some financial markets and institutions.
1.05 Institutions are creatures of their time and history plays a fundamental part in
understanding their evolution. In this chapter, I contend that there is nothing sacrosanct
about the notion of monetary sovereignty that has traditionally been attributed to the nation
State.
(p. 5) B. Definition of Sovereignty

1.06 Sovereignty has traditionally being defined as the supreme authority within a
territory. The State is the political institution in which sovereignty is embodied.
Sovereignty in public international law
1.07 Sovereignty in the sense of contemporary public international law denotes the basic
international legal status of a State that is not subject, within its territorial jurisdiction, to
the governmental (executive, legislative, or judicial) jurisdiction of a foreign State or to
foreign law other than public international law.4 It forms part of the fundamental principles
of general international law and it is considered to be one of the principal organizing
concepts of international relations.5 It protects the existence and the freedom of action of
States, as limited by international law, in their international relations as well as with
respect to their internal affairs. In particular, it protects their freedom of self-determination
over their political, constitutional, and socio-economic systems and cultural identity,6 their
territorial integrity and exclusive jurisdiction over their territory, and their personal
jurisdiction over their citizens and juridical persons established under their jurisdiction as
well as over matters with trans-frontier connections which have reasonably close links with
or effects upon the State’s territory.7
1.08 Vaughan Lowe argues that debates about sovereignty constitute a vehicle for specific
discussions over rights and duties of States.8
(p. 6) Monetary sovereignty
1.09 Monetary sovereignty is a particular attribute of the general sovereignty of the State
under international law. Some authors argue that the concept of monetary sovereignty
predates by thousands of years the concept of political sovereignty that was developed in
the Renaissance, since the authority to create money had been proclaimed by the rulers or
priesthood of ancient civilizations (Sumer, India, Babylon, Persia, Egypt, Rome, and
others).9
1.10 However, the modern understanding of the attributes of sovereignty is rooted in the
political thought that was developed in the Renaissance. The history and evolution of
sovereignty is intrinsically linked to the history and evolution of the nation State. Both
concepts were developed in Western Europe during the end of the fifteenth century and the
sixteenth century.
C. History of Sovereignty

1.11 The writings of Machiavelli, Bodin, and Hobbes are of particular relevance to the
understanding of the concept of sovereignty. Politics operated without this organizing
principle in the Middle Ages. It is generally agreed that the development of a system of
sovereign States culminated at the Peace of Westphalia in 1648.10
Sovereignty of the monarch
Bodin
1.12 Jean Bodin (1520–96) writing soon after the Massacre of the Huguenots on St
Bartholomew’s Day in 1572 developed in Les Six Livres de la République (1576) some of the
key ideas that surround the concept of sovereignty. Bodin was concerned with internal
order in a time of unrest and introduced his concept of sovereignty to bolster the power of
the French king over the rebellious feudal lords and the church: ‘It is clear that the
principal mark of sovereign majesty…is the right to impose laws generally on all subjects
regardless of their consent…If he is to govern the state well, a sovereign prince must be
above the law.’11
Bodin’s concept of souveraineté (sovereignty) is often regarded as the first systematic one
in modern European political philosophy and deserves a landmark status.12
(p. 7) Machiavelli
1.13 In the early sixteenth century, Niccolo Machiavelli (1469–1527) established some of
the foundations of modern political philosophy in his work The Prince (1513).13 According
to Machiavelli, princes should retain absolute control of their territories and should use any
means of expediency to accomplish this end. He relied on his experience of politics and
diplomacy in the city States of contemporary Italy and his sound knowledge of history to
elaborate on the basic principles of statehood. His aim was to show how to build a strong
principality through the use of effective statesmanship rather than the reliance on moral
considerations. The thrust of his advice is that the sovereign should have supreme authority
within his territory and his authority should lie beyond the reach of the rule of natural law,
canon law, Gospel precepts, or any of the norms or authorities relating to the then powerful
Christian tradition. The sovereign must demonstrate the readiness to perform evil as a
necessary means to the ultimate end which was central to Machiavelli’s writings: the
strength and well-ordering of the State. He was supreme within the State’s territory and
responsible for the well-being of this singular, unitary body. Machiavelli did not purport to
describe the nature of sovereignty and the content of the relationship between the
sovereign and the people. He was primarily concerned with the preservation of that
authority, providing advice as to the best model of government for the sake of the
government’s stability and not for the sake of the people’s well-being. And he confined his
attention to monarchical regimes rather than republics. Machiavelli is pragmatic rather
than ideologist. Force and restraint, cruelty and kindness, must be employed in their turn
when necessary to strengthen the authority of the monarch. He considers the creation of
strong armies as the only necessary means of holding power and legal authority, leaving no
doubt as to the importance of military power as source of sovereignty:
A Prince, therefore, should have no care or thought but for war, and for the
regulations and training it requires, and should apply himself exclusively to this as
his peculiar province; for war is the sole art looked for in one who rules, and is of
such efficacy that it not merely maintains those who are born Princes, but often
enables men to rise to that eminence from a private station; while, on the other
hand, we often see that when Princes devote themselves rather to pleasure than to
arms, they lose their dominions.14
Hobbes
1.14 The English philosopher Thomas Hobbes (1588–1679) further developed in Leviathan
(1651) the notion of sovereignty, which he described as the absolute and unlimited rule or
authority over the territory and the peoples in it. Though there is no direct reference to
Bodin’s writings in the pertinent paragraphs of Leviathan, there is a broad consensus
among theorists that there is a sequence and a common understanding of concepts between
the French and the English philosophers.15 Like Bodin (who wrote at a time of civil war in
(p. 8) France between Calvinist Huguenots and the Catholic monarchy) Hobbes also wrote
at a time of civil war. He believed that absolute sovereignty of the State over the national
territory was the only safeguard of a man’s preservation: ‘For where there is no
Commonwealth, there is, as hath been already shown, a perpetual war of every man against
his neighbour; and therefore everything is his that getteth it and keepeth it by force; which
is neither propriety nor community, but uncertainty.’16
1.15 The life of human beings was full of dangers and human nature was weak and for that
reason they agreed unconditionally to submit themselves to the absolute sovereignty of the
State in exchange for guaranteed internal civil order and protection from external threats.17
Activities and events beyond national borders are not an issue unless other nations threaten
to enter the sovereign territory. The Hobbesian concept of sovereignty in Leviathan is based
upon the theoretical premise that within the sovereign boundaries a State is entitled to
regulate the affairs of all individuals being subordinated thereto. Interestingly, Hobbes
establishes in rather clear terms the concept of monetary sovereignty.18 Coinage and the
creation of money as a means of exchange and a storage of value must belong to the
sovereign. His understanding is rather modern, in the sense that he points out that the
value of money is affected by the change of the laws in the country in which the money is
created. (p. 9) He notes that there are two methods by which money is made available for
public use: the first is the transfer of money to the public coffers by way of taxation and the
second is the reverse circulation of money from the government to the citizens by means of
public payments. In that, the Leviathan (artificial man) ‘maintains his resemblance with the
natural; whose veins, receiving the blood from the several parts of the body, carry it to the
heart; where, being made vital, the heart by the arteries sends it out again, to enliven and
enable for motion all the members of the same.’19
Sovereignty of the people
1.16 The advent of democracy as a political form of organizing the nation State and the
theory of the division of powers signified an important evolution in the understanding of the
notion of sovereignty and its roots. The various social contract theories consider that
sovereignty resides originally in individuals (the will of the people), who are the principal
sovereignty-holders. Rousseau’s social contract theory provides a fundamental basis for the
modern understanding of the general will of the State, as representative of the will of its
citizens. The individuals assemble or aggregate their individual wills into a unity: a general
or collective will. The holder or bearer of such collective will (to whom individuals transfer
their private will for the conduct of certain affairs) is the State, and its decisions require the
agreement of the original sovereignty-holders. This is the basis of democratic legitimacy.
Locke
1.17 John Locke (1632–1704), whose work Two Treatises of Government (1690) marked a
clear departure from the Hobbesian notion of sovereignty, considers that sovereign
authority is premised on the individual freedom of every person in the land to place the
legislative power into the hands of few with the ‘great end’ of enjoying their properties in
peace and safety. But the power is not absolute, defined merely by geographic sovereignty,
but it is limited by the obligation of sovereign authorities to respect the rights of every
citizen. This power cannot be exercised arbitrarily over the lives and fortunes of the people.
For it being but the joint power of every member of the society given up to that
person or assembly which is legislator, it can be no more than those persons had in
a state of Nature before they entered into society, and gave it up to the community.
For nobody can transfer to another more power than he has in himself, and nobody
has an absolute arbitrary power over himself, or over any other, to destroy his own
life, or take away the life or property of another. A man, as has been proved, cannot
subject himself to the arbitrary power of another; and having, in the state of Nature,
no arbitrary power over the life, liberty, or possession of another, but only so much
as the law of Nature gave him for the preservation of himself and the rest of
mankind, this is all he doth, or can give up to the commonwealth, and by it to the
legislative power, so that the legislative can have no more than this.20
Montesquieu
1.18 Charles de Montesquieu (1688–1755) examined extensively the notion of sovereignty,
in L’Esprit des lois [The Spirit of Laws] (1748).21 Montesquieu considers three species of (p.
10) government: republican, monarchical, and despotic. A republican government is that in
which the body, or only a part of the people, is possessed of the supreme power,
sovereignty. When the body of the people is possessed of sovereignty, it is called a
democracy. When the supreme power is lodged in the hands of a part of the people, it is
then an aristocracy. In a democracy the people are in some respects the sovereign, and in
others the subject.
1.19 There can be no exercise of sovereignty in a democracy unless expressed by the will
of the people. The people, in whom the supreme power resides, ought to have the
management of everything within their reach: that which exceeds their abilities must be
conducted by their ministers. Montesquieu established the separation of the legislative,
executive, and judicial functions of government in the following terms:
By virtue of the first, the prince or magistrate enacts temporary or perpetual laws,
and amends or abrogates those that have been already enacted. By the second, he
makes peace or war, sends or receives embassies; establishes the public security,
and provides against invasions. By the third, he punishes criminals, or determines
the disputes that arise between individuals. The latter we shall call the judiciary
power, and the other simply the executive power of the state.22
1.20 In the twenty-second book of The Spirit of Laws, Of Laws in Relation to the Use of
Money, the idea of the sovereign’s control over the use and regulation of money is
pervasive. He immediately argues in favour of the use of money, particularly among
commercial nations: ‘When a nation traffics with a great variety of merchandise, money
becomes necessary; because a metal easily carried from place to place saves the great
expenses which people would be obliged to be at if they always proceeded by exchange.’23
1.21 On the nature of money, he observes that money represents the value of all
merchandise.24 Metal is used as the sign of money ‘because it is consumed little by use; and
because, without being destroyed, it is capable of many divisions. A precious metal has
been chosen as a sign, as being most portable. A metal is most proper for a common
measure, because it can be easily reduced to the same standard.’ And he notes the
importance of governments almost naturally: ‘Every state fixes upon money a particular
impression, to the end that the form may correspond with the standard and the weight, and
that both may be known by inspection only.’25 He also provides an account of the exercise of
the State prerogative over money throughout history.26 He states: ‘it would be an excellent
law for all countries who (p. 11) are desirous of making commerce flourish to ordain that
none but real money should be current, and to prevent any methods from being taken to
render it ideal.’27
Hamilton
1.22 The Declaration of Independence of the United States of America and the
Constitution of the United States reflected a notion of sovereignty clearly anchored upon
the principles of democracy (the holders of sovereign power: ‘We the People…’) and the rule
of law. Alexander Hamilton wrote illuminatingly in The Federalist Papers about the nature
of sovereign power:
[T]here is in the nature of sovereign power an impatience of control that disposes

those who are invested with the exercise of it to look with an evil eye upon all
external attempts to restrain or direct its operations. From this spirit it happens
that in every political association which is formed upon the principle of uniting in a
common interest a number of lesser sovereignties, there will be found a kind of
eccentric tendency in the subordinate or inferior orbs by the operation of which
there will be a perpetual effort in each to fly off from the centre. This tendency is
not difficult to be accounted for. It has its origins in the love of power. Power
controlled or abridged is almost always the rival and enemy of that power by which
it is controlled or abridged.28
1.23 Hamilton and Madison were concerned about the balance between the powers of the
States and the powers of the Union (federal government). According to Hamilton, the
powers of the Union (ie, the attributes of the sovereign power vested upon the federal
Union) were: ‘the common defence of the members; the preservation of the public peace, as
well against internal convulsions as external attacks; the regulation of commerce with other
nations and between the States; the superintendence of our intercourse, political and
commercial with foreign countries’.29
Madison
1.24 According to Madison, the powers conferred on the government of the Union were:
1. Security against foreign danger;

2. Regulation of the intercourse with foreign nations;
3. Maintenance of harmony and proper intercourse among the States;
4. Certain miscellaneous objects of general utility;
5. Restraint of the States from certain injurious acts;
6. Provisions for giving due efficacy to all these powers. The powers falling
within the first class are those of declaring war and granting letters of
marque; of providing armies and fleets; of regulating and calling forth the
militia; of levying and borrowing money. 30
1.25 He includes the issuance of money (coins and paper money) as a prerogative of the
Union on the basis that,‘[h]ad every State right to regulate the value of its coin, there might
be as many different currencies as States, and thus the intercourse among them would be
impeded; (p. 12) retrospective alterations in its value might be made…and animosities be
kindled among the States themselves.’31
Alexis de Tocqueville
1.26 Alexis de Tocqueville32 wrote in Democracy in America:
In the United States, the sovereignty of the people is not an isolated doctrine,
bearing no relation to the prevailing habits and ideas of the people; it may be
regarded as the last link of a chain of opinions which binds the whole Anglo-
American world. That Providence has given to every human being the degree of
reason necessary to direct himself in the affairs that interest him exclusively is the
grand maxim upon which civil and political society rests in the United States. The
father of a family applies it to his children, the master to his servants, the township
to its officers, the county to its townships, the state to the counties, the Union to the
states; and when extended to the nation, it becomes the doctrine of the sovereignty
of the people.33
1.27 According to Tocqueville, ‘[t]he very essence of democratic government consists in

the absolute sovereignty of the majority.’ And he defined sovereignty as ‘the right of making
laws’.34
1.28 This is the basis of modern constitutionalism: the rule of law and the sovereignty of
the people, as original holders of such supreme power. The fact that power ultimately
resides upon the people explains why such power can be restricted. Indeed, the attributes
of sovereignty can also be curtailed if the people who hold such power so decide. The
implications of European integration and other developments that have affected monetary
sovereignty need to be understood in this light.
D. Money and Monetary Sovereignty under International Law:

Lex Monetae
The concept of money
1.29 The concept of money has different meanings in different contexts. Money in this
book is primarily analysed as a creature of the law, whose existence must be understood
within a legal framework.35
The functions of money
1.30 The economic definition of money is typically functional, based upon the four basic
functions of money: commonly accepted medium of exchange, means of payment, unit of
account, and store of value. Of these functions, the defining feature of money is that of (p.
13) being a widely accepted means of exchange, which explains the dynamic character of
money throughout history: from the sea salt used in Ancient Rome to pay the soldiers
(hence the name salary), to a variety of commodities and precious metals over the centuries
(with an intrinsic value), to the notes or paper money of today (with no intrinsic value, fiat
money), as well as other forms such as electronic money. The current technological and
financial innovations will undoubtedly continue to influence the evolution of the concept of
money in future. The recent development of the so-called virtual currencies, a type of
unregulated, digital money which is issued and controlled by its developers and used and
accepted among the members of a special virtual community as a medium of exchange and
unit of account, is an example of this evolution. Bitcoin (the online private crypto-currency),
Second Life’s virtual currency scheme, M-Pesa (the mobile payments solution pioneered in
Kenya), and PayPal are amongst some of the innovations that are changing the traditional
understanding of money.36
1.31 In common parlance, money is often used as a general term to cover all financial
assets. For the purposes of the conduct of monetary policy, only some of those assets are
included in the monetary aggregates used by the economists and the central banks to
define the money supply (M1, M2, M3…). The concept of money supply is, however,
different from the concept of money. Only the assets included in narrow definitions of the
money supply (M1), namely currency in circulation and demand deposits, come closest to
the definition of money as a means of payment.
Money and the law
1.32 The law tends to reflect a restrictive notion of money as ‘currency’ (physical notes
and coins), leaving aside other ‘monetary assets’ such as bank deposits. Since the monetary
essence of currency rests upon the power of the issuer, that is, the State (fiat money), and
since the State typically delegates this power to the central bank, which has the monopoly
of note issue, the study of monetary law and the study of central banking law go hand in
hand.
1.33 Though sometimes the notions of money and currency are used indistinctly, the
concept of money is broader than the concept of currency. The State can control the issue of
currency within its territory, but the creation of money is not exclusively the monopoly of
the State.
1.34 Economists tend to have a ‘broader’ understanding of the notion of money than
lawyers do. However, with regard to the functions of money, there is an element of
increasing confluence between law and economics and that concerns the attention given in
recent decades to the function of money as store of value. The value of money (in terms of
purchasing power) has become a concern for lawyers, economists, and policy-makers.37 The
conduct (p. 14) of a price-stability oriented monetary policy by an independent central bank
(which I discuss in depth in Chapter 2) is today enshrined in a legal framework, which adds
a new dimension to the role of the State in monetary affairs. In this context, the growth of
money in circulation, the choice of exchange regime, and other economic and financial
issues which have a bearing on the ‘value of money’ are also relevant for lawyers.
1.35 Public international law, as I explain below, focuses on the issue and regulation of
money by the State. Private law, on the other hand, focuses on the notion of payment and
the function of money as a means of payment,38 and on the protection of the private rights
of contracting parties and the discharge of monetary obligations.39 If the notion of money is
unsettled, so is the notion of payment. Payment has been defined as an act, such as the
transfer of money, which discharges the debt.40 Goode defines payment (settlement) as any
act accepted in performance of a monetary obligation.41 The private law of monetary
obligations exceeds, however, the scope of my study.42
Monetary sovereignty under public international law
1.36 The state sovereignty over the State’s currency, that is, the power to issue and
regulate money, is traditionally recognized by public international law.43 In 1929, the
Permanent Court of International Justice stated that ‘it is indeed a generally accepted
principle that a state is entitled to regulate its own currency.’44
1.37 This judgment is cited as authority of the State’s sovereignty over its currency.45
Treves,46 however, argues that the interpretation of the notion of sovereignty has changed
since 1929, and that the Court’s statement ‘can only be accepted as a figure of speech’ and
not as a ‘right’ of States.
[S]tate ‘sovereignty’ belongs to the area of fact and not to the area of law.
Sovereignty as the stable and undisturbed exercise of power within a given territory
is seen as a factual situation from whose existence international law draws
consequences which are the rights and obligations of states, in particular the state’s
right not to suffer interference from other states in the exercise of the power and
the obligation of other states not to interfere with the exercise of the power of the
sovereign state.47
(p. 15) 1.38 Burdeau accepts the Court’s submission with no further comment,48 and the
same applies for Mann.49 Mann contends that every country has exclusive authority to
replace its currency with a new currency and to fix the conversion of the old currency in
relation to the new one.50
1.39 Monetary sovereignty has a territorial dimension. The law of the currency is always
confined to a territory. It can only be enforced in that territory.51 This territoriality does not
preclude a voluntary surrender of sovereignty. But it implies that ‘limitations to sovereignty
cannot be presumed’.52
Lex monetae and legal theories of money
1.40 The ‘State theory of money’ holds that it is the jurisdiction of issue of a currency
which determines what is to be considered money and what nominal value it has (‘only
those chattels are money to which such character has been attributed by law’). Money is
only what is recognized as such by the laws of a State.
1.41 The best known proponent of the theory of lex monetae (literally, law of the currency)
is Mann, who developed it—as Proctor points out—in the light of the universal acceptance
of the principle of ‘nominalism’, which establishes that the parties contract by reference to
a currency, irrespective of any fluctuations that may occur in the value of the currency
between the time the debt was incurred and the time of payment.53 ‘The principle of
nominalism precludes the argument that a payment of a monetary obligation has become
impossible. Monetary obligations are “indestructible”. If a currency system become extinct,
the amount payable by the debtor will be ascertained to the recurrent link’,54 as indeed
happened with advent of the euro in 1999.
1.42 The State theory of money—recognized in modern constitutions55—has been typically
construed as a necessary consequence of the sovereign power over currency. With regard to
(p. 16) the acceptance of this theory in US law and doctrine, Wahlig points out that ‘lex
monetae is also recognised (even if not under this designation) in the United States, in the
guise of the “act of state doctrine” or also the “state theory of money”.’56
1.43 The scope of lex monetae has been debated in the legal literature. As I further
contend below, I support a broad interpretation of the State theory of money. Strictly
speaking, it has been argued that lex monetae should be distinguished from lex contractus
(or lex causae) which refers to the substantive law applied to a contract as a result of the
parties’ choice of law,57 an issue which was discussed with regard to the continuity of
contracts in the context of European Monetary Union, following the substitution of national
currencies by the euro. Under the theory of lex monetae, judges must recognize the validity
of the monetary law of other States. A distinction can be drawn—as Jean Victor Louis points
out—between a narrow concept of lex monetae limited to the definition of a currency in a
given territory and its relationship with the currency it may replace, and a broader concept
that covers the provisions adopted by a State with regard to the regulation of its currency.58
1.44 According to Mann, each sovereign State possesses the exclusive sovereign power to
determine what constitutes legal tender within its territory and what the nominal value of
that currency is. The definition of legal tender acts as a legal barrier imposed by the
authorities against the use of currency substitutes (such as foreign currencies and gold) to
settle debts.
1.45 Mann considers that money, like tariffs or taxation or the admission of aliens, is one of
those matters which, prima facie, must be considered as falling within the exclusive
domestic jurisdiction of States.59 This means that the State’s exclusive right to regulate its
money would fall under Article 2(7) of the Charter of the United Nations, which states:60
Nothing contained in the present Charter shall authorize the United Nations to
intervene in matters which are essentially within the domestic jurisdiction of any
state or shall require the Members to submit such matters to settlement under the
present Charter; but the application of this principle shall not prejudice the
application of enforcement measures under Chapter VII [which refers to ‘Action
with Respect to Threats to the Peace, Breaches of the Peace and Acts of
Aggression’].
1.46 Essentially, any reference to a monetary unit entails automatically a reference to the
municipal laws that define it. But the rules on legal tender and those aspects of the law of
the currency involving the exercise of powers by the State may only be enforced within the
territorial boundaries of its jurisdiction.
(p. 17) 1.47 With regard to the fate of national monetary law outside the boundaries of the
State, Mann cites a few cases where it was held that the domestic monetary legislation
applies only internally and does not affect contracts denominated in the currency if entered
into before the enactment of the legislation. In his view, there cannot be any doubt that
attempts to limit the international recognition of monetary changes must today be
considered as obsolete and extravagant. Both national and international law recognize the
right of the State to depreciate its own currency. Further, a State is within its rights to bring
about the external devaluation of its currency.61 Mann also contends that there is much
authority in support of the further right of the State to introduce exchange controls at its
discretion with all its incidental ramifications.62 Of course, as discussed later in this book,
such powers are curtailed if the State is part of a monetary union. The imposition of
exchange controls by one of the Member States participating in EMU (Cyprus in 2013) is
most controversial and raises significant legal and economic issues.
1.48 With regard to the question of whether the issuer of a currency may prohibit the use
of its currency by another country,63 there is at present no basis in international law to
support the view that the issuer may object to the currency being used by other countries.
In the UK and in the USA, the courts have explicitly recognized the unfettered right of the
sovereign (monarch or Congress) to grant legal tender status to specified foreign
currencies, without requiring the consent of the issuer.64
1.49 The ‘State theory of money’ contrasts with the ‘societary theory of money’, which
considers that the attribution of the character of money derives from the usages of
commercial life, and of practices in society in general, irrespective of the intervention of the
State.65 Another expression of the ‘societary theory of money’ is provided by Antonio Sainz
de Vicuña, who advocates an ‘institutional theory of money’, in which money is not limited
to ‘cash’, but encompasses a dematerialized concept (called ‘scriptural money’, which
includes demand deposits with credit institutions). This is based on the small proportion of
money physically represented in banknotes and coins, as compared with the generalized
use of the banking system for holding money and for payments. The wide acceptance and
use by society of scriptural money is based on an institutional framework of two pillars: (i)
an independent central bank that ensures the stability of the purchasing capacity of money
and its sound use as means of payment, and (ii) a legislative framework that supports such
independence, the solvency and liquidity of credit institutions, and the reliability of
scriptural money as (p. 18) means of payment.66 He considers that the concept of legal
tender is obsolete in view of the overwhelming use of scriptural money in today’s economy,
the limitation of the use of cash to the settlement of petty transactions, and the general
need for consent by the creditor for the settlement of debts in cash. The concept of legal
tender is thus limited to the official standardization of the design and the features of cash.
The value of money is dependent, in a world of no absolute anchors, on such an institutional
framework only.67
1.50 Though the societary theory of money provides an important complementary
approach to the legal study of money, as long as we have a system in which the State keeps
an important role in money creation (with regard to the issue of currency), control of the
money supply through monetary policy (a function entrusted to a central bank, usually with
independence from political instruction, yet a State function), and a certain degree of
control over the banking and financial system through regulation and supervision and
oversight of payment systems, the State theory of money—broadly understood as the public
legal framework in which the economic institutions of money and central banking operate—
remains valid in my opinion.
E. The Attributes of Monetary Sovereignty
1.51 The notion of monetary sovereignty is not expressly recognized or defined as such in
the Charter of the United Nations, nor in the Articles of Agreement of the International
Monetary Fund, nor in other key instruments of international law.68
It has been argued in the legal literature that monetary sovereignty includes the power to
issue the currency, to define the monetary unit and the notes and coins in multiples of that
unit, to require that payments in such notes and coins must be accepted as legal tender, to
decide whether or not the currency should be based on gold or silver, to depreciate and
appreciate the value of the currency, to impose exchange controls, and to take other
measures affecting the monetary system or monetary relations.69 Zimmermann views
monetary sovereignty in two ways; on the one hand, from the perspective of the ‘supreme
and irreducible authority of independent states’ and, on the other hand, from the
perspective of the ‘various sovereign powers’ (or attributes) that can be exercised by
different levels of governance (notion of ‘cooperative sovereignty’). According to this view,
in a monetary union like EMU, what has been transferred from the national to the
supranational level is the exercise of some sovereign powers or ‘state competences’, but not
‘monetary sovereignty’ per se.70
In the economic literature, Nobel laureate Mundell, bearing in mind the functions of money,
argues that monetary sovereignty comprises the right to determine what constitutes (p. 19)
the unit of account, the right to determine the means of payment—legal tender for the
discharge of debt—and the right to produce money.71 He argues that the most important
dimension of this monetary sovereignty is the right of a State to declare that which counts
as legal tender.72
1.52 In my view, monetary sovereignty includes:
(1) The power to issue notes and coins. The prerogative of issuing currency (ius
cudendae monetae) is a classic attribute of monetary sovereignty. This power is
typically a monopoly power, exercised by a country’s central bank. 73 A national
currency is both a symbol and a tool of national identity. A currency, like a language,
like a flag, can stimulate the cohesion among a group of people and build a nation.
Indeed, following the break-up of the Soviet Union in 1991, the nascent republics
were keen—as a manifestation of their newly gained independence and an assertion
of their sovereignty—to issue their own currency and to establish their own central
bank. There are other benefits related to the issue of currency, such as the potential
for generating seigniorage revenues.
(2) The power to regulate money (to dictate laws and regulations that affect the
external or internal dimension of money), the banking system (regulation of credit),
and the payment system (clearing and settlement).
(3) The power to control the money supply and interest rates (monetary policy). This
power is typically delegated to a central bank. The standard instruments of a market
oriented monetary policy (open market operations, discount policies, and reserve
requirements) also provide the central bank with a degree of flexibility in dealing with
banking problems (including the power to act as lender of last resort, as further
explained in Chapter 4 ).
(4) The power to control the exchange rate and to determine the exchange regime
(exchange rate policy). Responsibility for the formulation of exchange rate policy
usually rests with the government, though its implementation is often entrusted to the
central bank. The central bank often manages the official monetary reserves (both
gold reserves and foreign currency reserves), which are generally owned by the
government.
(5) The power to impose exchange and capital controls. Though this imposition runs
counter to the objectives of trade liberalization, it remains a tool of monetary
sovereignty, 74 albeit a controversial one, opposed by the advocates of unrestricted
capital movements or ‘capital account convertibility’ as further discussed in Chapter
13 . 75
(p. 20) 1.53 Does monetary sovereignty include the power to discriminate against foreign
nationals (or in favour of their own nationals)? This is a thorny issue, because though de
jure it can be argued that this alleged power runs counter to the principles of international
law,76 de facto it remains true that sovereign States do within their territory enact laws that
prejudice against foreign nationals, implicitly or explicitly. Freezing orders—of assets—
unilaterally imposed are an example of the coercive power of the State within its own
territory, when security or political considerations prevail.77 Other examples of unilateral
decisions taken by sovereign States—often in flagrant violation of their international
obligations—include the confiscation of monetary assets (expropriation without
compensation) and the repudiation of external debt obligations.
1.54 Mann argues that monetary sovereignty needs to be exercised by the State in
accordance with the principles of customary international law: ‘While normally the State is
entitled at its discretion to regulate its monetary affairs, there comes a point when the
exercise of such discretion so unreasonably or grossly offends against the alien’s right to
fair and equitable treatment or so clearly deviates from customary standards of behaviour
that international law will intervene.’78
Monetary laws must be in accordance with public international law. As Mann explains,
‘monetary laws are fully capable of giving rise to legal disputes concerning international
law within the meaning of Article 36(2) of the Statute of the International Court of
Justice.’79 This Article reads as follows:
The states party to the present Statute may at any time declare that they recognise
as compulsory ipso facto and without special agreement, in relation to any other
state accepting the same obligation, the jurisdiction of the Court in all legal
disputes concerning:
(a) the interpretation of a treaty;

(b) any question of international law;
(c) the existence of any fact which, if established, would constitute a breach
of an international obligation;
(d) the nature or extent of the reparation to be made for the breach of an
international obligation.
1.55 In the Case of Certain Norwegian Loans,80 cited by Mann, the Court held that ‘the
question of conformity of national legislation with international law is a matter of
international law.’81
(p. 21) F. The Erosion of Monetary Sovereignty

1.56 The monopoly power enjoyed by the State with regard to the issue and regulation of
money within its territory has been eroded or limited by a number of considerations in
recent years. Some of those limitations are consensual, a voluntary surrender of monetary
sovereignty, and some others have not been agreed by the State/s, but are the result of
globalization, the information revolution, and of economic and financial developments in the
last three decades.
1.57 The erosion of monetary sovereignty is related to the erosion of the general
sovereignty of the State. Though nation States remain the main actors in the international
community, power today is no longer the exclusive domain of the nation State.82 Centripetal
and centrifugal forces have diffused the power of the nation State, and today a variety of
actors, including international organizations, multinational corporations, regions, local
communities, and the civil society also exercise power.
The State no longer monopolizes the supreme and exclusive power to control affairs in a
given territory. If we look at the different types of power that the State can hold: political
power, military power, economic power, we realize that even if some States still reign
supreme within the territory of their jurisdiction in the political and military arena (though
in the case of a federal state, political power is shared, and in the case of a military alliance
or a defence organization, sovereignty is pooled, as with the North Atlantic Treaty
Organization (NATO)), in the economic arena few States can claim to be sovereign
nowadays. States need to comply with their international economic commitments,
regarding trade, investment, finance, and others.
1.58 As I have already discussed, a national currency can be an expression, a symbol of
national identity and national pride. However, there is nothing sacrosanct about money nor
about monetary sovereignty. In a way, there is nothing unique about this process. Other
symbols of national identity (even if not so closely associated with the notion of sovereignty
as money is) have also lost their sparkle in recent years: airlines used to be seen as a matter
of symbolic pride for the citizens of a State. No longer: the advent of privatization and the
upheaval in the airline industry in recent years have changed that perception.
Voluntary or consensual limitations of monetary sovereignty
The advent of European Monetary Union
1.59 At a regional level, the most clear example of consensual limitations of monetary
sovereignty is the establishment of EMU in 1999. The adoption of a single currency, the
euro, and the creation of the European System of Central Banks with responsibility to
formulate and implement the monetary policy of the Community have been described as
‘the most profound limitation to monetary sovereignty ever to be agreed by sovereign
states’.83 Member States participating in EMU agreed to transfer sovereign rights to the
European (p. 22) Union. Of course, the surrender of monetary sovereignty does not imply
the erosion of national sovereignty in other respects. It is a limited surrender, a non-
exclusive transfer of sovereign powers. The members of the Euro zone retain their national
sovereignty in those domains where no other consensual limitation has been agreed.84
1.60 Member States participating in EMU have given up their national currencies. I
contend that the bearer, the holder of monetary sovereignty is not the ECB, but the Member
States of the European Union that have adopted the single currency (the euro area as such
does not have legal personality).85 The Union’s ‘exclusive competence’ in monetary policy is
exercised by the ESCB as I explain in Chapter 7.
However, the language of the Treaty with regard to the exchange rate policy and the
external aspects of the euro is characterized by a notorious lack of clarity, as further
discussed in Chapter 9.86
1.61 Other ‘attributes of monetary sovereignty’ (as spelt out above) have remained at the
national level during the first years of the life of EMU, though ‘banking union’, discussed in
the second part of the book (Chapter 10), represents a further transfer of monetary
sovereignty to the ECB, with the ECB playing the key role in banking supervision—
according to the Single Supervisory Mechanism (SSM) Regulation—in the participating
Member States.
1.62 There is no provision in the Treaty which permits the revocation of EMU. However,
the new Article 50 of the Lisbon Treaty foresees the possibility of exiting the EU
altogether.87(p. 23) Furthermore, it can be argued that there are legal mechanisms that
already exist in EU law for one or more Member States to leave the Eurozone under Article
352 TFEU (thus the orderly consensual departure—or a ‘temporary exit’—of one or more
periphery States remains a legal possibility, according to some commentators).88
1.63 The wording ‘irrevocably fixed’ adopted by the Maastricht Treaty suggests that EMU
is ‘a trip with no return’, but the Member States retain—as a residual attribute of their
sovereignty—the possibility of reversing the current status quo by unanimous agreement
(ie, by signing a new Treaty to that effect).89 Furthermore, in the exercise of sovereign
rights, individual Member States of the euro area may choose to ignore the obligations of
the Treaty (notwithstanding the illegality of this action) and abandon the monetary union.
The latter has been proposed by several commentators following the sovereign debt and
financial crises in several Member States of the euro area. History teaches us that countries
have ignored and repudiated international obligations before. Revolutions and coups d’état
are notorious examples of such repudiation. And the USA itself ignored the Articles of
Agreement of the International Monetary Fund (IMF) when it de facto abandoned the par
value regime in 1971, as further discussed in Chapter 12.90
International obligations: The IMF Articles of Agreement
1.64 At the international level, the most relevant example of consensual limitations to the
monetary sovereignty of States is the Articles of Agreement of the International Monetary
Fund.91 These limitations were greater with the par value regime under the original Articles
(p. 24) of Agreement than they are nowadays. Since the collapse of the Bretton Woods
regime (de facto), and the Second Amendment to the Articles of Agreement (de jure), IMF
Member States reaffirmed some of the attributes of their monetary sovereignty with regard
to the conduct of exchange rate policy.92 However, IMF members must still comply with the
obligations under Article IV and Article VIII of the IMF Articles of Agreement, where the
jurisdiction (regulatory powers) of the Fund applies, as I further explain in Chapter 13.93
1.65 Andreas Lowenfeld94 suggests that the regime of conditionality of the International
Monetary Fund in the use of its resources is changing the traditional boundaries between
the domestic jurisdiction of the States and the international community. Lowenfeld points to
the ever increasing level of examination of a large variety of domestic policies in the IMF
programmes of structural reform: ranging from national budgets, taxes, interest rates, and
exchange rates to subsidies, wage policies, competition law, corporate governance, and
even accounting practice and legal reform. These domestic policies are subject to scrutiny,
negotiation, and commitment. The eagerness to get or maintain the IMF (conditional)
financial assistance may lead the legitimate political institutions in the country to design
the economic reform programme without a full analysis of its potentially negative social
implications.95 Lowenfeld suggests that in some cases the ‘jurisdictional barrier between
the international organization and the sovereign states’ has been overstepped or breached,
and that a new understanding regarding the relationship between the IMF (and other
international agencies) and the countries that need financial assistance is needed.96
Other limitations of national monetary sovereignty
1.66 The erosion of the traditional notion of sovereignty is also linked to the demise of
national frontiers in today’s global financial markets,97 despite the trend towards de-
globalization (or re-nationalization or re-domestication) that some financial markets and
institutions have experienced following the global financial crisis that commenced in 2007
and reached its zenith in 2008.
1.67 Sovereignty as a supreme power is typically exerted over the territory of the State:
principle of territoriality. It is therefore unsurprising that globalization and the cross-border
movement of persons, capital, goods, or services limit the scope of unfettered sovereignty.98
The growth in cross-border private capital flows (the volume of such flows, for instance in
the foreign exchange market, clearly dwarfs what national central banks and even
international organizations can do) is an example of a de facto erosion of monetary
sovereignty. Arguably, (p. 25) the ability to have a truly independent monetary policy
diminishes with the growth of cross-border capital flows.99
1.68 Cohen refers to the ‘deterritorialization’ of money, to express the reality that the
circulation of national currencies is no longer confined within the territorial frontiers of
nation States.100 Indeed, the extensive use of the US Dollar and other reserve currencies
are examples of this reality, an issue which is further discussed in Chapter 12. The problem
with this reality is also one of accountability, since central banks, such as the Federal
Reserve System, whose influence is international, remain accountable to national
constituencies.101
1.69 The growth in Eurocurrency markets entails a partial loss of monetary sovereignty.102
In the presence of ‘transnational money markets’, the lack of coercive power of the State
beyond its territory means that ‘the state does not have the power effectively to regulate
credit in its currency by banks outside its territory.’103 However, to the extent that bank
transfers in a particular currency involve clearing and settlement in the country of origin of
the currency, the mechanisms of control are reasserted and the notion of erosion of
sovereignty may be questioned.104
1.70 As was pointed out earlier, the government has the monopoly over the issue of
currency only—ie, notes and coins in circulation—but not over other assets that individuals
might hold instead of currency and that are contributing to the blurring of the definition of
money and to a de facto erosion of monetary sovereignty. Commercial banks have an
important role in the process of money creation: current accounts (demand deposits) are
used as means of payment. Demand deposits constitute the major part of the narrow
definition of the money supply (M1).105 This characteristic of bank liabilities provides the
rationale for many monetary and banking laws and regulations.
1.71 The role of banks and other private financial institutions in the creation of money
cannot be underestimated. There have also been radical proposals, which are not further
analysed here, suggesting the reliance on ‘private money’. Hayek and other economists in
the ‘free (p. 26) banking school’ have advocated the ‘denationalization of money’, opening
up the provision of currency to competition both from the private sector and from foreign
issuers of currency.106
1.72 The power to issue currency is a sovereign prerogative, but one that can become an
empty concept if the government is incompetent in the management of its currency or if
there is a loss of confidence in such conventional money. Citizens will then figure out some
way of devising a substitute currency—relying upon a foreign currency or establishing a
parallel currency or a virtual currency. Failing that, the society reverts to barter. A
sovereign can punish people who counterfeit the sovereign’s own currency, or who use an
alternative currency without the sovereign’s permission, but a sovereign is less able to
control the proliferation of faux currencies if society loses faith in the government’s
declared legal tender. In practice, the other limits of monetary sovereignty are thus defined
by monetary incompetence.107
1.73 The experience of inflation can be viewed as an ‘abuse of sovereignty’.108 Inflation
makes people turn to other forms of payment, for example, foreign currencies. The public
authorities have various ways of obtaining command over real resources: expropriation,
taxes, bond issues, and the issue of currency.109 In a market economy, taxes and bond issues
are preferred. However, the temptation to print money to finance government expenses
remains a powerful argument to depoliticize the management of money; hence the support
in the latter part of the twentieth century for central bank independence, analysed in
Chapter 2.
1.74 The degree to which a currency is a good store of value in international monetary
relations (‘hard currencies’ and ‘soft currencies’) is an economic consideration that can also
limit in practice the effectiveness of monetary control. Depreciation (the loss in value of a
currency vis-à-vis other currencies under a system of flexible exchange rates) and
devaluation (the loss in value of a currency vis-à-vis other currencies by official intervention
under a system of managed exchange rates) can lead to a de facto erosion of national
monetary sovereignty.
1.75 The choice of exchange regime adopted by a State clearly affects the external value of
the currency. Under a fixed exchange rate system, a national central bank only enjoys
control over monetary policy if it is the central bank which sets monetary policy for the
whole area. In the words of Robert Mundell, ‘when a country opts for fixed exchange
rates…it sacrifices policy sovereignty in the field of money.’110 In the case of a currency
board arrangement (discussed in Chapter 2), monetary sovereignty is greatly reduced. In
the case of dollarization, there is a surrender of monetary sovereignty.
(p. 27) G. Concluding Observations

1.76 One of the key attributes of sovereignty is the power to issue and regulate money.
This is referred to as monetary sovereignty, a dynamic concept which has been redefined in
recent decades through consensual and non-consensual limitations. The evolving nature of
this concept—in line with the evolving nature of monetary law—finds its latest
manifestation in the de-globalization (or re-nationalization) that some financial markets and
institutions have experienced following the global financial crisis. The contours of the
powers of the State keep on changing.(p. 28)
Footnotes:
1
See Alexander Hamilton, James Madison, and John Jay, The Federalist Papers (New York:
Mentor, New American Library, 1961; a reprint of the original McLean Edition of 1788) 229.
2 For a study of local currencies, see Mona Naqvi and James Southgate, ‘Banknotes, Local
Currencies and Central Bank Objectives’ (2013) Q4 Bank of England Quarterly Bulletin 317.
3 Dani Rodrik, The Globalization Paradox. Democracy and the Future of the World Economy
(New York and London: Norton, 2011), advocates the need to strengthen the nation State to
solve what he calls the ‘political trilemma of the World economy’. Rodrik argues that we
cannot have ‘deep economic integration’ (he uses the terms ‘hyper-globalization’), national
sovereignty (nation State) and democratic politics all at once (200–1). We can have at most
two out of three. Since democracy cannot be compromised, and he rejects the ‘global
governance’ option, he proposes a return to national sovereignty. I disagree though with
Rodrik’s solution to the ‘trilemma’; in my opinion, we need an adequate system of global
governance. The dichotomy between international markets and national laws and policies
can be best tackled by the internationalization of the rules and institutions governing global
markets. The answer is more international law and less national law. For a discussion on
this, see Thomas Cottier, John Jackson, and Rosa Lastra (eds), International Law in
Financial Regulation and Monetary Affairs (Oxford: Oxford University Press, 2012).
4
See Helmut Steinberger, ‘Sovereignty’ in Encyclopedia of Public International Law
(Amsterdam: North Holland, 1987) vol 10, 408.
5
See Marc Williams, ‘Rethinking Sovereignty’ in Eleonore Kofman and Gillian Youngs
(eds), Globalization: Theory and Practice (London: Pinter, 1996) 109. See also Alan James,
Sovereign Statehood (London: Allen and Unwin, 1986) 267 and Anne-Marie Slaughter, A
New World Order (Princeton: Princeton University Press, 2004). Dan Sarooshi, ‘The
Essentially Contested Nature of the Concept of Sovereignty: Implications for the Exercise
by International Organizations of Delegated Powers of Government’ (2004) 25 Michigan
Journal of International Law 1107, and John Jackson, ‘Sovereignty Modern: A New
Approach to an Outdated Concept’ (2003) 97 American Journal of International Law 782,
provide excellent legal studies on sovereignty. Jackson (790) argues that ‘most (but not all)
of the time that “sovereignty” is used in current policy debates, it actually refers to
questions about the allocation of power’.
6
See UNGA Res 2625 (XXV), Declaration of Principles of International Law Concerning
Friendly Relations and Cooperation among States in Accordance with the Charter of the
United Nations, 24 October 1970.
7
See Steinberger, above note 4, 410. Sovereignty is defined in the Black’s Law Dictionary
as ‘the supreme, absolute, and uncontrollable power by which any independent state is
governed; supreme political authority; the supreme will; paramount control of the
constitution and frame of government and its administration; the self-sufficient source of
political power, from which all specified political parties are derived; the international
independence of a state, combined with the right and the power of regulating its internal
affairs without foreign dictation’.
8
See Vaughan Lowe, ‘Sovereignty in International Economic Law’ in Wenhua Shan,
Penelope Simons and Dalvinder Singh (eds), Redefining Sovereignty in International
Economic Law (Oxford: Hart Publishing, 2008) 84. Lowe and myself were the examiners of
the PhD thesis presented by Claus Zimmermann on A Contemporary Concept of Monetary
Sovereignty, which he successfully defended at the University of Oxford on 9 December
2011. An expanded and updated version of this thesis has been subsequently published by
Oxford University Press in 2013 as a monograph bearing the same title. Zimmermann
advocates that monetary sovereignty is not only a positive concept but also a normative
concept expressing various sovereign values that, if properly analysed, provides regulatory
guidance and acts as a legitimacy benchmark for the exercise of sovereign powers strictly
speaking. He approaches monetary sovereignty as a dynamic and not as a static concept.
He holds there is a common pattern in most of the existing literature to confound the
erosion of formal State competencies with the erosion of sovereignty as a both positive and
normative concept.
9
See Robert A Mundell, ‘Money and the Sovereignty of the State’ in Axel Leijonhufvud
(ed), Monetary Theory and Policy Experience (Basingstoke: Palgrave/International
Economic Association, 2001) 298.
10
See Williams, above note 5, 111: ‘It is difficult to date precisely when sovereignty
became accepted and established. The Treaty of Westphalia (1648) is normally taken as the
starting point of the European states system, i.e., a system of sovereign states owing
allegiance to no superior.’ However, it is worth recalling that Spain started operating as a
nation State in 1492, following the union between Queen Isabella of Castile and King
Ferdinand of Aragon. The latter is thought by some to have inspired the figure of the
maverick Prince described in Machiavelli’s acclaimed work.
11
For a translation into English, see Jean Bodin, The Six Books of the Commonwealth
(Oxford: Basil Blackwell, 1955) Book I (The Final End of the Well-Ordered Commonwealth:
Concerning Sovereignty), at <http://www.constitution.org/bodin/bodin_.htm> (last visited
17 July 2014).
12
See ‘Sovereignty’ in Stanford Encyclopedia of Philosophy (31 May 2003, rev 8 June
2010), at <http://plato.stanford.edu/entries/sovereignty> (last visited 17 July 2014).
However, some authors argue that a contemporary of Bodin, François Grimaudet (1520–80),
had already printed a book in 1560 that proclaimed the doctrine of sovereignty. See
Mundell, above note 9, 302. Mundell also points out that Grimaudet in his treatise on ‘The
Law of Payment’ stated: ‘The value of money depends on the State; this is to say, in a
monarchy, upon the prince, and in an oligarchy, upon the State, which alone has the right to
coin money or to have it coined and stamp a valuation upon it.’
13
Niccolo Machiavelli, The Prince in Charles W Eliot, The Harvard Classics (New York:
Collier and Son, 1909–14) vol 36, Pt I, at <http://www.bartleby.com/36/1/> (last visited 17
July 2014).
14
Machiavelli, above note 13, ch 14, para 1.
15
See eg Joel Feinberg, ‘Autonomy, Sovereignty and Privacy: Moral Ideals in the
Constitutions?’ (1983) 58 Notre Dame Law Review 445, 448; Jean Bethke Elshtain,
‘Sovereign God, Sovereign State, Sovereign Self’ (1991) 66 Notre Dame Law Review 1355,
1363; Rett R Ludwikowski, ‘Supreme Law or Basic Law? The Decline of the Concept of
Constitutional Supremacy’ (2001) 9 Cardozo Journal of International and Comparative Law
253, 259; David Golove, ‘The New Confederalism: Treaty Delegations of Legislative,
Executive and Judicial Authority’ (2003) 55 Stanford Law Review 1697, 1705; Ronald A
Brand, ‘Sovereignty: The State, The Individual and the International Legal System in the
Twenty First Century’ (2002) 25 Hastings International and Comparative Law Review 279,
282–3; Joan Fitzpatrick, ‘Sovereignty, Territoriality and the Rule of Law’ (2002) 25 Hastings
International and Comparative Law Review 303, 308.
16
Thomas Hobbes, Leviathan (New York: Collier, 1962) 174.
17
Hobbes, above note 16, ch 17 (‘Of the Causes, Generation and Definition of the
Commonwealth’).
18
Hobbes, above, note 16, 174–6:
By concoction, I understand the reducing of all commodities which are not presently
consumed, but reserved for nourishment in time to come, to something of equal
value, and withal so portable as not to hinder the motion of men from place to
place; to the end a man may have in what place soever such nourishment as the
place affordeth. And this is nothing else but gold, and silver, and money. For gold
and silver, being, as it happens, almost in all countries of the world highly valued, is
a commodious measure of the value of all things else between nations; and money,
of what matter soever coined by the sovereign of a Commonwealth, is a sufficient
measure of the value of all things else between the subjects of that Commonwealth.
By the means of which measures all commodities, movable and immovable, are
made to accompany a man to all places of his resort, within and without the place of
his ordinary residence; and the same passeth from man to man within the
Commonwealth, and goes round about, nourishing, as it passeth, every part thereof;
in so much as this concoction is, as it were, the sanguification of the
Commonwealth: for natural blood is in like manner made of the fruits of the earth;
and, circulating, nourisheth by the way every member of the body of man. And
because silver and gold have their value from the matter itself, they have first this
privilege; that the value of them cannot be altered by the power of one nor of a few
Commonwealths; as being a common measure of the commodities of all places. But
base money may easily be enhanced or abased. Secondly, they have the privilege to
make Commonwealths move and stretch out their arms, when need is, into foreign
countries; and supply, not only private subjects that travel, but also whole armies
with provision. But that coin, which is not considerable for the matter, but for the
stamp of the place, being unable to endure change of air, hath its effect at home
only; where also it is subject to the change of laws, and thereby to have the value
diminished, to the prejudice many times of those that have it.
The conduits and ways by which it is conveyed to the public use are of two sorts:
one, that conveyeth it to the public coffers; the other, that issueth the same out
again for public payments. Of the first sort are collectors, receivers, and treasurers;
of the second are the treasurers again, and the officers appointed for payment of
several public or private ministers. And in this also the artificial man maintains his
resemblance with the natural; whose veins, receiving the blood from the several
parts of the body, carry it to the heart; where, being made vital, the heart by the
arteries sends it out again, to enliven and enable for motion all the members of the
same.
19
Hobbes, above note 16, 174–6.
20
John Locke, Two Treatises of Government (New York: New American Library, 1965) Pt II
(‘Of the Extent of Legislative Power’), para 135, at <http://press-pubs.uchicago.edu/
founders/documents/v1ch17s5.html> (last visited 13 September 2014).
21
See Charles de Montesquieu, The Spirit of Laws, 2 vols (London: G. Bell & Sons, 1878
and 1909), also at <http://www.constitution.org/cm/sol.txt> (last visited 17 July 2014).
22
See Montesquieu, above note 21, vol I, Bk XI, 162–3.
23
See Montesquieu, above note 21, vol II, Bk 22, ch 1 (‘Of Law in Relation to the Use of
Money’) 81.
24
Montesquieu, above note 21, vol II, Bk 22, ch 1 (‘Of Law in Relation to the Use of
Money’) 82.
25
Money’) 82.
26
Legislators have sometimes had the art not only to make things in their own nature the
representative of specie, but to convert them even into specie, like the current coin. Cæsar,
when he was dictator, permitted debtors to give their lands in payment to their creditors, at
the price they were worth before the civil war (Cæsar, Commentarii de Bello Civili, iii).
Tiberius ordered that those who desired specie should have it from the public treasury on
binding over their land to double the value (Tacitus, Annals, vi 17). Under Cæsar the lands
were the money which paid all debts; under Tiberius ten thousand sesterces in land became
as current money equal to five thousand sesterces in silver. The Magna Charta of England
provides against the seizing of the lands or revenues of a debtor, when his movable or
personal goods are sufficient to pay, and he is willing to give them up to his creditors; thus
all the goods of an Englishman represent money. The laws of the Germans constituted
money a satisfaction for the injuries that were committed, and for the sufferings due to
guilt. But as there was but very little specie in the country, they again constituted this
money to be paid in goods or chattels. This we find appointed in a Saxon law, with certain
regulations suitable to the ease and convenience of the several ranks of people. At first the
law declared the value of a sou in cattle; the sou of two tremises answered to an ox of
twelve months, or to a ewe with her lamb; that of three tremises was worth an ox of sixteen
months. With these people money became cattle, goods, and merchandise, and these again
became money.
See Montesquieu, above note 21, vol II, Bk 22, ch 1 (‘Of Law in Relation to the Use of
Money’) 83.
27
Money’) 84.
28
See Hamilton et al, above note 1, 111.
29
Hamilton et al, above note 1, 153.
30
Hamilton et al, above note 1, 256.
31
Hamilton et al, above note 1, 282. The United States has had a common currency since
1863.
32
Alexis de Tocqueville (1805–59) came to the United States in 1831 and later wrote his
two-volume study Democracy in America. The first volume was published in 1835 and the
second one in 1940. I am quoting here from Alexis de Tocqueville, Democracy in America
(New York: Vintage Classics, 1990).
33
See Tocqueville, above note 32, 418.
34
Tocqueville, above note 32, 254 and 123.
35
For a comprehensive legal study of money (focusing on private law issues), see generally
Frederick A Mann, The Legal Aspect of Money, 5th edn (Oxford: Clarendon Press, 1992)
461. Charles Proctor completed in 2005 an excellent revision of Mann’s work, Mann on the
Legal Aspect of Money, 6th edn (Oxford: Oxford University Press, 2005) and in 2012 the 7th
edn (Oxford: Oxford University Press, 2012). I sometimes refer to the 5th edition in this
chapter (Mann) and sometimes to the 6th edition (Proctor).
36
See generally European Central Bank, ‘Virtual Currency Schemes’, Report (October
2012), at <http://www.ecb.int/pub/pdf/other/virtualcurrencyschemes201210en.pdf> (last
visited 17 July 2014). In addition to virtual currencies, there are also parallel (local or
regional) currencies, like the Brixton pound, the Bristol pound or the Lewes pound. See also
Peter Sands, ‘Banking is Heading Towards its Spotify Moment’ Financial Times (28 June
2013).
37
See Antonio Sainz de Vicuña, ‘An Institutional Theory of Money’ in Mario Giovanoli and
Diego Devos (eds), International Monetary and Financial Law: The Global Crisis (Oxford:
Oxford University Press, 2010) 517; and ‘The Concept of Money in the XXIst Century’,
paper presented at the Committee on International Monetary Law of the International Law
Association (MOCOMILA) meeting, Tokyo (1 April 2004). In this latter paper Antonio Sainz
de Vicuña stated: ‘A currency is trusted by society and markets, when there is an
institutional framework that ensures preservation of purchasing capacity, ie price stability.
Money is then defined as the dematerialized “commodity” produced and managed by
central banks that serves the function of store of value.’
38
Without a means of payment and a unit of account, our system of trade and commerce
would have to revert to barter (or counter-trade).
39
See Proctor, 6th edn, above note 35, Pts II and III, for a lucid analysis of these issues.
40
See Proctor, 6th edn, above note 35, 160 n 2.
41
See Roy Goode, Commercial Law, 2nd edn (London: Penguin Books, 1995) 501.
42
See Proctor, 6th edn, above note 35, Pts II and III.
43
See Mann, 5th edn, above note 35, 461. See also Proctor, 6th edn, above note 35, 500.
44
Case Concerning the Payment in Gold of Brazilian Federal Loans Contracted in France
(France v Brazil), Judgment, 12 July 1929, PCIJ Ser A No 21, 44–5, at <http://
www.worldcourts.com/pcij/eng/decisions/1929.07.12_payment2.htm/> (last visited 17 July
2014) and Case Concerning the Payment of Various Serbian Loans Issued in France (France
v The Kingdom of the Serbs, Croats and Slovenes), Judgment, 12 July 1929, PCIJ Ser A No
21, 122, at <http://www.worldcourts.com/pcij/eng/decisions/1929.07.12_payment1.htm>
(last visited 17 July 2014).
45
See Mann, 5th edn, above note 35, 461 and Proctor, 6th edn, above note 35, 500. See
also Geneviève Burdeau, ‘L’exercice des compétences monétaires par les États’ (1988) 212
Recueil des Cours 211, 236; Dominique Carreau, Souveraineté et Coopération Monétaire
Internationale (Paris: Cujas, 1970) 52–4; and Milan Robert Shuster, The Public International
Law of Money (Oxford: Clarendon Press, 1973) 9.
46
See Tullio Treves, ‘Monetary Sovereignty Today’ in Mario Giovanoli (ed), International
Monetary Law: Issues for the New Millennium (Oxford: Oxford University Press, 2000) 111–
18.
47
Treves, above note 46, 112.
48
See Burdeau, above note 45, 236.
49
See Mann, 5th edn, above note 35, 461 and Proctor, 6th edn, above note 34, 500.
50
Mann noted that the right to replace a national currency in many respects flowed from
the universal recognition of the principle of nominalism: Mann, 5th edn, above note 35, 272.
The same point finds voice in the lex monetae principle; see Proctor, 6th edn, above note
35, 332–3.
51
See Treves, above note 46, 117: ‘[B]ecause any reference to a monetary unit
automatically entails a reference to the rules that define it, the rules on legal tender and
those involving the exercise of the powers of public authorities are territorial, in the sense
that they can be enforced in the territory of the state of the country.’
52
Treves, above note 46, 112.
53
See Proctor, 6th edn, above note 35, 16 and 225–8.
54
Proctor, 6th edn, above note 35, 339–40.
55
For example, see the US Constitution, Art 1, s 5, paras 5–6: ‘The Congress shall have the
power…5. To coin money, regulate the value thereof, and of foreign coin, and fix the
standard of weights and measures. 6. To provide for the punishment of counterfeiting the
securities and current coin of the United States.’ Though the power to issue currency has
been transferred from the national to the supranational arena in the European Union since
the advent of European Monetary Union, it is useful to recall that European constitutions
have referred to the State prerogative over monetary affairs in clear terms. See eg the
German Constitution (Grundgesetz), Art 73(4): ‘The Federation has exclusive power to
legislate in the following matters: 4. currency, money and coinage, weights and measures,
as well as the determination of standards of time’; the French Constitution, Art 34
(Legislative Powers): ‘(1) All legislation shall be passed by Parliament. (2) Legislation shall
establish the rules concerning:…the assessment bases, rates, and methods of collecting
taxes of all types; the issuance of currency’; the Italian Constitution, Art 117(2)(e): ‘The
state has exclusive legislative power in the following matters…e) money, protection of
savings, financial markets; protection of competition; currency system; state taxation
system and accounting; equalization of regional financial resources’; the Spanish
Constitution, Art 149(1)(11): ‘The State—central government—has exclusive power over the
monetary system’; the Greek Constitution, Art 80(2): ‘A law shall provide for the minting of
issuance of currency’.
56
See Bertold Wahlig, ‘European Monetary Law: the Transition to the Euro and the Scope
of Lex Monetae’ in Giovanoli (ed), above note 46, 123. The act of State doctrine maintains
that a nation is sovereign within its own borders, and its domestic actions may not be
questioned in the courts of another nation.
57
See Michael Gruson, ‘The Scope of Lex Monetae in International Transactions: a United
States Perspective’ in Giovanoli (ed), above note 46, 434–5.
58
See Jean Victor Louis, ‘The New Monetary Law of the European Union’ in Mario
Giovanoli (ed), above note 46, 154.
59
See Mann, 5th edn, above note 35, 462.
60
Wahlig, above note 56, 123, points out that Hugo Hahn also considers the currency-
issuing State’s exclusive right to regulate its money as covered by the Charter of the United
Nations (signed 26 June 1945, entered into force 24 October 1945), 1 UNTS 16, Art 2, para
7.
61
See Mann, 5th edn, above note 35, 464–5. The same point is reflected in the sixth edition
by Proctor, 6th edn, above note 35, 505–6.
62
See Mann, 5th edn, above note 35, 467, with references to the British, Canadian, and US
authorities and the International Claims Commission.
63
See generally François Gianviti, ‘Use of a Foreign Currency under the Fund’s Articles of
Agreement’ (17 May 2002), at <http://www.imf.org/external/np/leg/sem/2002/cdmfl/eng/
gianvi.pdf> (last visited 17 July 2014).
64
See in the UK the Wade case ([1601] 77 ER 232) and in the USA, the Tyson v United
States case (285 F 2d 19 (1960)). As Lee Buchheit pointed out to me in private
correspondence, Ecuador’s surprise announcement in early 2000 that it had dollarized its
economy was done without consulting the United States.
65
See Mann, 5th edn, above note 35, 12–14. See also René Smits, The European Central
Bank. Institutional Aspects (The Hague: Kluwer Law International, 1997) 194 n 186. The
societary theory of money first appeared in the literature with Friedrich Carl von Savigny in
the first half of the nineteenth century and has been developed further by Arthur Nussbaum
in his treatise Money in the Law—National and International (Brooklyn: The Foundation
Press, Inc, 1950).
66
See Sainz de Vicuña, ‘The Concept of Money in the XXIst Century’, above note 37.
67
Sainz de Vicuña, ‘The Concept of Money in the XXIst Century’, above note 37.
68
See Burdeau, above note 45, 236–7.
69
See Mann, 5th edn, above note 35, 461–2 and Treves, above note 46, 117.
70
See Claus D Zimmermann, ‘The Concept of Monetary Sovereignty Revisited’ (2013)
24(3) European Journal of International Law 797. While I find this study well written and
insightful, I disagree with his observation (799 n 10 and 800 n 11) that I somehow approach
monetary sovereignty as a static, positive concept, as a mere catalogue of State
competences. I contend that both sovereignty, in general, and monetary sovereignty, in
particular, are dynamic concepts that change over time. Indeed, my research in monetary
law in general, supports the evolving nature of such law.
71
See Mundell, above note 9, 303.
72
Mundell, above note 9, 303–4.
73
There is no compelling case for governments to monopolize the production of shoes,
sausages, or steel. The experience of the centrally planned economies showed that
monopoly decision-making in economic affairs obstructs the creation of wealth, not just for
a few, but for all. Why should monopoly decision-making in money be an exception? I
discuss this issue, and the proposals of the so-called ‘free banking economists’ that
advocate competition in currency in Rosa M Lastra, Central Banking and Banking
Regulation (London: Financial Markets Group/London School of Economics, 1996) 252–7.
74
Treves, above note 46, 115–16, points out that following the imposition of controls on
capital movements by Malaysia (one of the States involved in the Asian Crisis in the late
1990s) the International Monetary Fund’s directors broadly agreed ‘that the regime of
capital controls— which was intended by the authorities to be temporary—had produced
more positive results than many observers had initially expected’. Monetary sovereignty
with regard to the control of capital movements had shown its strength.
75
With regard to capital account convertibility, see Cynthia Lichtenstein, ‘International
Jurisdiction over International Capital Flows and the Role of the IMF: Plus ça change?’ in
Giovanoli (ed), above note 46.
76
With regard to the ‘non-discrimination obligation in customary international law’, John
Jackson remarks: ‘From time to time it is argued that countries are obliged under
customary international law to extend non-discriminatory treatment to other nations. Prior
to World War I, there was no such obligation.’ As summarized by Professor Georg
Schwarzenberger, customary law of the time recognized that: ‘Freedom of commerce is a
purely optional pattern of international economic law.’ See John Jackson, William Davey, and
Alan Sykes (eds), Legal Problems of International Economic Relations, 3rd edn (St Paul,
MN: West Publishing Co, 1995) 443.
77
See Treves, above note 46, 118. Treves also refers to freezing orders in implementation
of sanctions imposed by the UN Security Council.
78
Mann, 5th edn, above note 35, 472–3. Proctor argues for a distinction between the
internal and external aspects of monetary sovereignty, and argues that the external aspects
may be more amenable to challenge by other States: Proctor, 6th edn, above note 35, 501–
2.
79
Mann, 5th edn, above note 35, 468.
80
Case of Certain Norwegian Loans (France v Norway) [1957] ICJ Rep 9.
81
See Mann, 5th edn, above note 35, 468–9.
82
See Kenichi Ohmae, The End of the Nation-State (New York: Simon and Schuster, 1996)
and Susan Strange, The Retreat of the State: The Diffusion of Power in the World Economy
(Cambridge: Cambridge University Press, 1996).
83
See Treves, above note 46, 116.
84
The European Court of Justice ruled in the Costa v Enel case that ‘by creating a
Community of unlimited duration, having its own institutions, its own personality, its own
legal capacity and capacity of representation on the international stage and, more
particularly, real powers stemming from a limitation of sovereignty or a transfer of
sovereign powers from the States to the Community, the Member States have limited their
sovereign rights, albeit within limited fields, and have thus created a body of law which
binds their nationals and themselves.’ See Case 6/64 Costa v Enel [1964] ECR 585, 593
para 9.
85
This is in line with the established doctrine of monetary sovereignty, where the State, as
representative of the will of the people, is the holder of such sovereignty, even if the
exercise of some of its prerogatives—such as the monopoly of note issue—is the
responsibility of the central bank. Regarding the constitutional position of the European
Central Bank, which I further discuss in Chapter 7, see eg Chiara Zilioli and Martin
Selmayr, ‘The European Central Bank: an Independent Specialized Organization of
Community Law’ (2000) 37 Common Market Law Review 591 and René Smits, ‘The
European Central Bank in the European Constitutional Order’, Inaugural Lecture at the
University of Amsterdam (4 June 2003), subsequently published as René Smits, The
European Central Bank in the European Constitutional Order (Utrecht: Eleven International
Publishing, 2003).
86
See Kathleen McNamara and Sophie Meunier, ‘Between National Sovereignty and
International Power: what external voice for the Euro?’ (2002) 78 International Affairs 849.
87
Treaty of Lisbon Amending the Treaty on European Union and the Treaty Establishing
the European Community, 13 December 2007, OJ C 306/1 (‘Lisbon Treaty’), Art 50 reads as
follows:
1. Any Member State may decide to withdraw from the Union in accordance
with its own constitutional requirements.
2. A Member State which decides to withdraw shall notify the European
Council of its intention. In the light of the guidelines provided by the
European Council, the Union shall negotiate and conclude an agreement with
that State, setting out the arrangements for its withdrawal, taking account of
the framework for its future relationship with the Union. That agreement shall
be negotiated in accordance with Article 218(3) of the Treaty on the
Functioning of the European Union. It shall be concluded on behalf of the
Union by the Council, acting by a qualified majority, after obtaining the
consent of the European Parliament.
3. The Treaties shall cease to apply to the State in question from the date of
entry into force of the withdrawal agreement or, failing that, two years after
the notification referred to in paragraph 2, unless the European Council, in
agreement with the Member State concerned, unanimously decides to extend
this period.
4. For the purposes of paragraphs 2 and 3, the member of the European
Council or of the Council representing the withdrawing Member State shall
not participate in the discussions of the European Council or Council or in
decisions concerning it.
A qualified majority shall be defined in accordance with Article 238(3)(b) of the

Treaty on the Functioning of the European Union.
5. If a State which has withdrawn from the Union asks to rejoin, its request
shall be subject to the procedure referred to in Article 49.
For an analysis of Article 50 and other legal scenarios, see generally Phoebus Athanassiou,
‘Withdrawal and Expulsion from the EU and EMU; Some Reflections’, ECB Working Paper
No 10 (December 2009), at <http://www.ecb.int/pub/pdf/scplps/ecblwp10.pdf> (last visited
17 July 2014). This is also discussed in Chapter 7.
88
See Tolek Petch, Legal Aspects of the Eurozone Crisis (London: Slaughter and May,
2012) 158–9, para 4.32:
There are four cumulative requirements before recourse may be made to Article
352. First, action by the EU must be necessary. Secondly, that action must be within
the framework of the policies defined in the Treaties. Thirdly, it must be necessary
to attain one of the objectives set out in the Treaties. Finally, the Treaties must not
have provide the necessary powers.
89
See Treves, above note 46, 116 and Christoph W Herrmann, ‘Monetary Sovereignty over
the Euro and the External Relations of the Euro Area: Competences, Procedures and
Practice’ (2002) 7 European Foreign Affairs Review 4. For an opposite view, see Zilioli and
Selmayr, above note 85, 604.
90
Zimmermann, above note 70. In response to ‘the question as to whether, absent an
express treaty rule authorizing a unilateral withdrawal, a member state of a supra-national
organization may nevertheless assert its sovereignty by withdrawing from the
organization’ (815), Zimmermann suggests that any Member State (Greece for example)
‘may always decide to breach the rules of the monetary union and leave’ and also that, in
line with the ruling by the German constitutional court in the Maastricht case, ‘[e]ach
member state of a monetary union in its capacity as one of the “masters of the treaty” may
recover the conferred powers by simply leaving the union’ (816).
91
92
Following the de facto abandonment of the par value regime and until the entry into
force of the Second Amendment (effective 1 April 1978), this reassertion of sovereignty was
done in breach of the rules. See Treves, above note 46, 114. I further discuss the nature and
operations of the International Monetary Fund in Part III.
93
From the point of view of the consensual limitations of monetary sovereignty, Charles
Proctor mentioned, in his comments to this chapter, the dispute between the USA and China
over the valuation of the renminbi. In his opinion, this dispute emphasizes that—though the
issue and management of a currency falls under the domestic jurisdiction of a State—the
adoption of an exchange rate policy occurs within a framework of international law which
may involve obligations to other States.
94
See Andreas F Lowenfeld, ‘The International Monetary System and the Erosion of
Sovereignty. Essay in Honor of Cynthia Lichtenstein’ (2002) 25 Boston College International
and Comparative Law Review 257.
95
The issues surrounding the conditionality of the International Monetary Fund are
discussed in Chapter 13. See also Rosa M Lastra, ‘IMF Conditionality’ (2002) 4(2) Journal of
International Banking Regulation 167.
96
Lowenfeld, above note 94.
97
The term ‘erosion’ is borrowed in this context from Treves, above note 46, 117.
98
See Helen Stacey ‘Relational Sovereignty’ (2003) 55 Stanford Law Review 2029, 2040–
51.
99
See David Llewellyn, International Financial Integration: The Limits of Sovereignty
(New York: John Wiley & Sons, 1980) 198.
100
See Benjamin Cohen, ‘Life at the Top: International Currencies in the Twenty-First
Century’, Princeton University Essays in International Economics No 221 (December 2000)
1–2:
Currencies may be employed outside their country of origin for either of two
purposes: for transactions between nations or for transactions within foreign states.
The former purpose is conventionally referred to as ‘international currency use’, or
currency ‘internationalization’; the latter is described as ‘currency substitution’ and
can be referred to as ‘foreign-domestic use’. The top international monies are
widely used for both purposes.
101
See Ralph Atkins, ‘ECB Needs a Timely Response to Fed’s QE Tapering Move’ Financial
Times (26 June 2013): ‘As Richard Fisher, President of the Dallas Federal Reserve told the
Financial Times in London this week, even central banks whose influence extend way
beyond their shores remain accountable to national constituencies. “It is an oddity in a
globalized world”, he admitted.’
102
Initially, Eurocurrency financial instruments (Eurodollar deposits, Eurobonds …) were
denominated in dollars; the prefix ‘euro’ is due to the fact that the markets originated in
Europe. Eurodollar deposits are deposits denominated in US dollars and held outside the
jurisdiction of the United States.
103
104
See Mann, 5th edn, above note 35, 199–201, and Treves, above note 46, 117.
105
As acknowledged, the central bank can influence the banks’ reserve position by raising
and lowering interest rates (through open market operations and discount policies) and by
modifying the reserve requirements.
106
See Friedrich A von Hayek, Denationalization of Money (London: Institute of Economic
Affairs, 1976). Hayek’s first writing on this subject dates back to 1937, Monetary
Nationalism and International Stability (reprint, New York: Augustus M Kelly, 1971). For
further references on this issue, see Lastra, above note 73, 252–7.
107
I thank Lee Buchheit for this observation.
108
See Robert Mundell, ‘Monetary Unions and the Problem of Sovereignty’ (2002) 579
Annals of the American Academy of Political and Social Science 123, 127. Monetary
sovereignty is also restricted under a system of fixed but adjustable exchange rates,
because countries need to cooperate and engage in supranational decision-making.
109
See Charles Goodhart, Money, Information and Uncertainty, 2nd edn (London:
Macmillan, 1989) 44.
110
See Mundell, above note 9, 292–3. Mundell differentiates between policy sovereignty,
which refers to the ability to conduct policy independent of commitments to other countries,
and legal sovereignty, which refers to the ability of a State to make its own laws without
limitations imposed by any outside authority.
Central Banking Law
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
Monetary system — Monetary obligations — European Central Bank
(p. 29) 2 Central Banking Law
B. Rationale and Functions of Central Banks 2.07
Central banking functions 2.16
Note-issue 2.16
Monetary policy 2.25
Bankers’ bank and lender of last resort 2.48
Banking/financial supervision and regulation 2.55
Government’s bank 2.65
Management of gold and official foreign reserves 2.69
Debt management 2.75
Exchange controls 2.79
Development and promotional tasks 2.83
C. Monetary Stability and Other Central Bank Objectives 2.85

Institutional arrangements to promote monetary stability 2.101
D. Independent Central Banks: Theory and Practice 2.104

Introduction: The relations between the central bank and the government 2.104
The case for monetary independence 2.115
The legal articulation of central bank independence 2.124
Declaration of independence 2.125
Organic guarantees and professional independence 2.126
Functional or operational guarantees 2.129
Economic test of independence 2.130
Financial autonomy 2.131
Regulatory powers 2.132
The limits of central bank independence 2.133

The goal constraint: The case against ‘absolute’ independence 2.134
Democratic legitimacy 2.141
Ordinary versus extraordinary times 2.142
Historical example: the limits of the independence of the pre-1999
German Bundesbank 2.148
E. Central Bank Accountability and Democratic Legitimacy 2.159

Functional decentralization and the model of independent agencies 2.159
Democratic legitimacy of independent central banks 2.163
The accountability of independent central banks 2.172
The lawyers’ view and the economists’ view 2.176
The place of transparency in the framework of accountability 2.183
F. Supervisory Independence and Accountability 2.187

G. Central Bank Reserves and Central Bank Immunity 2.195
Central bank balance sheet and reserves 2.210
H. Currency Boards 2.221

The theory of currency boards 2.224
The history of currency boards 2.229
Currency boards and central banks 2.232
The problems with currency boards: credibility and commitment 2.235
Out of the realisation of the central bank’s power to determine the volume of credit
there arose the notion that it should consciously direct monetary policy along
‘scientific lines’. The question then arises: What is to be the criterion of this
‘scientific’ management? The criterion which has so far usually been adopted, that
of the stability of the general price level, has been suspect in theory and just as
unfortunate in practice…We have yet to wait for the formulation of some other
criterion in clearly delineated terms to allow of its adoption as a rule of monetary
policy.
An examination of the reasons for the eventual decision in favour of a central
banking as opposed to a free banking system reveals in most countries a
combination of (p. 30) political motives and historical accident which played a much
more important part than any well-considered economic principle. …Is it [central
banking] necessary in the interests of sound banking and a stable currency?1
A. Introduction
2.01 Central banking law is a relatively novel discipline. Central banks have traditionally
inhabited a ‘world of policy’. This does not mean there is no law. It means that the law has
generally played a limited role in central bank operations. Central banks are typically
established by law or statute, but beyond this initial act which gives them legitimacy and
generally sets out the goals, functions, and governance in generic terms, there is little
detailed law governing operational aspects (with the relative exception of the US Federal
Reserve System, anchored in the US administrative law tradition of independent regulatory
agencies). This situation is bound to change as central banks continuously increase their
role in shaping capital flows and financial markets. This is particularly relevant in those
cases where the central bank is endowed with responsibility for financial supervision and/or
resolution. The law, with its procedural and substantive guarantees, provides predictability
and certainty, as well as protection of individual rights. Like Gulliver tied up by the chains
that the Liliputians placed around to restrain him, the central bank needs to be increasingly
tied by the law and by adequate mechanisms of accountability.
2.02 Back in 1992, I developed the model of ‘accountable independence’ of central banks.2
This framework is even more needed in the light of their expanded mandate; with power
should come responsibility.
2.03 In this chapter, I study the notion of monetary stability, a fundamental policy objective
enshrined in national laws and international treaties, as well as other central banking
objectives. I also explore the institutional arrangements—independent central banks and
currency boards—that have been developed in recent decades in the pursuit of monetary
stability, as well as the limitations of such arrangements. In the case of central bank
independence, the need to enhance the credibility and long-sightedness of monetary policy
must be reconciled with the requirements of democratic legitimacy, accountability, and
transparency. The chapter also considers actions taken by central banks in response to the
global financial crisis (which commenced in 2007, reached its zenith in 2008, and mutated
into a sovereign debt crisis in some euro area Member States in 2010), from expanded
liquidity assistance to quantitative easing.
2.04 We need to remove the dust from our old ideas and realize that central banking in
ordinary times is not the same as central banking in extraordinary times. We also need to
understand that after living in extraordinary times, the return to ordinary times is
challenging.
2.05 My study aims to identify some key legal issues, notably the extent to which central
bank actions and operations are in conformity with the law and, when the law proves
insufficient (p. 31) or inadequate, the need for legal reform.3 The financial crisis has
evidenced that the pursuit of a price stability oriented monetary policy cannot be conducted
in isolation from other policy objectives, in particular financial stability. While in some cases
the law provides a degree of flexibility in the pursuit of several policy objectives, in some
other cases it does not. Of course, the law can always be revised.
2.06 The question posed by Vera Lutz Smith (cited in the initial quote opening this
chapter) is the defining one: is central banking necessary in the interests of sound banking
and a stable currency? Or in modern terminology, monetary stability and financial stability.4
B. Rationale and Functions of Central Banks

2.07 Central banking has evolved substantially throughout its relatively short history, from
the time in which the Swedish Riksbank and the Bank of England started operations (1668
and 1694 respectively) to central banks in contemporary times.5 While the original raison
d’être for the establishment of the first central banks was note issue and government
finance, this rationale has changed over time.6 The Federal Reserve System was founded in
1913 in response to the damaging banking crises of the beginning of the twentieth century,
while the main rationale for the creation of the Bundesbank in 1957 in Germany, a country
that had suffered from hyperinflation during the inter-war period, was price stability; this
price stability mandate was ‘inherited’ by the European System of Central Banks (ESCB),
(p. 32) established in 1999. History has played a fundamental role in the evolution and
expansion of central bank activities.7
2.08 A central bank is not only the monetary authority in the jurisdiction upon which it
operates; a central bank is also at the centre of the financial system of a modern economy.
The list of central bank functions is open-ended and dynamic, comprising note issue,
government finance, monetary policy, banking supervision and regulation, banker’s bank,
lender of last resort, smooth operation of the payment system, management of gold and
foreign reserves, conduct of foreign exchange operations, debt management, exchange
controls, development and promotional tasks, and others.8
2.09 There has always been a strong connection between the central bank and the
government. They have built a special relationship: the central bank has been consciously
awarded privileges by the government and, in exchange, has been expected to provide
certain services and functions for the government. Politics have always played an essential
role in central banking. Indeed, the government’s influence extends beyond the central
bank’s role as ‘government’s banker’, and affects the working of every function of the
central bank.
2.10 Central banking, I wrote in 1996, is not an ‘evil’. Though a product of history, and a
creature favoured by the State, a central bank may serve useful economic goals in the
pursuit of stable money and sound banking. Neither is central banking a ‘panacea’, nor the
crystallization of an ideal. Most of the functions of a central bank could be fulfilled by a
different public or private institution. Nevertheless, given the actual economic and political
framework of States today, central banks are seen as convenient instruments for the
conduct of some of their functions, particularly monetary policy and banking supervision.
The close link or interrelation between the different functions has made it advantageous to
entrust them to a single body, namely the central bank.
2.11 The limited role that law has played in central bank operations has had a beneficial
impact when it comes to international cooperation. Because central banks are not
constrained by the formality and democratic legitimacy that characterize the workings of
treasuries or ministries of finance, they have been much more adept at developing informal
networks of international coordination, such as the Basel Committee of Banking Supervision
(further analysed in Chapter 14), which has become the de facto international bank
regulator. The central bank fraternity, as a specialized group of highly professional, like-
minded people, has succeeded in establishing soft-law standards for cross-border banks,
something which would have been extraordinarily difficult had a formal mandate being
given by treaty to an international regulatory authority (given the concession or surrender
of sovereignty the creation of such an authority would entail). These advantages
notwithstanding, the time is ripe for a move from soft law to hard law and for greater
accountability.
(p. 33) 2.12 The relative importance of the raison d’être of a central bank has changed
over time and across countries. A similar conclusion was established in the landmark
decision of NML Capital, Ltd v Banco Central de la Republica Argentina where the US court
asserted: ‘We recognize that there is no definitive list of activities “normally understood” to
be central banking functions. Indeed, the definition of what constitutes a “central bank
activity” is likely to change over time.’9 Nowadays, the main rationale for central banking is
the twin mandate of monetary stability and financial stability. Because of the dynamic
character of their evolution, central banks are bound to keep on changing in future.10
However, they will certainly continue to exist for some time.
2.13 Central banks perform public functions (I refer to these as central banking functions,
ie, functions delegated by the government to the central bank in the pursuit of the public
interest) and corporate or commercial functions. The law typically refers to central banking
functions in rather sparse terms. In the case of litigation, the central bank is entitled to
sovereign immunity when it exercises central banking functions. Domestic statutes and
treaties that deal with sovereign immunity address the immunity of central banks and their
property as a special case,11 as discussed below.
2.14 The development of central banking law—as a relatively new discipline which sits
between administrative law, commercial law, banking law, regulation, and the interaction
between law and economics in the conduct of monetary policy—needs to take these
interfaces into account.12 Central banks are at the centre, equidistant from the government
and the financial system (they are both banker to the government and banker to the banks).
Central banking is thus defined by the relationships of the central bank upwards with the
government and downwards with the banking and financial system. The law must govern
both relationships.
(p. 34) 2.15 In the ensuing paragraphs, I provide a brief analysis of key central banking
functions, emphasizing which functions are ‘essential or necessary’—in the sense that they
are the very purpose of central banking—and which are not.13
Central banking functions
Note-issue
2.16 The privilege of issuing money—an attribute of monetary sovereignty—is considered
the first raison d’être of a central bank, a task generally associated with financing the
government, particularly in war-times. It is also this privilege that lets it act as lender of
last resort. Francis Baring, writing soon after the outbreak of the Napoleonic Wars, was the
first to point this out. In most countries, the standard arrangement today is the central bank
monopoly of note-issue.14
2.17 The central bank issues all the notes in circulation in a given jurisdiction. This
enables the central bank to control seigniorage (ie, the margin between the nominal value
of the notes issued and the costs of their production) and to determine the volume of note-
issue. The current system is one of fiat money, ie, inconvertible into gold or other precious
metals, paper money declared by the government to be legal tender for the settlement of
debts.
2.18 Alternative arrangements to this ‘standard’ monopoly of note-issue include minimal
competition (eg, the central bank issues notes, but allows other commercial banks to issue
their own notes backed on a one-to-one basis by central bank notes, as is the case in
Scotland15(p. 35) and Northern Ireland, where the major banks still have the right to issue
their own notes, though equivalently backed by Bank of England notes), currency boards
(explored later in this chapter) and real competition (the much wider free banking issue).16
2.19 A core issue in the free banking proposals is convertibility. Moving away from central
bank money, convertibility becomes essential to preserve confidence and prevent over-
issue. In such a scenario, penalties for failing to maintain convertibility should be clearly
defined. Accordingly, those who advocate institutional changes, removing the provision of
the monetary base from government control, or more radically abolishing central banks,
generally also advocate or predict that private money should be convertible into some asset
or object of value. Another tricky question with these free banking proposals is the
prescription of a currency as legal tender for the settlement of debts.
2.20 If private note-issues are prescribed as legal tender, because of the profit-maximizing
goals of the commercial banks, there will be a tendency towards over-issue. In such a (p.
36) context, convertibility into some other asset would indeed be essential. In an extreme
version, private fiat money, ie notes issued by commercial banks prescribed as legal tender
with no backing at all, would be impossible, because it would cause hyperinflation (though
some, included Hayek, have argued this is incorrect). Therefore, if one is going to provide
currency with a legal tender basis, it will have to be on a monopoly or quasi-monopoly basis,
and thus issued by a central bank. Private note-issues do not need to be prescribed as legal
tender, for a currency does not need to be legal tender in order to exist.17 Nonetheless,
even when private note-issues are not legal tender, the issuers obtain seigniorage.
2.21 The free banking proposals raise major economic issues and complex problems, in
terms of stability, sufficiency, and other factors, which exceed the scope of this study. An
additional difficulty in assessing the practical success of these theories is the lack of
sufficient evidence supporting their arguments.18
2.22 Hayek advocated the free choice in currency, opening up the provision of currency to
competition from both the private sector and from foreign issuers of currency. According to
Hayek, the value of the currencies could be related to a ‘rule’ (different from a monetary
base) such as convertibility to a basket of commodities.19 In a system of free banking, there
would be no need for a central pool of reserves, as an individual commercial bank would
keep its own reserves, and be responsible for the convertibility of its own—note and
deposit-liabilities. Among other representatives of the new generation of the free banking
school, the work by White, Glasner, and Selgin has been significant.20
2.23 The development of virtual currencies, such as Bitcoin, is another example of
competition in the provision of currency. The motivation for this ‘crypto-currency’ is to place
the process of money creation beyond the reach of central banks, thus challenging their
monopoly on (p. 37) currency issue and provided alternative (some argue cheaper and more
efficient) means of exchange and payment than those offered by banks and card companies
through a decentralized ledger system.21 However, the simplicity of the algorithm behind
the computer system at the heart of Bitcoin (a fixed formula to control the supply of
Bitcoins) contrasts with the complexity of economic policy-making and human behaviour,
not to mention the inherent vulnerabilities of Bitcoin and the need to comply with anti-
money-laundering legislation and other rules governing payments made adopting this new
math-based currency.22
2.24 Coming back to the intellectual arguments against free banking, opponents claim that
there is a natural tendency for free banking to gravitate around central banking. This might
help to explain why the historical examples of free banking arrangements have been
relatively scarce, and why in the end even when it comes to Bitcoin and other virtual
currencies, the following warning by Mark Williams may prove prescient: ‘Governments
should be wary of allowing any virtual currency, unless they first find a way of putting
central bankers back in charge.’23 Competitive banks can create economies of scale by
pooling and centralizing their reserves with some leading commercial banks.24 It is also
argued that under a free banking system, there would be a tendency for one private
currency to dominate the others, ‘because of the reduced transaction costs associated with
the use of a common currency, which would be immediately recognizable, readily
disposable and the unit of account’.25 Furthermore, Goodhart (1988) argues that if the bank
at the centre is a profit maximizing institution there will be commercial rivalries,
concluding that the metamorphosis toward a non-profit maximizing central bank was
natural.
Monetary policy
2.25 Monetary policy refers to the actions taken by the monetary authorities to affect the
supply and cost of money and credit. A legal definition is generally absent in central bank
statutes. Most central bank laws simply state that the central bank is in charge of monetary
policy and then enumerate the objectives and instruments of monetary policy (in rather
generic terms). The website of the Federal Reserve System defines monetary (p. 38) policy
as follows: ‘The term “monetary policy” refers to the actions undertaken by a central bank…
to influence the availability and cost of money and credit to help promote national economic
goals.’26
2.26 A definition of monetary policy is not found in the websites of the Bank of England27
nor of the European Central Bank28 that refer instead to the objectives of monetary policy
(stable prices) and benefits of price stability, to the monetary policy instruments, to the
transmission mechanism of monetary policy and to the decision making process (with the
Monetary Policy Committee (MPC) in charge in the case of the Bank of England, and the
Governing Council and Executive Board in the case of the European Central Bank).
2.27 In the case of dependent central banks, the government (Treasury or Ministry of
Finance) is responsible for the formulation of monetary policy and the central bank is
responsible for its implementation. In the case of independent central banks, the bank is
responsible for both the formulation and implementation of monetary policy. Most
independent central banks have operational independence. However, the goals are
determined by statute or treaty. Only a few central bank laws, notably the US Federal
Reserve Act (discussed below), leave discretion to the central bank as regards the choice of
goals. The relationship between objectives and functions and the limits imposed by the
statutory (or Treaty) mandate is fundamental to ascertain the issue of independence on the
one hand and whether central banks have operated within their mandate with the actions
taken to combat the global financial crisis on the other hand.
2.28 Is monetary policy necessary or redundant? In line with Hayek’s views, White claims:
In decades past the issue of alternative monetary frameworks has been treated
primarily as a question of desirability of ‘rules’ or ‘discretion’ for a monetary
authority. The rationale for the existence of monetary authority has gone
unquestioned.29
2.29 Consistent with their thesis about money creation, free banking economists advocate
the full depoliticization of the money supply process. Programmes for partial
depoliticization through central bank independence and legislated monetary rules are
regarded as milder, less efficient and stable proposals for monetary reform than a free
market monetary system.
2.30 Despite these dissenting voices, the majority of economists today accept monetary
policy as an important part of the economic policy of the State.30 Even some of those who
argue that a central bank is not the result of a natural evolution, and that some of its
functions should (p. 39) be ‘privatized’ or ‘liberalized’, still see a fundamental role for
monetary policy. Friedman, for instance, proclaims:
Experience suggests that the path of wisdom is to use monetary policy explicitly to
offset other disturbances only when they offer a ‘clear and present danger’.31
2.31 It is often argued that effective implementation of monetary policy requires the
subordination of individual or sectorial interests to macroeconomic interests and that this
demand cannot be fulfilled by a profit-making body. Thus, the need for a central bank as a
non-profit-maximizing institution.
2.32 Typically, monetary policy has a national/domestic jurisdictional domain as a tool of
economic policy available to steer the economy through good and bad times (the situation
of course is different in the case of the European Central Bank (ECB) as we discuss in Part
II of this book).
2.33 Over the last decades (up to the beginning of the global financial crisis) price stability
was universally considered as the primary goal of monetary policy (a primacy which has
been enshrined in laws and treaties). The view that the central bank should conduct a price-
stability-oriented monetary policy was forcefully advocated by Volcker:
The vacuous admonition that a monetary authority be all things to all men—for
growth, full employment and stability—risks confusion and misunderstanding of
what a central bank can really do.32
2.34 However, in light of the global financial crisis and the ensuing recession, increasing
attention is given to the goal of financial stability and to the promotion of growth and
employment. Financial stability considerations have led to the revision of the mandate of
the Bank of England and the activation of Article 127(6) of the Treaty on the Functioning of
the European Union (TFEU) to give supervisory responsibilities to the European Central
Bank.
2.35 Growth and employment considerations were behind the adoption of quantitative
easing (QE) policies in the USA, UK, and Japan (the specific case of the euro area, the
nature of the Outright Monetary Transactions, and the adoption by the ECB of other non-
standard instruments of monetary policy are discussed in Chapter 7 of this volume). QE
raises a number of economic issues that go beyond the scope of this study, such as the
extraterritorial effect of such policies and the potential for the so-called ‘currency wars’,33
the interaction between monetary policy and fiscal policy, and the relationship between the
central bank and the financial system (dependency on a quasi-life-support mechanism) (p.
40) and, indeed, the difficulties of ending QE, not only for the country adopting QE policies
but also for other countries—in particular emerging economies—that might suffer as a
result of the unwinding of such policies (the extraterritorial effect of the ‘tapering’ of QE
policies in the USA).34,35
34 35
2.36 Disagreements arise over the kind of ‘monetary policy’ (which strategy, type of rules,
instruments, and operations) the authorities should follow. These disagreements are often
economic rather than legal (from a legal perspective the choice of monetary (p. 41) policy
instruments generally falls within the discretionary realm of the monetary authorities).36
2.37 The issue of ‘rules versus discretion’, first raised by Simons in the context of
monetary policy in 1936, still raises much controversy. In the words of Bill White:
The task is less that of choosing between rules and discretion than of harmoniously
blending the two together. Rules are useful in that they greatly simplify the
policymaking process. …Rules also aid transparency and constrain the behaviour of
those whose integrity might be open to question. At the same time, discretion and
judgment will always be required in some measure, either to respond to the
unexpected or to seize some technical advantage.37
2.38 The necessity and effectiveness of monetary policy is often discussed at the
operational level. Conventional or standards instruments of a market-oriented monetary
policy are open-market operations, discount policies, and reserve requirements.38 The crisis
changed the traditional understanding of the tools available to the monetary authorities,
with a resort to unconventional measures in an effort to revive moribund markets and/or
troubled economies. Non-standard or unconventional instruments include credit support,
credit easing, interventions in foreign exchange and securities markets, provision of
liquidity in foreign currency, and quantitative easing (QE).39
2.39 When the central bank can no longer lower interest rates (they cannot fall below
zero), the central bank creates money (increases the quantity of money) and uses it to buy a
variety of assets such as government bonds or high quality corporate debt.40 ‘Under QE, a
central (p. 42) bank makes large scale asset purchases to boost the money supply, guide
medium-term interest rate expectations lower, alter risk premia across asset classes, and so
revive long-term growth and inflation expectations.’41 Claudio Borio and Piti Disyatat of the
Bank for International Settlements (BIS) set out a framework in 2009 to clarify the various
forms of unconventional monetary policy.42 Drawing on what they regard as the ‘two core
elements’ of monetary policy implementation, namely ‘interest rate policy’43 and ‘central
bank balance sheet policy’, they explain the various types of balance sheet policy that have
been adopted since 2007 to affect asset prices and financial conditions. They note that this
central bank balance sheet policy ‘should be considered in the broader context of the
consolidated public sector balance sheet. Importantly, central banks have a monopoly over
interest rate policy, but not balance sheet policy.’ The expansion of central banks balance
sheets (and associated increased financial risks) is seen as risking ‘their operational
independence and anti-inflation credentials’ in the longer term.
2.40 In another study on unconventional monetary policies (UMPs) prepared by IMF
staff,44 UMPs are divided into two categories: those that restore the proper functioning of
financial markets and intermediation (such as liquidity provision and outright purchases of
private and public assets) and those that provide further ‘monetary policy accommodation’
at the zero lower bound (such as purchases of government bonds and ‘forward guidance’).
The study contrasts the UMPs with monetary policy prior to the crisis, where central banks
in advanced economies ‘navigated calm and familiar seas’ (characterized by predictability
and well understood transmission mechanisms and reliance upon short-term interest rates
as the key policy tool) with the unmapped waters central banks have been sailing through
since 2007. The study cautions against calling monetary policy ‘to do too much’ and
questions whether the breathing space UMPs proved may delay much needed fiscal,
structural and financial sector reforms.
(p. 43) 2.41 As Charles Goodhart has pointed out,45 while during the ‘Great Moderation’
the independent central bank had one instrument (short-term interest rate) to hit one
medium target (price stability via an inflation target), the great financial crisis has
complicated the conduct of monetary policy with the consideration of other objectives
besides price stability: financial stability and growth; and the reliance on additional
instruments such as forward guidance on future short rates, QE in various guises, and
macro-prudential tools.
2.42 Not only central banks entered unmapped territory with QE policies, there are also
important distributional effects and issues of due process and proportionality that require
adequate evaluation in addition to the extraterritorial dimension mentioned above. Asset
purchase programmes have resulted in a huge expansion in the monetary base, with very
low interest rates. This is to the detriment of savers and to the benefit of indebted
businesses and households; ultra-loose monetary policy has also helped prop up financial
markets. Central banks’ world of policy must be increasingly subject to an adequate legal
framework in which such distributional effects are properly addressed. The jury is still out
on the benefits of QE and the unwinding of QE policies as central banking returns to
‘ordinary times’.46
2.43 Much has also been written about ‘forward guidance’,47 a term of art in central
banking circles. Forward guidance is not a policy instrument per se but rather a
communication strategy aimed to achieve a credible commitment to a future path of
interest rates in order to manage market expectations.48,49
48 49
While the Fed and the Bank of
England (the latter (p. 44) for a rather limited period of time) first aligned forward guidance
around an unemployment rate, the ECB did not link its commitment to any particular
target. But does forward guidance really reduce uncertainty and improve clarity in the
transmission mechanism of monetary policy? Goodhart’s law certainly comes to mind in the
light of the recent experience of the Bank of England’s communication strategy in this
regard. Indeed, as soon as a variable is chosen, that variable starts behaving in different
ways.50 In August 2013, the Bank of England predicted that unemployment was likely to
remain above 7 per cent until mid-2016, when instead that threshold was reached at the
end of 2013.51 As a result of the difficulties in understanding how the labour market is
behaving, forward guidance took a step back and, in February 2014 Mark Carney
announced that the Bank of England would no longer tie its policy decisions to a particular
indicator.52
2.44 The picture by Ingram Pinn53 portraying the heads of ECB, Fed and Bank of England
as the Three Wise Men following the star under the rubric of ‘forward guidance’ cleverly
summarizes the essence of forward guidance as a route into the unknown.
2.45 In many developing countries, the conduct of monetary policy generally presents
additional challenges, as the shift from direct instruments of monetary control, such as
credit ceilings on individual banks or interest rate controls, to indirect instruments, such as
open market operations or discount facilities, needs to be accompanied by the parallel
emergence and development of a money market and a market for government securities.
Emerging markets are particularly affected by changes in global monetary policy settings,
since foreign capital movements are often very large relative to their domestic financial
markets.54
2.46 In any case, the choice of monetary policy instruments will always be contingent upon
the scope of powers entrusted to the monetary authorities in accordance with their
statutory mandate55 and their proposed goals in the search for the ‘public interest’, and it
will also need to be measured against the potential distortionary effects on market
mechanisms and their short- and long-term costs for the financial community. For instance,
interest rate (p. 45) controls in the USA (Regulation Q) were abandoned in 1980 because
the original purpose of this regulation had been overrun by events in the marketplace.
2.47 Monetary policy is not an exact science. Goodhart’s law56—any observed statistical
regularity will tend to collapse once pressure is placed upon it for control purposes—is also
a good reminder that economics is a social science. Sproul in a speech delivered in 1955
proclaimed:
In fact, we can be certain that reliance upon any simple rule or set of rules would be
dangerous. Economic situations are never twice alike. They are compounded of
different elements—foreign and domestic, agricultural and industrial, monetary and
non-monetary, psychological and physical—and these factors are combined in
constantly shifting proportions. ‘Scientific’ analysis, unaided, can never carry the
enquirer to the heart of the economic situation. Judgement and wisdom—the power
to take a complex set of considerations into account and come to a balanced view of
them—are quite as needed as facts and theories. The Federal Reserve System needs
to operate in the light of all the information it can get, and it needs to have this
information organized and analyzed in such a way as to give the maximum amount
of illumination. But it also needs the guidance of practical wisdom which is born
only of experience.57
Bankers’ bank and lender of last resort

2.48 Historically, the central bank’s role as the bankers’ bank originates in the
spontaneous tendency of commercial banks (particularly if small and localized) to centralize
their reserves in one, two or a few well-established and leading commercial banks,58 or in a
clearinghouse association. The bank/s at the centre pool(s) the reserves and can also
provide services and facilities to the commercial banks that place interbank deposits with it/
them. We can look at this process as the formation of a ‘club’.
2.49 Nonetheless, this process does not explain the need for a central bank—as a public
authority—to be the manager of that club, since it could still be run by the leading
commercial banks. Why is it then, that Timberlake claims, ‘[c]entral banking policies could
never be rationalized by recourse to commercial banking principles?’59 The answer,
according to Goodhart, rests upon the metamorphosis from a competitive, profit-maximizing
institution to a non-competitive, non-profit-maximizing central bank, because, ‘[i]nsofar as
the central commercial bank(s) is a competitor, other banks will be unhappy about placing
deposits with it that increase the size of its book.’ He concludes that ‘the presence of an
independent, non-competitive central bank is likely to be welcomed by other banks …; the
transition of the Bank of England from a profit maximizing, competitive bank to such a
fuller role did occur naturally’.60
2.50 Historically, the centralization of reserves was ‘given a further impetus in many
countries by the need of the state to employ a bank to carry out certain financial functions
for it, such as issuing notes, holding deposits, making payments, and arranging loans at
home (p. 46) and abroad’.61 The fact that the central bank is at the same time the
government’s bank and the bankers’ bank has some advantages. For example, as the
government ‘banks at the central bank’ and the banks hold reserves with the central bank,
transactions between the government and the banking system are facilitated by crediting
and debiting their respective accounts. This dual role of the central bank also has certain
shortcomings: a politicized central bank will tend to favour the interests of the government
over the interests of the banking sector.
2.51 In its role as banker to the commercial banks, the central bank may undertake the
following functions:
(i) The acceptance of deposits to act as prudential reserves for these banks.
(ii) The provision of central clearance facilities for interbank transactions and the
operation of the payment system. In today’s world, payments are increasingly made
by electronic means, often referred to as electronic funds transfers, wire transfers or
paperless credit transfers. The wire-transfer system is composed of three principal
sub-systems: communication, clearing, and settlement. It is argued that central banks,
with or without supervisory responsibilities, should have a regulatory and oversight
role in the payment systems, 62 although it does not follow that they should also
operate them. As a matter of fact, public payment systems are often combined with
private ones. (For instance, in the USA, Fedwire is public, whereas the Clearing
House Interbank Payments System (CHIPS) is private.)
(iii) The day-to-day liquidity support to the commercial banks through its rediscount
or advance facilities; ‘ordinary’ provision of credit or regular lending.
(iv) The commitment to act as lender of last resort providing ‘extraordinary’ credit or
emergency liquidity assistance. The decision to serve as lender of last resort can be
taken either to support a single bank suffering from a liquidity crisis (individual bank
liquidity) or to preserve the stability of the banking system as a whole (systemic
concern), by supplying extra reserves to all banks suffering from large cash
withdrawals (market liquidity). An individual bank problem can, however, quickly
convert into a system problem, if a sudden collapse of confidence in one bank spreads
by contagion to other banks, as we further discuss in Chapter 3 . The nature of the
lender of last resort role involves different aspects:
(a) The discount rate at which the central bank lends, acting in its capacity as
lender of last resort, is an instrument of monetary policy. Only the ultimate
supplier of high-powered money can provide the necessary stabilizing function
in a nationwide scramble for liquidity. 63 The central bank can and does provide
market liquidity via open market operations and via other non-conventional
instruments.
(b) The lender of last resort is an instrument of banking supervision in a ‘crisis
situation’ stage. As part of its micro-prudential functions, the central bank via
the lender of last resort, provides assistance to a bank (or banks) suffering from
a liquidity crisis. The immediacy of the availability of central bank assistance
(the central bank (p. 47) being the ultimate supplier of high-powered money)
makes the lender of last resort (LOLR) a particularly suitable first line of
defence in a crisis. This ‘immediacy’ contrasts with the ‘time framework’ of
other crisis management instruments. Neither deposit insurance nor resolution
and bank insolvency proceedings can achieve this. By their very nature they are
lengthy and complicated processes which take into account the interests of
many stakeholders and are subject to greater legal constraints. The second
important feature of this LOLR assistance is the unlimited capacity of the
central bank to provide liquidity, either to the market in general or to individual
banks as needed. Central banks provide liquidity, not capital.
(c) The lender of last resort is a service provided by the central bank in its
capacity as bankers’ bank.
2.52 As I wrote in an article with Luis Garicano in 2010:64
The lender of last resort function can only be undertaken by a central bank. The
involvement of central banks in financial stability originates in their role as
monopolist suppliers of fiat money and in their role as bankers’ bank. Only the
ultimate supplier of money can provide the necessary stabilizing function in a
nationwide scramble for liquidity, as the financial crisis has amply evidenced, with
conventional and non-conventional monetary policy operations (quantitative easing
and others). This is a clear lesson of the crisis in the UK, where the problems of
Northern Rock caught the Bank of England by surprise: having timely information is
particularly crucial during financial crises and the best way to ensure access is to
have daily supervision by the central bank, as the literature has noted.65
2.53 Unprecedented emerging liquidity assistance has been a defining and evolving
feature of the responses to the global financial crisis since 2007, as is further discussed in
Chapter 4. Central banks around the world operated as lenders of last resort, market
makers of last resort, and, at times, as lender of primary resort or lenders of only resort.
The contours between the domain of monetary policy and the domain of emergency liquidity
assistance became increasingly blurred.
2.54 Furthermore, since the extraordinary provision of liquidity assistance amply
benefitted financial institutions that were not commercial banks, it is fitting to conclude
that today central banks are the ‘financiers’ banks’ and not simply the ‘bankers’ banks’.
Banking/financial supervision and regulation
2.55 The relationship between the central bank and the banking system involves two
distinct yet intimately related functions, for the central bank can act as ‘bankers’ bank’ (as
we just discussed) and as ‘banking supervisor and regulator’. The boundaries between
these two functions are at times blurred. In some countries these two functions have co-
existed since the beginning or for a long time. In other jurisdictions where the central bank
is not—at least de jure—in charge of banking supervision, the boundaries can be more
easily drawn. In the (p. 48) UK, the Bank of England has a long non-statutory tradition in its
role as ‘bankers’ bank’, while its banking supervisory functions have a shorter statutory
history, for Parliament passed in 1979 the Banking Supervision Act in response to the
secondary banking crisis and, then, as discussed in Chapter 3, banking supervision was
transferred in 1997 to the Financial Services Authority before it returned formally to the
Bank of England with the Financial Services Act 2012.
2.56 Furthermore, and as a logical consequence of the extension of emergency liquidity
assistance to non-bank institutions, some central banks after the crisis have also seen an
expansion of their supervisory powers beyond the banking system to the financial system at
large, an issue which is further discussed in Chapters 3 and 4.
2.57 When my first book on central banking was published in 1996, discussions about
banking supervision were confined to what today we refer to as ‘micro-prudential
supervision’. I wrote then: ‘Banking supervision is not a necessary nor exclusive function of
a central bank. It is evidently not necessary because there are central banks which are not
directly entrusted with this task. Neither is it exclusive, as responsibility for supervision can
be shared, and actually often is, with other regulatory bodies, public or private.’ Though
that statement remains valid with regard to micro-prudential supervision, the statement
needs to be qualified when it comes to macro-prudential supervision.
2.58 As acknowledged, in the aftermath of the global financial crisis a distinction is now
made between macro prudential supervision and micro prudential supervision. According to
the House of Lords Report on the Future of EU Financial Regulation and Supervision,66
‘macro-prudential supervision is the analysis of trends and imbalances in the financial
system and the detection of systemic risks that these trends may pose to financial
institutions and the economy. The focus of macro-prudential supervision is the safety of the
financial and economic system as a whole, the prevention of systemic risk. Micro-prudential
supervision is the day-to-day supervision of individual financial institutions.’
2.59 Such distinction has found its way into the law, though the arrangements with regard
to allocation of macro-prudential supervisory responsibilities vary across jurisdictions. In
the United Kingdom, the Bank of England is directly in charge of macro-prudential
supervision through the Financial Policy Committee. In the euro area, macro-prudential
supervision is to be shared between the national authorities, the European Systemic Risk
Board and the ECB (according to the regulation establishing the Single Supervisory
Mechanism, discussed in Part II of this book). In the USA, macro-prudential supervision—
systemic risk control—is the responsibility of the Financial Stability Oversight Council.
2.60 In 2010, Luis Garicano and myself contended that the central bank is the best
institution to deal with macro-prudential supervision because of because of its lender of last
resort role and its role in monetary policy:67
Monetary policy not only affects inflation rates, but the price (and thus the amount)
of risk taking. An excessively accommodating Federal Reserve convinced actors that
they would be saved from their folly (the famous ‘Greenspan put’) and led to
excessive risk taking. Thus, (p. 49) those in charge of monetary policy need to know
the amount of risk and instability in the system. Moreover, the absence of stable
prices harms the stability of the financial system, while financial fragility in turn,
negatively affects monetary stability.
Indeed one can argue that LOLR is macro-prudential action.68

2.61 The pendulum on the optimal institutional organization of supervision keeps on
changing with structural reforms in different jurisdictions keeping micro-prudential
supervision within or outside the central bank,69 depending upon historical, political, and
economic circumstances.70
2.62 Central banks or bank supervisory agencies may also be in charge of broader
financial sector regulation and supervision. The Dodd–Frank Act 2010 gives supervisory
powers to the Federal Reserve System with regard to those financial institutions that the
Financial Stability Oversight Council deems to be systemically significant.71 The global
financial crisis has also shown that systemic risk can arise from non-bank financial
institutions and from securities and derivatives markets.72
(p. 50) 2.63 As explained in Chapter 3, micro prudential supervision in a broad sense is a
process with four stages: licensing, supervision sensu stricto, sanctioning and crisis
management, which involves the central bank’s role of lender of last resort, deposit
insurance protection and special bank insolvency proceedings. The government often
delegates some banking supervisory functions to the central bank, though it can retain
responsibility for some of the stages (eg, the licensing stage). It can also delegate
responsibility for some or all stages to another agency or institution.
2.64 Bank regulation refers to the establishment of rules, to the process of rule-making,
and includes: Acts of the Legislator and statutory instruments issued by the competent
authorities nationally and supranationally, international rules (often ‘soft law’ standards),
and rules issued by self-regulatory organizations and by private bodies or ‘clubs’ (such as a
cooperative bankers’ association). This is further explained in Chapter 3.73
Government’s bank
2.65 Historically, in exchange for some monopolistic advantage in note-issue, or in
corporate status, the central bank (eg, Bank of England and Banque de France) was
expected to carry out certain functions for the government. It became standard practice for
the central bank to act as the bank to the government, holding its balance, acting as its
fiscal agent and ‘cashier’, its adviser in general economic and financial questions, etc.
Thornton nicely describes the origins of this role:
The ground on which the bank lends so much to the government is clearly that of
mutual convenience, as well as long habit. It is the only lender in the country on a
large scale; the government is the only borrower on a scale equally extended; and
the two parties, like two wholesale traders in a town, the one the only great buyer,
and the other the only great seller of the same article, naturally deal much with
each other, and have comparatively small transactions with those who carry on only
a more contracted business. The bank, moreover, in time of peace, is much
benefited by lending to government. It naturally, therefore, continues these loans
during war, which it had been used to grant at all antecedent periods.74
2.66 Undoubtedly, the position of banker to the government is a powerful one, as it

involves the following functions:
(i) The provision of lending facilities to the government has been a traditional
rationale for the establishment of central banks. However, the economic test of
central bank independence—further discussed below—is the prohibition or limitation
to monetize public debt. While dependent central banks are required to help finance
the fiscal deficits, either by granting direct credit facilities to the government or by
purchasing government securities directly from the issuer, central bank independence
prohibits or limits such financing. In the context of the European Monetary Union
(EMU), I discuss the implications of this prohibition enshrined in Treaty provisions,
and the measures (Outright Monetary Transactions and others) adopted (p. 51) to
combat the sovereign debt crisis in some euro area Member States in Part II of this
book.
(ii) The central bank runs the government bank accounts, acting as its fiscal agent.
(iii) The central bank gives technical advice to the government on monetary policy
and financial affairs at home and abroad. It is important for the government to have
access to specialized financial expertise, ‘untainted by the influence of any outside
interest’. 75 The forecasts of the central bank also play an important role in forming
decisions about a wide range of economic policies, as well as providing the
background to such technical advice to the government. The importance the
government gives to this advice (and its very significance) will vary according to the
degree of dependence or independence of the central bank in the fulfilment of its
tasks.
2.67 Other services (eg, fiscal agent or technical advisor), which the central bank provides
to the government, will presumably continue to exist though they could also be ‘privatized’.
In this latter case, the government could ‘buy’ technical advice from private institutions.
Nonetheless, the central bank is likely to keep its position as the ‘State’s bank’.
2.68 The development of the function of banker to the government, particularly in its role
of ‘finance to government’, was not so much the result of a natural evolution as a clear sign
(or imposition) of the ‘will’ of the State. The State was eager to develop a source of easy
borrowing facilities provided through the central bank. Thus, it awarded it with privileges
such as the monopoly of note-issue; the government did not gratuitously build up these
special relationships with the central bank. Smith recalls this process:
[The Bank of England] had always been a privileged and protected institution, and it
was in the interests not only of the Bank but also of the Government that it should
remain so. Its origins [of central banking] are to be found in the establishment of
monopolies, either partial or complete, in the note issue…Looking at the
circumstances in which they were created we find that the early ones were founded
for political reasons connected with the exigencies of State finance …76
Management of gold and official foreign reserves

2.69 The monopoly of note-issue historically determined that the central bank also
assumed responsibility as guardian of the country’s monetary reserves.77
2.70 The conduct of foreign exchange policy involves the determination of the exchange
rate and the exchange regime (or exchange arrangement), and the management of the
official monetary reserves (both gold reserves and foreign currency reserves). However, the
dividing line of what constitutes foreign exchange policy is often a fuzzy one. In any case,
responsibility for the formulation of the exchange rate policy usually rests with the
government, while responsibility for its implementation is generally entrusted to the central
bank. Accordingly, the central bank has traditionally conducted operations in foreign
exchange markets to sustain the national currency’s external value, following the guidelines
set by the government.
(p. 52) 2.71 The government’s responsibility in the field of foreign exchange policy is
rooted in historical and political reasons78 and in the consideration that the exchange rate
is not only a nominal anchor for the domestic price level,79 but is also a part of general
economic policy. As such, the exchange rate is linked to the trade and employment
objectives of a country, and has a clear impact upon its external competitiveness.
2.72 The central bank’s role in the guardianship of the country’s monetary reserves is
dynamic, and has acquired different dimensions over time, depending on the government’s
choice of exchange regime (fixed, floating, managed float). Though in many countries the
foreign exchange and gold reserves are generally owned by the government, the central
bank holds and manages official monetary reserves. In the USA, however, gold reserves are
held by the Secretary of the Treasury for the account of the Exchange Stabilization Fund
(ESF). The ESF monetizes these gold reserves by issuing gold certificate credits to the
reserve banks. Special drawing rights (SDRs) received by the US government are also held
by the ESF. The ESF periodically also monetizes SDRs by issuing SDR certificate credits to
the reserve banks. As regards foreign currency reserves, the Fed holds some of the foreign
currency balances; others are held by the ESF of the Treasury. The Federal Reserve Bank of
New York acts as an agent for both the Federal Open Market Committee, which directs the
foreign currency operations at the Fed, and the Treasury, by carrying out US foreign
currency operations.80
2.73 In the UK, the official foreign reserve assets are held by the Exchange Equalization
Account, which is formally under the control of the Treasury. The Bank of England acts as
agent to the Treasury in the operation of this Exchange Equalization Account.81
2.74 The conduct of foreign exchange policy in the euro area is discussed in Chapter 9, as
well as the complications that arise in terms of IMF representation (given that the IMF is
country- and member-oriented) and the holding and management of reserves. Central banks
of nations that are members of the IMF hold reserve positions in the IMF, including SDRs.
The provisions contained in the ESCB Statute regarding this issue give the ECB the right to
hold and manage the foreign reserve assets transferred to it by national central banks, but
also foresee that the ECB may hold and manage IMF reserve positions and SDRs.82
(p. 53) Debt management
2.75 Debt management is not a necessary function of a central bank.83 It is a function
linked to the finance of government. In many countries the ministry of finance (or the
Treasury) typically undertakes its own debt management.84 Though the institutional
arrangements for debt management vary from country to country,85 some jurisdictions have
adopted separate public agencies as Debt Management Offices (DMO), for example Nigeria
in 2000,86 while others have established such Offices within the Treasury/Ministry of
Finance, such as France in 2001.87 (In France and Spain the name ‘Treasury’—Tesoro in
Spain and Trésor in France—is the name given to their DMOs.)
2.76 Stressing the non-necessary nature of the central bank as debt manager, Acheson and
Chant88 claimed:
One method of directing the central bank’s efforts toward major goals such as price
stability and full employment would be through limiting its responsibility for debt
management, either through the delegation to another bureau or through
establishing a set of rules for debt management.
2.77 Fischer also maintained that the Treasury—or another agency—should manage the
national debt, so as ‘to avoid creating a conflict between the government’s desire to keep
debt service low and the goals of monetary policy’.89
2.78 Central banks holdings of sovereign bonds and the encouragement via government
policies and national and supranational rules (such as capital rules and the ‘fiction of risk-
free assets’ (p. 54) which receive favourable ratings by credit rating agencies) that banks
hold such sovereign debt, created a vicious link (the so-called ‘doom loop’) between bank
debt and sovereign debt, the subject of much controversy since the global financial crisis
commenced. This is further discussed in Part II of this book.
Exchange controls
2.79 The administration of exchange controls is not a necessary function of a central bank.
Exchange controls (ie, restrictions in the areas of capital transfers and international
payments) and exchange arrangements are often subject to different legislation and
regulation in many countries. The law of the IMF in this area is discussed in Chapter 13.
2.80 Exchange controls are an artificial barrier, intended to ‘protect’ national credit
markets. Once they are abolished, and individuals are free to transfer their funds abroad,
domestic direct credit controls are likely to be much less effective as a lever of monetary
policy, since they only cover domestic banks. Therefore, a government wishing to use some
sort of domestic credit controls (eg, quantitative credit controls) will be reluctant to remove
exchange controls.
Without exchange controls, intermediation that is blocked or penalized domestically
will simply be re-routed offshore…to the detriment of the domestic sector.90
2.81 At the EU level, these controls need to be eliminated to make the free circulation of
capital within the Community fully effective. Accordingly, EU Member States have been
removing such exchange restrictions. Though the freedom of capital movements was
originally enshrined in the Treaty Establishing the European Economic Community (‘EEC
Treaty’) alongside with the free movement of goods, persons, and services, its
implementation was the slowest of the four basic freedoms. The legal basis for the
liberalization of capital movements was given further impetus first by the 1986 Single
European Act, which defines the internal market as ‘an area without internal frontiers in
which the free movement of goods, persons, services and capital is enshrined’ (Article 8A of
the Single European Act), and then, by the Maastricht Treaty (what is now Article 63 TFEU)
which prohibited all restrictions on payments and on the movement of capital between
Member States, and between Member States and third countries as a precondition for the
adoption of the euro, as further discussed in Chapter 6.
2.82 In 1996, I wrote:
In the EU setting, the function of administration of exchange controls should be

redundant. There may, however, still be some setbacks in this process of
liberalization of capital movements. The idea of reintroducing capital controls as a
means of stabilizing exchange rates attracted some interest from the Belgian
Government and from Jacques Delors, the President of the European Commission at
the time, following the speculative attacks on European currencies that ultimately
led to the reform of the Exchange Rate Mechanism of the European Monetary
System (EMS) in August 1993.
And setbacks we have had…Indeed, the legality of the introduction of exchange controls in
Cyprus in 2013 has been the subject of considerable discussion.
Development and promotional tasks
2.83 Central banks in developing countries and emerging economies often fulfil
development tasks, as well. In these nations, the research department of the central bank is
frequently (p. 55) the best and at times the only economic policy research group in the
country.91 The conduct of monetary policy in such economies, in terms of projected goals
and instruments to be used, as well as the links between monetary operations and the
domestic financial structure, are generally different from central banking practices in the
developed world. I wrote in 1996:
In former centrally-planned economies, the transition towards a market economy is

a complex process, where the long-term benefits of market mechanisms are to some
extent overshadowed by the short-term sacrifices, i.e., a painful period of
adjustment that may even cause social unrest. Central banks in these transitional
economies92 are expected to fulfil certain objectives—particularly in terms of
inflation control, maintenance of a sound and competitive banking system and an
efficient payment systems—often with an insufficient array of instruments, lack of
human resources and inadequate institutional structure and legal framework. These
inadequacies harden an already painful period of transition, adding an extra burden
of responsibility to the central bank, which should not be the only agent to blame if
the objectives initially pursued are not accomplished.
2.84 Though these former centrally planned economies have in many cases completed
their transition process, interestingly the phenomenon of ‘overburdening’ (expecting
central banks to do more than they can or more than they should) presents challenges and
problems for central banks both in the developing and developed world in the aftermath of
the global financial crisis.
C. Monetary Stability and Other Central Bank Objectives

2.85 The preamble to the Federal Reserve Act of 1913 (the Act that led to the
establishment of the US Federal Reserve System) is a most illuminating legal provision for
understanding the history of money and central banking, two economic institutions whose
histories converged to some extent during the last hundred years. The preamble reads as
follows: ‘An Act to provide for the establishment of Federal Reserve Banks, to furnish an
elastic currency, to afford means of rediscounting commercial paper, to establish a more
effective supervision of banking in the United States, and for other purposes’ (emphasis
added).
2.86 I refer to this introduction to the Federal Reserve Act in other parts of the book, but
the focus in this section is the mandate given to the Federal Reserve System (the Fed): ‘to
furnish an elastic currency’. Elastic is not stable: elastic means adaptable, the ability to
stretch and then go back to its original form.93 The ‘stability culture’ is in itself a modern
phenomenon, which has influenced legislative developments in recent decades. Indeed, the
US Federal Reserve Act was (p. 56) modified to give due emphasis to the notion of ‘stable
prices’ as an important goal to be pursued by the Board of Governors and the Federal Open
Market Committee.94
2.87 Monetary stability can be defined in positive terms or in negative terms. In positive
terms, monetary stability refers to the maintenance of the internal value of money (ie, price
stability) as well as of the external value of the currency (ie, the stability of the currency vis-
à-vis other currencies, which is, in turn, influenced by the choice of exchange rate regime).
In negative terms, monetary stability refers broadly to the absence of instability.
2.88 In the field of monetary law, economic definitions and theories have often found their
way into the law through the adoption or reform of monetary legislation. In the latter part
of the twentieth century and the first years of the twenty-first century (the global financial
crisis has affected this consensus), it became generally accepted that the primary objective
of monetary policy as an instrument of economic policy should be price stability. Most
modern central bank laws still refer to this goal as their most important objective.95 This
was based on economic theory (vertical Philips curve in the long run and time
inconsistency96 as well as an understanding of the costs of inflation97) and supported by
empirical evidence: independent central banks do a better job than politicians at controlling
inflation.98
(p. 57) 2.89 The economic literature which influenced legal and political developments
relied on a notion of monetary stability that focused primarily on keeping inflation under
control. The standard definition of inflation is that it is a fall in the value of money, not just a
rise in the consumer price index.99 While the Treaty on the Functioning of the European
Union clearly establishes the primary objective of the ECB, it does not give a precise
definition of what is meant by price stability. The ECB’s Governing Council announced a
quantitative definition of price stability: ‘Price stability is defined as a year-on-year increase
in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2 per cent’,
and clarified that, in the pursuit of price stability, it aims to maintain inflation rates below,
but close to, 2 per cent over the medium term.100 A number of voices (including at one
stage the now Governor of the Bank of England, Mark Carney) have expressed support for
moving from inflation targeting to nominal income targeting.101 Though movements
(measured in percentage rate of change) in Consumer Price Indices (CPIs) or Retail Price
Indices have generally been used as a measurement of inflation,102 in recent years there
has also been a debate about the importance of other economic indicators to measure
inflation (such as the rate of unemployment or the growth of nominal gross domestic
product).
2.90 Some economists have expressed concerns about the limitations of using as measures
of inflation price indices of currently provided consumer goods and services. Goodhart, for
instance, suggested some time ago that an analytically correct measure of inflation should
take account of asset price changes, in particular of housing prices and of changes in
financial asset prices.103,104
103 104
William White was one of the few economists to warn about the
(p. 58) impending financial crisis; tellingly he monitored asset prices, not just inflation.105
Loose monetary policy has been blamed as a cause of the financial crisis.106 But how could
this happen during the so-called Great Moderation (the period since the late 1980s when
inflation appeared to have been subdued)?
2.91 At the beginning of the 1990s, the pursuit of monetary stability was considered the
primary objective of the monetary authority, the central bank, given the inflationary
excesses of demand-driven economic policies in the 1970s and 1980s. Governments needed
a brake to avoid taking destructive actions when the siren of inflationary temptation
appeared, and like Ulysses at the mast, central banks around the world were granted
independence to achieve inflation control. One goal: price stability, one instrument:
monetary policy was the recipe adopted almost universally. It was a relatively easy
paradigm to enact legally. Hence, central bank laws were changed to make price stability
the primary mandate and to grant independence to the central bank in the pursuit of this
objective. The Maastricht Treaty made it a condition sine qua non for entry into EMU, and
the International Monetary Fund made it often a ‘condition’ attached to the programmes of
reform that countries submitted in order to get access to Fund financing. And it seemed to
work remarkably well in the fight against inflation. But, as with any economic theory, it had
some fault lines. The first one refers to the primacy of the goal in all circumstances;
inflation is surely a concern in an inflationary environment but not in a deflationary one.
And in the context of the financial crisis 2007–9, central banks main concern shifted from
price stability to the need to restore financial stability. The second fault line refers to the
measurement of inflation. Following Goodhart’s law, any observed statistical regularity will
tend to collapse once pressure is placed upon it for control purposes,107 the measurement
of inflation based on the CPI largely ignored asset prices, in particular house prices, (p. 59)
thus being unable to identify and combat the ‘elephant in the room’, that is a large asset
price bubble that eventually burst in August 2007.108
2.92 Monetary stability can be defined as the lack of instability in the movement of prices.
It refers to the absence of erratic or unanticipated movements in the level of prices through
inflation or through deflation. Rapidly falling prices, the phenomenon of deflation (which
has afflicted the Japanese economy for years and whose real threat in Europe109 and other
countries has triggered much controversy in the aftermath of the financial crisis), can cause
as much ‘instability’ as rapidly rising prices. However, until relatively recently, the studies
of deflation as a phenomenon of monetary instability have been less numerous110 and their
influence on legal developments in this field has been more limited. Hence, the law tends to
reflect a notion of monetary stability as low inflation or keeping inflation under control.
However, the law needs to adjust to reflect the fact that monetary instability can be caused
both by rapidly rising prices and by rapidly falling prices, particularly when such
phenomena are ‘unanticipated’ or when they occur on a continuous basis. (The economic
literature on inflation distinguishes between anticipated and unanticipated inflation, with
the latter having a more pernicious effect upon the economy than the former.)
2.93 Monetary stability is a fundamental economic goal. However, there are other
important economic goals that the government needs to take into account in the design of
its economic policies: growth, employment, and financial stability. The question then arises:
what is the best way of achieving several goals? Up until the global financial crisis, the
solution adopted by the political authorities in many countries was to pursue growth and
employment directly through fiscal policy and other instruments of economic policy—
typically under political instruction—and to delegate the mandate of price stability and the
conduct of monetary policy to an independent central bank. This model relies upon the
pursuit of one goal: monetary stability; and uses one instrument: monetary policy. In the
eyes of many central-banking experts, since monetary policy was essentially a single
instrument, it could not simultaneously be assigned to more than one objective. This is
known as the Tinbergen Rule (named after Nobel Laureate Dutch economist Tinbergen),111
which states that for each and every policy target there must be at least one policy tool. If
there are fewer tools than targets, then some policy goals will not be achieved. If a
monetary tool is assigned two objectives, for example, it is unlikely to achieve both and may
end up achieving neither because of the related compromises necessarily involved.
According to this line of thought, monetary tools are best suited to achieving price stability,
while other policies and mechanisms should be applied to other objectives. Tinbergen’s
(1952) Rule that the number of achievable policy goals cannot exceed the number of policy
instruments suggests that a mechanical monetary policy rule targeting inflation can fail to
achieve the objectives of full employment and price stability.
(p. 60) 2.94 In the USA, the statement of the Federal Open Market Committee of 12
December 2012112 linked the continuation of the Fed’s low interest rate policy and of the
bond purchasing programme (an ‘accommodative stance of monetary policy’) to an
employment objective, in accordance with the Fed’s statutory mandate.113
2.95 A further twist to the definition of monetary stability is provided by its dual
dimension. As indicated above, in addition to the internal dimension, there is also an
external dimension, which refers to the value of the currency. The stability of exchange
rates and the issue of which is the best exchange rate arrangement for a given country
(fixed, floating, or some version of managed float) remain a matter of great controversy in
the economic literature. Since monetary laws tend to reflect the prevailing economic
theories of any given time (path dependency), and since the pendulum has shifted from
fixed to floating114 and back to fixed with all sorts of variations in between (managed float,
dirty floating, fixed but adjustable), the law tends to refer to the external dimension of
monetary stability (the stability of the currency) in rather ambiguous terms.115 We come
back to this issue in the second and third parts of this book.
2.96 Institutions are creatures of their time. When the Federal Reserve System was
established in 1913, the major concern in the USA was financial fragility in the banking
system. At the beginning of the twentieth century, banking crises and panics had caused a
great deal of distress in North America.116 The lender of last resort role of the Fed (discount
window (p. 61) lending) was conceived as an instrument to preserve financial stability. A
key objective of the US Federal Reserve Act of 1913 was to provide a more effective
supervision of banking in the United States; in modern terminology, we refer to this
objective as ‘financial stability’.117 Over the years, the Fed has developed a sophisticated
system of supervision which is also seen by the authorities as an effective instrument to
safeguard financial stability, as I further discuss in Chapters 3 and 4. The history of the Fed
illustrates the vicissitudes of monetary developments. Another important historical
consideration is the experience of deflation in the USA in the 1930s following the Great
Depression. At that time, the early 1930s, the emphasis was on growth and employment,
not on controlling inflation (not dissimilar to the economic situation in the aftermath of the
global financial crisis). Indeed, until the Second World War, during times of peace from
1850 to 1939 inflation was zero. However, for much of the post-war period, policy makers in
developed and developing countries have been worried about rising inflation, especially in
the late 1970s and early 1980s.
2.97 The so-called ‘oil shock’ of 1973—ie, the quadrupling of oil prices which plunged
much of the industrialized world into an era of soaring inflation and low and volatile
growth, known in economic jargon as stagflation—is a historical development which marked
a turning point in the understanding of the need for price stability. The oil shock destroyed
the post-war pattern where governments had tried to buy a little more growth with a little
more inflation (Philips curve), instead entrenching price stability as their primary
concern.118 Hence, the emphasis on price stability is a development that needs to be
understood in a historical context: that provided by the country experiences, economic
policies, and economic thinking which prevailed in the second half of the twentieth century.
This development has had important legal implications nationally and internationally,
particularly in the 1990s, as a substantial number of domestic laws as well as some
international treaties (most notably the Maastricht Treaty on European Union) made this
objective the primary goal of central banks/monetary agencies and as a number of
provisions have been elaborated to hold those institutions accountable for their success (or
failure) in pursuing this goal.
(p. 62) 2.98 Deflation,119 once considered a ghost of the past, has made its reappearance,
and Japan’s experience is an example of its damaging effects.120 Much has been written
about the war against deflation in Japan and the intended and unintended consequences of
the policies undertaken by Japanese Prime Minister Shinzō Abe to reverse years of falling
prices, the so-called ‘Abenomics’. Whether the ‘great monetary experiment’ of aggressive
central bank easing—with a large quantitative easing programme and a 2 per cent inflation
target announced by the governor of the Bank of Japan, Haruhiko Kuroda on 22 January
2013 in a joint statement with the Government121—will succeed in achieving ‘sustainable
economic growth’ remains to be seen. The jury is still out (and fiscal consolidation and
structural reforms are also needed) but the magnitude of the measures taken is a clear
example that inaction against deflation deepens its pernicious effects and prolongs the so-
called ‘deflationary spiral’, a deflationary trap in which expectations of continuing inflation
can be self-reinforcing.122
2.99 The consensus that surrounded the need to delegate control over the money supply to
an independent central bank in the early 1990s was also a recognition of the importance
given to monetary policy. Under the Keynesian policy modalities of the 1950s and 1960s
fiscal policy had primacy and demand management policies (goals of growth and
employment) were prevalent. With an independent central bank, priority is given to a
monetary policy aimed at achieving price stability.
2.100 In Germany, the pre-1999 Bundesbank stated that price stability was the primary
objective. The secondary objective of the Bundesbank was to support the general economic
policies of the Government (including growth and employment). German commentators of
the Bundesbank law referred to this provision of the law (which is also replicated in the
TFEU with regard to the ESCB: supporting the general economic policies of the European
Union, without prejudice to price stability) as the ‘squaring of the circle’, given that such
economic policies could sometimes conflict with the sacrosanct goal of price stability. In the
end, (p. 63) the trade-off between objectives is often a political decision. I wrote in the first
edition of this book:
Perhaps in the twenty-first century we shall witness the emergence of a rebalanced

framework of macroeconomic policy (with fiscal policy regaining part of its earlier
role) that may lead to a realignment of the goals to be pursued by the monetary
authorities, which in turn will lead to a new wave of legal reforms. Though the
importance of monetary stability as a foundation of the economic order, nationally
and internationally, will remain, it may lose the quasi-sacrosanct nature that it
enjoyed during the last quarter of the twentieth century.
Events since 2007 confirm this intuition.123

Institutional arrangements to promote monetary stability
2.101 Though there are other arrangements that can promote monetary stability, such as
legislated monetary rules (akin to the ones proposed by Milton Friedman124), in recent
years increasing attention has been given to the institutional aspects of money and
consequently to those institutional arrangements that can promote monetary stability, such
as independent central banks and currency boards. It is not that the merits of rules
regulating the quantity of money are neglected. Indeed the rules versus discretion
literature125 and the quantity theory of money have inspired not only the economic debate
and the way monetary economics has been taught since the 1970s but also monetary policy
in North America and Europe in the mid 1970s and early 1980s. Monetary targets—ie,
targets of growth for some monetary aggregate, typically announced at the beginning of the
target period—were adopted in Germany and Italy in 1974, Canada, Switzerland, and the
United States in 1975, in Australia, France, and the UK in 1976.126 However, strict
monetary targeting (ie, reliance on rigid monetary rules) was abandoned or modified by the
mid-1980s in the USA and the UK.127
(p. 64) 2.102 In 1998, the UK adopted inflation targeting128 (ie, a numerical target for the
rate of inflation, according to s 12.1 of the Bank of England Act 1998129), while in the USA,
the Federal Reserve has not adopted formally a commitment to a specific, known inflation
target.
2.103 In the context of the rules versus discretion monetary debate, it is interesting to
observe that the advent of central bank independence granted a substantial degree of
discretion (technical, not political) to central bankers within the realm of their legal
mandate to strive for monetary stability. In 1942, in the context the proposals that
eventually led to the establishments of the International Monetary Fund, John Maynard
Keynes famously noted: ‘Perhaps the most difficult question is how much to decide by rule
and how much to leave to discretion.’130 Indeed!
D. Independent Central Banks: Theory and Practice

Introduction: The relations between the central bank and the government
2.104 The relations between the central bank and the government have always been the
subject of much controversy. These relations involve several aspects: ownership, separate
juridical personality, and dependence/independence (which in turn is related to the issue of
control).
2.105 The issue of public or private ownership is of marginal importance these days,
though the ownership of reserves and the allocation of central bank profits can be a source
of contention in privately owned central banks, since the interests of private shareholders
may conflict with the central bank’s public responsibilities.131 A great number of central
banks were nationalized in the twentieth century (eg, the Bank of England was nationalized
in 1946), while others that were newly created were established as public agencies,
typically endowed with public ownership.132
(p. 65) 2.106 Most central banks these days enjoy separate juridical personality, which
means that they can sue or be sued, and are the subject of rights and obligations. The
attribution of separate legal personality is different from the granting of independence in
the exercise of some delegated government functions. While the former relates to its nature
as a person under law (exercising rights and obligations), the latter refers to its insulation
from short-term political pressures in order to achieve certain public policy objectives.
2.107 The issue of legal personality becomes more interesting in complex central banking
systems, such as the US Federal Reserve System or the European System of Central Banks.
2.108 The nature of the Federal Reserve System is intricate. The primary components of
the Federal Reserve System are the Board of Governors and the twelve regional Federal
Reserve Banks.133 The Federal Reserve System itself is not an entity; the entities with legal
personality are the Board of Governors, which is a federal government agency (ie, a public
body) created by Congress and accountable to Congress, and which performs
administrative functions134 (central banking functions), and the twelve Federal Reserve
Banks, which are separate legal entities,135 privately owned,136 organized as corporate
entities and with a different legal personality each. The Federal Reserve Banks perform a
duality of functions: central banking functions137 on the one hand (eg, administration of
monetary and credit policies) and corporate functions proper of a bank on the other (eg,
managing depository accounts for other banks).138
2.109 Complexity also characterizes the ESCB, which is composed of the ECB and the
national central banks (NCBs), as further discussed in Chapter 7. Neither the euro system
(which comprises the ECB and the national central banks of the Member States that have
adopted the euro) nor the ESCB have legal personality, and, therefore, they are not carriers
of rights and obligations. The entities that do have a legal personality are the ECB and the
NCBs.139 The legal position of the ECB and its independence have been the subject of much
debate in recent years. The European Court of Justice has defined the limits of the
independence of the ECB in the OLAF case,140 which is further explored in Chapter 7.
Article 13 of (p. 66) the Treaty on the European Union (TEU) clarifies the legal position of
the ECB, which is listed among the EU institutions. Pursuant to Article 282(3) TFEU, ‘[t]he
European Central Bank shall have legal personality. It alone may authorise the issue of the
euro. It shall be independent in the exercise of its powers and in the management of its
finances. Union institutions, bodies, offices and agencies and governments of the Member
States shall respect that independence.’
2.110 The NCBs act in a dual capacity.141 On the one hand they are the operational arms
of the ESCB when carrying out operations that form part of the tasks of the ESCB. On the
other hand, they are national agencies when performing non-ESCB functions.142 For these
reasons, while the law governing the ECB is solely EU law, the laws governing the status of
the NCBs emanate not only from EU sources, but also from their respective national
legislation. Furthermore, there are substantial differences between the range of functions
and responsibilities assigned to each NCB in the various jurisdictions that comprise the
euro area. In terms of capital structure, it should be noted that the NCBs are the ECB’s sole
shareholders.
2.111 To dissect the notion of independence, let us first consider the question of
independence from whom. In exercising its responsibilities, the central bank can be
dependent on, or independent from, the political instruction of the government, though in
the case of central banks with supervisory responsibilities, it is also independence from the
financial institutions to avoid regulatory capture. Dependence implies subordination to the
dictate of the political authorities. Independence aims to insulate the central bank from
short-term political influences, though independent central banks are still subject to some
degree of control over their activities by the government.143 They are also accountable as I
further discuss below.
2.112 Before the advent of central bank independence, the relationship between the
Treasury or Minister of Finance (MOF) and the central bank was a principal–agent type of
relationship in which the Treasury or MOF instructed the central bank what to do, and the
latter was subservient to the wishes of the former, whether that meant to finance
government deficits, or to use interest rate policy for a variety of government objectives.
(p. 67) 2.113 One problem with the ‘political argument’ in favour of central bank
independence is that its logic could theoretically justify the ‘depoliticization’ of other
economic policies, converting a democracy into a technocracy. Holtham claimed in 1993:
If monetary policy can be taken out of politics, why not take fiscal policy, too? In
fact, there is much more international evidence of fiscal policy being manipulated
for electoral ends than in the case with monetary policy. Yet, no one proposes that
fiscal policy should be put in the hands of independent functionaries.144
2.114 Having answered the question of independence from whom, let us then consider the
question of independence in what. The intellectual edifice of central bank independence has
been constructed upon the conduct of a price-stability oriented monetary policy (monetary
independence). However, the scope of independence can also be extended to other central
bank functions, either because their functioning is intimately linked to the conduct of a
price-stability oriented monetary policy or because the law says so (ie, the law specifies that
the central bank is independent in the conduct of all of its functions). Three observations
ought to be added. To begin, the central bank is necessarily ‘dependent’ in some functions,
for instance when it acts as an agent of the Treasury in the carrying out of foreign exchange
operations or when it acts as fiscal agent. Secondly, with regard to the pursuit of monetary
stability, central bank independence is limited to its internal dimension, ie, price stability.
The external dimension of monetary stability (concerning the exchange rate and the
formulation of exchange rate policy) generally rests with the government, even though its
implementation is often entrusted to the central bank.145 Thirdly, the goal constraint
effectively provides a delimitation of the contours of independence. Central bank
independence—in line with the theory of delegated powers—has to be understood within
the context of the goals that the institution is required to pursue, which are important
public goals needed for the proper economic functioning of the State. While maintaining
price stability is a fundamental goal, it is rarely—if ever—the sole objective. Financial
stability is also a key goal for central banks and other agencies. And if public funds are at
stake, central bank independence in the pursuit of financial stability is limited by the
government’s necessary involvement in the destiny of the financial institutions that have
received government assistance. Though the case for supervisory independence is gaining
momentum, as I explain below, supervisory independence is not the same as monetary
independence.
The case for monetary independence
2.115 Central bank laws in numerous jurisdictions granted independence or greater
operational autonomy to their central banks with an explicit price stability mandate in the
last decade and a half of the twentieth century. Central bank independence became a kind
of ‘graduation issue’ for countries wishing to exhibit or consolidate their credentials in
monetary stability and fiscal restraint.
(p. 68) 2.116 The movement towards enhanced independence for central banks was
supported by a nearly overwhelming consensus among scholars146 and policy makers that
independent central banks were desirable from the standpoint of public policy. The
argument for ‘monetary independence’ (ie, central bank independence in the pursuit of a
price-stability oriented monetary policy) is relatively straightforward. Inflation has no long-
range welfare benefits. But it does have significant costs. These costs include distortions in
economic activity, the costs of re-pricing real assets according to a changing nominal price
level, the costs of the effort people have to undertake to avoid losing the value of their
financial claims, and, in cases of very high inflation, the subtle but pervasive effects of
social demoralization.147 Because inflation is unequivocally bad for a society, everyone
would be better off if the political institutions maintained stable prices.
2.117 Experience has shown that political institutions often do not maintain stable prices.
They have several powerful incentives to expand the money supply beyond the rate of real
growth in the economy. In non-democratic societies, the control of the money supply is an
important instrument of economic policy that can address various political needs, most
notoriously the financing of government needs. In a democracy, political parties try to
appeal to various constituencies and, in their eagerness to increase economic activity, the
incumbent party may engage in inflationary policy in the period immediately before an
election in order to raise employment, and create a strong, if temporary, sense of euphoria
among voters that translates into votes for the politicians then in office.148
2.118 It is against this background that independent central banks found their
contemporary justification: monetary independence was conceived as a means to achieve
the goal of price stability.
2.119 Making a central bank independent interferes—to some extent—with the sovereign’s
right concerning the creation and regulation of money (lex monetae). Article I, section 8,
clause 5 of the US Constitution gives Congress the power ‘to coin money, regulate the value
thereof, and of foreign coin’.149 Congress delegated some powers to the Federal Reserve
System (p. 69) when it enacted the Federal Reserve Act in 1913. It is this first ‘democratic
act’ (passage of legislation by Congress) that gives legitimacy to the functions and
operations of the Federal Reserve System. The nature of delegated powers is fundamental
to frame independence within the existing system of checks and balances, and to
understand its constitutional scope and the nature of its limitations. Central bank
independence is not absolute, but relative. Central bank independence has an instrumental
nature, as a means to achieve a goal, namely price stability, a goal which is desirable for the
economic running of the State and for the welfare of society.
2.120 Central bank independence has been the preferred institutional arrangement to
promote monetary stability since the end of the 1980s and beginning of the 1990s. A
number of factors contributed to this development. In the European Union, the Maastricht
Treaty on European Union made legal central bank independence a conditio sine qua non to
participate in EMU, in addition to the four criteria of economic convergence and the
additional requirements regarding fiscal responsibility. In developing countries and
emerging economies, governments were strongly advised and sometimes compelled (eg, via
a ‘recommendation’ of the International Monetary Fund) to grant autonomy or
independence to their central banks.150 Central banks around the world have become by
law less subordinate to the dictate of political authorities.
2.121 The phenomenon of ‘independence’ is not, however, unique to central banking. It is
a feature inherent in an administrative law tradition in which certain powers are delegated
to certain agencies, with regulatory powers, as is further discussed below. This feature of
functional decentralization used to be considered more acceptable in those countries which
also favoured geographic decentralization (ie, a federal structure, such as the USA or
Germany, with power divided between the centre and the States (Länder in the case of
Germany)). The skills, expertise, and superior qualifications of technocrats (central bankers,
energy regulators, etc) compared with those of politicians with regard to the conduct of
their delegated functions, reinforce the case for independence.
2.122 Despite the economic merits of central bank independence,151 the actual decision to
grant independence is a political one. Relations between central banks and governments
have not always been easy. Indeed, quite often they are rather confrontational. The link
between economics and politics is a difficult and complex one, which changes across
countries and over time. This is true both for developed and for developing countries.
Monetary (central bank) independence is a way of accomplishing a partial depoliticization
of the money supply process, which provides an intermediate solution between full
depoliticization, as advocated in the free-banking proposals, and politicization, in which all
economic policy is under governmental control.
2.123 Legal guarantees concerning the organization and functions of central banks on the
one hand and the integrity and professionalism of central bankers on the other hand are an
(p. 70) important measurement of legal central bank independence. The incentive structure
of independent central bankers is different from that of elected politicians. Political
economy and political science have contributed to the understanding of this ‘incentive
structure’. However, these incentives need to be enshrined in the law in order to be
effective and enforceable.
The legal articulation of central bank independence
2.124 I recommend that the following elements be included in a law that truly safeguards
central bank independence:152 (1) declaration of independence; (2) organic guarantees and
professional independence; (3) functional or operational guarantees; (4) the ‘economic test
of independence’ (ie, the central bank’s ability to withstand government pressure to finance
government deficits via central bank credit); (5) financial autonomy; and (6) regulatory
powers.
Declaration of independence
2.125 A provision declaring that the central bank will be independent or autonomous from
the Government and that interest rate decisions will not be politicized.
Organic guarantees and professional independence
2.126 A number of provisions regulate the organization of the central bank and its
institutional relationships with the Government. I call these provisions ‘organic guarantees’
of independence,153 though some of the measures advocated also protect the scope of
‘professional’ or ‘personal’ independence. In particular, a law on central bank independence
should guarantee security of tenure (typically for a period of time longer than that held by
legislators) and well-defined appointment and removal procedures for central bank board
members. The provisions relating to the appointment, dismissal, and term of office of the
Governor and other central bank officials will give an indication of the degree of
dependence or independence that the government wishes to grant to the central bank.
There is an extensive literature on the need to provide for what we can call ‘pluralistic’
appointment procedure, to avoid politicization. Accordingly, membership of the central bank
governing bodies can be based upon (a) region, (b) sector and/or (c) expertise. In a
geographically decentralized structure of government (such as a federal country),
membership on the basis of region is important so as to represent the various interests of
various parts of the country (or Union, as in the case of the EU). Membership based upon
sector refers to the inclusion of the various sectors of the economy: industry, commerce,
agriculture. For instance, in the USA, the Federal Reserve Banks have a Board of Directors
with nine members each (and the president of each Federal Reserve Bank must be a person
of ‘tested banking experience’). Of those nine (p. 71) members, three members are known
as Class A Directors, who are required to be representatives of the member banks, and may
themselves be bankers. Three others are designated as Class B Directors, and must
represent industry, commerce, and agriculture in the district and must not be officers,
directors, or employees of any bank. The remaining three comprise the Class C Directors
and are appointed by the Board of Governors of the Federal Reserve System. In the UK the
main criterion for membership of the Monetary Policy Committee is expertise in either
monetary policy, financial markets, or the running of the economy in general (at the macro
or micro level). The ESCB combines a geographic criterion (because of the composition of
the European Central Bank and the national central banks) and criteria based on expertise
(the members of the Executive Board must be selected among ‘persons of recognized
standing and professional experience in monetary or banking matters’).
2.127 Another recommendation is for ‘professional independence’, which is enhanced by
the appointment of qualified candidates, well versed in monetary economics and central
banking theory and practice. Professional independence is also safeguarded by the
establishment of a list of incompatible or disqualifying activities so as to prevent conflicts of
interest. For instance, while in office central bankers should be precluded from
simultaneously holding private-sector jobs. Central bank officials should perform their
duties on a full-time basis (with the possible exception of academic/university
engagements). A central banker should not be simultaneously a financial adviser, an
employee or a shareholder of a bank, or a member of parliament, as those occupations
would engender conflicts of interests. Central bank officials should also be limited in
pursuing private employment in credit and financial institutions for a reasonable period
following their term of office. These restrictions are designed to preclude their
susceptibility to ‘private’ incentives while in office. Such provisions are particularly
necessary to avoid the ‘capture’ of the regulator by the regulated institutions (the so-called
‘revolving door’).
2.128 A further safeguard of professional independence refers to the procedures for
dismissal of central bank officials. Grounds for dismissal should be clearly defined in the
law, including criminal offence or serious misconduct and permanent incapacity. Grounds
for dismissal should not include ‘displeasure’ with central bank actions, or criticism that the
Governor or other members of the governing bodies are not fulfilling their obligations.
Functional or operational guarantees
2.129 The central bank law should include what I refer to as ‘functional’ or ‘operational
guarantees’ of independence, that is provisions that grant the central bank room for
manoeuvre with regard to the carrying out of its functions and operations, without
government interference.154 The law should provide provisions that safeguard the central
bank’s decisional autonomy in the exercise of this fundamental monetary policy function. A
dependent central bank is required to secure prior government approval of its monetary
policy decisions. An independent central bank does not require such prior approval.
Therefore, clear provisions regarding the instruments of monetary control (monetary
operations) available to the independent central bank are needed. Market-related (indirect)
instruments (p. 72) of monetary control, such as discount policies and open market
operations, are to be preferred over direct instruments of monetary control, such as credit
ceilings or interest rate controls. (However, reliance upon market-related instruments
needs to be accompanied by the development of the money market, as stated earlier.) With
regard to the proper understanding of ‘functional independence’, it is important to bear in
mind that most countries’ central banks do not have ‘goal independence’ (ie, the ability to
choose the goal; the Fed does have this type of independence within the constraints of its
statutory mandate), but ‘instrument independence’ (ie, the ability to choose the instruments
necessary to achieve the goal).155 The ‘goal constraint’ as I further discuss below is an
important limitation of central bank independence.
Economic test of independence
2.130 The key economic test of independence is the central bank’s ability to withstand
government pressure to finance government deficits via central bank credit. In this respect,
the central bank law should include provisions prohibiting or limiting the central bank’s
lending to the public sector. A truly independent central bank should be under no obligation
to extend credit to the government.156 This provision and others related to fiscal restraint
are further discussed with regard to the European Union in Chapter 8 and in the context of
the responses to the sovereign debt crisis in the euro area.
Financial autonomy
2.131 An independent central bank should be able to adopt its internal budget, in
accordance with criteria defined in the law so as to ensure that the bank’s expenditures are
reasonable. This criterion of financial autonomy was tested at the EU level in the OLAF
case. The European Court of Justice clarified that, though the ECB has its own resources
and budget (not included in the Community budget),157 it does not mean that it is exempt
‘from every rule of Community law’. Hence, the ECB is not exempt from the anti-fraud
investigations conducted by the Commission’s anti-fraud office (OLAF). Article 282,
paragraph 3 TFEU recognizes that the ECB is ‘independent in the management of its
finances’, as I further discuss in Chapter 7.
Regulatory powers
2.132 The power to issue rules and regulations is a measure of the autonomy (ability to
give rules to itself) of an agency. However, while in the USA this rule-making power of
independent regulatory commissions is consistent with the administrative law tradition of
the country, the legitimacy of rules and regulations issued by the central bank (or by an
independent agency) and not directly by the government was a contentious issue in civil law
countries. In the USA, rule-making is the administrative counterpart of what a legislative
body does when it enacts a statute. In the case of the Federal Reserve System (the Fed), the
Federal Reserve Act gives authority to the Fed to issue rules that are binding on depository
institutions and other institutions under its scope of influence (ie, limited application). Such
rules are codified in the Code of Federal Regulations (p. 73) (CFR) published in the Federal
Register by the Executive departments and agencies of the Federal Government.158 The EC
Treaty gives rule-making powers to the ESCB. Article 132 TFEU states that in order to
carry out the tasks entrusted to the ESCB, the ECB shall issue regulations (with general
application and binding in their entirety and directly applicable in all Member States),
decisions (binding in their entirety upon those to whom they are addressed), and
recommendations and opinions (the latter two with no binding force).
The limits of central bank independence
2.133 The notion of independence that I advocate is one developed in a paper co-written
with Geoffrey Miller in 1999.159 By an ‘independent’ central bank, we mean a particular
kind of institution that is independent in some respects, but highly constrained in others. In
particular, an independent central bank is relatively free of short-term political pressures:
its officers serve for long periods and may not be removed from office for disagreements
over policy with other government officials, and it does not take orders from any other
institution. In this respect it enjoys a high degree of autonomy. At the same time, an
independent central bank is constrained by its statutory goal or goals.
The goal constraint: The case against ‘absolute’ independence
2.134 Independent central banks remained constrained by their statutory objective or
objectives. Sometimes the objective is defined in narrow terms as a numerical target and
some others in broad terms. In some jurisdictions, most notably in the USA, the central
bank’s mandate may encompass several objectives, rather than a single or primary goal. As
mentioned earlier, the Fed is required by law to pay attention to a variety of unranked
targets, including stable prices, growth, and employment. Since independent central banks
can seldom choose their goals, the discussion about central bank independence mainly
focuses on the scope of powers delegated to central banks for the achievement of their
statutorily defined objectives.
2.135 The independent central bank can be seen as a form of pre-commitment by the
political system to tie its hands, like Ulysses at the mast, to avoid taking destructive actions
when the siren of inflationary temptation appears. If the central bank is truly independent
of the political cycle, and is truly committed to the goal of maintaining price stability
(monetary independence), it will not be subject to the pressures that tend to generate
inflation when monetary policy is in the hands of political actors. There is some evidence
that, in fact, this theory has practical merit: in the developed world, at least, independent
central banks tend to have a somewhat better record of achieving price stability than their
non-independent counterparts.160
(p. 74) 2.136 The case for monetary independence is often presented as a virtual absolute.
That is, the theory recognizes no limits on central bank independence, so long as the bank
itself is reliably pre-committed to achieving price stability. Taken at face value, the theory
would suggest that central banks should be completely insulated from politics. But this is
not the case in the real world. Even highly independent central banks, such as the Federal
Reserve Board, the pre-1999 Bundesbank, or the European Central Bank, do not enjoy this
kind of independence. Although they operate with a high degree of protection from political
pressures, they are far from isolated from the political process. And while maintaining price
stability is typically the primary goal of such institutions, it is rarely—if ever—the sole
objective.161 As discussed earlier, the charters of these banks often also contain clauses that
permit or require them to consider other objectives, such as maintaining the stability of the
financial system, enhancing employment, facilitating economic growth, and so on.
Moreover, even if the central bank charters purported to establish absolute independence,
they are only pieces of paper. A legislative charter can always be revised by subsequent
legislation; and even if the charter is embodied in a national constitution, the constitution
can always be amended or ignored. It is obvious that there are limits to central bank
independence in the real world, however much the economist’s pure theory might question
the rationale for such limits. Why do we observe, in fact, considerably less independence
than would be suggested by orthodox economic theory? Three answers suggest
themselves.162
2.137 First, it might be that the observed limits on the independence of central banks
around the world are the results of political compromise. Politicians may recognize that an
independent central bank provides significant benefits. If they are public-spirited, they will
understand and support the role of the independent central bank as a form of pre-
commitment to price stability even in the face of considerable political temptation. The
current cynicism about politics overlooks the fact that some politicians might actually wish
to be in office in order to deliver long-lasting prosperity for the country and that therefore,
they will not sacrifice that long-term goal for the short-term benefits of inflationary policies.
But even if politicians are purely self-interested, they may find a degree of central bank
independence to be in their interests, either because an autonomous bank can be blamed as
a scapegoat for failed or unpopular policies, or because the price stability that an
independent central bank can ensure allows the politician to milk interest groups for larger
financial support in the short run.163 However, these motivations that a politician may have
to favour independent central banks are likely, in the real world, to be counterbalanced by
conflicting motivations to acquire, maintain, and exercise power. Control over the price
level is one of the most important powers of any government, and politicians are likely to
give up that power only reluctantly—especially because politicians themselves tend to be
people who like and desire power. Thus, some limits of central bank independence are the
result of political compromise.
(p. 75) 2.138 A second possible explanation for the observed limits on central bank
independence is based on simple necessity. While an absolutely independent central bank
may be an appealing idea from a policy standpoint, in practice, institutions must be able to
operate. For example, the central bank must have officers to direct its operations. These
officers must be appointed somehow. One might suppose that to achieve maximum
independence from the political process, the officers could be appointed through some
ostensibly non-political process—for example, they might be selected by a panel of experts
who are not politicians, or vacancies may be filled by the incumbent officers. Yet it requires
little thought to realize that these alternative selection mechanisms are not themselves
immune from political influence. Members of the nominating panel must themselves be
nominated; and all parties involved in the process are human beings who are subject to the
normal pressures of friendship, loyalty, and inducement. And even if politics in the narrow
sense does not play a role, the process of insulating the officers of the central bank from
political influence also removes an important check on their behaviour, and thus allows the
bank’s officers greater flexibility to ignore the goal of price stability in the service of other
objectives. As a practical matter, politics has to play a role in the activities of central banks:
the goal of complete insulation from politics cannot be realized. In an imperfect world,
some compromise with the ideal of central bank independence is a practical necessity.
2.139 A third possibility is that the ideal of central bank independence is not an absolute
even in theory, even if we could overcome the political and practical impediments to
creating a fully independent central bank. If central bank independence—and the price
stability that such independence seeks to achieve—were unambiguously good in all
circumstances, it would be good social policy for the central bank to be replaced by a
computer that was programmed to achieve price stability in any and all circumstances, set
in motion, and equipped with fail-safe mechanisms to deter any future tampering with its
operations. If such a machine were to be constructed, as long as prices remain stable, the
element of human intervention would seem to be irrelevant. Such a central bank would be
both completely autonomous and absolutely goal-constrained. This machine, of course, does
not exist in reality, but we can construct it imaginatively in order to investigate the
theoretical point.164
2.140 Most people would not be comfortable with this level of independence in the central
bank. Even if we generally accept the economists’ view that price level stability is a good
and desirable thing, the idea of committing a central governmental function to a mechanical
operation appears bizarre and undesirable. Intuitively, it is not an appealing idea. This
intuition appears to be supported by observations described above of the structure of
central banks around the world. Although most of the world supports the concept of
independent central banks, no country has attempted to achieve the level of independence
of our hypothetical computer.165 It may be that these limits to central bank independence
reflect genuine concerns of social policy as well as the influence of politics or practicality.
The increasing complexities of monetary and financial management imply an expanding
two-way flow of consultation and cooperation between the central bank and the
government.
While a very high level of central bank independence is highly desirable, complete
independence is not, even if it could be achieved.
(p. 76) Democratic legitimacy
2.141 There are two principal limits on central bank independence that all democratic
societies should maintain. One of these limits of central bank independence principally
concerns the limitations of the goal, ‘the goal constraint’, an issue which is discussed in the
first section of this chapter. Important as stable prices are in ordinary times, the
commitment to preventing inflation should not impair a nation’s ability to respond to
fundamental threats or basic changes in its identity or extraordinary circumstances. The
other limit refers to the issue of democratic legitimacy, an issue which is surveyed below,
and which is related to the debate about central bank accountability. A democratic society
always retains the discretion to reinvent itself; and should the people of a country make a
considered, deliberate choice to seek some other goal, the institutions of central bank
independence should respect that decision.166
Ordinary versus extraordinary times
2.142 In ordinary times, countries do not face profound threats to, or alterations of, their
basic identity. Ordinary times are structured around more limited disputes that do not go to
the identity of the nation or to its basic security. In extraordinary times, when a country’s
basic identity or survival is at stake, as illustrated below with the example of Germany, the
government may need to raise revenues very quickly and efficiently in order to provide the
necessary funding for the enterprise. One means of raising revenues quickly is through
seigniorage167 (ie, the margin between the nominal value of the notes and coins issued and
the costs of their production), which can be rather substantial in the current system of fiat
money, paper money inconvertible into gold or other precious metals, as discussed earlier.
2.143 Seigniorage can be conceived of as a form of taxation. Like any tax, seigniorage
raises revenues to finance government operations. And like any tax, seigniorage introduces
distortions into economic activity. The utility of seigniorage increases when the demand for
government funds is sudden and unanticipated. There are two crucial differences between
seigniorage and ordinary taxes: the timing of their imposition and the fact that seigniorage
does not require parliamentary approval, while ordinary taxes do. Seigniorage taxes can be
imposed very quickly. Conventional taxes, however, require a much longer lead time. They
often require authorization from the parliament or other legislative body. Such a process
can be time-consuming, especially when interest groups enter to seek advantages for
themselves in the tax package being drafted. Even after new taxes have been imposed, the
collection process requires a substantial lead time, since the entities being taxed must be
given notice of their obligations and time to respond. The upshot is that, if the government
needs money quickly, seigniorage is likely to be preferable to ordinary taxation as a
temporary measure.
2.144 The cost of obtaining seigniorage revenues through inflationary finance is, of
course, inflation. But some level of inflation may need to be tolerated in order to achieve the
government’s compelling need to raise money quickly in times of crisis. Yet the government
(p. 77) cannot always be relied on to use the power of inflationary finance only when this
course is indicated by extraordinary circumstances. Seigniorage is a highly tempting means
of raising revenues to finance ordinary government operations, or to subsidize powerful
interest groups. Because its effects are pervasive—felt by the public in the form of price
increases—the actual interests that benefit from the policies can often be disguised. And
because the inflation tax can ordinarily be imposed by the monetary authorities without the
need for parliamentary approval or the consent of other government agencies, the inflation
tax may be politically easier than conventional taxes. Some features of central bank
institutional design can be understood as attempting to deal with the problem of how to
limit the government to imposing inflation taxes only in extraordinary times. For example,
many central bank laws contain strict prohibitions against central bank lending to the
government (the economic test of independence). These prohibitions are intended to
prevent the government from inflating the economy during ordinary times.
2.145 The problem of institutional design is how to distinguish the ordinary times from the
extraordinary ones. Can the financial crisis that commenced in 2007 and reached its zenith
in September 2008 be considered such an ‘extraordinary time’, one that justifies a
departure from regular principles of central bank operations? I tend to side with those that
contend that in 2008 we were living in extraordinary times, with a real danger that the
whole financial system would implode.168 Hence, central bank actions during that period
ought to be examined under this prism.
2.146 Indeed, in order to understand the expansionary monetary policy and
unprecedented liquidity assistance that the Fed provided during the 2007–9 crisis, it is
important to bear in mind that former Chairman Ben Bernanke, a student of the Great
Depression, clearly wanted to avoid a repeat of the 1930s. Milton Friedman and Anna
Schwartz in their authoritative Monetary History of the United States had advanced the
idea that the Great Depression had been triggered by the central bank’s reduction in the US
money supply from 1928 until the early 1930s.169 Chairman Bernanke’s intimate knowledge
of how the policies of the Federal Reserve System contributed to the crisis and exacerbated
the recession following the stock market crash of 1929 were clearly behind the Fed’s
decisive stance against the great financial crisis of the twenty-first century.
2.147 In extraordinary times, extraordinary measures are justified and restrictions can be
eased. The problem of course with justifying extraordinary measures is that by definition
such measures must be limited in time. Coming back to ordinary times—and the
corresponding abandonment of such extraordinary measures—is not always easy, as
exemplified by (p. 78) the debate that has surrounded ‘QE tapering’, the end of QE in
October 2014 (as discussed in paragraph 2.35), and the return to ‘normal’ monetary policy
instruments. That is also why accountability mechanisms are particularly important during
‘extraordinary times’.
Historical example: the limits of the independence of the pre-1999 German Bundesbank
2.148 The pre-1999 German Bundesbank has often been regarded by commentators and
policy makers as the bastion for price stability in Germany and a symbol of monetary
discipline around the world. The anti-inflationary record of the Bundesbank was typically
cited in the literature as the quintessential example of the inverse relationship between
inflation and central bank independence. However, even the most independent of central
banks has limits, as the history of the Bundesbank over the years proves.
2.149 In 1957, the Bank Deutscher Länder that had been set up by the Allies in 1948, as a
federally organized, provisional central banking institution in the western occupied zones,
was transformed into the Bundesbank through the enactment of the Bundesbank Law.170
The federal structure of the Bank Deutscher Länder (modelled upon that of the US Federal
Reserve System) was maintained in the Bundesbank, and the idea of independence was
embedded in the new legislation. This double degree of decentralization of power:
geographic (federalism) and functional (independence), satisfied the US occupying
authorities that wanted to establish strong institutional mechanisms against a possible
totalitarian backlash. However, the aim of stability (Stabilität), which became enshrined in
the 1957 Law, was not new. As David Marsh emphasizes in his excellent book on the
Bundesbank, ‘Stabilitätspolitik [in Germany] transcends the boundaries between
dictatorship and democracy’.171 Indeed, the German visceral hate for inflation and their
unwavering support for monetary stability dates back to the disastrous experience of
hyperinflation in 1923 in an economy already overburdened with onerous war debts and
reparations.172 Enormous popular discontent at the time paved the way for the rise of
National Socialism, with its dire consequences for the German nation. Adolf Hitler came to
power promising currency stability to the German people, though he eventually sacrificed it
(as well as the independence of the Reichsbank) because of the needs of the armaments
policy first and war thereafter.173
2.150 The provisions in the 1957 Bundesbank Law that encapsulate the idea of
independence for the sake of monetary stability were Articles 3 and 12 (modified after the
ratification of the (p. 79) Treaty of Maastricht).174 According to Article 3: ‘The Deutsche
Bundesbank regulates the amount of money in circulation and of credit supplied to the
economy, using the monetary powers conferred on it by this Act, with the aim of
safeguarding the currency, and sees to the execution of domestic and external payments.’
According to Article 12: ‘Without prejudice to the performance of its functions, the
Deutsche Bundesbank is required to support the general economic policy of the Federal
Cabinet. In exercising the powers conferred on it by this Act, the Bank is independent of
instruction from the Federal Cabinet’ (emphasis added).175
2.151 Though the Bundesbank Law entrusted the Bundesbank with ‘monetary powers’
with the ‘aim of safeguarding the currency’, those monetary powers were in fact restricted
to one instrument: the ability to raise and lower interest rates. The room for manoeuvre for
the independent Bundesbank was monetary policy. Exchange rate policy remained in the
hands of government. Former German Chancellor Helmut Schmidt had written in his
memoirs that ‘he regarded exchange rate policies…as important elements of general
foreign and strategic policy.’176 As discussed in paragraph 2.71, the exchange rate is not
only an anchor of external price stability but an important element in other governmental
economic policies, linked to the trade and employment objectives of a country, and with a
clear impact upon its external competitiveness. However, the need for co-ordination
between monetary policy—the internal dimension of monetary stability—and exchange rate
policy—the external dimension of monetary stability—cannot be ignored by independent
central bankers. Disputes over the exchange rate have been a frequent source of discord
between the Bundesbank and the Government. In these disputes, the government typically
prevailed, in particular when a greater national objective was at stake as, for instance, in
the case of German reunification, when the conversion rate between the Ostmark and the
Deutschmark was fixed at one to one for political imperatives, against the Bundesbank’s
advice. There have been other instances throughout its history in which the Bundesbank
has opposed unsuccessfully exchange rate policies pursued by the government. For
instance, in 1961 the Bundesbank opposed the Deutschmark revaluation, but was forced to
change its mind by the economics minister at the time, Ludwig Erhard.177 Nonetheless, the
government learnt over the years that discord with the Bundesbank could be destabilizing
for the political party in power.178 In 1969, the Deutschmark was re-valued after the
Bundesbank’s proposal was at first rejected by the Bonn government. The row helped
precipitate the defeat of Chancellor Kurt Georg Kiesinger.179
(p. 80) 2.152 The Bundesbank’s room for manoeuvre (ie, independence) was seriously
curtailed in the last decade through two major historical developments: German unification
and European Monetary Union. In the case of German unification, the interest at stake was
national identity, not price stability. The ERM (the exchange rate and intervention
mechanism of the European Monetary System (EMS)) was sacrificed in order to achieve a
greater national objective: the unity of the German people. In the case of EMU,
supranational integration was considered to be more important for the future of the
German nation than the maintenance of an independent central bank.
2.153 The fall of the Berlin Wall was an event of tremendous symbolic importance in the
history of Germany and in the history of Europe. Chancellor Kohl seized the historical
opportunity of bringing unity to the German people with courage and decisiveness, as well
as improvisation. The Chancellor had vision, but lacked a coherent blueprint of how to
accomplish unification. This is particularly evident when talking about monetary unification
(1 July 1990) which preceded full political reunification (3 October 1990). The timing of it
took everybody by surprise, including the Bundesbank. Kohl’s political instinct cautioned
him against long negotiations that could have dragged on for years, and possibly, hampered
the prospect of unity. The Bundesbank had expressed its view that the process of monetary
unification could not be rushed. However, the decision to go ahead was indeed ‘rushed’ and
on 6 February 1990 Kohl proposed ‘immediate’ talks on extending the Deutschmark to East
Germany. The Bundesbank opposed the conversion rate of one to one, based on sound
economic logic.180 But the government did not listen and went ahead with such parity: ‘One
for one, or else we will never be one.’ In 1991, Bundesbank President Karl Otto Pöhl
resigned. In his formal departure speech in August 1991,181 Pöhl reminded his audience
that when he had taken office, he had acknowledged that the Bundesbank, for all its
independence was legally required to support the government’s overall economic policies.
But he criticized the economic consequences of reunification: Germany was suffering a
‘homemade’ acceleration in price rises resulting from the failure to increase taxes to
finance German unity, a development that the Bundesbank had warned against, though
unsuccessfully.
2.154 Throughout the process of European monetary integration, the Bundesbank’s belief
that the abandonment of the Deutschmark (or any watering down of its Stabilität
credentials) would lead to a weaker and more inflation-prone European currency, helps
explain its lack of enthusiasm, or even reluctance in some instances, towards the advent of
monetary union in Europe and, in particular, towards the speed with which politicians
proposed to advance (p. 81) to it. In 1978, Chancellor Helmut Schmidt and French
President Valéry Giscard d’Estaing reached an accord to form a Franco-German zone of
monetary stability, which gave rise to the EMS. The Bundesbank expressed its misgivings
about the setting up of the EMS, fearful that the new system might undermine the pursuit
of monetary stability. In November 1978, Helmut Schmidt visited the Bundesbank to
persuade its members of the need for greater monetary cooperation in Europe. The
Chancellor reflected on the active role that Germany should play in this endeavour and
suggested that if the Bundesbank were to oppose the signing of the agreement setting up
the EMS, he might ask parliament to reduce the central bank independence through a
change to the Bundesbank Law.182 The goal here was supranational (European) integration
not price stability, Schmidt reminded his audience. The fear of Germany for itself and the
fear of France for Germany cannot be ignored in any discussion about the history of
European integration after the Second World War. Indeed the Treaty of the European
Economic Community which was signed in Rome in March 1957 (the very same year in
which the Bundesbank Act was passed by the German Parliament) as well as subsequent
revisions of the Treaty—in particular the Maastricht Treaty on European Union—have not
been alien to these fears. The political agenda in both France and Germany—indeed the
political agenda in the construction of Europe—has always been mindful of the need to
channel and contain the mighty power of Germany (political and economic) within a context
of European integration.
2.155 The Bundesbank was mostly concerned about its daily fight against inflation.
European integration has been a government’s goal, not a central bank goal.183 The
progress towards monetary union was tainted with incidents of discord between the Federal
Cabinet and the Bundesbank. In 1987, for instance, there was a discord over the setting up
of a Franco-German finance and economic council as part of a bilateral treaty to
‘harmonize’ economic policies between the two countries. The Bundesbank feared that such
a committee might compromise its independence. In the years that preceded the signing
and entry into force of the Maastricht Treaty (from 1988 to 1992–3) there were some
disagreements with Chancellor Helmut Kohl over European Monetary Union. The
Bundesbank, loyal to its tradition of monetary stability, tried to shift the discussion away
from the ‘political’ argument for EMU and towards the ‘technical’ discussion of what
economic conditions needed to precede the advent of monetary union. Those conditions—
the criteria of economic convergence—were formulated in onerous terms for German
partners (though in the end Germany struggled to qualify as much as other countries from
southern Europe) with regard to budget deficits and size of public debt, long term interest
rates, inflation rates, and exchange rate stability (within the ERM). Following the events of
1992–3, with the reformation of the exchange rate and (p. 82) intervention mechanism of
the EMS and the exit from the ERM of the Italian lira and the British pound, there was a
growing consensus that the Bundesbank’s position as the de facto anchor of the ERM was
politically hard to justify with its European partners, who had no voice and no vote in the
Bundesbank’s decisions. This was particularly evidenced by the high interest rate policy of
the Bundesbank in 1992–3, in response to a purely domestic problem: the rise in
inflationary pressures due to the costs of German reunification in the light of the
government’s failure to articulate an appropriate fiscal policy.184 The tightening of
monetary policy in Germany had a very negative impact upon the rest of Europe, which was
suffering from an economic slowdown and therefore needed lower interest rates.
2.156 As with German monetary unification, EMU was a political decision for the
government to take, not for the central bank. The Bundesbank succeeded in pressing
forward its arguments on some occasions. In the end, it was a pyrrhic victory, as the
Bundesbank became an integral part of the ESCB on 1 January 1999, with the transfer of
monetary policy responsibilities from the national to the supranational arena. However, as a
small consolation for the Bundesbank, the European Central Bank is located in Frankfurt
and modelled functionally upon the Bundesbank.
2.157 The independence of the Bundesbank and its corresponding ability to stand up to
the government’s wishes is also supported by a ‘positive record’ in which the Bundesbank
succeeded in pursuing a tight monetary policy against the government’s wishes. It is upon
this record that the anti-inflationary reputation of the Bundesbank grew so strong over the
years. For instance, in 1966 tight money precipitated the first post-war recession, and
contributed to the departure of Ludwig Erhard as Chancellor. In 1972 there was a row over
capital controls that led to the resignation of the economics minister, Karl Schiller, who
opposed such controls as running counter to the principles of market economics. In 1981–2
high interest rates discomfited the Bonn Government, helping Chancellor Helmut Schmidt’s
downfall. In 1992–3 tight Bundesbank policies increased problems for the ERM of the
European Monetary System and eventually led to the widening of the ERM bands and to the
exit from the system of the Italian lira and the British pound. In 1997, the German
Government, after strong opposition from the Bundesbank, abandoned its attempt to use
profits from revaluing the country’s gold reserves in order to meet the criteria of economic
convergence required to qualify for European Monetary Union.185
2.158 In summary, the independence of the Bundesbank has seldom been sacrificed on the
grounds that the economy was suffering. Indeed the ghosts of deflation and recession are
not as feared in Germany as in other countries. When it comes to price stability, the German
public is truly inflation-averse and is ready to accept the anti-inflationary policies proposed
by the central bank (through a rise in interest rates for instance). It is only when it comes to
other goals that compromise the very identity or security of the nation that independence
and price stability have been sacrificed.
(p. 83) E. Central Bank Accountability and Democratic

Legitimacy
Functional decentralization and the model of independent agencies
2.159 The model of independent agencies or independent regulatory commissions has a
long-standing tradition in the United States as a way of dealing with the increasing
intricacy of the functioning of the modern State. It is an effective way of dealing with the
regulation of complex realities: money, securities, energy, transport, telecommunications,
the environment, and others. Agencies have been described as ‘miniature governments’,
typically endowed with executive powers, quasi-legislative (rule-making) and quasi-judicial
(adjudication) powers. Since agencies are by definition technocracies (a ‘headless fourth
branch of government’, according to some commentators),186 a basic problem of political
legitimacy arises: how to reconcile their powers with the demands of a democracy. The
power of unelected agencies has always generated unease. For instance, Congressman
Patman stated in 1967: ‘In the United States we have, in effect, two governments…We have
the duly constituted Government…Then we have an independent, uncontrolled and
uncoordinated government in the Federal Reserve System, operating the money powers
which are reserved to Congress by the Constitution.’187
2.160 Indeed, in the United States, independent regulatory commissions have been the
subject of extensive debate and criticism.188 For instance, the 1971 Ash Council Report189
(the Report of the President’s Advisory Council on Executive Organization) on Selected
Independent Regulatory Agencies recommended that functions of six agencies, including
the Securities and Exchange Commission (SEC), should be transferred to single
administrators under the President. In particular the agencies were criticized for their
alleged lack of accountability and their excess of independence.
(p. 84) 2.161 Some other recent critiques have focused on the role the Fed had in
contributing to the ‘asset price bubble’ (easy and cheap credit) and then on the actions the
Fed has undertaken to combat the crisis following the bursting of the bubble. Ron Paul’s
book End the Fed,190 represents an extreme version of that critique. Others have focused on
the range of powers the Fed has and its perceived failure as regulator and supervisor.191
2.162 In many European jurisdictions, the advent of central bank independence on the one
hand and the establishment of agencies to regulate privatized utilities on the other hand
have signified a change in their administrative law tradition, which used to rely on
executive departments headed by a cabinet officer. Since important elements of that
tradition remain deeply embedded in the legal framework of many European countries, this
background is important to understand the debate about the legitimacy and accountability
of independent central banks.
Democratic legitimacy of independent central banks
2.163 The question of legitimacy pre-exists and is a pre-requisite of accountability.192
Democratic legitimacy is a pre-requisite for the establishment of an independent central
bank. The creation of such an entity must be the fruit of a democratic act (an act of the
legislator, a constitutional decision, or a treaty provision). This first source of legitimization
is fundamental in a democratic society. However, while this legal basis legitimizes the
establishment of the independent agency, it cannot by itself legitimize on a continuous basis
the exercise of the powers delegated to such agency. It is then in the continuing life of that
entity that accountability becomes necessary to ensure legitimacy: accountability is thus the
process of bringing back (by giving account, explaining, justifying, or taking measures of
amendment or redress) that independent entity to the procedures and processes of a
democratic society. This is, for instance, the basic rationale of judicial review of the central
bank’s actions or decisions: in a democracy no institution or individual can be above the
law. However, accountability also encompasses other ‘technical’ elements that are not
related to the ‘political’ legitimacy of the institution, such as performance control.
Accountability per se does not politicize a central bank. Conversely, while accountability is
needed to ensure on-going democratic legitimacy, legitimacy has two aspects: a formal,
normative one, which refers to (p. 85) legality of the political system and a societal or
empirical one, which is determined by the acceptance of or loyalty to the system.193
2.164 Taking on this double dimension of legitimacy further, Fabian Amtenbrink and
myself194contend:
Independent agencies raise questions, which touch upon the very fundaments of the
constitutional structure of a democratic state. …The people as holder of the pouvoir
constituant, the holders of the sovereign power, choose representatives united in a
parliamentary assembly to exercise power on their behalf. This legitimization of the
exercise of power is renewed in regular intervals through fair and free elections,
which may or may not result in the withdrawal of confidence of the people in the
previously chosen representatives. As such elections are more than just a repeating
legitimization of state power. They are at the same time a mechanism by which the
representatives are held accountable by the electorate for their past performance.
Next to this formal, normative approach which refers to legality of the political
system, legitimacy entails also a societal or empirical dimension, which is
determined by the acceptance of or loyalty to the system. Democratic legitimacy is
not only an issue of legally binding rules, but also an issue of perception. Indeed, it
is the perception of the people that their preferences are reflected by the policies
that are formulated and the decisions which are taken on their behalf. As the
somewhat romantic view of representative democracy as government of the people,
by the people and for the people hardly reflects the political realities, representative
democracy is understood as a system of limitation and control of power. The
institutional ideals envisaged by the trias politica principle, reduces the risk of
abuse, firstly, by standing in the way of a concentration of power in a single
institution, and, secondly, by providing for interbranch checks and balances aimed
at preventing the abuse of power.
2.165 The legitimacy of independent institutions may be understood by reference to the

‘Robinson Crusoe’ paradigm. Just as an individual—recognizing his own imperfection in the
face of possible temptations—imposes constraints upon himself, ‘in order to channel his
own expedient behaviour towards rationally selected norms’,195 a government, recognizing
its own weakness in the face of temptations, limits itself by allowing or creating
autonomous (p. 86) or independent bodies. This willingness to submit itself to restrictions
provides a degree of democratic legitimacy.
2.166 Central banks are not majoritarian, democratic institutions.196 Central banks are,
instead, technocratic bureaucracies, staffed by career employees and, typically, a few
leaders who have been appointed by the political authorities. It might be said that any
bureaucratic agency is non-majoritarian, since decisions are made by appointed officials
rather than elected ones. The problem is especially acute when the officers of the agency in
question enjoy legal protection against removal during their terms of office.197 But the
problem is greatly exacerbated in the case of central banks as compared with typical
bureaucracies. Central banks do not simply administer a technical regulatory scheme
affecting discrete industries or interests. They regulate price levels, which is one of the
most fundamental powers of government, and one of the most important practical concerns
of the public at large.198 Though they are accountable for their actions, central banks tend
to be more insulated from political control than other independent agencies. This political
insulation raises a basic issue of democratic legitimacy.
2.167 The case for central bank independence can be reconciled, in general, with the
theory of democratic self-determination. An analogy to the independent judiciary may be
useful in this respect.199 Like central banks, the judiciary administers an institution (a
nation’s laws) that goes to the core of a nation’s political identity. And like central bankers,
judges, in general, are not popularly elected in liberal democracies.200 The theory of judicial
legitimacy is much better developed than the theory of central bank legitimacy, so it is
enlightening to turn to this analogy for instruction. In the United States, the jurist
Alexander Bickel advanced an influential justification for the unelected judiciary in his book,
The Least Dangerous Branch.201 Bickel here observes that the power of the US Supreme
Court to invalidate legislation is nowhere explicitly found in the American Constitution, and
argues for a deferential use of that power given the explicit constitutional authorization for
Congress to make laws. More fundamentally, Bickel identified the ‘counter-majoritarian
difficulty’ as lying at the root of American constitutional theory: the fact that the
fundamental law of a democratic society is defined by an agency that itself is unelected and
constitutionally protected against democratic pressures. This issue, which haunts American
constitutional law theory, is even more problematic than the parallel issue as pertains to
central banks, since, at least in the case of central banks, the authority to control price
levels (p. 87) free of political influence is itself set forth in documents adopted through the
processes of ordinary law-making. In other respects, however, the issue for central banks is
similar to that for judges. What justification is there for vesting a fundamental democratic
power in an institution that is explicitly protected against democratic control?
2.168 As explained in the paper co-written with Geoffrey Miller, constitutional theorists
tend to focus on the unique features of a court to explain the institution of judicial review.
The court has a special expertise and legitimacy in interpreting the law that other bodies of
government do not have. Moreover, courts are ‘less dangerous’ than other political
institutions. They are less dangerous both because they are largely immunized from the
influence of special interests, and because they lack the powers that other governmental
agencies enjoy, such as the spending power or the power to exert compulsory force. With
regard to central banks, it is possible to devise a similar set of justifications for the conduct
of monetary policy by unelected officials who enjoy explicit protections against political
influence. First, as already noted, the problems of legitimacy for central banks are less than
for a court exercising judicial review because the central bank’s powers are explicitly
conferred by legislation adopted in the political process. For instance, the possibility of a
government override—if allowed by the legislation—actually nullifies independence.202
Secondly, the central bank, as a bank, can claim a special expertise in the things that banks
do, just as a court, as a court, can claim expertise and legitimacy in interpreting the law.
Central banks are specialized at managing the money supply and price levels. Thirdly,
central banks, like courts, are weak in most respects. They do not enjoy wide-ranging
authority to spend money, to execute the law, to bring the coercive power of the State
against private citizens. As with the courts, their powers in the area of their activity can be
justified by their weakness in other areas.
2.169 Technical expertise, for example, is a compelling argument only within a framework
of accepted values and institutions, a point we emphasize in our joint contribution. When
the fundamental identity, security, or values of a nation are in issue, the matter is no longer
one of technical methodology but instead concerns basic democratic choices. Central banks
should not be making these kinds of fundamental decisions. Similarly, the fact that a central
bank is a bank may justify its conduct of a nation’s banking business in ordinary times, but
in extraordinary times, the national interest becomes paramount to arguments for
legitimacy based on functional role. And the fact that a central bank is relatively powerless
over many governmental functions becomes irrelevant when the bank, by virtue of the
powers it does have, prevents or impedes much broader and more fundamental processes.
If, for example, a central bank refused to allow the government to raise funds necessary to
defend itself against invasion, the fact that the bank does not enjoy the power to coerce
others seems hardly a relevant concern. Or, if the public as a whole made a resolute and
considered judgment that price level stability was not a central value for the conduct of
economic policy, it hardly seems sensible to deny the public the right to self-determination,
even if such a decision is, in the view of contemporary economic theory, not a wise one.
2.170 The insulation of the central bank from politics does not pose a serious difficulty for
democratic functioning in ordinary times; but in extraordinary times, when the identity, (p.
88) security, or basic values of the nation are at stake, the autonomy of the central bank
can, and should, legitimately yield to other concerns. Again, the problem of institutional
design becomes that of distinguishing between the ordinary and the extraordinary.
Politicians and interest groups will always have the incentive to characterize issues as
extraordinary in order to wrest power away from the central bank. It would not be advisable
for a nation to allow too easy a recourse to this argument, because of the danger that the
value of central bank independence will be lost for very little gain. Usually, the central bank
is established, and given its autonomy, by legislation. If the central bank has performed well
and enjoys a high degree of public confidence (though confidence is hard to build up and
easy to destroy), the authorizing legislation will become deeply embedded in the political
fabric of the nation. In some countries, the central bank’s autonomy is even more deeply
embedded, at least from a legal point of view, by being contained in the political
constitution of the country or in a treaty (as in the case of the EU).
2.171 Very few countries, however, have ‘constitutionalized’ the independence of their
central banks (Chile in 1980 is a rare example). Most countries choose to grant
independence to their central banks through statute law. Even those countries that choose
the ‘constitutional path’ or the so-called ‘contractual path’ (as in New Zealand203) also
proceed through a ‘statutory path’. New Zealand and Chile enacted legislation in 1989. The
independence of the European Central Bank is guaranteed in the TFEU. It is a strong legal
commitment to independence, since the amendment of the TFEU would be a very difficult
and cumbersome procedure. Yet not an impossible one, since every democratic society
retains the right to reinvent itself.
The accountability of independent central banks
2.172 In all democratic societies there is a creeping tension between being accountable
for your actions and simultaneously enjoying a degree of independence in carrying them out
without fear or suspicion of political or social capture. The institutional position of central
banks is a prime example of this tension with arguments for and against ‘more’ or ‘less’
independence or accountability being voiced from various quarters.204 The consensus that
surrounds the case for central bank independence and its legal articulation does not extend
to the articulation of accountability. Both the measurement of accountability and the extent
to which independent central banks are held accountable for their actions remain a matter
of controversy and vary considerably from country to country.
2.173 Accountability can be defined as an obligation owed by one person (the accountable)
to another (the accountee205) according to which the former must give account of, explain,
(p. 89) and justify his actions or decisions against criteria of some kind,206 and take
responsibility for any fault or damage.
2.174 Four elements are at the core of any understanding of accountability:
(i) A holder of power (the ‘accountable’). Lord Acton’s dictum remains true: all power
tends to corrupt, absolute power corrupts absolutely. Hence, the need for
accountability whenever power is exercised. Power cannot be divorced from
responsibility. Accountability is first and foremost a mechanism to prevent the abuse
of power. 207
(ii) An authority to whom accountability is owed (the ‘accountee’). Who guards the
guardians? Accountability as an obligation must be owed to another party. The latter
becomes by virtue of this obligation in a position of authority vis-à-vis the
accountable. There are various types of accountability according to the authority that
exacts it. We speak of judicial accountability (or accountability to the judiciary) when
courts are the authority that enforce accountability. An obvious example is the judicial
review of administrative actions or decisions. When parliament is the accountee we
speak of parliamentary accountability (or accountability to parliament). We speak of
accountability to the public, to refer to the general public as the accountee.
(iii) The content of the obligation. The accountable, the holder of power, is under an
obligation (1) to give an account of his decisions or actions, (2) to explain and justify
the decision or the course of action taken and, (3) where error is proved or harm
inflicted, to own the responsibility and take appropriate measures of amendment or
redress. While there is no accountability without a duty to give account and explain,
the forms of amends or redress vary from one type of accountability to another. With
regard to the content of the obligation, a distinction is often made between
‘explanatory accountability’ where the obligation is to answer questions, to give
account of action, and ‘amendatory accountability’ where there is an obligation to
make amends and grant redress. Amendatory accountability presupposes failure,
fault, harm, or deviation from a given target.
(iv) Criteria of assessment. Any form of accountability presupposes that there are
objectives or standards according to which an action or decision might be assessed.
In other words, accountability implies an obligation to comply with certain standards
in the exercise of power or to achieve specific goals. The more complex the activity,
the more difficult it is to establish clear standards of conduct and specific outcomes—
in which case accountability becomes ever more evasive. The more specific the goals
and standards the more effective the accountability. This might induce the
‘accountees’ to resort to economic or other measurable criteria of performance
(hence the term ‘performance accountability’). Though central bank laws often
contain a variety of goals, in recent years the primary goal has become price stability.
Performance accountability is facilitated when there is one goal, rather than multiple
goals, and when that goal is narrowly defined rather than formulated in broad terms.
If there are multiple goals, a clear and unambiguous ranking is better than no ranking
at all.
(p. 90) 2.175 A further twist to understanding the notion of accountability is the distinction
between ex ante and ex post accountability. Accountability can either be exercised before/
during the process of taking the decision/action, or after the decision/ action has been
taken. It is with reference to this fact, the fact of concluding a decision or action, that we
define accountability as either a priori (ex ante) or a posteriori (ex post). An example of ex
ante accountability is where the ‘accountee’ takes part in the process of choosing the
holders of power, or where the consent of the ‘accountee’ is required for the decision of the
‘accountable’ to be final. For instance, the appointment procedures of central bank officials,
when such procedures require parliamentary approval, and the parliamentary debate of
inflation targets (if such a parliamentary debate is required) can be regarded as ways of
exercising accountability ex ante or through scrutiny. The reporting requirements and the
appearances of the central bank chairman or governor in front of parliamentary committees
are ways of exercising accountability through control or ex post.
The lawyers’ view and the economists’ view
2.176 Lawyers and economists tend to give emphasis to different issues when trying to
articulate the accountability of independent agencies. Lawyers tend to emphasize the
political dimension of accountability, the placing of the institution (the independent central
bank) within the existing system of checks and balances, in relation to the three branches of
the State—legislative, executive, and judiciary (the question of who regulates the regulators
or who guards the guardians). This political dimension is clearly related to the democratic
legitimacy of independent central banks. Accountability—from a legal perspective—should
be ‘diversified’ to include parliamentary accountability as well as judicial review of the
agency’s acts and decisions, and a degree of cooperation with the executive to ensure
consistent overall policy making. In a national context, parliament remains sovereign in its
legislative decisions, and one statute proclaiming the independence of an agency can
always be removed by another one revoking it. Parliamentary accountability should be
exercised through a variety of procedures and mechanisms, including annual reports and
appearances in front of parliament of public officials on a regular basis, and also in the case
of an emergency situation. Judicial review of the agency’s actions and decisions (conducted
by an independent and non-politicized judiciary) is essential to prevent and control the
arbitrary and unreasonable exercise of discretionary powers. This is a fundamental element
of the rule of law. The discretion of public officials should never be unfettered but subject to
legal control. Lawyers emphasize ‘input’ or process monitoring, while economists
emphasize output or performance monitoring.
2.177 Economists, while accepting this ‘institutional’ articulation of accountability, in
particular parliamentary accountability, tend to put the emphasis on performance
accountability on the one hand208 and on disclosure on the other. Performance control (the
question of how accountability is to be achieved) is concerned with the efficiency of an
independent institution and, as I have already pointed out, it is conditional upon the
objectives and targets imposed upon the central bank. Performance accountability has a
‘technical’ rather than a ‘political’ character. Disclosure can be viewed as a ‘market-based’
form of accountability, typically favoured in Anglo-Saxon countries, such as the USA and the
United Kingdom, where competition and transparency are considered to be the two main
pillars of a market (p. 91) economy. For instance, with regard to the transparency required
in the monetary policy decisions taken by an independent central bank, it is worth noticing
that the minutes of the Federal Open Market Committee (in the USA) or of the Monetary
Policy Committee of the Bank of England must be published.
2.178 With regard to the measurement of accountability, Fabian Amtenbrink has developed
eight criteria to measure such accountability:209
(1) the legal basis of the central bank (typically an act of parliament, but also a
constitutional or treaty provision in some instances);
(2) the monetary policy objectives (whether price stability is broadly or narrowly
defined and whether this goal coexists with others, such as growth and employment);
(3) the relationship with the executive branch of the government (from informal
discussions to formal consultations);
(4) the appointment and dismissal procedures (which are also a test of
independence);
(5) the override mechanism (which, if exercised, effectively nullifies independence);
(6) the relationship with parliament (the real test of accountability as parliament
should represent the will of the people);
(7) transparency (ie, disclosure); and
(8) budgetary accountability (the counterpart of financial autonomy).
2.179 In some of these categories, it becomes evident that independence and

accountability can be seen as opposite ends of a continuum.210 While too much
accountability may threaten the effectiveness of independence, too much independence
risks damaging appropriate accountability. A clear illustration of this tension is the liaisons
or relations between an independent central bank and the Treasury or Minister of Finance.
While too much liaison lessens independence, too little liaison comes at the expense of
accountability. The optimal trade-off between independence and accountability varies from
country to country, depending upon the political structure of government, the existing
system of checks and balances in a society, and the centralized or decentralized (both
geographically and functionally) structure of the State.
2.180 The design of the pre-1999 German Bundesbank and of the ESCB tilt on the side of
independence, with relatively weak parliamentary accountability. (Though the public
support enjoyed by the Bundesbank is far superior to that enjoyed by the European Central
Bank, and the support of public opinion is a form of de facto accountability.) The Reserve
Bank of New Zealand tilts on the side of accountability, because of the possibility of
government override. In the USA, the seven members of the Federal Reserve System Board
of Governors are appointed by the President, with the advice and consent of the Senate.
The President designates two members to be chairman and vice-chairman and these
designations must also receive the Senate’s approval. The Board of Governors is required to
submit an annual report of its operations to the Speaker of the House of Representatives,
‘who shall cause the same to be printed for the information of the Congress’, and special
reports twice each year (p. 92) on the State of the economy and the system’s objectives for
the growth of money and credit. The chairman—representing the Board—is responsible for
reporting biannually to both houses of Congress on the goals and conduct of monetary
policy. These are the so-called ‘Humphrey–Hawkins’ hearings, under the Full Employment
and Balanced Growth Act of 1978. The chairman of the Fed testifies in front of the Senate
Committee on Banking, Housing, and Urban Affairs; and the House Committee of Banking,
Finance, and Urban Affairs. Furthermore, the chairman and other Board members often
testify before the Joint Economic Committee of Congress and other congressional
committees.
2.181 According to the Bank of England Act 1998, the objective of price stability (inflation
target) to be pursued by the Monetary Policy Committee in the UK is specified by the
Chancellor of the Exchequer in terms of a particular index and quantified, with an
obligation imposed on the MPC to report back to the Chancellor if they deviate from the
target (by exceeding the bands imposed upon it). The minutes of the meetings of the
Monetary Policy Committee are published.211 The Bank also needs to produce an annual
report of its activities to the Chancellor of the Exchequer, who shall lay copies of every
report before Parliament.212 Other reporting requirements are spelt out in section 18 of the
Act (including the publication of the inflation report). The Act also contained a section on
‘reserve powers’213 that the Treasury can exercise in ‘extreme economic circumstances’. If
this provision were to be applied, it would effectively nullify the independence of the MPC.
Indeed, this ‘reserve provision’ illustrates the trade-off between independence and
accountability.
2.182 As further discussed later in this book, a statutory financial stability objective has
been given to the Bank of England by the Financial Services Act 2012. The enhanced
powers granted to the Bank of England as guardian of financial stability and supervisor of
the financial industry and financial infrastructures raise questions about the need to
provide adequate mechanisms of accountability (with power comes responsibility). The
revamped Court of Directors of the Bank can act as a mechanism of internal control and
good governance, but accountability still requires outside ‘control’ since an institution
cannot be the judge and the jury of its own role.214
An illustration of the challenges that the Bank of England faces in the light of its enhanced
powers is the investigation into the possible manipulation of the foreign exchange market—
and the suspension of a member of staff of the Bank of England—which highlighted the
conflicted position in which the Bank of England finds itself since it both participates in the
foreign exchange market and regulates many of its players.215
(p. 93) The place of transparency in the framework of accountability
2.183 Prior to the 1980s, transparency was hardly discussed in academic and policy
literature. The 1980s witnessed growing attention to the concept, which was reflected in
academic discussions across the disciplines of economics, political economy, information
theory, and law. In the 1990s, this trend was confirmed. Studies of the concept proliferated,
especially in the literature of international organizations, and ‘transparency’ was
established as a term of art in the relevant disciplines. Transparency is an essential feature
of governance in a market economy. The emergence of the current concern with
transparency coincided with the retreat of the welfare State, which resulted in a wave of
privatization since the 1980s and other structural reforms which reinforced the role of
markets in the allocation and management of resources. This link between transparency
and the market was further illustrated by the increased emphasis on transparency in the
1990s following the collapse of the Soviet Union and the global trend towards a market
economy.
2.184 The current concern for transparent political and economic structures suggests the
need to reach a common understanding of transparency. In this context, two elements are
essential: the availability and relevance of the information and the time framework in which
such information ought to be made available. Typically information is made available
through disclosure procedures, reporting requirements, and sometimes by granting the
recipient investigative powers or a general right of access to information. For information to
be available, some codes of transparency ought to impose on the given organization certain
duties regarding the quality of the information and its presentation. The information must
be accurate, clear, understandable, complete, and timely. There are two objectives that
transparency must achieve: to educate the public and to facilitate financial intermediation.
The realization of these two objectives will also contribute to establishing an on-going
dialogue between the central bank and the public.216 If the public understands and
evaluates the performance of the central bank, an important element of political
legitimization is introduced. In order to maintain its long-term status of independence, the
central bank needs the support of the financial and non-financial community. The public will
only lend its support if it is informed.
2.185 Any recent discussion of accountability often includes a reference to transparency
and vice versa. This poses the question of the relationship between the two concepts.
Accountability is an obligation to give account of, explain, and justify one’s actions, while
transparency is the degree to which information on such actions is available. The provision
of information is clearly an element of accountability. But accountability is not merely about
giving information. It must involve defending the action, policy, or decision for which the
accountable is being held to account. The provision of information (transparency) is hardly
ever a neutral account of what happened or of what is happening; hence the need for an
explanation or justification of the agency’s actions or decisions (ie, accountability).
2.186 The provision of information in the context of accountability, whether in an ex ante
investigation or an ex post requirement of disclosure, facilitates transparency. On the other
hand, a transparent economic and political environment enhances the effectiveness of (p.
94) accountability. The two concepts are therefore mutually enforcing, and they share the
provision of information as a common requirement.
F. Supervisory Independence and Accountability

2.187 Supervisory independence is not the same as monetary independence.217 To begin,
supervisory independence can be predicated both with regard to central banks (if they are
endowed with supervisory functions) and with regard to other agencies (if supervision
resides outside the central bank). Monetary independence is almost invariably central bank
independence.
2.188 The model of independent central banks that prevailed in the last two decades of the
twentieth century (the Bundesbank Model of monetary independence) was based upon one
goal—monetary stability—using one instrument—monetary policy—conducted by one
agency, the central bank. In stark contrast to this simple model, ‘supervisory independence’
presents a much more complex model. There are fundamental differences between
monetary independence and supervisory independence with regard to the goal/s, the means
or instruments, the personnel and the very nature of the supervisory work.218 The conduct
of prudential supervision involves several goals (financial stability, consumer protection,
conduct of business, prevention of money laundering), is related to other instruments
(macro supervision, competition, crisis management, emergency liquidity assistance, etc)
and generally implicates several entities/authorities nationally (central banks, Treasuries or
Ministers of Finance, supervisory agencies, etc), as well as supra-nationally and
internationally.
2.189 If public funds are at stake, central bank independence in the pursuit of financial
stability is limited by the government’s necessary involvement in the destiny of the financial
institutions that have received government assistance.219 This requires a different model of
accountability, with adequate institutional and procedural arrangements.
2.190 As regards the forms of accountability, when it comes to monetary policy, central
banks are generally given clear performance objectives (outputs which can be easily
measured). However, in the case of supervision, input or process monitoring is preferred,
because performance or outputs on the supervisory activity are often hard to measure.220
The fact that inputs, rather than output monitoring should be chosen also suggests
that providing a monetary authority (with a clear performance objective) with
independence is not the same as providing independence to a supervisor: if
delegation and output measurement cannot be used, then independence must be
more restricted with regard to financial supervision than with regard to monetary
policy.221
While central bank accountability with regard to monetary policy is typically ‘explanatory’,
the accountability of the central bank or the supervisory agency in the field of prudential
supervision and regulation is sometimes ‘explanatory’ and sometimes ‘amendatory’.
(p. 95) 2.191 As noted above, democratic accountability is a process, which involves
subjecting the accountable to the procedures and processes of a democratic society. As
such judicial review of the actions or decisions of an independent agency can function as an
instrument of democratic accountability. With regard to the regulatory and supervisory
function, courts should be able to review whether and to what extent the agency has
observed the rule of law.222 However, the degree of review will be limited in areas where
the agency exercises discretion both in the context of regulatory and supervisory functions.
In such cases the review is limited to observing whether and to what extent the agency has
observed the limits of its discretion. In order to establish a breach of the rule of law the
supervisory authority must be shown to have (manifestly) disregarded the limits of its
discretion.223
2.192 In the context of judicial review, the liability of financial regulatory and supervisory
authorities is a contentious issue. The issue of (State) liability for loss caused by the
inadequate supervision of banks,224 in the context of the damages action against the Bank
of England for the failure of Bank of Credit and Commerce International (BCCI)225 and in
the context of the Peter Paul case,226 has raised much controversy.
2.193 Another dimension is provided by the relevance of transparency in the framework of
monetary independence in contrast with the framework of supervisory independence. While
transparency in monetary policy is clearly advantageous, the benefits are less clear when it
comes to supervision and crisis management, due to the stigma effect of publicizing overt
assistance and the nature of bank runs (the belief in a panic is self-fulfilling).227 The
reporting requirements prescribed by law are the best way to ensure a regular flow of
information. They can include annual and other regular reports, extensive information of
regulatory and supervisory activities, as well as regular presentations by agency officials.
Similar to what can be observed for central banks with regard to monetary independence,
the difficulties in defining legal obligations in this regard lies in striking a balance between
the need for confidentiality and the need for information to be publicized. Goodhart
observes that providing accountability and transparency for banking supervisors is
particularly difficult, since the information that they get is frequently confidential and since
‘success’ is often measured by the absence of financial failures (considering also that the
optimal number of failures is not zero!).228 ‘Supervisory failures have to become public, but
supervisory (p. 96) successes in averting crisis often have to remain secret.’229 This
excludes complete openness in the decision-making process of the supervisory authorities.
2.194 As a final concluding observation, one problem in the design of an ‘accountable
independence’230 lies in the possible reversal of the intended objective of ‘depoliticizing’ the
conduct of monetary policy and/or supervision. Indeed, if too much independence may lead
to the creation of a democratically unacceptable ‘State within the State’, too much
accountability threatens the effectiveness of independence. The debate about independence
and accountability resembles the philosophical debate about freedom and responsibility:
independence without accountability would be like freedom without responsibility.
G. Central Bank Reserves and Central Bank Immunity

2.195 The financial crisis prompted central banks (both in developed and developing
countries) to act—often in extraordinary ways—in order to preserve financial stability. In
this section the investment of central bank reserves is considered.
2.196 Central banks raised the level of their reserves—substantially in some cases—and
engaged in an increasing number of ‘unconventional investments’, including derivative
transactions, equity holdings in financial institutions and non-financial companies, as well
as other activities not generally associated with the traditional objectives pursued by
central banks.
2.197 Central banks and their reserves can become ‘targets’ in order to attempt to obtain
‘attachments’ or to execute judgments against their defaulting or insolvent States.231
2.198 Central banks act in a dual capacity: on the one hand they perform ‘central banking
functions’ and, on the other hand, they can perform commercial functions.232 When they
perform functions for a public purpose, like monetary policy, central banks enjoy sovereign
immunity. (Whether immunity attaches is more complicated than merely ascertaining if the
function is governmental or commercial. The key feature to assess what constitutes a
‘central banking function’ is whether the central bank engages in such function for a public
purpose rather than a pecuniary purpose.) As noted earlier, domestic statutes and treaties
that deal with sovereign immunity address the immunity of central banks and their property
as a special case.
2.199 The theory of sovereign immunity has undergone a fundamental evolution in recent
years. The previously dominant theory that granted sovereigns an absolute immunity from
the jurisdiction and execution of their property by other States and or private individuals
has been abandoned or is in the process of being abandoned in most jurisdictions. The new
(p. 97) theory of sovereign immunity restricts immunity under certain circumstances,
namely when the sovereign engages in acts of a private law or commercial nature.
2.200 This restrictive interpretation has been encouraged by the vast expansion of
activities of the modern State in the economic sphere and in the context of sovereign debt
restructuring. As Sean Hagan points out, ‘[t]he traditional concept of absolute sovereign
immunity has been significantly eroded over the years under the laws of those jurisdictions
that typically govern international debt instruments’.233 These choices of laws—fora
conveniens—mainly refer to the State of New York in the USA; and English law, in the UK.
The United States of America adopted the restrictive approach to State immunity in 1952
and enacted the Foreign Sovereign Immunities Act in 1976. The United Kingdom enacted
the State Immunity Act in 1978.234 The European Convention on State Immunity (ECSI)235
and the United Nations Convention on Jurisdictional Immunities of States and Their
Property236 (UNCJIS) have also taken steps in the direction of adopting a restrictive
interpretation of sovereign immunity.
2.201 Despite this general trend, central banks and monetary authorities have enjoyed
what William Blair has called ‘special immunization’.237 This distinctive treatment furnished
to central banks is provided for by the Foreign Sovereign Immunities Act (FSIA) in the
USA238, by the State Immunity Act (SIA) in the UK239 and is also contemplated (p. 98) as a
prospective feature of the UNCJIS.240 These special immunization provisions protect, with
certain exceptions, foreign central bank property from judicial remedies such as pre-
judgment attachment and execution.241 It should be pointed out, however, that though
modern sovereign immunity law generally restricts attachment-type remedies to
commercial property, there is one large exception. The FSIA, the SIA, and the UNCJIS all
provide that a central bank’s property shall not be immune if the plaintiff’s holding a
contract in which the central bank has expressly waived the immunity to which its property
would otherwise be entitled.242
2.202 The immunity typically granted to central banks and monetary authorities ring-
fences their property, and includes a presumption of immunity ‘irrespective of the capacity
in which the bank held it or the purpose for which it was held’.243 Both in the provisions of
the UK’s SIA and the proposed wording of the UNCJIS, provide a presumption that states
that in spite of the apparently commercial nature of most central bank activities and
properties, these institutions act for non-commercial purposes. A special mention ought to
be made with regard to the immunities granted by treaties to supranational central banks,
such as the ECB. According to TFEU, Art 343, the ECB enjoys the same privileges and
immunities conferred on the European Community ‘in the territories of the Member
States…as are necessary for the performance of its tasks, under the conditions laid down in
the Protocol of 8 April 1965 on the privileges and immunities of the European Union’. In
addition, Art 39 (ex-Art 40) of the ESCB Statute repeats this provision stating that: ‘[t]he
ECB shall enjoy in the territories of the Member States such privileges and immunities as
are necessary for the performance of its tasks, under the conditions laid down in the
Protocol on the privileges and immunities of the European Union’.244
2.203 Matters of central bank immunity from jurisdiction and execution can arise either
under a domestic context (eg, claims brought within the central bank’s parent or home
State) or under an international context (eg outside of the central bank’s home State).
While the treatment of the immunity granted might vary depending on the particular
context, the focus of our research deals only with the international scenario: that is, with
the legal treatment and the immunities (from jurisdiction and execution) of central bank
reserves held (p. 99) outside of its parent State. As a result, when we refer to central bank
reserves, we mainly mean central bank reserve assets located abroad. As Tom Baxter
eloquently put it: ‘In some ways, central bank reserves are like a nation’s savings
account.’245
2.204 Interest in central bank immunities has reignited in recent times. Several factors
have contributed to this. Firstly, the crisis led to deterioration of the creditworthiness of
some sovereign States (both developed and developing). This challenged the traditional
view that States cannot become insolvent, and has given rise to claims and attachments
attempts against insolvent States. States have most of their properties and assets within
their territories. Because of the existence of domestic immunities, claimants often cannot
execute their judgments against sovereigns. Consequently, central banks are increasingly
targeted in order to either attach judgments against their governments, their property or
accounts, given that they often hold reserve assets abroad.246 The financial crisis has also
challenged the role that central banks play in the preservation of monetary and financial
stability. Central banks have widened the scope of their established policy tools and
intensified many of their open market operations in order to meet their policy objectives.
The expansion in the volume of certain dealings includes activities traditionally considered
as commercial in their nature, such as investment in equities and certain derivatives
transactions.
2.205 Focus on the laws and the jurisdiction of the USA and the UK when analysing the
issues of central bank immunity does not mean that additional perspectives have not been
developed.247 The reason for this Anglo-centric perspective stems from various factors.
First of all, around USD 3 trillion of the world’s central bank and sovereign US dollar-
backed reserves are held in US dollars with the Federal Reserve Bank of New York
(FRBNY).248 Thomas Baxter has stated that ‘the legal climate in the United States is
welcoming to central bank investment’ and that ‘the legal environment in the United States
is designed by Congress to incent central banks to place dollar reserves in the USA’.249
2.206 The FRBNY invests dollar reserves for foreign central banks and monetary
authorities. Typically, dollars are transferred into an account on the FRBNY books, which is
usually invested in the so-called ‘repo pool’ (a kind of comingled investment account) or in
Treasury or agency securities (ie, Fannie Mae, Freddie Mac, Ginnie Mae). Sometimes a
customer askes the FRBNY to convert a dollar balance into another currency through a
foreign exchange transaction. In these transactions, the actual foreign exchange that the
FRBNY purchases for our customer is held not with the FRBNY but with another banking
organization. There are also swap transactions that the FRBNY conducts with other central
banks. For example, the (p. 100) Fed established reciprocal currency arrangements, or
‘swap lines’, with the European Central Bank and the Swiss National Bank.250
2.207 Other factors that play a key role are the fact that London and New York are
arguably the leading, most developed financial centres of the world. Many States choose to
issue and place sovereign bonds under the laws and markets of these jurisdictions.
2.208 English and NY law are renowned for creating a secure environment in order to
foster financial transactions and also promote the investment of foreign reserves. Moreover,
English and NY law are often used in international financial transactions as the preferred
choices of laws. The International Swaps and Derivatives Association (ISDA) Master
Agreement for derivative transactions is considered a notable example.251
2.209 Other important fora where (central bank and sovereign) immunity issues have been
raised in recent years include countries that host institutions where central banks keep
their reserves and their properties. Notable cases include Belgium, where EUROCLEAR is
located,252 as well as the BIS, where central bank reserves are also held and kept.253 The
normative framework of the BIS details its immunities under the Hague Convention of
1930. These immunities include protection to the property and assets of the BIS as well as
‘the deposits entrusted to it’.254
Central bank balance sheet and reserves
2.210 The main interest for the purpose of central bank immunities lies with the reserves
that are held abroad (or foreign reserves). This is because within their territories, sovereign
States can self-determine their own absolute immunities from jurisdiction and execution. A
State, however, cannot decide what level of immunities is granted to it or its dependencies
and agencies (including central banks) within the jurisdiction of other countries.
(p. 101) 2.211 According to the IMF Balance of Payments Manual, 6th edition, 2009
(BOPM6), reserve assets are defined as: ‘those external assets that are readily available to
and controlled by monetary authorities for meeting balance of payments financing needs,
for intervention in exchange markets to affect the currency exchange rate, and for other
related purposes (such as maintaining confidence in the currency and the economy, and
serving as a basis for foreign borrowing)’.255 This definition also provides the economic
rationale that explains why countries keep reserves in the first place. These economic
reasons include trade financing, currency value management and the servicing of its debts.
2.212 The BOPM6 further states that ‘[r]eserve assets consist of monetary gold, SDR
holdings,256 reserve position in the IMF, currency and deposits, securities (including debt
and equity securities), financial derivatives, and other claims (loans and other financial
instruments).’ This evidences that central bank reserves include a plethora of different
types of assets with varying legal characteristics. The diversity is evidenced with the post
crisis move of many central banks of intensifying equity investments and purchasing many
distressed securities as a form of State aid. As Robert Jenkins considers, given that ‘central
bank reserves swelled to $500 Bn…[e]quities may join the traditional central bank holdings
of sovereign debt and gold’.257 This trend is seen as a ‘logical’ move given that many risky-
free investments currently exhibit a negative yield after taking into account inflation and
investment in stock has been regarded as a need in order to diversify the reserves
portfolio.258
2.213 Central banks are not the only institutions that can manage foreign reserves.
Nowadays, a country’s reserves (and its foreign reserves) can also be held through foreign
wealth funds or through the exchequer (Finance Ministry).259
2.214 The IMF’s BOPM6 defines central banks as: ‘the financial institution (or institutions)
that exercises control over key aspects of the financial system’, adding that: ‘It carries out
such activities as issuing currency, managing international reserves, transacting with the
IMF, and providing credit to deposit-taking corporations.’260 For those countries that lack a
particular entity named as a central bank (or in the case of currency unions, which can have
a system or network of central banks), the IMF considers that ‘the concept of monetary
authorities underlies reserves assets’.261 This means that typically reserves are associated
with monetary authorities that include, but are not limited to, central banks.262 The legal (p.
102) characterization of what constitutes a central bank depends heavily on their functions
(eg what they do, as I explained earlier in this chapter). Thomas Baxter points out that:
‘central bankers, for example, think of measures taken to invest dollar reserves as
classically sovereign activity, because these investments are done for public purposes. Yet,
the nature of the investment will be commercial.’263 As seen in the definition of reserve
assets provided in the IMF’s BOPM6, these investments can included all types of securities
and some commodities.
2.215 The distinction between activities and property held for commercial and non-
commercial purposes has been key in many instances. As stated before, this distinction is
present in many statutory instruments, like the SIA in the UK and the FSIA in the US. In the
case of the UK, there is a special additional presumption that protects central banks and
monetary authorities by categorizing all of their transactions and properties as non-
commercial in their nature. This presumption is not present in the USA’s FSIA, but has been
addressed in recent cases such as NML Capital, Ltd v Banco Central de la Republica
Argentina.
2.216 The distinction between non-commercial and commercial activities has been crucial
in many landmark decisions in the UK and the US. For example, before the entry into force
of the UK SIA, the commercial/ non-commercial categorization was essential in Trendtex
Trading Corp v Central Bank Nigeria264 and Hispano Americana Mercantil, SA v Central
Bank of Nigeria.265 In both cases, the English Court found that while the Central Bank of
Nigeria (CBN) was an independent agency from the State, it did not enjoy the immunities
that were typically granted to sovereigns. However, it is important to note that these
decisions preceded the entry into force of the SIA. As a result, some commentators agree
that a post-SIA decision in the lines of Trendtex is unlikely.266
2.217 In the USA, the case law regarding central bank immunities has evolved in a similar
direction. In the landmark Bancec case267, the US Supreme Court held that: ‘[d]uly created
instrumentalities of a foreign state are to be accorded a presumption of independent status.
This presumption may be over-come, however, where giving effect to the corporate form
would permit a foreign state to be the sole beneficiary of a claim pursued in United States
courts while escaping liability to the opposing party imposed by international law.’ This is
often referred to as the Bancec test and plaintiffs looking to attach judgments against the
properties of the central banks often invoke it before the US courts. The second leg of the
test (the fraud exception) states that if a central bank uses its legal personality in order to
escape liability and defraud creditors, then the corporate veil should be pierced.
2.218 However, the decision in NML Capital, Ltd v Banco Central de la Republica
Argentina points into an interpretation of the FSIA in the same direction as the UK’s SIA. In
this case, the plaintiffs (a holdout creditor)268 tried to execute a USD 2.4 billion against (p.
103) Argentina, by attaching the assets (deposits) that the Banco Central de la Republica
Argentina (BCRA) held with the FRBNY. The US Court of Appeals of the Second Circuit held
that: ‘regardless of the central bank’s level of independence from its parent state and (2)
that property of a central bank is held for its own account if used for central banking
functions, as such functions are commonly understood, irrespective of their commercial
nature’.269
2.219 The decision in NML Capital has been considered to be important in many ways.
First, it interprets the murky provisions of the FSIA providing additional protection to the
activities and properties of central banks. In addition, in times of financial crisis, it purports
to dissuade the proliferation of suits in the US courts brought by holdout creditors and so-
called vulture funds that specialize in purchasing defaulted sovereign debt.270
2.220 However, the latent element in the NML Capital decision is that in order to enjoy
immunity a central bank must hold its property for its own account.271 Whether the United
States’ Foreign Immunities Act offers less protection than other States because of the
language ‘for its own account’ is a matter of controversy.272
H. Currency Boards
2.221 Currency boards are adopted as an appropriate means of monetary stabilization in
jurisdictions with either a negative past record in monetary affairs (eg, hyperinflation in
Argentina) or a distrust in the ability of the domestic authorities to maintain currency
stability (eg, Hong Kong and Lithuania). A currency board can be construed as a type of
‘monetary rule’ where the external value of the currency is fixed in terms of the value of
another currency, backed by foreign reserves.273 In this respect, while independent central
bankers have a certain degree of discretion in the conduct of monetary policy, as long as
they achieve their statutory goal, currency boards enjoy little or no discretion. The
discipline and predictability of a currency board (currency boards can only issue notes (p.
104) and coins when there are foreign exchange reserves to back them) need to be
weighed, however, against the loss of freedom in the conduct of monetary policy and the
ability to tackle banking crises. The record of currency boards is mixed, with some relative
successes (eg Hong Kong) and some failures (eg Argentina, as the currency board was
abandoned in January 2002).
2.222 The debate about currency boards needs to be understood in the broader literature
about the types of exchange regimes: fixed, floating, or somewhere in between.274 There is
no consensus in the economics profession as to which is the best model. The pendulum has
shifted from pegged (Bretton Woods regime275) to floating276 and the issue remains
controversial. Assuming that they maintain a currency of their own, countries have three
basic choices with regard to their exchange regime:
(a) They can let their currency float freely in the exchange markets against all other
currencies;
(b) They can fix the price of their currency against a specific foreign currency or a
basket of foreign currencies;
(c) They can pursue intermediate approaches, letting rates float to some extent but
intervening to limit those fluctuations either ad hoc (managed floating) or pursuant to
some pre-determined parameters (target zones, crawling bands etc). 277
2.223 Currency boards fall within the second category: they are a species of the fixed peg
system. The difference between a currency board and a pegged exchange rate is one of
degree: ‘a currency board can be abandoned just as a pegged exchange rate can’ but
institutional arrangements render abandoning a currency board considerably more difficult,
thus providing extra credibility.278
(p. 105) The theory of currency boards
2.224 A currency board is a monetary authority that issues domestic currency (notes and
coins) subject to (1) an express commitment to exchange domestic currency with the
reserve currency at a specified fixed exchange rate and (2) the requirement that its
monetary liabilities be backed by reserves of foreign currency (or other foreign assets or
gold).279 The first requirement is the commitment to a fixed exchange regime. The second
requirement (the ‘backing rule’) is the commitment to convertibility, that is, the
commitment to hold adequate reserves to ensure that even if all holders of the domestic
notes and coins wish to convert them into the reserve currency, the board will be able to do
so. The notes and coins are convertible into the reserve currency at a fixed rate and on
demand.
2.225 A currency board pegs the exchange rate of the domestic currency vis-à-vis some
international ‘hard’ currency (‘reserve currency’ or ‘anchor currency’), such as the US
dollar, the euro, and previously the German mark. The currency board thus borrows the
‘credibility’ of the anchor currency, in the belief that by tying the exchange rate against
such foreign currency it will maintain monetary stability and predictability. Interest rates
and inflation in the country that adopts a currency board tend to be roughly the same as
those of the country of the anchor currency. A currency board effectively hires the monetary
policy services of a foreign central bank. This has prompted Salzberger and Voigt280 to
declare that from an institutional perspective a currency board is a form of international
delegation, in the sense that ‘monetary policy decisions are delegated internationally and
taken over by an organization beyond the immediate reach of domestic actors, namely, the
(foreign) central banks that serve as the anchor for the domestic currency.’281 In contrast to
the international delegation of domestic sovereign powers, the domestic delegation of rule-
making and executive powers—which is, of course, a very usual institutional arrangement—
occurs when such powers are delegated by the government to an independent
administrative body or agency created by the national legislature and which is subject to
the national constitution.282 (This domestic delegation can also be characterized as
functional decentralization.)
2.226 With regard to the conduct of monetary policy, some form of delegation—domestic
or international—is likely to occur as a ‘credibility-enhancing’ exercise. As Salzberger and
Voigt have observed, the delegation is domestic when the conduct of monetary policy is
delegated to an independent central bank. The delegation is international when the country
adopts a currency board arrangement.
With regard to the operational characteristics of currency board arrangements, one of the
main rules is that currency boards should hold 100 per cent reserves or more against the
notes and coins in circulation.283 Effectively, a currency board can only issue notes and
coins if they are backed by foreign reserves. The required foreign reserves of the anchor (p.
106) currency typically consist of low-risk, interest-bearing bonds and other assets
denominated in the anchor currency. An orthodox currency board would not accept
deposits.
2.227 Hong Kong’s linked exchange rate system, as a currency board system, requires
both the stock and flow of the monetary base to be fully backed by foreign reserves. Any
change in the monetary base must be fully matched by a corresponding change in foreign
US dollar reserves at a fixed exchange rate (which is HKD 7.8 to USD 1).284
The conduct of monetary policy under a currency board arrangement leaves no room for
discretion. The currency board increases the monetary base when the private sector wants
to sell foreign currency to it and buy the domestic currency at the fixed exchange rate, and
it decreases the monetary base when the private sector wants to finance a balance of
payment deficit by selling the domestic currency and buying foreign currency.285 Interest
rates adjust automatically. As Colares explains, the establishment of a currency board
amounts to abdication from the sovereign right to set interest rates.286 Dollarization/
euroization goes one step further, as a total abdication of monetary sovereignty, since the
domestic currency is replaced by the foreign currency (though the name dollarization refers
to the US dollar, the domestic currency can be replaced by another currency, such as the
euro or the yen).287
2.228 One of the key implications of the establishment of an orthodox currency board is
the fact that governments can no longer finance their budget deficits by printing money.
This occurs because the amount of money in circulation is strictly defined by the rules of
the currency board—in other words by the availability of foreign reserves which is beyond
the political control of the government. The rules of an orthodox currency board also imply
that the currency board cannot provide lender of last resort assistance to distraught banks
in times of systemic banking crises (unless, of course, it has surplus foreign exchange
reserves, as is the case in Hong Kong).288 As discussed below, this is the ultimate test of
confidence for any currency board: whether or not it can survive a financial crisis.
The history of currency boards
2.229 Currency boards were widely used in British colonies in the nineteenth century.289
Following the establishment of a currency board in Mauritius in 1849, many other British
colonies in Africa, Asia, the Middle East and the Caribbean also adopted this institutional
arrangement.290 There were also currency boards in independent countries such as (p. 107)
Argentina (1902–14 and 1927–9), Iraq (1931–49), Danzig (1922–3), Panama (1904–31), and
North Yemen (1964–71).291 With the end of colonialism central banks replaced most
currency boards by the 1970s, with Hong Kong abandoning its currency board in 1974. For
a time, currency boards survived only in small territories like the Cayman Islands, Brunei,
Bermuda, and Gibraltar. Hong Kong, however, re-established a currency board in 1983.292
2.230 Modern currency boards are different from the old colonial ones.293 According to
Williamson, the recent interest in this type of institutional arrangement is partly
attributable to the disappointing vulnerability of many central banks, particularly in
emerging economies, to political pressure to finance government deficits—which is also an
argument in favour of central bank independence—and partly attributable to disquiet about
the central bank’s use of monetary discretion.294 A currency board is in the end an
arrangement based on the legislative establishment of a certain ‘monetary rule’: ‘changes
in the monetary base will be equal to the country’s overall balance of payments surplus or
deficit’.295 It achieves credibility and stability at the expense of monetary sovereignty.
However, it still maintains a domestic issue of currency, which can satisfy the local
sentiment for keeping a national currency and for keeping the benefits of seigniorage.
2.231 Modern currency boards can be divided into two groups. Some countries, like
Argentina (1991–2002), Lithuania (1994), Latvia (1994), or Bulgaria (1997), have
established a currency board in response to an economic crisis or in support of a
stabilization programme. Other countries, like Brunei Darussalam, Djibouti, and member
countries of the East Caribbean Central Bank—all of them small economies with relative
little expertise in monetary management—have adopted a currency board because of its
simplicity and predictability.296
Currency boards and central banks
2.232 Currency boards can and do coexist with central banks. However, central banks that
operate in tandem with a currency board are restricted in their operations, because of the
lack of an autonomous monetary policy and because of the lack of flexibility in most cases to
deal with banking crises (through the provision of emergency liquidity assistance).
(p. 108) 2.233 According to Ho, legal frameworks of modern currency boards fall into
three categories:297 (1) The currency boards of the early 1990s (such as Argentina and
Lithuania) typically have separate currency board laws in addition to central bank laws. (2)
The currency boards of the late 1990s (Bulgaria, Bosnia, and Herzegovina) have the
relevant details of their currency board operations directly incorporated into their
respective central bank laws. (3) Hong Kong is a special case, in part because of its political
status (one country, two systems), in part because of its history (a British colony till
relatively recently), in part because of its status as a key financial centre in the world.
2.234 Ho argues that ‘upon the adoption of a currency board regime, the central bank, if
one exists, is likely to be adapted rather than abolished. The monetary policy role is
reduced, but the importance of other supporting functions is not diminished.’298 She also
recalls that although several authors with knowledge of the previous historical experience
of currency boards were puzzled by the coexistence of a currency board-like arrangement
and a central bank, in the modern version of currency board arrangements, this is not
surprising. First, the modern version was adopted by independent States rather than
colonies and therefore it was wrongly assumed that the central bank would be dismantled
as soon as the currency board was introduced. In the author’s view, ‘the policy alternatives
in the two eras are not comparable. In the historical case, the alternative to adopting a
currency board was not establishing a central bank, but employing some other form of
currency issuance and circulation. In the modern context, by contrast, currency boards are
adopted as an alternative way of conducting monetary policy, or an alternative exchange
rate regime, typically lodged in a central banking framework.’299
The problems with currency boards: credibility and commitment
2.235 The successful introduction of a currency board requires a flexible economy, a
strong fiscal position, adequate reserves, and a reasonably well-operated and well-
supervised banking system. In addition to these economic pre-requisites, the introduction of
a currency board is a political decision and hence requires close cooperation among several
authorities, including the Ministry of Finance, the central bank (if there is one in the
country), and the Ministry of Justice.300
2.236 The benefits of currency boards in terms of monetary stability need to be weighed
against the drawbacks in terms of policy flexibility to tackle problems and crises. Among
the benefits the following are typically cited:301 currency boards remove monetary policy
from the political arena; they signal the government’s commitment to fiscal restraint and
financial rectitude, trying to convince private market actors as well as other governments of
a serious intent to maintain discipline;302 currency boards tend to facilitate trade and
investment; the fixed-rate convertibility provides confidence to foreign investors that
contracts in the foreign currency will be honoured and therefore currency boards
contribute to more inward (p. 109) foreign investment. However, a currency board should
not be expected to be a cure-all: in particular, it does not correct investors’ short-
sightedness.303 Among the main drawbacks, it is important to point out the following: a self-
imposed loss of monetary sovereignty; governments cannot use monetary policy to respond
to economic shocks such as a reduction of exports or sharp changes in capital movements;
when investors sell the local currency and interest rates rise sharply, local banks are put
under pressure; a currency board usually cannot provide LOLR assistance to troubled banks
in times of banking crises; it sometimes makes exports of goods and services more
expensive, hence decreasing the competitiveness of export-oriented industries.304
2.237 The reputation of currency boards has been tarnished by the experience in
Argentina. The ultimate test for a currency board is its ability to withstand a financial crisis:
Hong Kong succeeded in this test. Argentina failed.
2.238 Argentina passed legislation setting the currency board as its preferred legal form
of self-discipline and credibility enhancement in 1991.305 In addition to the convertibility
law, Argentina also passed legislation to grant independence to the Central Bank.306 For ten
years, the country enjoyed the benefits of the currency board.307 However, some of its
drawbacks were creeping in and, after a tumultuous 2001, the country abandoned in
January 2002 the convertibility of the peso to the US dollar and moved to a floating
exchange regime,308 in the midst of a profound political and institutional crisis, one of the
worst experienced by the country in its eventful political history.309 Moreover, the Argentine
government defaulted on its private creditors’ debt repayments.310
2.239 The Argentine crisis illustrates the limitations of an orthodox currency board to deal
with banking crises. The requirement that domestic currency must be backed by the
reserve (p. 110) currency or other foreign assets and gold generally limits the scope of
LOLR assistance and monetary operations ‘to the amount of foreign exchange in excess of
that required for backing’.311 Since this emergency liquidity assistance is often helpful in
containing potentially contagious liquidity problems, its absence may have adverse
implications for the ability of the domestic banking system to defend itself against a
systemic crisis.312
2.240 As in other monetary and exchange rate regimes, weak banking conditions can
undermine the credibility of currency boards. Weak, unsound, or poorly managed banks are
more likely to take excessive risks and more likely to fail to respond to monetary signals,
especially interest rate volatility, in a predictable manner.313
2.241 A currency board is not ‘designed’ to address banking problems. A sound and well
functioning banking system is typically a precondition for the effective operation of a
currency board. Due to the tension between LOLR operations (where a degree of discretion
is necessary) and the rules of a currency board arrangement, a country wishing to establish
a currency board ‘amid a weak banking system’ has a difficult choice to make. A banking
crisis will certainly put a currency board under strain.314
The absence of an exit strategy in Argentina has also been the subject of some debate. It is
questionable whether the law must prescribe the circumstances under which the currency
board arrangement will be abandoned. It is likely that an explicit ‘exit policy’ will
undermine the credibility of the arrangement which is specifically designed to convince
international markets that monetary stability is guaranteed for the foreseeable future. In
fact, the country may send an even stronger signal of long-term commitment by
incorporating the legal provisions establishing the currency board in the constitution or
setting a special majority provision for future modifications of the primary legislation
governing its operation.
2.242 There is, of course, a clear trade-off between the long-term commitment to a
‘monetary rule’ (which enhances credibility) and the flexibility that is needed in the
management of a financial crisis.
Footnotes:
1
See Vera C Smith, The Rationale of Central Banking and the Free Banking Alternative
(Indianapolis, IN: Liberty Press, 1990 [1936]) 189–90.
2
Rosa M Lastra, ‘The Independence of the European System of Central Banks’ (1992)
33(2) Harvard International Law Journal 475.
3
On 18 February 2009, Ben Bernanke, then Chairman of the Federal Reserve System,
stated: ‘the Federal Reserve has done, and will continue to do, everything possible within
the limits of its authority to assist in restoring our nation to financial stability and economic
prosperity…’ (Ben Bernanke, ‘Federal Reserve Policies to Ease Credit and Their
Implications for the Fed’s Balance Sheet’, Speech at the National Press Club Luncheon,
National Press Club, Washington, DC (18 February 2009)). On 26 July 2012, Mario Draghi,
president of the European Central Bank, in what has become a famous quote said: ‘Within
our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me,
it will be enough.’ (Mario Draghi, President of the European Central Bank, Speech at the
Global Investment Conference in London (26 July 2012), at <http://www.ecb.int/press/key/
date/2012/html/sp120726.en.html> (last visited 18 July 2014)).
4
Financial stability is further analysed in Chapters 3 and 4, as well as Chapters 10, 11, and
14 in this volume. Financial stability has always been a key central banking goal, often in
the guise of other denominations: effective supervision of the banking system, sound
banking, prevention of financial crises, smooth running of the payments system, etc.
Thomas Baxter, ‘Financial Stability: The Role of the Federal Reserve System’, Paper
Presented at a Conference on the Future of Banking Regulation and Supervision in the EU,
held at the ECB, Frankfurt (15 November 2013), pointed out that ‘[t]he Federal Reserve’s
financial stability mandate is seen in the penumbra of the Federal Reserve Act’, and that
‘that is legally sufficient’ (deriving implied powers from the penumbra of other express
powers). In my opinion, the legal basis for such financial stability mandate can already be
found in the preamble to the Federal Reserve Act, in the words ‘effective supervision of
banking in the United States’ and in other provisions of the original Federal Reserve Act. In
his presentation Baxter further pointed out that the express terms of the Dodd–Frank Act
place financial stability within the Federal Reserve’s legal mandate. See also Dodd–Frank
Wall Street Reform and Consumer Protection Act (enacted 21 July 2010, Pub L No 111–203,
124 Stat 1376, HR 4173) (hereinafter Dodd–Frank Act 2010) and the Federal Reserve Act
(enacted 23 December 1913, 38 Stat 251, 12 USC 226).
5
Howard Davies and David Green, Banking on the Future. The Fall and Rise of Central
Banking (Princeton, NJ: Princeton University Press, 2010) provide a brief history of central
banking in chapter 1, where—drawing on Forrest Capie—they argue (11) that a proper
theory of central banking as we know it today, was not articulated until Henry Thornton’s
seminal book, An Enquiry into the Nature and Effects of Paper Credit in the United
Kingdom (London: George Allen & Unwin, 1939 [1802]; repr Fairfield, NJ: A M Kelley,
1978). And on related grounds, it can be argued that although the Riksbank was founded
earlier, the Bank of England was the first to take on full central banking responsibilities.
6
See generally Charles Goodhart, The Evolution of Central Banks (Cambridge, MA: MIT
Press, 1988).
7
Path dependence theories—acknowledging that history matters—have become a useful
tool in social sciences, in particular economics and politics. See generally Paul Pierson,
Politics in Time: History, Institutions, and Social Analysis (Princeton, NJ: Princeton
University Press, 2004).
8
An analysis of central banking functions—upon which this section draws upon—is found
in Rosa M Lastra, Central Banking and Banking Regulation (London: Financial Markets
Group/London School of Economics, 1996) 249–86. See also Patricia S Pollard, ‘A Look
Inside Two Central Banks: The ECB and the Federal Reserve’, Federal Reserve Bank of St
Louis (January–February 2003) 18, at <https://research.stlouisfed.org/publications/review/
03/01/Pollard.pdf> (last visited 18 July 2014).
9
NML Capital, Ltd v Banco Central de la Republica Argentina, 652 F 3d 172, 175 (2nd Cir
2011).
10
For example, the Dodd–Frank Act 2010 changed the functionality of the Federal Reserve
System. In ‘The Functionality of the Fed’, a lecture at Queen Mary University of London on
7 October 2011, Thomas Baxter, General Counsel of the Federal Reserve Bank of New York
described the functionality of the Fed making an analogy with the three legs and the top of
a stool. The first leg is the monetary policy function, the second leg is the supervisory
functions (which after Dodd–Frank extends beyond banking supervision as further
explained below) and the third leg is the financial services functionality (the bankers’ bank
role) since the central bank is a bank. The latter includes the provision of lender of last
resort or emergency liquidity assistance. Sitting on top of these three functions is the
financial stability function, the overarching function.
11
Thomas Baxter and David Gross, ‘Special Immunities of Sovereigns: The Matter of
Central Bank Immunity’ in Lee Buchheit and Rosa M Lastra (eds), Sovereign Debt
Management (Oxford: Oxford University Press, 2014) examine the recent case law
(litigation related to Argentina) to elucidate how sovereign immunity works—under US law
—with respect to a central bank holding its dollar reserves in an account at the Federal
Reserve Bank of New York. They conclude that following the NML Capital Ltd 652 F 3d at
190, an independence requirement is no longer needed and that going forward, the analysis
of the matter of central bank immunity will only focus on whether the funds are property of
the central bank ‘held for its own account’ under 28 USC s 1611(b)(1).
12
A central bank is both a regulatory agency and a bank; this means that we need both
administrative law and commercial law for the proper understanding of central banks and
their operations. Thomas Cottier and Lucia Satragno claim—in their chapter, ‘The Potential
of Law and Legal Methodology in Monetary Affairs’ in Thomas Cottier, Christian Titje and
Rosa M Lastra (eds), The Rule of Law in Monetary Affairs (Cambridge: Cambridge
University Press, forthcoming 2014)—that the role of law in monetary affairs is limited to
constitutional issues as regards the management of the public monopoly of money and that
it does not extend to operational monetary policies, which are led exclusively on the basis of
economic analysis and models. They suggest that the task ahead is to define a legal
framework to identify the substantive principles and factors which should frame and inform
future monetary policy.
13
William Blair, ‘Legal Status of Central Bank Investments under English Law’ (1998)
57(2) Cambridge Law Journal 374, explains that central banking is a functional endeavour,
rather than a nominal one. As a result, a central bank or a monetary authority is
characterized by what it does, rather than how it is legally set up to perform its objectives.
14
Currency in circulation comprises notes and coins. The central bank issues the notes,
but the minting of coins (a marginal fraction of the total currency in circulation) is typically
delegated to a different institution. In the United Kingdom, for instance, the Royal Mint is
responsible for the issue of UK coins, while the notes are issued by the Bank of England. In
the USA, coins are produced by the United States Mint. The coins are then sold to Federal
Reserve Banks which in turn are responsible for putting coins into circulation and
withdrawing them. In the EU, according to Article 128 of the Consolidated versions of the
Treaty on European Union and the Treaty on the Functioning of the European Union, 2010
OJ C 83/01 vol 53 (30 March 2012), <http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?
uri=OJ:C:2010:083:0047:0200:en:PDF> (last visited 18 July 2014) (hereinafter
TFEU):
1. The European Central Bank shall have the exclusive right to authorise the
issue of euro banknotes within the Union. The European Central Bank and the
national central banks may issue such notes. The banknotes issued by the
European Central Bank and the national central banks shall be the only such
notes to have the status of legal tender within the Union.
2. Member States may issue euro coins subject to approval by the European
Central Bank of the volume of the issue. The Council, on a proposal from the
Commission and after consulting the European Parliament and the European
Central Bank, may adopt measures to harmonise the denominations and
technical specifications of all coins intended for circulation to the extent
necessary to permit their smooth circulation within the Union.
Thus for coins, euro-area countries are responsible for issuing them. The national mint
physically produces the coins and the national central bank puts them into circulation. The
denominations and technical specifications are laid down by the Council of the EU, and the
European Central Bank approves each the volume and value of coins to be issued each year.
15
If Scotland had become independent as per the result of the referendum held on 18
September 2014, one of the most contentious issues was the proposal for a currency union.
Alas, 2,001,926 (55.3%) voted to remain in the United Kingdom, so the debate is now of
historical interest. Alex Salmond, then Scotland’s First Minister, had suggested that an
independent Scotland could have formed a currency union with the rest of the UK, with the
Bank of England as lender of last resort standing behind Scotland’s financial sector. The
Governor of the Bank of England, Mark Carney, had highlighted some of the difficulties of
entering a currency union, including the loss of national sovereignty, the risks to the pursuit
of financial stability, and the need for adequate foundations, in particular as regards the
provision of fiscal support to ‘bail out’ another country. See the editorial ‘Carney in
Currency Warning to Scotland’ Financial Times (30 January 2014). Indeed, the risks
currency unions pose in the absence of an adequate fiscal framework have been amply
demonstrated by the Eurozone’s experience. Alex Salmond had also suggested that an
independent Scotland could opt unilaterally to use the pound in the absence of a monetary
union (sterlingization). Alistair Darling, leader of the pro-union campaign had branded it the
‘Panama plan’ (Panama adopted ‘dollarization’ in 1904). See John Kay, ‘Currency Unknowns
Weigh in an Independent Scotland’ Financial Times (26 February 2014). See also Treasury
report, ‘Scotland Analysis: Currency and Monetary Policy’ (23 April 2013), at <https://
www.gov.uk/government/uploads/system/uploads/attachment_data/file/191786/
ScotlandAnalysis_acc-1.pdf>. The Treasury report set out in detail the advantages and
disadvantages of the potential currency options open to an independent Scotland, including:
a formal sterling currency union with the continuing United Kingdom; using sterling
unilaterally, with no formal agreement; joining the euro; or introducing a new Scottish
currency.
16
There are several theoretical scenarios—with or without a central bank—of commercial
banks competing in the provision of currency. (Scotland—as Geoffrey Wood reminded me—
operated without a central bank between 1695–1844, though there is dispute over whether
there was de facto access to the Bank of England’s acting in that role). These scenarios, as
set out in Lastra, above note 8, are as follows:
(a) Commercial banks issue notes convertible into central bank money not on
a one-to-one basis, but rather on a fractional reserve basis. As a result,
seigniorage is shared between the central bank and the note-issuing
commercial banks. The convertibility of commercial bank notes into central
bank money allows the central bank to control interest rates and conduct
monetary policy. It was, however, argued in the UK in the first half of the
nineteenth century, before the passage of Peel’s Act in 1844 (which meant the
triumph of the currency school principle over the banking school principle)
that the freedom of private banks to issue their own notes greatly complicated
the conduct of monetary policy.
(b) Commercial banks issue notes not convertible into central bank money
but into some other object or asset of value, (ie, gold, basket of commodities,
other currencies) though central banks may, or may not, exist (for instance, to
undertake supervisory and lender of last resort activities). The government
still defines the monetary unit, but in terms of a commodity standard for
instance. Seigniorage is shared between the central bank (if the central bank
also issues its own notes) and the commercial banks. Yet the central bank
cannot control interest rates as effectively, because the private note-issues are
not convertible into central bank money. Interest rates will thus respond to
pressures on bank reserves.
(c) Commercial banks are allowed to define their own liabilities in terms of
whatever collections of goods or assets they might wish. The Government no
longer defines the monetary unit. In this context central banks might as well
disappear.
17
As Goodhart, above note 6, 22–3, recalls, ‘[d]uring the course of the XIXth century, the
designation of the note issue of the Central Bank as a “legal tender” was a sign of
weakness. …Thus the notes of the Reichsbank and the Swiss National Bank (except at times
of war) were not legal tender, whereas the notes of the banks of issue in Italy were legal
tender. …’
18
For a comprehensive study of the free banking cases, see Kurt Schuler, ‘The World
History of Free Banking: An Overview’ in Kevin Dowd (ed), The Experience of Free Banking
(London: Routledge, 1992). However, the often-cited historical experience of Scotland, from
1716 to 1845, widely surveyed by White (see Lawrence H White, Free Banking in Britain:
Theory, Experience and Debate, 1800–1845 (Cambridge: Cambridge University Press,
1984)), was not that stable and successful, according to Goodhart, above note 6, 51–2.
19
Friedrich A von Hayek’s proposals were clearly defined in Denationalization of Money
(London: Institute of Economic Affairs, 1976), though his concern about this subject goes
back to 1937 (Monetary Nationalism and International Stability (New York: Augustus M
Kelly, 1971 [1937]), or even before, as one of his students at the London School of
Economics, Vera Smith, published in 1936 The Rationale of Central Banking (above note 1),
paying special attention to the role of note-issuing. Hayek’s argument was
‘refined’ (according to his own words) in Denationalization of Money—The Argument
Refined (London: Institute of Economic Affairs, 1978), becoming more radical, envisioning
private fiat monies; and redefined in ‘Market Standards for Money’ (1986) 6 Economic
Affairs 4), with a more realistic view on the impracticability of some aspects of his
proposals, at least in a near future.
20
See White, above note 18, and Lawrence H White, Competition and Currency. Essays on
Free Banking and Money (New York: New York University Press, 1989). As defined by
White, above note 18, 1, ‘free banking’ is ‘the system under which there are no political
restrictions on the business of issuing paper currency convertible into full-bodied coin’. See
also George A Selgin, The Theory of Free Banking (Totowa, NJ: Rowman & Littlefield, 1988)
and David Glasner, Free Banking and Monetary Reform (Cambridge: Cambridge University
Press, 1989).
21
For a currency that is not backed by any central authority, Bitcoin’s value lies in people’s
confidence to use it. But trust is built over time. As reported in the FT of 26 February 2014,
following fears of USD 400 million theft after Bitcoin’s oldest exchange—Mt Gox—went
dark, some Bitcoin advocates said that they are building the towers and bridges of
tomorrow’s finance, and that they put themselves at risk in doing so. See ‘Bitcoin Pays Price
of Building New Financial Order’ Financial Times (26 February 2014). See also Wolfgang
Munchau, ‘Our Flawed Financial System is Reflected in Bitcoin’ Financial Times (3 March
2014) and John Gapper, ‘Bitcoin Needs to Grow Out of its Obsessive Adolescence’ Financial
Times (13 March 2014).
22
For a discussion of some of the problems associated with Bitcoin see eg John Authers, ‘It
is Time to Take the Bitcoin Bubble Seriously’ Financial Times (12 December 2013); John
Gapper, ‘Bitcoin is More than a Currency for Speculators’ Financial Times (6 February
2014); and Jean-Pierre Landau, ‘Beware the Mania for Bitcoin, the Tulip of the 21st
Century’ Financial Times (17 January 2014).
23
See Mark Williams, ‘A Dangerous Mistake Lies at Bitcoin’s Intellectual Foundation’,
Financial Times (11 February 2014).
24
Thornton, above note 5, surveys how most smaller country banks found it more
convenient to centralize their reserves with a bigger bank, a ‘London banker’ (one of the
London clearing banks). The ‘London bankers’ in turn held interbank balances at the Bank
of England. See also Walter Bagehot, Lombard Street. A Description of the Money Market
(London: Smith, Elder & Co, 1915 [1873]) for the role of the central bank as bankers’ bank.
25
Charles Collyns, ‘Alternatives to the Central Bank in the Developing World’,
International Monetary Fund Occasional Paper No 20 (1983) 3. On the issue of economies
of scale in money, see also Roland Vaubel, ‘The Government’s Money Monopoly:
Externalities or Natural Monopoly’ (1984) 37 Kyklos 45.
26
See Federal Reserve System, Federal Open Market Committee, at <http://
www.federalreserve.gov/monetarypolicy/fomc.htm> (last visited 18 July 2014).
27
Bank of England, Monetary Policy, at <http://www.bankofengland.co.uk/monetarypolicy/
Pages/default.aspx> (last visited 18 July 2014).
28
European Central Bank, Monetary Policy, at <http://www.ecb.int/mopo/html/
index.en.html> (last visited 18 July 2014).
29
See White, above note 18, 137. See also White, above note 18, 138–9: ‘Free banking as a
monetary system comprises two conceptually distinct elements: (1) unregulated issue of
transferable bank liabilities and (2) unmanipulated supply of basic cash.’
30
See eg Mark Goodfriend and Robert G King, ‘Financial Deregulation, Monetary Policy
and Central Banking’ (1988) 74(3) Economic Review (Federal Reserve Bank of Richmond)
19.
31
See Milton Friedman, ‘The Role of Monetary Policy’ (1968) 58(1) American Economic
Review. See also Milton Friedman and Anna J Schwartz, A Monetary History of the U.S.,
1867–1960 (Princeton: Princeton University Press, 1963).
32
See Paul Volcker, ‘Reflections of a Central Banker’ Wall Street Journal (16 October
1990).
33
The phrase ‘currency war’ was coined by Brazilian Minister of Finance Guido Mantega
in 2010. The issue, however, is not new. Competitive currency devaluations have pernicious
effects upon the economic relations between States, in particular upon their trading
relations. See paragraph 14.202 and footnote 263, Chapter 14.
34
The first hint by the then Chairman of the Federal Reserve System, Ben Bernanke of a
possible quantitative easing ‘tapering’ in a Congressional testimony in May 2013 sent
shockwaves throughout global stock markets and government bond markets (bond yields
around the Work rose sharply as investors anticipated an end to QE, thus triggering a sell-
off in bond markets), with the US Dollar rising and with the uncertainty also undermining
the so-called ‘carry trades’ (borrowing in a low interest rate currency to invest in higher
yielding assets). See James Politi, ‘Fed Chief Hints on Money Flow’ Financial Times (22 May
2013). It is rather remarkable that major market movements can be triggered by comments
shrouded with a degree of uncertainty, if not ‘mystery’ (a mystery is defined in the Oxford
dictionary as ‘something that is difficult to understand or explain’). Small wonder then that
investors scrutinize every word uttered by the chairman of the Fed. This signalling of the
unwinding of QE on 22 May 2013 was followed first by a more precise statement on 19 June
2013, in which Bernanke set out the case for slowing the pace of QE as the US economy
picks up momentum (Ben Bernanke, Press Conference (19 June 2013), at <http://
www.federalreserve.gov/mediacenter/files/FOMCpresconf20130619.pdf> (last visited 17
July 2014)) and later by two actual ‘tapering’ exercises in December 2013 and January
2014. The first decision to ‘taper’ the monthly asset buying from USD 85 billion to USD 75
billion was announced on 18 December 2013 (Federal Reserve System, Monetary Policy
Press Release (18 December 2013), at <http://www.federalreserve.gov/newsevents/press/
monetary/20131218a.htm> (last visited 17 July 2014)).
The second decision to ‘taper’ or reduce the monthly asset purchases by another USD 10
billion to USD 65 billion was announced two days before Bernanke stepped down as
Chairman of the Fed on 29 January 2014 (Federal Reserve System, Monetary Policy Press
Release (29 January 2013), at <http://www.federalreserve.gov/newsevents/press/monetary/
20140129a.htm>(last visited 17 July 2014)). In both cases, the Federal Open Market
Committee (FOMC) reinforced its ‘forward guidance’ of low interest rates. It is also
significant that in both cases the ‘tapering’ decisions had extraterritorial effects upon
emerging markets, causing turbulence in Turkey, South African, India and Argentina. For a
discussion on this, see eg Dave Shellock, ‘Fed’s Additional Taper Move and EM Rate Rises
Cause Turbulence’ Financial Times (30 January 2014). India’s central bank governor Mr
Rajan has criticized the US for running ‘selfish economic policies’, stating that
‘international monetary cooperation has broken down’. See ‘India’s Central Bank Chief Hits
at West’ Financial Times (31 January 2014). A further decision to taper the monthly asset
purchases by another USD 10 billion to USD 55 billion a month was announced 19 March
2014. See Federal Reserve System, Monetary Policy Press Release (19 March 2014), at
<http://www.federalreserve.gov/newsevents/press/monetary/20140319a.htm> (last visited
17 July 2014). The 30 April 2014 FOMC meeting tapered USD 10 million, the 18 June FOMC
meeting tapered USD 10 million, the 30 July FOMC meeting tapered USD 10 million, and
the 17 September FOMC meeting tapered USD 10 million. QE finally came to an end on 29
October 2014 when the FOMC tapered its last USD 15 billion of monthly asset purchases
(Federal Open Market Committee, Press Release, 29 October 2014 <http://
www.federalreserve.gov/newsevents/press/monetary/20141029a.htm>).
The FOMC directed the Open Market Trading Desk at the Federal Reserve Bank of New
York to conclude the current asset purchase programme by the end of October 2014
(Federal Reserve Bank of New York, Statement Regarding Purchases of Treasury Securities
and Agency Mortgage-Backed Securities, 29 October 2014 <http://www.ny.frb.org/markets/
opolicy/operating_policy_141029a.html>).
The end of QE and a return to ‘normal’ monetary policy, as a result of an improvement in
the US labour market, will no doubt have implications for foreign exchange markets and
commodities markets, influencing economic conditions in emerging economies.
As reported by Atkins, Jaime Caruana (BIS General Manager) has highlighted that central
banks not only have to manage expectations about short term interest rates but also face
the ‘unfamiliar’ challenge of managing long-term interest rates. See Ralph Atkins, ‘Bond
Markets Jitters Support Bears’ Case for Plunge to Earth’ Financial Times (5 June 2013).
Atkins also pointed out that ‘QE has artificially lifted asset prices globally’.
35
The word taper means a thin candle, and by extension something that gradually narrows
and comes to an end. As explained in Robin Harding, ‘A Year in a Word: Taper—Keeping the
Markets in Expectation’ Financial Times (31 December 2013), taper acquired a new
meaning in the context of the policies adopted by the US Federal Reserve System: to taper
was to slow asset purchases.
36
Cottier and Satragno, above note 12, suggest that the law should regulate the
operational aspects of monetary policy.
37
William White, ‘Changing Views on How Best to Conduct Monetary Policy’, Speech at
the Central Bank Governors’ Club Meeting in Nafplio, Greece (18 October 2002), at
<www.bis.org/speeches/sp021018.htm> (last visited 17 July 2014).
38
White, above note 37:
What do we mean by the policy instrument? Here too there has been a significant
evolution over time. Some decades ago, the academic literature would have
emphasized the importance of the reserves supplied by the central bank to the
banking system, and the implications (via the money multiplier) for the growth of
money and credit. Today, it is more broadly understood that no industrial country
conducts policy in this way…There has been a decisive shift towards the use of the
short term interest rates as the policy instrument.
James Paulsen, ‘Fed Drains Punch Bowl, But Don’t Leave the Party Yet’ Financial Times (18
March 2014), says:
Monetary policy is actually a joint effort implemented by both the Federal Reserve
and the marketplace. …The Fed primarily controls reserve injections and the level
of short-term interest rates, but these only represent two aspects of total monetary
power. Bond vigilantes establish the level of long term yields and, in combination
with the Fed, determine the slope of the yield curve. Finally the pace of money
velocity (how fast the money supply turns over) is determined by collective private
sector spending propensities.
39
Milton Friedman talked about ‘helicopters of cash’: ‘Let us suppose now that one day a
helicopter flies over this community and drops an additional $1000 in bills from the sky. …
Let us suppose further that everyone is convinced that this is a unique event which will
never be repeated.’ See Milton Friedman, ‘The Optimum Quantity of Money’ in Milton
Friedman, The Optimum Quantity of Money and Other Essays (Chicago: Adline Publishing
Company, 1969) 4–5. For an analysis of non-standard measures, see Claudio Borio and Piti
Disyatat, ‘Unconventional Monetary Policies: An Appraisal’, Bank for International
Settlement Working Paper No 292 (November 2009), at <http://www.bis.org/publ/
work292.pdf> (last visited 18 July 2014), and Jean-Claude Trichet, ‘Unconventional
Monetary Policy Measures: Principles—Conditions—Raison d’être’ (January 2013)
International Journal of Central Banking 229.
40
In the case of the United States, through its unprecedented QE policies, the Federal
Reserve System tried to fulfil its statutory mandate of growth and maximum employment (in
addition to price stability). The Fed made large-scale asset purchases (mortgage-backed
securities and Treasury securities) that increased its balance sheet from USD 0.9 trillion in
2007 to USD 2.9 trillion at the end of 2012. The Fed also changed its communication
policies since rates reached the zero bound. This exercise has been referred to as ‘forward
guidance’. From 2011 to 2012, it announced a specific date for how long it anticipated that
the federal funds rate would be at ‘exceptionally low levels’, and over time incrementally
extended that horizon by two years. In December 2012, it replaced the time horizon with an
unemployment threshold—as long as inflation remained low, the Fed anticipated that the
federal funds rate would be exceptionally low for at least as long as the unemployment rate
was above 6.5%. See Marc Labonte, ‘Federal Reserve: Unconventional Monetary Policy
Options’ Congressional Research Service (19 February 2013), at <http://www.fas.org/sgp/
crs/misc/R42962.pdf> (last visited 18 July 2014). See above notes 34 and 35.
41
See Lawrence Mutkin, ‘Prospect of ECB Easing Drives Eurozone Bond Rally’ Financial
42
Borio and Disyatat, above note 39, consider QE as a mix of ‘bank reserves policy’ and
‘quasi debt-management policy’, while ‘credit easing’ is a mix of ‘credit policy’ and ‘quasi
debt management policy’. The Swiss National Bank’s policy of intervention in the foreign
exchange market to prevent the appreciation of the Swiss franc is another example of the
range of measures undertaken by central banks to combat the crisis.
43
Borio and Disyatat, above note 39.
The fulcrum of the implementation of interest rate policy is the market for bank
reserves. This is a peculiar market. By virtue of its monopoly over this asset, the
central bank can set the quantity and the terms on which it is supplied at the
margin. As such, the central bank is able to set the opportunity cost (‘price’) of
reserves, the overnight rate, to any particular level, simply because it could stand
ready, if it so wished, to buy and sell unlimited amounts at the chosen price. This is
the source of the credibility of the signal.
44
International Monetary Fund, ‘Unconventional Monetary Policies—Recent Experience
and Prospects’ (18 April 2013), at <http://www.imf.org/external/np/pp/eng/
2013/041813a.pdf> (last visited 18 July 2014).
45
Charles A E Goodhart, Presentation on Instruments and Objectives of Monetary Policy at
a conference on Evolution in Monetary Law and Policy, Glasgow University (14 June 2013).
46
See above note 34 and paras 2.145–2.147 below. See also ‘The Bank of England’s Big
Test is Yet to Come. Five Years On, Success of QE Still Hinges on a Smooth Exit’ Financial
Times (6 March 2014) and Nigel Wilson, ‘We Need Economic Rehab Not a Quick Fix of
Cheap Money’ Financial Times (8 March 2014). At the time of adding the finishing touches
to this chapter (31 October 2014), the improvement in the US economy contrasts with the
economic weakness in Europe and Japan, thus prompting different monetary policy
responses. While the US has now ended its QE programme (above note 34), the Bank of
Japan is embarking on fresh QE (see Jacob M Schlesinger, Eleanor Warnock, and Takashi
Nakamichi, ‘Bank of Japan Announces Massive Stimulus Move’ Wall Street Journal (31
October 2014), at <http://online.wsj.com/articles/bank-of-japan-announces-massive-
stimulus-move-1414773082>), and the ECB is considering its options as deflation fears
remain despite the latest round of monetary stimulus. See below paragraph 7.43.
47
Wolfgang Munchau explained in ‘Forward Guidance Only Works if You Do it Right’
Financial Times (8 July 2013) that ‘[t]he original concept of forward guidance goes back to
papers written by economists Paul Krugman in 1988 and Gautti Eeggertsson and Michael
Woodford in 2003. It deals with how a central bank can get long-term interest rates to fall
at a time when short-term rates—over which it has control—are close to zero. Forward
guidance is not merely a promise to keep rates low. It is a promise to keep them lower for
longer than is warranted’.
48
See Andrew Filardo and Boris Hofmann, ‘Forward Guidance at the Zero Lower Bound’,
Bank for International Settlements (9 March 2014), at <https://www.bis.org/publ/qtrpdf/
r_qt1403f.pdf> (last visited 18 July 2014). Gavyn Davies in ‘Unwinding the World’s Biggest
Economic Experiment’, Financial Times (22 June 2013), compared the exit from QE to
landing a plane on an aircraft carrier and possibly in stormy seas. In an interview with the
Financial Times (Claire Jones, ‘BIS Chief Urges Central Banks to Hold Steady as They Exit
Easing’ Financial Times (27 June 2013)), Jaime Caruana, BIS General Manager, questioned
the effectiveness of unconventional monetary policy measures, since he felt that the
exercise in buying time had not been accompanied by appropriate balance sheet, fiscal and
structural policies. Mr Caruana also said that the proliferation of cheap money had also
inflated asset-price bubbles.
This view was echoed by Andrew Haldane, who warned against the ‘disorderly reversion’ of
‘the biggest government bond bubble in history’. See the editorial entitled ‘The Challenge of
Normality’s Return’ Financial Times (13 June 2013).
49
Callow considers that forward guidance on policy rates is one of the three forms of non-
conventional measures adopted by central banks in response to the crisis (the other two
being large asset purchases—quantitative easing—and exceptional liquidity assistance). See
Julian Callow, ‘Monetary Policy Glasnost Should be Embraced’ Financial Times (2 January
2014).
50
See below note 56. See also ‘Much Ado About Forward Guidance. Bank of England’s
tautological policy serves little purpose’ Financial Times (23 January 2014), questioning the
purpose of Mark Carney’s biggest innovation in the conduct of monetary policy. ‘Guidance,
it was hoped, would provide extra monetary stimulus when interest rates were already
ultra-low.’ On 21 March 2014, the Financial Times (‘Yellen’s Line Puts US Treasuries on
Edge’) reported—following Yellen’s first FOMC meeting as Fed chairwoman—that the Fed
would consider a broad range of measures (and not simply one labour market indicator) in
deciding when to raise rates: ‘Guidance based on qualitative assessments…also creates
more volatility.’
51
See Chris Giles, ‘Carney is Dressing Old Policy in the Governor’s New Clothes’ Financial
Times (27 January 2014). Giles writes: ‘That link between unemployment and interest rates
has gone, but without acknowledgement.’ See also Chris Giles, ‘Carney Must Avoid Another
Enforced Error’ Financial Times (6 February 2014).
52
See the editorial ‘A Change of Heart for Central Bankers. Forward Guidance Takes a
Step Back in both US and UK’ Financial Times (15 February 2014).
53
Financial Times (21–22 December 2013).
54
See eg Institute of International Finance, ‘Capital Flows to Emerging Market
Economies’, Research Note (June 2013), at <www.iif.com/press/press+422.php>
(last visited 18 July 2014). While emerging markets benefitted from the Fed’s loose
monetary policy, its eventual tightening is likely to uncover and exacerbate emerging
market vulnerabilities.
55
Such scope of powers will vary depending on the exchange regime, the degree of
independence of the central bank and the openness of the economy.
56
Charles A E Goodhart, Monetary Theory and Practice: The UK Experience (London:
MacMillan, 1984) 96.
57
Allan Sproul, ‘Reflections of a Central Banker’ [Speech given in 1955] (1989) 14 Federal
Reserve Bank of New York Quarterly Review 25. Sproul is quoting Young.
58
See Thornton, above note 5, 169; Smith, above note 1, 138; and Goodhart, above note 6,
37.
59
Richard H Timberlake, Jr, The Origins of Central Banking in the U.S. (Cambridge, MA:
Harvard University Press, 1978) 223.
60
Goodhart, above note 6, 38 and 73. He also remarks that this transition from a
competitive, profit-maximizing central bank to a non-competitive, non-profit-maximizing
central bank is so difficult to achieve, that most other central banks outside Europe were
set up by legislation as non-profit-maximizing, non-competitive ab initio.
61
Goodhart, above note 6, 35.
62
See Bruce J Summers, ‘Clearing and Payment Systems: The Central Bank’s Role’ in
Patrick Downes and Reza Vaez-Zadeh (eds), The Evolving Role of Central Banks—Papers
presented at the Fifth Seminar on Central Banking (Washington, DC: IMF, 1991) 30.
63
It can be argued that a nationwide demand for basic money can be satisfied by
borrowing it abroad, in the case of a nation on an international monetary standard (such as
gold).
64
Luis Garicano and Rosa Lastra, ‘Towards a new Architecture for Financial Stability:
Seven Principles’ (2010) 13(3) Journal of International Economic Law 597.
65
See Charles Goodhart and Dirk Schoenmaker, ‘Institutional Separation between
Supervisory and Monetary Agencies’ in Charles Goodhart (ed), The Central Bank and the
Financial System (Basingstoke: MacMillan Press, 1993) and Charles Goodhart, ‘Price
Stability and Financial Fragility’ in Goodhart (ed), The Central Bank and the Financial
System. Joseph G Haubrich, ‘Combining Bank Supervision and Monetary Policy’, Federal
Reserve Bank of Cleveland Economic Commentary (November 1996). Joe Peek, Eric S
Rosengren, and Geoffrey M B Tootell, ‘Is Bank Supervision Central to Central
Banking?’ (1999) 114(2) Quarterly Journal of Economics 629.
66
European Union Committee, House of Lords, ‘The Future of EU Financial Regulation
and Supervision’, 14th Report of Session 2008–9 (17 June 2009), at <http://
www.publications.parliament.uk/pa/ld200809/ldselect/ldeucom/106/106i.pdf> (last visited
18 July 2014).
67
Garicano and Lastra, above note 64.
68
Though some of the instruments in the macro-prudential toolkit are relatively new, some
other tools (perhaps with a different name and for a different policy objective) were applied
in the past. See generally David Bholat, ‘Macro-prudential Policy: Historical Precedents and
Possible Legal Pitfalls’, Birkbeck University of London Monthly Seminar Series (25 October
2013), at <http://www.lccge.bbk.ac.uk/news/seminar> (last visited 18 July 2014).
69
The fact that the central bank may assume both a macro-monetary policy role and a
micro-banking supervisory role is often explained in terms of consistency in the conduct of
the central bank policies. As monetary policy affects the working of the banking system
with a clear impact on banking supervision and regulation, and as a sound banking system
is a necessary condition for maintaining monetary stability, I have claimed since 1996 that
independence to pursue stable money should be accompanied by independence to pursue
sound banking. Deposit insurance—further discussed in Chapter 4—is often administered
by an agency or institution other than the central bank, though often working in close
connection with it. For example, in the USA, the Federal Deposit Insurance Corporation
(FDIC) is a separate agency from the Federal Reserve System.
70
Charles Goodhart, above note 6, writing in the late 1980s, argued that the main core
and rationale of central banking was to be found in its micro-supervisory role, and not
necessarily in its macro-economic role in monetary policy. His argument ran as follows. The
need for a central bank arises from the special nature of banks’ asset portfolios, non-
marketable or at least non-marketed, funded by liabilities also convertible into cash at a
fixed-nominal value (demand deposits). Even if banks did not offer any monetary payment
services, and funded themselves only with time deposits or certificates of deposit (CDs);
even if these payment services were separated and segregated to financial intermediaries
whose asset portfolios were limited to holding safe assets, we would still need a central
bank to prevent crises affecting sizeable parts of the banking sector, ie, systemic crises. For,
the risk of contagion and possible abuse by bankers might otherwise erode the public’s
confidence in the banking system. Therefore, in conditions of information asymmetries, the
profile of the bank’s asset portfolio justifies the need for a central bank.
71
The Dodd–Frank Act 2010 deals with the definition, supervision and resolution of
systemically important financial institutions (SIFIs), which are referred as ‘non-bank
financial companies’ with systemic significance. Under s 113 (a)(1) of the Act, the Financial
Stability Oversight Council (FOSC) may determine that a SIFI (‘non-bank financial
company’) should be subject to the supervision of the Federal Reserve System ‘if material
financial distress…or the nature, scope, size, scale, concentration, interconnectedness or
mix of activities…could pose a threat to financial stability of the United States’. Section 165
of the Act provides that the Federal Reserve System shall impose more stringent
supervisory standards to SIFIs ‘with assets of $50 billion or more’, in the following areas:
‘risk based capital requirements and leverage limits, liquidity requirements, overall risk
management requirements, resolution plans, credit exposure report and concentration
limits’. Title II of the Dodd–Frank Act extends the FDIC model of resolution to SIFIs. The
Federal Reserve System and the FDIC will make a recommendation to the Treasury
Secretary as to whether he/she should appoint FDIC as receiver for a non-bank financial
company (SIFI).
72
See Rosa M Lastra, ‘Systemic Risk, SIFIs and Financial Stability’ (2011) 6(2) Capital
Markets Law Journal 197.
73
As was noted earlier, it is not always easy to draw the boundaries between the central
bank’s functions as bankers’ bank and banking supervisor and regulator. The central bank’s
role of lender of last resort was cited to illustrate this ambiguity. Moreover, one could argue
that the adoption of minimum capital requirements can be perceived both as a supervisory
role (statutorily backed), as well as a qualification for entry and a rule of good conduct for
continuing membership in a club, to maintain the quality standards of any private or public
association of banks. See paragraphs 3.07–3.13.
74
Thornton, above note 5, 105–6. See also generally Vilaseca Marcet, La Banca Central y
el Estado (Barcelona: Bosch, 1947).
75
Collyns, above note 25, 3.
76
Smith, above note 1, 167.
77
Smith, above note 1, 148.
78
Michele Frattianni, Jurgen Von Hagen, and Christopher Waller, The Maastricht Way to
EMU, Princeton University Essays in International Finance No 187 (1992) 35, at <https://
www.princeton.edu/~ies/IES_Essays/E187.pdf> (last visited 18 July 2014), recall that
Former German Chancellor H Schmidt had written in his memoirs that ‘he regarded
exchange rate policies…as important elements of general foreign and strategic policy’.
79
Nonetheless, in today’s world, interest rate and exchange rate policies are increasingly
interrelated. Stanley Fischer, ‘Modern Central Banking’, Paper presented at the Bank of
England’s Tercentenary Celebration, London (June 1994), published in Forrest Capie et al
(eds), The Future of Central Banking: The Tercentenary Symposium of the Bank of England
(Cambridge: Cambridge University Press, 1994), says: ‘Exchange rate and foreign reserve
management can hardly be divorced from interest rate determination, though the Treasury
frequently shares or is responsible for these tasks.’
80
See Federal Reserve Bank of New York, ‘Exchange Stabilization Fund’, Fedpoint (May
2007), at <http://www.newyorkfed.org/aboutthefed/fedpoint/fed14.html> (last visited 18
July 2014).
81
See HM Treasury, ‘Management of the Official Reserves’, at <https://www.gov.uk/
government/uploads/system/uploads/attachment_data/file/236352/
management_of_the_official_reserves_2013_14.pdf> (last visited 18 July 2014), and HM
Treasury, ‘HMT Exchange Equalisation Accounts’ (15 July 2013), at <https://www.gov.uk/
government/collections/hmt-eea> (last visited 18 July 2014).
82
See Statute of the European System of Central Banks and of the European Central Bank
(hereinafter ESCB Statute), Art 30.5, in conjunction with Articles 30.1 and 31.1.
83
See Marta Castello-Branco and Mark Swinburne, ‘Central Bank Independence: Issues
and Experience’, IMF Working Paper No 91/58 (1 June 1991) 47.
84
Rosa M Lastra and Lee Buchheit (eds), Sovereign Debt Management (Oxford: Oxford
University Press, 2014) extensively deal with issues of sovereign debt management and
sovereign debt restructuring. The United Nations Conference on Trade and Development
(UNCTAD) released Principles on Promoting Responsible Sovereign Lending and Borrowing
on 10 January 2012. (These principles are available at: <http://www.unctad.info/upload/
Debt%20Portal/Principles%20drafts/SLB_Principles_English_Doha_22-04-2012.pdf> (last
visited 13 September 2014)). The first principle states: ‘Lenders should recognize that
government officials involved in sovereign lending and borrowing transactions are
responsible for protecting public interest (to the State and its citizens for which they are
acting as agents).’
85
See generally the Public Debt Management (PDM) Network (at <http://
www.publicdebtnet.org/public/> (last visited 13 September 2014)), an initiative by the
Organisation for Economic Co-operation and Development (OECD) and the Italian Treasury
aimed at building, sharing, and developing knowledge on public debt management. As it
states on its home page, the PDM Network encourages and facilitates permanent discussion
on debt management related matters among all actors who are actively concerned with
public debt management, all over the world. (Tellingly it says: ‘Sovereign debt has a long
history. In the past debt was often issued to finance war and other extraordinary events.
Most recently Public Debt has been used for more peaceful ends, such as real investments,
health care, education and communication systems and the establishment of a social
security system.’)
86
See Nigeria Debt Management Office, at <http://www.dmo.gov.ng/backgroundb.php>
87
See Agence France Trésor (AFT), at <http://www.aft.gouv.fr> (last visited 18 July 2014).
The AFT is tasked with handling public debt and treasury management. It was created by a
Ministry of the Economy, Finance and Foreign Trade order on 8 February 2001 in the form
of a department with national scope (to manage the central government debt), reporting to
the Head of the Treasury Directorate and managed by a Chief Executive.
88
Keith Acheson and John F Chant, ‘Bureaucratic Theory and the Choice of Central Bank
Goals’ (1973) 5(2) Journal of Money, Credit and Banking 653.
89
Fischer, above note 79, 4.
90
Charles Goodhart, Money, Information and Uncertainty, 2nd edn (London: MacMillan,
1989) 374.
91
See Fischer, above note 79, 4 and Volcker, above note 32.
92
Central banks in former communist countries faced major problems such as: the shift
from a mono-bank (ie, a State-owned bank exercising both ‘central’ and ‘commercial’
banking functions) to a two-tier banking system (ie, a central bank in charge of monetary
policy and other typical central bank functions, and a separate commercial banking
system); the establishment of an appropriate bank supervisory structure; the shift from
direct instruments of monetary control to indirect instruments and the need for a parallel
development of a money market; the bank privatization process; the bad loans overhang;
the absence of control mechanisms over the enterprises to which banks lend money and the
inter-enterprise arrears; the lack of generally accepted accounting and auditing standards;
and the inefficiency of the payment systems.
93
Andromachi Georgosouli, in an unpublished manuscript entitled ‘Financial
Resilience’ (cited with the permission of the author) addresses the problem of financial
vulnerability shifting away from the financial stability metaphor towards a resilience-
oriented scheme of regulation. She defines financial resilience as ‘adaptive capacity to
change’, which ‘is measured in terms of one’s ability to learn, prepare and, where
appropriate, cope and recover from future contingencies’. She concludes:
Compared to stability-focused regimes, resilience regulation is more consonant to

the logic of a capitalist economy. This is because it focuses on the transition of the
financial system from one state of being to the next rather than on the system’s
resistance and its capacity to bounce back to a perceived normality. While financial
stability calls for policies that focus on the magnitude and level of contingency of
destabilising episodes, financial resilience calls for policies that focus on the socio—
structural implications of destabilising episodes irrespective of their magnitude and
degree of contingency at a given point in time. Contrary to financial stability-driven
systems of regulation, ‘resilience regulation’ gives equal consideration to consumer
resilience and systemic resilience and thus it is more likely to lead to more
equitable management of financial vulnerability. Her departure from the ‘financial
stability-centred view’ that currently prevails in the literature, provides a fresh
approach to the current debate on the subject.
94
Section 2(a) of the Federal Reserve Act (12 USC 225a), which was added by Act of 16
November 1977 (91 Stat 1387) and amended by Acts of 27 October 1978 (92 Stat 1897) and
23 August 1988 (102 Stat 1375) and 27 December 2000 (114 Stat 3028) refers to ‘stable
prices’. Section 2(a) also refers to other policy objectives: ‘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 economy’s long run
potential to increase production, so as to promote effectively the goals of maximum
employment, stable prices, and moderate long-term interest rates.’
95
See eg François Gianviti, ‘The Objectives of Central Banks’ in Mario Giovanoli and Diego
Devos (eds), International Monetary and Financial Law (Oxford: Oxford University Press,
2010) 449.
96
The ‘time inconsistency’ or ‘dynamic inconsistency’ literature (the time inconsistency
argument was first formulated by Finn E Kydland and Edward C Prescott in ‘Rules Rather
than Discretion: The Inconsistency of Optimal Plans’ (1977) 85(3) Journal of Political
Economy) provides a theoretical economic rationale for central bank independence (CBI).
Time inconsistency emphasizes the need for a credible and binding pre-commitment to a
particular mandate that effectively prevents violations ex post. Without such commitment,
rational agents will disbelieve the authorities and behave in ways that prevent them from
achieving their original goals. CBI is one way (though not the only way) of formulating a
credible and binding commitment to price stability. Other ways include legislated monetary
rules, an exchange rate peg, a currency board, and a constitutional amendment binding the
government to price stability.
97
Inflation is considered a grave disease for the economic well-being of a country; it is an
unlegislated tax; it increases uncertainty, discourages investment, and brings conflict into
industrial relations. It also has pernicious social effects including the arbitrary
redistribution of income and wealth, and the erosion of and disincentive to savings.
98
See Lastra, above note 8, 13–24, for a broader explanation of the arguments for and
against central bank independence, and Lastra, above note 2, 476–82. With regard to the
economic literature on this issue, see eg Alex Cukierman, Central Bank Strategy, Credibility
and Independence: Theory and Evidence (Cambridge, MA: MIT Press, 1994).
99
See definition of ‘inflation’ in Peter Newman, Murray Milgate, and John Eatwell (eds),
The New Palgrave Dictionary of Money & Finance (London: Macmillan Press Ltd, 1992).
Inflation is a process of continuously rising prices, or equivalently, of a continuously falling
value of money. The late Milton Friedman famously stated: ‘Inflation is always and
everywhere a monetary phenomenon in the sense that it is and can be produced only by a
more rapid increase in the quantity of money than in output.’ See Milton Friedman, ‘The
Counter-revolution in Monetary Theory’, First Wincott Memorial Lecture, delivered at
Senate House, University of London (16 September 1970), published as Institute of
Economic Affairs Occasional Paper No 33 (1970) 24.
100
European Central Bank, ‘The Definition of Price Stability’, at <http://
www.ecb.europa.eu/mopo/strategy/pricestab/html/index.en.html> (last visited 18 July
2014).
101
Stephen D King, When the Money Runs Out. The End of Western Affluence (New
Haven, CT: Yale University Press, 2013) calls for a change in the mandate of central banks
so that they target nominal income growth rather than inflation.
102
Monetary stability can be defined in narrow terms or in broad terms. In the UK and
New Zealand it is defined in narrow terms as 2 per cent increase per annum in CPI.
103
See Charles A E Goodhart, ‘Time, Inflation and Asset Prices’, London School of
Economics, Financial Markets Group Special Paper No 117 (1999). Few economists have
contributed as much to the history and understanding of central banking in theory and
practice as Charles Goodhart has. For long relegated to the abstruse universe of the
specialist, central banking has now come to the front of economic policy debate. This
process has been facilitated in no small way by the writings, teachings, and policy advice of
Charles Goodhart.
104
At the EU level, Eurostat has investigated how to bring price changes for owner-
occupied housing into its harmonized index of consumer prices (HICP). See European
Commission, Legislation relating to Harmonized Indices of Consumer Prices, at <http://
epp.eurostat.ec.europa.eu/portal/page/portal/hicp/legislation> (last visited 18 July 2014).
According to the Council Regulation (EC) No 1688/98 of 20 July 1998 amending
Commission Regulation (EC) No 1749/96 concerning the geographic and population
coverage of the harmonised index of consumer prices, OJ L 214/23 (31 July 1998), the HICP
only covered expenditure in monetary transactions in goods and services that are used for
the direct satisfaction of individual needs and wants, thus excluding imputed rents and
mortgage interest payments from the HICP coverage. See also Commission Regulation (EC)
No 2602/2000 of 17 November 2000 laying down detailed rules for the implementation of
Council Regulation (EC) No 2494/95 as regards minimum standards for the treatment of
price reductions in the Harmonised Index of Consumer Prices, OJ L 300/16 (29 November
2000), and ECB Opinion CON/2012/77 of 19 October 2012 on a proposal for a Commission
regulation amending Regulation (EC) No 2214/96 concerning harmonised indices of
consumer prices, at <http://www.ecb.int/ecb/legal/pdf/c_07320130313en00050012.pdf>
105
William White was Economic Adviser and Head of the Monetary and Economic
Department of the Bank for International Settlements from May 1995 to June 2008. His
speeches and the BIS Annual Reports which included numerous warnings about the perils
of the bubbles that were emerging in international financial markets were all but ignored.
In a speech he gave at the Reserve Bank of India on 14 December 2001, subsequently
revised as ‘Changing Views on How Best to Conduct Monetary Policy’ (18 October 2002), at
<http://www.bis.org/speeches/sp021018.htm> (last visited 18 July 2014), he questioned:
Can monetary policy do anything to head off financial cycles…? And should it?
Chairman Greenspan has recently eloquently argued that there are very great
practical difficulties in such an approach. How can one determine when asset prices
are deviating from ‘fundamentals’? Which asset prices should one focus on? If
interest rates are raised and there is no overt inflation, will this not cause inflation
to undershoot desired levels? Counterarguments might be that a combination of
credit growth, asset price increases and high investment can give reliable signals of
approaching trouble; see the recent work of my colleagues Claudio Borio and Philip
Lowe. Tightening policy might imply temporarily undershooting CPI targets a little,
but not tightening might eventually lead to undershooting them a lot once the
bubble (if it is one) collapses. These issues are receiving increasing attention from
central bankers, particularly those who also have a mandate for preserving financial
stability as well as price stability.
106
See Rosa M Lastra and Geoffrey Wood, ‘The Crisis of 2007–2009: Nature, Causes and
Reactions’ (2010) 13(3) Journal of International Economic Law 531.
107
See Goodhart, above note 56, 96.
108
See generally Rosa M Lastra, ‘Central Bank Independence and Financial
Stability’ (2010) 18 Estabilidad Financiera Banco de España 49.
109
See Martin Wolf, ‘The Spectre of Eurozone Deflation’ Financial Times (12 March 2014).
110
See eg Paul Krugman, ‘Can Deflation be Prevented?’ (2002), at <http://
www.pkarchive.org/economy/deflator.html> (last visited 17 July 2014); Manmohan Singh
Kumar et al, ‘Deflation: Determinants, Risks and Policies—Findings of an Interdepartmental
Task Force’, IMF Occasional Paper No 221 (June 2003), at <https://www.imf.org/external/
pubs/ft/def/2003/eng/043003.pdf> (last visited 18 July 2014).
111
Jan Tinbergen, On the Theory of Economic Policy (Amsterdam: North Holland
Publishing Co, 1952).
112
See the statement of the Federal Open Market Committee in Federal Reserve System,
Monetary Policy Press Release (12 September 2012), at <http://www.federalreserve.gov/
newsevents/press/monetary/20121212a.htm> (last visited 18 July 2014):
If the outlook for the labor market does not improve substantially, the Committee
will continue its purchases of Treasury and agency mortgage-backed securities, and
employ its other policy tools as appropriate, until such improvement is achieved in a
context of price stability. In determining the size, pace, and composition of its asset
purchases, the Committee will, as always, take appropriate account of the likely
efficacy and costs of such purchases.
113
Ben Bernanke, Press Conference (12 December 2012), at <http://
www.federalreserve.gov/media center/files/FOMCpresconf20121212.pdf> (last visited 18
July 2014). As stated earlier, former Fed Chairman Ben Bernanke first uttered the phrase
‘tapering’ (tapering the Fed’s asset purchases) on 22 May 2013. This signalling of the
unwinding of QE was followed by a statement on 19 June 2013, in which Bernanke set out
the case for slowing the pace of QE as the US economy picks up momentum. See above note
34.
Forward guidance, or guidance on future monetary policy, requires effective central bank
communication of this pre-commitment to future policy. The key issue in the use of this tool
is credibility, since there is no guarantee that once this forward guidance is issued (eg
committing to keep low interest rates for an extended period of time), central bankers will
not change their mind. Indeed, this is what happened already. See above note 34. Thus, in
order to manage market expectations adequately any guidance needs to reinforce words
with actions. See Martin Wolf, ‘Forward Guidance for the Bank of England’ Financial Times
(5 July 2013) and Wolf, above note 109.
114
Milton Friedman’s seminal 1953 paper on ‘The Case for Flexible Exchange Rates’,
published in Milton Friedman, Essays in Positive Economics (Chicago: University of Chicago
Press, 1953), at a time in which the par value regime provided a backbone of external
stability is an example of this controversy.
115
TFEU, Arts 138 and 219 are an example of the ambiguity that reigns with regard to
exchange rate policy. Indeed, such provision can be referred to as a ‘calculated obfuscation
for political purposes’, as I further discuss in Chapter 9.
116
The Panic of 1907, also known as the 1907 Bankers’ Panic, commenced in New York
and spread throughout the nation. The panic might have deepened if not for the
intervention of financier J P Morgan who pledged large sums of his own money, and
convinced other New York bankers to do the same, to shore up the banking system. At the
time, the United States did not have a central bank to inject liquidity back into the market.
In 1908, Senator Nelson W Aldrich, father-in-law of John D Rockefeller, Jr, established and
chaired a commission to investigate the crisis and propose future solutions, leading to the
creation of the Federal Reserve System. See Federal Reserve Bank of Minneapolis, ‘Born of
a Panic: Forming the Fed System’ (1 August 1988), at <http://minneapolisfed.org/
publications_papers/pub_display.cfm?id=3816> (last visited 18 July 2014).
117
As mentioned earlier, Thomas Baxter, above note 4, pointed out that ‘[t]he Federal
Reserve’s financial stability mandate is seen in the penumbra of the Federal Reserve Act’,
and that ‘that is legally sufficient’ (deriving implied powers from the penumbra of other
express powers). In my opinion, though, the legal basis for such financial stability mandate
can already be found in the preamble to the Federal Reserve Act, in the words ‘effective
supervision of banking in the United States’ and in other provisions of the original Federal
Reserve Act. In his presentation Baxter further pointed out that the express terms of the
Dodd–Frank Act 2010 place financial stability within the Federal Reserve’s legal mandate.
118
Much has been written about the oil shock (or oil shocks) in the context of inflation, the
ensuing banking practices where petrodollars were ‘recycled’ to loans to Latin America and
the international debt crisis that exploded in 1982 (Mexico being the first country to default
on its international debt). Suffice it to say here (as Chapter 14 further explores these
issues) that the oil shock rocked the world’s economy, as the Financial Times summarized in
two articles published on the 30th anniversary of the oil shock of 17 October 2003: see
‘Time to End the US Oil Embargo’ Financial Times (15 October 2013); Ed Morse, ‘US
Energy Revolution Will End Old Opec Regime’ Financial Times (14 October 2013).
119
See Manmohan S Kumar, ‘Deflation, the New Threat?’ (2003) 40(2) Finance and
Development 16, at <http://www.imf.org/external/pubs/ft/fandd/2003/06/pdf/kumar.pdf>
(last visited 18 July 2014):
There are different intensities of deflation. Deflation may be relatively mild, with
aggregate price indices declining only by a percent or so, and temporary, lasting not
more than a few quarters; or it may be mild but persist for several years; or it may
be sustained and virulent, with economic stagnation and high unemployment
accompanying falling prices and costs, as during the Great Depression of the 1930s,
the most severe deflation of the twentieth century.
As Kumar points out in the article, ‘if it is unanticipated, deflation leads to a redistribution
of income from debtors to creditors.’
120
Kumar, above note 119. See also Tim Callen and Jonathan D Ostry (eds), Japan’s Lost
Decade. Policies for Economic Revival (Washington, DC: IMF, 2003).
121
See Joint Statement of the Government and the Bank of Japan on Overcoming Deflation
and Achieving Sustainable Economic Growth (22 January 2013), at <http://www.boj.or.jp/en/
announcements/release_2013/k130122c.pdf> (last visited 18 July 2014).
122
As reported in the Financial Times leading article on Japan on 25 March 2014, ‘the
more government debt a central bank buys, the greater the appearance of “fiscal
dominance”…[T]he boundaries are already blurred. Dealers talk about “the BoJ trade”,
buying bonds at auction from the finance ministry then flipping them immediately to the
central bank…[T]he BoJ’s grip on the market is nothing more or less then central bank
financing of the fiscal deficit.’ See Ben McLannahan, ‘Japanese Debt: Still Climbing’
Financial Times (25 March 2014).
123
As reported in ‘Carney’s Central Bank for all Seasons’ Financial Times (19 March
2009), Mark Carney, Governor of the Bank of England, is pushing through an internal
overhaul (of directorates and roles) in order to fit the demands of a modern central bank,
‘introducing a single mission statement under which the Bank of England declares a goal of
promoting the good of the UK by maintaining monetary and financial stability’. Central
bankers ‘cannot be tunnel-vision economists or specialists on the intricacies of bank capital,
but need to be central bankers for all seasons, capable of understanding the big picture’.
124
Milton Friedman formally proposed his monetary rule—for a constant growth of the
money supply at a rate roughly equal to underlying productivity growth—in Milton
Friedman, Program for Monetary Stability (New York: Fordham University Press, 1960).
Friedman had already advanced some of his ideas in 1948, in Milton Friedman, ‘A Monetary
and Fiscal Framework for Economic Stability’ (1948) 38 American Economic Review 245.
125
The rules versus discretion economic literature—which interestingly resembles the
rules versus discretion debate in administrative law—dates back to Henry C Simons, ‘Rules
versus Authorities in Monetary Policy’ (1936) 44 Journal of Political Economy 1. Most of the
recent economic literature on central bank independence has followed the so-called time
inconsistency argument, first formulated by Kydland and Prescott, above note 96, and
further developed by Robert J Barro and David B Gordon, ‘Rules, Discretion, and
Reputations in a Model of Monetary Policy’ (1983) 12 Journal of Monetary Economics 101.
126
According to some commentators, the introduction of strict monetary targeting can be
regarded as marking a sharp break with the Keynesian macroeconomic policy making of the
1960s and 1970s, which had culminated in the high inflation of the late 1970s. See eg John
S Fforde, ‘Setting Monetary Objectives’ (1983) 23 Bank of England Quarterly Bulletin 200.
127
From an operational point of view there is a beneficial legacy of monetary targeting,
namely the continuing, albeit non-mechanical, concern with the growth of the quantities of
a range of financial assets (included in monetary aggregates) and the understanding of the
value of publishing and monitoring detailed information about the authorities’ actions and
intentions. See the definition of ‘monetary targeting’ in Newman et al (eds), above note 99.
128
New Zealand was the first country to adopt inflation targeting, according to the
Reserve Bank of New Zealand Act 1989. The theoretical work on inflation targeting has
been developed by the Swede Lars E O Svensson in the seminal articles: Lars E O Svensson,
‘Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets’ (1997) 41
European Economic Review 1111 and Lars E O Svensson, ‘Inflation Targeting as a
Monetary Policy Rule’, Paper presented at the Sveriges Riksbank–IIES Conference on
Monetary Policy Rules in 1998, later published as Lars E O Svensson, ‘Inflation Targeting as
a Monetary Policy Rule’ (1999) 43 Journal of Monetary Economics 607.
129
Bank of England Act 1998, s 12.1 reads as follows: ‘The Treasury may by notice in
writing to the Bank specify for the purposes of Section 11 (a) what price stability is to be
taken to consist of, or (b) what the economic policy of Her Majesty’s Government is to be
taken to be.’
130
John Maynard Keynes, ‘Proposals for an International Clearing Union’ in D Moggridge
(ed), The Collected Writings of John Maynard Keynes, Vol 25 (London: The Macmillan Press,
1980).
131
‘Central Bank Ownership Issues’ was the title of a presentation by Daniel Lefort,
General Counsel of the BIS, in Cambridge on 7 September 2005 in the Central Banking
Annual Training Course, organized by Central Banking Publications.
132
The particular proprietary structures used to create central banks or monetary
authorities vary considerably; they can be established as a privately owned institution, a
private corporation that is controlled by the State, a joint venture between the State and
private investors, a public law body created through statute or constitutional provisions or
by a treaty. The latter is the case of the ECB, as a central bank whose array of functions and
jurisdictional domain are determined by a Treaty instrument, the Maastricht Treaty (today
TFEU). See Rosa M Lastra, ‘The Evolution of the European Central Bank’ (2012) 35
Fordham International Law Journal (Special Issue: ‘From Maastricht to Lisbon: the
Evolution of European Union Institutions and Law’) 1260.
133
The Federal Open Market Committee (FOMC), established in 1933, adds another layer
of complexity to the understanding of the System.
134
12 USC 241.
135
Rules of Organization of the Board of Governors, s 4 issued pursuant to 5 USC 552.
136
12 USC 282, 323. See also the Bylaws of the Federal Reserve Bank of New York
(FRBNY), Art 4, at <http://www.newyorkfed.org/aboutthefed/ny_bylaws.html> (last visited
18 July 2014).
137
The central banking functions are conferred by statute or by express delegation of
authority pursuant to 12 USC 248(k).
138
In 1997–8, I acted as an expert witness in the case Bank Markazi Iran v Federal
Reserve Bank of New York, Case No 823 presented before the Iran–United States Claims
Tribunal at the Hague, the Netherlands (1997–9). The Tribunal reached its decision on 16
November 1999, Award No 595-823-3. At stake in the case were the issues of
independence, control, and separate juridical personality. I was asked by the FRBNY to
assess the independence of the Federal Reserve Bank of New York and of the Federal
Reserve System. To this effect, I wrote an expert opinion on the nature, independence, and
operations of the Federal Reserve System. I was a member of the legal team of the FRBNY
in subsequent hearings, held at The Hague on 1–2 December 1998. During the hearing,
Judge Gaetano Arangio-Ruiz asked me about the relation between separate legal personality
and dependence/independence. I responded by saying that separate legal personality does
not mean necessarily independence, or dependence.
139
See TFEU, Arts 13 and 129, and ESCB Statute, Arts 9 and 14. See also Rene Smits, The
European Central Bank, Institutional Aspects (The Hague: Kluwer Law International, 1997)
92–3.
140
See Case C-11/00 Commission of the European Communities v European Central Bank
[2003] ECR I–7147, para 92 (hereinafter ‘the OLAF [European Anti-Fraud Office] case’).
141
See Chapter 7 in this volume.
142
According to ESCB Statute, Art 14(4),
National central banks may perform functions other than those specified in this
Statute unless the Governing Council finds, by a majority of two thirds of the votes
cast, that these interfere with the objectives and tasks of the ESCB. Such functions
shall be performed on the responsibility and liability of national central banks and
shall not be regarded as being part of the functions of the ESCB (emphasis added).
According to ESCB Statute, Art 12(1):
The Executive Board [of the ECB] shall implement monetary policy in accordance
with the guidelines and decisions laid down by the Governing Council. In doing so
the Executive Board shall give the necessary instructions to the national central
banks. …[T]he ECB shall have recourse to the national central banks to carry out
operations which form part of the tasks of the ESCB.
143
In ‘Monetary and Financial Stability’, a presentation at a conference at the London
School of Economics on 27 April 2006, Thomas Baxter (General Counsel of the Federal
Reserve Bank of New York) defined independence as freedom from control of another, not
freedom from influence of another and explained—focusing on funding, structure and
culture—that the difference between control and influence is one of degree.
144
See Gerald Holtham, ‘No Case for Independent Central Bank’ Financial Times (3
September 1993). Bryan Hopkin and Douglas Wass, ‘The Flows in Central Bank Freedom’
Financial Times (22 January 1993) also maintain that if monetary policy is to be taken out of
the hands of politicians, because they cannot be trusted to give inflation the priority that it
deserves, then other instruments of policy, which have a bearing on inflation (they cite
government borrowing, taxation competition policy and public sector pay) should also be
taken out of their hands.
145
Former German Chancellor H Schmidt wrote in his memoirs that he regarded exchange
rate policies as ‘important elements of general foreign and strategic policy’. See Lastra,
above note 8, 276.
146
See eg Michael Parkin and Robin Bade, ‘Central Bank Laws and Monetary Policies: A
Preliminary Investigation’, Research Report No 7804, University of Western Ontario,
London, ONT (November 1977); Vittorio Grilli, Donato Masciandaro, and Guido Tabellini,
‘Political and Monetary Institutions and Public Financial Policies in the Industrial
Countries’ (1991) 13 Economic Policy 341; Alberto Alesina and Laurence Summers, ‘Central
Bank Independence and Macro-economic Performance: Some Comparative Evidence’ (1992)
25(2) Journal of Money, Credit and Banking 151; Alex Cukierman, Steven Webb, and Bilin
Neyapti, ‘Measuring the Independence of Central Banks and its Effects on Policy
Outcomes’ (1992) 6(3) World Bank Economic Review 353. It is interesting to observe that
the empirical studies supporting central bank independence have contributed a novel
feature to the law and economics literature. Rather than applying economic tools to legal
matters (as with cost-benefit analysis applied in the field of torts), those empirical studies
apply a legal index (based upon a number of selected legal provisions/indicators) for the
purpose of developing economic and statistical tests that show a negative correlation
between central bank independence and inflation.
147
See Geoffrey P Miller, ‘An Interest Group Theory of Central Bank Independence’ (1998)
27 Journal of Legal Studies 433, 436.
148
There is another inflation motivation as well: politicians can disrupt interest group
deals by creating unanticipated inflation, which then causes the interest groups to return to
the politicians with more campaign contributions. I thank Geoffrey Miller for bringing this
point to my attention. For a further elaboration on this issue, see Miller, above note 147,
436–45.
149
US Congress’ right to regulate interstate commerce (US Constitution, Art I, s 8, cl 3)
encompasses banking and other financial services as the courts have come to define and
interpret this clause. Congress also has the right to make any law that is ‘necessary and
proper’ for the execution of its enumerated powers (US Constitution, Art I, s 8, cl 18).
150
I further discuss the expansion of IMF ‘structural conditionality’ into areas like legal
reform in Chapter 13. See also the article I wrote on IMF conditionality in Rosa M Lastra,
‘IMF Conditionality’ (2002) 4(2) Journal of International Banking Regulation 167.
151
See Lastra, above note 8, 13–24, for a review of the main arguments for (economic,
political and technical) and against independence (the latter include democratic legitimacy,
the need for consistent economic policy, and capture).
152
I have had the opportunity of participating in programmes of legal technical assistance
in the field of central banking during my stint at the International Monetary Fund, and in
the summer of 2003, with regard to the People’s Republic of China (PRC) in an ADB
programme of legal technical assistance co-ordinated by the Washington, DC based
International Law Institute. The new Law of the People’s Republic of China on the People’s
Bank of China (PBC)— ie, the new Central Bank Law of the PRC—was promulgated on 27
December 2003 and came into force on 1 February 2004. Article 7 of the new Law contains
a declaration of independence of the PBC from the State Council with regard to the
implementation of monetary policy.
153
As articulated elsewhere (see eg Lastra, above note 2, 475–519; and ch 1 Lastra, above
note 8) the legal framework of independence ought to include a number of organic and
functional guarantees that range from the appointment and dismissal procedure to the
relations between the central bank and the Treasury or Minister of Finance.
154
See Case C-11/00 OLAF case, para 134: ‘Article 108 EC (now Art 130 TFEU) seeks, in
essence, to shield the ECB from all political pressure in order to enable it effectively to
pursue the objectives attributed to its tasks, through the independent exercise of the
specific powers conferred on it for that purpose by the EC Treaty and the ESCB Statute.’
See also Case C-11/00 OLAF case, paras 135 and 126.
155
See Lastra, above note 8, 36–8 and 44–8.
156
See Latin American Shadow Financial Regulatory Committee, ‘Central Bank
Independence: the Right Choice for Latin America’, Statement No 4, Montevideo, 18
October 2001, at <http://www.aei.org> (last visited 18 July 2014).
157
See Case C-11/00 OLAF case, para 132.
158
The Code is divided into fifty titles which represent broad areas subject to Federal
regulation. Each title is divided into chapters which usually bear the name of the issuing
agency. Title 12 refers to Banks and Banking and Chapter II of Title 12 refers to rules
issued by the Federal Reserve System.
159
This paper, which was presented at a joint conference in Stockholm in December 1999,
was subsequently published as a book chapter. See Rosa M Lastra and Geoffrey Miller,
‘Central Bank Independence in Ordinary and Extraordinary Times’ in Jan Kleineman (ed),
Central Bank Independence. The Economic Foundations, the Constitutional Implications
and Democratic Accountability (The Hague: Kluwer Law International, 2001) 31–50.
160
See eg Cukierman, above note 98. As discussed elsewhere, above note 8, 16–18, the
experience in developing countries or emerging economies is different.
161
See Forrest Capie and Geoffrey Wood, ‘Central Bank Independence: Can it Survive a
Crisis?’ in Owen Humpage (ed), Money, History, and Finance: Essays in Honour of Michael
Bordo (Cambridge: Cambridge University Press, 2014). See also Geoffrey Wood, ‘Is the ECB
too independent?’ in Jens Holscher (ed), 50 Years of the German Mark (New York: Palgrave,
2001) 75.
162
In this section of the chapter I draw substantially on Lastra and Miller, above note 159.
163
On the rent-extraction motivation for central bank independence, see Miller, above note
147, 436.
164
Lastra and Miller, above note 159.
165
166
167
Historically, and as applied to money, seigniorage was a levy on metals brought to a
mint for coining, to cover the cost of the minting and to provide revenue to the ruler, who
claimed it as a prerogative. In recent monetary literature the term has been revived and
applied to the revenue derived by a note issuing authority. See eg Cukierman, above note
98, 47: seignorage revenues are the amount of real resources obtained by the government
by means of new base money injections.
168
Martin Wolf, ‘America Owes a lot to Bernanke’ Financial Times (5 June 2013) stated:
Central banks, including the Fed, are doing the right thing. It they had not acted as
they have over the past six years, we should surely have suffered a second Great
Depression. Avoiding such a meltdown and then helping economies recover is the
job of central banks. My criticism, albeit more of the ECB than of the Fed, is not
that they have done too much, but that they have done too little. …Exceptional
times call for exceptional measures’ (emphasis added).
169
See Ben Bernanke, Essays on the Great Depression (Princeton, NJ: Princeton University
Press, 2000), and Friedman and Schwartz, above note 31. See also Allan H Meltzer, A
History of the Federal Reserve System (Chicago: University of Chicago Press, 2009), vols 1–
2. An entertaining account of the boom in the 1920s that eventually lead to the bust in 1929
is provided by Bill Bryson, One Summer. America 1927 (London: Doubleday, 2013) 234–7.
170
See Gesetz über die Deutsche Bundesbank [Act concerning the Deutsche Bundesbank],
as last amended by Article 9 of Gesetz zur Optimierung der Geldwäscheprävention [Act to
Optimise the Prevention of Money Laundering] of 22 December 2011 (Federal Law Gazette
I, page 2959). For an English translation of the Bundesbank Law, see the official website of
the Bundesbank at <http://www.bundesbank.de/Redaktion/EN/Downloads/Bundesbank/
Tasks_and_organisation/bundesbank_act.pdf?__blob=publicationFile> (last visited
18 July 2014).
171
David Marsh, The Most Powerful Bank: Inside Germany’s Bundesbank (New York:
Times Books, 1992) 13. In this section on the historical example of the pre-1999
Bundesbank I draw substantially on Marsh’s book.
172
The heavy burden of reparations imposed on Germany in 1919 in the Versailles Peace
Treaty was criticized by John Maynard Keynes in The Economic Consequences of the Peace
(London: Macmillan, 1919). Keynes argued forcefully that the reparations payments
discussed at Versailles were far too high and that the peace was to be Carthaginian. See
Arminio Fraga, ‘German Reparations and Brazilian Debt: a Comparative Study’ (1986)
2(163) Princeton University Essays in International Finance.
173
Marsh, above note 171. The incident is recalled by David Marsh in ch 4 of his book, in
particular 99–101. Marsh interestingly points out (75): ‘The Reichsbank’s profoundly
undemocratic nature made it, in a sense, a perfect tool in Hitler’s hands. It shared with the
Führer the precept that monetary stability had to be dispensed from above, rather than
created by the people themselves’ (emphasis added).
174
The wording of these provisions is reproduced in part in TFEU, Art 127 and Protocol on
the Statute of the European System of Central Banks and the European Central Bank,
annexed to the Treaty establishing the European Community, OJ C 83, 30 March 2010, at
<http://www.ecb.int/ecb/legal/pdf/c_08320100330en_ecb_statute.pdf> (last visited 18 July
2014) (hereinafter ECSB Protocol), Art 2: ‘The primary objective of the ESCB shall be to
maintain price stability. Without prejudice to the objective of price stability, the ESCB shall
support the general economic policies in the Community.’
175
Bundesbank Law, Art 12 has been referred to by some German authors as the ‘squaring
of the circle’: independent from the government in the conduct of monetary policy, but
supporting the general economic policy of it. See eg Klaus Stern, Das Staatsrecht der
Bundesrepublik Deutschland. Vol. II: Staatsorgane, Staatsfunktionen, Finanz- und
Haushaltsverfassung, Notstandsverfassung (Munich: CH Beck, 1980) 463–508.
176
This is recalled by Frattianni et al, above note 78.
177
See ‘Bundesbank’s Record in Standing up to Bonn Government’ Financial Times (1
October 1993).
178
As Marsh, above note 171, 146, points out: ‘Three Chancellors—Ludwig Erhard in
1966, Kurt Georg Kiesinger in 1969, and Helmut Schmidt in 1982—owe their downfall
directly or indirectly to the actions of the Bundesbank. All three leaders were ousted not by
defeat in general elections, but as a consequence of shifts in coalitions, sparked off by
controversies over monetary policy.’
179
Marsh, above note 171.
180
See eg Marsh, above note 171, 178:
At the beginning of 1990, the rate used for exchanging east marks against D-marks
in commercial transactions was 4.5 to 1. On the free exchange market (illegal
according to the East German authorities) the rate was 7 to 1.
He further recalls on page 186:
Too low a level for the east mark against the D-mark would sharply cut East German
incomes and encourage more migration to the west. Too high a rate would, on the
other hand, spark greater unemployment and this would also spur desperate East
Germans to seek the prosperity of the Federal Republic. At the end of March [1990],
the Bundesbank suggested that the east-mark assets and payments should be
converted into D-marks on the basis of 2 to 1.
181
Marsh, above note 171, 35.
182
Marsh, above note 171, 168.
183
See Anamaria Viterbo, ‘The ECHR’s Protection of Property Rights against Inflation vs.
the EC Price Stability Principle’, European University Institute Working Papers, RSCAS No
2006/38 (2006) 11:
At that time Germany was the only EC Member State to have a constitutional
guarantee for monetary stability. Before being amended to the new provisions of the
EC Treaty, Art. 88 of the German Basic Law (Grundgesetz, dated 23 May 1949)
contained a constitutional mandate to the Federal Government to establish a ‘note-
issuing and currency bank’ in the form of a federal Bank. The term ‘currency bank’
was interpreted as entailing that the tasks of the Bank were to supply the economy
with funds and to safeguard the value of money: Art. 88 GG ensured stability and
made the Bundesbank the guardian of the currency.
184
As Karl Blessing, a former Bundesbank president (as well as Reichsbank senior official
during the Nazi regime) eloquently put it: ‘The less it is supported by fiscal policy, the
tougher monetary policy has to be.’ See Karl Blessing, Speech at Mainz University (24
February 1966), quoted in Marsh, above note 171, 161.
185
See ‘Bonn Backs Down Over Gold Reserve Revaluation’ Financial Times (4 June 1997).
186
See Chiara Zilioli, ‘Accountability and Independence: Irreconcilable Values or
Complementary Instruments for Democracy? The Specific Case of the European Central
Bank’ in Georges Vandersanden et al (eds), Mélanges en Hommage à Jean-Victor Louis
(Brussels: ULB, 2003) 398 n 18 where she cites Robert Litan and William Nordhaus,
Reforming Federal Regulation (New Haven, CT: Yale University Press, 1983) 50:
[Independent Commissions] are in reality miniature independent governments set

up to deal with the railroad problem, the banking problem or the radio problem.
They constitute a headless ‘fourth branch’ of the government, a haphazard deposit
of irresponsible agencies and uncoordinated powers. They do violence to the basic
theory of the American Constitution that there should be three branches of
government and only three.
187
Congressman Wright Patman, Chairman of the House Banking & Currency Committee,
‘Speech of 16 October 1967’ (1967) 34(5) Vital Speeches of the Day 138, at <http://pdc-
connection.ebscohost.com/c/speeches/9874391/federal-reserve> (last visited 13 September
2014).
188
There are two kinds of ‘independent’ agencies in the USA: those whose independence
is ostensibly created by statutes which protect officials against dismissal by the President
(such as the Fed, the SEC, and others) and those which are given separate status within the
government, but which are subject to ostensibly plenary control by the President (such as
the Environmental Protection Agency, EPA). Theoretically, this distinction is important,
because while there is Supreme Court precedent upholding some independent agencies in
the first sense, there is still a constitutional cloud over them because the US Constitution
nowhere provides for a ‘fourth’ branch of government. I thank Geoffrey Miller for his
observation on this distinction. See Geoffrey Miller, ‘Independent Agencies’ (1986) Supreme
Court Review 41, 50–8.
189
The Report is quoted in Kenneth Culp Davis, Administrative Law and Government, 2nd
edn (St Paul, MN: West Publishing Co, 1975) 20–2.
190
Ron Paul, End the Fed (New York: Grand Central Publishing, 2009).
191
Glen Hubbard, Hal Scott, and John Thornton, ‘The Fed’s Independence at Risk’
Financial Times (20 August 2009), discuss the classic lender of last resort role of the central
bank. They state that the Fed’s ability to act as lender of last resort depends upon its
economic credibility and political independence, attributes which they claim the Fed has
compromised in the crisis, since it has assumed credit risk by lending against insufficient
collateral. In this same line of thought, Marvin Goodfriend presented a paper at the London
School of Economics in September 2009, entitled ‘Central Banking in the Credit Turmoil: an
Assessment of Federal Reserve Practice’ in which he argued that LOLR/credit policy
executed by the Fed was really debt-financed fiscal policy. And that a new Treasury–Fed
accord for credit policy—to supplement the 1951 accord on monetary policy—was needed
because of the expansion of Fed lending today (in scale, in reach beyond depository
institutions and in acceptable collateral). He suggested that such an Accord should
establish guidelines so that pressure to misuse Fed credit policy for fiscal purposes does not
undermine the independence of the Fed. However, the Dodd–Frank Act 2010 has greatly
curtailed the powers of the Fed with regard to LOLR operations, as discussed earlier.
192
This point is made by Zilioli, above note 186, 403. Zilioli further points out that ‘the
independent government must be established and the power transferred to it, through a
legal act adopted, in accordance with the constitutional framework of the State, by the
democratically elected representatives of the people.’
193
See Amaryllis Verhoeven, The European Union in Search of a Democratic and
Constitutional Theory (The Hague: Kluwer Law International, 2002) 10–11. She further
argues at 364:
The principle of institutional balance is akin to the age-old ideal of ‘trias politica’. …
Institutional balance requires organising the decision-making process in such a way
that all interests concerned duly take part in the deliberative process. What is
needed then is to develop yardsticks against which the representativity (sic) of the
various actors taking part in the decision-making process is assessed. Three issues
are of particular concern here. First, while traditional constitutional theory focuses
almost exclusively on territorial representation, criteria must be forged in order to
ensure functional representation. This, in turn, requires reassessing the role of civic
society and the capacity of functional interests to enhance civil society’s voice
without capturing it. Second, the requirement of representativity does not imply
that each and any individual actor must be representative of a particular interest. …
Third, the whole are of delegated rule-making, which takes place in a constitutional
near-void, must be underpinned by clear constitutional rules and principles. Again,
an institutional balance approach, focusing on who does what and when and how
delegated rule-making can take place, offers a fruitful model of constitutional
design.
194
See Fabian Amtenbrink and Rosa M Lastra, ‘Securing Democratic Accountability of
Financial Regulatory Agencies—A Theoretical Framework’ in Richard Victor de Mulder (ed),
Mitigating Risk in the Context of Safety and Security. How Relevant is a Rational Approach?
(Rotterdam: Erasmus School of Law & Research School for Safety and Security (OMV),
2008) 115, 121.
195
See James Buchanan, The Limits of Liberty: Between Anarchy and Leviathan (Chicago:
University of Chicago Press, 1975) 93.
196
Lastra and Miller, above note 159. See also Giandomenico Majone, ‘Independence
versus Accountability? Non-Majoritarian Institutions and Democratic Government in
Europe’, European University Institute Working Paper (1994).
197
For discussion in the American context, see eg Gary Lawson, ‘The Rise and Rise of the
Administrative State’ (1994) 107 Harvard Law Review 1231; Miller, above note 188; Peter L
Strauss, ‘The Place of Agencies in Government: Separation of Powers and the Fourth
Branch’ (1984) 84 Columbia Law Review 573; Symposium: ‘Administering the
Administrative State’ (1990) 57 University of Chicago Law Review 331; A Symposium on
Administrative Law: ‘The Uneasy Constitutional Status of Administrative Agencies’ (1987)
36 American University Law Review 277.
198
199
Lastra and Miller, above note 159. See also Charles Goodhart and Ellen Meade,
‘Central Banks and Supreme Courts’ (2004) 218 Moneda y Crédito 11.
200
Although this is not a universal pattern; some US states, for example, allow popular
election of judges. See Lastra and Miller, above note 159.
201
Alexander M Bickel, The Least Dangerous Branch, The Supreme Court at the Bar of
Politics (Indianapolis: Bobbs-Merrill, 1962) 16.
202
See Rosa M Lastra, memorandum submitted to the UK House of Commons at the
request of the Treasury Select Committee in its inquiry into ‘The Accountability of the Bank
of England’, ordered by the House of Commons to be printed, 23 October 1997, House of
Commons, Session 1997–8, HC 282, 28–30.
203
In New Zealand, the Governor of the Reserve Bank of New Zealand and the Minister of
Finance sign a ‘policy targets agreement’ according to s 9(4) of the Reserve Bank of New
Zealand Act 1989. See Lastra, above note 8, 65–8.
204
See Rosa M Lastra, ‘How Much Accountability for Central Banks and
Supervisors?’ (2001) 12(2) Central Banking 69; Rosa M Lastra and Heba Shams on ‘Public
Accountability in the Financial Sector’ in Eilis Ferran and Charles Goodhart (eds),
Regulating Financial Services and Markets in the Twenty-First Century (Oxford: Hart
Publishing, 2001) 165–88; Lastra, above note 108; Amtenbrink and Lastra, above note 194;
and Rosa M Lastra, ‘Central Banking After the Crisis’, Review (2010) 13(2) International
Finance 321.
205
This usage is borrowed from Dawn Oliver, ‘Law, Politics and Public Accountability: The
Search for a New Equilibrium’ (1994) Public Law 248.
206
Oliver, above note 205, 246.
207
Amtenbrink and Lastra, above note 194, 121.
208
See eg Fischer, above note 79.
209
See Fabian Amtenbrink, The Democratic Accountability of Central Banks: A
Comparative Study of the European Central Bank (Oxford: Hart Publishing, 1999) ch 2. See
also the review I wrote of Mr Amtenbrink’s book, (2000) Public Law 151–3.
210
Zilioli, above note 186, 413, points out that accountability and independence are not
incompatible, but complementary.
211
Bank of England Act 1998, s 15. However, it transpired in a testimony by Paul Fisher in
front of the House of Commons Treasury Select Committee that the records of its rate-
setting meetings have been destroyed (11 March 2014). For a critique of this ‘vandalism of
the historical record’, see Chris Giles, ‘Rescue the Tapes from the Bank of England’s
Dustbins’ Financial Times (13 March 2014): ‘[O]nce the minutes are agreed [by the
members of the MPC], staff are instructed to delete the minute’s audio recordings.’
212
Bank of England Act 1998, s 4.
213
Bank of England Act 1998, s 19.
214
See Report HC 874 (21st report of Session 2010–12) of the Treasury Committee of the
House of Commons following its inquiry into the accountability of the Bank of England (8
November 2011), at <http://www.publications.parliament.uk/pa/cm201012/cmselect/
cmtreasy/874/874.pdf> (last visited 18 July 2014).
215
See ‘Forex Scandal Hits the Bank of England’ Financial Times (6 March 2014); ‘Scandal
Puts City Reputation on the Line’ Financial Times (6 March 2014); and ‘Another Cloud over
Threadneedle Street’, Editorial, Financial Times (7 March 2014).
216
See also Zilioli, above note 186, 405.
217
See generally Amtenbrink and Lastra, above note 194. See also Chapter 3 in this
volume.
218
See also Marc Quintyn and Michael Taylor of the International Monetary Fund in a
paper on ‘Regulatory and Supervisory Independence and Financial Stability’, IMF Working
Paper WP/02/46 (March 2002), at <http://www.imf.org/external/pubs/ft/wp/2002/
wp0246.pdf> (last visited 13 September 2014).
219
We should remember the adage: ‘he who pays the piper calls the tune’.
220
221
222
Amtenbrink and Lastra, above note 194.
223
Amtenbrink and Lastra, above note 194.
224
See Mads Andenas, ‘Liability for Supervisors and Depositors’ Rights: the BCCI and the
Bank of England in the House of Lords’ (2001) 22(88) The Company Lawyer 226. See also
Mads Andenas and Duncan Fairgrieve, ‘To Supervise or to Compensate? A Comparative
Study of State Liability for Negligent Banking Supervision’ in Mads Andenas and Duncan
Fairgrieve (eds), Judicial Review in International Perspective (The Hague: Kluwer Law
International, 2000) 333–60.
225
The case against the Bank of England—Three Rivers District Council v Governor and
Company of the Bank of England (No 3) [2000] 2 WLR 1220; [2000] 3 All ER 1; [2000]
Lloyd’s Rep Bank 235, HL—was abandoned on 2 November 2005, when BCCI liquidators
Deloitte Touche Tohmatsu dropped their claim (against the Bank of England), after
receiving a legal ruling that it would not be in the best interests of BCCI’s creditors to
continue with the lawsuit.
226
Case C-222/02 Peter Paul and others v Bundesrepublik Deutschland [2004] ECR I–
09425.
227
228
See Charles Goodhart, ‘Regulating the Regulator—An Economist’s Perspective on
Accountability and Control’ in Eilis Ferran and Charles Goodhart, Regulating Financial
Services and Markets in the 21st Century (Oxford: Hart Publishing, 2001) 162–3.
229
Goodhart, above note 228, 54.
230
See Lastra, above note 8, 49–59.
231
See Paul Lee, ‘Central Banks and Sovereign Immunity’ (2003) 41 Columbia Journal of
Transnational Law 327, 394 n 250.
232
Acta iure gestionis are activities of a commercial nature carried out by a foreign State
or one of its subdivisions or agencies, which acts are not immune from the jurisdiction and
process of local courts under the modern doctrine of restrictive foreign sovereign immunity.
Acta iure imperii are activities of a governmental or public nature carried out by a foreign
State or one of its subdivisions, which qualify for State immunity under the modern doctrine
of restrictive foreign sovereign immunity.
233
Sean Hagan, ‘Designing a Legal Framework to Restructure Sovereign Debt’ (2005) 36
Georgetown Journal of International Law 299.
234
See Robert Reed, ‘A Comparative Analysis of the British State Immunity Act of
1978’ (1979) 3 Boston College International and Comparative Law Review 175, at <http://
lawdigitalcommons.bc.edu/cgi/viewcontent.cgi?article=
1600&context=iclr> (last visited 18 July 2014).
235
According to Article 15, a foreign State enjoys immunity from local Courts in all
circumstances except those specified in other provisions of the Convention. Those
circumstances include most of those which would be regarded as acts jure gestionis, as well
as certain others, such as waiver of immunity, which are generally admitted to permit
proceedings against a foreign State.
236
United Nations Convention on Jurisdictional Immunities of States and Their Property
(adopted 2 December 2004 at the 65th plenary meeting of the UNGA by Resolution A/RES/
59/38) (hereinafter UNCJIS). Nonetheless, it has not yet entered into force because not
enough parties have ratified it. As of 30 May 2013, twenty-eight States are signatory and
only fourteen have ratified it. The current status of the UNCJIS is available at <http://
treaties.un.org/pages/ViewDetails.aspx?
src=TREATY&mtdsg_no=III-13&chapter=3&lang=en>
237
Blair, above note 13. It is worth noting that that subject includes both attachment
(which is a pre-judgment provisional remedy) and execution (which is a post-judgment non-
provisional means to enforce a judgment). Courts are circumspect about pre-judgment
orders involving a sovereign but less tolerant after judgment has been entered. This is one
of the problems with Argentina, where judicial disrespect is one source of the country’s
problems.
238
Foreign Sovereign Immunities Act (enacted 21 October 1976, Pub L 94-583, 90 Stat
2891) s 1611(b)(1) (hereinafter FSIA) states that:
(b) Notwithstanding the provisions of section 1610 of this chapter, the property of a
foreign state shall be immune from attachment and from execution, if—(1) the
property is that of a foreign central bank or monetary authority held for its own
account, unless such bank or authority, or its parent foreign government, has
explicitly waived its immunity from attachment in aid of execution, or from
execution, notwithstanding any withdrawal of the waiver which the bank, authority
or government may purport to effect except in accordance with the terms of the
waiver.
239
State Immunity Act 1978 (c 33), at <http://www.legislation.gov.uk/ukpga/1978/33/pdfs/
ukpga_ 19780033_en.pdf> (last visited 14 September 2014) (hereinafter SIA), Art 13(4) and
(5) establish immunity from execution as well as a presumption in favour of central banks
and monetary authorities that states that: ‘[p]roperty of a State’s central bank or other
monetary authority shall not be regarded…as in use or intended for use for commercial
purposes.’
240
UNCJIS, Art 21(c) establishes that the property of a central bank or a monetary
authority of a State shall not be considered as property specifically in use or intended for
use by the State for other than government non-commercial purposes. This would shield the
property of central banks from post judgment measures of constraint.
241
They mainly shield a central bank’s assets against pre-judgment attachment (this is the
case, for example, in the United States). A discussion of the law in the UK is provided for in
Bank of England, ‘Green Paper on Improving the Efficiency of the Enforcement of
Judgments in the European Union: the Attachment of Bank Accounts’ SEC(2006)1341. For a
detailed discussion of the immunities that central banks enjoy under US law see: Thomas
Baxter, ‘Recent Developments in Key Legal Issues of International Reserves Investments’,
Remarks at the Central Reserve Bank of Peru on the Foreign Sovereign Immunities Act and
Central Bank Immunity in the United States (16 November 2010), at <http://
www.newyorkfed.org/newsevents/speeches/2010/bax101119.html> (last visited 18 July
2014).
242
I am grateful to Lee Buchheit for observations on this point. The importance of such
contractual waivers in documents that central banks sign cannot be overlooked.
‘Fortunately’, most central banks no longer borrow in the international markets in their own
name nor do they guarantee such borrowings by other public sector entities. But this used
to be a common practice, as Lee Buchheit mentioned to me in his comments on this chapter.
243
Malcolm Shaw, International Law, 6th edn (Cambridge: Cambridge University Press,
2008) 745.
244
ESCB Protocol (No 4) 230.
245
Baxter, above note 4.
246
‘Too Sovereign to be Sued: Immunity of Central Banks in Times of Financial Crisis’,
Note (2010–11) 124(2) Harvard Law Review 550.
247
See Lijiang Zhu, ‘State Immunity from Measures of Constraints for the Property of
Foreign Central Banks: The Chinese Perspective’ (2007) 6(1) Chinese Journal of
International Law 67. See also Takehiro Nobumori, ‘Recent Development of Sovereign
Immunity Law in Japan from a Comparative Perspective of Central Banks’ (2008) 125
Banking Law Journal 885; and Johann de Jager, ‘Safeguarding the Crown Jewels:
Immunities of Foreign Central Banks and the South African Reserve Bank in South
Africa’ (2009) 21 South African Mercantile Law Journal 145.
248
Reagan Reynolds, ‘NML Capital, Ltd v Banco Central de la Republica Argentina: The
Second Circuit Reinforces Immunity Protection over Foreign Central Banks’ (2012) 20
Tulane Journal of International & Comparative Law 520.
249
250
Michael Fleming and Nicholas Klagge, ‘The Federal Reserve’s Foreign Exchange Swap
Lines’ (2010) 16(4) Current Issues in Economics and Finance, at <http://
www.newyorkfed.org/research/current_issues/ci16-4.html> (last visited 18 July 2014).
251
Blair, above note 13.
252
A large volume of interests in securities are held and or settled through custodian
banks and clearinghouses in Belgium. A green paper from the Bank of England, above note
241, describes the special provisions in Belgian law in order to protect the seizure of cash
and securities settlement accounts stating that:
[I]n Belgium, statutory law prevents attachments from being made on cash and
securities settlement accounts with Belgian settlement bodies (i.e. the National
Bank of Belgium, Euroclear Bank S.A/N.V and Euroclear Belgium). With respect to
cash, the following is provided: ‘Any cash settlement account with a management
body or a settlement agent for a system, as well as any transfer of amounts, via a
credit institution established under Belgian or foreign law, to be credited to such
cash settlement account, cannot be seized, sequestered or blocked in any way by a
participant (other than the management body or the settlement agent), a
counterparty or a third party’ (Art. 9 of the Law of 28 April 1999 implementing the
1998 Settlement Finality Directive as amended by the Law of 19 November 2004.
With respect to securities, similar provisions are foreseen in art. 11 of the Royal
Decree no 62 of 10 November 1967, art. 472 of the Companies Code and art. 10 of
the law of 2 January 1991).
253
See Steven Meyerowitz, ‘Argentina’s Central Bank’s Assets in Federal Reserve Account
are Not Subject to Attachment Under the FSIA, Second Circuit Rules’ (2009) 7(7) Pratt’s
Journal of Bankruptcy Law 658.
254
Statutes of the Bank for International Settlements (20 January 1930, as amended 27
June 2005), Art 55. A full document, with the basic normative texts that govern the BIS and
its relationships with its Member States and host countries, is available at <http://
www.bis.org/about/legal.htm> (last visited 18 July 2014). The BIS is headquartered in
Switzerland and has representative offices in Hong Kong and Mexico.
255
IMF Statistical Department, ‘Balance of Payments Manual’, 6th edn (April 2009)
(hereinafter IMF BOPM6), at <https://www.imf.org/external/pubs/ft/bopman/bopman.pdf>
256
The legal aspects underpinning Special Drawing Rights (SDR) are governed under
Articles of Agreement of the International Monetary Fund (Bretton Woods, NH, adopted 22
July 1944, entered into force 27 December 1945), Arts XV–XXV (hereinafter IMF Articles of
Agreement). However, SDR’s are not considered to be claims against the IMF as discussed
by Jeff Chelsky, ‘The SDR and Its Potential as an International Reserve Asset’ (May 2011) 58
Economic Premise, The World Bank, at <http://siteresources.worldbank.org/INTPREMNET/
Resources/EP58.pdf> (last visited 18 July 2014).
257
Robert Jenkins, ‘Markets Insight: Swiss Example Questions Need for QE Unwinding’
Financial Times (29 May 2013).
258
See Sarah Jones, ‘Central Banks Load Up on Equities’ Bloomberg (25 April 2013).
259
Linda Goldberg, Cindy E Hull, and Sarah Stein, ‘Do Industrialized Countries Hold the
Right Foreign Exchange Reserves?’ (2013) 19(1) Current Issues in Economics and Finance,
at <http://www.newyorkfed.org/research/current_issues/ci19-1.html> (last visited 18 July
2014).
260
IMF BOPM6, above note 255, para 4.67.
261
IMF BOPM6, above note 255, para 4.70.
262
‘Monetary authorities’ can also include currency boards, which can coexist with central
banks. A detailed discussion of currency boards is provided by Lastra, above note 8, 78–9.
263
264
Trendtex Trading Corp v Central Bank Nigeria [1977] 1 All ER 881.
265
Hispano Americana Mercantil, SA v Central Bank of Nigeria [1979] 64 ILR 221.
266
Hispano Americana v Central Bank of Nigeria is considered an exemption because,
while the case was heard in 1979 (SIA was enacted in 1978), the proceedings had been
initiated before the entry into force of SIA and thus, could not be applied retroactively.
267
First Nat’l City Bank v Banco Para el Comercio Exterior de Cuba (Bancec), 462 US 611,
613–14 (1983).
268
The term ‘vulture fund’ typically applies to companies like NML Capital that acquire
sovereign debt at a discount and then seek to realize on it.
269
Reynolds, above note 248.
270
‘Too Sovereign to be Sued’, above note 246.
271
Baxter and Gross, above note 11, examine the recent case law (litigation related to
Argentina) to elucidate how—under US law—sovereign immunity works with respect to a
central bank holding its dollar reserves in an account at the Federal Reserve Bank of New
York. They conclude that following the NML Capital Ltd 652 F 3d at 190, an independence
requirement is no longer needed and that going forward, the analysis of the matter of
central bank immunity will only focus on whether the funds are property of the central bank
‘held for its own account’ under 28 USC s 1611(b)(1).
272
On the one hand, it can be argued that this feature renders the protection offered in
the USA less attractive than the protection granted by other reserve seeking forums, such
as the BIS, which grants additional immunity from execution to its depositors. On the other
hand, it can be argued that if a central bank is holding property not for its own account but
for some other juridical entity, like a sovereign State, then this property is not the central
bank’s property, so it is not unprotected with respect to an order directed at the central
bank. Of course, if a central bank is holding property of the sovereign as ‘fiscal agent’ and
the sovereign has waived immunity, then the sovereign may be less protected than it would
be otherwise.
273
Some of the most enthusiastic academic exponents of currency boards (as well as of
dollarization) are Steve Hanke and Kurt Schuler, who have written extensively about the
benefits of currency boards (and dollarization) in countries where there is lack of
confidence in domestic monetary and other economic policies. See eg Steve H Hanke, ‘On
Dollarization and Currency Boards: Error and Deception’ (2002) 5 Policy Reform 203, and
Steve Hanke and Kurt Schuler, ‘Currency Boards and Currency Convertibility’ (1993) 12(3)
Cato Journal 687.
274
International Monetary Fund, Annual Report on Exchange Arrangements and Exchange
Restrictions (latest edn 2013), at <https://www.imf.org/external/pubs/nft/2013/areaers/
ar2013.pdf> (last visited 18 July 2014), contains a classification of exchange rate
arrangements. Currency boards are, together with exchange arrangements with no
separate legal tender, listed in the ‘hard pegs’ category.
275
An excellent summary of the history of the Bretton Woods regime is provided by Peter
Kenen in Newman et al (eds), above note 99, entry ‘Bretton Woods system’. In his essay,
Kenen recalls the arguments put forth by the League of Nations (see Ragnar Nurkse,
International Currency Experience: Lessons of the Interwar Period (Geneva: League of
Nations, 1944)), in terms that were widely endorsed at the time. The setting of exchange
rates, he concluded, could not be left to market forces:
Freely fluctuating rates involve three serious disadvantages. In the first place, they
create an element of risk which tends to discourage international trade. Secondly,
as a means of adjusting the balance of payments, exchange fluctuations involve
constant shifts in labour and other resources between production for the home
market and production for export. Such shifts may be costly…and are obviously
wasteful if the exchange market conditions that call for them are temporary. Thirdly,
experience has shown that fluctuating exchanges cannot always be relied upon to
promote adjustment. Any considerable or continuous movement of the exchange
rate is liable to generate anticipations of a further movement in the same direction.
(Nurske: 210.)
276
In his seminal paper of 1953, Milton Friedman defended ‘The Case for Flexible
Exchange Rates’ in F Milton, Essays in Positive Economics (Chicago: Chicago University
Press, 1953).
277
See eg Fred Bergsten (Institute of International Economics), ‘Alternative Exchange
Rate Systems and Reform of the International Financial Architecture’, Testimony before the
Committee on Banking and Financial Services United States House of Representatives,
Washington, DC (21 May 1999) at <http://www.iie.com/publications/papers/
bergsten0599.htm> (last visited 18 July 2014).
278
See Atish R Ghosh, Anne-Marie Gulde, and Holger C Wolf, Currency Boards: The
Ultimate Fix? (Washington, DC: IMF, 1998) 5.
279
Veerathai Santiprabhob, ‘Bank Soundness and Currency Board Arrangements: Issues
and Experience’ IMF Paper on Policy and Assessment No PPAA/97/11 (1 December 1997) 1,
at <https://www.imf.org/external/pubs/ft/ppaa/ppaa9711.pdf> (last visited 18 July 2014).
280
See Eli M Salzberger and Stefan Voigt, ‘On Constitutional Processes and the Delegation
of Power, with Special Emphasis on Israel and Central and Eastern Europe’ (2002) 3
Theoretical Inquiries in Law 207.
281
Salzberger and Voigt, above note 280, 247.
282
Salzberger and Voigt, above note 280, 213.
283
See Hanke and Schuler, above note 273, 690.
284
I am grateful to Stefan Gannon for observations on this point. Hong Kong’s Basic Law,
Art 111 clearly states that ‘the issue of Hong Kong currency must be backed by a 100 per
cent reserve fund’. Section 3(1) of the HK Exchange Fund Ordinance (which reinforces and
implements the provisions of the Basic law concerning the monetary legislation in Hong
Kong) further states: ‘There shall be established a fund to be called “the Exchange Fund”
which shall be under the control of the Financial Secretary…’.
285
See John Williamson, What Role for Currency Boards? (Washington, DC: Institute of
International Economics, 1995) 4.
286
See eg Juscelino F Colares, ‘Formal Legal Theory and the Surrender of Political Control
over Monetary Policy: What Can Ulysses’ Journey to Ithaca Teach Argentina about
Appropriate Legal Form?’ (2003) 36 Cornell International Law Journal 151, 168–9. See also
Benjamin J Cohen, The Geography of Money (Ithaca, NY: Cornell University, 1998).
287
See eg Michael Gruson, ‘Dollarisation and Euroisation’ in Current Developments in
Monetary and Financial Law (Washington, DC: IMF, 2003) vol 2, ch 31.
288
I am grateful to Charles Goodhart for observations on this point.
289
And without anyone apparently noticing comprise the monetary arrangements of the
Channel Islands and the Isle of Man today. I thank Geoffrey Wood for this remark.
290
See Williamson, above note 285, 5. See also Hanke and Schuler, above note 273, 691–2.
291
See Williamson, above note 285, 6.
292
Williamson, above note 285, 8.
293
See generally Corrinne Ho, A Survey of the Institutional and Operational Aspects of
Modern-Day Currency Boards (Basel: Bank for International Settlements Monetary and
Economic Department, 2002) 2. Corrinne Ho argues that:
There are several fundamental reasons why modern currency boards cannot be
literal replicas of their historical counterparts. First, the function of currency
boards has broadened. Earlier currency boards were simply a mechanism to
transform a metropolitan currency (mainly sterling) into a form that was convenient
for local use, a practical solution to the rather mundane problem of currency
issuance, typically in a colony. In the modern, post-colonial context, however, they
are an alternative approach to conducting monetary policy. Second, the political and
economic landscapes have changed. Modern currency board economies are
independent sovereign entities, not colonies. They have no recourse to a parent
country and are expected to take responsibility for their own monetary affairs.
Furthermore, with the increasing importance of the banking sector and exposure to
international capital flows, modern currency board economies must deal with issues
that were either non-existent or relatively insignificant in the historical context.
294
See Williamson, above note 285, 1.
295
Williamson, above note 285.
296
See generally Santiprabhob, above note 279, 2.
297
See Ho, above note 293, 18.
298
Ho, above note 293, 7 (original emphases).
299
Ho, above note 293, 6.
300
See generally Charles Enoch and Anne-Marie Gulde, Making a Currency Board
Operational (Washington, DC: IMF, 1997) 3.
301
See Williamson above note 285, 13–19.
302
See generally Beth A Simmons, ‘Money and the Law: Why Comply with the Public
International Law of Money?’ (2000) 25 Yale Journal of International Law 323.
303
See Frank Partnoy, ‘Why Markets Crash and What Law Can Do About It’ (2000) 61
University of Pittsburgh Law Review 741, 781.
304
See Williamson, above note 285, 19–29.
305
Ley de Convertibilidad del Austral [Convertibility Law] No 23.928 (28 March 1991).
306
Carta Organica del Banco Central de la Republica Argentina, Law No 24.244 (22
October 1992).
307
For an analysis on this issue, see eg Geoffrey Miller, ‘Constitutional Moments, Pre-
commitment, and Fundamental Reform. The Case of Argentina’ (1993) 71 Washington
University Law Quarterly 1061, 1083–5.
308
On 6 January 2002, with the enactment of the Public Emergency and Exchange
Regulations Reform Law No 25,561 (as amended by Law No 25,820) (hereinafter
Emergency Law), the fixed peg system between the peso and the US dollar (in force for
more than ten years) came to an end.
309
See Gabriel Gómez Giglio, ‘Emergency Law and Financial Entities in Argentina’ (2003)
10 Journal of International Banking Law and Regulation 397 n 13.
For the purpose of clarification and for a better understanding, note that President De la
Rúa resigned on 20 December 2001, amid nationwide rioting after he decreed a freeze on
bank withdrawals on 3 December 2001. The following ten days saw four more presidents, a
debt default and a messy devaluation. On 23 December 2001, Congress elected Senator
Alfredo Rodriguez Saá to continue the presidential mandate who resigned on 30 December
2001, due to lack of political support. On 2 January 2002, Eduardo Duhalde was elected
President by Congress to complete the mandate of former President De la Rúa, namely up
to December 2003. Seeking to assuage popular anger, Mr Duhalde’s interim government
then tried to force banks, foreign creditors and investors to shoulder much of the losses
from the currency devaluation and the debt default.
310
Gómez Giglio, above note 309:
Argentina’s default was the biggest ever seen by a country. As regards private
creditors, the total amount of the debt default—including arrears—reached $76.7bn
by the end of 2003. About half of this amount is owed to some 600,000 retail
investors, based mainly in Italy, Germany and Japan. To complicate matters further,
any restructuring shall have to cover 152 separate issues of bonds issued in 14
different currencies and under eight legal frameworks.
311
See Santiprabhob, above note 279, 1.
312
See generally Carlos Zarazaga, ‘Argentina, Mexico and Currency Boards: Another Case
of Rules versus Discretion’ (1995) Federal Reserve Bank of Dallas Economic Review (4th
Quarter) 14. See also Ghosh et al, above note 278, 6.
313
See Santiprabhob, above note 279, 6–7 and 12.
314
Santiprabhob, above note 279.
Supervision, Regulation, and Financial Stability
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
Financial system — Monetary system — Monetary obligations — European Central Bank
(p. 111) 3 Supervision, Regulation, and Financial Stability
B. Definition of Supervision and Regulation 3.06
Regulation 3.07
Supervision—macro- and micro-prudential supervision 3.14
The supervisory process 3.18
Licensing, authorization, chartering 3.23
Supervision stricto sensu 3.26
Sanctioning 3.35
Crisis management 3.39
Judgement-based supervision 3.40
C. Separation between Monetary and Supervisory Functions 3.51

Arguments for separation 3.53
Arguments against separation 3.54
D. Financial Stability 3.58

Financial stability and macro-prudential supervision 3.60
Financial stability and micro-prudential supervision 3.72
Councils for financial stability 3.80
E. The Optimal Number of Supervisory Authorities 3.85

F. Public versus Private Supervision 3.94
G. Independence versus Politically Directed Process 3.101
H. Institution versus Business Function 3.110
I. Institution versus Supervisory Function 3.114
J. Structural Reforms 3.116
A basic continuing responsibility of any central bank—and the principal reason for
the establishing of the Federal Reserve—is to assure stable and smoothly
functioning financial and payment systems. These are prerequisites for, and
complementary to, the central bank’s responsibility for conducting monetary policy.
…Historically, in fact, the ‘monetary’ functions were largely grafted onto the
‘supervisory’ functions, not the reverse.1
A. Introduction
3.01 This chapter deals with supervision (macro and micro), regulation, and financial
stability, considering issues of institutional design.
3.02 The debate about the optimal allocation of responsibilities with regard to the
supervision of financial institutions is a matter of great controversy.2 From the point of view
of monetary law and monetary theory, a major issue at stake in this organizational structure
is the role (p. 112) of the central bank—as monetary authority and bankers’ bank—and in
particular whether banking supervision should be inside or outside the central bank. With
or without direct supervisory responsibilities, a central bank is typically responsible for
financial stability, a concept that cannot be dissociated from monetary stability. (The
absence of stable prices harms the stability of the financial system; financial fragility, in
turn, negatively affects monetary stability.)
3.03 The trend after the global financial crisis is to give the central bank responsibility for
financial stability (macro-prudential supervision) and for micro-prudential supervision
(directly as in the case of the European Central Bank (ECB) or indirectly as in the case of
the Bank of England). Back in 1996 I wrote:
Independence to pursue stable money should be accompanied by independence to

pursue sound banking (whether supervision is in the hands of the central bank or of
another supervisory agency), because a sound banking system is a necessary
condition for maintaining monetary stability…[C]entral banks are often better
suited than other public agencies to monitor banks’ capital, asset quality, liquidity
and those elements that comprise…supervision. Further, the lender of last resort
role of the central bank in a liquidity crisis or in the case of a payments system
problem justifies the central bank’s involvement in supervision.3
3.04 As regards the optimal number of supervisory authorities, some jurisdictions have
opted for a single authority to regulate and supervise the financial industry, while other
jurisdictions—most notably the USA—retain a highly fragmented regulatory and supervisory
landscape. In the aftermath of the financial crisis the model of a ‘single regulator’ has been
abandoned in countries such as the UK.
3.05 There are other issues relating to this institutional design: private versus public
supervision; independent versus politically directed process; institutional versus functional
regulation; and the use of supervisory functions as an organizing principle of supervision,
that will be discussed later in this chapter.
B. Definition of Supervision and Regulation

3.06 Many commentators use the terms ‘regulation’ and ‘supervision’ interchangeably.
However, they are conceptually different. Supervision (micro-supervision) has to do with
monitoring and enforcement, and regulation with rule-making.
(p. 113) Regulation
3.07 Banking regulation refers to the establishment of rules, to the process of rule-making,
and includes legislative acts and statutory instruments issued by the competent authorities
nationally and supranationally, international rules (often financial ‘soft law’ standards), and
rules issued by self-regulatory organizations and private bodies or ‘clubs’, such as a
cooperative bankers’ association.
Banking regulation draws from national, supranational, and international sources. At a
national level the competent authorities are (though this varies from country to country) the
government—through the ministry of finance or Treasury—the central bank, and/or the
bank regulatory agency/agencies. At the level of the European Union, Member States must
comply with treaty provisions (primary EU Law) and with regulations, directives and other
legislative instruments (secondary EU Law). At an international level, rules that emanate
from international organizations suffer from the ‘eternal’ problem of international law:
effective enforcement. The distinct force and effect of rules is important in order to
understand the various sources of banking law and regulation.
3.08 The design of ‘optimal’ regulation is a complex art. Not only do we have different
levels of governance in trying to define who should be in charge, what needs to be
regulated, the boundaries and the limits of such regulation but also in any regulatory
system of private activities, we need to combine the need to protect safety and soundness
with the need to make a profit and to take risks. This involves a delicate balancing act. For
example, what is the difference between ‘normal risk’ and ‘excessive risk’ and who should
define it?
3.09 Under a national system of public regulation (in contrast to private or self-regulation)
it is the government—the competent national public authorities—that usually determines
the amount of regulation necessary, and the amount of permissible risk. The criteria under
which these judgements are made generally refer to safety and soundness and prevention
of systemic risk. Certainly, an ‘arbitrary, capricious or abuse of discretion’ standard would
be inadmissible. However, the criteria can be too rigid or static for a sector which is
becoming more flexible and dynamic, and facing increasing competition from other
financial intermediaries providing similar products and services but subject to lesser
regulation (shadow banking and shadow markets).
3.10 The reasons for regulating banks have been amply studied in the literature.4 It is the
existence of market failures and deficiencies that provides the economic rationale for
banking regulation. Negative externalities or spill-overs—the costs to society of banking
failures—are substantial and, by far, exceed the private costs to individual financial
institutions; that is why a key aim of regulation is to internalize such externalities.
Information asymmetries or deficiencies—a feature of the services industry in general—are
particularly acute in (p. 114) banking; the phenomenon of ‘bank runs’ under a fractional
reserve system,5 the ‘liquidity transformation’ and other public interest considerations
exacerbate banking problems. Payment and clearing systems exhibit ‘natural monopoly’
characteristics; and, after the crisis of 2007–9, financial stability is increasingly considered
a public good.6
3.11 The balance sheet structure of a traditional bank exhibits features that are a potential
source of fragility and thus require regulatory attention, namely the asset-liability maturity
mismatch (long term and relatively illiquid assets funded by short-term liquid liabilities),
low liquidity (percentage of liquid assets in relation to total assets), low capitalization
(which is both a cause and a consequence of regulation), and a risky asset portfolio (trade-
off between risk and profitability).
3.12 The aim of banking and financial laws is to protect individuals (depositors, investors,
policy-holders), to ensure the smooth conduct of the business (fair, efficient and transparent
markets) and to safeguard the payment system and the stability of the financial system at
large, preventing and containing systemic risk and systemic crises.
3.13 Historical experience suggests that governmental banking regulation was not a
‘natural’ product but a by-product or reaction to crises and conflicts. Though the specific
purposes of banking regulation are the safety and soundness of the financial system, the
ultimate goal is to safeguard confidence and trust.
Supervision—macro- and micro-prudential supervision
3.14 In the aftermath of the global financial crisis, a consensus has emerged regarding the
difference between macro and micro prudential supervision, as was pointed out in Chapter
2. According to the House of Lords Report on the Future or EU Supervision and Regulation:
[M]acro-prudential supervision is the analysis of trends and imbalances in the

financial system and the detection of systemic risks that these trends may pose to
financial institutions and the economy. The focus of macro-prudential supervision is
the safety of the financial and economic system as a whole—the prevention of the
materialization of systemic risk. Micro-prudential supervision is the day-to-day
supervision of individual financial institutions. The focus of micro-prudential
supervision is the safety and soundness of individual institutions and also consumer
protection. The same or a separate supervisor can carry out these two functions. If
different supervisors carry out these functions they must work together to provide
mechanisms to counteract macro-prudential risks at a micro-prudential level.7
3.15 Macro-prudential supervision is thus analogous to the oversight of the forest, while
micro prudential supervision is analogous to the oversight of individual trees. Macro-
prudential supervision should target the causes of systemic risk.
3.16 From an institutional perspective, the exercise of macro-prudential supervision is
given to either newly created councils for financial stability such as the Financial Stability
Oversight (p. 115) Council in the USA, or to the central bank, such as the Bank of England
in the UK, where the Financial Policy Committee is in charge of this task.8 In the EU, the
European Systemic Risk Board (not a new institution) shares macro-prudential supervisory
responsibilities with national authorities, and according to the Single Supervisory
Mechanism (SSM) Regulation, also with the European Central Bank, as further discussed in
Chapters 10 and 11 of this volume.
3.17 On-going discussions are trying to identify the powers and instruments macro-
prudential authorities should have.9 Given the lack of a commonly accepted theoretical
paradigm on the definition of systemic risk, this is no easy task. Systemic risk—further
analysed in Chapter 4—refers to the likelihood of correlated failure, to the risk or
probability of breakdown of the entire financial system, as opposed to breakdowns in
individual parts or components. But a widely accepted definition is still missing. All classes
of financial intermediaries, markets and infrastructures can be systematically important at
some level.
The supervisory process
3.18 Rather than adopting a ‘monolithic’ approach to the notion of (micro-prudential)
supervision, I like to think about supervision in terms of the functions it involves for the
supervisory authorities, from the beginning of the business life of a supervised entity (entry
into the market through a licence or authorization) to its end, which in banking is less
straightforward than in other businesses, since bank failures have relevant public policy
implications.
3.19 Supervision in a broad sense can be understood as a process with four stages or
phases: (1) licensing, authorization, or chartering (entry into the business); (2) supervision
stricto sensu; (3) sanctioning or imposition of penalties in the case of non-compliance with
the law, fraud, bad management, or other types of wrongdoing; and (4) crisis management,
which comprises lender of last resort, deposit insurance, resolution, and bank insolvency
proceedings.10
3.20 Supervision in a narrow sense (ie, supervision stricto sensu) refers to the oversight of
financial firms’ behaviour, in particular risk monitoring and risk control. In this narrow
sense, prudential supervision is the on-going monitoring and oversight of the health of the
banks and the banking system, in particular asset quality, capital adequacy, liquidity,
management, internal controls, and earnings.
(p. 116) 3.21 Because supervision monitors the degree to which the bank abides by the
rules, there is a connection between the two concepts. The very process of supervision is
subject to regulation.11 Most supervisory authorities are also endowed with regulatory
responsibilities.12 However, banking law extends beyond the supervisory process and deals
with other issues, such as the legal form of the corporation and the bank–customer
relationship.
3.22 The rationale of banking regulation is related to the business of banking itself rather
than to the character of bankers. Supervision should support and encourage good
management.
Licensing, authorization, chartering
3.23 Licensing is a key first step in the supervisory process. It acts as a catalyst or filter
for a safe and sound banking system. However, while entry barriers should not be too lax,
neither should they be so restrictive that they lead to inadequate competition. The law
ought to consider the following issues in the licensing process: the conditions to obtain a
licence (minimum capital, competence, and integrity of management and others); the list of
activities that banks can do (an important issue with regard to the development of capital
markets, as securities firms may find it hard to compete with banks, particularly if the latter
are ‘protected’ by the government); the entry of foreign banks; the authority to revoke a
licence, and the relations between banks and industry/commerce.
3.24 The role of banks in controlling corporations is a fundamental issue. Broadly
speaking, there are two main models of bank–corporate relations: what we can refer to as
the Anglo-Saxon model, in which the bank maintains a purely commercial relationship with
its corporate clients, without direct ownership connections, and the traditional German-
Japanese model of closer and continuing relationships, often with direct equity involvement
(cross-shareholdings) and participation in corporate decisions. The Anglo-Saxon model is
concerned about current performance and equity prices (short-termism), while under the
traditional German-Japanese model long-term strategies are encouraged and, in case of
trouble, reorganization is favoured over liquidation. The Anglo-Saxon model fosters
transparency and market discipline, rather than confidential flows of information. In recent
years, there has been a convergence towards some of the features of the Anglo-Saxon
model.
3.25 Banking laws often require that the authorities give their approval (a licence in some
cases, a registration procedure in some other cases) to various forms of bank expansion: via
branches (legally dependent units), subsidiaries (legally independent units), joint ventures,
and takeovers or mergers. The interaction between competition and regulation is never
easy. The demands of competition—as well as the demands of financial services
liberalization—are often in conflict with the demands of regulation—in particular when it
comes to ‘protective’ regulation.
Supervision stricto sensu
3.26 Although banks in a market economy are operated by their management to generate
profits (and thereby take risks), and their shareholders expect a reasonable return on their
(p. 117) investment, it is widely recognized that banks are different from other profit-
seeking businesses because of their role in the payment system, in the financial system at
large, and in the national economy and that, therefore, they require a higher degree of
supervision (and regulation) than other types of businesses.
3.27 Supervision refers to the on-going monitoring of the health of the banks and the
banking system, in particular asset quality, capital adequacy, liquidity, management,
internal controls, and earnings. Supervision is exercised through an array of instruments or
techniques13 that range from off-site and on-site examinations (or inspections) to reporting,
statistical requirements, unpublished internal ratings,14 internal controls and reliance on
‘gatekeepers’ such credit rating agencies and independent external auditors.15
Supervision should not focus exclusively on a single element or tool, regardless of how
important that tool may be—such as capital requirements—but rather needs to comprise a
variety of strategies.
3.28 Both the elements of supervision (ie, capital adequacy, asset quality, and the others)
and the techniques of supervision are subject to regulation, that is, they are spelt out and
described in the law.
3.29 Capital regulation has become of such paramount importance in recent years that
some economists tend to equate capital regulation with banking regulation.
3.30 Low capitalization in banking is both a cause and a consequence of regulation. There
is a simultaneous interaction between capital and regulation: a two-way effect. Capital
adequacy is a ‘cause’ of regulation. Capital provides the buffer, the safety margin, to protect
bank solvency. But the emphasis on capital adequacy is also a ‘consequence’ of regulation.
If banks are protected by a ‘safety net’ they tend to hold lower levels of capital (indeed, this
has been the case historically with banks holding lower levels of capital than other
corporations). The existence of an implicit government guarantee generates moral hazard
incentives that may induce banks to take excessive or irresponsible risks and/or to be (p.
118) undercapitalized. The primary purpose of capital is to cushion both equity owners and
debt-holders from unexpected losses. In the presence of an official safety net, the level of
capitalization becomes less significant to the bank managers and shareholders and more
significant to the regulators, as taxpayers become potential losers if the bank fails. Thus,
regulators impose minimum capital requirements upon banks. Undoubtedly, capital has its
benefits, absorbing losses, enhancing public confidence, reducing the incentive for
excessive risk taking, lowering the probability of bank failure, etc. However, augmenting
capital is not by itself a panacea for bank regulation.16 Considerations of asset loss pervade
the concept of capital adequacy; the quality of the asset portfolio was and is the key to
‘sound banking’.17 Capital requirements do not take into account the competence, depth,
and integrity of management (including compensation and other incentives), which also
plays a crucial role in sound banking.18
Because the quality and riskiness of the bank’s asset portfolio is difficult to assess at any
given time, lending restrictions are often applied.
3.31 Loan classification is in my opinion the next regulatory frontier where a common
financial language is badly needed. The way loans are classified according to their credit
risk (good, substandard, problem, doubtful, non-performing, loss), the determination of loan
loss reserves19 and what constitutes ‘forbearance’20 vary across jurisdictions and
institutions, further (p. 119) complicating meaningful cross-border comparisons when it
comes to resolution, stress tests or consolidated supervision.
3.32 The linkage between the intensity of supervision and the level of capitalization is an
interesting example of the interaction between supervision and regulation.21 However, in
the aftermath of the 2007–9 global financial crisis, it is clear that banks had too little
capital, too thin a buffer to absorb losses and that capital requirements were inadequate.22
Basel III—the name given to the new capital and liquidity standards adopted by the Basel
Committee in December 201023—is an attempt to respond to the limitations of Basel I and
Basel II.
3.33 The regulation of lending limits is another interesting example of the interaction
between supervision and regulation, since supervisors use some of these limits—defined in
banking laws or regulations—as a proxy for excessive risk concentration. For example, large
credit exposures to a single party or group of connected counterparties are limited by law.24
Other restrictions refer to loans to subsidiaries; the rationale being that if the subsidiary
runs into difficulties, that may affect the soundness of the whole bank (as happened in
Barings).25(p. 120) Lending limits to non-bank subsidiaries are an important issue when
talking about financial groups/financial conglomerates. Connected lending (loans to
insiders) has been a major problem in several countries in Latin America. In order to
prevent corruptive practices and abuse of position for personal interests or benefit, it is
important to restrict lending to directors, officers, and employees, as well as their families
and friends. Finally, lending to shareholders is also subject to limitations in some
jurisdictions, though the practice on this issue differs greatly across countries, depending
on the role that banks play in controlling corporations, an issue which I briefly discussed in
paragraph 3.24 with regard to the licensing process. (Incidentally, we need to devise
adequate leverage limits, with the same underlying philosophy that has guided the design
of lending limits.)
3.34 The regulation and supervision of the banking business has traditionally been based
on the lending function of commercial banks. Lending regulation typically combines
mandatory rules, capital and liquidity requirements with a considerable degree of official
protection. Today, however, bank lending represents a relatively small proportion of capital
flows and international financing. As banks have become more involved in trading, in the
securities and derivatives markets, regulation and supervision need to address the
challenges presented by the new lines of business, without creating a competitive
disadvantage for banks vis-à-vis other financial intermediaries. Trading regulation is
different from lending regulation; it is mainly a disclosure-based regime with fiduciary
rules, conduct of business rules, and internal systems of controls and risk management; it
also relies to a large extent on market discipline mechanisms and self-regulation. As banks
continue their expansion into the securities business, the degree of official protection
should diminish (or altogether disappear in some cases), and public mandatory rules and
intervention need to be replaced by market supervisory mechanisms. Less official
protection is the price banks must pay for greater reliance on market supervision.
Sanctioning
3.35 The success of banking and financial regulation is always dependent upon its effective
enforcement. Penalties for wrongdoing should be clearly spelt out in the law, their severity
varying depending on the nature of the wrongdoing (civil versus criminal penalties).
However, penalties should not be applied for political considerations or because of
displeasure with bank management policies. Courts of justice need to be independent in
order to assess cases without political pressures.
3.36 Sanctions or penalties can be broadly classified into two types: those that affect the
bank and those that affect bank management. ‘Institutional sanctions’ (such as monetary
fines, cease and desist orders, closer supervision, restrictions in activities, prompt
corrective action, revocation of a licence, and closure) affect the institution, and thereby,
shareholders. ‘Personal sanctions’ (such as temporary or permanent inability to be a banker,
fines, loss of job, call of attention, management overhaul, and imprisonment) penalize
management directly.
3.37 In response to corporate and financial scandals such as Enron and the multiple
fallouts associated with the global financial crisis (the Madoff fiasco and others), there is a
trend to give increasing attention and emphasis to personal sanctions in the light of the
fiduciary duties of directors, managers, and officers. This was the rationale behind the
approval of the Sarbanes–Oxley Act of 2002 in the USA and it is also at the root of the
enforcement culture that supervisors and regulators are increasingly espousing.
(p. 121) 3.38 Effective enforcement (compliance with the law and imposition of sanctions
in the case of infringement) is a key feature of hard law. Enforcement is the greatest
challenge in the development of international financial soft law. Soft law standards are not
binding in the way hard law is. Monitoring and promoting the observance with standards
(‘observance’ is to soft law what enforcement is to hard law) aims to replicate the
‘enforcement culture’ by applying a number of mechanisms or policies (quasi-sanctions) in
the case of ‘non-observance’: name and shame, denial or restriction of market access and
others. These issues are further discussed in Chapter 14 in this volume.
Crisis management
3.39 Crisis management in banking involves an array of instruments that extend beyond
the insolvency proceedings that are the only tool typically available to deal with corporate
bankruptcy in other industries. Such an array of instruments includes the lender of last
resort role of the central bank, deposit guarantee schemes, resolution tools, and special
bank insolvency proceedings (judicial or extra-judicial). There are other instruments that
the authorities use to deal with banking crises such as the government’s implicit protection
of depositors, banks (the so-called ‘too-big-to-fail’ (TBTF) doctrine), and the payment
system. Reliance on the official safety net is the subject of much criticism in the literature
and much controversy in policy-making circles. Crisis management is discussed in Chapter
4.
Judgement-based supervision
3.40 In the UK, the concept of ‘judgement-based supervision’ is an approach favoured by
the legislative reforms that have seen the dismantling of the Financial Services Authority
and the establishment of a Prudential Regulatory Authority, as a subsidiary of the Bank of
England, as well as a Financial Conduct Authority.26 The adoption of a ‘more judgement-
focused approach to regulation so that business models can be challenged, risks identified
and action taken to preserve financial stability’27 is a key feature of the new supervisory
regime.
3.41 However, a clear definition of judgement-based supervision is not apparent.
Supervisory activity by definition entails a judgement, a degree of discretion. Back in 1942,
in the context of the proposals that led to the establishment of the International Monetary
Fund, John Maynard Keynes famously stated: ‘Perhaps the most difficult question is how
much to decide by rule and how much to leave to discretion.’28 This is the eternal challenge
in administrative law, as it is in monetary policy. It is also the challenge the authorities face
when trying to establish what exactly judgement-based supervision is. As regards the
‘forward-looking’ feature, it is worth recalling that though the law can be proactive,
regulation after crisis (hence reactive, backward looking) is a constant in the history of
finance.29
(p. 122) 3.42 judgement-based supervision is not fundamentally different from (micro-)
supervision generally. It addresses the ‘how’ to supervise, rather than the ‘what’ or the
‘who’. It is not meant to be ‘supervision-lite’, it is meant to be strong supervision but with a
change in emphasis. The approach embedded in judgement-based supervision has been
defined as a reduction in the reliance on rules and an increased focus on the spirit of
regulation.30
3.43 It is perhaps worth reflecting upon a couple of issues. First, to be able to exercise
‘judgement’ one must have knowledge. This has implications in terms of adequate formation
and pay. The latter in particular is fundamental if the supervisory authority wishes to attract
the brightest minds. Secondly, the authorities should be aware that supervision and crisis
management are part of a seamless process, in which the supervision of healthy institutions
turns into crisis management when they run into trouble. Such a process requires a very
close link and effective communication with the resolution authorities. Supervision, the
authorities should remember, is a thankless task, where successes are hidden and failures
trumpeted.
3.44 There is a body of thought that suggests that rules are inevitably more effective than
human judgement, because judgement is affected by human tendencies to overconfidence
and bias.31 At the heart of the debate is the question whether rule-based limits on the size
of financial institutions are necessary to protect against the inability of supervisors to
guarantee that their judgement will provide sufficient protection to society. But this is
beyond the scope of this chapter.
3.45 From the perspective of organizational economics,32 supervisors need to be allowed
to think differently (group think was another cause of the crisis) and should not be
penalized if they act as ‘whistle blowers’ or have contrarian views. After all, the goal of
supervision should be a sound financial system, both for those that offer financial services
and for those who demand them. The interests of bankers must be aligned with the
interests of society. In any case, judgement-based supervision should never be a substitute
for good governance and sound risk management. Due diligence and internal risk controls
remain the firm’s responsibility.
3.46 The balance between rules and discretion varies in each of the supervisory stages.
This means that a ‘judgement-based approach’ is more suitable in some stages of the
supervisory process than in some others.
3.47 By definition, the first stage, the entry into the business—via licensing, authorization,
or chartering in the case of banks and simpler registration procedures in the case of other
financial entities—must be rule-based. The issues at stake, the balance between competition
and regulation and the function of this stage as catalyst or filter in the design of a sound
banking market cannot be left to discretion.
(p. 123) 3.48 When it comes to the second stage, supervision stricto sensu, the on-going
monitoring and oversight of the health of the banks and the banking system, in particular
asset quality, capital adequacy, liquidity, management, internal controls, and earnings (the
very definition of prudential supervision), is clearly a judgemental function and, hence, the
balance tilts towards discretion, albeit on the basis of clear and transparent rules. Risk
monitoring and risk control entail a great deal of judgement. The various supervisory tools
(reports and statistical requirements, internal ratings (capital adequacy, asset quality,
management, earnings, and liquidity (CAMELS) and others), on-site examinations, internal
audits, off-site examinations, consultations with senior management and others (disclosure,
fiduciary duties, reliance on external gatekeepers, such as credit rating agencies and
auditing firms) require that supervisors exercise forward-looking judgement. It is as much
an art as a science. And then there are ‘pieces’ that are still missing in the ‘supervisory
puzzle’ (and that hinder adequate cross-border assessments, valuations, and international
comparisons), such as an adequate system of loan classification (the establishment of a
common financial language when it comes to the asset side of banks’ balance sheets) and
effective rules regarding the reliance on external gatekeepers: independent external audits,
credit ratings, legal counsel and others.
3.49 As regards, the third stage, ‘sanctioning’ must be, by definition, rule-based. Neither
‘institutional sanctions’ nor ‘personal sanctions’ can be subject to judgement calls. The
ladder of sanctions needs to be clearly known ex ante. The full force of the law is needed to
afford adequate protection and guarantees.
3.50 The crisis management stage relies upon a mix of rules and discretion/judgement.
While lender of last resort is clearly discretionary, explicit deposit insurance and resolution
and insolvency proceedings should be rule-based. Again, no one would like to be deprived of
any property rights by some sort of ‘judgement call’. A ‘hard law’ based approach (defined
ex ante) is needed: debtors and creditors demand credibility and certainty. This is their
protection and it is clearly rule-based. Early intervention (such as ‘prompt corrective
action’) and preventive measures including living wills rely upon a mix of rules and
discretion (though they should be rule-based if early intervention implies closure or
restriction in activities, ie, if early intervention has a ‘sanctioning’ component). As for
government policies of implicit protection of depositors, banks (the ‘too-big-to-fail doctrine’)
or the payment system, it is a murky terrain, often subject to judgement calls (sometimes
terrible judgement calls). The discretionary nature of rescue packages does not contribute
to certainty and predictability and it reinforces pernicious moral hazard incentives.
C. Separation between Monetary and Supervisory Functions

3.51 The separation between the monetary and the supervisory functions of a central bank
is a contentious issue in the institutional design of supervision. The central bank has a
fundamental role with regard to monetary stability and financial stability. Central bankers’
duties towards the maintenance of ‘financial stability’ typically referred before the global
financial crisis to the maintenance of the safety and soundness of the banking system.33(p.
124) Sound banking in turn relates to the following central bank functions: central banks as
bankers’ banks (including their role in the payments system) and lender of last resort, and
central banks as supervisory agencies (when they are entrusted with supervisory functions),
as discussed in Chapter 2.
3.52 In the post global financial crisis world, the central bank’s functionality in the pursuit
of financial stability has extended beyond the banking sector to encompass the financial
sector generally.34 For example in the USA, under the Dodd–Frank Act 2010, the Federal
Reserve System will be given responsibility to supervise any financial institution (any non-
bank financial company) that is deemed to be systemically important by the Financial
Stability Oversight Council.
Arguments for separation
3.53 Banking supervision is not a necessary or exclusive function of a central bank.35 It is
evidently not necessary because there are central banks not directly entrusted with this
task; neither is it exclusive, as responsibility for supervision can be shared, and actually
often is, with other regulatory agencies. Goodhart and Schoenmaker in a seminal
contribution36 claimed that the main arguments for separating monetary and supervisory
functions are the potential conflicts of interests, the likely preferability of a single financial
regulator (in a context of blurring frontiers between different types of financial
intermediaries), and the danger of reputational damage.37 Furthermore, since managerial
time is limited, and since supervisory issues—particularly in times of crisis—are very time
consuming, a case can be made for the central bank to focus its attention on the important
and demanding task of conducting monetary policy.38 Conflicts of interest are possible when
the prime concern of the monetary authorities is to keep an external objective, such as a
fixed exchange rate. This was the case with the crisis of the exchange rate and intervention
mechanism (ERM) of the (p. 125) European Monetary System in 1992–3,39 when the
interest rate deemed necessary to keep participating in the ERM endangered financial
stability.
Arguments against separation
3.54 According to Goodhart and Schoenmaker,40 the main arguments against separation
are the central bank’s lender of last resort role (especially in the case of systemic failure)
and its oversight function in the payment system (whether or not the central bank
participates in the operation of that system). The safeguard of systemic stability might be
adversely affected if supervision is transferred from the central bank to a specialized
agency, since the ethos, culture, and priorities of the separate supervisory agency may
come to focus on conduct of business and consumer protection issues, leaving aside
systemic considerations.41 Another argument against separation is the need for consistency
between monetary policy and supervisory decisions. Those formulating monetary policy
must have a comprehensive and intimate understanding of the workings of the banking
system, and bank supervisors must understand the policy environment within which they
operate. There are also advantages of synergy in placing banking supervision under the
central bank, because of the knowledge central banks have about the health of individual
credit institutions and the financial system as a whole. Owing to its lender of last resort
role, the central bank has a keen interest in monitoring the solvency of the institutions to
which it may eventually have to lend.
3.55 In emerging economies, the case for keeping supervision under the wing of the
central bank is strengthened because of the scarcity of qualified staff and adequate funding.
Central banks tend to have greater independence from government officials, better funding,
greater knowledge, and expertise (and a certain pride in doing their job well) than other
government agencies. Frequently, the research department of the central bank is the only
serious economic research group in the country. However, some big emerging economies,
such as the People’s Republic of China (PRC), have also transferred supervision away from
the central bank (in the case of the PRC, to the Chinese Banking Regulatory Commission).
3.56 The debate about the supervisory responsibilities of central banks (and about central
bank independence in banking supervision, which I further discuss below) is linked to the
discussion of the goals and history of central banks. The Federal Reserve System was set up
in 1913 ‘to establish a more effective supervision of banking’,42 following the banking crises
of the nineteenth and early twentieth centuries (attributable to the inability of banks to
convert their demand deposits into cash). The Fed conceives of its monetary policy role as
having been largely grafted onto its supervisory functions, and regards its supervisory and
regulatory functions as a prerequisite and complement to its monetary policy
responsibilities.
3.57 The European Central Bank had a clear mandate with regard to monetary policy from
the very beginning but no corresponding mandate with regard to financial supervision till
the SSM Regulation. The twin banking and sovereign debt crises in the euro area evidenced
the inadequacy of the principle of decentralized banking supervision in a monetary (p. 126)
union.43 The implications of banking union in the EU are discussed in Chapters 10 and 11 in
this volume.
D. Financial Stability

3.58 Financial stability has come to the forefront of academic and policy discussions
following the Global Financial Crisis 2007–9.44 In this section, I discuss the relationship
between financial stability and macro-prudential supervision on the one hand, and between
financial stability and micro-prudential supervision on the other hand. Institutional
arrangements to safeguard financial stability are also considered.
3.59 The involvement of central banks in financial stability originated in their role as
monopolist suppliers of fiat money45 and in their role as bankers’ bank. Only the ultimate
supplier of money could provide the necessary stabilizing function in a nationwide scramble
for liquidity,46 as the global financial crisis amply demonstrated.
Financial stability and macro-prudential supervision
3.60 Financial stability has long been an elusive idea, difficult to define in positive terms.
Before the onslaught of the 2007–9 Global Financial Crisis, financial stability was regarded
as a broad and discretionary concept that generally referred to the safety and soundness of
the financial system and to the stability of the payment and settlement systems.47 The
achievement of this objective typically encompassed a variety of elements, such as good
licensing policies, good supervisory techniques, adequate capital and liquidity, competent
and honest management, internal controls, early warning systems, transparency, and
accountability (effectively the domain of supervision). It also evoked the smooth operation
of the payment systems.48(p. 127) Financial stability, sound banking, smooth payment
systems, contagion and systemic are all part of the same family.
3.61 The consistency between one instrument (monetary policy) and one goal (price
stability) that is present in the pursuit of monetary stability contrasts with the multiplicity
of instruments (lender of last resort (LOLR), supervision, regulation, crisis management,
fiscal support, etc), and other goals that exist in the pursuit of financial stability.49
3.62 Acknowledging the lack of a clearly established analytical and operational framework
for the understanding of financial stability (a concept more identifiable in its negative
definition—as absence of instability—than in ‘positive terms’), Tommaso Padoa-Schioppa
referred to it as a ‘land in between’ monetary policy and supervision.50 According to Padoa-
Schioppa, financial stability was defined ‘as a condition in which the financial system would
be able to withstand shocks, without giving way to cumulative processes, which impair the
allocation of savings to investment opportunities and the processing of payments in the
economy. In the jargon of my early years in central banking, this function used to be labeled
as maintaining “orderly conditions” in the financial system.’51
3.63 Notwithstanding this definition, he indicated that ‘although a number of central
banks publish financial stability reports regularly, they tend either to avoid the question of
how to define financial stability entirely or to explicitly acknowledge the elusiveness of a
consistent definition.’52 Padoa-Schioppa used a broad notion of ‘financial system’ (for the
purposes of defining financial stability), one that encompassed ‘all financial intermediaries
and markets, as well as market infrastructures and the regulatory system governing it’.53
3.64 It was only by reference to times of crises, when the central bank was seen to have a
‘real role’ (as lender of last resort) in the pursuit of financial stability. However, this
perspective has changed. The preservation of financial stability has become an overarching
policy objective, in which central bank involvement is recommended.54 In addition, financial
stability has become associated with a broader nexus of financial market participants,
institutions and even sovereign countries.
(p. 128) 3.65 The conceptual aspects of financial stability have been in a state of flux for
some time.55 The lack of a clear definition of financial stability led Goodhart to assert that:
‘(t)here is no clear “bottom line,” except a negative one of trying to avoid instances of
instability. There is no clear instrument for a Central Bank to wield unilaterally’.56
3.66 The vagueness surrounding the definition made it problematic to formulate adequate
policies for accomplishing financial stability. As Serge Jeanneau pointed out, some of these
difficulties included: ‘defining what is meant by the term; quantifying the objective; and
dealing with the large number of dimensions, many involving trade-offs’.57 The interaction
between financial stability and other policy objectives, such as price and macroeconomic
stability has also been the subject of much controversy.
3.67 As a result of these conceptual shortcomings, the tools and measures aimed gauging
financial stability were mostly related to the safety and soundness of individual institutions
(micro-prudential), instead of focusing on systemic risks. This purportedly led supervisors to
lose focus of the risks that affected the financial system as a whole (macro-prudential).
3.68 The lack of a widespread definition of what constitutes financial stability has also
implied that ‘the notion of financial stability is often discussed in terms of the concept of
systemic risk and its sources’.58 Financial instability can spill over into the real economy
and across borders, affecting growth, trade and the payments systems. The contagion effect
is a key feature of systemic risk. This is further discussed in Chapter 4.
3.69 Many regulators and supervisors are aware of the ambiguities surrounding the
definition of financial stability. In a survey conducted by the International Monetary Fund
(IMF), a large majority (88 per cent) of respondent jurisdictions and institutions59 had a
formal financial stability mandate, while the definitions of financial stability were ‘provided
by a majority of respondents (73 per cent), of which 81 per cent were informal’.60 This
evidences that while a number of countries had adopted financial stability objectives at the
time of the survey, these mandates had not yet been formally defined.
3.70 In a special report, the Bank for International Settlements (BIS) has categorized some
of the existing definitions of financial stability that could shed some light in order to better
demarcate its operational implementation. The so-called Ingves Report (named after its
chair, Stefan Ingves, governor of the Sveriges Riksbank) presented at least five sets of
definitions (p. 129) of financial stability in the literature. These categories include
definitions: (1) in terms of preconditions (rather than outcomes); (2) defining it as an
absence of financial instability (in the negative sense); (3) the smooth functioning of the key
elements that form the financial system (in the positive sense); (4) robustness to shocks;
and (5) smooth functioning and robustness to shocks.61
From an economic perspective, financial stability can be considered as an international
public good.62 Financial stability transcends institutional boundaries and geographic
borders.63 Like a tsunami that does not respect national boundaries, episodes of financial
instability have a transnational dimension, thus requiring a cross-border solution.
3.71 As a public good, global financial stability has two characteristics: it is inexhaustible
(non-rivalrous) and also non-excludable (or non-exclusive).64 The non-rivalrous nature of
financial stability implies that its enjoyment by one jurisdiction will not reduce the amount
of stability available to another country. While its non-exclusivity means that countries that
invest heavily to attain it cannot exclude other States from enjoying some of its benefits. As
is the case of other public goods, there are incentives for some countries to ‘under-invest’ in
achieving financial stability (market failure) in order to free-ride on the investments of other
jurisdictions. This can lead to the potential ‘underproduction’ of financial stability at a
cross-border basis.65
Financial stability and micro-prudential supervision
3.72 The financial crisis has changed many preconceptions regarding the relationship
between financial stability, systemic risk management and prudential supervision. One of
these ideas was the so-called ‘composition fallacy’ that assumed that financial stability
depended on the aggregate of the safety and soundness of all participating institutions.66 As
a result, this perspective relied on monitoring the safety and soundness of individual
entities. The perception was that if individual institutions were stable, the system as a
whole would also enjoy financial stability. However, the composition fallacy proved to be
misguided.
3.73 Overreliance on the micro-prudential aspects of supervision meant that supervisors
could lose track of systemically important financial institutions. In addition, nonbank
financial institutions of systemic importance could be left outside of the scope of the
analysis. During the peak of the crisis, financial instability stemmed from entities such as
investment bank Lehman Brothers and global insurer AIG.
3.74 If prudential supervision is transferred away from the central bank, while the latter
retains a role with regard to the safeguard of financial stability, the main organizational
challenge is to establish adequate mechanisms of close and continuous communication and
flow of (p. 130) information between the central bank and the supervisory agency/agencies,
particularly in times of crisis. This is a real challenge as the experience in the UK with the
Financial Services Authority (FSA) and the tripartite Memorandum of Understanding (MoU)
clearly evidenced with the Northern Rock debacle in 2007.67
3.75 It is more difficult to keep financial stability as a key central banking goal once
supervision is transferred to a separate agency. If a central bank wishes to have or retain a
real role in financial stability, then it often ‘needs’ to have supervisory powers. Without
these powers, the central bank effectively becomes a ‘monetary agency’ (with lender of last
resort responsibilities), limited in its ‘positive’ reinforcement of such stability to monitor,
analyse, and disseminate information about developments in the financial system, to
contribute to international standard-setting, and to influence legislative developments in
this field and other research and advisory functions. The transfer of prudential supervision
away from the central bank effectively deprives the central bank of a major instrument to
deal with financial stability.
3.76 The pendulum has definitely shifted in the direction of hardening the financial
stability mandate of the central bank. While in the first edition I wrote: ‘[I]n the words of a
former member of the Bank of England, the financial stability committee is a “glorified
briefing committee.” It has no real decision-making powers. …The safeguard of financial
stability in positive terms does not include any real power’, the situation is clearly different
today and the Bank of England has a clearly defined financial stability mandate according to
the Financial Services Act 2012.
3.77 There appears to be broad consensus that the neglect of financial stability
considerations prior to the global financial crisis was one of its causes. This has led to the
reinforcement of the twin mandate of central banking: financial stability as a necessary
counterpart to monetary stability. In order to identify negative trends (instability), central
banks can draw on the statistical information that they already gather for monetary policy
purposes, on the information gathered by themselves about banks and other financial
institutions (the classic axiom supporting a supervisory role for the lender of last resort: ‘If I
am going to assist you on a rainy day I need to know what happens on a sunny day’), on the
information gathered by other supervisory agencies, on additional powers to request
information from shadow institutions or markets that can trigger systemic risk.68 The
central banks should (p. 131) have a view of the ‘forest’ even though other supervisory
agencies continue to supervise the health of each individual ‘tree’.69
3.78 The legislative changes in the UK illustrate the revamping of central banking in the
pursuit of financial stability. The Bank of England is much more than a monetary authority,
though its mandate with regard to monetary policy remains a fundamental part of its
functionality. The Bank is at the centre of the new financial supervisory landscape in the
UK. Since the Banking Act of 2009, the Bank has a central role in the UK’s special
resolution regime (SRR) for failing banks (which it administers via its Special Resolution
Unit) and, with the entry into force of the Financial Services Act 2012 (on 1 April 2013) the
Bank has clear statutory responsibility for financial stability. The Financial Services Act
2012 established an independent Financial Policy Committee (FPC) with responsibility for
macro-prudential supervision, a new micro-prudential regulator as a subsidiary of the Bank
—the Prudential Regulatory Authority—and an expanded remit as the supervisor of financial
market infrastructures.70
3.79 An analogy can be made between the courts of justice and the conduct of supervision.
Micro-supervision is akin to a ‘court of first instance’, macro-supervision/financial stability
is akin to ‘court of appeal’, while monetary policy is akin to a ‘supreme court’. The
qualifications typically required (or expected) of supreme court justices (or justices in
courts of appeals) are typically higher than the qualifications of judges in courts of first
instance.
Councils for financial stability
3.80 Though financial stability transcends national boundaries and though the crisis
exposed the dichotomy between global markets and national laws and policies, the (p. 132)
institutional responses post-crisis have proceeded for the most part along national lines,
leading either to the establishment of councils of financial stability or to the reinforcement
of the powers of the central bank in this area. In the USA, the Financial Stability Oversight
Council was set up by the Dodd–Frank Wall Street Reform and Consumer Protection Act.71
3.81 In the EU there have been two waves of institutional reform, which are discussed in
the second part of this book. The first wave led to the establishment of the European
Systemic Risk Board (ESRB); the second wave culminated in the creation of the banking
union with the ECB being granted some macro-prudential supervisory powers, in
accordance with SSM Regulation.72
3.82 The need to coordinate the work of the national or regional councils or committees
and to ensure that their work is consistent with the work of the Financial Stability Board
(FSB) in order to identify macro-economic trends that can have a negative impact on
financial markets remains a daunting challenge in the design of an adequate international
financial architecture.73 Financial stability is a national, regional, and international goal.
3.83 As mentioned above, in the UK, the Financial Services Act 2012 (which entered into
force on 1 April 2013)74 established the Financial Policy Committee (de facto in existence
since 2011) as a committee of the Bank of England.75
3.84 The creation of financial stability councils and other macro-prudential oversight
institutions or committees within the central bank is also taking place across other
developed and emerging jurisdictions. Latin American countries like Chile, Mexico, and
Brazil have all established financial stability councils.76 Other countries that have created
financial stability councils include South Africa, Korea, and New Zealand.77
(p. 133) E. The Optimal Number of Supervisory Authorities

3.85 The optimal number of supervisory authorities, one for the whole financial system
separate from the central bank as in Sweden, one for each sector of the financial industry,78
or multiple authorities in each sector of the financial industry as in the USA, has become a
controversial subject in recent times. However, there is no empirical evidence that justifies
the superior wisdom of any given model of organizing financial supervision.
3.86 The model that each country adopts is often rooted in historical and political
considerations. A trend towards consolidation took place with the establishment of the now-
defunct FSA in 1997, even though the UK was not the first country to adopt this supervisory
model—Norway and Denmark had had a single authority for the entire financial sector for
some time. The FSA was significant because it represented the adoption of this model by a
country where capital markets were well developed and because it triggered a wave of
change in other European countries, such as Germany,79 which adopted a single supervisor
in 2002.
3.87 In the eyes of many, the unification of financial market supervision was considered to
be an appropriate response to the rise in financial conglomerates and complex financial
groups. Abrams and Taylor contended that ‘the structure of the regulatory system needs to
reflect the structure of the markets that are regulated.’80
3.88 The case for a single supervisor was also supported by other arguments. The number
of people employed by a single authority is likely to be lower than the combined staff
numbers of multiple authorities. Firms may find it expensive, confusing, and time-
consuming to answer similar questions to various supervisors; instead of their having to
deal with a multiplicity of authorities, a single supervisor enables ‘one stop-shopping’ for
financial institutions.81
(p. 134) 3.89 However, the wisdom of having a single supervisor—particularly in large
countries—remains contested. Some argue that the central bank is best suited to conduct
banking supervision. Some others—including myself—fear that the concentration of power
in a single authority can lead to a situation of lack of accountability and problems of
institutional legitimacy.
3.90 In response to the global financial crisis this trend has been reversed and the central
bank is again firmly in charge of financial stability issues in a number of jurisdictions
including the UK. However, while the repatriation of a financial stability mandate to the
Bank of England, to be pursued in tandem with its price stability mandate, is a welcome
development, the wisdom of some of the other structural changes is less persuasive. Since
all supervisory structures failed during the financial crisis (whether a single authority, twin-
peak or multiple authorities), changes in structure, per se, are unlikely to lead to a better
system of supervision. The failure was not in the ‘who’ to supervise, but in the ‘how’, and in
the priority given to the objective of financial stability. What is needed is better supervision
and regulation, an efficient and credible resolution process and a better ranking of
objectives. There also remain concerns about the issues of coordination—which, if anything,
have become more relevant and problematic given the multiplicity of authorities—and
adequate forms of accountability.82
3.91 It is possible to combine centralization of some economic competences with
decentralization of some others. The USA is an interesting example of a single monetary
area with a single currency, combined with an extremely fragmented supervisory landscape
and a complex regulatory system based upon federal law (financial laws enacted by
Congress), state law (laws enacted by state legislatures, particularly relevant in terms of
insurance companies), regulation by agencies (the Federal Reserve System (Fed) and the
Securities and Exchange Commission (SEC) have rule-making powers), and self-regulation
(in the field of securities, the rules of the self-regulatory organizations).
3.92 Banking in the USA is subject both to federal law and to state law.83 There are several
banking supervisory authorities at the federal level: the Federal Reserve System, the Office
(p. 135) of the Comptroller of the Currency, and the Federal Deposit Insurance
Corporation.84 There are also supervisory authorities at the state level. The securities
industry is subject to a combination of federal law and self-regulation (with some elements
of state law). The Securities and Exchange Commission is a federal agency which oversees
the exchanges and administers the federal system for the registration of new issues of
securities. The exchanges (such as the New York Stock Exchange) are self-regulatory
organizations with powers to promulgate rules for their member firms and listed
companies. The Financial Industry Regulatory Authority (FINRA) was created in July 2007
through the consolidation of the National Association of Securities Dealers (NASD) and the
member regulation, enforcement, and arbitration functions of the New York Stock
Exchange. It also performs market regulation under contract for the NASDAQ (National
Association of Securities Dealers Automated Quotation System) Stock Market, the American
Stock Exchange, the International Securities Exchange, and the Chicago Climate
Exchange.85 The Sarbanes–Oxley Act of 2002—which introduced sweeping reforms with
regard to corporate governance—does not change much the regulatory structure of US
securities markets. Investment companies (including mutual funds) are regulated almost
exclusively at the federal level by the SEC since the enactment of the 1940 Investment
Company Act and the 1940 Investment Advisers Act.86 Insurance in the USA has remained a
matter of state law since the McCarran–Ferguson Act of 1945,87 though pension funds are
subject to federal law since the enactment of the Employee Retirement Income Security Act
(ERISA) in 1974.88 The US financial regulatory landscape also comprises other regulators,
such as the Commodities Future Trading Commission (CFTC) for financial derivatives
(commodity futures and options).
3.93 The failure to provide adequate supervision over large sectors of the financial market
triggered a process of legislative reform. The US slightly redesigned its financial regulatory
system through the enactment of the Dodd–Frank Act 2010. Amongst the ‘architectural’
issues included in the new legislation (a somewhat watered-down version of some earlier
proposals) are: the powers to the Fed with regard to the supervision of the largest bank-
holding companies and other systemically significant financial firms, the extension of the
resolution authority of the Federal Deposit Insurance Corporation (FDIC) (a new resolution
process to unwind failing systemically important financial institutions), the creation of a
Bureau (p. 136) of Consumer Financial Protection and the abolishment of the Office of
Thrift Supervision (distributing its powers among the Federal Reserve System, the Office of
the Comptroller of the Currency, and the FDIC), the establishment of a Financial Services
Oversight Council, Council (chaired by the Secretary of the Treasury and with
representation from all the regulatory agencies) tasked with identifying risks to financial
stability that could arise from the activities of both firms and markets and determining how
best to respond to emerging threats, some modest consolidation,89 and more coordination
between the SEC, the CFTC, and others.90 The Fed has also expanded its remit, since its
supervisory power can be extended to systemically significant non-bank financial
institutions. Under the orderly liquidation authority regime, the FDIC can be appointed as a
receiver for systemically important financial institutions (SIFIs). However, following the
enactment of the Dodd–Frank Act on 21 July 2010, the US financial architecture remains
fragmented and ‘multi-peaked’.
F. Public versus Private Supervision

3.94 Public supervision, that is, supervision exercised by the public authorities, presents
several possible options: (i) the government can exercise these tasks directly through a
government department or cabinet office; (ii) the government can carry out this function
indirectly by delegating it to a supervisory agency under political instruction; (iii) the
government can delegate these responsibilities to an independent agency (eg, independent
central bank or independent securities regulator). In practice, the government often
delegates certain supervisory functions and retains responsibility for others such as
licensing and crisis management. The government can also share the supervisory
responsibilities with a self-regulatory organization.
Market supervision, that is, supervision exercised by market institutions, should never be
underestimated as either a complement to or a substitute for public supervision. Financial
firms are subject to continuous monitoring by their competitors, institutional investors,
customers, counter-parties, rating agencies, and other private agents. In fact, there is some
evidence to support this view: Barth, Caprio, and Levine91 find evidence (pre-crisis) that
countries with government policies that promote the private monitoring of banks tend to
have better bank performance and more stability.92
(p. 137) 3.95 This was, however, not the case during the global financial crisis. As Alan
Greenspan stated in a congressional testimony: ‘Those of us who have looked to the self-
interest of lending institutions to protect shareholders’ equity, myself included, are in a
state of shocked disbelief. …Yes, I’ve found a flaw. I don’t know how significant or
permanent it is. But I’ve been very distressed by that fact.’93 Accordingly and with regard to
market discipline mechanisms Stephanou remarks that, ‘…what is clear in retrospect is that
too much faith had been placed on market discipline as a prudential tool, and that the crisis
has showed its limitations’.94
3.96 Indeed, a mix of private and public supervision is increasingly regarded as the most
efficient way of monitoring the activities of financial firms. For instance, with regard to risk
capital supervision, the Basel II Accord in its Third Pillar (market discipline) included
elements of private supervision through the internal ratings system and through disclosure
requirements (the EU framework on capital requirements for banks and investment firms
endorsed the Basel II guidelines on this point) that were maintained post-crisis in the new
accord named Basel III (with an expansion in the risk disclosures under the Third Pillar).95
3.97 Though the trend in modern finance to reinforce market discipline is welcome, it is
not without pitfalls. In particular, the dangers of regulatory capture cannot be ignored. In
some instances, there is a fine line between being ‘market friendly’ and being ‘market
captive’.96
3.98 Exclusive reliance on private supervision (market discipline) and private regulation
(rules or standards set by self-regulatory organizations) would imply the absence of any
official involvement by a public authority in the financial system. However, a system based
only on private supervision and regulation would be both unfeasible and unacceptable as
long as the government keeps an implicit or explicit role in the resolution of a crisis. Official
protection justifies public supervision and regulation; the greater the protection, the
greater the degree of justifiable public involvement in supervision.
3.99 Any shift from public to private supervision or self-regulation also implies a shift in
the onus of responsibility. While reliance on private supervision places the onus of
responsibility on (p. 138) management, reliance on public supervision places it on the
authorities. Such a shift should be welcomed by supervisors, since as Goodhart points out:
[T]he conduct of supervision is a thankless task, which is all too likely to tarnish the
reputation of the supervisor. …The best that a supervisor can expect is that nothing
untoward happens. A supervisor is only noticed when he/she angers the regulated
by some restrictive or intrusive action, or when supervision fails in the sense that a
financial institution collapses or a customer gets ripped off. One can talk oneself
blue in the face of the desirability of allowing some freedom for banks or other
financial institutions to fail, etc., but supervisors will always tend to get a bad press
when that does happen.97
3.100 The last global financial crisis has shown that the pursuit of the private interest is at
times greatly misaligned with the pursuit of the common good and that, with cross border
banks and financial institutions, national solutions alone or uncoordinated national solutions
are not enough to combat systemic risk.
G. Independence versus Politically Directed Process

3.101 I have argued in my writings since 1992 that independence to pursue stable money
should be accompanied by independence to pursue a sound financial system, and
complemented by appropriate mechanisms of accountability. The need for independence
from political instruction of the supervisory authority is recognized in the Core Principles
for Effective Banking Supervision, issued by the Basel Committee in 1997 and reviewed in
2006 and 2012. According to Principle 2:
[T]he supervisor should possess operational independence, transparent processes,

sound governance, budgetary processes that do not undermine autonomy and
adequate resources, and is accountable for the discharge of its duties and use of its
resources. The legal framework for banking supervision should include legal
protection for the supervisor.98
3.102 Notwithstanding the need to free supervisors from political pressure, monetary
independence and supervisory independence are not the same, as discussed earlier in
Chapter 2.99 To begin, the relative simplicity of ‘monetary policy independence’ contrasts
with the complexity of ‘supervisory independence’. The one goal, one instrument, one
agency of the former contrasts with the several goals, several instruments and, often,
several agencies of the latter.100
3.103 While central bank accountability with regard to monetary policy is typically
‘explanatory’ (unless the law of the central bank is amended or the governor is removed
from (p. 139) office, there is very little room for granting redress with regard to monetary
policy decisions), the accountability of the central bank or the supervisory agency in the
field of prudential supervision and regulation is sometimes ‘explanatory’ and sometimes
‘amendatory’.
3.104 As the Treasury Select Committee concluded in its inquiry in July 2011, there are
serious concerns about the accountability of the revamped Bank of England.101 With power
comes responsibility and accountability. (Lord Acton’s dictum—‘Power corrupts, absolute
power corrupts absolutely’—resonates in the background of the corridors of power, as a key
reminder of the importance of accountability.)
3.105 The issue of the legal liability of the supervisory authorities for loss caused by the
inadequate supervision of banks has been discussed in the UK, first in the context of the
damages action against the Bank of England102 for the failure of Bank of Credit and
Commerce International103 and, more recently, in the Northern Rock case against the FSA.
The issue of (state) liability for loss caused by the inadequate supervision of banks has also
been discussed in the context of the Peter Paul case.104
3.106 There are arguments both in favour and against imposing liability for damages on
financial regulators. However, as remarked by Barrie Ingham the balance tips in favour of
immunity mainly because, ‘[t]o the extent that liability undermines the efficacy of the
regulator, it should be removed where to do so will not disproportionately harm the
interests of individuals’.105
3.107 The ‘Methodology for Assessing Implementation of the IOSCO Objectives and
Principles of Securities Regulation’106 recognizes the legal protection of regulators as a key
issue for the independence of the regulators in their pursuit of financial stability.
The design of a proper legal framework for supervisory independence thus needs to take
into account the multi-faceted and rather ‘decentralized’ nature of supervision. Supervision
stricto sensu typically relies on a large number of staff to perform examinations and other
tasks. In contrast, decisions on interest rate policy are generally taken by relatively few (p.
140) people (the governor/chairman and the members of the executive board/monetary
policy committee).107
3.108 The appointment procedures of independent central bankers and other guarantees
enshrined in the law to protect ‘monetary policy independence’ cannot be easily replicated
with regard to the exercise of supervision, since it would be impractical (too expensive and
time consuming) to demand the same standards and to apply the same procedures to the
cohort of supervisors. This notwithstanding, the need to distance banking from politics is of
paramount importance in many developing countries, where banks and their supervisors
are more likely to be subject to the whims of politicians. Certain supervisory decisions (such
as the closure or non-closure of a bank)108 need to be ‘depoliticized’. A certain degree of
independence is needed to protect supervisors and regulators (as well as competition
authorities) from political pressures and from the dangers associated with corruption,
connected lending, and nepotism.109 Ruth de Krivoy—on the basis of her experience as
Central Bank Governor in Venezuela during the country’s banking crisis in the 1990s—
makes a strong case for keeping supervision within an independent central bank:
Giving supervisory powers to an independent central bank is especially

advantageous if public institutions are weak, coordination between different public
sector agencies is troublesome, or skilled human resources are scarce. Central
banks [in emerging economies, such as Venezuela] are usually a country’s most
prestigious and well-equipped institutions, and are in a good position to hire,
motivate and keep skilled staff.110
3.109 In the aftermath of the global financial crisis and because of the fiscal costs of the
bailouts or rescue packages, there is greater political interference and reduced
independence for central banks and supervisory agencies. This latter trend is in stark
contrast with the movement towards independence that characterized the framework of
central banks prior to the global financial crisis.
H. Institution versus Business Function

3.110 Supervision has traditionally been organized by institution, irrespective of the
business function or range of functions that the institution undertakes. However, as banks
engage into the securities and insurance business (and as insurance companies engage in
securities and new lines of business), the case for supervision/regulation by institution
becomes weaker. Inter-industry affiliation and inter-industry competition in the financial
sector—according to some commentators—suggests the need for increased reliance on
regulation by business function rather than by institution. Under a system of supervision by
business function, supervisors focus on the type of business undertaken, regardless of
which institutions are involved in that particular business. This means that one institution
could be (p. 141) subject to several supervisors if it carries out different types of businesses
(for instance banking, securities, and insurance).111
3.111 As defined by Greenspan:112
Functional regulation is thought of as a system in which each separate ‘function’—

such as commercial banking, investment banking or mortgage banking—is
supervised by the same regulatory body, regardless of the function’s location within
a particular financial institution. Practically, this means that a single financial
organisation would have several functional regulators, and that different functions
would be somehow separated, most likely through the creation of legally separate
subsidiaries, within the broad financial organisation.
3.112 The organizational structure of the German Federal Authority for the Supervision of
Financial Services (BaFin) consists of three supervisory directorates for banking
supervision, insurance supervision, and securities supervision/asset management and three
cross-sectoral departments dealing with cross-sectoral issues.113 However, the change in
structure has not signified a change in the substantive laws underlying supervision, such as
the German Banking Act (Gesetz über das Kreditwesen, KWG), the Insurance Supervision
Law (Versicherungsaufsichtsgesetz, VAG), and the German Securities Trading Act (Gesetz
über den Wertpapierhandel, WpHG). The justification for keeping these laws is that
‘although financial services supervision has been organised in a single body, this does not
mean that existing sectoral differences between the banking and insurance businesses will
be disregarded. These differences have led to the development of specific supervisory
methods and rules for banks and insurance companies which have proved to be
successful.’114
3.113 Another alternative to the cross-sector organization of financial supervision is
provided by the Dutch supervisory model, introduced in the second half of 2002.115 It can
be characterized as a functional model based on the objectives of supervision or ‘twin-
peaks’116(p. 142) approach. Before the SSM, the Dutch central bank (De Nederlandsche
Bank, DNB) was the institution responsible for prudential supervision in the pursuit of
financial stability. The Authority for Financial Markets (AFM) is the authority responsible
for conduct of business supervision. Both supervisory authorities cover the full cross-sector
width of financial markets (all institutions in banking, securities, insurance, and
pensions).117 This objective-based model of supervision used in the Netherlands was first
adopted in Australia and is now being implemented in the UK (under a twin peak central
bank based model).118
I. Institution versus Supervisory Function

3.114 The FSA in the UK, launched in 1997, was governed by the Financial Services and
Markets Act of 2000,119 and was initially organized by regulatory/supervisory functions,
rather than by institution. According to the then FSA Chairman, Howard Davies,120 the UK
had adopted a system based upon what he referred to as ‘regulatory functions’:
authorization, supervision, enforcement, in addition to support functions. This approach
was preferred at that time over the other three models/approaches considered, namely, (1)
the establishment of one regulator based upon a federation of regulators with matching
business strings of the previous regime; (2) the wholesale–retail split as the dividing
organizing principle; and (3) the so-called ‘twin-peaks’ approach, whereby system concerns
and prudential consideration would be kept separate from investor protection and conduct
of business rules (ie, a system of regulation by objective or finality, as adopted in the
Netherlands).
3.115 With the replacement of the FSA in April 2013 by two new regulatory authorities
this is now all history. But history, lest we forget, is a useful teacher. In the words of Jorge
Santayana, ‘those who cannot remember the past are condemned to repeat it’.
J. Structural Reforms

3.116 Rather than changing the supervisory structure, some of the regulatory responses to
the financial crisis have focused on structural reforms. Under the rubric of ‘structural
reforms’ we can group together a number of legislative changes or proposals that aim to
change the permissible scope of bank activities, the legal form of banks,121 and/or the
balance sheet structure of commercial banks and other financial institutions.
(p. 143) 3.117 The key objective in many of these initiatives is to circumscribe the scope of
institutions that receive governmental protection, to separate ‘utility banking’ from ‘casino
banking’. Proposals range from narrow banking to a full-scale mutualization of the financial
industry.122
3.118 In the UK, the Independent Commission on Banking (ICB) was established by the
Government in June 2010 to consider structural and related non-structural reforms to the
UK banking sector to promote financial stability and competition. The Commission was
asked to report to the Cabinet Committee on Banking Reform by the end of September
2011. Its members, Sir John Vickers (Chair), Clare Spottiswoode, Martin Taylor, Bill Winters
and Martin Wolf, published an Interim Report in April 2011 and the final report in
September 2011. The report recommended that UK retail deposit takers (Barclays, HSBC,
Lloyd’s, RBS, and Santander UK) and the largest building society (Nationwide) keep equity
capital at 10 per cent of risk adjusted assets (thus higher than the 7 per cent of Basel III). It
also recommended that large banking groups should have a loss absorbing capacity of 17–
20 per cent.
3.119 The most controversial and talked about part of the Vickers Report is the structural
separation between domestic retail services and global wholesale and investment banking
operations. According to the Vickers report, the best policy approach is to require retail
ring-fencing of UK banks, since this should make it easier and less costly to resolve banks
that get into trouble and should increase the resilience of the UK retail banking system.
Functional separability (via ring-fencing) and geographic separability (via adequate rules on
cross border resolution, discussed in Chapter 4) should ensure a safer banking system.
3.120 The Parliamentary Commission on Banking Standards took into account many of the
recommendations of the Vickers Report. The Government has also embraced some of them
via the passage of the Financial Services (Banking Reform) Act which received Royal Assent
on 18 December 2013. The Act provides for the separation of core activities (deposit taking)
which must be carried out by ring-fenced bodies from excluded activities (trading in
investments) which ring-fenced bodies are not permitted to do.123
(p. 144) 3.121 The common denominator behind the Liikanen Report124 in Europe, the
Volcker rule in the USA and the Vickers Report (and ensuing legislation in the UK) is the
need to protect depositors and to prevent the use of depositors’ money to finance risky
trading activities and the avoidance of TBTF policies that lead to an implicit or explicit
government guarantee (deteriorating the fiscal position of the government and putting at
risk taxpayers’ money). They aim at limiting the incentives for banks to take on excessive
risks with insured deposits.
3.122 The so-called Volcker rule adopted by the Dodd–Frank Act 2010 prohibits federally
insured ‘banking entities’ from engaging in proprietary trading (subject to certain
exceptions) and restricts their relationships with hedge funds and private equity funds. It is
a limited structural reform. A return to Glass Steagall, ie, complete legal separation
between commercial banking and investment banking business appeared impractical (given
the funding structure of modern banks, the interconnectedness, the use of derivatives
markets, etc). Glass Steagall, however, had three benefits: first, legal clarity and
predictability; secondly, it contributed to the depth, volume and diversification of the US
financial market, in contrast to the (universal) bank dominated systems in Continental
Europe (I contend that the strength of the US capital markets and securities firms/
registered broker dealers was fostered by Glass Steagall); and, thirdly, it established clear
expectations amongst depositors and investors about the scope of protection of their
deposits and investments, by establishing clear legal lines of separation (lessening the
incentives to game the system). The demise of Glass Steagall in 1999 coincided with the
increase in excessive risk practices (securitization and others) that together with other
factors contributed to the great financial crisis.
3.123 The existence of different solutions (Vickers/UK, Volcker rule, and Liikanen) is
problematic, since they provide incentives for financial institutions to go ‘jurisdiction
shopping’, opportunities for regulatory arbitrage. While Liikanen proposes the ring-fencing
of trading activities, Vickers advocates the ring-fencing of retail activities, and the Volcker
rule limits proprietary trading, without ring-fencing. (Of course, in the case of the UK, if
Liikanen becomes law, the UK will have to adopt the Liikanen proposals—as long as it
remains in the EU and committed to the obligations of the single market.)125
3.124 Furthermore, (and this applies both to Liikanen and to Vickers), whenever a fence or
boundary is established, there is an incentive for institutions to place themselves or part of
their business inside or outside the boundary depending on what appears to be more
advantageous or beneficial for them.126 Though the Liikanen report is a welcome initiative
to deal (p. 145) with bank structural reform, it is not sufficiently bold in my opinion;
perhaps a reflection of the background of the members of the group, perhaps a reluctance
or hesitation to alter the universal banking model prevailing in continental Europe.
3.125 The efforts to address the too-big-to-fail issue have so far focused on the ‘to fail’ part
of TBTF. But we also need to address the issue of size (the ‘too big’ of TBTF), which requires
adequate competition law and policy. That is something that neither Liikanen nor Vickers
address properly. The reasons for saving troubled banks these days go beyond the
protection of insured depositors. If we want to reduce taxpayers’ liability, we must also
address the issue of size. No institutions should be too big or too complex to fail. If that
requires smaller size or simplicity then that should be the solution we should contemplate,
regardless of vested interests.
3.126 The implicit government guarantee must stop. The problems of ‘extracting
rents’ (rather than merely profit taking) remain.127 Acute moral hazard problems persist.
The solutions to these problems are not readily apparent, since they also require a ‘cultural
change’, as acknowledged by the Report of the Parliamentary Commission on Banking
Standards.128
3.127 The IMF—in its Global Financial Stability Report 2014—points out that the world’s
largest banks still receive implicit public subsidies worth as much as USD 590 billion
because of their status as too important to fail. The implicit subsidies take the form of the
benefit that accrues to banks and investors because of the bailout assumption. If bankers
know the government is likely to bail them out, they may take more risk. In addition,
investors are willing to lend to banks at lowers cost because they see the likelihood of a
bailout as a form of insurance.129
3.128 The use of the tax system is another solution to address these problems. The UK
Government targeted compensation by imposing a one-off 50 per cent tax on bonus pools of
a number of financial institutions in the UK130 and recently launched a consultation paper
in which tough rules on bonuses, including provisions to claw back the bonuses in certain
(p. 146) circumstances, are outlined.131 Some economists have advocated the imposition of
a (global) tax on financial transactions, akin to the Tobin tax. The IMF issued a report on 27
June 2010 recommending that countries consider adopting two taxes: a ‘Financial Stability
Contribution’ (FSC) and a ‘Financial Activities Tax’ (FAT).132 Some academics have
proposed a tax on bank liabilities, claiming that though ‘[b]ank regulation requires banks to
keep their equity above a specified level, yet corporate taxation encourages the banks to
use more debt and less equity.’133
3.129 Regulatory and corporate governance changes have also been proposed as an
alternative to the tax system. In any case we cannot become complacent; the philosophical
challenge remains: any system that privatizes gains and socializes losses is contrary to the
very logic of capitalism. In order to solve this quandary not only do we need to address the
unfair subsidization of larger banks but we also need to change the system of managerial
incentives.
Footnotes:
1
See ‘Federal Reserve Position on Restructuring of Financial Regulation Responsibilities’,
Presented to the Bush Commission in December 1983, in Charles Goodhart, The Evolution
of Central Banks (Cambridge, MA: The MIT Press, 1988) 6–7.
2
See also Chapter 11 in this volume; Rosa M Lastra, ‘The Governance Structure for
Financial Regulation and Supervision in Europe’ (2003) 10(1) Columbia Journal of European
Law 49; Rosa M Lastra, ‘Central Bank Independence and Financial Stability’ (2010) 18
Estabilidad Financiera Banco de España 49; Rosa M Lastra, ‘Systemic Risk, SIFIs and
Financial Stability’ (2011) 6(2) Capital Markets Law Journal 197; Rosa M Lastra, ‘Modelos
de Regulación Financiera en el Derecho Comparado: Organización de la Supervisión por
Funciones “Twin Peaks” y Organización por Sectores Supervisados; Reunión o Separación
de Funciones en el Banco Central’ in Santiago Muñoz Machado (ed), Derecho de la
Regulación Bancaria y Financiera (Madrid: Iustel, 2013); and Rosa M Lastra, ‘Systemic Risk
and Macroprudential Supervision’ in Eilis Ferran, Niamh Moloney, and Jennifer Payne (eds),
Oxford Handbook of Financial Regulation (Oxford: Oxford University Press, forthcoming
2014).
3
See Rosa M Lastra, Central Banking and Banking Regulation (London: Financial Markets
Group/London School of Economics, 1996) 160.
4
See eg Charles Goodhart et al, Financial Regulation Why, How and Where Now? (London
and New York: Routledge, 1998); Kern Alexander and Rahul Dhumale (eds), Research
Handbook on International Financial Regulation (Cheltenham: Edward Elgar, 2012); M
Brunnermeir et al, Fundamental Principles of Financial Regulation (Geneva/London:
International Center for Monetary and Banking Studies/Centre for Economic Policy
Research, 2009); Sara Connolly and Alistair Munro, Economics of the Public Sector
(London: Prentice Hall Europe, 1999); and David Llewellyn, ‘The Economic Rationale for
Financial Regulation’, Financial Service Authority Occasional Paper No 1 (1999) 13, at
<http://finra.complinet.com/net_file_store/new_rulebooks/f/s/
FSA_Occasional_Paper1_Economic_Rationale_for_Regulation_99.pdf> (last visited 23 July
2014).
5
For a recent analysis, see Paul Davies, ‘Liquidity Safety Nets for Banks’ (2013) 13(2)
Journal of Corporate Law Studies 287.
6
Public goods are characterized by their non-excludability and non-rivalry. Non-
excludability means that after the good or service is supplied to one person, it is not
feasible to avoid its consumption by other users. Non-rivalry implies that the quantity of the
good is not affected by its first use.
7
House of Lords, European Union Committee, ‘The Future of EU Financial Regulation and
Supervision’ (17 June 2009), at <http://www.publications.parliament.uk/pa/ld200809/
ldselect/ldeucom/106/106i.pdf> (last visited 23 July 2014).
8
See Bank of England, Financial Stability Committee, at <http://
www.bankofengland.co.uk/financial stability/Pages/fpc/default.aspx> (last visited 23 July
2014).
9
See Jacek Osiński, Katharine Seal, and Lex Hoogduin, ‘Macroprudential and
Microprudential Policies: Toward Cohabitation’, IMF Discussion Note No SDN 13/05 (21
June 2013) 25, at <http://www.imf.org/external/pubs/ft/sdn/2013/sdn1305.pdf> (last visited
23 July 2014); and Recommendation of the European Systemic Risk Board of 4 April 2013
on Intermediate Objectives and Instruments of Macroprudential Policy (ESRB/2013/1), OJ C
170/01 (15 June 2013). Though some of the instruments are relatively new, some other tools
(perhaps with a different name and for a different policy objective) were applied in the past.
After all, lender of last resort is also a macro-prudential tool. See generally David Bholat,
‘Macro-prudential Policy: Historical Precedents and Possible Legal Pitfalls’, Birkbeck
University of London Monthly Seminar Series (25 October 2013), at <http://
www.lccge.bbk.ac.uk/news/seminar> (last visited 23 July 2014).
10
See Lastra, above note 3, 108–44.
11
Regulators set the rules and supervisors implement and enforce such rules. This point is
made by Bryan Quinn, ‘Rules v Discretion: The Case for Banking Supervision in the Light of
the Debate on Monetary Policy’ in Charles A E Goodhart (ed), The Emerging Framework of
Financial Regulation (London: Central Banking Publications, 1998) 119.
12
These considerations are particularly relevant in the debate about the governance
structure for financial regulation and supervision in the EU which I discuss in Chapters 10
and 11 in this volume.
13
For a description of each of these supervisory techniques, see Lastra, above note 3, 111–
22.
14
Lastra, above note 3, 111–22. The determination of the financial condition, of the
soundness of a bank is not an exact science. The purpose of rating systems is to determine
in practice what constitutes soundness. In the USA, following criticisms of the General
Accounting Office regarding the existence of divergent approaches, the federal regulatory
agencies adopted similar rating systems in 1978–79, referred to as the Uniform Financial
Institutions Rating System (UFIRS). For banks, the rating system is commonly known as the
‘CAMEL system’, which has two principal elements. First, an assessment is made of five
critical aspects of an institution’s operations and condition: Capital adequacy, Asset quality,
Management, Earnings and Liquidity (thus, the acronym CAMEL), which are rated on a
scale of 1 through 5, with 1 being the most favourable. The second element combines the
five factor ratings into a composite rating. Composite rating 1 indicates a sound institution.
Composite rating 2 indicates a fundamentally sound institution with modest weaknesses
which can be corrected in the normal course of business. Composite rating 3 indicates a
combination of weaknesses ranging from moderately severe to unsatisfactory. Composite
rating 4 indicates an immoderate volume of asset weaknesses, or a less than satisfactory
combination of other conditions. Composite rating 5 indicates that corrective action and
constant supervisory attention are necessary.
15
Reliance on external rating agencies and other ‘gatekeepers’ has been the subject of
much controversy after the crisis, given the regulatory reliance on ratings and the
incentives for financial intermediaries to ‘outsource’ their own risk management and
practices of due diligence to the gatekeepers. See generally John Coffee, Gatekeepers: The
Professions and Corporate Governance (Oxford: Oxford University Press, 2006). For a
recent discussion, see Andrea Miglionico, ‘Market Failure or Regulatory Failure? The
Paradoxical Position of Credit Rating Agencies’ (2014) 9(2) Capital Markets Law Journal
194.
16
A risk-adjusted capital framework—like the Basel framework—creates distorted
incentives when it comes to asset allocation and pro-cyclicality, as evidenced during the
financial crisis 2007–9 and ensuing sovereign debt crisis in the Eurozone. Securitization,
the causa proxima of the crisis, received favourable treatment under Basel I; a low or zero
risk weighting was assigned to sovereign bonds with no limit on a bank’s exposure to a
single sovereign. Jens Weidman, ‘Stop Encouraging Banks to Buy Government Debt’
Financial Times (1 October 2013), suggested that we need to address the regulatory
treatment of sovereign exposures and end the ‘fiction of risk-free assets’ which receive
favourable ratings by credit rating agencies. The experience of the last few years has shown
that a banking crisis can lead to a sovereign debt crisis (Ireland, Iceland) and that sovereign
debt crises can lead to banking crises (Greece). Breaking the vicious link between bank and
sovereign debt is at the root of the political agreement that led to the creation of the
banking union in the EU: but banking union is not enough to break this vicious link. The
problem has not been solved. See ‘Eurozone Banks Load up on State Debt’ Financial Times
(2 April 2014).
17
This is to some extent consistent with the Modigliani–Miller theorem (named after
Franco Modigliani and Merton Miller) which suggests that, in the absence of taxes,
bankruptcy costs, and others, the value of a firm is unaffected by how that firm is financed
(debt or equity). What counts is the flow of assets. The market value of the firm depends
only on the income stream generated by its assets.
18
See Robert Litan, ‘Taking the Dangers Out of Bank Deregulation’ (1986) 4(4) Brookings
Review 102: ‘Examinations are costly and time-consuming and the most important aspect of
a bank’s balance sheet, the quality of its asset portfolio, is difficult to assess at any given
time. Perhaps in recognition of those limitations, federal regulators are increasing capital
requirements.’
19
Loan loss reserves are a form of capital that are not included in core capital, but can be
included in Tier 2 capital to a limited extent. The reason for the special treatment of loss
reserves is that these funds play an especially important role in ensuring that the bank is
taking account regularly—through deductions from current earnings—of future losses that
are statistically predictable on the basis of its past experience. With proper loss reserving,
the bank’s reported net income should be a reasonably accurate indication of the bank’s
basic earning power. Absent adequate provisioning for loan losses, a bank’s earnings are
likely to be overstated and can mislead both stockholders and the markets as to the bank’s
underlying strength. Basel III limits the eligible loan-loss reserves for inclusion in Tier 2 to
a maximum of 1.25 percentage points of credit risk–weighted risk assets calculated under
the standardized approach. See Basel Committee on Banking Supervision, ‘Basel III: A
Global Regulatory Framework for More Resilient Banks and Banking Systems’ (December
2010, revised June 2011) para 60, at <http://www.bis.org/bcbs/basel3.htm> (last visited 14
July 2014).
20
The treatment of non-performing loans (NPLs) and issues of loan classification in
general (to provide a common financial language internationally) constitute a current area
of my research—beyond the scope of this volume—where I am joining efforts with David
Bholat and staff of the Bank of England as well as other academics to try to fill in what we
think is a relevant gap in the banking literature, one that has important policy implications.
Forbearance by a bank occurs when it seeks to provide a measure of support to a customer
struggling to meet its loan obligations. The ‘concession’ ranges from ignoring a breach of a
loan covenant, to changing the terms of the loan, such as the interest rate paid or the loan
amount or giving the borrower more time to meet its obligations, to providing some form of
active payment relief. For a recent study on forbearance see Martin Arrowsmith and Martin
Griffiths, ‘SME Forbearance and its Implications for Monetary and Financial
Stability’ (2013) Q3 Bank of England Quarterly Bulletin, at <http://
www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2013/qb130401.pdf>
21
This approach, with better capitalized banks receiving less attention—a regulatory
incentive that favours greater capitalization—and undercapitalized banks being subject to
intense scrutiny, and possibly prompt corrective action (PCA), or structured early
intervention and resolution (SEIR), was adopted by law in the USA (through Federal
Deposit Insurance Corporation Improvement Act (enacted 19 December 1991, Pub L 102–
242, 105 Stat 2236–2393) (hereinafter FDICIA)) and has gained much support amongst
academics in recent years. Some of the statements issued by the US and the European
Shadow Financial Regulatory Committees (see the American Enterprise Institute, at
<http://www.aei.org> (last visited 23 July 2014) and the European Shadow Financial
Regulatory Committee, at <http://www.esfrc.eu> (last visited 23 July 2014)) are evidence of
this support.
22
In a joint article with Geoffrey Wood we argued that the 2007–9 crisis was a solvency/
capital financial crisis, not a mere liquidity banking crisis. See Rosa M Lastra and Geoffrey
Wood, ‘The Crisis of 2007–2009: Nature, Causes and Reactions’ (2010) 13(3) Journal of
International Economic Law 531.
23
In addition to capital rules, both the Basel Committee and the Financial Stability Board
(FSB) have been busy issuing new ‘soft-law’ rules post-crisis. For example, Basel Committee
on Banking Supervision, ‘Core Principles for Effective Banking Supervision’ (September
2012) 13, at <http://www.bis.org/publ/bcbs230.pdf> (last visited 23 July 2014), addresses
issues not covered in the original 1997 document, such as: corporate governance, the
treatment of systemically important banks, and recovery and resolution plans. The FSB has
published a number of documents containing regulatory and supervisory principles, the
most relevant being the ‘Key Attributes of Effective Resolution Regimes for Financial
Institutions’ (October 2011), at <http://www.financialstabilityboard.org/publications/
r_111104cc.pdf> (last visited 23 July 2014).
24
The aim of these restrictions is to prevent excessive risk concentration (too many eggs
in the same basket). The Basel Committee in its 1991 Guidelines recommended the target
of 25 per cent of total capital as a limit for single exposures and in a recent analysis
proposes to tighten this limit to a 25 per cent of Common Equity Tier 1 or Tier 1 capital due
to the new tighter definition of capital employed, see the Basel Committee on Banking
Supervision, ‘Supervisory Framework for Measuring and Controlling Large Exposures’,
Consultative Document (March 2013), at <http://www.bis.org/publ/bcbs246.pdf> (last
visited 23 July 2014). In the EU, an EC Directive of 2006 rules that a credit institution may
not incur an exposure to a client or group of connected clients of more than 25 per cent of
its own funds. See Directive 2006/48/EC of the European Parliament and of the Council of
14 June 2006 relating to the taking up and pursuit of the business of credit institutions, OJ L
177 (30 June 2006). This Directive also forbids banks from incurring large exposures which
in total exceed 800 per cent of their own funds.
25
In the USA, according to the Federal Reserve Act (enacted 23 December 1913, 38 Stat
251, 12 USC 226), s 23(a) and (b), the capital limit for banks on unsecured lending to one
affiliate is 10 per cent and to all affiliates is 20 per cent.
26
The Financial Services Act, which received Royal Assent on 19 December 2012,
establishes a new supervisory structure, which became operational on 1 April 2013. The Act
creates a new Financial Policy Committee (FPC) within the Bank, to look at the wider
economic and financial risks to the stability of the system, a new Prudential Regulation
Authority (PRA) responsible for the day-to-day supervision of financial institutions that
manage significant risk on their balance sheet, and an independent conduct of business
regulator, the Financial Conduct Authority (FCA), with responsibility for conduct of
business, transparency in financial services, and consumer protection.
27
See Rosa M Lastra, ‘Defining Forward-looking Judgement-based Supervision’ (2013)
14(3–4) Journal of Banking Regulation 221. This subsection draws heavily on this article.
28
John Maynard Keynes, ‘Proposals for an International Clearing Union’ in D Moggridge
(ed), The Collected Writings of John Maynard Keynes, Vol 25 (London: Macmillan, 1980).
29
See Lastra, above note 27.
30
Hector Sants, ‘Update on the Regulatory Reform Programme & European Issues’,
Speech at the Cityweek Conference (7 February 2012), at <http://www.fsa.gov.uk/library/
communication/speeches/2012/0207-hs.shtml> (last visited 23 July 2014).
31
See eg Geoffrey P Miller and Gerald Rosenfeld, ‘Intellectual Hazard: How Conceptual
Biases in Complex Organizations Contributed to the Global Financial Crisis’ (2010) 33(2)
Harvard Journal of Law and Public Policy 833, at <www.harvard-jlpp.com/33-2/807.pdf>
(last visited 23 July 2014); Daniel Kahneman, Thinking, Fast and Slow (New York: Farrar
Strauss & Giroux, 2011) 222 (ch 21, ‘Intuitions vs Formulas’).
32
See Luis Garicano and Rosa M Lastra, ‘Towards a New Architecture for Financial
Stability: Seven Principles’ (2010) 13(3) Journal of International Economic Law 597.
33
As Christos Hadjiemmanuil and Mads Andenas pointed out, ‘…the concepts of “financial
stability” and “bank safety and soundness”, which guide prudential supervision, are broad
and imprecise. They do not provide operational criteria for administrative action, but
require application of discretion on an individual basis’. See Christos Hadjiemmanuil and
Mads Andenas, ‘Banking Supervision and European Monetary Union’ (1999) 1(2) Journal of
International Banking Regulation 84, 96.
34
As already mentioned in Chapter 2 in this volume, Thomas Baxter, in a contribution
entitled ‘Financial Stability: The Role of the Federal Reserve System’, Paper presented at a
Conference on the Future of Banking Regulation and Supervision in the EU, held at the
ECB, Frankfurt (15 November 2013), pointed out that ‘[t]he Federal Reserve’s financial
stability mandate is seen in the penumbra of the Federal Reserve Act’, and that ‘that is
legally sufficient’ (deriving implied powers from the penumbra of other express powers). In
my opinion, the legal basis for such financial stability mandate can already be found in the
preamble to the Federal Reserve Act, in the words ‘effective supervision of banking in the
United States’ and in other provisions of the original Federal Reserve Act. In his
presentation, Baxter further pointed out that the express terms of the Dodd–Frank Act 2010
place financial stability within the Federal Reserve’s legal mandate. See also Dodd–Frank
Wall Street Reform and Consumer Protection Act (enacted 21 July 2010, Pub L No 111–203,
124 Stat 1376, HR 4173) (hereinafter Dodd–Frank Act 2010).
35
Supervision can be separated from the central bank and yet the central bank always
keeps a regulatory role.
36
See Charles Goodhart and Dirk Schoenmaker, ‘Should the Functions of Monetary Policy
and Banking Supervision be Separated?’ (1995) 47 Oxford University Papers 539.
37
Monetary authorities are respected if they succeed in keeping inflation under control;
their actions and decisions find echo in the press. So do their mistakes or failures. But there
is a certain equilibrium, a balance between positive and negative press. Supervisors who
succeed in their task are typically ignored or merely receive a neutral approval by the
public and the press. However, supervisors that fail in their actions are the subject of
intense criticism, scrutiny, and, as evidenced by some recent developments, even legal
liability.
38
See Charles A E Goodhart, ‘The Organizational Structure of Banking Supervision’,
Financial Stability Institute Occasional Paper No 1 (November 2000) 29–30, at <http://
www.bis.org/fsi/fsipapers01.pdf> (last visited 23 July 2014).
39
Goodhart, above note 38, 33–4.
40
Goodhart and Schoenmaker, above note 36.
41
Goodhart and Schoenmaker, above note 36.
42
See Introduction to the Federal Reserve Act of 23 December 1913.
43
See generally Rosa M Lastra and Jean-Victor Louis, ‘European Economic and Monetary
Union: History, Trends, and Prospects’ (2013) Yearbook of European Law 1 and Rosa M
Lastra, ‘Banking Union and Single Market: Conflict or Companionship?’ (2013) 36(5)
Fordham International Law Journal 1189.
44
See generally Rosa M Lastra, ‘Systemic Risk and Macroprudential Supervision’ in
Ferrán Eilis, Jennifer Payne, and Niamh Moloney (eds), Oxford Handbook of Financial
Regulation (Oxford: Oxford University Press, forthcoming 2015). See also Subir Gorkan,
‘Financial Stability’, Speech at the SAARCFINANCE Governors’ Symposium, Kumarakom,
Kerala, India (10 June 2011); and Ian MacNeil, ‘Financial Stability Moves Centre
Stage’ (2012) 6(4) Law and Financial Markets Review.
45
Lastra, above note 44.
46
This was a clear lesson of the crisis in the UK, where the problems of Northern Rock
caught the Bank of England by surprise. Having timely information is particularly crucial
during financial crises and the best way to ensure access is to have daily supervision by the
central bank. See Garicano and Lastra, above note 32.
47
Most central banks, with or without supervisory responsibilities, regard this
responsibility for financial stability as one of their key duties. However, many central bank
laws do not explicitly refer to this mandate nor formally define what it means: see Tommaso
Padoa-Schioppa, ‘Central Banks and Financial Stability. Exploring a Land in Between’,
Policy Panel Introductory Paper presented at the Second ECB Conference on The
Transformation of the European Financial System (24–5 October 2002), at <https://
www.ecb.europa.eu/events/pdf/conferences/tps.pdf> (last visited 23 July 2014). (This
speech was published in Tomasso Padoa-Schioppa, Regulating Finance (Oxford: Oxford
University Press, 2004) ch 8.) In the case of the European Central Bank, the EU Treaty
includes a specific reference to financial stability in Consolidated versions of the Treaty on
European Union and the Treaty on the Functioning of the European Union, 2010 OJ C 83/01
vol 53 (30 March 2010) (hereinafter TFEU), Art 127(4).
48
In a pre-crisis book on the subject of financial stability, Garry Schinassi, Safeguarding
Financial Stability. Theory and Practice (Washington, DC: IMF, 2006) 77, provides the
following definition: ‘Financial stability is defined as the ability of the financial system to
facilitate and enhance economic processes, manage risks and absorb shocks. Moreover,
financial stability was considered a continuum, changeable over time and consistent with
multiple combinations of finance’s constituent elements.’
49
See generally Garicano and Lastra, above note 32.
50
See Padoa-Schioppa, ‘Central Banks and Financial Stability’, above note 47.
51
Padoa-Schioppa, ‘Central Banks and Financial Stability’, above note 47. Padoa-Schioppa
also argued that price stability is a necessary but not sufficient condition for financial
stability. Furthermore, he pointed out: ‘In the long-term, price stability is a powerful
facilitator of financial stability, but is, in turn, not sustainable without financial stability.’
52
Padoa-Schioppa, ‘Central Banks and Financial Stability’, above note 47.
53
Padoa-Schioppa, ‘Central Banks and Financial Stability’, above note 47.
54
The International Monetary Fund (IMF) has recommended that central banks need to
play an important role in the institutional arrangement in charge of macroprudential policy.
See Erlend W Nier, Jacek Osiński, Luis I Jacome, and Pamela Madrid, ‘Towards Effective
Macroprudential Policy Frameworks: An Assessment of Stylized Institutional Models’, IMF
Working Paper No 11/250 (1 November 2011), at <https://www.imf.org/external/pubs/ft/wp/
2011/wp11250.pdf> (last visited 23 July 2014). On the purported benefits of central bank
involvement, see Cheng Hoon Lim et al, ‘The Macroprudential Framework: Policy
Responsiveness and Institutional Arrangements’, IMF Working Paper No 13/166 (18 July
2013), at <https://www.imf.org/external/pubs/ft/wp/2013/wp13166.pdf> (last visited 23 July
2014).
55
William Allen and Geoffrey Wood, ‘Defining And Achieving Financial Stability’ (2006)
2(2) Journal of Financial Stability 152.
56
Charles A E Goodhart, ‘A Framework for Assessing Financial Stability?’ (2006) 30
Journal of Banking & Finance 3415.
57
Serge Jeanneau, ‘Financial Stability Objectives and Arrangements—What’s New?’ in M S
Mohanty, BIS Papers No 76: The Role of Central Banks in Macroeconomic and Financial
Stability (February 2014) 47, at <http://www.bis.org/publ/bppdf/bispap76e_rh.pdf> (last
visited 23 July 2014).
58
See Gabriele Galati and Richhild Moessner, ‘Macroprudential Policy—A Literature
Review’, Bank for International Settlements Working Papers No 337 (February 2011), at
<http://www.bis.org/publ/work337.pdf> (last visited 23 July 2014).
59
According to the IMF, ‘[t]he survey was sent to 63 countries and the European Central
Bank (ECB), including all countries in the G-20 and those subject to mandatory Financial
Sector Assessment Programs (FSAPs).’ The response rate for the survey was 80 per cent
(51 respondents out of 63). See International Monetary Fund, ‘Macroprudential Policy: An
Organizing Framework. Background Paper’ (14 March 2011) 2, at <https://www.imf.org/
external/np/pp/eng/2011/031411a.pdf>.
60
IMF, ‘Macroprudential Policy’, above note 59.
61
See Bank for International Settlements, ‘Central Bank Governance and Financial
Stability’, Report by a Study Group (May 2011) 32, at <http://www.bis.org/publ/othp14.pdf>
62
Joel P Trachtman, ‘The International Law of Financial Crisis: Spillovers, Subsidiarity,
Fragmentation and Cooperation’ (2010) 13(3) Journal of International Economic Law 719.
63
Dirk Schoenmaker, ‘A New Financial Stability Framework for Europe’ (2008) 13(3) The
Financial Regulator.
64
Thomas J Miceli, The Economic Approach to Law (Stanford, CA: Stanford University
Press, 2004) 32.
65
Miceli, above note 64, 32 n 46.
66
See Osiński et al, above note 9, 6.
67
See House of Commons, Treasury Committee, ‘The Run on the Rock’, Fifth Report of
Session 2007–08 (24 January 2008), at <http://www.publications.parliament.uk/pa/
cm200708/cmselect/cmtreasy/56/56i.pdf> (last visited 23 July 2014). See also Financial
Services Authority, ‘The Turner Review: A Regulatory Response to the Global Banking
Crisis’ (March 2009), at <http://www.fsa.gov.uk/pages/Library/Corporate/turner/
index.shtml> (last visited 23 July 2014).
68
A recent IMF Discussion Note that analyses the interactions and possible overlaps and
conflicts between macro-prudential and micro-prudential policies proposes some
mechanisms for aligning both policies in the pursuit of financial stability. Specially, it
suggests that:
Reaching a common view on systemic risk based on shared information will reduce
incentives for disagreements and uncoordinated policy action by the respective
authorities, and can add to the credibility of the measures that are taken. The
overall view of the macroprudential authority should incorporate the bottom-up
observations by the microprudential authority, and should feed into the latter’s
assessment of the implications for the institutions it supervises. Joint discussion is
indispensable for mutual understanding and for increasing the likelihood of a well-
founded and shared view.
See Osiński et al, above note 9.

69
Accordingly, the IMF made clear the position on this issue by stating that ‘[i]t is
desirable for the central bank to play an important role in macroprudential policy. …This
can harness the expertise of the central bank in systemic risk identification and its
incentives to ensure macroprudential policy is pursued effectively. It can also help shield
macroprudential policymaking from political interference that can slow the deployment of
tools or bias their use toward other objectives.’ See International Monetary Fund, ‘Key
Aspects of Macroprudential Policy’ (10 June 2013) 7, at <http://www.imf.org/external/np/pp/
eng/2013/061013b.pdf> (last visited 23 July 2014). Moreover, consistent with this position a
recent IMF policy study finds that ‘the macroprudential framework that gives the central
bank an important role is associated with more timely use of macroprudential policy
instruments’. This finding emphasizes as well the relevance of coordination between macro-
prudential and monetary policy. See Lim et al, above note 54.
70
Graham Nicholson noted in a speech at Queen Mary University of London on 14 January
2014:
In contrast to monetary policy, the Bank had no statutory responsibility for financial
stability. Financial stability has always been understood to be a responsibility of the
central banks and the lender of last resort is based on the need to prevent
contagion and maintain financial stability. But such responsibility as the Bank had
for financial stability was a shared responsibility. While there was no ‘hard law’ on
the issue of financial stability, in 1997 the Bank, the Treasury and the FSA entered
into a Memorandum of Understanding to establish a framework of cooperation in
the field of financial stability (the Tripartite MOU)…[T]he problem when it emerged
was not one of overlap, but of underlap…[W]hen introducing the 2012 Act to
Parliament, Chancellor George Osborne announced: ‘…we are making the Bank of
England the single point of accountability for financial stability, ensuring there is a
decisive answer to the questions; Who is in charge?’
See Graham Nicholson, ‘The Role and Responsibility of the Bank of England under the Post-
crisis Regulatory Framework’, Guest Lecture at the Centre for Commercial Law Studies,
Queen Mary University of London (17 January 2014), at <http://www.law.qmul.ac.uk/events/
podcasts/nicholson_2014/index.html> (last visited 14 September 2014).
Section 2A of the 1998 Bank of England Act as amended by the 2012 Act gives the Bank the
responsibility ‘to protect and enhance the stability of the Financial System of the UK’.
71
The Act, named after Senator Christopher Dodd and Congressman Barney Frank, was
signed by President Obama on 21 July 2010. The Financial Services Oversight Council
(FOSC) comprises the heads of each of the principal federal financial regulators (replacing
the President’s Working Group on Financial Markets) and is chaired by the Secretary of the
Treasury. See US Department of Treasury, ‘About FOSC’, at <http://www.treasury.gov/
initiatives/fsoc/about/Pages/default.aspx> (last visited 23 July 2014).
72
The SSM Regulation confers some macro-prudential powers to the ECB. See Council
Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the
European Central Bank concerning policies relating to the prudential supervision of credit
institutions, OJ L 287/63 (29 October 2013) (hereinafter SSM Regulation), at <http://eur-
lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2013:287:0063:0089:EN:PDF>
73
See Jose Viñals et al, ‘Creating a Safer Financial System: Will the Volcker, Vickers, and
Liikanen Structural Measures Help?’, IMF Staff Discussion Notes No 13/4 (2013), at <http:/
/www.imf.org/external/pubs/ft/sdn/2013/sdn1304.pdf> (last visited 23 July 2014).
74
Financial Services Act 2012 (enacted 19 December 2012, c 21), at <http://
www.legislation.gov.uk/ukpga/2012/21/contents/enacted> (last visited 23 July 2014).
75
Emma Murphy and Stephen Senior, ‘Changes to the Bank of England’ (2013) Q1 Bank of
England Quarterly Bulletin, at <http://www.bankofengland.co.uk/publications/Pages/
quarterlybulletin/n12pre release.aspx> (last visited 23 July 2014). The Financial Services
Act 2012 was amended by the Financial Services (Banking Reform) Act 2013 enacted in
December 2013, available at <http://www.legislation.gov.uk/ukpga/2013/33/contents/
enacted>.
76
In Chile, the Consejo de Estabilidad Financiera was created in October 2011. In turn,
Mexico created the Consejo de Estabilidad del Sistema Financiero (CESF). See Rosa M
Lastra and Enmanuel Cedeno-Brea, ‘Latin American Financial Reforms’, Working Paper
presented at the 92nd MOCOMILA meeting (April 2013).
77
IMF, ‘Key Aspects of Macroprudential Policy’, above note 69, 46.
78
In Spain, up to the entry into force of the SSM Regulation (discussed in Chapter 10),
banks were supervised by the Banco de España, securities firms by the Comisión Nacional
del Mercado de Valores, and insurance companies and pension funds by the Dirección
General de Seguros y de Fondos de Pensiones.
79
Following the adoption on 22 April 2002 of the Law on Integrated Financial Services
Supervision (Gesetz über die integrierte Finanzaufsicht, FinDAG), the Federal Financial
Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin) was
established on 1 May 2002. The functions of the former offices for banking supervision
(Bundesaufsichtsamt für das Kreditwesen, BAKred), insurance supervision
(Bundesaufsichtsamt für das Versicherungswesen, BAV) and securities supervision
(Bundesaufsichtsamt für den Wertpapierhandel, BAWe) have been combined in a single
State regulator, the BaFin. The BaFin is a federal institution governed by public law that
belongs to the portfolio of the Federal Ministry of Finance. See the website of the Federal
Financial Supervisory Authority, BaFin, <http://www.bafin.de> (last visited 23 July 2014).
See generally Bundesanstalt für Finanzdienstleistungsaufsicht, ‘Gründe für eine integrierte
Finanzmarktaufsicht’, at <http://www.bafin.de/SharedDocs/Aufsichtsrecht/DE/Gesetz/
Archiv_findag/findag_bis_111205.html> (last visited 14 September 2014).
80
See Richard K Abrams and Michael W Taylor, ‘Issues in the Unification of Financial
Sector Supervision’, IMF Working Paper No 213 (December 2000) 3, <http://www.fep.up.pt/
disciplinas/pgaf924/PGAF/issues_in_unification_supervision.pdf> (last visited 23 July 2014).
81
An excellent summary of the pros and cons of the two models (integrated financial
supervisor versus specialist supervisor) is found in Karel Lannoo, ‘Supervising the
European Financial System’, Centre for European Policy Studies Policy Brief No 21 (May
2002), at <http://aei.pitt.edu/1987/1/PB21.pdf> (last visited 23 July 2014). See also Howard
Davies, ‘Euro-regulation’ (1999) 1(2) Journal of International Banking Regulation 114–15.
82
Notwithstanding the critique made sometimes of the now defunct FSA as a ‘regulatory
Leviathan’ in the Anglo-Saxon tradition there is less ‘reverence’ for the decisions of the
authorities. I once asked Howard Davies, FSA Chairman, what his response would be to
allegations that the FSA would concentrate too much power in the same hands. And he said:
The culture in this country as well as in the City is quite open. …Here, there is no
automatic reverence for the decisions of the regulators, there is a common culture
of criticising. …I don’t feel as if we are the kind of organisation which is going to sit
in its ivory tower, handing its decisions to the financial markets; that is not our
culture. …Our environment…is much less directly and rigidly regulated than
anywhere else you can think of, be it the US, Japan or many European countries. …
[emphasis added].
See Rosa M Lastra, ‘The City’s Troubleshooter: Interview with Howard Davies’ (1998) 5(3)
Parliamentary Brief 28, 34.
83
The Gramm–Leach–Bliley Act (enacted 12 November 1999, Pub L 106-102, Stat 113 Stat
1338) represented the breakdown of the Glass–Steagall wall between commercial and
investment banking. This 1999 Act expanded the activities permissible for affiliates of banks
and created a new category of bank holding company, the ‘financial holding company’.
However, despite the blurring of the distinctions among financial institutions, the regulatory
systems for different types of institutions remain separate. See eg Jonathan R Macey,
Geoffrey P Miller, and Richard S Carnell, Banking Law and Regulation (New York: Aspen
Law & Business, 2001) 33–6 and 443–9.
84
The FDIC has ‘three hats’ as supervisor, insurer, and receiver of failed banks. The Dodd–
Frank Act 2010 extends the resolution powers of the FDIC with regard to systemically
important financial institutions.
85
FINRA is involved in registering industry participants, examining securities firms,
regulating markets and writing rules. For summary of its activities, see ‘About the Financial
Industry Regulatory Authority’, at <http://www.finra.org/AboutFINRA/index.htm> (last
86
Howell E Jackson and Edward L Symons, Regulation of Financial Institutions (St Paul,
MN: West Group, 1999) 812–50. Open-end investment companies are otherwise known as
mutual funds. Hedge funds are not required to register with the SEC as investment
companies under the Investment Company Act of 1940. In the past, hedge fund advisers
were not required to register under the Investment Advisers Act of 1940 (15 USC 80b-10).
However, in December of 2004, the SEC issued a final rule and rule amendments requiring
certain hedge fund managers to register as investment advisers under the Act. See
Securities Exchange Commission, 17 CFR Parts 275 and 279: Registration Under the
Advisers Act of Certain Hedge Fund Advisers (2004), at <http://www.sec.gov/rules/final/
ia-2333.htm> (last visited 23 July 2014).
87
Jackson and Symons, above note 86, 431–42 and 588–90. The US financial regulatory
landscape also comprises other regulators, such as the Commodities Future Trading
Commission for financial derivatives (commodity futures and options).
88
Jackson and Symons, above note 86, 611–17.
89
Some academics advocated the need for greater consolidation of the regulatory
agencies. See Howell E Jackson, ‘A Pragmatic Approach to the Phased Consolidation of
Financial Regulation in the United States’, Harvard Public Law Working Paper No 09-19 (12
November 2008), at <http://ssrn.com/abstract=1300431> (last visited 23 July
2014). See also Howell E Jackson, ‘Regulatory Reform in the New World’, Remarks at the
Hart Seminar, London (16 June 2009).
90
One of the most controversial aspects of the new legislation is the so-called ‘Volcker
rule’ (named after Paul Volcker). The Volcker rule (s 619 of the Dodd–Frank Act 2010, which
takes the form of a new s 13 of the Bank Holding Company Act (enacted 9 May 1956, Pub L
84-511, 70 Stat 133) and new s 27B of the Securities Act (enacted 27 May 1933, Pub L
73-22, 48 Stat 74) prohibits federally insured ‘banking entities’ from engaging in
proprietary trading (subject to certain exceptions) and restricts their relationships with
hedge funds and private equity funds. Although the Dodd–Frank Act 2010 deals with many
issues, it does not tackle the very severe problems of Fannie Mae and Freddie Mac. But this
would be the subject for another book.
91
James R Barth, Gerard Caprio, and Ross Levine, ‘Bank Regulation and Supervision:
What Works Best?’ (2004) 13 Journal of Financial Intermediation 205.
92
Richard Ferguson, ‘Alternative Approaches to Financial Supervision and Regulation’,
(1999) 16(2) Journal of Financial Services Research 297, suggests that market information
(contained in either bond ratings or equity performance) tends to be a better predictor of
future banking performance than supervisory information, indicating that there is an
important role for market self-regulation.
93
Edmund L Andrews, ‘Greenspan Concedes Error on Regulation’, The New York Times
(23 October 2008).
94
Constantinos Stephanou, ‘Rethinking Market Discipline in Banking Lessons from the
Financial Crisis’, The World Bank Financial Policy Development Unit Financial and Private
Sector Development Vice Presidency Policy Research Working Paper 5227 (March 2010), at
<http://elibrary.worldbank.org/content/workingpaper/10.1596/1813-9450-5227> (last
95
The Basel Committee reiterated the key role of robust market discipline in fostering a
safe and sound banking system by expanding an existing Core Principle into two new ones
dedicated respectively to greater public disclosure and transparency, and enhanced
financial reporting and external audit, see Principles 27 and 28 in the new text of the ‘Core
Principles for Effective Banking Supervision’, above note 23. For a study on the disclosure
paradigm, see Emilios Avgouleas, ‘The Global Financial Crisis and the Disclosure Paradigm
in European Financial Regulation: The Case for Reform’ (2009) 6 European Company
Financial Law Review 440.
96
The economic literature on ‘regulatory capture’ is well known: any given industry would
try to influence the outcome of the regulatory process for its own benefit, rather than the
public interest. Industry lobbies can exert undue influence, as shown by the Enron debacle.
See Padoa-Schioppa, Regulating Finance, above note 47, 48–51.
97
See Goodhart, above note 38, 30–1.
98
See ‘Core Principles for Effective Banking Supervision’, above note 23.
99
For a different opinion, see Marc Quintyn and Michael W Taylor, ‘Regulatory and
Supervisory Independence and Financial Stability’, IMF Working Paper WP/02/46 (March
2002), at <http://www.imf.org/external/pubs/ft/wp/2002/wp0246.pdf> (last visited 14
September 2014). Quintyn and Taylor argue that regulatory and supervisory independence
is important for financial stability for the same reasons that central bank independence is
important for monetary stability.
100
The main message in the design of appropriate accountability mechanisms in financial
supervision is: keep it simple and have clear goals, if possible just one for one agency. This
is an important consideration behind the recent reform of the Dutch model of financial
supervision, where there is one goal for the prudential supervisor and one goal for the
conduct of business supervisor. See Annet Jonk, Jeroen Kremers, and Dirk Schoenmaker, ‘A
New Dutch Model’ (2001) 6(3) Financial Regulator 35.
101
House of Commons, Treasury Committee, ‘Accountability of the Bank of England’,
Twenty-first Report of Session 2010–12, HC 874 (8 November 2011), at <http://
www.publications.parliament.uk/pa/cm201012/cmselect/cmtreasy/874/874.pdf> (last visited
23 July 2014).
102
As I explained in Chapter 2 in this volume, the case against the Bank of England (Three
Rivers District Council v Governor and Company of the Bank of England (No 3) [2000] 2
WLR 1220; [2000] 3 All ER 1; [2000] Lloyd’s Rep Bank 235, HL) was abandoned on 2
November 2005, when Bank of Credit and Commerce International (BCCI) liquidators
Deloitte Touche Tohmatsu dropped their claim (against the Bank of England), after
receiving a legal ruling that it would not be in the best interests of BCCI’s creditors to
continue with the lawsuit.
103
See Mads Andenas, ‘Liability for Supervisors and Depositors’ Rights: The BCCI and the
House of Lords’ (2001) 22 Company Lawyer 226. See also Mads Andenas and Duncan
Fairgrieve, ‘To Supervise or to Compensate? A Comparative Study of State Liability for
Negligent Banking Supervision’ in Mads Andenas and Duncan Fairgrieve (eds), Judicial
Review in International Perspective. Liber Americorum in Honour of Lord Slynn of Hadley
(The Hague: Kluwer Law International, 2000) 333–60.
104
Case C-222/02 Peter Paul and others v Bundesrepublik Deutschland [2004] ECR I–
09425.
105
See Barrie Ingham, ‘The Justifications for Immunity from Damages Liability for UK
Financial Regulators’ (2010) 31(10) Company Lawyer 317.
106
International Organization of Securities Commission (IOSCO), ‘Methodology for
Assessing Implementation of the IOSCO Objectives and Principles of Securities
Regulation’ (October 2003), at <http://www.ebrd.com/downloads/legal/securities/
IOSCOPD155.pdf> (last visited 14 September 2014).
107
Though the central bank also needs a team of economists to do the forecasting, to
study the transmission mechanisms of monetary policy, etc.
108
Other ‘banking decisions’ that deal with issues of competition, such as the approval or
rejection of a banking merger, also need to be freed from political interference, whether
they are taken by competition authorities or by bank supervisory authorities.
109
See Ruth de Krivoy, Collapse. The Venezuelan Banking Crisis of 1994 (Washington, DC:
The Group of Thirty, 2000).
110
de Krivoy, above note 109, 203–4.
111
The Group of 30 published in 2008 an extensive report identifying the four different
approaches to financial supervision employed worldwide as: Institutional, Functional,
Integrated, and Twin Peaks. See G30 Working Group on Financial Supervision, ‘The
Structure of Financial Supervision: Approaches and Challenges in a Global
Marketplace’ (2008), at <http://www.group30.org/rpt_06.shtml> (last visited 23 July 2014).
112
Alan Greenspan, ‘Financial Innovations and the Supervision of Financial Institutions’,
Paper presented in Proceedings of the 31st Annual Conference on Bank Structure and
Competition, Federal Reserve Bank of Chicago (May 1995).
113
The first of these cross-sectoral departments deals with risk analysis and financial
market studies, and the BaFin’s participation in international supervisory forums. The
second cross-sectoral department deals with consumer protection issues as well as cross-
sectoral legal issues. The third cross-sectoral department focuses on the integrity of the
financial system. See <http://www.bafin.de> (last visited 23 July 2014).
114
See <http://www.bafin.de> (last visited 23 July 2014).
115
The Dutch model became operational in September 2002, following the entry into force
of the necessary Ministerial and Royal decrees and after all the necessary steps had been
finalized (such as the change of name of the former securities regulator ‘Stichting Toezicht
effectenverkeer’ into the ‘Autoriteit Financiële Markten’ or Authority on Financial Markets,
AFM). The merger between DNB (the Dutch central bank, with responsibility for the
prudential supervision of banks and securities firms) and the Pensioen- en
Verzekeringskamer (PVK) (the authority responsible for the prudential supervision of
insurance companies and pension funds) was established by law, which went into force on 1
November 2004. A new Act for Financial Supervision (Wet op het Financieel Toezicht),
implementing the split between prudential supervision and conduct of business entered into
force in January 2007. Dutch legislation is available at <http://www.overheid.nl> (last
116
The ‘twin-peaks’ approach was advocated by Michael Taylor in seminal paper. ‘“Twin
Peaks”: A Regulatory Structure for the New Century’, Centre for the Study of Financial
Innovation, London (1995).
117
See the Dutch Ministry of Finance, ‘Financial Supervision in the Netherlands’ (March
2004), at <http://www.minfin.nl> (last visited 23 July 2014). See also Jeroen Kremers, Dirk
Schoenmaker, and Peter Wierts, ‘Cross Border Supervision: Which Model?’ in Richard
Herring and Robert Litan (eds), Brookings–Wharton Papers on Financial Services
(Washington, DC: Brookings Institution, 2003) 225.
118
However, as pointed by Marcus Killick, this supervisory model also failed to prevent the
2007–9 global financial crisis. In 2008, the Dutch government was forced to purchase the
banking and insurance arms of the Fortis Group regulated by the Dutch Central Bank
(DNB). See Marcus Killick, ‘“Twin Peaks”—A New Series or a New Chimera? An Analysis of
the Proposed New Regulatory Structure in the UK’ (2012) 33(12) Company Lawyer 366.
119
The Bank of England Act 1998 transferred responsibility for banking supervision from
the Bank of England to the FSA.
120
121
The legal form of banks and the advent of limited liability (considering also the history
of double liability shares in the USA and partly paid shares in the UK) should be reviewed
further. However, an in-depth study of whether other forms of corporate organization, such
as a mutual or a cooperative, might more effectively curb excessive bank risk-taking, is
beyond the scope of this volume.
122
The narrow banking proposals have been again endorsed by John Kay, ‘Narrow
Banking. The Reform of Banking Regulation’, Centre for the Study of Financial Innovation
(15 September 2009), at <http://www.johnkay.com/wp-content/uploads/2009/12/JK-Narrow-
Banking.pdf> (last visited 23 July 2014); while Lawrence J Kotlikoff has made a case for the
mutualization of the financial industry in his book Jimmy Stewart is Dead: Ending the
World’s Ongoing Financial Plague with Limited Purpose Banking (Chichester: John Wiley &
Sons, 2010).
123
Section 4 of the Financial Services (Banking Reform) Act 2013 inserts a new Part 9B
(sections 142A–142Z1) into the Financial Services and Markets Act 2000 (‘FSMA’) providing
for ring-fencing. The announcement by Barclays of job cuts in its investment banking
activities was greeted by many in the UK as a welcome development. See eg ‘Britain Gives
Up on the Bulge Bracket’ Financial Times (9 May 2014):
The mixture of too-big-to-fail institutions and aggressive risk-taking activities is

unappealing. It leaves taxpayers exposed to unjustifiable tail risks. …Investment
banking is a volatile activity suited to partnerships, or institutions where pay can be
significantly varied from year to year. …It [global investment banking] led these
banks [Barclays and RBS] to neglect their core function as utilities, to the detriment
of their retail customers.
See also ‘Barclays Cuts 7000 Jobs in Investment Banking Retreat’ Financial Times (9 May
2014), citing higher regulatory requirements (capital rules, ring-fencing retail banking and
rules to defer a greater proportion of pay) as driving Barclays’ retreat from global
investment banking, and questioning the alleged benefits of universal banking.
124
In January 2012, European Commissioner Michel Barnier set up a high level expert
group to examine possible ways to reform the structure of the EU banking sector, chaired
by Erkii Liikanen. See High-level Expert Group on Bank Structural Reform, Report
(Brussels, 2 October 2012) (hereinafter Liikanen Report), at <http://ec.europa.eu/
internal_market/bank/docs/high-level_expert_group/report_en.pdf> (last visited 23 July
2014).
125
See House of Lords, House of Commons, Parliamentary Commission on Banking
Standards, First Report of Session 2012–13, HL Paper 98, HC 848 (21 December 2012), at
<http://www.publications.parliament.uk/pa/jt201213/jtselect/jtpcbs/98/98.pdf> (last visited
23 July 2014) and House of Lords, European Union Committee, ‘European Banking Union:
Key Issues and Challenges’, 7th Report of Session 2012–2013, HL Paper 88 (12 December
2012), at <http://www.publications.parliament.uk/pa/ld201213/ldselect/ldeucom/88/88.pdf>
126
See generally Rosa M Lastra and Charles Goodhart, ‘Border Problems’ (2012) 13(3)
Journal of International Economic Law 705.
127
See John Plender, ‘Just Targeting Symptoms of the Crisis is too Neat’ Financial Times
(25 February 2010):
Bankers in the boom were being paid bonuses not for brilliance but for excessive
risk taking via leverage and for oligopolistic super-profits. Now they have been
offered a state safety net and a steep yield curve, whereby they borrow at low cost
to invest in higher yielding assets. This guarantees easy, low risk profits, on which
they nonetheless expect bonuses.
128
See Parliamentary Commission on Banking Standards, ‘Changing Banking for Good’,
Fifth Report (12 June 2013), at <http://www.publications.parliament.uk/pa/jt201314/
jtselect/jtpcbs/27/27ii02.htm> (last visited 23 July 2014).
129
International Monetary Fund, ‘Moving from Liquidity to Growth Driven Markets’,
Global Financial Stability Report 2014 (March 2014) ch 3, at <http://www.imf.org/External/
Pubs/FT/GFSR/2014/01/index.htm> (last visited 23 July 2014) looks at the issue of ‘too
important to fail’ and provides new estimates of the implicit funding subsidy received by
systemically important banks. The subsidy comes from the expectation that the government
will support large banks if they get into distress. Though financial reforms have helped
reduce this subsidy, it remains sizeable. Policymakers—the report claims—should aim to
remove this advantage to protect taxpayers, ensure a level playing field, and promote
financial stability.
130
The announcement was made by the then Chancellor of the Exchequer in a pre-budget
report in December 2009. See ‘Darling Unveils Super-tax Plans for Bankers’ Bonuses’, BBC
News (9 December 2009), at <http://news.bbc.co.uk/1/hi/business/8403249.stm> (last
visited 23 July 2014). See also the recent note by Antony Seely, ‘Taxation on Banking’,
Standard Note No 5251 (27 May 2014), at <www.parliament.uk/briefing-papers/
sn05251.pdf> (last visited 23 July 2014).
131
Bank of England, ‘Clawback’, Consultation Paper (March 2014), at <http://
www.bankofengland.co.uk/pra/Documents/publications/policy/2014/clawbackcp6-14.pdf>
(last visited 13 July 2014). On 16 April 2013, the European Parliament approved the text of
CRD 4 (Directive 2013/36/EU of the European Parliament and of the Council of 26 June
2013 on access to the activity of credit institutions and the prudential supervision of credit
institutions and investment firms, amending Directive 2002/87/EC and repealing Directives
2006/48/EC and 2006/49/EC Text with EEA relevance) which, among other things, imposes
a cap on bankers’ bonuses.
132
The International Monetary Fund, ‘A Fair and Substantial Contribution by the Financial
Sector’, Final Report for the G-20 (27 June 2010), at <http://www.imf.org/external/np/g20/
pdf/062710b.pdf> (last visited 23 July 2014). The IMF’s recommended financial stability
contribution is similar to a financial stability fee that Sweden adopted in 2009, a direct levy
on Swedish banks, based on bank liabilities and equity.
133
See Mark Roe and Michael Tröge, ‘How to Use a Bank Tax to Make the Financial
System Safer’ Financial Times (25 March 2014).
Part I Developments at the National Level, 4 Crisis
Management
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
Financial system — Monetary system — Monetary obligations — European Central Bank
(p. 147) 4 Crisis Management
B. The ‘Anatomy of a Crisis’ 4.05
C. Lender of Last Resort 4.08
Principles 4.09
The problems of moral hazard and adverse selection 4.15
Theory and practice 4.21
Lender of last resort and the 2007–9 financial crisis 4.29
The question of ambiguity 4.36
D. Deposit Insurance 4.37

Structure of deposit insurance 4.42
Explicit versus implicit deposit insurance 4.43
Preferred creditors 4.51
Mandatory versus contingent guarantee 4.55
E. Bank Resolution and Insolvency 4.59

Lex specialis versus lex generalis 4.59
Objectives of bank insolvency laws 4.68
Rescue packages and resolution procedures 4.74
Cross-border bank resolution and insolvency 4.86
Developments before the 2007–9 crisis 4.93
Developments after the 2007–9 crisis 4.103
F. Systemic Risk and Systemic Crises 4.113

Definition of systemic risk 4.117
Transmission mechanisms 4.125
The inter-bank, inter-institution, inter-instrument channel 4.128
The payments system channel 4.134
The information channel 4.146
The psychological channel 4.153
SIFIs 4.158
Final observations on systemic risk: prevention and resolution 4.165
I want to talk for a few minutes with the people of the United States about banking.
I want to tell you what has been done in the last few days, why it was done, and
what the next steps are going to be. …We had a bad banking situation. Some of our
bankers had shown themselves either incompetent or dishonest in their handling of
the people’s funds. They had used the money entrusted to them in speculations and
unwise loans. This was of course not true in the vast majority of our banks but it
was true in enough of them to shock the people for a time into a sense of insecurity
and to put them into a frame of mind where they did not differentiate but seemed to
assume that the acts of a comparative few had tainted them all. It was the
Government’s job to straighten out this situation—and do it as quickly as possible—
and the job is being performed.
Franklin D Roosevelt, Radio Address, 12 March 1933
A. Introduction
4.01 Sound banking is essential for maintaining monetary and financial stability. Yet, the
fragility of the banking industry is a permanent feature in financial history. The global
financial crisis 2007–9 is a stern reminder of this fragility. In his authoritative record on the
recurrent nature of crises, Charles Kindleberger describes how displacement, euphoria,
distress, panic, and crisis have occurred decade after decade, century after century.1
(p. 148) 4.02 Though crises have been—and will continue to be with us—our
understanding of crisis management needs to be rewritten after the 2007–9 debacle.2
Bank crisis management—the focus of this chapter—comprises an array of official and
private responses that extends beyond the insolvency proceedings that are the only tool
typically available to deal with corporate bankruptcy in other industries.
As regards the official responses, public authorities have at their disposal both preventive
(ex ante) mechanisms to strengthen the banking system (such as macro- and micro-
prudential supervision, counter-cyclical regulation, and increased transparency and
disclosure) and remedial (ex post) instruments—to ‘steer the boat through a rough sea’3—
when confronted with failed or failing banks.
4.03 Remedial measures constitute crisis management and include (1) the lender of last
resort role of the central bank, both in the cases of market support and of individual
liquidity support; (2) deposit insurance schemes; (3) government policies of implicit
protection of depositors, the payments system and banks (guarantees, insurance or
purchase of assets, recapitalization and other forms of support; the ‘too-big-to-fail doctrine’
and its variants— too important to fail, too interconnected to fail, too complex to fail, too
many to fail, too big to save—often apply); (4) prompt corrective action and recovery and
resolution plans (living wills); (5) resolution and insolvency laws (lex specialis versus lex
generalis); and (6) others, such as the suspension of convertibility of deposits into cash
(seldom used nowadays).4
4.04 The notion of systemic risk is also considered in this chapter. Though a commonly
accepted definition is still missing, systemic risk refers to the possibility that the financial
difficulties in one institution or more spill over to a larger number of other institutions or
the financial system as a whole, often creating a disruption in the monetary and payment
systems. Some questioned the very existence of systemic risk prior to 2007.5(p. 149)
However, after the 2007–9 global financial crisis, it is difficult to dispute that systemic risk
is real and that periods of instability or events of systemic risk pose a threat not only to the
financial system but also to the economy at large. The transmission mechanisms of a crisis
domestically and internationally, the linkages and interconnections between institutions and
markets cannot be ignored. No chain is stronger than its weakest link.
B. The ‘Anatomy of a Crisis’

4.05 The best description of the ‘anatomy of a crisis’ is provided, in my opinion, by
Kindleberger,6 drawing on Minsky.7 The first stage in the build-up to a crisis is a
‘displacement’, some sudden event that changes investor behaviour, expectations, and
profit opportunities, such as the beginning or end of a war, an invention or new technology,
surprising financial success, or some other political or economic development.8 If the
opportunities for profit brought about by the displacement dominate, a ‘boom’ is considered
to be under way, leading in some cases to investor ‘euphoria’.
4.06 Throughout history, a number of assets and commodities have been the object of
speculation, from tulips to stocks.9 As firms or individuals see others making profits from
‘speculative’ transactions, they tend to follow (a pattern that has been characterized as
‘herd behaviour’) in the expectation that gains can be made rather easily.10
When the number of firms and households indulging in these [speculative] practices
grows large, bringing in segments of the population that are normally aloof from
such ventures, speculation for profit leads away from normal, rational behaviour to
what has been described as ‘manias’ or ‘bubbles’. The word mania emphasizes the
irrationality; bubble foreshadows the bursting.11
4.07 Speculative excesses propagate quickly through the monetary system.12 Prices
increase. At the peak of the market, some investors decide ‘to take their profits and sell
out’.13 This (p. 150) sends a signal to other investors, prompting them to exit the market,
too. Prices begin to decline, leading to a situation of ‘financial distress’, which may or may
not be followed by a crash or panic.14 Sometimes, market developments, policy responses,
or regulatory solutions prevent the financial distress from turning into a panic. In many
other occasions, however, ‘the race out of real or long-term financial assets and into money
may turn into a stampede’15 leading to a ‘crash’ or a ‘panic’.16
Kindleberger’s style of narrative captures the dynamics of the unfolding of a crisis as much
as the eloquence of his argument. His brilliant diagnosis of a crisis provides a durable
template against which to measure any financial crisis. However, Kindleberger himself
acknowledges that his interest in Manias, Panics and Crashes ‘is more in [crisis] diagnosis
than in therapy and prognosis’.17
C. Lender of Last Resort

4.08 The name ‘lender of last resort’ owes its origins to Sir Francis Barings, who in 1797
referred to the Bank of England as the ‘dernier resort’ from which all banks could obtain
liquidity in times of crisis.18 The lender of last resort role (LOLR) of the central bank
remains a major rationale for most central banks around the world, both in developed and
developing countries.19 It is the immediacy of the availability of central bank credit (the
central bank being the ultimate supplier of high-powered money) that makes the LOLR
particularly suitable to confront emergency situations. LOLR provides the first line of
defence.
(p. 151) Principles
4.09 LOLR comes in two forms.20 The first form is the traditional Thornton–Bagehot ‘LOLR
model’: collateralized lines of credit to individual illiquid, but solvent,21 banks (the
Thornton–Bagehot ‘principles’ are not legal principles, but rather doctrinal principles);22
the second form (emergency liquidity assistance, ELA) is the provision of ‘market liquidity
assistance’ via ordinary open market operations and via extraordinary or unconventional
measures. Under the Thornton–Bagehot model,23 the following principles (which are not
legal principles—unless enshrined in the law—but rather doctrinal principles attributed to
LOLR) apply: (1) the central bank should prevent temporarily illiquid but solvent banks
from failing—this type of lending is by nature short-term; (2) the central bank should be
able to lend as much as is necessary (only the ultimate supplier of high-powered money has
this ability), but charge a high rate of interest (some commentators interpret it as a ‘penalty
rate’);24 (3) the central bank should accommodate anyone with good collateral, valued at
pre-panic prices;25 (4) the central bank should make its readiness to lend clear in advance.
(p. 152) 4.10 The central bank’s LOLR role is discretionary, not mandatory. The central
bank assesses not only the question whether the situation is of illiquidity or insolvency, but
also whether the failure of an institution can trigger by contagion the failure of other
institutions. The risk of contagion is not easy to assess. It is difficult to calculate ex ante
how far a crisis can extend. Market sentiment is often hard to predict and, sometimes,
irrational, which renders any rational prediction meaningless. The dynamic of a panic is
typically self-fulfilling. Indeed, it is the consideration of market sentiment that prompted
Thornton back in 1802 to suggest that providing liquidity to the market (lending on
security) was the best way of containing a panic. Bagehot and Thornton contend that the
LOLR responsibility is to the market, to the entire financial system and not to specific
institutions.
4.11 Central banks’ laws tend to provide scarce guidance with regard to their lender of
last resort operations. One exception is the US legislation on this topic, which happens to
be very detailed and rather extensive.26 Access to the discount window is governed by
Regulation A27 (the first regulation adopted by the Federal Reserve Board at its creation)
which refers to the extension of credit—through advances or discounts—in both ordinary
and extraordinary circumstances, and which has been periodically revised over time.28
Most other countries do not have such detailed operational rules.
4.12 The Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 199129
linked the intensity of supervision to the level of capitalization, with severe treatment for
‘critically undercapitalized’ depository institutions.30 Under FDICIA, Federal Reserve banks
should (p. 153) lend only to viable institutions, with penalties imposed in the case of
extended lending to undercapitalized institutions, thus shifting the financial burden from
the Federal Deposit Insurance Corporation to the Federal Reserve System if the latter chose
to lend via its discount window lending (DWL) to insolvent or critically undercapitalized
institutions.
4.13 The crisis, as we further discuss below, substantially expanded the extraordinary
liquidity assistance provided by the Fed. The Emergency and Economic Stabilization Act
(EESA) enacted in 2008 highlighted some systemic risk situations where LOLR assistance
could be justified.31 The legislative authority invoked in many cases since March 2008 to
lend not only to banks but to other financial market participants was section 13.3 of the
Federal Reserve Act, which allowed the Fed to lend to financial institutions other than a
regulated depository institution because of ‘unusual and exigent circumstances’.32 This was
the first time since the 1930s that this provision was used. Section 13.3 (‘Discounts for
Individuals, Partnerships, and Corporations’) reads as follows (before the Dodd–Frank Act
amendment):
In unusual and exigent circumstances, the Board of Governors of the Federal

Reserve System, by the affirmative vote of not less than five members, may
authorize any Federal reserve bank, during such periods as the said board may
determine, at rates established in accordance with the provisions of section 14,
subdivision (d), of this Act ‘to discount for any individual, partnership, or
corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of
exchange are indorsed or otherwise secured to the satisfaction of the Federal
Reserve bank: Provided, That before discounting any such note, draft, or bill of
exchange for an individual, partnership, or corporation the Federal reserve bank
shall obtain evidence that such individual, partnership, or corporation is unable to
secure adequate credit accommodations from other banking institutions. All such
discounts for individuals, partnerships, or corporations shall be subject to such
limitations, restrictions, and regulations as the Board of Governors of the Federal
Reserve System may prescribe’.33
4.14 Interestingly, some would say alarmingly, the authority to provide lender of last resort
assistance under section 13(3) of the Federal Reserve Act has been curtailed significantly
by the Dodd–Frank Wall Street Reform and Consumer Protection Act.34 The Dodd–Frank Act
2010 requires that any emergency lending programmes and facilities authorized by the
Federal Reserve under section 13(3) of the Federal Reserve Act must have ‘broad-based
eligibility’ and must be approved by the Secretary of the Treasury.35 Thus, the Fed cannot
(p. 154) engage in rescues of individual firms (ie, cannot use this authority for the ‘purpose’
of assisting a ‘single and specific company’). This represents a significant restriction on the
prior authority that the Fed used in 2008 in the cases of AIG and Bear Stearns.
The problems of moral hazard and adverse selection
4.15 The operational aspects of the LOLR functions are affected by problems of
asymmetric information, namely moral hazard and adverse selection.36
4.16 The existence of a public ‘safety net’ creates a moral hazard, that is, a set of
incentives for the protected to behave differently—irresponsibly, carelessly, or less
conservatively—simply because of the existence of protection. Lending to insolvent
institutions increases the potential for moral hazard, because of the perceived relaxation in
the exercise of the principles of the LOLR.37 Moreover, institutions can also engage in
excessive risk-taking in an attempt to ‘gamble for resurrection’.
4.17 Central banks can suffer losses and end up with marked-down collateral and bad
loans in their own balance sheets. The differentiation between illiquidity and insolvency
refers to the multiple challenges and difficulties experienced in the valuation of various
assets. Concerns about liquidity can be uncertainty about insolvency.
4.18 To mitigate the risks of moral hazard and adverse selection, it is important to
demarcate clearly what the central bank can do and what the central bank cannot do—or
should not do—through its LOLR. The central bank can provide emergency liquidity—quick
cash upfront—over a short period, when no other sources of funding are readily available.
4.19 What the central bank cannot do is to lend over an extended period or lend to
institutions with a high probability of insolvency—committing taxpayers’ money—without
the explicit approval of the fiscal authority. Any extended lending becomes the
responsibility of the fiscal authority.38 The central bank can provide liquidity, not capital.39
The (p. 155) central bank should not use its LOLR to bail out bank owners; the ultimate
responsibility of the LOLR remains to the market, to the entire financial sector and not to
any particular institution.
4.20 The central bank, before exercising its discretion to act or not to act as LOLR, should
conduct a cost–benefit analysis of the results of its intervention (this is, of course, a difficult
exercise, since it is done under pressure and with the need to reach a decision as promptly
as possible). The costs are typically the risk of loss to the central bank and the creation of
moral hazard incentives. The benefits accrue from the speed, flexibility, and decisiveness
with which the central bank can cope with an emergency crisis.40 In this cost–benefit
analysis due consideration should be given to the interests of depositors, other creditors,
shareholders, and taxpayers.
Theory and practice
4.21 Developments in the marketplace and in the way central banks operate have altered
what I refer to as the ‘conventional wisdom’ on LOLR. In theory, with developed money and
inter-bank markets the central bank should only be called upon to assist an institution when
other sources of financing have dried up, that is, when there is a perception in the market
that such institution is already suffering from insolvency problems. In practice, the
immediacy of the need for assistance often makes it difficult to assess at that moment
whether the institution is illiquid or insolvent.41 A situation of bank illiquidity (lack of liquid
funds) can be an indication of technical insolvency (value of liabilities exceeds market value
of assets) or can quickly turn into insolvency if assets are sold at a loss value or ‘fire-sale’
price. Goodhart suggests that it is a ‘myth’ to suggest that it is possible to distinguish
between illiquidity and insolvency.42
4.22 Arguably, if a solvent bank could nearly always get liquidity from a source other than
the central bank, then the concern about inter-bank exposure and contagion as a
justification for LOLR would be less cogent: as long as the failure of bank A does not cause
bank B to become insolvent because of inter-bank exposure, then bank B can get liquidity
financing in the market. Unfortunately, the failure of an insolvent institution (or the troubles
of an (p. 156) institution which is about to become insolvent) can still bring difficulties to
solvent ones, because of information deficiencies and other market imperfections.43
4.23 As a response to the inefficiency and inadequacy of the regulation related to the
bank’s liquidity requirements during the global financial crisis, the Basel Committee on
Bank Supervision (BCBS) launched in December 2010 a new set of international financial
standards, Basel III, introducing two completely new liquidity requirements: the net stable
funding ratio (NSFR) and the liquidity coverage ratio (LCR).44 The NSFR is a ratio to
determine the proportion between the available stable funding and the long-term assets of
the banks, with the aim to improve the funding liquidity of the banks by limiting the level of
maturity transformation.45 The LCR is a ratio that demands banks to maintain a stock of
high-quality liquid assets considered to be sufficient to cover the net cash outflows in an
emergency situation,46 thus preventing sale of assets at fire sale prices in stress
scenarios.47
4.24 The theory that the lender of last resort role of the central bank is applied to cases of
temporary illiquidity is thus challenged by the practice. Central banks often provide support
to insolvent rather than illiquid institutions. In these circumstances, the short-term nature
of the LOLR assistance is likely to be insufficient to solve the troubles of such institutions.
Therefore, in practice, the LOLR will be the first step in a chain or process that is likely to
include a bank resolution proceeding.
4.25 The central bank should be held accountable for the use of its discretionary LOLR
powers. Such accountability needs to be articulated carefully, particularly in cases where
the central bank has no direct role in bank supervision; due consideration should also be
given to the degree of central bank independence from the Treasury or Ministry of Finance
with regard to the exercise of the LOLR function.
4.26 Because an inherent subsidy exists whenever the central bank lends to an insolvent
institution, under the EU rules on State aid, the granting of emergency aid to banking
institutions can be considered illegal in some cases.48 The Luxembourg Court of Justice
recognized in (p. 157) a groundbreaking decision, the Züchner case, that EC competition
rules are also applicable to the banking sector.49
4.27 The State aid policy of the EC runs parallel to the antitrust or competition policy.50
The State aid policy is built upon the general premise that aid granted by a Member State
which distorts competition or affects trade is incompatible with the common market, and is
thus prohibited. The granting of illegal aid may confer an unfair economic advantage to a
recipient undertaking, discriminating against those undertakings which do comply with the
rules. State aid will only be compatible with the common market if it has been notified to
and cleared by the Commission.
4.28 On 5 December 2007, the EU Commission in its approval of the rescue aid package
for Northern Rock significantly concluded ‘that the emergency liquidity assistance provided
by the Bank of England on 14th September 2007, which was secured by sufficient collateral
and was interest-bearing, did not constitute state aid’.51 The Commission Communication of
13 October 2008 further reiterated this point.52 In establishing a single market in financial
services, it is important that the TFEU’s State aid rules are applied consistently and equally
to the banking sector, though with a regard to the peculiarities and sensitivities of the (p.
158) financial markets.53 In August 2013, the Commission published another
Communication extending the ‘crisis rules’ for banks.54
Lender of last resort and the 2007–9 financial crisis
4.29 The financial crisis has changed our understanding of central banking, emergency
liquidity assistance and systemic risk. Unprecedented emergency liquidity assistance has
been a defining and evolving feature of the responses to the global crisis that commenced
in 2007. The expansion of central bank liquidity operations turned what ought to be
extraordinary into ‘ordinary’, ordinary in the sense that with the crisis—as we pointed out in
Chapter 2—central banks often became the lender of primary or only resort, and at times
market makers of last resort. Rather than discouraging its use, the central bank has been
keen to encourage various types of LOLR operations, whatever qualification one wishes to
attribute to them: ordinary or extraordinary. Furthermore, the contours between the
domain of monetary policy and the domain of emergency liquidity assistance became
increasingly blurred.
4.30 In the UK the Bank of England launched the Special Liquidity Scheme (SLS)55 in April
2008, to deal with the failure of the interbank markets to return to normality by injecting
liquidity to the banks in the UK, on a temporary basis. Funding was offered on a longer-
term basis in the euro area through long-term refinancing operations (LTROs)56 and in the
USA via the TAF (Term Auction Facility).57 The European Central Bank (ECB) in response to
the sovereign debt crisis in some euro areas Member States purchased assets through its
Securities Market Programme58 (to restore the monetary transmission mechanism), which
(p. 159) was later replaced by the Outright Monetary Transactions59 and provided ample
liquidity to the banking system, as further discussed in Part II of this volume.
4.31 The Federal Reserve System embarked on a massive programme of emergency
liquidity assistance during the financial crisis.60 To the traditional DWL for depository
institutions and open market operations (OMOs), a number of facilities and programmes
were added. The expanding list of facilities was characterized by the widening range of
acceptable collateral, the lengthening of the term of the loan and the ability to reach non-
depository financial institutions (such as Bear Stearns, the investment bank, and AIG, the
insurance company).
4.32 For example, in October 2008, the Fed opened the commercial paper funding facility;
in November 2008, the Fed announced the Term Asset-Backed Securities Lending Facility
(TALF), with a longer duration than any previous facility, at least one year, and available to
all US persons. Many of these facilities had broad eligibility and were often characterized
by the widening range of acceptable collateral and the lengthening of the term of the
lending.
4.33 As it has been already mentioned, the legal basis invoked since March 2008 to justify
the establishment of new facilities and the extension of emergency liquidity assistance to
non-bank financial institutions was section 13.3 of the Federal Reserve Act (an authority
which has been curtailed by the Dodd–Frank Act 2010).
4.34 It is also worth recalling that in September 2008 following the collapse of Lehman
Brothers some US financial firms such as Goldman Sachs61 and Morgan Stanley62 became
bank holding companies in order to benefit from the Fed’s liquidity facilities.
4.35 Mark Carney, Governor of the Bank of England, in his Mansion House speech on 12
June 2014, stated that non-banks should also have access to the Bank of England’s
facilities.63
(p. 160) The question of ambiguity
4.36 A final word on ‘constructive ambiguity’, a term often used to refer to lender of last
resort operations. In my opinion, ambiguity is seldom (if ever at all) constructive. There is a
need to be clear about the responsibility for lender of last resort before any crisis arises.
There is also a need to be clear about the procedures, about the way things will work out
and about which institutions can apply for ELA. Then, of course, the very provision of
assistance should remain at the discretion of the authorities. It is this discretionary element
—this uncertainty about whether or not the emergency liquidity assistance will be provided
—that reduces the moral hazard incentives inherent in any support operation. But there
should not be any doubt about who is in charge and how the assistance will be provided.
The law ought to be clear about these issues. I quite like the term ‘constructive certainty’
coined by Tom Huertas in the context of resolution.64
D. Deposit Insurance

4.37 Deposit insurance has been the subject of much debate in the literature.65 In 1959,
Milton Friedman expressed a widely held view when he asserted that the introduction of US
federal deposit insurance after the bank crisis of 1929–33, as part of the New Deal
legislation under President Franklin D Roosevelt, was ‘the most important structural
change in our monetary system in the direction of greater stability since the post-Civil War
tax on state bank notes’.66
4.38 Deposit insurance has been adopted by law in many jurisdictions around the world,
particularly in the last two decades. However, its very existence has been a matter of
controversy, though views have changed with the global financial crisis. Indeed, the Basel
Committee on Banking Supervision did not include deposit insurance as a key principle in
its 1997 (p. 161) Core Principles of Effective Banking Supervision67 but has now included it
as a key element of the framework for systemic protection.68 Further, in March 2009, the
Basel Committee and the International Association of Deposit Insurers published the ‘Core
Principles for Effective Deposit Insurance Systems’.69
4.39 Deposit insurance has become a ‘political fact of life’ in our current regulatory
structure. Politicians of all colours know that depositors must be protected. Such protection
is best articulated through an explicit and well-designed deposit insurance scheme, ideally
to be funded from contributors from the industry (more in good times, less or no
contributions in bad times).
4.40 Though pre-funding (where contributions are levied on the banks in advance) is
naturally opposed by the banking industry as a cost or burden, it has the advantage of
internalizing the cost of protection, thus reducing moral hazard incentives. At the end of the
day, the main beneficiaries of deposit insurance are depositors and the depositary
institutions themselves.70 Post-funding, where after the event levies are made on the
industry or paid by the taxpayer creates problems of access to immediate cash.
4.41 The public expects that their money will be safe with any bank that has a banking
licence. Thus, in the event of a bank failure, it is politically damaging for the government of
the day to allow depositors to suffer losses.
Structure of deposit insurance
4.42 A deposit guarantee scheme can be defined as an insurance policy written to certain
depositors by the other banks in the national banking system concerned.71 The structure of
deposit guarantee schemes varies greatly from country to country, with differences with
regard to their funding, coverage, and administration.72 This chapter does not analyse all
(p. 162) the policy and structural features of deposit insurance. Instead, it focuses on three
legal issues that are relevant from the point of institutional design. The first issue is the
difference between explicit and implicit deposit insurance. The second issue is the status of
preferred creditors that insured depositors have under an explicit deposit guarantee
scheme. The third issue is the mandatory nature of deposit insurance, as opposed to the
contingent nature of the lender of last resort role of the central bank.
Explicit versus implicit deposit insurance
4.43 Explicit deposit insurance is the formal creation of a deposit guarantee scheme by
law, with specific rules concerning the extent of the ‘insurance’ or protection, the operation
of the scheme, and the type of deposits/depositors protected. Explicit deposit insurance can
be useful as an instrument of protective bank regulation. Explicit deposit insurance has
traditionally served two purposes: consumer protection and the prevention of bank runs.
The latter contributes to the broader objective of financial stability.
4.44 These objectives were reflected in a set of core international principles for an
effective deposit insurance system agreed between the International Association of Deposit
Insurers and the Basel Committee and first published in 2009.73
4.45 The rationale behind the first objective is the presumed inability of ordinary
depositors to monitor the riskiness of banks in which they place their funds as well as the
potentially severe cost of deposit losses to individual savers. The case for consumer
protection on the basis of information asymmetries, lack of sophistication, is well known.
But there is more to it: a depositor is not generally interested in getting a return/yield;
rather, a depositor enters into a deposit agreement expecting the bank to act as guardian/
custodian and cashier for credit/debit operations. The risk profile of investors (in capital
markets) is somewhat different from the risk profile of most depositors, since the former
expect a return on their investments, while the latter do not [generally] wish to take risks
with their deposits.
4.46 The rationale behind the second objective is the inherent fragility of the banking
system. Because of the ‘first come, first serve’ nature of bank liabilities, and because bank
main assets (loans) are highly illiquid, and worth less at liquidation than on a going concern
basis, depositors have a rational propensity ‘to run’ at the first sign of trouble. Bank failures
become highly contagious, thereby exposing the financial system to the risk of depositor
panics. In terms of design, this second objective requires credibility (which in turn entails
sufficient coverage) and public awareness. A third rationale of explicit deposit insurance (in
addition to consumer protection and prevention of bank runs) is that it allows the public
authorities to close banks—typically small banks given the difficulties of dealing with too-
big-to-fail institutions—more easily, as it becomes politically acceptable to liquidate
insolvent institutions, in the knowledge that unsophisticated depositors are protected. In
terms of design this requires prompt payment.
(p. 163) 4.47 Under an explicit deposit guarantee scheme, depositors are only paid once
the bank is closed and liquidated. Thus, there can be no deposit insurance if the bank
remains open.74
4.48 Implicit deposit insurance, as opposed to explicit deposit insurance, is a ‘blanket
guarantee’ for all sorts of depositors (insured and uninsured), other creditors, shareholders,
and even managers. Implicit deposit insurance often presupposes that the bank remains in
business (either because it is ‘too big to fail’ or because it is politically difficult to close the
bank) thus creating pervasive moral hazard incentives. While explicit deposit insurance is
applied ex post (following the closure of a bank), implicit deposit insurance is often applied
while a bank is still in operation.
4.49 Explicit deposit insurance inflicts limited damage upon taxpayers, and depends on the
funding of the scheme. Implicit deposit insurance on the other hand has the potential of
shifting the burden onto taxpayers.
4.50 The existence of an implicit government guarantee in the case of institutions that
qualify as ‘too big to fail’ (TBTF) or ‘too important to fail’ is a further challenge in the
institutional design of deposit insurance.
Indeed, as we have already pointed out, there are good economic reasons for protecting
depositors in both large and small banks. The difficulty is that while a cash pay-out can
suffice in the case of smaller banks (a small bank may be allowed to ‘fail’ provided
depositors are promptly and fully compensated and arrangements are made to ensure that
these depositors continue to have access to banking services), large banks that are
considered ‘too big to fail’ often need to be maintained as going concerns in order not to
lead to loss of essential lending and payment functions.75 This implicit government
guarantee is a massive problem in the design of our current banking system76 and also
leads to serious concerns about unfair competition for banks that are not TBTF and
therefore do not enjoy this implicit guarantee.
Preferred creditors
4.51 Explicit deposit insurance is a guarantee limited to one type of creditors—insured
depositors—which by definition become ‘preferred’ in that, in the event of liquidation, their
claims will be paid out by the insurance fund (up to the amount covered under a deposit
protection scheme). Under explicit deposit insurance, uninsured depositors, other creditors,
shareholders, and managers are not protected by the insurance fund or scheme. Therefore,
in principle, explicit deposit insurance is more compatible with market discipline, as
uninsured depositors and other creditors have an interest in monitoring the solvency of the
bank while it is still in operation.
4.52 Explicit deposit insurance can co-exist with bank resolution and insolvency laws that
give preference to depositors and also with laws that do not establish such depositor
preference in their bankruptcy or resolution procedures. In some jurisdictions, insolvency
laws have (p. 164) a system of depositor preference, while in some other jurisdictions,
depositors’ claims run pari passu with other creditors’ claims.77,78
77 78
4.53 Explicit deposit insurance, by limiting the protection to ‘insured depositors’, exposes
uninsured depositors, general creditors, subordinated debt-holders, shareholders, and
management to increased risk exposure, thereby encouraging them to monitor and limit the
riskiness of the bank (to avoid risking being removed from office).79 These incentives are
very important, particularly in the case of shareholders, whose limited liability renders bank
managers to be more prone to lend on a high risk–high return basis.80
4.54 Explicit deposit insurance must be set at a level that enables national authorities to
accept the political consequences of bank liquidations.
Mandatory versus contingent guarantee
4.55 Deposit insurance provides a guarantee on certain deposits that is non-contingent. It
provides legal certainty as to the way that depositors will be protected and the amount
covered, should a bank be closed. Lender of last resort, on the other hand, is contingent.
The injection of liquidity in times of crisis is not mandatory, but discretionary, that is,
subject to the discretion of the central bank authority. There is always a degree of
uncertainty regarding the provision of emergency liquidity assistance by the central bank.
4.56 While explicit deposit insurance protects mainly the depositors, lender of last resort
protects mainly the financial system (systemic considerations, comprising a broader set of
constituencies and stakeholders).
To minimize the risk of moral hazard, it is important to demarcate what each institutional
arrangement can do and what it cannot do or should not do (an issue which has been
already discussed at para 4.08 above). Explicit deposit insurance can protect insured
depositors, but it cannot—nor should—protect other depositors or creditors, or
shareholders, or managers.
(p. 165) 4.57 The design of explicit deposit insurance is also relevant from the perspective
of resolution, since many banks are funded primarily by deposits rather than by wholesale
markets.
4.58 In my opinion, deposit guarantee schemes should be mandatory and explicit in
nature, credible and limited in the amount covered.81 We return to this issue in Chapter 10
of this book when talking about the third pillar of banking union in the EU.
E. Bank Resolution and Insolvency

Lex specialis versus lex generalis
4.59 Bank resolution and insolvency laws differ from country to country. In some
jurisdictions, banks are treated like other corporations, subject to the general insolvency
law (lex generalis). Ordinary insolvency principles are then applied to banks (with some
modifications for financial contracts, netting and setoff) typically under judicial proceedings
(the approach prevalent till the global financial crisis in some European countries). In other
jurisdictions, banks are subject to a special insolvency regime, administered by the bank
supervisor or the depositor protection agency.
4.60 Court involvement (judicial procedures) tends to prevail when banks are subject to
lex generalis, while extra-judicial procedures (administered by an agency) tend to be the
rule when banks are subject to lex specialis.
4.61 In the USA, since 1933, banks have not been subject to general corporate bankruptcy
procedures (such as Chapter 11 of the US bankruptcy code) but to special bank insolvency
proceedings that take into account the nature of bank deposits and the systemic
implications of bank failures.82 This special administrative resolution procedure is
administered by the Federal Deposit Insurance Corporation (FDIC). FDIC acts not only as
insurer of deposits and administrator of the deposit insurance system (as well as a Federal
Bank supervisor), but also as ‘receiver’ when a bank fails. In some cases, the FDIC may also
be appointed as ‘conservator’. A receiver is typically appointed for the purpose of
liquidation, while a conservator is appointed to conserve assets and to try to put the
institution back in order.
4.62 The Dodd–Frank Act 2010 expanded the remit of lex specialis through the
establishment of the Orderly Liquidation Authority (OLA). Title II of the Dodd–Frank Act
grants OLA to the FDIC in situations in which a financial company is failing and federal
regulatory agencies and government authorities first determine that the granting of such
authority is necessary.
(p. 166) 4.63 In the UK, bank insolvencies before the global financial crisis were treated
under the same rules as other companies. The crisis, however, strengthened the case for lex
specialis. A special resolution regime for banks was introduced through the adoption of the
Banking Act 2009.
4.64 Reforms have taken place in a number of jurisdictions worldwide.83 Indeed, the need
to develop a special framework to deal with failing banks has been fostered by international
efforts, as further discussed below.
4.65 The term ‘resolution’ has become a term of art in the aftermath of the financial crisis.
Bank resolution sits at the end of the spectrum of the supervisory process (supervision and
crisis management as part of a seamless process) when we are already in crisis
management but before actual insolvency. Resolution is typically part of the ‘pre-insolvency
phase’ for failing banks though in some instances resolution also encompasses actual
insolvency. Crisis management is not always linear, and in some cases several instruments
can be used simultaneously (for example, a liquidity injection can take place at the same
time as a resolution tool is applied).
4.66 Resolution tools by definition try to secure access to critical banking functions and try
to preserve the value of banking institutions for the welfare of society. Orderly resolution is
a fundamental part of sound crisis management for banks and for other financial
institutions.
4.67 A significant development in this field was the publication in April 2009 by the
International Monetary Fund (IMF) and the World Bank of a study entitled ‘An Overview of
the Legal, Institutional, and Regulatory Framework for Bank Insolvency’,84 which provided,
for the first time, clear guidance with regard to international best practices for establishing
frameworks to deal with bank insolvency.
Objectives of bank insolvency laws
4.68 According to the IMF/World Bank Report, the primary objective of a bank insolvency
framework is to safeguard the stability of the financial system; this includes ‘the smooth
functioning of payment and settlement systems; the protection of the depositing public; and
the preservation of the credit intermediation function’.85
General insolvency laws seek to fulfil two principal objectives:86 fair and predictable
treatment of creditors and maximization of assets of the debtor in the interests of
creditors.87
(p. 167) 4.69 The case for lex specialis is based upon the need to preserve access to
critical banking functions during a crisis88, financial stability considerations and—in some
jurisdictions like the USA—the principle of minimization of costs to the public purse/to
taxpayers.
4.70 Eisenbeis and Kaufman claim that the public policy objective of resolving banks
should be to reduce costs (both public and private) and permit free entry and exit of failed
banks at minimal costs to society.89 The bank should be closed as the market value of its net
worth tends to zero, because at this moment, direct losses are only born by shareholders. If
the bank is declared legally insolvent when the market value of its net worth is already
negative, losses will accrue not only to shareholders, but also to uninsured creditors and/or
to the insurance fund/the government.90 This objective was reflected in the USA with the
adoption of FDICIA in 1991. FDICIA includes the possibility of adopting ‘prompt corrective
action’ (PCA) if the level of bank capitalization falls below thresholds specified in the
statute, including the possibility of structured early intervention and resolution (SEIR)
before the capital reaches zero.
4.71 In banking, the definition of insolvency (the trigger point for a resolution or
insolvency proceeding) is a matter of controversy,91 and the line of demarcation between
illiquidity (lack of liquid funds) and insolvency is not always clear—as it has already been
pointed out. An economically insolvent bank is not always declared legally insolvent by the
responsible authorities and may instead be offered financial assistance. A bank is
considered to have failed when the competent authorities order the cessation of its
operations and activities. However, the authorities are often wary of liquidating a bank (in
part because an ‘orderly liquidation of assets’ is not always easy, owing to the possible
contagion effect on other institutions) and therefore choose instead to rehabilitate the bank.
4.72 Liquidation is costly: a valuable depositor base gets dissipated, vital banking services
in a community may be disrupted, and confidence in the banking system may be seriously
damaged.92 Occasionally, the liquidation of one institution may trigger runs on other
institutions.93
(p. 168) 4.73 Indeed, though a clear policy that banks that have failed ought to exit the
banking system might appear desirable in some cases: the social cost of closing a bank is
significant, as banks are often—particularly in emerging economies—the main repository of
the savings of the public and a major source of credit to the economy. That is why failed
banks are often not liquidated, but subject to reorganization or rehabilitation.
Rescue packages and resolution procedures
4.74 Because liquidation is costly (though it might be the only appropriate solution in some
cases, for example instances of massive fraud such as Bank of Credit and Commerce
International), other resolution procedures that include some form of reorganization,
restructuring, or rehabilitation are recommended. The need to preserve the value of
banking institutions and access to their critical banking functions is a fundamental rationale
of these procedures. Before we discuss the resolutions tools or procedures recommended
after the global financial crisis, let us briefly examine the notion of bail-out.
4.75 The term ‘bail-out’ comprises forms of liquidity and solvency support provided by the
central bank, the government or a governmental authority that put at risk taxpayers’
money. Private rescue packages (like the recapitalization of long-term capital management
(LTCM) in 1998) are not ‘bail-outs’ according to this definition.
Rescue packages can take a variety of forms including new loans, soft loans, deposits, asset
or securities purchases, assumption of liabilities, and capital injections. In many cases the
management of the institution is revamped.
4.76 Bail-outs or public ‘rescue packages’—ubiquitous during the global financial crisis—
are a suboptimal solution for a number of reasons, notably the pernicious link or doomed
loop between banking crises and sovereign debt crises, in ample evidence during the
Eurozone debt crisis (2010–12).94
4.77 The granting of ‘State aid’ (ie, funding coming directly or indirectly from the
government) in a ‘rescue package’ is indeed most controversial. A delicate balance between
the interests of taxpayers, on the one hand, and the interests of depositors as well as other
bank creditors and bank shareholders, on the other hand, needs to be reached.
4.78 As noted in paragraph 4.28 above, when the EU Commission approved the rescue aid
package for the UK mortgage lender Northern Rock in December 2007, it stated that:
…the emergency liquidity assistance provided by the Bank of England on 14th
September 2007, which was secured by sufficient collateral and was interest-
bearing, does not constitute state aid. …However the guarantee on deposits granted
by the Treasury on 17th September, as well as the measures granted on 9th
October, which provided further liquidity and guarantees to Northern Rock and
were secured by a Treasury indemnity, do constitute state aid.95,96
95 96
(p. 169) 4.79 Government-led rescue packages may not only induce moral hazard
behaviour, but may also pose questions of fair competition, particularly when the too-big-to-
fail doctrine (and its many variants: too complex to fail, too important to fail, too
interconnected to fail, like in the Bear Stearns rescue, etc) is applied, as other smaller or
less troubled institutions may have to navigate through crises or problems on their own.
4.80 In the USA, FDICIA (1991) requires the resolution of bank failures on a ‘least cost
basis’ to the insurance fund, unless it threatens to trigger a payment system breakdown, in
which case FDIC and Fed may recommend a more costly solution.97
4.81 But how do you move beyond bail-out? The answer appears to lie in the design of
good resolution procedures. A resolution ‘toolkit’ should include a variety of strategies
including:98 sale of assets, sale of whole business (private sector purchase of assets and
assumption of liabilities—takeover or merger99), establishment of a ‘bridge’ bank,
temporary public ownership or nationalization,100 asset separation (transfer of bad assets to
another institution), and bail-in. In addition there should be recovery and resolution plans
(RRPs), also known as living wills.101
4.82 The Key Attributes—further discussed in paragraph 4.104 below—recommend that
‘[r]esolution authorities should have at their disposal a broad range of resolution powers’102
and state that ‘the objective of an effective resolution regime is to make feasible the
resolution of financial institutions without severe systemic disruption and without exposing
taxpayers to loss, while protecting vital economic functions through mechanisms which
make it possible for shareholders and unsecured and uninsured creditors to absorb losses
in a manner that respects the hierarchy of claims in liquidation’.103 According to the Key
Attributes:
The resolution regime should include: (i) stabilisation options that achieve
continuity of systemically important functions by way of a sale or transfer of the
shares in the firm or of all or parts of the firm’s business to a third party, either
directly or through a bridge institution, and/or an officially mandated creditor-
financed recapitalisation of the entity that continues providing the critical functions;
and (ii) liquidation options that provide for the orderly (p. 170) closure and wind-
down of all or parts of the firm’s business in a manner that protects insured
depositors, insurance policy holders and other retail customers.104
The bail-in tool symbolizes the ‘philosophical’ change, from ‘bail-out’ to ‘bail-in’, from a
public solution where taxpayers bear the cost to a private solution where creditors bear the
cost, and illustrates the practical difficulties and challenges in designing credible resolution
tools.105
4.83 Bail-in is a resolution technique, a stabilization tool that offers a way for rapid
recapitalization and avoids value destruction by keeping an institution as a going
concern.106 Bail-in has been defined as a power, statutory and/or contractual, pursuant to
which—either automatically or subject to the exercise of discretion—specified liabilities of a
bank are partially or fully extinguished or converted into equity, upon the occurrence of a
specified trigger event.107 The discussion about the trigger event has been regarded as one
of the most controversial aspects in the design of bail-in powers.108 In the EU context,
however, the design of the bail-in tool has now been settled according to the Bank Recovery
and Resolution Directive (BRRD).109
(p. 171) 4.84 Bail-in by definition addresses capital rather than liquidity. Hence, it needs to
be complemented with liquidity provision by the central bank. Indeed, the two key
challenges when discussing the effectiveness of bail-in are liquidity and credibility (given
the stigma likely to be associated with the use of bail-ins).110 Credibility in turn is related to
the ‘sufficiency’ of ‘bail-in able’ debt, a key issue when it comes to the funding of many
European banks, which still rely to a large extent on deposit funding.
4.85 Whether bail-in debt or CoCos111 will provide adequate loss absorbency capacity in a
crisis remains to be tested. Let us hope that they do not go down the route of subordinated
debt (the ‘darling’ of many advocates of market discipline in the design of bank capital
regulation before the crisis) which did not work well during the financial crisis neither as a
loss absorber nor as a buffer.
Cross-border bank resolution and insolvency
4.86 If crisis management at the national level is complex, with the involvement of several
authorities, the interests of many stakeholders, a variety of instruments, and diverse goals,
this complexity is far greater in the case of cross-border bank crisis management.112 Such
complexity affects lender of last resort (where cross-border provision of liquidity remains a
major challenge), deposit insurance arrangements (an even bigger challenge) and
resolution and insolvency proceedings.113
(p. 172) 4.87 Financial markets and institutions have grown more international in recent
years, but their supervision, regulation, and crisis management remain constrained by the
domain of domestic jurisdictions (although, in Europe, the advent of banking union aims to
align banking markets and their supervision and resolution—and eventually deposit
insurance, too).114 In good times, this dichotomy may not present acute problems; the
situation, however, is very different in bad times. In any financial crisis, it is necessary to
have a clear and predictable legal framework in place to govern how a financial institution
would be resolved in an orderly fashion so as not to undermine financial stability.
4.88 Insolvency and resolution procedures have traditionally been nationally based, entity-
centric and sector specific. When it comes to the design of adequate cross-border bank
resolution and insolvency, we need both the harmonization of bank resolution insolvency
rules and regimes, as well as the effective coordination between insolvency proceedings
involving different jurisdictions (clear private international law rules).115
4.89 In the absence of an international insolvency ‘hard-law’ legal regime, the solution to
the resolution of a bank with branches and subsidiaries in several countries is based on
national legal regimes—albeit increasingly subject to comparable resolution regimes and
rules, as per the international efforts discussed below—and on the voluntary framework for
cooperation between different national authorities (often along the lines of Memoranda of
Understanding, MoUs). This cooperation is often uneasy, and the division of responsibilities
between home and host country authorities remains a matter of controversy. At the
European level, single resolution is now the second pillar of banking union, as further
discussed in Chapter 10.
4.90 Though considerable progress has been achieved in the last five years—at the
European level with the BRRD116 and at the international level via soft-law
recommendations such as the FSB Key Attributes—the field of cross-border resolution and
insolvency is still in its infancy.
4.91 The crisis taught us that institutions may claim to be global when they are alive (as in
the case of Lehman Brothers); but they become national when they are dead, as the former
Governor of the Bank of England, Mervyn King, famously put it. In the aftermath of Lehman
Brothers, no one wishes another chaotic resolution. The alternative, a ‘bail-out’ package, is
equally unpalatable, as discussed earlier. By analogy with the World Trade (p. 173)
Organization’s (WTO) dispute settlement, which is a central pillar of the multilateral trading
system, in the field of international finance we need to devise appropriate institutional
mechanisms for the settlement of financial disputes and adequate ‘hard-law’ rules. (In this
regard, the BRRD is a fundamental step in the right direction.)
4.92 The crisis has shown that the pursuit of the private interest is at times greatly
misaligned with the pursuit of the common good and that, with cross-border banks and
financial institutions, national solutions alone or uncoordinated national solutions are not
enough to combat systemic risk.
Developments before the 2007–9 crisis
4.93 Whenever one surveys the legal issues related to the regulation, supervision, and
resolution of cross-border banking, one needs to refer to the work of the Basel Committee
on Banking Supervision as the de facto informal ‘international bank regulator’.117 The Basel
Committee’s Cross-border Bank Resolution Group developed a set of recommendations that
resulted from its stocktaking of legal and policy frameworks for cross-border crises
resolutions and its follow-up work to identify the lessons learned from the global financial
crisis.118 A number of principles developed by the Basel Committee throughout the years to
deal with the cross-border supervision of branches and subsidiaries can be applied when
dealing with cases of insolvency of a bank operating in different jurisdictions. In particular,
the principle of ‘parental responsibility’ (or home-country control) in the supervision of
branches—as legally dependent units—and the consideration that subsidiaries become
independent legal entities under the laws of the country of incorporation (ie, under the laws
of the host country) are principles observed generally and often included in Memoranda of
Understanding between supervisory authorities in different countries.119 The principle of
consolidated supervision has also been taken into account120 with regard to the Crisis
Management Groups (FSB Key Attributes).
4.94 The principle of consolidated supervision means that parent banks and parent
supervisory authorities monitor the risk exposure of the banks or banking groups for which
they are responsible, as well as the adequacy of their capital, on the basis of the totality of
their business wherever conducted. Consolidated supervision is based on the assumption
that financial groups form a single economic entity. However, when one comes to the
question of the liquidation of a failed multinational bank, or of a complex financial group
with activities and business units with different legal entities incorporated in several (p.
174) jurisdictions—the example of Lehman Brothers—the assumption that financial groups
form a single economic entity is not valid in a bankruptcy scenario, since the group is split
up into its many legal entities, and foreign branches are sometimes treated/liquidated as
separate units.121
4.95 US law applies the single entity approach to the liquidation of a US bank with foreign
branches.122 The Federal Deposit Insurance Corporation as receiver of a failed bank
collects and realizes all assets, and responds to all claims of the institution regardless of
their situs.123 However, US law typically (as well as the law in other jurisdictions) applies
the separate entity approach to the liquidation of US branches of a foreign bank.124 The
inconsistency of the US legal approach to the liquidation of multinational banks, depending
on whether it is dealing with foreign branches in the US or with US branches of a foreign
bank, illustrates the difficulties of reaching a common international platform with regard to
the resolution of multinational banks.125 Indeed, in the words of Charles Randell, this
regime subjects ‘a (p. 175) failed foreign branch, with locally held capital and liquidity, to a
territorial insolvency proceeding, in effect seeking to replicate the insolvency of a
subsidiary’.126
4.96 Before the financial crisis, there was some work that was carried with regard to
cross-border insolvency generally. The Model Law on Cross-Border Insolvency, that the
United Nations Commission on International Trade Law (UNCITRAL) adopted in Vienna in
May 1997,127 deals with the recognition of foreign insolvency proceedings, the cooperation
between judicial authorities and administrators, and other issues concerning the
coordination of concurrent insolvency proceedings in multiple jurisdictions. However, it
contains an optional clause whereby special insolvency regimes applicable to banks may be
excluded from its scope.
4.97 In 1999, UNCITRAL commenced work on the Legislative Guide on Insolvency Law,
considering corporate insolvency. Work proceeded through a joint colloquium with the
Association of International Insolvency Practitioners (INSOL, a worldwide federation of
national associations for accountants and lawyers who specialize in insolvency) and the
International Bar Association (IBA). The Legislative Guide was completed in 2004 and
adopted by the United National General Assembly on 2 December 2004.128
4.98 The World Bank has coordinated the effort of the UNCITRAL Legislative Guide with
its own Global Bank Insolvency Initiative to articulate a set of standards on insolvency and
creditor rights for the purposes of the bank/ fund initiative on Standards and Codes.
Accordingly, the World Bank, in collaboration with staff of the Fund and UNCITRAL and
other experts, has prepared a document, setting out a unified insolvency and creditor rights
standard (the ‘ICR Standard’), which integrates the World Bank Principles for Effective
Creditor Rights and Insolvency Systems (one of the twelve areas under the joint World Bank
and International Monetary Fund initiative on standards and codes) and the UNCITRAL
Recommendations (included in the UNCITRAL Legislative Guide on Insolvency). This
document was published on 21 December 2005. UNCITRAL Working Group V on insolvency
started working on the treatment of corporate groups in insolvency in 2006, examining both
domestic and cross-border issues.
4.99 The ICR standard (one of the twelve areas identified by the bank and the fund in their
joint initiative)129 is used for the purposes of assessing member countries’ observance in
the Reports on the Observance of Standards and Codes (ROSCs). The ICR standard
recognizes that banks may require special insolvency laws when it talks about
‘exclusions’ (in point 3): ‘Exclusions from the application of the [general] insolvency law
should be limited and clearly identified in the insolvency law.’ The explanatory footnote
concerning these ‘exclusions’ further states: ‘Highly regulated organizations such as banks
and insurance (p. 176) companies may require specialized treatment that can appropriately
be provided in a separate insolvency regime or through special provisions in the general
insolvency law.’
4.100 In Latin America, two multilateral treaties, the Montevideo Treaties of 1889 and
1940, and the Bustamante Code sanctioned by the sixth Panamerican Conference (Havana
Conference) of 1928, established private international law rules concerning bankruptcy.130
These treaties provide for the recognition and enforcement of foreign bankruptcies.131
4.101 The difficulty in reaching some common standards in this area of law was illustrated
by the hurdles and delays that the EU has faced over the years in trying to agree on some
common principles on bank insolvency. Indeed, only in 2001132 was the Directive on the
Winding Up and Liquidation of Credit Institution adopted,133 though the proposed directive
was published in 1988. This Directive did not seek to harmonize national legislation
concerning reorganization measures and winding-up proceedings; rather, it ensured mutual
recognition and coordination of these procedures by Member States, based upon the
principle of home-country control. In addition to this Directive, the EU insolvency regime
consists of one regulation on insolvency proceedings134 and one directive concerning the
reorganization and winding-up of insurance undertakings (Directive 2001/17/EC of 19
March 2001).135
4.102 These EU rules were mainly of a private international law character. They
introduced the principles of unity and universality of bankruptcy (discussed in para 4.95
above), but they did not seek to harmonize in a substantive way national legislation
concerning insolvency proceedings, different across the Member States of the EU.
Developments after the 2007–9 crisis
4.103 In response to the global financial crisis, soft-law initiatives dealing with cross-
border resolution have proliferated. Three important documents were published in 2010:
the IMF released a paper dealing with cross-border resolution in July 2010136; in March
2010, the Cross-Border Resolution Group of the Basel Committee launched a set of
recommendations (p. 177) to improve the cross-border crisis management and resolution
regimes;137 and in November 2010, the FSB published a set of recommendations to
promote effective resolution regimes on systemically important financial institutions
(SIFIs).138 The recommendations by the Basel Committee and the FSB were endorsed by
the G20 Leaders in June 2010 and in November 2010, respectively. Following these
endorsements, the Basel Committee was mandated to conduct an assessment on the
implementation of such recommendations, which it did with a report published in July
2011.139 The Basel Committee recommended that the supervisory authority work together
with the government and the relevant authorities to adopt a clear framework for crisis
management, recovery and resolution.140
4.104 In October 2011, the Financial Stability Board (FSB) released the ‘Key Attributes of
Effective Resolution Regimes for Financial Institutions’ (‘Key Attributes’).141 The Key
Attributes constitute a new internationally agreed standard (soft law) that lays out the
responsibilities, tools, and powers that national resolution regimes should have to enable
authorities to resolve a failing SIFI in an orderly manner, protecting vital economic
functions and without having to resort to taxpayers’ money. Countries are expected to
incorporate these standards into national law, and the IMF is also likely to include the
adoption of resolution tools for banks and financial institutions as ‘conditions’ in its
programmes of financial assistance.
4.105 The Key Attributes set out twelve essential features of national resolution regimes:
(1) scope; (2) resolution authority; (3) resolution powers; (4) set-off, netting,
collateralization, segregation of client assets; (5) safeguards; (6) funding of firms in
resolution; (7) legal framework conditions for cross-border cooperation, (8) crisis
management groups; (9) institution-specific cross-border cooperation agreements; (10)
resolvability assessments; (11) recovery and resolution planning; and (12) access to
information and information sharing.
4.106 To assess the considerable progress achieved in this area, it is useful to follow a
four-pillar approach to cross-border resolution and insolvency, favoured in the IMF
document,142 and consisting of (1) harmonization, (2) recognition, (3) cooperation and
information sharing, and (4) funding and burden sharing.
The Key Attributes do address harmonization, recognition, and cooperation. However, there
is still a long way to go when it comes to funding and burden sharing (the fourth pillar).
(p. 178) 4.107 The Key Attributes have achieved a degree of harmonization (via soft law),
but further work is need in some areas, in particular the triggers for resolution and
insolvency (we need a commonly agreed definition of resolution and insolvency akin to the
definition of capital), the rights of creditors and debtors (principle of non discrimination
against foreign creditors), creditor hierarchy, and burden sharing.
4.108 In terms of the second pillar, the recognition of foreign resolution measures is still
problematic and uncertain, conditioned by traditional private international rules
(reciprocity, public order, etc), and limited by the administrative nature of bank resolution
measures. Recognition of administrative foreign insolvency measures requires clear,
predictable, and ex ante rules that accelerate the recognition process, thereby eliminating
uncertainties. The Key Attributes anticipate a recognition process, but the enforcement
mechanism is still missing.
4.109 The focus of the Key Attributes is cooperation and information sharing at the
international level. However, more is needed to change the ad hoc nature of cross-border
resolution and insolvency of banks and other financial institutions. In a crisis ex ante
binding commitments and rules work better than ex post ad hoc solutions. In order to
observe the Key Attributes, jurisdictions need to remove obstacles to cross-border
cooperation and revise their legal framework. The Key Attributes fundamentally reinforce
the role of the college of supervisors for the resolution and insolvency, by calling for the
establishment of broader crisis management groups (CMGs) and institution-specific
cooperation arrangements. Since supervision and crisis management are part of a seamless
process, consolidated supervision must be accompanied by consolidated resolution. Though
CMGs and MoUs may ensure ex ante cooperation and information sharing, the financial
crisis exemplified that such cooperation and information sharing rely upon an amount of
goodwill that tends to evaporate during a crisis. National authorities tend to address
negative externalities in their territory without considering the impact of cross-border
failure upon foreign jurisdictions. Moreover, there is always time-inconsistency in their
behaviour, rendering the enforcement of promises made upon non-binding arrangements
difficult. The Key Attributes also allow national authorities to take independent action to
protect national financial stability, which is not compatible with the universality approach to
insolvency.
4.110 In my opinion, the need for ex ante binding rules providing predictability and legal
certainty calls for a convention or treaty. Such convention or treaty should be of a limited
scope, covering the actual conduct of a cross-border resolution and leaving aside the more
controversial aspects, notably burden sharing (in the case of bail-out). A convention could
be signed—to begin—by a selected group of countries that have advanced sufficiently in this
area (say USA, UK, Switzerland and, possibly, also EU).143
4.111 In connection with the implementation of the Key Attributes, the FDIC (in the US)
and the Bank of England (in the UK) issued a joint paper in December 2012. This paper
focuses on the application of ‘top-down’ resolution strategies that involve a single resolution
authority (p. 179) applying its powers to the top of a financial group, that is, at the parent
company level. Also, the paper discusses how such a top-down strategy could be
implemented for a US or a UK financial group in a cross-border context.144
4.112 At the EU level, the BRRD145 is the centrepiece of the new regulatory regime in this
area. It co-exists—as discussed further in Part II of this book—with the Single Resolution
Mechanism, the second pillar of banking union.146 The BRRD provides national authorities
with common powers and instruments to pre-empt bank crises and to resolve any financial
institution in an orderly manner in the event of failure, while preserving essential bank
operations and minimizing taxpayers’ exposure to losses.147
F. Systemic Risk and Systemic Crises
4.113 ‘Systemic risk’ (‘contagion risk’) in a general sense is a phenomenon not confined to
economics or to the financial system. For instance, with regard to the area of health,
throughout history there have been epidemic diseases (the Great Plague in the Middle
Ages, the Spanish flu after the First World War) where widespread contagion and
contamination have had devastating effects.
Systemic risks are for financial market participants what Nessie, the monster of
Loch Ness, is for the Scots (and not only for them): Everyone knows and is aware of
the danger. Everyone can accurately describe the threat. Nessie, like systemic risk,
is omnipresent, but nobody knows when and where it might strike. There is no proof
that anyone has really encountered it, but there is no doubt that it exists.148
4.114 In the economic literature, systemic risk is predominantly analysed as a feature of

the financial system. The fear that problems in a few institutions can spread to other
institutions and potentially bring the entire financial system to a halt, has prompted much
empirical and theoretical economic research. The Great Depression in the 1930s provides a
widely cited historical example that this fear is not without foundation. Friedman and
Schwartz conclude their excellent study of the Great Contraction, with the following words:
It is a sound general principle that great events have great origins. …Yet it is also
true that small events at times have large consequences and that there are such
things as chain reactions and cumulative forces. It happens that a liquidity crisis in
a fractional reserve banking system is precisely the kind of event that can trigger—
and often has triggered—a chain reaction. And economic collapse often has the
characteristic of a cumulative process. …Because (p. 180) no great strength would
be required to hold back the rock that starts a landslide, it does not follow that the
landslide will not be of major proportions.149
4.115 Within the financial system, banks are particularly prone to contagion and panics.
The literature on banks runs and ‘financial fragility’ focusing on the banking system
(‘domino effect’, chain reaction in the case of a liquidity shortage, negative spill-over
effects) is extensive.150 Systemic risk may also occur in other parts of the financial sector,
such as securities markets (with simultaneous declines in the prices of a large number of
securities in one or more markets in a country or across countries) and derivatives markets.
4.116 Notwithstanding the dissenting voices prior to 2007,151 in the aftermath of the
2007–9 financial crisis, it is difficult to dispute that systemic risk is real and that periods of
instability or events of systemic risk pose a threat not only to the financial system but also
to the real economy—on a global dimension. Indeed, inadequate systemic risk control is
considered to be one of the causes of the crisis.152 And as a response to this inadequacy, the
concept of macro-prudential supervision has been embraced around the World.153
Definition of systemic risk
4.117 Like the related concept of financial stability, definitions of systemic risk have been
in a state of flux.154 Systemic risk refers to the risk or probability of breakdowns in an
entire system, as opposed to breakdowns in individual parts or components.155 It is the
likelihood (p. 181) of correlated failure.156 But a widely accepted definition is still missing.
Systemic risk is difficult to address if it cannot be defined.157
4.118 In order to better capture its cross-border outreach, Hal Scott has defined systemic
risk as ‘the risk that a national, or the global, financial system will break down’.158 While for
some authors this risk can be identified with default or credit risk, in my opinion, any risk
(liquidity risk, legal risk, interest rate risk, exchange rate risk, etc) can grow into systemic
proportions when its negative impact extends beyond an individual institution and affects or
threatens to affect other institutions, often creating a disruption in the monetary and
payments systems within a country or across different jurisdictions. Systemic risk can be
defined as the risk that financial difficulties at one or more financial institution could spill
over to a large number of other financial institutions or the financial system as a whole.
4.119 Systemic risk is closely associated with financial instability. In fact, the lack of
consensus regarding a definition of financial stability (as discussed in the previous chapter)
has resulted in the fact that the ‘notion of financial stability is often discussed in terms of
the concept of systemic risk and its sources’.159 According to the IMF, systemic risk
management aims to contain the ‘build-up of systemic vulnerabilities over time’.160
4.120 Andromachi Georgosouli has pointed out161 that the notion of systemic risk control
requires an understanding of resilience as adaptability, thus a dynamic consideration.162
The varying nature of systemic risk is conceptualized in its structural and cyclical time
dimensions. The structural dimension is a static or cross-sectional view of ‘the distribution
of risks across the financial sector’.163 Like a snapshot, it looks at the vulnerabilities of a
financial system (or a set of systems) in a particular point in time. Conversely, the cyclical
dimension of systemic risk follows such vulnerabilities over time.164 That is to say that
systemic risk is in constant (p. 182) change, and varies with the economic cycle. The
dynamic nature of systemic risk helps to understand why many macro-prudential and
systemic risk management policies are also dynamic in their nature and can often include
measures that move in an opposite direction to the economic cycle (ie, counter-cyclical
policies).
4.121 As Shin explains, one of the causes of systemic risk is excessive credit growth:
Excessive asset growth and greater reliance on non-core liabilities are closely
related to systemic risk and interconnectedness between banks. In a boom when
credit is growing rapidly, the growth of bank balance sheets outstrips available core
funding, and asset growth is mirrored in the greater cross-exposure across banks.
…Systemic risk increases through greater cross-holdings between intermediaries.
…In this respect, systemic risk is pro-cyclical and excessive asset growth lies at the
heart of the increase in bank interconnectedness. Therefore, addressing excessive
asset growth in booms will go a long way toward mitigating systemic risks and the
cross-exposure across banks.165
4.122 The decline in lending standards undoubtedly contributed to the crisis. What is
interesting about Shin’s approach166 is that it relies on a mix of micro- and macro-
prudential supervision, since the tools he proposes also require adequate micro-prudential
supervision (leverage caps are equivalent to the traditional lending limits in constraining
asset growth). It also offers a more holistic approach to supervision than mere reliance on
capital regulation. It focuses on the A of the CAMEL system (capital, assets, management,
earnings, and liquidity), which is always the most difficult element to supervise, as was
pointed out in Chapter 3.
4.123 As for the distinction between the macro and micro dimensions of systemic risk,
interestingly, it is not a novel idea. A literature review on the concept prepared by Galati
and Moessner trace the term ‘macro-prudential’ back to the late 1970s as part of the
working language used in unpublished documents of the Cooke Committee (the predecessor
of the BCBS).167 In 2003, Kaufman and Scott identified ‘macro’ and ‘micro’ concepts of
systemic risk.168 In the same year, Claudio Borio at the Bank for International Settlements
(BIS) had also recommended that existing prudential frameworks be re-oriented to include
a macro-prudential focus.169
(p. 183) 4.124 A ‘macro’ concept of systemic risk can be found in the Group of Thirty
Report on ‘Global Institutions, National Supervision and Systemic Risk’,170 which defines it
as ‘the risk of a sudden, unanticipated event that would damage the financial system to
such an extent that economic activity in the wider economy would suffer. To qualify as
systemic shocks must reverberate through and threaten the financial system and not just
some small part of it.’ Mishkin also favoured this ‘macro’ approach.171 A ‘micro’ definition
of systemic risk is provided by the BIS as ‘the risk that the failure of a participant to meet
its contractual obligations may in turn cause other participants to default with a chain
reaction leading to broader financial difficulties…’.172 Former Bank of England Governor
George described this ‘domino effect’ as occurring ‘through the direct financial exposures
which tie firms together like mountaineers, so that if one falls off the rock face others are
pulled off too.’173,174
173 174
Transmission mechanisms
4.125 The definition and understanding of systemic risk would be incomplete without a
reference to the transmission mechanisms, the channels of propagation of a crisis. What
makes a crisis of a systemic nature is not so much the trigger event (causa proxima) but
these transmission mechanisms, domestically and internationally. If the linkages are strong,
the potential for systemic instability increases. If the connections are weak, there is less of
a threat of systemic risk. It is the understanding of the interconnections of the system that
needs much greater research and analysis in the aftermath of the global financial crisis.
4.126 Both the occurrence of ‘shocks’ and the extent of the subsequent propagation,
however, are difficult to predict. Nobody could have foreseen that the subprime mortgage
crisis that commenced in the USA in 2007 would unsettle global financial markets to the
extent it did. Confidence deteriorated sharply in the course of 2007–8 and reached its
zenith in September–October 2008. This uncertainty has damaging consequences, since
once a (p. 184) crisis strikes the consequences can be very severe both for the financial
sector and for the real economy (negatively affecting output and general welfare).
4.127 The channels of contagion or transmission mechanisms can be classified into four
categories (sometimes the various transmission mechanisms also become interconnected
among themselves):175 (1) the inter-bank, inter-institution, inter-instrument channel; (2) the
payment systems channel; (3) the information channel; and (4) the psychological channel.
The crisis has evidenced the systemic impact of non-bank financial institutions, such as AIG
(an insurance company) or Lehman Brothers (an investment bank, not a commercial bank),
which suggests the need to re-examine the traditional mechanisms for transmission of risk.
The inter-bank, inter-institution, inter-instrument channel
4.128 This channel of financial contagion is rooted in the tight network of credit
interconnections in the banking system, where problems in one bank/financial institution
can quickly get propagated, affecting other sound institutions.176 Banks, particularly within
a domestic jurisdiction, tend to be closely interconnected through interbank deposits and
loans and through payment systems.177 In addition, to the extent that banks operate across
national borders, they link the countries in which they operate. The increased globalization
of the financial services has strengthened the links between different jurisdictions and as a
result, also facilitated the spill-over effects in financial services sector. For example, the
failure of Icelandic banks in 2008 affected their depositors beyond Iceland and required the
intervention of the UK and Dutch authorities to protect British and Dutch depositors who
placed their savings in these banks operating under the ‘single passport regime’.178
4.129 Derivatives have brought a new dimension to this transmission mechanism. Schinasi
and others179 have identified several factors which magnify systemic risk in derivatives
markets. The amounts involved are very large and the counterparty exposures are typically
concentrated in few global players; the linkages between institutions, markets, and
financial centres in OTC (over-the-counter) derivatives activities can also trigger a chain
reaction in the case of a major counterparty’s default.180
(p. 185) 4.130 The collapse of Lehman Brothers—the largest bankruptcy in US history—
and the subsequent panic are the classic example of the ‘domino effect’ explained earlier in
this chapter. The chronology of events preceding Lehman’s bankruptcy is well reflected in
the report of the Financial Crisis Inquiry Commission (Angelides Commission).181 The
Angelides Commission also stated that ‘the worst market disruption in postwar American
history and an extraordinary rush on the safest possible investments’ started following the
bankruptcy of Lehman Brothers, takeover of Merrill Lynch, and the rescue of AIG as market
participants suspected that many other large financial institutions could also fail.182
4.131 The role of derivatives in transmitting problems between different types of financial
institutions was clearly demonstrated during the financial crisis when the AIG’s non-
insurance business (securities lending programme and credit default swaps (CDS) portfolio)
caused huge losses, pushing the largest insurance group to the brink of collapse. The US
government had to step in with a $182 billion loan by the Federal Reserve System, the
largest loan in the history of mankind (in the words of a senior Fed official). It is interesting
to observe that much of this assistance was used to close out AIG’s CDS and securities
lending contracts with its counterparties—mostly banks or investment banks, to which the
funds were transferred in the end. This fact also demonstrates that the inter-institution
transmission channel is a two-way transmission mechanism of systemic risk. The
Counterparty Risk Management Policy Group also identified two derivatives-related
mechanisms in which dealers can adversely affect counterparties: (1) requesting (or not
accepting when requested) assignments or novations of trades, and (2) requesting that a
counterparty close out derivatives transactions (especially those that are in-the-money to
the counterparty and thus require the return of collateral);183 both of which were witnessed
during the collapse of AIG.184
4.132 The on-going debate about the role of CDS in magnifying risk provides a new
dimension to the understanding of the systemic considerations of derivatives markets and
the initiatives for central clearing (when a central counterparty interposes itself between
the counterparties of the financial transaction) for the OTC derivatives.185 The importance
of a clearing house and their smooth functioning during the crisis was widely acknowledged
by the authorities.186
(p. 186) At the same time it was accepted that the resilience of the financial market
infrastructures cannot be taken for granted187 and that the financial market infrastructures
must be subject to adequate regulatory requirements and supervision.188
4.133 Gary Gorton believes that it was the (wholesale) run on the repurchase market
(‘repo market’) during 2008—a bank run not so much on depository institutions, but on the
shadow banking system—that caused the crisis.189 Gorton and Metrick argue that the panic
of 2007–8 was a run on the sale and the repo market, which is a very large short-term
market that provides financing for a wide range of securitization activities and financial
institutions. Repo transactions are collateralized, frequently with securitized bonds. They
refer to the combination of securitization plus repo finance as securitized banking, and
argue that these activities were at the heart of the crisis. Concerns about the liquidity of
markets for the bonds used as collateral led to increases in repo haircuts—the amount of
collateral required for any given transaction. With declining asset values and increasing
haircuts, the US banking system was, they suggest, effectively insolvent. Though Gorton
singles out the repo market, other markets, such as the commercial paper market, also
suffered a ‘run’. Though some authors do not fully agree with Gorton and Metrick’s
conclusions,190 there is a consensus regarding the need to address the risks in repo
markets.191
(p. 187) The payments system channel
4.134 There is a complex network of exposures among banks and other financial
intermediaries through the payment and settlement systems. Systemic risk considerations
with regard to clearing and settlement systems have been the subject of extensive analysis
by academics and policy makers.192
4.135 The fundamental underlying risks in these systems are similar to those encountered
by financial institutions in general: operational risk (such as the failure of a computer, as in
the case in the Bank of New York in 1985), liquidity risk (reception of final or ‘good’ funds
not being realized at the desired time but at an unspecified time in the future), credit risk
(failure of an insolvent participant with a subsequent loss of principal), and legal risk.
4.136 The growth of wire transfers or paperless credit transfers (electronic fund transfers)
is a concern for regulators nationally and internationally,193 given the massive amounts
involved in such transfers and the speed of the transactions.194
4.137 The inability of one financial institution to fulfil its payment obligations in a timely
fashion results in the inability of other financial institutions to fulfil their obligations in that
clearing and settlement system, or in other systems, or in the failure of that clearing house
or other (p. 188) clearing houses.195 The fear is that such inability to settle payment
obligations could then lead to a severe liquidity shortage as healthy and solvent institutions,
not having received the payments expected at settlement time, might be unable to settle
their own payments obligations.196
4.138 Banks tend to play a key role in wholesale and retail payment and settlement
systems. Banks may be linked to a network providing clearing and settlement facilities or
they may use correspondent accounts with other banks.
4.139 In net settlement systems payments (such as Clearing House Inter-bank Payments
System (CHIPS) in the USA), banks send numerous payment instructions to other banks
during a certain period, typically a day, and, at the end of that period, the instructions are
netted and settled. However, without additional provisions, net settlement systems are
relatively vulnerable to systemic risk, since gross exposures accumulating between
settlement times can become very large. Systemic risk considerations have become a factor
in the move to real-time gross settlement systems.197
4.140 In real-time gross settlement systems (RTGS), such as FedWire in the USA or
TARGET2 (Trans-European Automated Real-time Gross Settlement Express Transfer
System) in the EU, payment finality is virtually immediate for every transaction (intra-day
settlement), so that the systemic risk from unsettled claims appears to be more limited than
in a net settlement system. However, RTGS have also their own problems, because of the
incentive to delay outgoing payments, which can lead to a system ‘gridlock’198 and the need
for collateral to support intra-day borrowing from central banks.199
4.141 Correspondent banks provide payment services for groups of usually smaller or
foreign banks, which are not linked to the primary domestic net or gross settlement
systems. The failure of an important correspondent bank can directly affect a large number
of those institutions.
4.142 At the international level, and in contrast to national inter-bank systems, foreign
exchange and securities transactions involve the settlement of two ‘legs’. In the foreign
exchange market, the existence of different time zones can create ‘Herstatt risk’, which
occurs because of the need to settle different legs of a single transaction in different
markets, and in different time zones.200 An analogous risk to Herstatt risk in securities
transactions is that the (p. 189) delivery of the securities might not coincide with payment,
that is, the ‘payment leg’ may have a different timing from the ‘delivery leg’. Increased
concerns about principal risk in securities settlement have led to major initiatives to
achieve ‘delivery versus payment’ (DVP), the simultaneous settlement of both transaction
legs.201
4.143 There is an on-going academic debate about whether private payment arrangements
(clearing houses, self-regulation) could be more efficient than and equally stable as current
regulated banking systems and partly public payment systems in industrial countries.202
‘Free banking’ economists point to the disciplinary effects of market forces203 and historical
episodes of relatively unregulated and publicly unprotected banking systems in various
countries that appeared, in the view of these authors, to be at least as stable as their more
regulated counterparts.204
4.144 Though there were no major failures of the payment systems during the financial
crisis of 2007–9—indeed, the payment system proved to be extraordinarily resilient during
the crisis, in part due to the significant degree of international harmonization and effective
coordination—policymakers do not wish to relax the regulatory and supervisory framework
for systemically important payment systems. This is evidenced by the recent publication of
the new Principles for Financial Market Infrastructures, replacing previous international
standards for payment systems.205
4.145 In Europe, the ECB and the national central banks have been involved in payment
systems as operators and participants of those systems, as providers of central bank money
for settlement, as catalysts, and as oversight authorities.206 The considerable imbalances in
TARGET2 (TARGET2 replaced TARGET in November 2007) which occurred following the
financial crisis fuelled the debate about the hidden balance-of-payments crisis in Europe
and about the problems in the payment system in the Eurozone.207 However, it has been
argued that the (p. 190) imbalances were simply a symptom of the financial crisis;208 the
system itself has so far proven robust.
The information channel
4.146 This channel is relevant both in the case of banking markets and in the case of
capital markets, where the information concerning asset prices can have systemic
implications. Problems of asset valuation haunted bankers and their regulators during the
global financial crisis. In a rapidly falling market, market valuation techniques lead to a
rapid deterioration of previously healthy balance sheets. Mark-to-market is attractive when
prices go up, it can be a nightmare when prices spiral down. Yet, one does not break the
thermometer just because the room is cold: the room will remain cold with or without
thermometer. What matters is how one responds to the information.
4.147 In the years prior to the global financial crisis, management failed to conduct
appropriate due diligence, in particular with regard to subprime loans and relied
unthinkingly on ratings. Ken Scott and John Taylor, who blame the toxic assets on banks’
balance sheets as one of the causes of the crisis, emphasize how ‘maddeningly complex’
securitization was and suggest that ‘mandated transparency is the only solution’.209 The
report published by Anton Valukas on his investigations of Lehman Brothers raises
eyebrows about the use of a questionable accounting artifice that allowed Lehman to move
assets off balance sheet to flatter its results. This suggests that in some cases complexity
and opacity can be intended to misrepresent the true financial implications of certain
transactions or to conceal financial distress.210
4.148 Traditional bank assets, loans, are inherently opaque to outsiders. The non-
marketability of loans creates uncertainty, making it difficult to assess the creditworthiness
of banks and the risk profile of their strategies. Thus, depositors and other bank creditors
have limited information (information asymmetries or deficiencies) about their banks’ asset
portfolios and are often not able to assess their soundness. Banks have a specialized role in
monitoring and screening their borrowers. Typically, this information is not available to the
general public.
4.149 An adverse piece of news, such as the failure of a particular bank, will lead
depositors at other institutions to re-evaluate the soundness and risk profile of their own
bank.211 Although it is (p. 191) relatively easy to distinguish the solvent from the insolvent
institution ex post, that is, after the crisis, it can be difficult in practice to do so before a
crisis. Ex ante information is frequently not sufficiently available, timely, or reliable to make
the distinction with confidence. Banks often fail to disclose relevant information,
particularly as they approach insolvency.212
4.150 Brunnermeier and others213 have looked at the problems that arise when both
‘funding liquidity’ dries up and ‘market liquidity’ evaporates, and have developed their
theory of ‘liquidity spirals’. Funding liquidity refers to the ease with which investors can
obtain funding. Market liquidity refers to the ease to raise money by selling assets at a
reasonable price.214
When markets are illiquid, market liquidity is highly sensitive to further changes in
funding conditions. This is due to two liquidity spirals. …First, a margin spiral
emerges if margins are increasing in market illiquidity. In this case, a funding shock
to the speculators lowers market liquidity, leading to higher margins, which tightens
speculators’ funding constraint further, and so on. …The margin spiral forces
traders to de-lever during downturns. …Second, a loss spiral arises if speculators
hold a large initial position that is negatively correlated with customers’ demand
shock. In this case, a funding shock increases market illiquidity, leading to
speculator losses on their initial position, forcing speculators to sell more, causing a
further price drop, and so on. These liquidity spirals reinforce each other, implying
a larger total effect than the sum of their separate effects.215
4.151 The so-called ‘domino model’ of contagion—based on book-value accounting and

default as trigger for contagion—offers, in the view of the authors of the Geneva Report, a
rather obsolete view of our financial system, which is largely market-based and relies on
market value accounting and market-sensitive measures of risk.216 Defaults need not even
materialize to generate contagion, since adverse price changes may be sufficient. Leverage
is pro-cyclical. When many market participants ‘de-lever’ at the same time, liquidity
disappears down a black hole. As asset prices drop, losses mount and ‘margins/haircuts’
increase. In the presence of ‘fire-sale externalities’ and ‘inter-connectedness externalities’,
government regulation and intervention are justified. Systemic risk, in the view of the
authors of the Geneva Report, has as much to do with asset quality as with how assets are
funded (maturity of the funding). The mismatch between short-term funding and long-term
assets (either highly illiquid assets or assets with potential low market liquidity in a crisis)
was a source of instability in 2007–8 as well as in other previous crises.217
(p. 192) 4.152 When liquidity dries up, it disappears altogether rather than being allocated
elsewhere. Liquidity should be understood in terms of the growth of balance sheets (ie, as a
flow) rather than as a stock.218
When haircuts rise, all balance sheets shrink in unison. Thus, there is a generalized
decline in the willingness to lend. When a bank such as Northern Rock finds itself at
the receiving end of a run by its creditors, it cannot simply turn to another creditor
to take up the slack, for all other creditors are simultaneously curtailing their
lending.219
The psychological channel
4.153 ‘Panics also travel through psychological conduits.’220 The psychological argument
is related to the information channel. Public perception is very important. A failure of one
bank may cause the public to believe that other banks will fail. The belief in a panic is self-
fulfilling. Market sentiment can shift suddenly and quickly. ‘Herd behaviour’ is a recurring
pattern in ‘boom and bust’ cycles.
4.154 There is an element of irrationality in the way a crisis unfolds. Kindleberger talks
about the rationality of individuals and the irrationality of markets.221 The terms distress,
euphoria, mania, panic have a psychological connotation. They express emotions that often
get out of control. Of course, these conduits are difficult to quantify. But they are real. The
psychological channel, the Minsky moment, the loss of confidence in an institution or
market, whether informed or uninformed, rational or irrational is a traditional transmission
mechanism.
4.155 Given that confidence and trust are preconditions of well-functioning markets, it is
easy to realize that the loss of confidence in an institution or market (whether informed or
uninformed, rational or irrational) will undermine the functioning of that institution or
market.
4.156 The resolution of a crisis also presents, in some cases, a psychological component:
the mere belief that the problem has been solved will bring investors back to the market
and will operate as a positive incentive to open up again the sources of credit. It is not so
much the ability to lend but the willingness to do so that really counts in the resolution of a
financial crisis. ‘The mere knowledge that one can get money is frequently sufficient to
moderate or eliminate the desire.’222
4.157 A combination of information asymmetries and externalities provides the rationale
for banking and financial regulation. The literature on contagion has expanded dramatically
in the aftermath of the crisis.223 Clas Wihlborg summarizes the new view on systemic risk
as (p. 193) follows: ‘Sufficiently large loss in asset value and capital in the financial system
with highly leveraged financial institutions and mark-to-market valuation induces fire sales
that create additional losses when most financial institutions struggle to restore capital and
the “buy side” of market dries up’.224
SIFIs
4.158 The global financial market is not a huge global homogenous market. It is more like
a spider’s web or a radial web with multiple interconnections and linkages,225 in which local
markets permeate each other and in which a few players dominate the scene. The size or
importance of some of these players (the term SIFIs is now in vogue) is a source of concern
globally and nationally.226 The image of the baobabs in The Little Prince reminds us of the
dangers of SIFIs:
There were some terrible seeds on the planet that was the home of the little prince,
and these were the seeds of the baobab. …A baobab is something you will never be
able to get rid of if you attend to it too late. It spreads over the entire planet. …And
if the planet is too small and the baobabs are too many, they split it into pieces. …
After explaining how he cleaned the seeds of the baobabs every day he added:
Sometimes, there is no harm in putting off a piece of work until another day. But
when it is a matter of baobabs, that always means a catastrophe. I knew a planet
that was inhabited by a lazy man. He neglected three little bushes...
(p. 194) So, as the little prince described it to me, I have made a drawing of that planet. I do
not much like to take the tone of a moralist. But the danger of the baobabs is so little
understood, and such considerable risks would be run by anyone who might get lost on an
asteroid, that for once I am breaking through my reserve. …I say plainly, ‘watch out for the
baobabs’.227
4.159 Today’s systemically important financial institutions are an extension of the ‘too big
to fail’ doctrine. SIFIs enjoy an implicit government guarantee, which generates pernicious
moral hazard incentives. That implicit protection must be priced according to market
mechanisms. (Let us call it ‘market discipline in protection’.)228 A major challenge lying
ahead in the treatment of SIFIs is the boundary problem or perimeter issue.229 As with
territorial waters in fishing disputes amongst countries, where you draw the line of
regulation, protection and government assistance is likely to lead to disagreements. Once a
definition of SIFI or global SIFI is established, a clear boundary is drawn and with it an
incentive for financial institutions to position themselves on one side or another of the
boundary, whichever seems more advantageous.
4.160 According to the FSB Recommendations, ‘global SIFIs are institutions of such size,
market importance, and global interconnectedness that their distress or failure would cause
significant dislocation in the global financial system and adverse economic consequences
across a range of countries’.230
4.161 The definition of a SIFI is also dynamic: what is systemic today is not necessarily
what will be systemic in future. Moreover, the fact that most SIFIs have a cross-border
dimension, calls for a cross-border solution, supra-nationally and/or internationally. In the
USA, the Dodd–Frank Act 2010 deals with the definition, supervision, and resolution of
SIFIs, which are referred to as ‘non-bank financial companies’ with systemic
significance.231 Under section 113(a)(1) of the Act, the Financial Stability Oversight Council
(FOSC) may determine that a SIFI (‘non-bank financial company’) should be subject to the
supervision of the Federal Reserve System ‘if material financial distress…or the nature,
scope, size, scale, concentration, interconnectedness or mix of activities…could pose a
threat to the financial stability of the United States’. Section 165 of the Dodd–Frank Act
2010 provides that the Federal Reserve System shall impose more stringent supervisory
standards to SIFIs ‘with assets of $50 billion or more’, in the following areas: ‘risk based
capital requirements and leverage limits, liquidity requirements, overall risk management
requirements, resolution plans, credit exposure report and concentration limits’. Title II of
the Dodd–Frank Act extends—as pointed out earlier—the FDIC model of resolution to SIFIs.
The Federal Reserve System and the FDIC will make a recommendation to the Treasury
Secretary as to whether he/she should appoint FDIC as receiver for a non-bank financial
company (SIFI) under the Orderly Liquidation Authority.232 The aim of the OLA is to act
preventively (p. 195) both by the FDIC in doing the respective due diligence of the SIFIs
and by the SIFIs in writing ‘living wills’ that foresee the possibility of their liquidation. The
mandate of the FDIC as receiver is to liquidate the SIFI (however, it can opt to transfer
assets to a ‘bridge company’).233
4.162 The extension of lex specialis to non-bank financial companies that are systemically
significant is, of course, one of the lessons learnt from the messy bankruptcy of Lehman
Brothers. As noted above, the FSB released a series of recommendations in 2010, and Key
Attributes in 2011, that called for an assessment of the legislative and other changes to
national resolution regimes and policies needed to accomplish effective resolution of
SIFIs.234 Credible resolution is key to addressing the problems created by SIFIs/‘too big to
fail’.235
4.163 In November 2011, the Basel Committee issued a framework for global systemically
important banks (G-SIBs). The G-SIBs rules assess the externalities from a global
perspective (ie, where distress or failure would disrupt the global financial system), making
no distinctions about impacts on individual jurisdictions.236 The G20 leaders endorsed these
rules at their November 2011 meeting and asked the Basel Committee and the FSB to work
on extending the framework to domestic systemically important banks (D-SIBs). The
Committee released a consultative paper in August 2012.237
4.164 In October 2012, the Basel Committee issued its rules for dealing with D-SIBs.238
While not all D-SIBs are significant from a global perspective, the failure of such a bank
could have a much greater impact on its domestic financial system and economy than that
of a non-systemic institution. Some of these banks may have cross-border externalities,
even if the effects are not global in nature. Against this backdrop, the Basel Committee
created a set of principles on the assessment methodology and the higher loss absorbency
requirement (p. 196) for D-SIBs. The framework complements G-SIB rules by focusing on
the impact that the distress or failure of banks will have on the domestic economy. Given
that the D-SIB rules complement the G-SIB framework, the Committee considers that it
would be appropriate if banks identified as D-SIBs by their national authorities are required
by those authorities to comply with the principles in line with the phase-in arrangements for
the G-SIB framework (ie, from January 2016).
Final observations on systemic risk: prevention and resolution
4.165 Following up on the analogy drawn by Stiglitz239 between a crisis and a small boat
in a rough sea, crisis management involves both good steering of the boat through a storm
as well as any due diligence and preventive measures to streng then the design of the boat.
4.166 The management of a systemic crisis will vary depending upon the geographical
reach of the crisis (national, regional, or international),240 the economic development of the
country, and the level of involvement of the private sector.
4.167 The 2001 Argentine crisis—a combination of currency, banking, and debt problems
with very negative effects upon the real economy—was mainly confined to Argentina
(though it had damaging spill-over effects upon Uruguay, it left relatively unaffected other
countries in Latin America). The crises in Thailand, Indonesia, South Korea, Malaysia in
1997–98 and the banking and sovereign debt crises in the euro area constitute an example
of regional crisis. The debt crisis of the 1980s and the financial crisis of 2007–9 constitute
examples of international crises.
4.168 A system crisis (a generalized financial crisis) is treated by the authorities
differently from an isolated individual bank failure in a sound economy. When confronting a
system crisis, the government can choose to deal with each troubled bank on a case-by-case
basis, using a mix of strategies or resolution tools, or the government can choose an ‘overall
strategy’ to deal with all the actual or potential troubled institutions. The difficulty of
calculating ex ante the total amount of the losses and the speed with which a system crisis
unfolds add to the complexity of its resolution.
4.169 At the beginning of a system crisis, the authorities may provide emergency liquidity
assistance to banks under stress, hoping for an early restoration of confidence.241 However,
if banks and institutions start failing, the government will often be compelled to provide
solvency assurances to depositors and to design a coherent policy—with an expeditious
decision-making process and a clear voice—to overcome the crisis. The government faces
the delicate and difficult policy choice of whether and when to commit fiscal resources to
recapitalize banks. Timing is always important. As Kindleberger suggested, with regard to
LOLR: ‘As for timing, it is an art. That says nothing and everything.’242
(p. 197) 4.170 Massive liquidity injections by the central bank may halt the problem. This
is why the central bank is the first line of defence, and why the ‘first’ macro-prudential
responsibility sits naturally within the central bank. But in circumstances where even such
liquidity injections are insufficient, two extreme solutions remain available to governments:
the government can inject capital into all troubled institutions and the government can do a
large-scale liquidation. Direct government injection of capital into the troubled institutions,
as happened in the global financial crisis, in Sweden at the beginning of the 1990s or in
Venezuela in 1994, often leads to a de facto nationalization of the assisted banks (or of the
whole banking system); it also complicates the conduct of monetary and fiscal policies.
4.171 Liquidation on a large scale, on the other extreme, is seldom—if ever—considered a
viable option, because of its detrimental effects on the workings of a market economy,
because of a potential ‘domino effect’ on other (sound) financial institutions (the very
malaise the government is trying to avoid) and because of the difficulty in judging whether
the problems are permanent or merely cyclical or temporary. The banking crisis in Russia in
the summer of 1995 illustrates how liquidation of a large number of small institutions can,
under certain circumstances, be beneficial for the restoration of confidence in the
system.243
4.172 Between these two radical options, de facto nationalization (saving all institutions)
and liquidation (letting all institutions fail), there are a variety of solutions and policies
available to governments to confront a system crisis. There are of course multiple varieties
of recapitalization: from a partial minimum injection of capital to full nationalization. There
are policies that look at the ‘bad assets’ (like the first Troubled Asset Relief Program (TARP)
in the USA, with the terminology later changing from ‘toxic assets’ to the better-sounding
‘legacy assets’), ranging from guarantees, insurance, purchases and transfers of assets to
straight write-offs. There are also debt-restructuring techniques such as the ones applied in
the resolution of the Latin American debt crisis of the 1980s and more recently in other
countries.244
4.173 The government can also ask other private institutions to provide assistance to
troubled banks. The so-called ‘convoy rescues’ were common in the past.245 LTCM in 1998
was an example of a private rescue. In the UK, such a mix of government assistance and
private assistance was named the ‘lifeboat’ operation and was applied following the
secondary banking crisis of 1974. The lifeboat—in the form of loans to the secondary banks
—was coordinated by the big four clearing banks and the Scottish clearing banks. A
centralized agency can also be created to dispose of the assets of the failed institutions.
Such a centralized solution was adopted in the resolution of the US thrift crisis of the 1980
(Resolution (p. 198) Trust Corporation created by the 1980 Financial Institutions Reform,
Recovery and Enforcement Act (FIRREA)) and in the resolution of the US financial crisis
2007–9 with TARP.246
4.174 There are no easy solutions to systemic crises. And at the end of the tunnel of such a
crisis there is often the spectrum of an economic crisis (recession) or a social crisis.247
Footnotes:
1
See Charles P Kindleberger, Manias, Panics and Crashes. A History of Financial Crises,
3rd edn (New York: John Wiley & Sons, 1996). The book was originally published in 1978.
2
For an analysis of the causes of this crisis—which affected the financial system at large—
and the regulatory responses, see Rosa M Lastra and Geoffrey E Wood, ‘The Crisis of 2007–
2009: Nature, Causes and Reactions’ (2010) 13(3) Journal of International Economic Law
531.
3
The use of this ‘transportation analogy’ is borrowed from Joseph Stiglitz, who wrote an
article on ‘Boats, Planes and Capital Flows’ Financial Times (25 March 1998). In that article
he eloquently stated: ‘Although one cannot predict when it [a crisis] might happen, the
chances of their [the boats] being broadsided by a wave are significant, no matter how well
they are steered. Bad steering, though, increases the chances of disaster and a leaky boat
makes it inevitable.’
4
Tommaso Padoa-Schioppa pointed out that the suspension of convertibility had been
sometimes used by public authorities ‘as a tool to buy time (for example in Argentina)’.
However, he thinks it has more drawbacks than advantages. ‘Not only are its legal
foundations unclear, but its effectiveness as a real solution has been shown to be limited.
Ultimately, confidence is unlikely to be supported by the statutory possibility, and the actual
use, of the suspension of such a crucial obligation as the repayment of what is, for good
reason, called a demand deposit.’ See Tommaso Padoa-Schioppa, ‘Central Banks and
Financial Stability. Exploring a Land in Between’, Policy Panel Introductory Paper presented
at the Second ECB Conference on The Transformation of the European Financial System
(24–5 October 2002), at <https://www.ecb.europa.eu/events/pdf/conferences/tps.pdf> (last
visited 14 July 2014). Another example is the case of Cyprus. In March 2013, the Cypriot
government implemented measures that suspended the cross-border convertibility of the
euro by applying capital controls that limited individual withdrawals, transactions with
credit and debit cards, among others. See Courtney Weaver and Michael Stothard, ‘Cyprus
Imposes Severe Capital Controls’ Financial Times (27 March 2013).
5
For example, George Kaufman concluded in his review of the empirical evidence of bank
contagion that concerns about systemic stability were greatly exaggerated: see George
Kaufman, ‘Bank Contagion: A Review of the Theory and Evidence’ (1994) 8 Journal of
Financial Services Research 123. Kaufman further elaborates his views in ‘Bank Failures,
Systemic Risk and Bank Regulation’ (1996) 6(1) Cato Journal 17, at <http://www.cato.org/
sites/cato.org/files/serials/files/cato-journal/1996/5/cj16n1-2.pdf> (last visited 14 July 2014).
6
This section draws heavily on ch 2 of Kindleberger’s book, above note 1, 11–19. The
expression ‘anatomy of a crisis’ is also borrowed from Kindleberger.
7
See Hyman P Minsky, John Maynard Keynes (New York: Columbia University Press, 1975)
and Hyman P Minsky, ‘The Financial Stability Hypothesis: Capitalistic Processes and
Behaviour of the Economy’ in Charles Kindleberger and Jean-Pierre Laffargue (eds),
Financial Crises: Theory, History and Policy, 3rd edn (New York/Cambridge: Cambridge
University Press, 1982) 13. A sixth edition was published by Macmillan in 2011. Citations in
this chapter are from the 3rd edition.
8
Kindleberger, above note 1, 12 and 34–8.
9
For a list of ‘objects of speculation’, see Kindleberger, above note 1, 38–9.
10
Kindleberger, above note 1, 13. ‘Pure speculation…involves buying for resale rather than
use in the case of commodities, or for resale rather than income in the case of financial
assets.’
11
Kindleberger, above note 1, 13. The impact of psychology in a crisis is an element that
Kindleberger emphasizes throughout his book. At 23, he clearly states: ‘Manias and panics,
I contend, are associated on occasion with general irrationality or mob psychology…or
hysteria.’
12
Kindleberger, above note 1, 2 and 44–65 (ch 4, ‘Fuelling the Flames: Monetary
Expansion’). Kindleberger recalls (22) the hyperbolic language used to describe this
phenomenon: ‘manias…insane land speculation…blind passion…financial orgies…frenzies…
feverish speculation…epidemic desire to become rich quick…wishful thinking…intoxicated
investors…turning a blind eye…people without ears to hear or eyes to see…investors living
in a fool’s paradise…easy credibility…overconfidence…over-speculation…overtrading…a
raging appetite…a craze…a mad rush to expand’.
13
Kindleberger, above note 1, 14.
14
Kindleberger, above note 1, 86. ‘Meteorological metaphors are especially called into
play…the oppressive atmosphere that precedes a storm.’
15
Kindleberger, above note 1, 15. ‘Liquidation is sometimes orderly, but more frequently
degenerates into panic.’
16
Kindleberger, above note 1, 97–8. A crash is a collapse of the price of assets, or perhaps
the failure of an important firm or bank.
[A panic is] a sudden fright without cause from the god Pan, may occur in asset
markets or involve a rush from less to more liquid assets. Financial crisis may
involve one or both, and in any order. …The system is one of positive feedback. A
fall in prices reduces the value of collateral and induces banks to call loans or
refuse new ones, causing…prices to fall still further. Further decline in collateral
leads to more liquidation. If firms fail, bank loans go bad, and then banks fail. As
banks fail, depositors withdraw their money. …Prices, solvency, liquidity and the
demand for cash…are interrelated. Not only banking institutions…, but households,
firms and banks are very similar to a row of bricks, the fall of one endangering the
stability of the rest.
17
18
See Thomas M Humphrey and Robert E Keleher, ‘The Lender of Last Resort: A Historical
Perspective’ (1984) 4(1) Cato Journal 275. How unfitting that the heirs of the man who
named the function—Sir Francis Barings—lived to see the Bank of England failing to rescue
Barings in 1995!
19
I draw in this section on the following articles: Rosa M Lastra, ‘Lender of Last Resort.
An International Perspective’ (1999) 48(2) International and Comparative Law Quarterly
340; Rosa M Lastra and Andrew Campbell, ‘Revisiting the Lender of Last Resort’ (2009)
24(3) Banking and Finance Law Review; and Rosa M Lastra, ‘Central Bank Independence
and Financial Stability’ (2010) 18 Estabilidad Financiera Banco de España 49.
20
This distinction is key in the context of the European Central Bank (ECB), as further
discussed in Chapter 10 in this volume, given the ECB’s own restrictive interpretation of
Article 14.4 of the Statute of the European System of Central Banks and of the European
Central Bank (hereinafter ESCB Statute) (a provision which allows national central banks
(NCBs) to perform non-ESCB tasks on their own responsibility and liability). This
interpretation is somewhat awkward and clouded with uncertainty, since the ECB can
provide some forms of emergency liquidity assistance (ELA) (open market operations and
discount policies for example) but not others (classic collateralized lines to individual
institutions, which remain the responsibility of the national central banks, at their own cost,
but with the fiat of the ECB). Article 18 of the ESCB Statute is a perfectly valid legal basis
for the ECB to provide the two forms of ELA/LOLR. The case for a more expansive
interpretation of Article 14.4 has been reinforced with banking union. The problem is of
course the fiscal backstop. …
21
Though the issue of solvency is often inserted here, Geoffrey Wood reminded me in his
comments on this chapter that Ralph George Hawtrey, The Art of Central Banking, 1st edn
(London: Longman, 1932), had pointed out it is not easy quickly to determine solvency, and
not necessary either so long as acceptable collateral is offered. See also Geoffrey E Wood,
‘The Lender of Last Resort Reconsidered’ (2000) 18(2–3) Journal of Financial Services
Research 203.
22
See Lastra, ‘Lender of Last Resort’, above note 19, 340–61; and Lastra and Campbell,
above note 19.
23
The theoretical foundations of the lender of last resort doctrine were first set by
Thornton in 1802 and then by Bagehot in 1873, who further elaborated and refined them.
See Henry Thornton, An Enquiry into the Nature and Effects of the Paper Credit of Great
Britain (London: George Allen & Unwin, 1939 [1802]; repr Fairfield, NJ: AM Kelley, 1978);
Walter Bagehot, Lombard Street. A Description of the Money Market (London: Smith, Elder
& Co, 1915 [1873]). Recent studies of the work of Thornton and Bagehot on the LOLR are
found in Thomas M Humphrey, ‘The Classical Concept of the Lender of Last Resort’ (1975)
61(1) Federal Reserve Bank of Richmond Economic Review 2; Michael D Bordo, ‘Alternative
Views and Historical Experience’ (1990) 76(1) Federal Reserve Bank of Richmond Economic
Review 18.
24
Charles Goodhard contends that Bagehot’s proposal that LOLR lending be at ‘high’ rates
is incorrectly translated into ‘penalty’ rates. See Charles A E Goodhart, ‘Myths about the
Lender of Last Resort’ (1999) 2(3) International Finance 339. Several authors have
suggested a rate lower than the market rate. Goodhart argues that the cost of the initial
[borrowing] tranche should be kept very low to avoid the stigma problem associated with
borrowing from the central bank. See Charles A E Goodhart, The Regulatory Response to
the Financial Crisis (Cheltenham: Edward Elgar, 2009) 71. See also Rafael Repullo, ‘Who
Should Act as a Lender of Last Resort? An Incomplete. Contract Model’ (2000) 32(3) Journal
of Money, Credit and Banking 580; Rafael Repullo, ‘Liquidity, Risk Taking, and the Lender of
Last Resort’ (2005) International Journal of Central Banking 47, at <ftp://ftp.cemfi.es/pdf/
papers/repullo/Liquidity%202005.pdf> (last visited 14 July 2014); and Jean-Charles Rochet,
Why There Are So Many Banking Crises? The Politics and Policy of Bank Regulation
(Princeton, NJ: Princeton University Press, 2008) 89.
25
The traditional lender of last resort practice, namely that the institution receiving
assistance should provide ‘good’ collateral, has been the subject of much debate and
criticism during the global financial crisis due to the widening range of acceptable
collateral.
26
12 USC 221ff. Congress has assigned to the Federal Reserve Board responsibility for
implementing certain laws pertaining to a wide range of banking and financial activities.
The Board implements those laws in part through its regulations, which are codified in title
12, ch II, of the Code of Federal Regulations (CFR). See Board of Governors of the Federal
Reserve System, Regulations, at <http://www.federalreserve.gov/bankinforeg/
reglisting.htm> (last visited 14 July 2014).
27
In the USA, the discount window lending (DWL) operates according to rules set up in
the Federal Reserve Act (enacted 23 December 1913, 38 Stat 251, 12 USC 226), ss 10a and
10b, and in the implementing Regulation A. See 12 CFR ch II, Pt 201, ‘Extension of Credit
by Federal Reserve Banks’ (Regulation A), available at <http://www.gpo.gov/fdsys/pkg/
CFR-2011-title12-vol2/pdf/CFR-2011-title12-vol2-part201.pdf> (last visited 14 July 2014).
There are rules that specify the short-term nature of the lending (60 days, 120 days …) as
well as the penalty rate applicable and the type of instruments that can be used as
collateral.
28
The central bank can also agree to supply emergency liquidity to foreign institutions
operating in the country. The Federal Reserve Act, s 13.14 allows the Federal Reserve
Banks to lend to a branch or agency of a foreign bank; it reads as follows:
Subject to such restrictions, limitations, and regulations as may be imposed by the

Board of Governors of the Federal Reserve System, each Federal Reserve bank may
receive deposits from, discount paper endorsed by, and make advances to any
branch or agency of a foreign bank in the same manner and to the same extent that
it may exercise such powers with respect to a member bank if such branch or
agency is maintaining reserves with such Reserve bank pursuant to section 7 of the
International Banking Act of 1978. In exercising any such powers with respect to
any such branch or agency, each Federal Reserve bank shall give due regard to
account balances being maintained by such branch or agency with such Reserve
bank and the proportion of the assets of such branch or agency being held as
reserves under section 7 of the International Banking Act of 1978. For the purposes
of this paragraph, the terms ‘branch’, ‘agency’, and ‘foreign bank’ shall have the
same meanings assigned to them in section 1 of the International Banking Act of
1978.
29
Federal Deposit Insurance Corporation Improvement Act (enacted 19 December 1991,
Pub L 102–242, 105 Stat 2236–2393, 12 USC 1823(c)(4)) (hereinafter FDICIA).
30
An institution is critically undercapitalized, according to s 38 of the Federal Deposit
Insurance Act (enacted 21 September 1950, Pub L 81–797, 64 Stat 873), as amended by
FDICIA, when ‘it fails to meet any level specified under subsection c(3)(a)’ (ie, when the
leverage ratio of tangible equity is less than 2 per cent of total assets).
31
Emergency Economic Stabilization Act (enacted 3 October 2008, Pub L 110–343, 22 Stat
3765) (hereinafter EESA).
32
Federal Reserve Bank of New York, ‘Forms of Federal Reserve Lending’ (July 2009), at <h
ttp://www.newyorkfed.org/markets/Forms_of_Fed_Lending.pdf> (last visited 14 July 2014).
33
Christian Johnson has conducted an analysis of the extensive use of this provision during
the crisis, in ‘Exigent and Unusual Circumstances: The Federal Reserve and the U.S.
Financial Crisis’ in Kern Alexander and Niamh Molongy (eds), Law Reform and Financial
Markets (London: Edward Elgar, 2011) 269.
34
Dodd–Frank Wall Street Reform and Consumer Protection Act (enacted 21 July 2010,
Pub L No 111–203, 124 Stat 1376, HR 4173), available at <http://www.sec.gov/about/laws/
wallstreetreform-cpa.pdf> (last visited 14 July 2014), commonly referred to as the Dodd–
Frank Act 2010 or simply Dodd–Frank.
35
See Federal Reserve Act, s 13, available at <http://www.federalreserve.gov/aboutthefed/
section13.htm> (last visited 14 July 2014). A programme or facility that is structured to
remove assets from the balance sheet of a single/specific company or that is established to
assist a single/specific company avoid bankruptcy, resolution or insolvency proceeding will
not be considered a programme or facility with broad-based eligibility. The Dodd–Frank Act
2010 requests the Federal Reserve to give immediate notice and periodic reports to
Congress regarding any s 13(3) facility and also to disclose information concerning the
participants and the amount of individual transactions in all credit facilities under s 13(3)
and borrowers or counterparties in discount window and open market transactions. See
Bank for International Settlements, ‘Central Bank Governance and Financial Stability’,
Report by a Study Group (May 2011), at <http://www.bis.org/publ/othp14.pdf> (last visited
14 July 2014). See also Board of Governors of the Federal Reserve System, Monthly Report
on Credit and Liquidity Programs and the Balance Sheet (March 2012), available at <http://
www.federalreserve.gov/monetarypolicy/clbs-appendix-c-201203.htm> (last visited 14 July
2014) and Dodd–Frank Act 2010.
36
See George Akerlof, ‘The Market for Lemons: Quality Uncertainty and the Market
Mechanism’ (1970) 84(3) Quarterly Journal of Economics 488.
37
Regulatory forbearance has been associated with moral hazard. See High-level Expert
Group on Bank Structural Reform, Report (Brussels, 2 October 2012) 121, at <http://
ec.europa.eu/internal_market/bank/docs/high-level_expert_group/report_en.pdf> (last
visited 14 July 2014) (hereinafter Liikanen Report).
38
In the EU, the prohibition of monetization of government debt, also known as ‘monetary
financing’ in accordance with the provisions of Art 123 TFEU applies. See Treaty on the
Functioning of the European Union, 2008 OJ C 115/47 (hereinafter TFEU), Art 123
(formerly Art 101 of the Treaty Establishing the European Community, 2006 OJ C 321 E/37
(hereinafter EC Treaty)).
39
Federal Reserve credit should not be used as a substitute for capital. Anna Schwartz
claims that the Federal Reserve System has misused its discount window facility throughout
the years, lending to insolvent rather than to illiquid institutions. LOLR loans over an
extended period have been losing propositions for the Fed, that is, the Fed has lost money
on its DWL and, any delay in closing an insolvent institution shifts the risk and the cost from
depositors— insured and uninsured—to taxpayers. Schwartz more radically concludes that
the discount window should be eliminated and that the Fed can be an effective LOLR if
restricted to open market operations; if the concern is with systematic liquidity, then a
general injection of high-powered money will do. See Anna J Schwartz, ‘The Misuse of the
Fed’s Discount Window’ (1992) 75(4) Federal Reserve Bank of St Louis Review 58.
40
Though some argue that if an institution goes bust, there will always be another
institution to pick up the pieces, in practice, in a condition of panic, the central bank needs
to keep things going until a market is found for the assets of the assisted institution.
41
A bank is considered to have failed when the competent authorities order the cessation
of its operations and activities. If the bank is declared legally insolvent at the exact moment
the market value of its net worth reaches zero, direct losses are only suffered by
shareholders. If that declaration occurs when the market value of its net worth is already
negative, losses will accrue not only to shareholders but also to uninsured creditors and/or
to the insurance fund. See Henry N Schiffman, ‘Legal Measures to Manage Bank Insolvency
in Economies in Transition’ in Rosa M Lastra and Henry N Schiffman (eds), Bank Failures
and Bank Insolvency Law in Economies in Transition (The Hague: Kluwer Law
International, 1999) 135.
42
See Goodhart, ‘Myths about the Lender of Last Resort’, above note 24. Back in 1993,
Goodhart and Schoenmaker argued that ‘with an efficient money and inter-bank market, a
commercial bank that is generally believed to be solvent, can, almost always, obtain
sufficient additional money to meet its liquidity difficulties’, and therefore, the central bank
will generally act as LOLR ‘in circumstances where the solvency of the borrower is subject
to doubt’. See Charles Goodhart and Dirk Schoenmaker, ‘Institutional Separation between
Supervisory and Monetary Agencies’ in Charles Goodhart (ed), The Central Bank and the
Financial System (Basingstoke: MacMillan Press, 1993).
43
The names of the banks that receive LOLR loans but do not fail are not likely to be
publicized. Indeed, any publicity might erode frail confidence, possibly causing a run on the
institution (the very effect the central bank is trying to prevent through its LOLR
assistance).
44
The Basel III directive establishes that the banks have until 2015 to comply with the
LCR ratio and until 2018 to comply with the NSFR ratio. See Basel Committee on Banking
Supervision, ‘Basel III: A Global Regulatory Framework for More Resilient Banks and
Banking Systems’ (December 2010, reviewed June 2011), at <http://www.bis.org/bcbs/
basel3.htm> (last visited 14 July 2014) (hereinafter Basel III). The LCR was amended in
January 2013 and the final requirements for banks’ LCR related disclosures was published
in January 2014. See Basel Committee on Banking Supervision, ‘Work on the Liquidity
Coverage Ratio finalised by the Basel Committee’, Press Release (12 January 2014), at <htt
p://www.bis.org/press/p140112c.htm> (last visited 14 July 2014). Also, the Basel Committee
launched in January 2014 a public consultation to some proposed revisions to the NSFR,
see Basel Committee on Banking Supervision, ‘Revisions to the Net Stable Funding Ratio
proposed by the Basel Committee’, Press Release (12 January 2014), at <http://
www.bis.org/press/p140112b.htm> (last visited 14 July 2014).
45
For a recent analysis, see Paul Davies, ‘Liquidity Safety Nets for Banks’ (2013) 13(2)
Journal of Corporate Law Studies 287. See also European Shadow Financial Regulatory
Committee (ESFRC), ‘Basel III: The Need for Simplicity in Capital and Liquidity
Requirements’, Statement No 33 (24 January 2011), at <http://www.esfrc.eu/id63.html>
46
ESFRC, Statement No 33, above note 45.
47
See Basel III, above note 44.
48
For a discussion on the granting of State aid during the financial crisis and its
implication on competition, see Costanza Russo, ‘Bail Out Plans: Do they Really Envision
State Exit and Bank Repayments? A View From a Competitive Assessment
Perspective’ (2010) 4 European Business Law Review. For an analysis of the new rules
specifically applicable to the banking sector, see Costanza Russo, ‘The New Course of EU
State Aid Rules During the 2007–2009 Financial Crisis’ in Kern Alexander (ed), Research
Handbook of International Financial Regulation (Cheltenham: Edward Elgar, 2012).
49
See Case 172/80 Züchner v Bayerische Vereinsbank [1981] ECR 2021. The Court’s
decision made it clear that the banking sector is only exempted from the competition rules
to the extent that any anti-competitive conduct by banks is imposed on them by the
monetary authorities.
50
TFEU, Art 107(1) (previously Art 87(1) EC Treaty). Article 107(3)(b) TFEU exceptionally
allows for aid to remedy a serious disturbance in the economy of a Member State.
51
European Commission, ‘State Aid: Commission Approves UK Rescue Aid Package for
Northern Rock’, Press Release IP/07/1859 (5 December 2007), at <http://europa.eu/rapid/
press-release_IP-07-1859_ en.htm?locale=en> (last visited 14 July 2014)
(hereinafter EC Press Release IP/07/1859): ‘However, the guarantee on deposits granted by
the Treasury on 17th September, as well as the measures granted on 9th October, which
provided further liquidity and guarantees to Northern Rock and were secured by a Treasury
indemnity, do constitute state aid.’ On 17 March 2008, six months after the first State aid
measures (‘rescue aid’) took place, the UK authorities submitted to the Commission a
restructuring plan. The Commission then launched an in-depth investigation into this
‘restructuring aid’. See European Commission, ‘State Aid: Commission Launches In-depth
Investigation into UK Restructuring Aid Package for Northern Rock’, Press Release IP/
08/489 (2 April 2008), at <http://europa.eu/rapid/press-release_IP-08-489_en.htm> (last
52
European Commission, ‘The Global Application of State Aid Rules to Measures Taken in
Relation to Financial Institutions in the Context of the Current Global Financial Crisis’,
Communication, OJ C 270 (25 October 2008) para 51, at <http://ec.europa.eu/competition/
state_aid/legislation/banking_crisis_paper.pdf> (last visited 14 July 2014):
[T]he Commission considers for instance that activities of central banks related to
monetary policy, such as open market operations and standing facilities, are not
caught by the State aid rules. Dedicated support to a specific financial institution
may also be found not to constitute aid in specific circumstances. The Commission
considers that the provision of central banks’ funds to the financial institution in
such a case may be found not to constitute aid when a number of conditions are
met, such as: the financial institution is solvent at the moment of the liquidity
provision and the latter is not part of a larger aid package; the facility is fully
secured by collateral to which haircuts are applied, in function of its quality and
market value; the central bank charges a penal interest rate to the beneficiary; the
measure is taken at the central bank’s own initiative, and in particular is not backed
by any counter-guarantee of the State.
53
From the beginning of the global financial crisis in the autumn of 2008 to December
2010, the Commission issued four communications which provided detailed guidance on the
criteria for the compatibility of State support to financial institutions with the requirements
of Art 107(3)(b) of TFEU: (1) Communication on the application of State aid rules to
measures taken in relation to financial institutions in the context of the current global
financial crisis (Banking Communication); (2) Communication on the recapitalization of
financial institutions in the current financial crisis: limitation of aid to the minimum
necessary and safeguards against undue distortions of competition (Recapitalization
Communication); (3) Communication from the Commission on the treatment of impaired
assets in the Community banking sector (Impaired Assets Communication); and (4)
Communication on the return to viability and the assessment of restructuring measures in
the financial sector in the current crisis under the State aid rules (Restructuring
Communication). See European Commission, ‘State Aid Temporary Rules Established in
Response to the Economic and Financial Crisis’, at <http://ec.europa.eu/competition/
state_aid/legislation/temporary.html> (last visited 14 July 2014). See also Regulation (EU)
No 806/2014 of the European Parliament and of the Council of 15 July 2014 establishing
uniform rules and a uniform procedure for the resolution of credit institutions and certain
investment firms in the framework of a Single Resolution Mechanism and a Single
Resolution Fund and amending Regulation (EU) No 1093/2010, OJ L 225/1 (30 July 2014),
Art 19.
54
European Commission, ‘Communication on the Application, From 1 August 2013, Of
State Aid Rules to Support Measures in Favour of Banks in the Context of the Financial
Crisis’ (‘Banking Communication’), OJ C 216/01 (30 July 2013), at <http://eur-lex.europa.eu/
legal-content/EN/ALL/?uri=CELEX:52013XC0730(01)> (last visited 14 July 2014).
55
Bank of England, ‘Special Liquidity Scheme’, at <http://www.bankofengland.co.uk/
markets/Pages/sls/default.aspx> (last visited 14 September 2014).
56
European Central Bank, Press Release (8 December 2011), at <http://
www.ecb.europa.eu/press/pr/date/2011/html/pr111208_1.en.html> (last visited 14 July
2014). For an analysis of these measures, see Rosa M Lastra, ‘The Evolution of the
European Central Bank’ (2012) 35 Fordham International Law Journal (Special Issue: ‘From
Maastricht to Lisbon: The Evolution of European Union Institutions and Law’) 1260.
57
Board of Governors of the Federal Reserve System, Regulatory Reform—Transaction
Data (updated 2 August 2013), at <http://www.federalreserve.gov/newsevents/
reform_taf.htm> (last visited 14 July 2014).
58
Decision of the European Central Bank (ECB/2010/5) of 14 May 2010 establishing a
Securities Markets Programme, OJ L 124/8, 20 May 2010.
59
They were announced on 2 August 2012, and the technical details were published in
European Central Bank, Press Release (6 September 2012), at <http://www.ecb.int/press/
pr/date/2012/html/pr120906_1.en.html> (last visited 14 July 2014).
60
See FRBNY, ‘Forms of Federal Reserve Lending’, above note 32.
61
Goldman Sachs, ‘Goldman Sachs to Become the Fourth Largest Bank Holding Company’,
Press Release (21 September 2008), at <http://www.goldmansachs.com/media-relations/
press-releases/archived/2008/bank-holding-co.html> (last visited 14 July 2014).
62
Morgan Stanley, ‘Morgan Stanley Granted Federal Bank Holding Company Status By
U.S. Federal Reserve Board of Governors’, Press Release (21 September 2008), at <https://
www.morganstanley.com/about/press/articles/6933.html> (last visited 14 July 2014).
63

Now, recognising the centrality of markets doesn’t mean the Bank has a naïve faith
that all markets always function smoothly. The City’s markets are not those of a
textbook. We all know that real markets can seize up in crises of confidence,
threatening financial stability and the wider economy.
Just as there will be times when central banks must backstop the banking system,
there are also times when they should backstop core markets in a way that supports
their contribution to the real economy but doesn’t encourage excessive risk taking.
That need was behind the recent transformation of the Bank of England’s sterling
market framework for banks, and it is why I can announce that, in the coming year,
the Bank will widen access to our facilities to include the largest broker-dealers
regulated in the UK and to those central counterparties authorised to operate in UK
markets. We will also look into whether we should further develop our capacity to
lend in currencies other than sterling.
See Mark Carney, Speech given at the Lord Mayor’s Banquet for Bankers and Merchants of
the City of London at the Mansion House, London (12 June 2014) 10, at <http://
www.bankofengland.co.uk/publications/Documents/speeches/2014/speech736.pdf> (last
64
See Thomas Huertas, ‘A Resolvable Bank’, Paper Presented at the Conference on
Managing and Financing European Bank Resolution, London School of Economics (24
March 2014). On constructive ambiguity, see eg Xavier Freixas, ‘Optimal Bail Out Policy,
Conditionality and Constructive Ambiguity’, Working Paper No 400 (1999), at <http://
ssrn.com/abstract=199054> (last visited 14 July 2014); Dmitri Vinogradov,
‘Deconstructive Effects of Constructive Ambiguity in Risky Times’, Paper Presented at the
Presented at the Conference on Monetary Policy and Financial Stability—What Role for
Central Bank Communication? (Amsterdam, 15–16 November 2010), at <https://
www.ecb.europa.eu/events/conferences/shared/pdf/joint_dnb/Vinogradov.pdf> (last visited
14 July 2014); and Sylvester Eijffinger and Rob Nijskens, ‘A Dynamic Analysis of Bail Outs
and Constructive Ambiguity’, Paolo Baffi Centre Research Paper No 2012-119 (1 July 2012),
at <http://ssrn.com/abstract=2118439> (last visited 14 July 2014).
65
See Rosa Maria Lastra and Douglas Wayne Arner, ‘Comparative Aspects of Depositor
Protection Schemes’ in Douglas Wayne Arner and Jan-Juy Lin (eds), Financial Regulation. A
Guide to Structural Reform (Hong Kong: Sweet & Maxwell Asia, 2003) 463; Rosa M Lastra
and Rym Ayadi, ‘Proposals for Reforming Deposit Guarantee Schemes in Europe’ (2010)
11(3) Journal of Banking Regulation 210; and Rosa M Lastra (ed), Cross-Border Bank
Insolvency (Oxford: Oxford University Press, 2011) 14–22. See also Gillian Garcia, ‘Deposit
Insurance and Crisis Management’, Working Paper WP/00/57 (International Monetary Fund,
March 2000), at <http://www.imf.org/external/pubs/ft/wp/2000/wp0057.pdf> (last visited 14
July 2014); Peter Cartwright, ‘Understanding, Awareness and Deposit Insurance’ in John R
LaBrosse, Rodrigo Olivares-Caminal, and Dalvinder Singh (eds), Financial Crisis
Management and Bank Resolution (London: Informa Law, 2009).
66
Milton Friedman, The Control of Money. A Program for Monetary Stability (New York:
Fordham University Press, 1959) 21.
67
Basel Committee on Banking Supervision, ‘Core Principles for Effective Banking
Supervision (Basel Core Principles)’ (Bank for International Settlements, September 1997),
at <http://www.bis.org/publ/bcbsc102.pdf> (last visited 14 July 2014) (hereinafter ‘Basel
Core Principles 1997’).
68
See Basel Committee on Banking Supervision, ‘Core Principles for Effective Banking
Supervision’ (Bank for International Settlements, September 2012) 10, 22–23, at <http://
www.bis.org/publ/bcbs230.pdf> (last visited 14 July 2014) (hereinafter ‘Basel Core
Principles 2012’).
69
See Basel Committee on Banking Supervision and the International Association of
Deposit Insurers, ‘Core Principles for Effective Deposit Insurance Systems’ (June 2009), at
<http://www.bis.org/publ/bcbs156.pdf> (last visited 14 July 2014) (hereinafter ‘Core
Principles for Effective Deposit Insurance Systems’).
70
See ‘Core Principles for Effective Deposit Insurance Systems’, above note 69, Principle
11. See generally Jessica Cariboni, Elisabeth Joossens, and Adamo Uboldi, ‘The Promptness
of European Deposit Protection Schemes to Face Banking Failures’ (2010) 11(3) Journal of
Banking Regulation 191; Franklin Allen, Elena Carletti, and Agnese Leonello, ‘Deposit
Insurance and Risk Taking’ (2011) 27(3) Oxford Review of Economic Policy 464; Khan
Anichul Hoque and Hasnat Dewan, ‘Deposit Insurance Scheme and Banking Crises: A
Special Focus on Less-developed Countries’ (2011) 41 Empirical Economics Journal 155;
and Financial Stability Board, ‘Thematic Review on Deposit Insurance System’, Peer Review
Report (8 February 2012), at <http://www.financialstabilityboard.org/publications/
r_120208.pdf> (last visited 14 July 2014).
71
This was the definition provided by Simon Gleeson in a lecture to my students in
December 2013.
72
For a study of these issues, see eg Richard Dale, ‘Deposit Insurance in Theory and
Practice’ (2000) 8(1) Journal of Financial Regulation and Compliance 36; Gillian Garcia,
‘Deposit Insurance: A Survey of Actual and Best Practices’, International Monetary Fund
Occasional Paper No 197 (January 2000), at <http://www.imf.org/external/pubs/nft/op/197/
index.htm> (last visited 14 July 2014). In the EU, a new directive on deposit guarantee
schemes was approved by the EU Council on 3 March 2014. This proposed directive would
revamp the existing Directive 94/19/EC and its subsequent amendments. The new directive
was adopted by the EU Parliament on 16 April 2014: see Directive 2014/49/EU of the
European Parliament and of the Council of 16 April 2014 on deposit guarantee schemes, OJ
L 173/149 (12 June 2014).
73
See ‘Core Principles for Effective Deposit Insurance Systems’, above note 69.
74
See ESFRC, ‘A New Role for Deposit Insurance in Europe’, Statement No 5 (18 October
1999), at <http://www.esfrc.eu/id60.html> (last visited 14 July 2014).
75
In Lastra and Wood, above note 2, we explain that this does not mean that either
management or shareholders are protected. It means simply that the operations of the bank
are continued.
76
The angst against bonuses also needs to be understood in this light. See eg ‘Barclays
Sparks Bonus Outrage’ Financial Times (6 March 2014), where Andrew Tyrie (chairman of
the House of Commons Treasury Select Committee) was cited as saying: ‘The new
consensus emerging on pay remains seriously flawed.’
77
In June 2013, it was agreed by the European Council that depositor preference would be
introduced into the bank resolution framework for Europe. Depositor preference has also
been introduced by law in the UK with the entry into force of the Financial Services
(Banking Reform) Act 2013 (enacted 18 December 2013, 2013 c 33), <http://
www.legislation.gov.uk/ukpga/2013/33/contents/enacted> (last visited 14 July 2014).
Depositor preference is also set by law in the USA, Australia, China, and Switzerland.
78
A recent study on deposit preference states that:
Depositor preference and collateralization of borrowing may reduce the cost of

settling the conflicts among creditors that arises in case of resolution or bankruptcy.
This net benefit, which may be capitalized into the value of the bank rather than
affect creditors’ expected returns, should result in lower overall funding costs and
thus a lower probability of distress despite increasing encumbrance of the bank’s
balance sheet. The benefit is maximized when resolution is initiated early enough
for preferred depositors to remain fully protected.
See Daniel C Hardy, ‘Bank Resolution Costs, Depositor Preference, and Asset
Encumbrance’, IMF Working Paper No WP/13/172 (International Monetary Fund, July
2013), at <http://www.imf.org/external/pubs/ft/wp/2013/wp13172.pdf> (last visited 14 July
2014).
79
See Rosa M Lastra, Central Banking and Banking Regulation (London: Financial
Markets Group/London School of Economics, 1996) 130.
80
See Richard S Dale, ‘Deposit Insurance, Policy Clash over EC and US Reforms’ in
Frederick C Shadrack and Leon Korobow (eds), The Basic Elements of Bank Supervision
(New York: Federal Reserve Bank of New York, 1993).
81
The work of the Basel Committee and the International Association of Deposit Insurers,
in particular the core principles for effective deposit insurance systems, published on 12
March 2009 is the most relevant example of international harmonization (albeit of a soft law
nature) in this area. See ‘Core Principles for Effective Deposit Insurance Systems’, above
note 69.
82
On bank failures, see eg Thomas H Jackson, ‘Bankruptcy, Non-bankruptcy Entitlements,
and the Creditors’ Bargain’ (1982) 91 Yale Law Review 857; Vanessa Finch, Corporate
Insolvency Law (Cambridge: Cambridge University Press, 2009); Douglas G Baird and
Robert K Rasmussen, ‘Anti-bankruptcy’ (2010) 119 Yale Law Journal 648; Andrew Campbell
and Rosa M Lastra, ‘Definition of Bank Insolvency and Types of Bank Insolvency
Proceedings’ in Lastra (ed), above note 65; and Dirk Schoenmaker, Governance of
International Banking. The Financial Trilemma (Oxford: Oxford University Press, 2013) 72–
89.
83
There have been revisions to resolution regimes in Australia, Germany, France,
Netherlands, Spain, Switzerland, and others. See Financial Stability Board, ‘Implementing
the FSB Key Attributes of Effective Resolution Regimes—How Far Have We Come?’ (19
April 2013), at <http://www.financialstabilityboard.org/publications/r_130419b.htm> (last
84
See International Monetary Fund and the World Bank, ‘An Overview of the Legal,
Institutional, and Regulatory Framework for Bank Insolvency’ (17 April 2009), at <http://
www.imf.org/external/np/pp/eng/2009/041709.pdf> (last visited 14 July 2014) (hereinafter
IMF, ‘Framework for Bank Insolvency’).
85
IMF, ‘Framework for Bank Insolvency’, above note 84.
86
See Schiffman, above note 41, 89–90.
87
See eg Gerald N Olson, ‘The Inadequacy of Bank Insolvency Resolution’ in Lastra and
Schiffman (eds), above note 41, 112–13. According to Olson, while the primary objective of
bank insolvency law is to maintain public confidence in the banking system, bankruptcy
laws seek to achieve three objectives: (1) protect creditors from each other; (2) protect
creditors from dishonest debtors; (3) protect honest debtors from creditors by discharge.
88
Eva Hüpkes, ‘Managing Financial Failures in an Evolving Economic and Financial
Environment’ in Robert Bliss and George Kaufman (eds), Financial Institutions and
Markets, vol I (London: Palgrave Macmillan, 2008).
89
Robert A Eisenbeis and George G Kaufman, ‘Cross Border Banking: Challenges for
Deposit Insurance and Financial Stability in the European Union’ in Harald Benink, Charles
A E Goodhart, and Rosa M Lastra (eds), Prompt Corrective Action and Cross-Border
Supervisory Issues in Europe, LSE’s Financial Markets Group Special Paper Series No 71
(London: Financial Markets Group, London School of Economics, 2007).
90
Krimminger, on the contrary, states that ‘mandatory intervention should be triggered
before capital is exhausted if further losses are to be avoided. If it is clear that the bank is
not improving, this suggests that earlier action is more likely to limit losses to the insurance
fund or public fiscal.’ See Michael Krimminger, ‘Controlling Moral Hazard in Bank
Resolutions: Comparative Policies & Considerations in System Design’ (July 2006), at <http:
//ssrn.com/abstract=1123224> (last visited 14 July 2014).
91
There are two traditional definitions of insolvency in commercial bankruptcy laws:
failure to pay obligations as they fall due (equitable insolvency) and the condition when
liabilities exceed assets (balance sheet insolvency).
92
See Jonathan R Macey and Geoffrey P Miller, Banking Law and Regulation (Boston:
Little Brown and Company, 1992) 644–5 and generally ch 8.
93
As mentioned in para 4.52 above, in the presence of a system of depositor preference,
depositors’ claims are typically paid before those of general creditors. If a country has a
deposit guarantee scheme, the insured depositors are paid off up to the insurance limit;
uninsured depositors and other creditors are likely to suffer losses in their claims.
94
See generally Rosa M Lastra and Lee Buchheit, Sovereign Debt Management (Oxford:
Oxford University Press, 2014).
95
See EC Press Release IP/07/1859, above note 51.
96
See eg Rosa M Lastra, ‘Northern Rock, UK Bank Insolvency and Cross-Border
Insolvency’ (2008) 9(3) Journal of Banking Regulation 165; Malcolm Knight, ‘Mitigating
Moral Hazard in Dealing with Problem Financial Institutions: Too Big to Fail? Too Complex
to Fail? Two Interconnected to Fail?’ in LaBrosse et al (eds), above note 65, 258–9; Eva
Hüpkes, ‘Allocating Costs of Failure Resolution: Shaping Incentives and Reducing Moral
Hazard’ in Lastra (ed), above note 65.
97
See FDICIA, 12 USC 1823(c)(4).
98
See Regulation 806/2014, Art 22.
99
A takeover or merger as a tool for dealing with a financially distressed bank (also called
purchase and assumption in the USA, that is, the purchase of assets and assumption of
liabilities) can be ‘unassisted’, when the acquirer assumes all assets and liabilities (also
called ‘whole bank’s acquisition’), or ‘assisted’, when the liabilities, in whole or part, and
the good assets go to the acquirer (also referred to as ‘clean bank’s acquisition’). In an
assisted transaction, the bad assets are subject to special administration, ‘good bank–bad
bank’ acquisition model.
100
Sometimes, failed banks may be placed under special administration, in the form of
bridge banks, new banks, special funds, or other arrangements. This is often meant to be a
temporary solution in order to take over the operations of a failed bank and preserve its
going concern value, until a more permanent solution to the problems or an acquirer is
found.
101
See Lastra (ed), above note 65; Rosa M Lastra and Thomas Huertas, ‘Living
Wills’ (2011) 11 Estabilidad Financiera Banco de España 23; Rosa M Lastra, Gillian Garcia,
and Maria Nieto, ‘Bankruptcy and Reorganization Procedures for cross-border banks in the
EU: Towards an Integrated Approach to the Reform of the EU Safety Net’ (2009) 7(3)
Journal of Financial Regulation and Compliance; and Lastra, above note 96, 165.
102
Financial Stability Board, ‘Key Attributes of Effective Resolution Regimes for Financial
Institutions’ (October 2011), at <http://www.financialstabilityboard.org/publications/
r_111104cc.pdf> (last visited 14 July 2014) (hereinafter FSB, ‘Key Attributes’).
103
FSB, ‘Key Attributes’, above note 102.
104
FSB, ‘Key Attributes’, above note 102.
105
As Thomas Huertas explains, the three stages of the resolution process (beyond the
recovery phase, and as long as there is no ‘forbearance’) include (1) the trigger point; (2)
the stabilization options for the first 36–48 hours (typically available over a weekend,
comprising recapitalization via bail-in, liquidity provision, access to financial markets
infrastructures, and handling qualified financial contracts, including derivatives and
repurchase agreements); and (3) the restructuring options over a longer period of time, six
months or more. See Huertas, above note 64. Resolvability hinges on the structure of
liabilities.
106
On bail-in, see eg Thomas Huertas, ‘The Road to Better Resolution: From Bail Out to
Bail In’, Financial Markets Group of the London School of Economics, Special Paper No 195
(December 2010), at <http://www.lse.ac.uk/fmg/workingPapers/specialPapers/PDF/
SP195.pdf> (last visited 14 July 2014); Simon Gleeson, ‘Legal Aspects of Bank’s Bail-Ins’,
Financial Markets Group of the London School of Economics, Special Paper No 205
(January 2012), at <http://www.lse.ac.uk/fmg/workingPapers/specialPapers/PDF/
SP205.pdf> (last visited 14 July 2014); and Charles Randell, ‘The FSB’s Key Attributes: The
Road to Cross-Border Resolution of Financial Institutions’, Scoping Paper prepared for the
Cross-Border Resolution Symposium, Bingham Centre for the Rule of Law (18 June 2012),
paper cited with the permission of the author.
107
Nicola Kemp, ‘Bail-in Powers, from Simple Concept to Complex Reality’ (2011) 26(11)
Butterworths Journal of International Banking and Financial Law 695.
There are two types of bail-in: bail in via write down (partial wind-down) of debt and bail-in
via conversion of debt into equity.
108
See Protocol No 1 to the European Convention for the Protection of Human Rights and
Fundamental Freedoms (adopted 20 March 1952, entered into force 18 May 1954) 213
UNTS 262, Art 1 (hereinafter First Protocol ECHR); European Convention for the Protection
of Human Rights and Fundamental Freedoms (Rome, 4 November 1950, entered into force
3 November 1953) 213 UNTS 222, Art 6 (hereinafter ECHR), concerning the right to a fair
hearing in the determination of civil rights. The ‘spirit’ of the bail-in technique, as well as
the spirit of prompt corrective action (PCA) in the USA or the now ubiquitous concept of
living wills (recovery and resolution plans) is the same: act early, act promptly, act
preventively before losses are potentially inflicted upon taxpayers. (As the old English
adage says, an ounce of prevention is worth a pound of cure.) See Rosa M Lastra, ‘From
Bail-out to an Adequate Resolution Framework’, Contribution to a Roundtable with Paul
Tucker on The Challenges of Cross Border Resolution, Blavatnik School of Government,
Oxford University (2 May 2012), at <http://fordnovemberconference.files.wordpress.com/
2013/11/cross-border-resolution-workshop-report.pdf> (last visited 14 July 2014). The UK
launched a consultation on bail-in powers implementation in the UK in March 2014: see HM
Treasury, ‘Bail-in Powers Implementation’, Closed Consultation (13 March 2004), at <https:/
/www.gov.uk/government/consultations/bail-in-powers-implementation-including-draft-
secondary-legislation/bail-in-powers-implementation> (last visited 14 July 2014), following
the entry into force of the Financial Services (Banking Reform) Act 2013.
109
The BRRD was published in the Official Journal in June 2014. See Directive 2014/59/EU
of the European Parliament and of the Council of 15 May 2014 establishing a framework for
the recovery and resolution of credit institutions and investment firms and amending
Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC,
2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU)
No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council, OJ L
173 (12 June 2014) 190, at <http://eur-lex.europa.eu/legal-content/EN/TXT/?
uri=uriserv:OJ.L_.2014.173.01.0190.01.ENG> (last visited 14 July 2014)
(hereinafter Bank Recovery and Resolution Directive, BRRD). See also Regulation 806/2014,
Art 27.
110
See Jianping Zhou et al, ‘From Bail-out to Bail-in: Mandatory Debt Restructuring of
Systemic Financial Institutions’, IMF Staff Discussion Note No SDN/12/03 (24 April 2012),
at <https://www.imf.org/external/pubs/ft/sdn/2012/sdn1203.pdf> (last visited 14 July 2014),
who suggest that if the use of bail-in could be perceived by the market as a sign of the
concerned institution’s impending insolvency, it could trigger a run by short term creditors
and aggravate the institution’s liquidity problem.
Lorenzo Bini Smaghi, former member of the ECB Executive Board in a dinner speech in
Frankfurt on 14 November 2013 (‘The Changing Role of Central Banks in the Crisis’) said
that requesting an automatic bail-in may lead to a weakening of the banking system during
turbulent times:
By requesting an automatic bail-in, in all cases the process of bank recapitalization

to a weakening—rather than a strengthening—of the banking system, especially
during turbulent times. Consider the case in which a bank is asked to raise capital
by a given deadline, in order to comply with the new supervisory requirements.
Given that investors know that shareholders and junior bondholders will be bailed-
in if the deadline is missed, they will be reluctant to participate to [sic] the capital
increase unless they are convinced that others will also join. The risk of missing the
deadline may actually scare away current shareholders. This is a typical problem of
coordination failure, described by Keynes in the form of the beauty contest. It
requires public intervention, or the expectation of public intervention, to avoid
increased uncertainty or multiple equilibrium.
111
Contingent convertibles (also known as CoCo bonds, CoCos, or contingent convertible
notes) differ from regular convertible bonds in that the likelihood of the bonds converting to
equity is ‘contingent’ on a specified trigger event, such as the stock price of the company
exceeding a particular level for a certain period of time.
112
See Regulation 806/2014, Preamble, recital 2, which provides:
Divergences between national resolution rules in different Member States and

corresponding administrative practices and the lack of a unified decision-making
process for resolution in the banking union contribute to that lack of confidence and
market instability, as they do not ensure predictability as to the possible outcome of
a bank failure.
113
According to a report by the Institute of International Finance, ‘[t]o achieve a common
framework for cross-border resolution, common standards or at least mutual recognition by
national resolution authorities of each other’s actions will be an essential part of the
harmonization process of resolution around the world. The current bilateral administrative
agreements and the crisis management groups suggested by the Key Attributes is a good
step but national authorities need to take a step further to adopt global outcomes more
detailed and more formal international understandings.’ See Institute of International
Finance, ‘Making Resolution Robust—Completing the Legal and Institutional Frameworks
for Effective Cross-Border Resolution of Financial Institutions’ (June 2012), at <http://
www.iif.com/download.php?id=vVrz1cqvQzI=> (last visited 14 July 2014)
(hereinafter IIF, ‘Making Resolution Robust’).
114
See Rosa M Lastra, ‘Cross-Border Bank Insolvency: Legal Implications in the Case of
Banks Operating in Different Jurisdictions in Latin America’ (2003) 6(1) Journal of
International Economic Law 79; Rosa M Lastra, ‘Cross-Border Resolution of Banking Crises’
in Douglas D Evanoff, George G Kaufman, and John R LaBrosse (eds), International
Financial Stability: Global Banking and National Regulation (Singapore: World Scientific
Publishing Co Pte Ltd, 2007); Rosa M Lastra and Rodrigo Olivares-Caminal, ‘Cross-Border
Insolvency: The Case of Financial Conglomerates’ in LaBrosse et al (eds), above note 65;
and in the relevant chapters of Lastra (ed), above note 65. See also Regulation 806/2014,
Preamble, recital 6.
115
Such coordination in turn is conditional upon the adoption of either territoriality or
universality of insolvency.
116
This is discussed in Part II of this volume. See BRRD.
117
See generally Charles A E Goodhart, The Basel Committee on Banking Supervision, 1st
edn (Cambridge: Cambridge University Press, 2011), at <http://dx.doi.org/10.1017/
CBO9780511996238> (last visited 14 July 2014).
118
See Basel Committee on Banking Supervision, ‘Report and Recommendations of the
Cross-border Bank Resolution Group’ (March 2010), at <http://www.bis.org/publ/
bcbs169.htm> (last visited 14 July 2014) (hereinafter ‘Report of the Cross-border Bank
Resolution Group’).
119
In 1997 the Basel Committee published the ‘Core Principles for Effective Banking
Supervision’ (see ‘Basel Core Principles 1997’, above note 67) revised in 2006 and 2012,
which have important implications for the supervision of international banks. The Basel
Core Principles for Effective Banking Supervision are intended to serve as a basic reference
for supervisory and other public authorities worldwide to apply in the supervision of all
banks within their jurisdictions.
120
See Rosa M Lastra and Rodrigo Olivares Caminal, ‘From Consolidated Supervision to
Consolidated Resolution’ in John Raymond LaBrosse, Rodrigo Olivares-Caminal, and
Dalvinder Singh (eds), Managing Risk in the Financial System (Cheltenham: Edward Elgar,
2011) 308.
121
See Daniel Zuberbuhler, ‘The Financial Industry in the 21st Century. Introduction’,
Speech at the Bank for International Settlements (Basel, 21 September 2000) 2, at <http://
www.bis.org/review/rr000921c.pdf> (last visited 14 July 2014).
122
The single entity approach to liquidation goes hand in hand with the principle of unity
and universality of bankruptcy, which means that there is only one competent court to
decide on the bankruptcy of a bank and that the bankruptcy law of the country in which the
insolvency has been initiated is effective in all other countries in which the bank has assets
or branches. Thus, this principle assigns extraterritorial effect to the adjudication of
bankruptcy. In contrast, the separate entity doctrine goes hand in hand with the principle of
plurality of bankruptcy, which means that bankruptcy proceedings are only effective in the
country in which they are initiated, and that therefore there is a plurality of proceedings, as
they need to be initiated in every country in which the insolvent bank holds realizable
assets or branches. Thus, this principle assigns territorial effect to the adjudication of
bankruptcy. Under a separate entity approach, local creditors receive preferential
treatment, as local assets in a domestic branch of a foreign bank are segregated for their
benefit.
123
See Christopher T Curtis, ‘The Status of Foreign Deposits under the Federal Deposit
Preference Law’ (2000) 21(2) University of Pennsylvania Journal of International Economic
Law 237, 254.
124
A general principle, which has been applied in several jurisdictions, is that the home
office is ultimately liable for a deposit placed in its foreign branch, thereby rejecting the
doctrine of separate entity, which implies that the deposit would be legally payable only at
the foreign branch. With regard to the liability of a bank’s home office for deposits placed in
a foreign branch, it is important to mention some legislative developments in the USA.
Amendments to the New York Banking Law and to the Federal Reserve Act were introduced
in 1994 providing that the home office of a bank located in the USA will not be required to
repay a deposit made at a foreign branch if the branch cannot repay the deposit due to an
act of war, insurrection, or civil strife, or to an action by the foreign government of the
country in which the branch is located, unless the bank has expressly agreed in writing to
repay the deposit under such circumstances. Both amendments apply only to deposits that
cannot be repaid owing to political risk. Traditionally, home offices have been responsible
for credit risks of their foreign branches, such as losses due to insolvency, fraud, theft, fire,
natural disaster, and so forth. These traditional home office liabilities will not be affected by
the amendments. Thus, though the general rule remains that a depositor placing funds in
the foreign branch of a US bank is a creditor of the bank as whole, and not merely of the
branch or office where the deposit was made, and that therefore he/she has recourse—for
the repayment of his/her deposit—against the bank at its home office, there is now an
exception to this general rule in the case of political risk. Both amendments (to the New
York Banking Law and to the Federal Reserve Act) were legislative responses to two court
decisions (Trinh v Citibank, 850 F 2d 1164 (6th Cir 1988) and Wells Fargo Ltd v Citibank,
936 F 2d 723 (2d Cir 1991)), which held that a bank domiciled in New York was responsible
to a depositor for funds deposited in a foreign branch when the deposits were expropriated
or frozen by the foreign country in which the branches were located. In response to these
decisions, some banks began lobbying for legislation that would protect the home office
assets of US banks from claims by foreign branch depositors where those deposits could not
be repaid as a result of local government action. This practice is sometimes referred to as
the ‘ring-fencing’ of foreign branch deposits.
125
See Thomas C Baxter, Jr, Joyce M Hansen, and Joseph H Sommer, ‘Two Cheers for
Territoriality: An Essay on International Bank Insolvency Law’ (2004) 78(1) American
Bankruptcy Law Journal 57.
126
See Charles Randell, ‘A Tale of Two Banks’, Paper Presented at the Conference on
Managing and Financing European Bank Resolution, organized by the London Financial
Regulation Group, London School of Economics (24 March 2014), cited with the permission
of the author.
127
UNCITRAL Model Law on International Commercial Arbitration, 24 ILM 1302 (1985),
Art 1(2) (hereinafter UNCITRAL Model Law). See also Chapter 14 in this volume.
128
See UNCITRAL Legislative Guide on Insolvency Law, at <http://www.uncitral.org/
uncitral/en/uncitral_texts/insolvency/2004Guide.html> (last visited 14 July 2014).
129
The other eleven areas are: accounting; auditing; anti-money laundering and
countering the financing of terrorism (AML/CFT); banking supervision; corporate
governance; data dissemination; fiscal transparency; insurance supervision; monetary and
financial policy transparency; payment systems; and securities regulation.
130
Regarding the Bustamante Code and the Montevideo Treaties, see Juan M Dobson,
‘Treaty Developments in Latin America’ in Ian Fletcher (ed), Cross-Border Insolvency:
Comparative Dimensions, The Aberystwyth Insolvency Papers, vol 12 (London: United
Kingdom National Committee of Comparative Law, 1990) 237.
131
See also Kurt Lipstein, ‘Early Treaties for the Recognition and Enforcement of Foreign
Bankruptcies’ in Fletcher (ed), above note 130, 228.
132
An analysis of this new regime can be found in Erwin Nierop and Mikael Stenström,
‘Cross-Border Aspects of Insolvency Proceedings for Credit Institutions—A Legal
Perspective’, Paper Presented at an International Seminar on Legal and Regulatory Aspects
of Financial Stability, Basel (21–23 January 2002), at <http://www1.worldbank.org/finance/
assets/images/Nierop___Stenstrom.pdf> (last visited 14 July 2014).
133
See Directive 2001/24/EC of the European Parliament and of the Council of 4 April
2001 on the Reorganisation and Winding up of Credit Institutions, OJ L125/15 (5 May
2001), at <http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:
2001:125:0015:0023:en:PDF> (last visited 14 July 2014).
134
See Council Regulation (EC) No 1346/2000 of 29 May 2000 on Insolvency Proceedings,
OJ L160/1 (30 June 2000), at <http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?
uri=OJ:L:2000:160:0001:0018: en:PDF> (last visited 14 July 2014).
135
See Directive 2001/17/EC of the European Parliament and of the Council of 19 March
2001 on the Reorganisation and Winding-up of Insurance Undertakings, OJ L110/28 (20
April 2001), at <http://amf.gov.al/pdf/ligje/7_Directive%202001%20Reorganisation.pdf>
136
See International Monetary Fund, ‘Resolution of Cross-Border Banks—A Proposed
Framework for Enhanced Coordination’ (11 June 2010), at <http://www.imf.org/external/np/
pp/eng/2010/061110.pdf> (last visited 14 July 2014) (hereinafter IMF, ‘Proposed
Framework for Enhanced Coordination’).
137
See ‘Report of the Cross-border Bank Resolution Group’, above note 118.
138
SIFIs—according to the FSB Recommendations—are financial institutions ‘whose
disorderly failure, because of their size, complexity and systemic interconnectedness, would
cause significant disruption to the wider financial system and economic activity’. See
Financial Stability Board, ‘Reducing the Moral Hazard Posed by Systemically Important
Financial Institutions—FSB Recommendations and Time Lines’ (20 October 2010), at <http:
//www.financialstabilityboard.org/publications/r_101111a.pdf?frames¼0> (last visited 14
July 2014) (hereinafter ‘FSB Recommendations and Time Lines’). See paragraphs 4.158–
4.164 and paragraph 14.195.
139
This report mainly concludes that, while many reforms regarding resolution policies are
underway globally, additional work remains to be done especially in the area of cross-border
resolution. See Basel Committee on Banking Supervision, ‘Resolution Policies and
Frameworks—Progress So Far’ (July 2011) <http://www.bis.org/publ/bcbs200.pdf> (last
140
See ‘Basel Core Principles 2012’, above note 68, 14 (Section III, ‘Preconditions for
Effective Banking Supervision’).
141
FSB, ‘Key Attributes’, above note 102. For an exhaustive analysis on the application of
the Key Attributes to the depositary and investment banks, see Randell, above note 106.
142
IMF, ‘A Proposed Framework for Enhanced Coordination’, above note 136, identifies
some of these core coordination standards.
143
This permanent solution is advocated in Lastra (ed), above note 65. This solution was
also advocated by Rodge Cohen, Speech at The Meeting of the Systemic Resolution
Advisory Committee of the Federal Deposit Insurance Corporation Held in the Board Room
Federal Deposit Insurance Corporation Building, Washington, DC (21 June 2011), at
<https://www.fdic.gov/about/srac/11JuneMeetingMins.pdf> (last visited 14 September
2014), and, more recently, in IIF, ‘Making Resolution Robust’, above note 113.
144
In the USA, the strategy has been developed in the context of the powers provided by
the Dodd–Frank Act 2010. In the UK, the strategy has been developed on the basis of the
powers provided by the UK Banking Act 2009 (entered into force 21 February 2009, c 1)
and in anticipation of the further powers to be provided by the European Union Bank
Recovery and Resolution Directive. See Federal Deposit Insurance Corporation and the
Bank of England, ‘Resolving Globally Active, Systemically Important Financial
Institutions’ (10 December 2012), at <http://www.bankofengland.co.uk/publications/
Documents/news/2012/nr156.pdf> (last visited 14 July 2014).
145
See BRRD (above note 109 and Chapter 10, note 3) and Regulation 806/2014.
146
See Regulation 806/2014, Preamble, recital 11.
147
See Nusret Cetin, ‘The EU Proposal for Bank Recovery and Resolution’ (4 October
2012), at <http://ssrn.com/abstract=2214943> (last visited 14 July 2014), and
Rosa M Lastra and Jean-Victor Louis, ‘European Economic and Monetary Union: History,
Trends, and Prospects’ (2013) Yearbook of European Law 1.
148
George Sheldon and Martin Maurer, ‘Inter-Bank Lending and Systemic Risk: An
Empirical Analysis for Switzerland’ (1998) 134 Swiss Journal of Economics and Statistics
685.
149
See Milton Friedman and Anna Schwartz, The Great Contraction 1929–1933 (Princeton,
NJ: Princeton University Press, 1965) 123. See also Irving Fischer, ‘The Debt Deflation
Theory of Great Depressions’ (1933) 1 Econometrica 337.
150
See Martin Summer, ‘Banking Regulation and Systemic Risk’ (2003) 14 Open
Economies Review 43. See Olivier De Bandt and Philipp Hartmann, ‘Systemic Risk: A
Survey’, European Central Bank Working Paper No 35 (November 2000) 10–13, at <https://
www.ecb.europa.eu/pub/pdf/scpwps/ecbwp035.pdf> (last visited 14 July 2014).
151
See above note 5.
152
Gadbaw, referring to the financial crisis, states that ‘[s]ystemic failure and its
counterparty systemic risk have entered our public policy lexicon’. See R Michael Gadbaw,
‘Systemic Regulation of Global Trade and Finance: A Tale of Two Systems’ (2010) 13(3)
Journal of International Economic Law 551, 552. On the topic, see also generally Rosa M
Lastra, ‘Systemic Risk, SIFIs and Financial Stability’ (2011) 6(2) Capital Markets Law
Journal 197.
153
Please see Chapter 3 in this volume for more detail on the concept of macro- and micro-
prudential supervision and the emergence of the councils for financial stability.
154
Davis defines systemic risk as a ‘disturbance in financial markets which entails
unanticipated changes in prices and quantities in credit or asset markets, which lead to a
danger of failure of financial firms, and which in turn threatens to spread so as to disrupt
the payments mechanism and capacity of the financial system to allocate capital’. See Philip
Davis, Debt, Financial Fragility and Systemic Risk (Oxford: Clarendon Press, 1992) 117.
155
See Adriano Lucatelli, Finance and World Order—Financial Fragility, Systemic Risk and
Transnational Regimes (Westport, CT: Greenwood Press, 1997) 70–4; European Central
Bank, ‘The Concept of Systemic Risk’ in European Central Bank, Financial Stability Review
2009 (December 2009) 134, at <http://www.ecb.europa.eu/pub/pdf/other/
financialstabilityreview200912en.pdf> (last visited 14 July 2014); Steven L Schwarcz,
‘Systemic Risk’ (2008) 97(1) Georgetown Law Journal 193; Jean-Claude Trichet, ‘Systemic
Risk’, Clare Distinguished Lecture in Economics and Public Policy at the Clare College,
University of Cambridge (10 December 2009), at <http://www.ecb.europa.eu/press/key/
date/2009/html/sp091210_1.en.html> (last visited 14 July 2014); John B Taylor, ‘Systemic
Risk and the Role of Government’, Dinner Keynote Speech at the Conference on Financial
Innovation and Crises, Federal Reserve Bank of Atlanta, Jekyll Island, GA (12 May 2009);
Anna Gelpern, ‘Financial Crisis Containment’ (2009) 41 Connecticut Law Review 1051; Erik
F Gerding, ‘Code, Crash, and Open Source: The Outsourcing of Financial Regulation to Risk
Models and the Global Financial Crisis’ (2009) 84 Washington Law Rev 127; Amir E
Khandani, Andrew W Lo, and Robert C Merton, ‘Systemic Risk and the Refinancing Ratchet
Effect’, Harvard Business School Working Paper 10-023 (10 June 2010), at <http://
www.hbs.edu/faculty/Publication%20Files/10-023.pdf> (last visited 14 July 2014).
156
See John Coffee, ‘Systemic Risk after Dodd-Frank: Contingent Capital and the Need for
Regulatory Strategies Beyond Oversight’ (2011) 111 Columbia Law Review 795, 816; and
Schwarcz, above note 155, 200.
157
For instance, the ‘systemic risk exception’ in FDICIA in the USA only refers to ‘serious
adverse effects on economic conditions or financial stability’. See FDICIA, 12 USC 1823(c)
(4)(G)(i).
158
Hal S Scott, ‘Reducing Systemic Risk through the Reform of Capital Regulation’ (2010)
13(3) Journal of International Economic Law 763, 763.
159
Gabriele Galati and Richhild Moessner, ‘Macroprudential Policy—A Literature Review’,
Bank for International Settlements Working Paper No 337 (February 2011) 13, at <http://
www.bis.org/publ/work337.pdf> (last visited 14 July 2014).
160
International Monetary Fund, ‘Key Aspects of Macroprudential Policy’ (10 June 2013) 7,
at <http://www.imf.org/external/np/pp/eng/2013/061013b.pdf> (last visited 14 July 2014).
161
Andromachi Georgosouli, Financial Resilience (unpublished Ms; cited with the
permission of the author) addresses the problem of financial vulnerability shifting away
from the financial stability metaphor towards a resilience-oriented scheme of regulation.
She defines financial resilience as ‘adaptive capacity to change’, which ‘is measured in
terms of one’s ability to learn, prepare and, where appropriate, cope and recover from
future contingencies’. She concludes:
Contrary to financial stability-driven systems of regulation, ‘resilience regulation’

gives equal consideration to consumer resilience and systemic resilience and thus it
is more likely to lead to more equitable management of financial vulnerability.
162
See generally Nicholas Taleb, Antifragile: Things That Gain From Disorder (New York:
Random House, 2012).
163
Recommendation of the European Systemic Risk Board of 4 April 2013 on Intermediate
Objectives and Instruments of Macroprudential Policy (ESRB/2013/1), OJ C 170/01 (15 June
2013).
164
Douglas J Elliott, Greg Feldberg, and Andreas Lehnert, ‘The History of Cyclical
Macroprudential Policy in the United States’, Federal Reserve Board, Divisions of Research
& Statistics and Monetary Affairs, Finance and Economics Discussion Series Working Paper
No 2013-29 (15 May 2013), at <http://www.federalreserve.gov/pubs/feds/
2013/201329/201329pap.pdf> (last visited 14 July 2014).
165
See Hyun Song Shin, ‘Macroprudential Policies Beyond Basel III’, BIS Papers No 60
(December 2011), at <http://www.bis.org/publ/bppdf/bispap60b.pdf> (last visited 14 July
2014). Shin suggests that the following macro-prudential policy tools should be used to
address excessive asset growth: (1) loan to value (LTV) and debt service to income (DTI)
ratios to limit bank lending; (2) leverage caps that tie total assets to bank capital, as a
constraint on new lending; and (3) a levy on non-core bank liabilities (ie non-deposits) to
address the under-pricing of risk in the financial system by mitigating pricing distortions
that lead to excessive asset growth (an example of this corrective tax is the so-called
Financial Stability Contribution (FSC) recommended by the IMF in its report to the G20 of
June 2010). See International Monetary Fund, ‘A Fair and Substantial Contribution by the
Financial Sector’, Final Report for the G20 (June 2010), at <http://www.imf.org/external/np/
g20/pdf/062710b.pdf> (last visited 14 July 2014).
166
See Lastra and Wood, above note 2, 542.
167
Galati and Moessner, above note 159, 13.
168
See George G Kaufman and Kenneth E Scott, ‘What is Systemic Risk and Do Bank
Regulators Retard or Contribute to It?’ (2003) 7(3) Independent Review 371.
169
See Claudio Borio, ‘Towards a Macroprudential Framework for Financial Supervision
and Regulation?’, Bank for International Settlements Working Paper No 128 (February
2003), at <http://www.bis.org/publ/work128.pdf> (last visited 14 July 2014).
170
See G30 Working Group, ‘Global Institutions, National Supervision and Systemic Risk’,
Study Group on the Evolutions of Supervision and Regulation Report (July 1997) at <http://
www.group30.org/rpt_23.shtml> (last visited 14 July 2014).
171
Mishkin defined systemic risk as ‘…the likelihood of a sudden, usually unexpected,
event that disrupts information in financial markets, making them unable to effectively
channel funds to those parties with the most productive investment opportunities…’. See
Frederic Mishkin, ‘Comment on Systemic Risk’ in George Kaufman (ed), Research in
Financial Services: Banking, Financial Markets and Systemic Risk (Greenwich, CT: JAI
Press, 1995) vol 7, 32.
172
See Bank for International Settlements, 64th Annual Report (13 June 1994) 177, at
<http://www.bis.org/publ/arpdf/archive/ar1994_en.pdf> (last visited 14 July 2014).
173
See Edward A J George, ‘The New Lady of Threadneedle Street. Governor’s Speech of
24 February 1998’ (1998) 38(2) Bank of England Quarterly Bulletin 173. Geoffrey Wood
pursued this metaphor and pointed out to me the following: ‘Of course, if the mountaineers
are properly anchored, as they should be, then if the one who is moving falls then he is
saved, albeit dangling, and the others safe.’ Quoted in Lastra, above note 152, 201 n 18.
174
A recent IMF study on systemic risk monitoring proposes an interesting guidance on
the use of the existing monitoring tools based on six fundamental questions policymakers
are expected to ask. These questions are: ‘Is potentially excessive risk building up in
financial institutions? Are asset prices growing too fast? How much is the sovereign risk a
source of systemic risk? What are the amplification channels among sectors and through
the broader domestic economy? What are the amplification channels through cross-border
spillovers? What is the probability of a systemic crisis?’ See Nicolas R Blancher et al,
‘Systemic Risk Monitoring (“SysMo”) Toolkit—A User Guide’, International Monetary Fund
Working Paper No 13/168 (17 July 2013), at <http://www.imf.org/external/pubs/ft/wp/2013/
wp13168.pdf> (last visited 14 July 2014).
175
Huang identifies three main channels of financial contagion: (1) the asset market
channel, (2) the banking channel, and (3) the currency channel: see Haizhou Huang,
‘Research Summary: Financial Contagion: ABC Channels’ (2000) 1(2) IMF Research
Bulletin, at <http://www.imf.org/external/pubs/ft/irb/2000/eng/02/index.htm#sum2> (last
176
See eg Jean-Charles Rochet and Jean Tirole, ‘Interbank Lending and Systemic
Risk’ (1996) 28 Journal of Money, Credit and Banking 733.
177
See eg Ross Cranston, Principles of Banking Law, 2nd edn (Oxford: Oxford University
Press, 2002) 66–7.
178
See House of Commons, Treasury Committee, ‘Banking Crisis: The Impact of the
Failure of the Icelandic Banks’, Responses from the Government and the Financial Services
Agency to the Committee’s Fifth Report of Session 2008–09 (19 June 2009) <http://
www.publications.parliament.uk/pa/cm200809/cmselect/cmtreasy/656/656.pdf> (last visited
14 July 2014).
179
See Garry Schinasi et al, ‘Modern Banking and OTC Derivatives Markets—The
Transformation of Global Finance and its Implications for Systemic Risk’, International
Monetary Fund Occasional Paper No 203 (9 January 2000) 49–58, at <http://www.imf.org/
external/pubs/nft/op/203/> (last visited 14 July 2014); see also Adam R Waldman, ‘OTC
Derivatives and Systemic Risk: Innovative Finance or the Dance into the Abyss?’ (1994) 43
American University Law Review 1023.
180
For further conceptual analysis of financial derivative transactions, see indicatively G30
Working Group, ‘Derivatives: Practices and Principles’, Special Report (1993), at <http://
www.group30.org/rpt_29.shtml> (last visited 14 July 2014); Basel Committee on Banking
Supervision, ‘Risk Management Guidelines for Derivatives’ (July 1994), at <http://
www.bis.org/publ/bcbsc211.pdf> (last visited 14 July 2014); Simon Firth, Derivatives: Law
and Practice (London: Sweet and Maxwell, 2003).
181
Financial Crisis Inquiry Commission, ‘The Financial Crisis Inquiry Report: Final Report
of the National Commission on the Causes of the Financial and Economic Crisis in the
United States’ (2011) 324–43, <http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-
FCIC.pdf> (last visited 14 July 2014) (hereinafter ‘Financial Crisis Inquiry Report’).
182
‘Financial Crisis Inquiry Report’, above note 181, 353.
183
Counterparty Risk Management Policy Group, ‘Containing Systemic Risk: The Road to
Reform’ (6 August 2008) 79 <http://www.crmpolicygroup.org/docs/CRMPG-III.pdf> (last
184
For further analysis of the insurance sector during the 2007–9 crisis, see Scott E
Harrington, ‘The Financial Crisis: Systemic Risk and the Future of Insurance
Regulation’ (2009) 76(4) Journal of Risk and Insurance 785.
185
In September 2009, the Pittsburgh G20 summit published a leaders’ statement in which
it set out the agreement that: ‘All standardized OTC derivative contracts should be traded
on exchanges or electronic trading platforms, where appropriate, and cleared through
central counterparties by end-2012 at the latest. OTC derivative contracts should be
reported to trade repositories. Non-centrally cleared contracts should be subject to higher
capital requirements.’ See European Commission, ‘Leaders’ Statement: The Pittsburgh
Summit’ (24–25 September 2009), at <http://ec.europa.eu/commission_2010-2014/
president/pdf/statement_20090826_en_2.pdf> (last visited 14 September 2014).
186
In its 2008 Financial Stability Report, the Bank of England stated the UK and global
financial market infrastructures continued to function effectively and the UK clearing house
LCH. Clearnet successfully closed out its positions (interest rate swap default comprised of
more than 66,000 trades) even without using all of the margin available and despite being
‘exposed to the risk of sharp market movements across a wide range of products’.
According to the report, this illustrates ‘the ability of a clearing house to protect market
participants from bilateral counterparty risk, even in the event of default of a major
participant’. See Bank of England, ‘Financial Stability Report’, Issue No 24 (October 2008)
20, at <http://www.bankofengland.co.uk/publications/Documents/fsr/2008/fsrfull0810.pdf>
187
Ben S Bernanke, ‘Clearinghouses, Financial Stability, and Financial Reform’, Speech
given at the Financial Markets Conference, Stone Mountain, Georgia (4 April 2011) <http://
www.federalreserve.gov/newsevents/speech/bernanke20110404a.pdf> (last visited 14 July
2014).
188
See Committee on Payment and Settlement Systems, Technical Committee of the
International Organization of Securities Commissions, ‘Principles for Financial Market
Infrastructures’ (April 2012), at <www.bis.org/publ/cpss101a.pdf> (last visited 14 July
2014).
189
See Gary Gorton and Andrew Metrick, ‘Securitized Banking and the Run on the Repo’
Yale ICF Working Paper No 09-14 (9 November 2010), at <http://ssrn.com/
abstract=1440752> (last visited 14 July 2014). See Gary Gorton and Andrew
Metrick, ‘Securitized Banking and the Run on the Repo’ (2012) 104 Journal of Financial
Economics 425.
190
There is on-going debate about issues related to the repo market, including its
measurement, types of collateral backing repo transactions, and data required to identify
institution- and system-level risks. See Arvind Krishnamurthy, Stefan Nagel, and Dmitry
Orlov, ‘Sizing up Repo’, National Bureau of Economic Research Working Paper No 17768
(January 2012), at <http://www.nber.org/papers/w17768> (last visited 14 July 2014); Tobias
Adrian, Brian Begalle, Adam Copeland, and Antoine Martin, ‘Repo and Securities Lending’
in Risk Topography: Systemic Risk and Macro Modeling (Chicago: University of Chicago
Press, 2013). The European Repo Council also highlighted the shortcomings of Gorton and
Metrick’s findings: see International Capital Markets Association, European Repo Council,
‘Haircuts and Initial Margins in the Repo Market’ (8 February 2012), at <http://
www.icmagroup.org/assets/documents/Maket-Practice/Regulatory-Policy/Repo-Markets/
Haircuts%20and%20initial%20margins%20in%20the%20repo%20market_8%20Feb%20201
2.pdf> (last visited 14 July 2014).
191
The Committee on Payment and Settlement Systems (CPSS), having examined the
extent to which the clearing and settlement infrastructure for repos contributed to the
instability in some repo markets, suggested various ways to strengthen repo clearing and
settlement arrangements (see CPSS, ‘Strengthening Repo Clearing and Settlement
Arrangements’ (September 2010), at <http://www.bis.org/publ/cpss91.pdf> (last visited 14
July 2014). In the USA, the Tri-party Repo Infrastructure Reform Task Force published
recommendations to modify tri-party repo settlement process, in order to reduce market’s
reliance on intraday credit provided by clearing banks. The reforms are now being
implemented and, according to the latest report, tri-party repo market participants have
made a good progress. See Federal Reserve Bank of New York, ‘Update on Tri-Party Repo
Infrastructure Reform’, Statement (13 February 2014), at <http://www.newyorkfed.org/
newsevents/statements/2014/0213_2014.html> (last visited 14 July 2014). See ‘Fed Opens
its Doors Wider to Repo Trading’ Financial Times (20 March 2014): ‘The Federal Reserve
has assumed a much bigger role in a key funding market that has long been a prime
component of the unregulated shadow banking system, reflecting central bank concerns
that it poses a systemic risk.’
192
For a conceptual legal analysis of clearing and settlement systems, including references
to systemic risk, see generally Benjamin Geva, Bank Collections and Payment Transactions:
A Comparative Legal Analysis (Oxford: Oxford University Press, 2001) chs 1 and 7–8; and
Robert C Effros (ed), Payment Systems of the World (New York: Oceana Publications, 1994).
For a recent analysis of the legal risk in connection with the payment systems, see Benjamin
Geva, ‘Global and Cross-Border Credit Transfers: The Role of Legislation in Addressing
Legal Risk for Participants’ in Mario Giovanoli and Diego Devos (eds), International
Monetary and Financial Law. The Global Financial Crisis (Oxford: Oxford University Press,
2010) 545. For an economic analysis of these issues, see David Folkerts-Landau, ‘Systemic
Financial Risk in Payment Systems’ in International Monetary Fund, Determinants and
Systemic Consequences of International Capital Flows, Occasional Paper No 77
(Washington, DC: IMF, 1991) 46; David B Humphrey, ‘Payments Finality and Risk of
Settlement Failure’ in Anthony Saunders and Lawrence H White (eds), Technology and the
Regulation of Financial Markets: Securities, Futures, and Banking (Lexington, MA:
Lexington Books, 1986) 97; Richard Dale, ‘Risk Management and Public Policy in Payment,
Clearing and Settlement Systems’ (1998) 1(2) International Finance 229. See also
Committee on Payment and Settlement Systems, ‘Delivery versus Payment in Securities
Settlement Systems’ (September 1992), at <http://www.bis.org/publ/cpss06.pdf> (last
visited 14 July 2014); Committee on Payment and Settlement Systems, ‘Settlement Risk in
Foreign Exchange Transactions’ (March 1996), at <http://www.bis.org/publ/cpss17.pdf>
(last visited 14 July 2014); CPSS, ‘Principles for Financial Market Infrastructures’, above
note 188; Board of Governors of the Federal Reserve System, Policy Statement on Payments
System Risk (Washington, DC: Board of Governors of the FRS, 30 May 2001).
193
The CPSS and the International Organization of Securities Commissions (IOSCO)
issued in 2012 a new set of standards, for payment, clearing, and settlement systems,
including central counterparties: see CPSS, ‘Principles for Financial Market
Infrastructures’, above note 188 (PFMIs). These new standards are designed to ensure that
the infrastructure supporting global financial markets is more robust and thus well placed
to withstand financial shocks. The principles apply to all systemically important payment
systems, central securities depositories, securities settlement systems, central
counterparties, and trade repositories (collectively ‘financial market infrastructures’). They
replace the three existing sets of international standards set out in the ‘Core Principles for
Systemically Important Payment Systems’ (CPSS, 2001); the ‘Recommendations for
Securities Settlement Systems’ (CPSS-IOSCO, 2001); and the ‘Recommendations for
Central Counterparties’ (CPSS-IOSCO, 2004). CPSS and IOSCO have strengthened and
harmonized these three sets of standards by raising minimum requirements, providing
more detailed guidance, and broadening the scope of the standards to cover new risk-
management areas and new types of financial markets infrastructures. See Committee on
Payment and Settlement Systems, ‘Principles for Financial Market Infrastructures’ (April
2012), at <http://www.bis.org/publ/cpss101.htm> (last visited 14 July 2014).
194
In the USA, for example, the dollar volume of payments made by wire transfers far
exceeds the dollar volume of payments made by other means.
195
See Charles Freedman and Clyde Goodlet, ‘Large-Value Clearing and Settlement
Systems and Systemic Risk’ (1996) 7(2) North American Journal of Economics & Finance
153.
196
See Folkerts-Landau, above note 192, 6–7.
197
See Cranston, above note 177, ch 10.
198
See De Bandt and Hartmann, above note 150, 33.
199
I am grateful to Charles Goodhart for observations on this point.
200
The Herstatt risk is named after the failure of Bankhaus Herstatt in 1974. On 26 June
1974, the German Bundesaufsichtsamt für das Kreditwesen withdrew the banking licence of
Bankhaus Herstatt, a small bank in Cologne active in the foreign exchange market, and
ordered it into liquidation during the banking day, but after the close of the interbank
payment system in Germany. Prior to the announcement of Herstatt’s closure, several of its
counterparties had, through branches or correspondents, paid Deutschmark to Herstatt on
that day through the German payment system, against anticipated receipts of US dollars
later the same day in New York in respect of maturing spot and forward transactions. Upon
the termination of Herstatt’s business at 10:30 am Eastern Standard time (3.30 pm in
Frankfurt) on 26 June, Herstatt’s New York correspondent bank suspended outgoing US
dollar payments from the Herstatt account. This action left Herstatt’s counterparty banks
exposed for the full value of the Deutschmark deliveries made (credit risk and liquidity
risk). Moreover, banks which had entered into forward trades not yet due for settlement
with Herstatt lost money in replacing the contracts in the market (replacement risk), while
others had deposits with Herstatt (traditional counterparty risk).
201
See CPSS, ‘Delivery versus Payment in Securities Settlement Systems’, above note 192.
See also Cranston, above note 177, 289.
202
For a recent study on the payment systems, see Geoffrey P Miller and Fabrizio Cafaggi,
‘Governing Global Payments Markets: The International Payments Framework—A New
Actor on the Scene’ in Geoffrey P Miller and Fabrizio Cafaggi, The Governance and
Regulation of International Finance (Cheltenham: Edward Elgar, 2013) ch 4.
203
See Charles Calomiris and Charles Kahn, ‘The Role of Demandable Debt in Structuring
Optimal Banking Arrangements’ (1991) 81 American Economic Review 497.
204
See Lawrence H White, Free Banking in Britain: Theory, Experience, and Debate, 1800–
1845 (Cambridge: Cambridge University Press, 1984); Arthur Rolnick and Werner Weber,
‘Inherent Instability in Banking: The Free Banking Experience’ (1986) 5(3) Cato Journal
877; Kevin Dowd (ed), The Experience of Free Banking (London: Routledge, 1992); Kevin
Dowd, Competition and Finance (London: Macmillan, 1996) ch 7; Charles Calomiris and
Charles Kahn, ‘The Efficiency of Self-regulated Payments Systems: Learning from the
Suffolk System’ (1996) 28 Journal of Money, Credit, and Banking 767.
205
See Stephanie Czák, Johannes Lindner, and Markus Mayers, ‘The Eurosystem’s
Oversight Role’ in Tom Kokkola (ed), The Payment System: Payments, Securities and
Derivatives, and the Role of the Eurosystem (Frankfurt am Main: ECB, 2010).
206
See Czák et al, above note 205.
207
The unlimited credit facilities made available since the establishment of the TARGET2
system by the national central banks of the Eurosystem and by the ECB were the main
subject of criticism. Since every country needs a relatively steady amount of central bank
money for its domestic transactions, payment orders to other countries, which reduce the
domestic stock of money, must be offset by a continuous issuing of new refinancing credit,
ie the creation of new central bank money. A country’s TARGET liabilities also indicate the
extent to which its central bank has replaced the capital markets to finance its current
account deficit, as well as any possible capital flight, by creating new central bank money
through corresponding refinancing credit. See Hans-Werner Sinn, ‘Die Riskante
Kreditersatzpolitik der EZB’, 103 Frankfurter Allgemeine Zeitung (4 May 2011) 10.
208
See Hans-Werner Sinn and Timo Wollmershäuser, ‘Target Loans, Current Account
Balances and Capital Flows: The ECB’s Rescue Facility’ (2012) 19(4) International Tax and
Public Finance 468; Jens Ulbrich and Alexander Lipponer, ‘Is the Build-up of TARGET2
Balances a Question of Self-contained Risk?’ (2012) 5(4) Journal of Risk Management in
Financial Institutions 390.
209
See Kenneth Scott and John Taylor, ‘Why Toxic Assets are so Hard to Clean Up’ Wall
Street Journal (20 July 2009).
210
See Anton R Valukas, ‘Lehman Brothers Holdings Inc, Ch 11 Proceedings Examiner’s
Report’ (11 March 2010) 733–34, at <http://jenner.com/lehman/> (last visited 14 July 2014).
For press coverage, see Financial Times (13–14 March 2010). See also Lastra and Wood,
above note 2, 542; and Andrew Ross Sorkin, Too Big to Fail: The Inside Story of How Wall
Street and Washington Fought to Save the Financial System—And Themselves (New York:
Penguin Books, 2011).
211
See Varadarajan Chari and Ravi Jagannathan, ‘Banking Panics, Information, and
Rational Expectations Equilibrium’ (1988) 43 Journal of Finance 749, and Charles Jacklin
and Sudipto Bhattacharya, ‘Distinguishing Panics and Information-based Bank Runs:
Welfare and Policy Implications’ (1988) 96 Journal of Political Economy 568 and by many
commentators thereafter.
212
See Kaufman and Scott, above note 168.
213
See Markus K Brunnermeier, Andrew Crockett, Charles Goodhart, Avinash D Persaud,
and Hyun Song Shin, The Fundamental Principles of Financial Regulation, Geneva Reports
on the World Economy 11 (Geneva/London: International Center for Monetary and Banking
Studies/Centre for Economic Policy Research, 2009) (hereinafter ‘Geneva Report’); Markus
K Brunnermeier and Lasse H Pedersen, ‘Market Liquidity and Funding Liquidity’ (2009) 22
Review of Financial Studies 2201.
214
Geneva Report, above note 213, 14:
Funding liquidity is high…when it is easy to raise money. Typically, when a

leveraged trader, such as a bank, dealer or hedge fund, purchases an asset as
collateral and borrows (short term) against it. However, he cannot borrow the entire
price. The difference between the security’s price and its value as collateral—the
margin or haircut—must be financed by the financier’s own equity capital.
215
Brunnermeier and Pedersen, above note 213, 2204–2205.
216
Geneva Report, above note 213, 15–19.
217
Geneva Report, above note 213, xix.
218
Geneva Report, above note 213, 24.
219
Geneva Report, above note 213, 23.
220
See Kindleberger, above note 1, 109.
221
222
223
See Franklin Allen and Douglas Gale, ‘Systemic Risk and Regulation’ in Mark Carey
and René M Stulz (eds), The Risks of Financial Institutions (Chicago: University of Chicago
Press, 2007) 341; Tobias Adrian and Hyun Song Shin, ‘Liquidity, Monetary Policy, and
Financial Cycles’ (2008) 14(1) Current Issues in Economics and Finance 1; Tobias Adrian
and Hyun Song Shin, ‘Liquidity and Financial Cycles’, Bank for International Settlements
Working Papers No 256 (July 2008), at <http://www.bis.org/publ/work256.pdf> (last visited
14 July 2014); Anil K Kashyap, Raghuram G Rajan, and Jeremy C Stein, ‘Rethinking Capital
Regulation’, Paper prepared for Federal Reserve Bank of Kansas City Symposium on
Maintaining Stability in a Changing Financial System, Jackson Hole, Wyoming (21–23
August 2008), at <http://www.kc.frb.org/publicat/sympos/2008/KashyapRajanStein.
08.08.08.pdf> (last visited 14 July 2014); Lucian A Bebchuk and Itay Goldstein, ‘Self-
Fulfilling Credit Market Freezes’, NBER Working Papers No 16031 (May 2010), at <http://
www.nber.org/papers/w16031> (last visited 14 July 2014); Miguel A Segoviano and Charles
A E Goodhart, ‘Banking Stability Measures’, IMF Working Paper No WP/09/4 (January
2009), at <https://www.imf.org/external/pubs/ft/wp/2009/wp0904.pdf> (last visited 14 July
2014); Geneva Report, above note 213; Brunnermeier and Pedersen, above note 213;
Douglas W Diamond and Raghuram G Rajan, ‘Fear of Fire Sales and the Credit Freeze’, BIS
Working Papers No 305 (March 2010), at <http://www.bis.org/publ/work305.pdf> (last
visited 14 July 2014); Tobias Adrian and Hyun Song Shin, ‘Liquidity and Leverage’ (2010)
19(3) Journal of Financial Intermediation 418; Viral V Acharya and Anjan V Thakor, ‘The
Dark Side of Liquidity Creation: Leverage-Induced Systemic Risk and Implications for the
Lender of Last Resort’, Paper presented at a seminar at the Federal Reserve Bank of
Chicago (March 2010), at <http://www.aeaweb.org/aea/2011conference/program/
retrieve.php?pdfid=d¼372> (last visited 14 July 2014); Viral V Acharya et al,
‘Measuring Systemic Risk’, AFA 2011 Denver Meetings Paper (May 2010), at <http://
ssrn.com/abstract=1573171> (last visited 14 July 2014); Viral V Acharya et al, ‘A
Tax on Systemic Risk’, Paper presented at the Conference on Bank Crisis Prevention and
Resolution, Amsterdam (2–3 June 2010), at <http://www.cepr.org/meets/wkcn/1/1741/
papers/Acharya.pdf> (last visited 14 July 2014).
224
See Clas Wihlborg, ‘Reforming Liquidity Requirements/Pros and Cons of Separate
Liquidity Requirements’, Presentation at the Conference on Reforming Financial Regulation
and Supervision: The Road Ahead, London School of Economics (24 January 2011), at
<http://www.lse.ac.uk/fmg/events/conferences/past-conferences/2011/
financialRegulation_24Jan2011/CWihlborg_Presentation.pdf> (last visited 14 July 2014).
Wihlborg reviews the current literature, in particular the factors that exacerbate contagion,
namely: asset price declines below fundamental values and contraction of credit supply,
problems with creditor guarantees, lack of capital buffer, interconnectedness, margin
requirements, ‘liquidity spirals’ (self-fulfilling illiquidity/lack of buyers), opaqueness about
the solvency of financial institutions, and incentives to hoard liquid assets (lack of buyers),
for example, as a result of expected forbearance.
225
Andrew Haldane, chief economist of the Bank of England, has looked at the lessons that
ecology, epidemiology, and genetics provide in order to understand financial networks and
complex financial systems. See eg Andrew G Haldane and Robert M May, ‘Systemic Risks in
Banking Ecosystems’ (2011) 469 Nature 351, at <http://www.nature.com/nature/journal/
v469/n7330/full/nature09659.html> (last visited 14 July 2014). See Lastra (2011) above
note 152.
226
If banks are able to borrow at artificially low rates because creditors do not believe that
they will be allowed to fail, this encourages moral hazard. See International Monetary
Fund, Global Financial Stability Report: Moving from Liquidity- to Growth-Driven Markets
(April 2014), at <http://www.imf.org/external/pubs/FT/GFSR/2014/01/pdf/text.pdf> (last
visited 14 September 2014).
227
Antoine du Saint-Exupéry, The Little Prince, trans. Richard Howard (Boston: Harcourt,
Inc, 1940).
228
See Lastra and Wood, above note 2, 542.
229
See eg Geneva Report, above note 213. See also Charles A E Goodhart and Rosa M
Lastra, ‘Border Problems’ (2010) 13(3) Journal of International Economic Law 705, and
Thomas F Huertas and Rosa M Lastra, ‘The Perimeter Issue: to What Extend Should Lex
Specialis be Extended to Systematically Significant Financial Institutions? An Exit Strategy
from Too Big to Fail’ in Lastra (ed), above note 65.
230
See ‘FSB Recommendations and Time Lines’, above note 138.
231
See above note 138. See also Heidi Schooner, ‘US Bank Resolution Reform: Then and
Again’ in Lastra (ed), above note 65, 403.
232
For a recent detailed analysis of the functioning of the OLA, see Stavros Gadinis, ‘From
Independence to Politics in Financial Regulation’ (2013) 101 California Law Review 327, at
<http://scholarship.law.berkeley.edu/facpubs/1924> (last visited 14 July 2014). According to
Gadinis, ‘the OLA embodies a new balance between agencies’ technical expertise and
politicians’ increased accountability: it affords the Treasury Secretary a decisive role in
launching and shaping a government intervention and retains independent agencies as
skilled collaborators and effective enforcers.’
233
Matt Saldaña, ‘Developments in Banking Law: VI. Parallel Regimes: Bankruptcy and
Dodd-Frank’s Orderly Liquidation Authority’ (2012) 31 Review of Banking & Financial Law
531.
234
See ‘FSB Recommendations and Time Lines’, above note 138, and FSB, ‘Key
Attributes’, above note 102. The publication of the Key Attributes was accompanied by a list
of 29 global systemically important banks, to be updated annually based on new data and
published by the FSB each November.
235
Credible resolution procedures with regard to SIFIs require lex specialis. A general
insolvency framework (lex generalis) does not adequately address the systemic
consequences of distressed SIFIs. Charles Randell concluded in his paper, above note 106,
that with the introduction of national resolution powers, appropriate resolution planning,
resolvability assessments, and (where necessary) changes to the structure of financial
institutions, it should be possible to remove a number of institutions from the ‘too big to
fail’ category. However, uncertainties about cross-border cooperation probably represent
the biggest single obstacle to a comprehensive solution to the ‘too big to fail’ problem, and
lead to significant uncertainty for investors as well as challenges to the rule of law.
236
See Basel Committee on Banking Supervision, ‘Global Systemically Important Banks:
Assessment Methodology and the Additional Loss Absorbency Requirement’ (November
2011), at <http://www.bis.org/publ/bcbs207.pdf> (last visited 14 July 2014).
237
Basel Committee on Banking Supervision, ‘A Framework for Dealing with Domestic
Systemically Important Banks’, Consultative Document (June 2012), at <http://www.bis.org/
publ/bcbs224.pdf> (last visited 14 July 2014).
238
See Basel Committee on Banking Supervision, ‘Dealing with Domestic Systemically
Important Banks: Framework Issued by the Basel Committee’, Press Release (11 October
2012), at <http://www.bis.org/press/p121011.htm> (last visited 14 July 2014).
239
See Stiglitz, above note 3.
240
See De Bandt and Hartmann, above note 150, 10–13.
241
Furthermore, if the crisis has been magnified because of a weak bank supervisory
structure or because of supervisory and regulatory mistakes those issues also need to be
redressed in order to restore confidence in the banking system.
242
See Kindleberger, above note 1, 163.
243
See Anders Aslund, ‘When a Banking Crisis Is a Good Thing’ Financial Times (13
September 1995): ‘A government-ordered inspection of the banks could not possibly clean
up the wild Russian banking sector. Fortunately, the market is doing the cleaning up
instead.’
244
For a comprehensive treatment see Lastra and Buchheit, above note 94.
245
See Takeo Hoshi, ‘Financial Regulation: Lessons from the Recent Financial
Crises’ (2011) 49(1) Journal of Economic Literature 120. See also Takeo Hoshi, ‘The Convoy
System for Insolvent Banks: How it Worked and Why it Failed in the 1990s’ (2002) 14(2)
Japan and the World Economy 155.
246
US Department of Treasury, TARP Programs, at <http://www.treasury.gov/initiatives/
financial- stability/TARP-Programs/Pages/default.aspx> (last visited 14 July 2014).
247
See Aditya Chakrabortty, ‘Wall Street crash, Sweden or Japan—which past crisis tells us
what lies in store?’ The Guardian (15 October 2008), at <http://www.theguardian.com/
business/2008/oct/15/banking-europe/print>.
Part I Developments at the National Level, 5 Law
Reform in Emerging Economies
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
Financial system — International financial system — Monetary system — Monetary obligations —
(p. 199) 5 Law Reform in Emerging Economies
B. The Importance of the Legal Framework 5.06
C. Reform Agenda: The ‘Washington Consensus’ 5.10
D. Beyond the ‘Washington Consensus’ 5.17
E. The Law Reform Process 5.28
Stages of the law reform process 5.29
Some features of the law reform process 5.30
Issues in the law reform process 5.36
Methods of law reform 5.43
Development of a home-grown legal system 5.44
Local adaptation of an existing foreign legal regime 5.46
Reception of foreign law 5.48
Adoption of model laws and of model clauses 5.52
Harmonization and other techniques of regulatory convergence 5.58
Adoption of international financial standards (‘soft law’) 5.61
Commerce and manufactures can seldom flourish long in any state which does not
enjoy a regular administration of justice, in which the people do not feel themselves
secure in the possession of their property, in which the faith of contracts is not
supported by the law, and in which the authority of the state is not supposed to be
regularly employed in enforcing the payment of debts from all those who are able to
pay. Commerce and manufactures, in short, can seldom flourish in any state in
which there is not a certain degree of confidence in the justice of government.
Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations [1776]
Commercial credit may be defined to be that confidence which subsists among

commercial men in respect to their mercantile affairs. …In a society in which law
and the sense of moral duty are weak, and property is consequently insecure, there
will, of course be little confidence or credit, and there will also be little commerce.
Henry Thornton, An Enquiry into the Nature and Effects of the Paper Credit of
Great Britain [1802]
A. Introduction
5.01 The term ‘emerging economies’ is rather imprecise.1 It encompasses both developing
countries (also referred to in the past as Third-World countries or Less Developed
Countries) and transitional economies (formerly communist countries). It is also a dynamic
term: the (p. 200) words developing, emerging, or transitional reflect a state of flux in the
long march through development. A common feature of these jurisdictions is the emphasis
given in recent years to institutional and legal reform, which has become an essential
component of ‘development’. Indeed, the major new thrust of ‘development’ economics in
the 1990s was the recognition of the crucial role of institutions in permitting an economy to
function effectively.2
5.02 This chapter focuses primarily on monetary and financial law reforms. While in
former communist countries, market-based financial systems have been typically created
from scratch, in developing countries in Latin America and other regions of the world there
is already a legal infrastructure, which cannot be ignored in the reform process.
5.03 Regulation after crisis is a constant in both developed and developing countries.
Following the Latin American financial and debt crises in the 1980s3 and the Asian crises in
1997 (which also affected by contagion other countries, notably Russia in 1998) major
monetary and financial reforms took place. In terms of substance (contents of the reforms
programmes), those reforms have tackled many of the issues that have been discussed in
the preceding four chapters.
5.04 In terms of process, law reform can follow different routes: adoption of a model law
or treaty, adoption of standards (‘soft law’) set by the Basel Committee on Banking
Supervision and other ‘international standard-setters’ (further analysed in Chapter 14),
adoption of harmonized rules (as in the case of the EC), drafting or revising laws based or
inspired upon the laws of another country/ countries (or a compromise law), and others. As
further explained in Chapter 13, an important catalyst in the reform process is the adoption
by a country of a ‘programme’ in order to qualify for International Monetary Fund (IMF)
conditional financial assistance, since such programme will typically include a number of
legislative reforms (for example laws on resolution, or laws on central bank independence)
as ‘conditions’ for the disbursal of funds.
5.05 The law reform process does not only encompass the creation or amendment of laws.
It also includes the implementation of rules, the dissemination of legal information, the
building of institutions that effectively support the legal environment, such as independent
courts, central banks, regulatory agencies, and others. The ownership, sustainability,
sequencing, and interconnectedness of the legal reforms are often mentioned as indicators
of its potential success.
(p. 201) B. The Importance of the Legal Framework

5.06 It was once a general practice in economics to pay due respect to the law. The
opening paragraphs of this chapter illustrate how Adam Smith (widely regarded as the
founding father of economics as an autonomous discipline) and Henry Thornton (who laid
down important foundations of financial economics) paid close heed to the legal framework.
However, in the course of the twentieth century, economics started gravitating towards
mathematics and other ‘hard sciences’. This meant that the two social sciences started
drifting apart from each other, which contributes to explaining the difficulties in holding an
effective interdisciplinary dialogue. However, in recent years, economists have begun to
appreciate again the importance of sound legal structures and ‘institutions’ for the proper
functioning of markets and for the success of economic reform. Nihil novi sub sole!
5.07 When economists write about ‘institutions’, they typically mean law.4 Nobel Laureates
Ronald Coase5 and Douglass North6 have stressed the important role that legal norms and
institutions play in the functioning of markets. Douglass North defines institutions as the
formal and informal rules governing human interactions.
Institutions are the rules of the game in a society or, more formally, are the humanly
devised constraints that shape human interaction. …That institutions affect the
performance of economies is hardly controversial. That the differential performance
of economies over time is fundamentally influenced by the way institutions evolve is
also not controversial.7
5.08 Some of the recent work done by economists on institutions has focused on a
particular set of them, namely those that protect property rights and ensure that contracts
are enforced. Dani Rodrik and Arvind Subramanian refer to them as market-creating
institutions, since, without them, markets cannot exist or, if they do exist, they would
function very poorly.8 They also acknowledge, however, the importance of other institutions,
which they classify into market regulating, market stabilizing, and market legitimizing.
Other definitions focus on the degree of property rights protection, the degree to which
laws and regulations are properly applied, and the extent of corruption.9 Corruption, where
it exists, is certainly a major obstacle to any process of legal and institutional reform.10
(p. 202) 5.09 The collapse of the former Soviet Union signified the collapse of an economic
model based on collectivism and State planning. The political, economic, and legal
implications of the abandonment of communism and the embracement—to a greater or
lesser degree—of capitalism have been significant. A market economy cannot be supported
in an institutional vacuum. Hence the enthusiasm in recent years for a proper legal and
institutional infrastructure.
C. Reform Agenda: The ‘Washington Consensus’

5.10 Reform programmes in emerging economies in the 1990s were influenced by the so-
called ‘Washington Consensus’. This term was coined by John Williamson in 1989 to
summarize the main policy reforms that he argued were needed in Latin America as of that
date.11 The list included ten items: fiscal discipline, reordering public expenditures
priorities to be pro poor and pro growth (ie, switching expenditures to basic health care,
education, and infrastructure), tax reform, liberalization of interest rates, a competitive
exchange rate, trade liberalization, liberalization of inward foreign direct investment,
privatization, deregulation, and property rights.
5.11 Though it was never Williamson’s intent to define an ideology with this phrase,12 the
reality is, that for better or for worse, it has become associated with the neo-liberal agenda
and, hence, often blamed for the ills of globalization by those who opposed reform. In
addition to this meaning which equates Washington consensus with neo-liberalism, a second
alternative interpretation is that ‘the Washington consensus represents the policies
collectively pursued by the Washington-based international institutions that dispense advice
to developing countries: the Bretton Woods institutions (the IMF and the World Bank), the
Inter-American Development Bank, the US Treasury, and perhaps the US Federal
Reserve.’13
5.12 Williamson explains that with the exception of the fifth item (a competitive exchange
rate) he did a good reporting job reflecting what was important in Latin America at that
time.14 Nonetheless, he concedes that he omitted a number of reforms that should have
been on the agenda, such as institutional reforms (which he and other economists refer to
as ‘second-generation reform’) and income distribution.15
(p. 203) 5.13 The importance of legal and institutional reform for the success of the overall
reform process has long been advocated by lawyers.16 In the aftermath of the financial
crisis, after a long period when economics tended toward mathematics, statistics, and
physics in its search for an optimal interdisciplinary balance, attention should now turn
toward its institutional and legal linkages (without, of course, losing sight of the many
contributions that ‘hard sciences’ have signified in the evolution of the economics
profession).17
5.14 Though the Washington Consensus as originally proposed by Williamson ‘has simply
ceased to exist’,18 its legacy remains. It has contributed to the discussion of where
economic reform should be heading and has emphasized the importance of maintaining
prudent macroeconomic policies (stable money and fiscal restraint).
5.15 Salacuse argued19 that until the 1980s most developing countries adopted a
development model (which he refers to as ‘Development Model I’) based upon public
ordering, State planning, reliance on public sector enterprises, pervasive regulation,
restrictions on the private sector, and restrictions on foreign influences (‘closed
economies’). This Development Model I influenced the legal system in many ways, with
administrative law rather than commercial law being considered as the basic law of
economic and business activity in many countries. By the mid 1980s, however, the faith in
the power of the State to bring about development had declined. ‘The end of communism in
Eastern Europe and the Soviet Union in 1989 deprived many developing countries of
sources of moral and material support for Development Model I.’20 The failure of
Development Model I and the debate of what constituted good economic reform led to the
formulation of a new model of development, ‘Development Model II’. According to Salacuse,
the four most important elements of Development Model II were: reliance on markets and
private ordering, privatization, deregulation, and ‘openness’ (to the world) with regard to
trade and investment. From a legal point of view, the movement from ‘plan back to
contract’21 implied a shift from administrative law to a private law system capable of
sustaining business and market transactions (commercial law, contracts, and property
rights). It also implies a change in approach to regulation (less pervasive and invasive) and
a reinforcement of the legal and institutional mechanisms to protect individual rights.
Independent courts of justice are essential for the proper functioning of markets.
5.16 Though Salacuse’s models are rather crude and overlook the complexity and variance
of development efforts across regions and over time they offer a simplified template to
analyse the current state of affairs which is certainly a more complex, diverse, and
uncertain policy environment, in which both the public and private sector have a significant
role to play. (p. 204) Indeed, the emphasis on institutional reform presupposes the existence
of a set of public institutions. The importance of the State can never be underestimated.22
D. Beyond the ‘Washington Consensus’

5.17 Following the fall of the communist Soviet block and the ensuing transition from
centrally planned economies to market-oriented economies, the comparisons between
socialism and capitalism (or between developed capitalist economies and emerging or
transitional ones) ceased to be topical.23 The ‘new comparative economics’24 focused
instead on assessing the economic efficiency of institutions across capitalist countries.
5.18 The ‘Law and Finance’ or ‘Legal Origins Theory’ (also widely referred to as ‘LLVS’,
because of the combined initials of the authors’ last names)25 studies the association or link
between the legal system and economic development using an empirical methodological
approach. The seminal paper by La Porta et al examined the legal rules covering investor
protection and their enforcement in forty-nine countries.26 The regression results suggested
that the legal origin or heritage of certain rules were a decisive factor in determining
greater levels of investor protection. Countries with a Common Law origin generally fared
better than those with Germanic, French, and Scandinavian origins.
5.19 The legal origins theory quickly rose to prominence.27 The papers were widely cited
and influenced policy reforms, for example the World Bank’s 2004 Doing Business report.
However, they also drew ample criticisms, in particular because of the over-simplification of
legal regimes, since they code the law in very basic terms.28
(p. 205) 5.20 Fifteen years after the presentation of the Law and Finance literature, a new
Legal Theory of Finance (LTF) has emerged. The LTF studies advocate for a stronger
recognition of the role of law as a constitutive element of finance.29 According to one of its
main proponents, Katharina Pistor, the LTF has been the result of a ‘collective, multi-year,
interdisciplinary research endeavor’ that ‘set out to critique existing theories in economics
and sociology on the relation of law and finance and culminated in the development of a
new theory, the legal theory of finance’.30
5.21 According to the LTF, financial markets are: (1) a rule-bound system; (2) essentially
hybrid; (3) affected by the law-finance paradox; and (4) affected by the elasticity of law.31
5.22 A ‘rule-bound system’ means that ‘financial markets do not exist outside of legal
rules, but are constituted by them’.32 Law permeates financial relationships (‘deregulation
is a misnomer’) and derives from different (public or private) sources. The ‘essentially
hybrid’ nature of financial systems entails that they are not ‘state or market, private or
public’ but eclectic.33
5.23 The ‘law-finance paradox’ explains that while legal rules lend credibility to financial
commitments, they are often unenforced—because in some cases enforcement could bring
down the financial system as a whole. An example could be a no-bail-out rule for banks that
is contravened by a State in a situation of systemic threat.
5.24 Finally, the ‘elasticity of law’ concept is of great importance for financial law reforms
in emerging markets. This building block relates to the political economy of finance and the
differential treatment between power-wielding countries and financial trend-setting bodies
and emerging economies.
5.25 Law is described as a pyramidal structure that is elastic at the apex, but more rigid
towards the periphery. The elasticity of law is defined as ‘the probability that ex ante legal
commitments will be relaxed or suspended in the future’.34
5.26 As a corollary to the elasticity of law, emerging markets are peripheral in the political
economy of international financial regulation. This means that they hold less clout when it
comes to international financial law reforms. On the other hand, a reduced set of countries
and financial rule-setters (like the Basel Committee on Bank Supervision (BCBS), the
Financial Stability Board (FSB), and the IMF) exercise most of the power. The result is that
the law becomes more rigid for emerging countries, while it is more elastic or malleable for
countries at the apex. The paradox of this particular statement in the light of the 2007–9
financial crisis, is that for the so-called peripheral countries (which were not at the heart of
the crisis), the law is more rigid than for the advanced countries at the apex.
5.27 The elasticity of law component of the LTF draws particular attention to an important
question: why do emerging market economies (that were not directly affected by the recent
(p. 206) crisis) need to adopt the financial regulatory reforms currently being proposed?
The answer to this question raises important legitimacy and democratic concerns for
emerging economies regarding the international (soft law) financial standards and the main
standard setting bodies that promote such rules.
E. The Law Reform Process

5.28 In this section, I discuss the stages, features, issues, and methods of law reform
(which, in a broad sense, is a permanent feature in the history of law), with emphasis on
monetary and financial law reform. As mentioned in the preface, the collapse of communism
in Eastern Europe and the former Soviet Union was the catalyst of the renewed emphasis
on law reform programmes. It is the experience of that time that is latent in this section.
Stages of the law reform process
5.29 Law reform is not simply about enacting laws. It is a process that encompasses the
following stages:
(1) Creation of laws or amendment of laws. With regard to law drafting, it is

important to establish clear guidelines with regard to the legislative process, the way
that laws are proposed, prepared, enacted, and updated.
(2) Implementation of laws through rules and regulations. Regulations are sometimes
issued by a government department, sometimes by an independent agency with
delegated rule-making powers.
(3) Dissemination of legal information. This stage deals with how laws, regulations,
and court decisions are recorded, authenticated, and disseminated to government
bodies, courts of justice, lawyers, academics, the business community, non-
governmental organizations, and the general public. It is sometimes referred to as
‘regulatory transparency’.
(4) Effective enforcement and sanctions in the case of non-compliance with the law.
(5) Building of institutions that efficiently support the legal environment, such as
independent courts of justice, regulatory agencies, private bar groups or associations,
law schools, and other training institutions.
(6) Legal education. The letter of the law does not change the minds of the people.
Legal education is needed. The introduction of new teaching methodologies in law
schools, the training of lawyers and government officials in new laws and legal
concepts (with emphasis on commercial law rather than administrative law in the
legal studies), the cooperation and exchange of students with law schools in countries
firmly anchored in the principles of a market economy, and the information to the
general public about the role of law in a market economy are important components
of this process of legal education. Though legal and economic structures can be
dismantled overnight, the same cannot be said about their construction.
(7) Judicial reforms. 35 The aims of these reforms will vary depending upon the
specific legal tradition and circumstances in each country. In some cases, such
reforms will seek (p. 207) to limit corruption and to safeguard the independence of
the judiciary. In some other cases, the reforms will seek to improve the functioning of
the judiciary, through the training of judges and the efficiency in the handling of
cases, with rapid and low-cost enforcement of court decisions.
(8) Alternative mechanisms of dispute resolution, such as arbitration, conciliation,
and mediation, ought to be established or strengthened.
Some features of the law reform process

5.30 The law should add clarity, certainty, and predictability to any reform process. In
addition, the ownership, sustainability, proper sequencing, and interconnectedness of the
law reform process are four indicators of its potential success.36
5.31 The ‘ownership’ of legal reforms signifies that countries should make their ‘own’
decisions about the direction of their legal systems. It refers to the issue of legitimacy, and,
in countries with democratic regimes, to the issue of democratic accountability. Countries
should be aware of the problems of transplanting laws or of adopting model laws, which
may provide useful lessons as a tested system or a reference guide, yet need to be adapted
or modified to fit local institutions. I further discuss these issues in Chapters 13 and 14.
5.32 A proper ‘sequencing’ of legal reforms is fundamental to guaranteeing that an
adequate infrastructure and resources are available to ensure their effective
implementation. For instance, banking and securities laws need to be preceded by adequate
contract, property, company, secured transactions, registration, and bankruptcy laws. The
importance of appropriate sequencing with regard to economic reforms (eg, financial
markets liberalization ought to be accompanied by adequate regulation and prudential
supervision) has also been advocated by many economists.37
5.33 The law reform process ought to be ‘sustainable’. This implies a long-term horizon on
the part of national legislators and on those who advise with regard to specific legal
reforms. It takes time to design programmes and to establish institutions.38 Laws must not
just be passed, they need to be widely known, applied, and enforced. Changes in public
attitude (p. 208) take time to settle. The public and the business community need to be
educated about the rule of law in a market economy.
5.34 The legal foundations of a market economy are ‘interconnected’. They are akin to the
pillars of a building: the building can only be sustained if all the pillars are in place.
Weakness in one area will affect success in other areas. Reforms cannot be designed or
carried out in isolation. A comprehensive and consistent approach is needed. For instance,
privatization requires an adequate protection of property rights.
5.35 A robust legal and institutional framework gives emerging economies the resilience
they sometimes have lacked in the past. Such a framework can better shield the country
against the onslaught of a financial crisis. In a paper published by IMF staff in 2010 it is
recognized that in some cases ‘countries that had improved policy fundamentals and
reduced vulnerabilities in the pre-crisis period reaped the benefits of these reforms during
the crisis’.39 According to this view, the resilience that some emerging market countries
have exhibited can be partly attributed to these reforms.40,41
40 41
This position seems to
underline the importance of monetary and financial law reforms in the post-Washington
consensus era.
Issues in the law reform process
5.36 The legal framework of a market economy consists of a number of substantive and
procedural rules with regard to the functioning of the economy. Some of those rules flourish
better when the system is democratic, such as the recognition and protection of property
rights or the existence of independent courts of justice. However, market-oriented law
reforms have also been adopted in non-democratic societies. This has been the case, for
instance, in the People’s Republic of China and its so-called ‘gradualist approach’ towards
market economics.
5.37 The financial law reform process is bound to have a ‘substantive law’ component and
a ‘procedural and enforcement mechanism’ component.42 The first element relates to the
rules which govern activities in financial markets. The second aspect refers to the
establishment (p. 209) of supervisory authorities, independent courts of justice, alternative
dispute resolution mechanisms, and others. In developing countries and emerging market
economies, the reform or the creation of sound mechanisms of supervision and
enforcement, both judicial and administrative, is often more difficult than the reform of the
substantive rules.43
5.38 The issues that ought to be included in a programme of monetary and financial law
reform are not different from the ones already discussed in the preceding chapters.44 In
this subsection, I discuss the preconditions for a successful reform programme in this field,
that is, the laws that need to be in place for a market economy to function properly.
5.39 The legal infrastructure of a market economy typically comprises a number of basic
foundations:
(1) Laws that clearly define and protect private property rights. The right to
inheritance should also be recognized. Expropriation should be confined to
exceptional cases for a public purpose and respecting the principles of non-
discrimination, prompt, adequate, and effective compensation, and due process of
law/judicial review.
(2) Contract laws. The sanctity of contracts, pacta sunt servanda, is at the core of
commercial transactions. The law ought to protect the rights and enforce the
obligations of counterparties, including lenders and borrowers. The availability of
credit is also contingent upon the existence of security; hence the need for laws on
collateral, on secured transactions.
(3) Corporate or company laws with adequate corporate governance standards and
fiduciary duties for management and the protection of shareholders’ rights.
(4) Bankruptcy laws to address defaults and restructurings, and special resolution
proceedings for banks. The rights of creditors must be adequately defined and
protected in an insolvency proceeding. However, bankruptcy laws should not
‘penalize’ entrepreneurship and private initiative.
(5) Laws on registration (land registration and a general system of registration).
Registration provides legal certainty and is a complement to the protection of
property rights.
(6) Administrative laws to prevent the arbitrary exercise of discretion by the public
authorities and to effectively organize the work of government.
(7) Competition or antitrust laws to prevent excessive concentration of power, abuse
of dominant position, and collusive price setting.
(8) Tax laws and an adequate system of tax collection. Taxes ought to provide the
government with sufficient financial resources to meet its obligations and to support a
minimum social safety net. The level of taxation is a policy decision, which has
fundamental consequences for the citizens. Excessive taxes unduly interfere with the
system of private incentives and, if there is labour and capital mobility, excessive
taxes can drive firms or individuals out of the country.
(9) An accounting code. (p. 210)
(10) Laws regarding payments and payment systems.
(11) Laws for the ‘transitional period’, which can vary according to the level of
economic and legal development, such as privatization laws, foreign investment laws,
and others.
(12) Labour laws that establish a fair balance between the protection of workers
(with unemployment benefits and right to collective action) and the protection of
employers (allowing them to fire employees on the basis of fair compensation, and
creating a favourable environment for private initiative).
5.40 These legal reforms have been typically considered as ‘preconditions’ for successful
monetary and financial law reforms in emerging economies.
5.41 Monetary and financial law reform also needs to take into account the particular
economic and political circumstances of the country seeking such reform. ‘Transition
economies’ exhibited a particular set of problems, because of the ‘legacy of the past’. In the
field of banking, this legacy comprised the so-called ‘debt overhang’, (that is, the
substantial amount of ‘bad loans’ inherited—in the case of formerly centrally planned
economies—from the communist period), the absence or inadequacy of control mechanisms
and credit assessment over the State-owned enterprises which receive loans, the shift from
a ‘mono-bank’ to a two-tiered banking system (ie, a central bank on the one hand and a
commercial banking system on the other), the need to develop a system of banking
supervision, an inefficient payment system, and the lack of accounting, statistics, reporting,
and auditing standards.
5.42 The transformation of socialist banking systems was bound to be difficult. In the early
stages of transition, financial law reform tended to concentrate on setting up a basic
infrastructure in banking and capital markets, strengthening financial supervision,45 and
building the appropriate skills in the commercial sector and the administrative
authorities.46 During the first half of the 1990s, most countries adopted new banking laws,
including minimum capital and capital adequacy requirements, licensing and exit rules, and
overall banking supervision arrangements. Once the basic foundations were in place and
skills had been strengthened, deeper reforms were considered, in particular the
recapitalization of insolvent banks and financial restructuring of heavily indebted
enterprises. Securities markets were often built from scratch.47
(p. 211) Methods of law reform
5.43 The law reform process can follow different routes. In this subsection I survey these
various approaches, which sometimes can be combined. I discuss in further detail the
growth of international soft law in Chapter 14.
Development of a home-grown legal system
5.44 This choice entails the development of a domestic legal system, based upon the
national regulatory structures and legal tradition. From the point of view of national
sovereignty and respect for the local culture, the development of an indigenous legal
system has a ‘certain romantic appeal’ (in the words of Jackson).48 However, not only is it
costly to develop such a system, but also, given that one cannot ‘reinvent the wheel’ and
given the uncertainty about the outcome (which can only be assessed in the long-term), it is
not sensible to ignore ‘foreign’ legal and regulatory examples. Tested and successful
solutions elsewhere—particularly in the field of monetary law and financial regulation—are
always worth some consideration.
5.45 It is possible, however, to design a system that combines the reception of some
foreign laws with the development of some indigenous rules and institutions.
Local adaptation of an existing foreign legal regime
5.46 This approach, whereby existing foreign solutions are modified to meet local needs,
prevails in many programmes of technical assistance and advice by foreign legal experts.49
It has the advantage that the chosen legal regime has demonstrated its ability to function in
at least one other country.50
5.47 Jackson refers to it as the ‘domestication’ of foreign regulatory structures.51 Though
foreign regulatory structures comprise both substantive rules and enforcement
mechanisms, many programmes of technical assistance only cover the local adaptation of
substantive rules. However, without appropriate enforcement mechanisms, the success and
effectiveness of foreign substantive rules can be compromised. Jackson gives the example of
the US federal securities law, which comprises not only substantive rules, but an
institutional infrastructure (with the Securities and Exchange Commission, the New York
Stock Exchange, and other self-regulatory organizations) and enforcement mechanisms: ‘A
country that adopts (p. 212) US federal securities laws has taken only a relatively small step
toward achieving an effective system of securities regulation.’52
Reception of foreign law
5.48 This approach refers to the reception or importation of foreign law into a domestic
legal structure. The importation of a foreign legal regime can proceed through a ‘wholesale’
approach or through a ‘piecemeal’ approach. It can encompass the incorporation of both
substantive rules and enforcement mechanisms.
5.49 Law reform programmes in Eastern Europe and the former Soviet Union in the 1990s
often imported legal concepts from commercial legal systems anchored in the principles of
a market economy as if they were ‘legal transplants’ (analogy with surgery) to replace
malfunctioning organs.53 The viability and success of the transplant is contingent, inter alia,
on the compatibility between the socio-political structure and the legal culture between the
‘donor’ State and the ‘recipient’ State.54 The ‘recipient’ or ‘importing’ country needs to
ensure that the legal concepts or rules to be ‘transplanted’ fit into the existing legal
framework.
5.50 It has been suggested that in a number of cases emerging economies were shielded
from the negative impact of the high point of the global financial crisis because of the
degree of maturity of their financial markets. This view argues that while most emerging
economies did suffer the effects of the global slowdown in economic activity (through trade
linkages and the banking channel), some countries were better isolated than others because
of the developing stage of their capital markets and the reduced levels of activities
regarding the financial innovations and instruments (such as securitization) that were at the
heart of the crisis.55 This view seems to highlight the inherent risks that institutional
transplants, financial products, and services can carry with them.
5.51 In order to promote a developing country as an international financial services centre,
Jackson56 proposed—using Nepal as an example—the selective direct incorporation of a
foreign (and successful) regulatory system, such as the US system of securities regulation.
Jackson’s approach is a variant of the method of ‘importation’ of foreign laws, in which both
substantive rules and enforcement mechanisms are directly incorporated into a domestic
legal system (as a complete ‘substitute’ for domestic regulation). A firm conducting
business in the relevant developing country (in his example, Nepal) would simply have to
comply with the rules of another designated jurisdiction with strong regulatory structures
and be supervised by foreign authorities. In essence, the developing country imports
financial law and regulation from another country in the same way as another country
imports goods (p. 213) or services. Jackson favours this approach, because he believes it
would enhance credibility amongst foreign investors and allow the local professionals to
benefit from ‘advanced rules’.57 However, he acknowledges some of the potential objections
to his proposal, such as the loss of sovereignty, political unacceptability, and delays in the
development of efficient domestic institutions and rules.
Adoption of model laws and of model clauses
5.52 A model law is a set of legislative provisions that States can adopt by enacting it into
domestic law. According to the website of the United Nations Commission on International
Trade Law (UNCITRAL) a model law is a suggested pattern for lawmakers in national
governments to consider adopting as part of their domestic legislation.58 A model law
serves as a reference point or guide, a checklist for the law reformer. A model law is not
intended to serve as detailed legislation for direct incorporation into local legal systems. It
should therefore combine carefully worded and relatively detailed legal text with a high
degree of flexibility to be able to adapt to the local needs and circumstances of the country
seeking reform. The advantages a model law offers are a substantial degree of
harmonization and predictability for investors. This is the case for instance with the
UNCITRAL model laws, such as the UNCITRAL Model Law on Electronic Commerce and
Electronic Signatures.59
5.53 A model law can be drawn from a broad range of legal systems. For instance, in
Eastern Europe, the text of an EBRD (European Bank for Reconstruction and Development)
model law on secured transactions published in 199460 is compatible with the civil law
concepts which underlie many Central and Eastern European legal systems and, at the
same time, draws on common law systems which have developed many useful solutions to
accommodate modern financing techniques.
5.54 The idea of the model law is advantageous as it sets a standard. However, problems
arise if the model law is not adapted to the local needs and legal tradition of the country
seeking reform. Model laws can be publicly available, as in the case of the EBRD model law,
or limited in their availability to those countries seeking technical assistance from a given
organization.
5.55 In addition to model laws (legislative instruments), there are model contracts, model
clauses, and uniform rules that private contracting parties can adopt voluntarily and
incorporate in their transactions. Contractual incorporation of foreign law is also identified
by Jackson as a method of incorporation of foreign law into domestic transactions.61
(p. 214) 5.56 The International Chamber of Commerce plays an important role in forging
internationally agreed rules and standards that companies adopt voluntarily and that can be
incorporated in contracts.62
5.57 The idea behind model contracts and clauses is to provide a sound legal basis upon
which parties to international contracts can quickly establish an even-handed agreement
acceptable to both sides. Another example is the ISDA (International Swaps and Derivatives
Association) Master Agreement, which has become the standard agreement used in over-
the-counter (OTC) derivatives transactions.63
Harmonization and other techniques of regulatory convergence
5.58 Law reform in the Member States of the European Union (actual and prospective) has
been a frantic activity. Two techniques of regulatory convergence have been influential in
advancing the integration goals of the European Union: mutual recognition and minimum
harmonization. Mutual recognition presupposes the equivalence of the objectives of
national legislations and the existence of similar public interest goals. Mutual recognition
implies and requires mutual trust. Mutual trust in turn is fostered through the adoption of
common rules. At the EU level this has been mainly achieved through the technique of
minimum harmonization or harmonization of essentials. Mutual recognition and minimum
harmonization have been typically accompanied by other pillars: home country control and
the single banking licence.
5.59 Eastern European countries which have acceded or are in the course of acceding
towards an enlarged European Union have dedicated Herculean efforts towards law reform
in general and financial reform in addition to the simultaneous efforts to adopt and
implement the acquis communautaire.64,65
64 65
5.60 It is also important to bear in mind that ‘regulatory competition’ in the EU implies
that Member States will strive to tailor and adapt the applicable legal framework in order to
(p. 215) satisfy business preferences and attract investment and tax revenues or even repel
undesirable firms.66 In response, private parties will engage in ‘regulatory arbitrage’
selecting the best regulatory environment for their activities, which in turn may lead to
‘regulatory emulation’ by States and regulators.
Adoption of international financial standards (‘soft law’)
5.61 International financial standards are typically ‘soft law’. They have contributed to law
reform initiatives in both developed and developing countries, as I discuss in greater detail
in Chapter 14.
5.62 The soft/hard law distinction is quite tricky and generates a great deal of
controversy.67 The essential feature of ‘soft law’ is that it cannot be enforced by formal legal
means because it is not legally binding.68 Hard law is binding in a coercive, externally
imposed way. Soft law is observed in a voluntary, self-imposed way. Enforcement is the key
element in distinguishing between hard and soft law.
5.63 The growth of international financial standards fills a legal vacuum. In the absence of
a formal international regulator, international financial soft law standards are agreed
among regulators, supervisors, or other national authorities and groups of experts. The
Basel Committee on Banking Supervision, the Financial Stability Board, the International
Organization of Securities Commissions (IOSCO), the International Association of Insurance
Supervisors (IAIS), and others have become important ‘international financial standard
setters’. Their rules are addressed to national authorities that in turn undertake the
obligation to implement them in their national jurisdictions.
5.64 International financial standards also steer the direction of financial law reform in
those emerging economies that include the implementation of a particular set of standards
as a ‘condition’ under an IMF programme of (conditional) financial assistance, an important
issue which I further explore in Chapter 13.
5.65 The rise and rise of soft law poses important issues for emerging economies. First and
foremost there are concerns—further explored in Chapter 14–about legitimacy and
representation. In comparison to the number of emerging economies in the world, very few
are power-yielding members in these financial regulatory forums. For example, out of the
(p. 216) twenty-seven member institutions that form the Basel Committee, only ten can be
considered as representing emerging markets and developing countries.69
5.66 A similar situation occurs in the IMF where as of March 2011, advanced countries
held 59.5 per cent of the voting shares,70 while emerging markets and developing countries
held 40.5 per cent of the voting shares. This composition will change as a result of on-going
reforms under the IMF’s 14th General Review of Quotas.71 Emerging markets and
developing countries are anticipated to gain from the new distribution of quotas and voting
shares in the IMF as an aggregate, though some individual countries stand to gain while
others will lose. For example, the group of African countries as well as the group
comprising the Middle East, Malta, and Turkey will see a net reduction to their quota and
voting shares. On the other hand, Asian countries will see both their quota shares and
voting shares increase.72
5.67 The international legal system must address these democratic deficit concerns.73
Footnotes:
1
Back in 1981, Antoine van Agtmael was trying to start a ‘Third-World Equity Fund’ to
invest in developing-country shares, but his efforts to attract money were being constantly
rebuffed. ‘Racking my brain, at last I came up with a term that sounded more positive and
invigorating: emerging markets. “Third world” suggested stagnation; “emerging markets”
suggested progress, uplift and dynamism.’ See Antoine van Agtmael, The Emerging
Markets Century. How a New Breed of World Class Companies is Overtaking the World
(New York: Free Press, 2007). In 2001, Jim O’Neill, chief economist of Goldman Sachs,
came up with the acronym ‘BRICs’ for the next four countries it expected to enter the
economic big league: Brazil, Russia, India, and China. See also Lynge Nielsen,
‘Classification of Countries based on Their Level of Development: How it is Done and How it
Could be Done’, IMF Working Paper WP/11/31 (February 2011), at <https://www.imf.org/
external/pubs/ft/wp/2011/wp1131.pdf> (last visited 25 July 2014).
2
See generally John Williamson and Pedro-Pablo Kuczynski (eds), After the Washington
Consensus: Restarting Growth and Reform in Latin America (Washington, DC: Institute for
International Economics, 2003).
3
Liliana Rojas-Suarez lists the following financial crises in some Latin American and
Caribbean countries: Colombia (1998), Argentina (1994, 2001), Venezuela (1994), Brazil
(1999), Ecuador (2001), Uruguay (2001), and the Dominican Republic (2003). See Liliana
Rojas-Suarez, ‘The International Financial Crisis: Eight Lessons for and from Latin
America’, Center for Global Development Working Paper 202 (27 January 2010), at <http://
www.cgdev.org/sites/default/files/1423709_file_Rojas_Suarez_Lessons_FINAL_web.pdf>
4
This point has been often made by John Jackson, the world’s leading authority in the field
of international trade law.
5
See Ronald H Coase, The Firm, the Market and the Law (Chicago: The University of
Chicago Press, 1988). This book is a collection of Coase’s main papers, including his two
seminal articles: ‘The Nature of the Firm’ [1937] and ‘The Problem of Social Cost’ [1960].
6
See Douglass C North, Institutions, Institutional Change and Economic Performance
7
North, above note 6, 3.
8
See Dani Rodrik and Arvind Subramanian, ‘The Primacy of Institutions (And What This
Does and Does Not Mean)’ (2003) 40 Finance and Development 32, at <http://www.imf.org/
external/pubs/ft/fandd/2003/06/pdf/rodrik.pdf> (last visited 25 July 2014). This article
draws upon Dani Rodrik, Arvind Subramanian, and Francesco Trebbi, ‘Institutions Rule:
The Primacy of Institutions and Integration in Economic Development’, National Bureau of
Economic Research Working Paper No 9305 (October 2002), at <http://www.nber.org/
papers/w9305> (last visited 25 July 2014).
9
See eg Hali Edison, ‘Testing the Links. How Strong are the Links between Institutional
Quality and Economic Performance’ (2003) 40 Finance and Development 36, at <http://
www.imf.org/external/pubs/ft/fandd/2003/06/pdf/edison.pdf> (last visited 25 July 2014).
10
For a definition of corruption, see World Bank, Helping Countries Combat Corruption:
The Role of the World Bank (September 1997) 8, at <http://www1.worldbank.org/
publicsector/anticorrupt/corruptn/corrptn.pdf> (last visited 14 September 2014).
Corruption in public service can be defined as the abuse of public office for private gain,
through bribery, patronage and nepotism, the theft of State assets, or the diversion of State
revenues.
11
See John Williamson, ‘What Washington Means by Policy Reform’ in John Williamson
(ed), Latin American Adjustment: How Much Has Happened? (Washington, DC: Institute for
12
See John Williamson, ‘From Reform Agenda to Damaged Brand Name’ (2003) 40(3)
Finance and Development 10, at <https://www.imf.org/external/pubs/ft/fandd/2003/09/pdf/
williams.pdf> (last visited 25 July 2014).
13
14
Williamson, above note 11. With regard to item four of his list (liberalization of interest
rates), in retrospect Williamson wishes he had formulated this more broadly as financial
liberalization accompanied by appropriate financial supervision.
15
Williamson, above note 11. He points out that the importance of institutional reforms in
complementing ‘first generation’ liberalizing reforms was first emphasized by Moíses Naím,
‘Latin America: The Second Stage of Reform’ in Larry Diamond and Marc F Plattner (eds),
Economic Reform and Democracy (Baltimore: Johns Hopkins University Press, 1995).
16
Indeed, while working as a consultant in the Legal Department of the International
Monetary Fund in 1992–3, a major thrust of the work at the time (technical assistance in
the field of monetary and banking law) was the importance of legal and institutional
reforms for the success of the overall reform process in developing countries and emerging
economies.
17
See Rosa M Lastra, Central Banking and Banking Regulation (London: Financial
Markets Group of the London School of Economics, 1996) 7.
18
19
See Jeswald W Salacuse, ‘The Legal Architecture of Emerging Markets’ in Rosa M
Lastra (ed), The Reform of the International Financial Architecture (The Hague: Kluwer
Law International, 2001) 47.
20
Salacuse, above note 19, 58. Salacuse identifies the policies advocated by the so-called
Washington consensus with the Development Model II.
21
Salacuse, above note 19, 63. Salacuse also recalls (at 56) that the growth of State
economic regulation in the 1950s and 1960s had signified a movement ‘from contract to
plan’ (a phrase coined by Robert Seidman).
22
Trevor A Manuel, then Minister of Finance of the Republic of South Africa, pointed out
that ‘[m]ost African States need to expand, not contract, their public sector and
dramatically improve its efficiency in delivering quality public services. This demands
institutional capacity, especially in areas of regulation, service delivery and social
spending.’ He further argues that ‘[t]he Problem in Africa is that most states are weak and
limited, not that states try to do everything and account for 50 percent or so of national
income, as in other regions.’ See Trevor A Manuel, ‘Africa and the Washington Consensus.
Finding the Right Path’ (2003) 40(3) Finance and Development 18, 19–20, at <http://
www.imf.org/external/pubs/ft/fandd/2003/09/pdf/manuel.pdf> (last visited 25 July 2014).
23
Manuel, above note 22.
24
Simeon Djankov et al, ‘The New Comparative Economics’ (2003) 31 Journal of
Comparative Economics 595.
25
The authors are Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert
Vishny.
26
Rafael La Porta et al, ‘Law and Finance’ (1998) 106(6) Journal of Political Economy
1113. See also Rafael La Porta et al, ‘The Economic Consequences of Legal Origin’ (2008)
46(2) Journal of Economic Literature 285; and Rafael La Porta et al, ‘Corporate Ownership
around the World’ (1999) 54(2) Journal of Finance 471.
27
See Thorsten Beck, Asli Demirgüç-Kunt, and Ross Levine, ‘Law and Finance: Why does
Legal Origin Matter?’, World Bank Policy Research Working Paper 2904 (October 2002), at
<http://elibrary.worldbank.org/doi/pdf/10.1596/1813-9450-2904> (last visited 25 July 2014).
28
See eg Anne-Julie Kerhuel and B Fauvarque-Cosson, ‘Is Law an Economic Contest?
French Reactions to the Doing Business World Bank Reports and Economic Analysis of the
Law’ (2009) 57 American Journal of Comparative Law 811; and Kenneth W Dam, The Law–
Growth Nexus: The Rule of Law and Economic Development (Washington, DC: Brookings
Institution Press, 2006). Other studies have not been able to replicate the original results
(see eg Holger Spamann, ‘The “Antidirector Rights Index” Revisited’ (2010) 23(2) Review of
Financial Studies 467) nor to confirm the main hypothesis (see eg John Armour et al,
‘Shareholder Protection and Stock Market Development: An Empirical Test of the Legal
Origins Hypothesis’ (2009) 6(2) Journal of Empirical Legal Studies 343).
29
See Katharina Pistor, ‘Law in Finance’ (2013) 41 Journal of Comparative Economics 311–
14.
30
Pistor, above note 29, 311.
31
32
33
Pistor, above note 29, 314, citing Perry Mehrling, ‘Essential Hybridity: A Money View of
FX’ (2013) 41(2) Journal of Comparative Economics 255.
34
35
See World Bank, ‘Legal and Judicial Reform Project’, at <http://www.worldbank.org/
projects/P074001/legal-judicial-reform-project?lang=en> (last visited 14
September 2014). By consistently enforcing clear rules, an independent and impartial
judicial system supports legal reform and promotes economic and social development. An
effective judiciary applies and enforces laws and regulations impartially, predictably, and
efficiently. Economic growth and social development cannot be sustained and promoted in
countries where the justice system fails. We assist governments to develop and implement
judicial reform programmes to achieve sustainable economic growth and social
development based on empowerment, opportunity, and security for all citizens.
36
See generally Katerina Mathernová (Legal Department, World Bank), ‘The World Bank
and Legal Technical Assistance: Initial Lessons’, World Bank Research Working Paper No
1414 (January 1995), at <http://elibrary.worldbank.org/doi/pdf/10.1596/1813-9450-1414>
37
See eg van Agtmael, above note 1 and Nielsen, above note 1.
38
See Charles W Calomiris, ‘The IMF’s Imprudent Role as Lender of Last Resort’ (1998)
17(3) Cato Journal 275, 279:
[R]eal reform in the banking system takes years to accomplish because it entails
new ways of measuring and managing risk, new regulations, and new supervisory
procedures. These changes are both politically difficult (because the politically
powerful must forego subsidies) and technically challenging. The time horizon
necessary to implement successful reform is at least five years. …Building effective
financial institutions, and reforming the legal and regulatory environment in which
they operate, is a protracted and difficult learning process, even when countries
have the political will to do so. The horizon of IMF crisis assistance and
conditionality (typically two years or so) is simply not suited to achieve true reform
in the banking system.
39
IMF, Strategy, Policy, and Review Department, ‘How Did Emerging Markets Cope in the
Crisis?’ (15 June 2010) 5, at <http://www.imf.org/external/np/pp/eng/2010/061510.pdf>
40
A similar argument has also been made for Latin American emerging economies. See
United Nations Economic Commission for Latin America and the Caribbean (UNECLAC),
‘La Inversión Extranjera Directa en América Latina y el Caribe’ in Crisis financiera
internacional, sector bancario e inversión extranjera directa en América Latina y el Caribe
(United Nations, 2011) 177.
41
Some of these reforms included: the development of capital markets, pension system
reforms, adoption of risk-based supervisory standards for banks, promotion of intraregional
economic integration, reduction of State ownership of banks, and other State-owned
enterprises, the legal establishment of central bank independence, open entry to foreign
banks, corporate governance reforms, amongst others. See generally Joseph J Norton,
Financial Sector Law Reform in Emerging Economies (London: British Institute of
International and Comparative Law, 2000). For banking and financial reforms undertaken in
Latin American emerging countries, see Serge Jeanneau, ‘Banking Systems: Characteristics
and Structural Changes’ in Evolving banking systems in Latin America and the Caribbean:
Challenges and Implications for Monetary Policy and Financial Stability, BIS Papers No 33
(February 2007), at <http://www.bis.org/publ/bppdf/bispap33.pdf> (last visited 25 July
2014). See also Rosa M Lastra and Enmanuel Cedeno-Brea, ‘Latin American Financial
Reforms’, Working Paper presented at the 92nd MOCOMILA meeting, Lima, Peru (April
2013).
42
See Howell E Jackson, ‘The Selective Incorporation of Foreign Legal Systems to Promote
Nepal as an International Financial Services Centre’ in Christopher McCrudden (ed),
Regulation and Deregulation—Policy and Practice in the Utilities and Financial Services
Industries (Oxford: Oxford University Press, 1998) 372.
43
Jackson, above note 42.
44
Goodhart and others argue that the general analysis of, rationale for, and principles of
financial regulation are not fundamentally different in emerging and developing countries
from in developed economies. In their view, the need for regulation is even greater in
emerging markets than elsewhere in the light of their vulnerabilities; prophylactic rules
based on numerical ratios are more important, since less reliance can be placed in more
sophisticated internal mechanisms. See Charles Goodhart et al (eds), Financial Regulation
Why, How and Where Now? (London: Routledge, 1998) 99.
45
See generally Malcom D Knight, Arne B Petersen, and Robert T Price, Central Bank
Reforms in the Baltics, Russia and the other Countries of the Former Soviet Union
(Washington, DC: IMF, 1997).
46
See generally Steven M Fries and Timothy D Lane, ‘Financial and Enterprise
Restructuring in Emerging Market Economies’ in Gerard Caprio, David Folkerts-Landau,
and Timothy D Lane (eds), Building Sound Finance in Emerging Market Economies
(Washington, DC: IMF/World Bank, 1993) 21–42 and 64–8.
47
Black summarizes the institutional and legal preconditions for strong securities markets:
The complex institutions that support strong securities markets can’t be built
quickly. …Some institutions can precede market development. Others will grow only
as the securities market grows. …Investor protective rules are only part of the
framework that supports securities markets, but they can perhaps speed the
development of other elements of this framework. …Accounting rules are a central
part of information disclosure. Here, the International Accounting Standards
Committee is not far from completing a workable set of International Accounting
Standards that countries can draw on in preparing their own rules, or even adopt
wholesale. Another important long-term step…is to establish or strengthen business
schools (for investment bankers and accountants) and law schools (for securities
lawyers and regulators). The payoff from training young people will be measured in
decades. But if the investment isn’t made, the decades will go by, and the country
still won’t have the prerequisites it needs. Significant piggybacking is feasible here;
a country can establish a program (perhaps with foreign aid funding) to send top
students to foreign professional schools. In developed countries, scholars often
think of good corporate governance as revolving around subtle variations in
director independence, the existence and role of the audit committee, constraints
on the corporate control market, and the like. In developing countries, corporate
governance is often much more basic. These countries need honest judges and
regulators, good disclosure rules, and the beginnings of a culture of honesty before
it makes sense to worry whether public company boards have, say, a majority of
independent directors.
See Bernard S Black, ‘The Legal and Institutional Preconditions for Strong Securities
Markets’ (2001) 48 UCLA Law Review 781, 847–9.
48
Jackson, above note 42, 373.
49
See Marc Gillen and Pittman Potter, ‘The Convergence of Securities Laws and
Implications for Developing Securities Markets’ (1998) 24 North Carolina Journal of
International Law and Commercial Regulation 83, 89–90; Andrew T Guzman, ‘Capital
Market Regulation in Developing Countries: A Proposal’ (1999) 39 Virginia Journal of
International Law 607, 616–23.
50
However, this approach is not without drawbacks. Black, above note 47, points out that
the country ‘needs to understand that if it engages five sets of foreign advisors, they will
propose five different laws, which will be inconsistent with each other and with the
country’s existing laws. Local draftsmen need to be closely involved in the drafting process,
to ensure that the rules fit into the existing legal framework and build on existing
terminology and practice to the extent possible.’
51
Jackson, above note 42.
52
Jackson, above note 42, 375.
53
See Loukas Mistelis, ‘Regulatory Aspects: Globalization, Harmonization, Legal
Transplants and Law Reform—Preliminary Remarks’ in Rosa M Lastra (ed), The Reform of
the International Financial Architecture (London: Kluwer Law International, 2001) 168–70.
54
Mistelis, above note 53. See also Otto Kahn-Freund, ‘On Use and Misuse of Comparative
Law’ (1974) 37 Modern Law Review 1.
55
Rosa M Lastra and Geoffrey Wood list the excessive complexity of some financial
instruments and the overuse of securitization as potential causes of the global financial
crisis. See Rosa M Lastra and Geoffrey Wood, ‘The Crisis of 2007–2009: Nature, Causes and
Reactions’ (2010) 13(3) Journal of International Economic Law 531.
56
See Jackson, above note 42, 373–4.
57
Jackson, above note 42, 387–8.
58
See UNCITRAL website, <http://www.uncitral.org> (last visited 25 July 2014).
59
UNCITRAL website, above note 58. UNCITRAL legislative texts, such as conventions,
model laws, and legislative guides, may be adopted by States through the enactment of
domestic legislation. UNCITRAL non-legislative texts, such as the UNCITRAL Arbitration
Rules, can be used by parties to international trade contracts. Since model laws are not
international conventions, there are no signatories to them. However, UNCITRAL monitors
enactments of UNCITRAL Model Laws into domestic legislation. This information is
provided in the ‘UNCITRAL Texts and Status’ area of the UNCITRAL website. This list is
updated as soon as the Secretariat is informed of changes in status or new enactments.
60
See European Bank for Reconstruction and Development, ‘Model Law on Secured
Transactions’ (1994), at <http://www.ebrd.com/downloads/research/guides/secured.pdf>
(last visited 14 September 2014).
61
Jackson, above note 42, 380–1.
62
See International Chamber of Commerce (ICC) website, <http://www.iccwbo.org> (last
visited 25 July 2014). The ICC has several commissions. The Commission on Commercial
Law and Practice (CLP) develops ICC model contracts and ICC model clauses which give
parties a neutral framework for their contractual relationships. These contracts and clauses
are carefully drafted by experts of the CLP Commission without expressing a bias for any
one particular legal system.
63
ICC website, above note 62. See also paragraph 14.46.
64
There is no single definition of what constitutes the acquis: for some purposes, use is
made of a very broad definition to include, in addition to the treaties, regulations,
directives, and decisions, the Case Law of the Court of Justice, and non-binding Acts such as
resolutions and recommendations. For this reason, the Commission issued a
Communication to the Council, the European Parliament, the European Economic and
Social Committee, and the Committee of the Regions in which it advocated a narrower
definition, encompassing primary law and binding secondary legislation (ie, regulations,
directives, and decisions). See Commission of the European Communities, ‘Updating and
Simplifying the Community Acquis’, Communication to the Council, the European
Parliament, the European Economic and Social Committee, and the Committee of the
Regions, COM(2003)71 final (11 February 2003).
65
See Lajos Bokros ‘A Perspective on Financial Sector Development in Central and Eastern
Europe’ in Lajos Bokros, Alexander Flemming, and Cari Votava (eds), Financial Transition in
Europe and Central Asia—Challenges of the New Decade (Washington, DC: The World Bank,
2001) XXX:
While the transition economies are in the process of building political and economic
systems based on those in Western Europe, the financial systems in these ‘model
economies’ are evolving rapidly into new models. The financial landscape in
Western European countries is experiencing deep economic, institutional and legal
changes of its own and—being a standard of reference for transition economies—in
fact it represents a rapidly moving target.
66
See generally Roger Van den Bergh, ‘Regulatory Competition or Harmonization of Laws?
Guidelines for the European Regulator’ in Alain Marciano and Jean-Michel Josselin (eds),
The Economics of Harmonizing European Law (Cheltenham: Edward Elgar, 2002); Stephen
Woolcock, ‘Competition among Rules in the Single European Market’ in William Bratton et
al (eds), International Regulatory Competition and Coordination: Perspectives on Economic
Regulation in Europe and the United States (Oxford: Clarendon Press, 1996).
67
See eg Christine M Chinkin ‘The Challenge of Soft Law: Development and Change in
International Law’ (1989) 38 International and Comparative Law Quarterly 850; Andrew T
Guzman and Timothy L Meyer, ‘International Soft Law’ (2010) 2 Journal of Legal Analysis
171; Matthias Goldmann, ‘We Need to Cut Off the Head of the King: Past, Present, and
Future Approaches to International Soft Law’ (2012) 25 Leiden Journal of International Law
335; Alan Boyle and Christine M Chinkin, The Making of International Law (Oxford: Oxford
68
See Mario Giovanoli, ‘A New Architecture for the Global Financial Markets: Legal
Aspects of International Financial Standard Setting’ in Mario Giovanoli (ed), International
Monetary Law. Issues for the New Millennium (Oxford: Oxford University Press, 2000) 35.
69
These are (in alphabetical order): Argentina, Brazil, China, India, Indonesia, Mexico,
Russia, Saudi Arabia, South Africa, and Turkey.
70
See IMF, Finance Department, ‘Quota and Voting Shares Before and After
Implementation of Reforms Agreed in 2008 and 2010’, at <http://www.imf.org/external/np/
sec/pr/2011/pdfs/quota_tbl.pdf> (last visited 25 July 2014). See <https://www.imf.org/
external/np/sec/pr/2011/pr1164.htm>.
71
See paragraph 13.03, and paragraphs 13.29–13.30.
72
This effect is largely driven by an increase of China’s quotas and voting shares. See IMF,
‘Quota and Voting Shares’, above note 70.
73
See generally Chris Brummer, Soft Law and the Global Financial System: Rule Making in
the 21st Century (Cambridge: Cambridge University Press, 2011).
Part II Developments at the EU Level, 6 History of
Monetary Integration in Europe
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
Financial system — International financial system — Monetary system — Monetary obligations —
(p. 219) 6 History of Monetary Integration in Europe
B. Progress Towards Monetary Union in Europe 6.06
The early years 6.08
The Werner Report: the seeds of the three-stage approach to EMU 6.17
The ‘snake’ 6.22
The European Monetary Cooperation Fund 6.27
The collapse of the Bretton Woods par value system 6.29
The European Monetary System 6.32
Developments in the 1980s: The Single European Act 6.41
The ‘Delors Report’ 6.44
C. The Maastricht Treaty on European Union 6.50

Stage One of EMU 6.56
Stage Two of EMU 6.61
Stage Three of EMU 6.76
D. Degrees of Integration 6.80

Customs union 6.82
Common market/internal market 6.87
Monetary union 6.96
Economic union 6.99
Political union 6.103
E. Optimum Currency Areas 6.106

F. Impact of EMU upon Other Regional Groupings 6.111
Europe will not be created at a stroke or emerge fully formed; it will be created by
tangible achievements whose first effect is to generate a spirit of solidarity.
Robert Schuman, Paris Conference, 9 May 1950, based on a memorandum prepared
by Jean Monnet
A. Introduction
6.01 The European Union is often quoted as a paradigm of an integration process. The
gradual development of a single market, the progressive liberalization of economic
activities, the free movement of goods, persons, services, and capital, the achievement of
monetary union, and the further ideals of political integration have often been hailed by
other countries and organizations as an interesting development of an ‘ever closer union’
amongst the citizens of a regional area. According to its own website, ‘[t]he EU is a unique
economic and political partnership between 28 European countries that together cover
much of the continent.’1
The European Union (EU) is a family of democratic European countries, committed
to working together for peace and prosperity. It is not a State intended to replace
existing (p. 220) states, but it is more than any other international organisation. The
EU is, in fact, unique. Its Member States have set up common institutions to which
they delegate some of their sovereignty so that decisions on specific matters of joint
interest can be made democratically at European level. This pooling of sovereignty
is also called European integration.2
6.02 The history of the European Community/European Union,3 as the history of any other
organization, is a history of successes and failures. Sometimes, it has been praised for its
achievements, some other times it has been criticized for its shortcomings or for its
excessive ambitions or for its alleged democratic deficit. Overall, the positive aspects of
integration have generally outweighed the negative ones, as evidenced by the appeal the
Union exerts over prospective members. However, the momentum towards further
integration suffered a serious setback in 2005, with the suspension of the ratification
process of the Treaty establishing a Constitution for Europe, which had been signed in
Rome in October 2004.4 After a ‘period of reflection’, the Member States agreed instead to
maintain the pre-existing treaties, but to amend and renumber them, restoring several
reforms that had been proposed in the Constitution. An international agreement was thus
drawn up and signed in December 2007: the Treaty of Lisbon.5 It amends the Maastricht
Treaty (Treaty on European Union) and the Treaty establishing the European Community
(also known as the Treaty of Rome, EEC Treaty). In this process, the Rome Treaty was
renamed the Treaty on the Functioning of the European Union (hereinafter TFEU).
(p. 221) 6.03 Monetary union is considered to be one of the European Union’s greatest
successes. Though European Monetary Union (EMU)6 is often justified on economic
grounds, the political will to achieve a single currency in Europe has been the driving force
behind integration in this field. There are, however, some clouds on the horizon and doubts
about the sustainability of the monetary union in the long run were revived with the
Eurozone debt crisis.7
6.04 The schedule of changes and the deadlines foreseen for the different stages to be
accomplished in the gradual realization of economic, monetary, and political integration
have not always been fulfilled. However, the chronological sequence of the steps to be taken
in the building up of the Union offers a valuable experience for other regional groupings in
the world pursuing similar integration patterns. Even the delays in the accomplishment of
some objectives are instructive with regard to the understanding of what works and what
does not work in an integration process. The law has been a fundamental instrument in the
progressive achievement of the goals of the European Union.
6.05 In the ensuing sections, I analyse the history of monetary union, the stages of
European integration (customs union, common market/internal market, monetary union,
economic union, and political union), the theory of optimum currency areas (OCAs), and the
impact of EMU upon other regional groupings.
B. Progress Towards Monetary Union in Europe

6.06 The history of European monetary cooperation is linked to the history of international
monetary cooperation (the subject of Chapter 12). The Bretton Woods par value regime
provided an anchor for international monetary stability until its demise in the early 1970s.
It is no coincidence, in my opinion, that the real momentum for monetary integration came
after the international anchor ceased to exist (though the Werner Report predated the
break-up of Bretton Woods).
6.07 In the following paragraphs, I bring together international and European
developments in order to understand the progress from monetary cooperation towards
monetary integration in Europe. Today, EMU is a reality amongst those Member States that
have surrendered national monetary sovereignty and that are tied together by unified
institutional arrangements: the European Central Bank as the central bank of the Union and
the euro as the single currency.
The early years
6.08 After the Second World War, and with the formal establishment of the International
Monetary Fund (IMF) and the World Bank (International Bank for Reconstruction and (p.
222) Development, IBRD),8 the emerging system paved the way for a relatively long
historical period of international monetary stability. The par value regime, often referred to
as the Bretton Woods regime, meant that the value of currency was defined in terms of gold
or, alternatively, in terms of the US dollar of 1 July 1944, which had a fixed gold value (one
ounce of gold was equal to $35).
The IMF mandate was to maintain the good order of this predictable and ‘stable’
international monetary system, by enforcing rules about adjustment in international
monetary relations and by providing temporary resources to deal with short-term balance of
payments problems.
6.09 The IMF had a much greater influence upon European developments than the IBRD.
It was the Marshall Plan rather than the World Bank that played the major role in the
reconstruction and recovery of war-torn European economies. US Secretary of State
George Marshall unveiled the ‘European Recovery Program’ (which became known as the
Marshall Plan) in his famous Harvard commencement speech in June 1947, where he
announced a programme of massive financial assistance to Europe. The Marshall Plan,
which was supervised by the US Economic Cooperation Administration (ECA), contributed
to the establishment of a multilateral system of European payments: the European
Payments Union (EPU) in 1950. The EPU was a mechanism for settling payments amongst
seventeen West European Countries: Austria, Belgium, Denmark, France, West Germany,
Greece, Holland, Iceland, Ireland, Italy, Luxembourg, Norway, Portugal, Sweden,
Switzerland, Turkey, and the United Kingdom.9 The EPU was a clearing union which
encouraged movement towards full currency convertibility. After the creation of the
Organisation for European Economic Cooperation (OEEC), the Bank for International
Settlements operated the EPU as an agent for the OEEC.10 By 1958, member currencies
became de facto fully convertible, ie, transferable between each other (de jure in 1961 on
formal acceptance of Art VIII of the IMF Articles of Agreement).
(p. 223) 6.10 Against this background of international monetary stability, the drafters of
the 1957 Treaty of Rome Establishing the European Economic Community (the EEC Treaty)
only included scarce references to the concept of ‘money’ in the original EEC Treaty.11
Indeed, the few provisions dealing with coordination of national monetary policies (Arts
104–109 EEC Treaty) are included in a chapter dedicated to ‘balance of payments’ (ch 3
EEC Treaty).12
6.11 The objectives of the Community were to promote a harmonious development of
economic activities, a continuous and balanced expansion, an increase in stability, an
accelerated raising of the standard of living, and closer relations between the States
belonging to it, and these objectives were to be achieved by establishing a common market
and progressively approximating the economic policies of Member States.13
The liberalization of trade in goods, services, and capital requires the liberalization of cross-
border payments.14 However, under the original Treaty of Rome, the liberalization of cross-
border payments did not mean that all restrictions on the movements of capital were to be
abolished. Capital movements were not fully liberalized.15 Under Article 67 of the EEC
Treaty (abolished), Member States were to ‘progressively abolish between themselves all
restrictions on the movement of capital belonging to persons resident in the Member States
and any discrimination based on the nationality or on the place of residence of the parties
or on the place where such capital is invested’.16 The influence of the Bretton Woods regime
in these provisions is clear, since the IMF Articles of Agreement provide for current account
convertibility, but not capital account convertibility. The IMF jurisdiction over payments
extends only to restrictions on current international transactions; controls on international
movements of capital are not subject to approval by the Fund.17
(p. 224) 6.12 Member States of the EEC were required to liberalize capital movements to
the extent necessary to ensure the proper functioning of the common market, which was a
matter to be assessed by the Council in accordance with Article 69 of the EEC Treaty (now
Arts 82–89 TFEU).18 Similarly, in relation to cross-border payments, the provisions relating
to exchange rate and monetary policy were intended to be a matter of intergovernmental
concern among the Member States and were not intended to create rights enforceable by
private persons.19
6.13 Proctor notes that in those early days the provisions of the Treaty of Rome dealing
with capital flows and balance of payments ‘began life in a relatively rudimentary form’ and
attributes the lack of further integration by way of judicial intervention from the European
Court of Justice to the lack of direct effect of the provisions on capital movements and
exchange controls of Articles 67–71.20
6.14 In 1958, a Monetary Committee with advisory status was established under Article
105(2) EEC (now Art 127 TFEU). In 1964, the Committee of Governors of the Central Banks
of the Member States was established in order to promote cooperation between the Central
Banks of the Member States.21 The seeds of the future institutional arrangements for
monetary integration had already been planted.22
6.15 In February 1968, the Commission proposed that Member States commit themselves
to adjusting their exchange rate parities only by common agreement and to considering the
elimination of margins on each other’s currencies around the established parities.23 Making
use of Article 105 EEC Treaty (now 127 TFEU), the Commission and Council began a series
of attempts to alleviate monetary crises in particular Member States and to co-ordinate
economic and monetary policy in order to achieve greater stability within the Community.24
In that context, on 12 February 1969, the ‘Barre Report’, named after Raymond Barre, then
Governor of the central bank of France, called for concerted economic policies for the
purpose of ensuring the attainment of agreed medium-term objectives in the field of
monetary co-ordination. The Council agreed with many features of the Barre Report and
committed members to prior consultation before a member altered its economic policies in
such a way as to have an important impact on other members.25
(p. 225) 6.16 In a related move, the Committee of Governors of Central Banks agreed on 9
February 1970 to provide lines of credit to support Member States in times of monetary
crisis.26
The Werner Report: the seeds of the three-stage approach to EMU
6.17 The Heads of State and Government of the countries of the EEC meeting at The
Hague in December 1969 decided that the Community would have to be transformed
progressively into an economic and monetary union.27 A committee was appointed, under
the chairmanship of the then Prime Minister of Luxembourg, Pierre Werner, to study the
possibilities of such union. The committee submitted its final report, named after its
Chairman, in October 1970.
6.18 The Werner Report was the first concrete proposal for monetary integration in
Europe.28 It envisaged the achievement of economic and monetary union within ten years
according to a three-stage plan. The ultimate goal was to achieve full liberalization of
capital movements, the irrevocable fixing of parities, and even the replacement of national
currencies with a single currency. The Report also recommended that the co-ordination of
economic policies be strengthened and guidelines for national budgetary policies drawn up.
6.19 In the words of the Report, ‘the Group has not sought to construct an ideal system in
the abstract. It has set out rather to determine the elements that are indispensable to the
existence of a complete economic and monetary union. The union as it is described here
represents the minimum that must be done, and is a stage in a dynamic evolution which the
pressure of events and political will, can model in a different way.’29
6.20 The Report required that the essential features of public budgets (including variations
in their volume, the size of balances and the methods of financing) would have to be
decided at the Community level. It also stated that regional and structural policies should
no longer be exclusively within the jurisdiction of the member countries.30
6.21 The Werner Report led to adoption of a Resolution by the Council and the
representatives of the Governments of the Member States on 22 March 1971.31 Although
unable to agree on some of the key recommendations of the Report, the Six gave their
approval in principle to the introduction of EMU in three stages.32 The first stage, involving
the narrowing of currency fluctuation margins, was to be launched on an experimental
basis and did not entail any commitment regarding the continuation of the process. As a
forerunner to the (p. 226) future Community system for the central banks, a European Fund
for monetary cooperation was proposed.
The ‘snake’
6.22 In March 1972, the Six introduced—through a Council Resolution of March 197233—
the so-called ‘snake in the tunnel’, that is, a mechanism for the managed floating of
currencies (the ‘snake’) within narrow margins of fluctuation against the dollar (the
‘tunnel’).
6.23 In accordance with the Member States’ response to the Werner Report, the long-term
objective of the new arrangement remained the elimination of any margin of fluctuation
between the currencies of the Community as the first stage of full monetary integration.34
Member States agreed that exchange rate fluctuations between the national currencies and
the dollar were to be kept within 0.75 per cent, which meant that the currencies of the
Member States would fluctuate by at most 1.5 per cent around their bilateral central rates.
6.24 The maintenance of fluctuation margins was mainly to be safeguarded by intervention
in currency markets, which was the responsibility of the central banks of the Member
States.35 It was argued that the attempt to control intra-Community exchange rate volatility
would serve the objective of the EMU by promoting trade in goods and services and
facilitating capital movements. It would also reduce the cost of servicing the Common
Agricultural Policy, a crucial political concern.
6.25 Thrown off course by the oil crises, the weakness of the dollar, and the differences in
economic policy, the ‘snake’ lost most of its members in less than two years and was finally
reduced to a ‘mark’ area comprising West Germany, the Benelux countries, and Denmark.36
6.26 The ‘snake’ was a forerunner of the exchange rate and intervention mechanism of the
European Monetary System, further discussed below.
The European Monetary Cooperation Fund
6.27 The European Monetary Cooperation Fund (EMCF) was established in 1973 to
promote the narrowing of the margins of fluctuation between the currencies of the Member
States.37 The EMCF facilitated the central bank cooperation required for the functioning of
the ‘snake’. The EMCF was endowed with separate legal personality and had purely
technical functions.38
6.28 The EMCF provided for the administration and settlement of claims resulting from
interventions in the foreign exchange market. The Fund was entrusted with three
interrelated tasks: the promotion of the proper functioning of the progressive narrowing of
the margins of fluctuation of the Community currencies against each other, the conduct of
interventions (p. 227) in Community currencies on the exchange markets, and the carrying
out of settlements between central banks leading to a concerted policy on reserves.39
The collapse of the Bretton Woods par value system
6.29 In the early 1970s, and despite the initial acceptance of the Werner Plan by the
Member States, the political and economic momentum for further monetary integration was
lost. A turning point in this ‘loss of momentum’ was the announcement by US President
Nixon on 15 August 1971 that the USA would no longer carry its obligation to deliver gold
for US dollars at the parity which had been established in 1944 and applied since the IMF
started operations. According to Mundell, ‘the biggest casualty of the breakup of the
international monetary system was the plan for European Monetary Union put into motion
at the Hague Summit in 1969’.40
6.30 The abandonment of the par value regime signified a worldwide shift to flexible
exchange rates. Within the European Community, the maintenance of narrow fluctuation
margins among the currencies participating in the ‘currency snake’ arrangement became
increasingly difficult. The ‘snake’ began to unravel. The attempts to preserve some
elements of the Bretton Woods system in Europe largely failed and the ‘snake’ became
transformed into a Deutschmark zone after the withdrawal of the pound, the lira, the punt,
and the French franc.41
6.31 Inflation, oil crises, instability, and economic slowdown shaped the international
economic landscape in the 1970s and, with an uncertain future, countries became more
‘inward looking’. When the European Commission proposed the move into stage two as
suggested by the Werner Report, there was no agreement at the Economic and Financial
Affairs Council (ECOFIN) and the project of EMU as envisaged in the Werner Report was
abandoned in December 1974.
The European Monetary System
6.32 The par value regime had been an external ‘anchor’ of monetary stability. With its
demise, currency instability became a feature of the European and global economic order.
The need for an ‘anchor’ became a matter of serious concern for European policy makers in
the late 1970s.
6.33 In 1977, Roy Jenkins, President of the European Commission at that time,
recommended progress in the monetary area. In 1978, Helmut Schmidt of Germany and
Valéry Giscard d’Estaing of France proposed a ‘zone of monetary stability in Europe’, which
became known as the European Monetary System (EMS). The European Council, after
meeting in Bremen, issued a communiqué on 7 July 1978 announcing its intention to create
the European Monetary System as an institutional arrangement to establish closer
monetary cooperation leading to a zone of monetary stability in Europe. A Resolution of the
Council (p. 228) on 5 December 1978 established the European Monetary System and an
Agreement of 13 March 1979 among the central banks of the EC set forth the operating
procedures.42
6.34 Despite the weak legal value of this Resolution, the EMS became the primary
arrangement of monetary cooperation in the EC from its inception to the advent of
European Monetary Union. The EMS was a ‘creature’ of the Franco-German alliance, an
alliance which has often been regarded as the ‘engine’ of European integration.
The EMS had three fundamental objectives: to stabilize the exchange rates in order to
rectify the existing instability, to reduce inflation, and to prepare for eventual European
monetary unification through cooperation.
6.35 The EMS consisted of two main elements. First, the establishment of the European
Currency Unit (ECU) as a basket of currencies. The share of each of the participating
currencies in the basket was determined by the percentage of their State’s contribution to
the gross national product (GNP) of the Community. The value of the composite currency
derived from the addition of all the currency elements.43 The ECU was not legal tender but
it served as unit of account in Community affairs, as a means of payment between the
monetary authorities in the Community, and as a store of value (reserves at the central
banks).
6.36 The second element of the EMS was the establishment of the exchange rate and
intervention mechanism (ERM). The ERM was conceived as a system of fixed but adjustable
exchange rates (a successor to the snake). The ERM was a parity grid of bilateral exchange
rates, with interventions limiting the swings in currency prices between pre-announced
floors and ceilings.44 The currencies could fluctuate against each other within a maximum
band of plus or minus 2.25 per cent (or 6 per cent for currencies at the beginning of their
participation in the ERM). The central banks were committed to intervening in order to
attempt to maintain their currencies within the established fluctuation margins. The central
bank of each participant had an obligation to deposit with the EMCF 20 per cent of its US
dollars and gold holdings in renewable swaps of three months’ duration. In return, the
EMCF issued ECUs to the participant. The ERM set for each one of the participating
currencies a central exchange rate against the ECU. That, in turn, gave them central cross-
rates against one another.
6.37 An important contemporaneous development at the international level was the
Second Amendment of the IMF Articles of Agreement of 1 April 1978, which established the
right of members to adopt exchange rate arrangements of their choice, including (i) the
maintenance by a member of a value for its currency in terms of the special drawing right
or another denominator, other than gold, selected by the member, or (ii) cooperative
arrangements by which members maintain the value of their currencies in relation to the
value of the currency or currencies of other members, or (iii) other exchange arrangements
of a (p. 229) member’s choice.45 This discretion is, of course, without prejudice to the
overarching obligations of IMF Members (a) to endeavour to direct their economic and
financial policies toward the objective of fostering orderly economic growth with reasonable
price stability, with due regard to its circumstances; (b) to seek to promote stability by
fostering orderly underlying economic and financial conditions and a monetary system that
does not tend to produce erratic disruptions; and, crucially, (c) to avoid manipulating
exchange rates or the international monetary system in order to prevent effective balance
of payments adjustment or to gain an unfair competitive advantage over other members.46 I
further discuss these obligations in Chapter 13.
6.38 In 1987, the EMS rules were strengthened through an agreement reached in Basel
and Nyborg on monetary policy cooperation.47 However, and despite this ‘strengthening’,
speculative attacks in September 1992 led to the exit from the ERM of the British pound
and to the temporary suspension of intervention limits for the Italian lira. Further
turbulence in the foreign exchange markets in 1993 led the ministers of finance and central
bank governors of the Community to adjust the ERM in August 1993, widening the
fluctuation margins from plus or minus 2.25 per cent to plus or minus 15 per cent (although
the British pound and the Italian lira remained outside the system).48
6.39 The 1992 Maastricht Treaty on European Union included membership of the ERM of
the EMS in two of the four criteria of economic convergence that Member States must meet
in order to qualify for monetary union.49
6.40 The ERM has ‘survived’ in a revised form (called ERM II) as an exchange rate
mechanism between the euro and the national currencies of the countries not participating
in the euro area. An agreement of 1 September 1998 between the European Central Bank
and the National Central Banks of the Member States outside the euro area laid down the
operating procedures for the ‘exchange rate mechanism in stage three of Economic and
Monetary Union’.50 To join the euro area, the aspiring EU Member States must first join the
ERM II for two years before adopting the euro.51
(p. 230) Developments in the 1980s: The Single European Act
6.41 The Single European Act,52 which was signed in Luxembourg and The Hague in 1986
and came into force on 1 July 1987, was the first major amendment of the founding treaties
of the European Communities. The Single European Act (SEA) was the institutional catalyst
for the revival of the internal market project. It also demonstrated that further European
integration was not unrealistic.
6.42 Once the Community had settled some internal disputes in the early 1980s (budget,
UK financial contribution, and others), it was time for new political initiatives to advance
the European project. With regard to the monetary aspect of this project, Article 20 of the
SEA inserted a new chapter in the EC Treaty on ‘Cooperation in Economic and Monetary
Policy’. Under Article 102A of the EEC Treaty (now Art 102 TFEU), Member States were
required to cooperate in order to ensure the convergence of economic and monetary
policies taking into account the experience acquired in cooperation within the framework of
the European Monetary System.
6.43 The SEA gave fresh impetus to the liberalization of capital movements. A single
market in financial services requires free flow of capital, and this liberalization is a
precondition to advance to monetary integration.
The ‘Delors Report’
6.44 The establishment of the internal market brought a new stimulus to the objective of
further integration. On the one hand, the decision to complete the single market gave
renewed impetus to the view that ‘one market needs one money’53 (though in the end the
driving force supporting the argument that a single currency was a necessary condition for
a successful single market was political rather than economic). On the other hand, the
decision to lift exchange controls, through the adoption of the 1988 Directive on the
liberalization of capital movements,54 triggered concerns about the possibility that the
ERM’s fixed but adjustable exchange rates would generate speculative movements that
could lead to exchange rate realignments.55 This led some economists at the time to warn
against the so-called ‘inconsistent quartet’ of policy objectives: free trade, full capital
mobility, pegged (or fixed) exchange rates, and independent national monetary policies.56 At
least one of these objectives had to go. The only long term solution to this inconsistency—as
Padoa-Schioppa (p. 231) suggested—was to complement the internal market with monetary
union,57 thus abandoning national control over domestic monetary policies.
6.45 The renewed interest in monetary union (which coincided with an economic upturn in
Europe) was given an official seal of approval in June 1988, when the Hanover European
Council concluded that ‘in adopting the Single Act, the Member States of the Community
confirmed the objective of progressive realization of economic and monetary union.’58 The
Heads of State meeting in the Council set up a committee to examine the means of
achieving the economic and monetary union, the so-called Delors Committee (named after
its Chairman).59
6.46 While Jean Monnet is rightly considered as one of the founding fathers of European
integration, Jacques Delors—the then President of the European Commission—can surely be
regarded as a founding father of EMU.
6.47 The ‘Delors Report’, the Report on Economic and Monetary Union in the European
Community, was published in April 1989.60 It proposed the introduction of economic and
monetary union in three stages, including an institutional framework to allow policy to be
decided and executed at the Community level in economic areas of direct relevance to the
functioning of EMU. The Report proposed the creation of a new monetary institution,
namely the European System of Central Banks (ESCB), which would become responsible for
formulating and implementing monetary policy as well as managing external exchange rate
policy.61
6.48 Stage One of the development of EMU would involve the increased cooperation
between central banks with relation to monetary policy, the removal of obstacles to
financial integration, the monitoring of national economic policies, and the co-ordination of
budgetary policy.62 Stage Two would be the preparatory stage for the final phase of EMU. It
would see the establishment of the ESCB, the progressive transfer of monetary policy to
European institutions and the narrowing of margins of fluctuations in the currencies within
the ERM.63 Finally, during Stage Three, the fixing of exchange rates between national
currencies would occur with their eventual replacement by a single European currency and
the transfer of responsibility for the conduct of monetary policy from the national to the
supranational arena.64
(p. 232) 6.49 The Delors Report was adopted by the European Council in its Madrid
summit in June 1989. The European Council decided to launch the first stage of EMU on 1
July 1990, the date of entry into effect of the 1988 Directive on freedom of capital
movements.65
C. The Maastricht Treaty on European Union

6.50 In December 1989, the Strasbourg European Council called for an intergovernmental
conference that would identify what amendments needed to be made to the Treaty in order
to attain economic and monetary union. The work of this intergovernmental conference and
the one on political union (both launched at the Rome European Council in December 1990)
led to the Treaty on European Union (the so-called Maastricht Treaty), which was formally
adopted by the Heads of State and Government at the Maastricht European Council in
December 1991 and signed on 7 February 1992.
6.51 While the Single European Act captured the momentum gained in the launching of
the ‘internal market programme’ and prepared the way for further monetary cooperation,
the Maastricht Treaty capitalized on the political momentum gained on the road towards
EMU (though the economic arguments on the costs and benefits of EMU were finely
balanced66). The drafting, signature, ratification, and implementation of the Maastricht
Treaty provide a good example of the ‘ups and downs’ of European integration. The Treaty
represents a compromise between those who favour a federal Europe and those who oppose
it. Its ambiguity in many provisions is rooted in this difficult balance.
6.52 The Maastricht Treaty made extensive amendments to the EC Treaty for the purpose
of ensuring a gradual movement of the Member States towards full economic and monetary
union.67 The Maastricht Treaty adopted the proposals of the ‘Delors Report’ by providing
for a ‘three-stage’ approach to introduce economic and monetary union by the end of the
century. The Treaty came into effect on 1 November 1993, following the final ratification by
Germany.
6.53 The Maastricht Treaty is greatly influenced by the ‘monetary stability’ culture that I
discussed in Chapter 2. This is essential to understand the unyielding commitment of the
European Central Bank to its primary objective.
6.54 Paradoxically, the Treaty gained binding legal force at a time when some European
Member States were more preoccupied about their growth prospects and their
unemployment problems than they were about the pursuit of price stability. The economic
slowdown in many European countries, the currency turmoil triggered by the ERM crisis in
September 1992, and the momentous historical events that took place in the European
continent at the beginning of the 1990s—namely German reunification, the break-up of the
former Soviet (p. 233) Union, the transition in Eastern European and newly created
Republics in the former USSR from centrally planned economies to market economies, the
break-up and war in Yugoslavia (a name which already belongs to history)—signified a
change in priorities in Europe.
6.55 Despite these geopolitical and economic considerations, the project of EMU was not
abandoned nor side-lined.
Stage One of EMU
6.56 In accordance with the conclusions of the Madrid European Council on 26 and 27
June 1989, the first stage of economic and monetary union began on 1 July 1990 (and lasted
until 31 December 1993). However, the entry into force of the Treaty on European Union on
1 November 1993 marked the genuine starting point of preparations for Economic and
Monetary Union.
6.57 In Stage One, capital flows were to be liberalized (the principle of freedom of capital
movements was incorporated into the Treaty) thus implying the removal of exchange
controls. By the end of December 1993 and before the beginning of Stage Two on 1 January
1994, Member States were also required to revise their domestic laws so as to prohibit
national central banks from providing overdraft or other credit facilities to their central
governments or other public authorities and also to prohibit privileged or favourable access
by central governments and other public authorities to facilities from financial
institutions.68
6.58 Member States were further obliged to co-ordinate their economic policies with the
Council69 and to adopt multi-annual economic programmes designed to secure durable
economic convergence necessary to achieve the EMU objective. In addition, Member States
were required to regard their exchange rates as matters of concern to the Community as a
whole and to seek to avoid undue exchange rate fluctuations.
From an institutional perspective, the Committee of Governors of the Central Banks of the
Member States of the European Economic Community was given additional responsibilities.
These were laid down in a Council Decision of 12 March 1990 and included holding
consultations and promoting the co-ordination of the monetary policies of the Member
States with the aim of achieving price stability. In view of the relatively short time available
to advance to monetary union and the complexity of the tasks involved, the preparatory
work for Stage Three of EMU was also initiated by this Committee of Governors.
6.59 During the negotiations of the Maastricht Treaty, the United Kingdom obtained its
famous ‘opt-out’ clause, exempting it from the third stage of EMU. A protocol annexed to
the Treaty stipulated that the UK was not required to introduce the single currency even if
it fulfilled the convergence criteria. The protocol was necessary in order to secure the UK
ratification of the Treaty. Denmark, which had also secured a monetary opt-out, rejected the
Treaty in a referendum held in June 1992,70 and it subsequently obtained an agreement
exempting (p. 234) it from several provisions of the Treaty. Sweden also rejected the euro in
a referendum in September 2003. (Sweden has no formal opt-out but availed itself of the
possibility of not complying with several of the convergence criteria in order to obtain a
semi-permanent status as a derogation State.)
6.60 During the process of ratification of the Treaty, the speculation sparked off by the
negative result of the first Danish referendum, the uncertainty surrounding the French
referendum, and the speculative attacks that led to the widening of the fluctuation margins
of the exchange-rate mechanism cast some doubts both on the feasibility of the EMU
project and on the timing for its completion. But the project remained on track.
Stage Two of EMU
6.61 Stage Two of EMU began on 1 January 1994, in accordance with the EC Treaty,
following the Maastricht Treaty revision. The EMCF and the Committee of Central Bank
Governors were replaced by the European Monetary Institute, the predecessor of the ESCB.
No formal decision was needed for the transition to this second stage, during which
Member States were to make significant progress towards economic policy convergence.
Precise but non-binding rules on public financing were adopted and a new type of
monitoring, this time of public finances, was introduced and carried out by the Commission.
6.62 From 1 January 1994, a number of Treaty provisions, Arts 56–60 of the EC Treaty
(now 63–66 and 75 of the TFEU) introduced arrangements to fully liberalize capital
movements within the EU Member States.71
6.63 The co-ordination of monetary policies was institutionalized in Stage Two by the
establishment of the European Monetary Institute (EMI).72 The tasks of the EMI were
twofold: (1) strengthening cooperation between the national central banks and the co-
ordination of Member States’ monetary policies (during this stage, monetary policy
remained in the hands of the national authorities); (2) carrying out the necessary
preparatory work for establishment of the ESCB, which was to conduct the single monetary
policy.
6.64 Member States had to ensure that they would co-ordinate their economic policies
with the Council, endeavour to avoid excessive government deficits, and ensure that their
national law was compatible with the Treaty and with the Statute of the ESCB, with special
reference to independence of their national central bank. They were also required to make
significant progress towards convergence of their economies, since the move to the third
stage was conditional on fulfilment of the four convergence criteria laid down in the Treaty.
6.65 During the Madrid European Council of 15 and 16 December 1995, Member States
expressed their political determination that the third stage of Economic and Monetary (p.
235) Union was to go ahead on 1 January 1999 in accordance with the convergence criteria,
the timetable, the protocols, and the procedures laid down in the Treaty.73 On the basis of
the discussions initiated by the Commission’s Green Paper, the fifteen Heads of State or
Government spelled out the scenario and the timetable for introducing the single currency,
which they decided to call the ‘euro’.
6.66 Rounding off two years of intensive work by all the EU institutions, the Dublin
European Council of 13 and 14 December 1996 noted that there was political agreement on
all the necessary foundations for setting the single currency in place: the legal framework
for the use of the euro, the Stability and Growth Pact for ensuring strict budgetary
discipline (which was adopted in 1997), and the structure of the new exchange rate
mechanism for those Member States not joining the euro zone (the ERM II).
6.67 At the same time the EMI presented the designs of the banknotes that would be put
into circulation from 1 January 2002. The euro became a tangible reality for the general
public.
6.68 Throughout 1996 and 1997 the economic upturn, with inflation rates at exceptionally
low levels, stable exchange rates,74 and a general improvement in the state of public
finances, paved the way for the majority of Member States to switch to the euro in 1999.
6.69 Most of the necessary preparatory work for an orderly transition to the third stage
and the smooth operation of EMU was completed by the end of 1997. The first Euro
Regulation (further examined in Chapter 7) was adopted following the Amsterdam
European Council of June 1997.75 The fifteen Heads of State or Government also adopted
the resolutions on the Stability and Growth Pact76 (analysed in Chapter 8) and on the new
exchange rate mechanism (ERM II) at the Amsterdam summit.
6.70 The Luxembourg European Council (December 1997) completed this legislative
framework by spelling out the principles and procedures for closer economic co-ordination
during the third stage of EMU.77
6.71 The transition to the third stage was subject to the achievement of a high degree of
durable economic convergence measured against four criteria laid down by Art 121 EC
Treaty (now Art 140 TFEU), which refer to price stability, sustainability of government
financial positions (non-excessive budgetary deficits), stability within the ERM, and low
long-term (p. 236) interest-rate levels. These four economic criteria as well as the legal
criterion of central bank independence (Art 109 EC Treaty, now Art 131 TFEU) constitute
the necessary requirements to qualify for monetary union.
6.72 The weekend of 1–3 May 1998 will go down in history as a milestone on the road to
Economic and Monetary Union. On the basis of a recommendation adopted by the Economic
and Financial Affairs Council (ECOFIN) (Economics and Finance Ministers), and having
consulted the European Parliament, the Council, meeting at the level of Heads of State or
Government, unanimously decided that eleven Member States, namely Belgium, Germany,
Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal, and Finland,
fulfilled the necessary conditions for adopting the single currency on 1 January 1999.78
6.73 The following instruments were also adopted on 3 May 1998: a joint communiqué
stating that the bilateral central rates currently in force within the exchange rate
mechanism were to be used on 1 January 1999 in determining the irrevocable conversion
rates for the euro vis-à-vis the currencies of the participating Member States, and a
regulation on the denominations and technical specifications of euro coins.79 The regulation
laying down the conditions in which the currencies of the participating Member States will
be replaced by the euro from 1 January 1999 was only adopted on 31 December 1998.80
6.74 The Heads of State or Government also reached political agreement on the names of
the persons to be recommended for appointment to the Presidency, Vice-Presidency, and
Executive Board of the European Central Bank. The appointments of Mr Wim Duisenberg as
President, Mr Christian Noyer as Vice-President, and Mr Otmar Issing, Mr Tommaso Padoa-
Schioppa, Mr Eugenio Domingo Solans, and Mrs Sirkka Hämäläinen as members of the
Executive Board were confirmed on 26 May 1998.
6.75 The European Central Bank was therefore established on 1 July 1998, succeeding the
European Monetary Institute, based in Frankfurt. It became operational on 1 January 1999.
Stage Three of EMU
6.76 On 1 January 1999, the third stage began. At that point, (a) the ECU (euro) became a
currency in its own right (meaning that it ceased to be a composite currency whose value
depended on the currencies of which it was composed; most of these were now legally
abolished and replaced by the single currency); (b) the Council fixed the irrevocable fixed
rates at which participating currencies were to be substituted by the euro; (c) the ECB and
the ESCB took up their full powers and assumed responsibility for the single currency from
the first day of the third stage; and (d) participating Member States became subject to an
absolute obligation to avoid excessive government deficits.
(p. 237) 6.77 Commentators often divided this third and final stage into Stage 3(a) and
Stage 3(b).81 Stage 3(a) referred to the irrevocable locking of exchange rates that took
place on 1 January 1999. Stage 3(b) referred to the actual introduction of euro banknotes
and coins that took place on 1 January 2002.
6.78 In 2000, Greece asked that its progress towards convergence be reassessed. The
Commission issued a favourable opinion and the ‘derogation’ was abrogated by the Council.
Greece thus embarked on the third stage of EMU on 1 January 2001.
6.79 In September 2001, the first euro notes and coins were distributed to banks and
companies. Individuals wishing to acquaint themselves with their new currency could
inspect the notes and coins at their bank. Information campaigns explained the new safety
measures for protecting the European currency against counterfeiting. As of mid-December
individuals could buy mini-kits of euro coins in order to acquaint themselves with the new
currency. On 1 January 2002, cash payments could be effected in euros and the European
currency quickly replaced the former national currencies in everyday payments. The
changeover period during which both the euro and the national currencies were used
together—the so-called ‘dual circulation’—lasted up to two months in some countries. On 28
February 2002, the former national currencies lost their status as legal tender, with ‘old’
national notes and coins exchanged at national banks on terms set by each Member State.
Transition to the euro was completed.
D. Degrees of Integration

6.80 One significant characteristic of the EC integration process has been its changing
nature and dynamic character. The EC has proved adept at evolving in terms of objectives
to be achieved, institutions, policies and responsibilities, techniques, mechanisms, and
procedures to move forward. The challenge in the late 1950s and in the 1960s was the
consolidation of the customs union; the challenge in the 1970s was the consolidation of the
EEC institutions and the first enlargement; the challenge in the 1980s was the single
market programme and the second enlargement; the challenge in the 1990s was the
realization of monetary union and the need for institutional reform. The challenge since the
year 2000 has been the enlargement eastwards and the deepening of the union through
constitutional reform and the prospect of further political integration.
6.81 In this section, I examine the various stages or degrees of European integration:
customs union, common market/internal market, monetary union, economic union, political
union.
Customs union
6.82 In international trade relations, a customs union is formed when two or more
countries agree to remove all barriers to free trade with each other, while establishing a
common external tariff against other nations.
(p. 238) 6.83 The legal basis for the customs union was the 1957 EEC Treaty. According to
its Article 23 (now Art 28 TFEU), ‘the Community shall be based upon a customs union
which shall cover all trade in goods and which shall involve the prohibition between
Member States of customs duties on imports and exports and of all charges having
equivalent effect, and the adoption of a common customs tariff in their relations with third
countries.’ The provision makes it clear that the customs union has both internal and
external aspects.
6.84 The internal aspect requires the elimination of customs duties and charges having
equivalent effect on goods in free circulation within the Community. The external aspect
involves the adoption of the common customs tariff. The EC Treaty declares that ‘by
establishing a customs union between themselves Member States aim to contribute, in the
common interest, to the harmonious development of world trade, the progressive abolition
of restrictions on international trade, and the lowering of customs barriers.’82
6.85 The provisions regarding a common commercial policy (Arts 131–134 EC Treaty, now
Arts 206 and 207 TFEU) relate both to the external needs of a customs union and to the
broader needs of a common market.
6.86 The customs union was completed on 1 July 1968 (eighteen months earlier than the
deadline laid down in the Treaty): all customs duties and restrictions among the six
founding Member States of the Community were eliminated and the Common Customs
Tariff (CCT) (an external tariff which applies to third country goods) was introduced.
Customs checkpoints at borders between EU countries disappeared in 1993. The first stage
of integration was completed.
Common market/internal market
6.87 The second stage of European integration was the creation of a common market
amongst the participating Member States. The legal basis of the common market is also to
be found in the original 1957 EEC Treaty. The common market was to be progressively
established during a transitional period of twelve years ending on 31 December 1969.83
6.88 However, the creation of a common market proved to be a much more complex and
multifaceted process than the rather straightforward establishment of a customs union. The
very denomination of this ‘one market’ has given rise to three different terms over time:
‘common market’, ‘single market’, and ‘internal market’. Though these three terms express
the same integration goal, the EC Treaty refers only to the ‘common market’ (this term
appears thirty-three times in the EC Treaty) and the ‘internal market’ (this term appears
seventeen times in the EC Treaty).84 The term ‘single market’ does not appear in the EC
Treaty though it is frequently used by the European Court of Justice and by commentators
of EC law, often as a synonym of ‘internal market’. In the TFEU, the term (p. 239) ‘internal
market’ appears forty eight times while the other terms do not appear a single time. It
seems that the drafters of the TFEU chose to harmonize the wording of the Treaty, perhaps
for the sake of clarity.
6.89 The term ‘common market’ was not defined in the original EEC Treaty. The so-called
Spaak Report,85 which formed the basis for the EEC Treaty, described the ‘common market’
in the following terms:
The objective of a common European market must be to create a vast zone of

common economic policy, constituting a powerful unit of production, and making
possible continuous growth, an increase in stability, an accelerated raising of the
standard of living and the development of harmonious relations between the States
which it unites…However, these advantages of a common market can only be
achieved if time is granted and means are collectively made available to permit
necessary adaptations to be made, if practices which distort competition between
producers are ended and if co-operation between the States is established in order
to ensure monetary stability, economic growth and social progress. This is the basic
reason why, where in theory liberalization of trade at a world wide level appears to
be desirable, a true common market can in the end only be realized between a
limited group of States, which one would wish to be as broad as possible.86
6.90 In the 1980s it became clear that progress towards one market required new political
initiatives and more flexible strategies for integration. This was the context in which a new
term, the ‘internal market’ was coined. A White Paper on the Internal Market (not a legally
binding document) was published in 1985, containing a list of almost 300 measures needed
to remove physical, technical, and fiscal barriers.87 This White Paper was followed by the
revision of the EC Treaties in 1986 with the Single European Act, which is the legal basis of
the internal market. According to the new Article 8A (currently Art 14(2) EC Treaty)
introduced in the EEC Treaty by the SEA: ‘The internal market shall comprise an area
without internal frontiers in which the free movement of goods, persons, services and
capital is ensured in accordance with the provisions of this Treaty.’
6.91 The internal market programme was a ‘revamping’ of the original common market
objective. The SEA introduced a number of ‘devices’ or procedures (eg, the requirement of
qualified majority, the use of Directives, the 1992 ‘deadline’) to speed up its
accomplishment.
6.92 The notion of the ‘common market’ is fundamental to the European project (‘One
Market, One Europe’). In fact, the ‘common market’ is, together with the economic and
monetary union, the basic mechanism by which the Community seeks to achieve its
overarching tasks.88
(p. 240) 6.93 The common market involves the removal of barriers to trade, direct and
indirect, technical and non-technical, between the Member States. It is therefore a form of
negative integration because it entails measures which Member States shall abolish and
actions which they shall refrain from taking. In Gaston Schul,89 the European Court of
Justice ruled that the concept of a common market ‘involves the elimination of all obstacles
to intra-Community trade in order to merge the national markets into a single market
bringing about conditions as close as possible to those of a genuine internal market. It is
important that not only commerce as such but also private persons who happen to be
conducting an economic transaction across national frontiers should be able to enjoy the
benefits of that market.’90
6.94 The establishment of the common market also requires positive integration, the co-
ordination of Member State policies. The approximation of laws and regulations is
considered to be of fundamental importance in this respect.91 The term ‘common market’ is
associated with competition policy and State aid policies (Arts 81–89 EC Treaty, now Arts
101–109 TFEU) and with the Common Agricultural Policy (EC Treaty, Art 32(4), now Art 38
TFEU in Title III on Agriculture and Fisheries),92 which involve law-making at the
Community level.93
6.95 Though great advances have been made in the establishment of a single market, the
truth of the matter is that this multifaceted and ambitious stage of integration has not been
completed yet.
Monetary union
6.96 The concept of the monetary union, the focus of Part II of this book, was first
introduced in the EEC Treaty by the 1986 Single European Act—through the inclusion of a
new Article 102A—and is now firmly anchored in EU law since the entry into force of the
1992 Maastricht Treaty on European Union. The concept of the monetary union has also
been confirmed in Article 119(2)(3) of the Lisbon Treaty on the Functioning of the European
Union. Monetary Union has three components: (1) an integrated Community monetary
system; (2) an institutional structure, with a European Central Bank at its centre; (3) a
single currency, the euro, replacing present national currencies in all the participating
Member States.94
(p. 241) 6.97 Monetary Union is a reality: integration in this field has been achieved to its
full extent by the transfer of sovereign powers from the national to the supranational arena.
The euro as a single currency was recognized as a symbol of the Union, in Article I-8 of the
EU Constitution. The monetary policy of the Community (of those Member States whose
currency is the euro) is one and indivisible and the European Central Bank is the institution
responsible for its formulation. Article I-13 of the EU Constitution clearly stated that the
Union shall have exclusive competence in the monetary policy for the Member States whose
currency is the euro.95 The TFEU does not recognize the euro as a symbol nor monetary
policy as indivisible but instead states in its Article 119(1) and (2) that the activities of the
Member States and the Union shall include ‘a single currency, the euro, and the definition
and conduct of a single monetary policy and exchange-rate policy’. Additionally, Article 282
of the TEFU recognized the European Central Bank together with the ESCB responsible for
the conduct of monetary policy of the Union.96
6.98 Since monetary sovereignty is an attribute of sovereignty (as discussed in Chapter 1)
monetary union can also be seen as a prelude to a potential future political union. Banking
union—a further transfer of sovereignty—is examined in Chapter 10.
Economic union
6.99 While the meaning of monetary union is clear, the term economic union is a bit of a
misnomer. In much of Europe today (ie, in the euro-zone) there is one currency, one
monetary policy and one central bank. The reality of ‘oneness’ is conveyed by the term
monetary union (and banking union strengthens this oneness). There has been a real
transfer of sovereign responsibilities from the national to the supranational arena in the
monetary field.
6.100 Economic union is, in fact, economic policy co-ordination, since Member States—
participating or not in monetary union—are still in charge of their fiscal policies (albeit
subject to EU rules) and retain other important national prerogatives with regard to their
‘economic policies’, as further discussed in Chapter 8.
6.101 The sequencing of monetary union and economic union that has taken place at the
EU is not necessarily a paradigm that other regional groupings in the world may wish to
follow. In the run up to EMU it was argued by many that monetary union could only be
securely achieved as the culmination of a general process of convergence (the view of
German ‘Economists’). In the end, the view that early moves toward monetary union would
put pressure on members to converge in other economic respects prevailed (the view of
French ‘Monetarists’).97 A compromise was finally reached, since the German view that a
convergence of macroeconomic policies and performances was needed for monetary union
determined the choice of criteria of economic convergence and the Stability and Growth
Pact.
6.102 The need for economic and social cohesion is of great relevance in the light of the
enlargement of the EU eastwards, with the accession of new Member States. In this
respect, the (p. 242) need for a regional policy to reduce structural differences between the
various regions of Europe and the backwardness of the less developed regions remains
clear.
Political union
6.103 A political union, the establishment of a true federal State, with transfer of
sovereign powers from the national to the supranational arena with regard to defence
policy, security, justice, and other affairs, would be the final stage of European integration.
Whether or not it will ever be achieved depends upon the political will of the Member
States. Within the EU there are those who passionately believe in an ever closer union and
those who with equal passion argue that no more integration (and certainly no more
political integration) is needed.
6.104 The EU is indeed a complex reality. According to Article 4(2) TFEU, the Union has
competence to define and implement common foreign and security policy, including defence
policy. The TFEU also creates a European External Action Service and the diplomatic
service will operate under the patronage of a High Representative for Foreign Affairs and
Security Policy.
6.105 The European project of integration was born out of hopes and fears: the fear of
France for Germany and the fear of Germany for itself,98 the fears of wars and divisions,
and the hopes of peace and prosperity, bringing forces together to build a better future. And
those hopes and fears remain at the heart of any further integration.
E. Optimum Currency Areas

6.106 An OCA refers to the ‘optimum’ geographic domain within which the general means
of payments is either a single common currency or several currencies whose exchange
values are pegged to one another with unlimited convertibility for both current and capital
transactions, but whose exchange rates fluctuate in unison against the currencies of the
rest of the world.99 The concept of OCAs was developed in the context of debates over the
relative merits of fixed versus flexible exchange rates. The pioneering work in this field was
done by Nobel laureate Robert Mundell (1961),100 though Ronald McKinnon (1963)101 and
Peter Kenen (1969)102 were also influential in the development of the OCA theory. In
particular, the realization that in addition to the fixity of exchange rates (within the OCA),
the complete freedom of capital movements is another precondition for an optimal currency
area.
(p. 243) 6.107 The OCA doctrine has been influential in the development of a theoretical
economic justification for European Monetary Union (though controversy remains
regarding the relevance of the OCA criteria for deciding to form a monetary union on
economic grounds).103 Interestingly, both those who favoured EMU and those who opposed
EMU used arguments drawn from Mundell’s own work. As McKinnon explains, this
paradox, where Mundell appears to be on both sides of the debate over monetary
unification in Europe, is resolved by noting that there are two Mundell models: the earlier
Mundell of 1961 and the later Mundell of 1969–70.104
6.108 Mundell himself acknowledges an evolution in his ideas, by pointing out that while
his 1961 article presented a qualification to the case for flexible exchange rates,105 by 1966
he had reached ‘the conclusion that a movement to generalized flexible exchange rates
would be a step backward for the international monetary system’ thus distancing himself in
this issue from his mentors James Meade and Milton Friedman.106
6.109 The interpretation of the ‘earlier Mundell’—which reflects a post-war Keynesian
mindset—considers that ‘an independent national monetary policy with exchange rate
flexibility is the most efficient way to deal with asymmetric shocks.’107 On the basis of this
interpretation much of the British press and many economists still argue—not without
reason, in the light of the lessons learnt from the eurozone debt crisis—that ‘a one-size-fits-
all monetary policy run from Frankfurt’ cannot be optimal for Britain.108
(p. 244) 6.110 In 1969, Mundell presented a paper in New York called ‘The Case for a
European Currency’. A revised version of this paper, entitled ‘A Plan for a European
Currency’ was then presented at a Conference on Optimum Currency Areas in Madrid in
March 1970.109 (He also presented a paper entitled ‘Uncommon Arguments for Common
Currencies’.) These papers constitute, according to McKinnon, ‘the later Mundell’, the one
whose arguments are considered to provide a theoretical endorsement of European
monetary integration.110 In 1970, Mundell’s work explains how having a common currency
across countries can mitigate asymmetric shocks by better reserve pooling and portfolio
diversification.111 In his paper ‘A Plan for a European Currency’ Mundell suggests that ‘the
exchange rate should be taken out of both national and international politics within Europe.
Rather than moving towards more flexibility in exchange rates within Europe, the economic
arguments suggest less flexibility and a closer integration of capital markets.’112
F. Impact of EMU upon Other Regional Groupings

6.111 The arrival of EMU has ignited interest in cooperative monetary arrangements in
other parts of the world: Latin America (Mercosur), Asia, and Africa. However, it would be a
misconception to apply a particular model of integration to any other group of countries.
Though there are some common principles and techniques that can be extrapolated from
the EU experience and applied to other regional groupings pursuing further economic and
monetary integration (eg, the need for binding fiscal rules and the fact that a monetary
union can be successfully implemented without first forming a political union),113 there are
many elements that can only be understood and adequately solved in situ, that is, taking
into account the particular historical, political, economic, geographic, and other
circumstances of the countries that want to achieve greater integration.
6.112 Ortega y Gasset, renowned twentieth-century Spanish writer and philosopher, once
stated that ‘a nation is a unity forged in history with a common destiny’.114 Though he had
in mind the nation State, the idea of a ‘common destiny’ is a useful motto to approach
integration. Of course, such ‘common destiny’ can be brought about by a variety of
circumstances: geographic proximity, sharing natural resources, and others. The process of
achieving integration is a complex one. In developing countries, the difficulties are further
compounded by the lack of adequate institutions to support legal and economic reform.115
The remnants of colonialism also need to be taken into account.
(p. 245) 6.113 Honohan and Lane have examined the impact of European Monetary Union
on Africa.116 They consider, inter alia, the advantages that regional monetary integration
could have as an external source of restraint upon the fiscal and monetary behaviour of
governments, ‘given the record of macroeconomic mismanagement in many African
countries’.117
Cohen examines the wider economic implications of EMU for the developing world.118
6.114 Economic considerations (as well as political stability) are indeed important.
However, the single most important obstacle that developing countries face in their pursuit
of effective integration is the lack of the necessary institutional and legal mechanisms to
achieve the objectives of regional economic and monetary integration. The making of
integration is founded upon an institutional and legal structure. This is a fundamental
feature of the European integration process. The European Union is a Community of Law,
as Gunter Hirsch eloquently stated: ‘The Community derives its legitimacy, its political
standing and its claim to continuity from its capacity as a community of law, in fact, it is but
a community of law. Created as it were by the law, the law is what it brings forth.’119
According to its own website:
The EU is based on the rule of law: everything that it does is founded on treaties,
voluntarily and democratically agreed by all member countries. These binding
agreements set out the EU’s goals in its many areas of activity.120
(p. 246)
Footnotes:
1
European Union, ‘How the EU Works’, at <http://europa.eu/about-eu/index_en.htm> (last
2
‘The European Union at a Glance’, at <http://www.europeanunion.promotion.org.pl> (last
3
The term European Union (EU) was formally introduced by the Treaty on European Union
(signed 7 February 1992), OJ C 325/5 (24 December 2002) (the so-called Maastricht
Treaty), Art A of which stated that the Union was founded on the three existing European
Communities, supplemented by the policies and forms of intergovernmental cooperation
established in the (Maastricht) Treaty (common foreign and security policy and cooperation
in the fields of justice and home affairs). The Maastricht Treaty, Art G renamed the
European Economic Community as the European Community. (As acknowledged, the EEC
was one of the three European Communities established by Germany, France, Italy,
Belgium, Luxembourg, and the Netherlands in the 1950s; the other two being the European
Atomic Energy Community (EURATOM), and the European Coal and Steel Community.) The
1997 Treaty of Amsterdam (Treaty on European Union (Consolidated Version), 2 October
1997, entered into force 1 May 1999), and the 2003 Treaty of Nice amended both the EC
Treaty and the Treaty on European Union and renumbered both (Treaty of Nice, amending
the Treaty on European Union, the Treaties Establishing the European Communities and
Certain Related Acts, 11 December 2000, OJ C 80/01 (10 March 2001)). The Treaty of
Lisbon (signed 13 December 2007, entered into force 1 December 2009), OJ C 306/01
further amended the Treaty on European Union (TEU) and the Treaty Establishing the
European Community. The former retained its title, while the latter became the Treaty on
the Functioning of the European Union (TFEU). The Treaty of Lisbon entered into force on
1 December 2009. See Consolidated versions of the Treaty on European Union and the
Treaty on the Functioning of the European Union, 2010 OJ C 83/01 vol 53 (30 March 2010)
(hereinafter TFEU). The complex and intricate structure of the European Union makes it
difficult sometimes for legislators and commentators to make the correct distinctions.
4
The Treaty establishing a Constitution for Europe (Rome, signed 29 October 2004) OJ C
310 (16 December 2004). The proposed EU Constitution was thrown into a legal limbo
following the rejection of the Treaty in referenda in France (28 May 2005) and the
Netherlands (1 June 2005). The suspension of the ratification process (according to the
declaration of the European Council Brussels summit on 16–17 June 2005 to allow for a
‘period of reflection’) did not equate to the abandonment altogether of the Constitution.
Had it been ratified, the Treaty establishing a Constitution for Europe would have replaced
all existing Treaties, except for the Treaty establishing the EURATOM.
5
It was originally intended to be ratified by all Member States by the end of 2008. The
timetable failed primarily due to the initial rejection of the Treaty in 2008 by the Irish
electorate, a decision which was reversed in a second referendum in 2009 after Ireland
secured a number of concessions related to the Treaty.
6
EMU is an acronym that stands both for ‘European Monetary Union’ (as used in this
context) and for ‘Economic and Monetary Union’, a meaning which is historically and
legally correct. See eg the reference to ‘economic and monetary union’ in Art 59 TFEU.
7
See eg Daniel Gros, Thomas Mayer, and Angel Ubide, ‘EMU at Risk’, Seventh Annual
Report of the CEPS Macroeconomic Policy Group (1 June 2005), at <http://www.ceps.eu/
book/emu-risk-7th-annual-report- ceps-macroeconomic-policy-group> (last visited 25 July
2014) and Daniel Gros, ‘Will EMU Survive 2010?’, CEPS Commentary (17 January 2006), at
<http://www.ceps.be/book/will-emu-survive-2010> (last visited 25 July 2014).
8
The IMF and the World Bank were set up in 1944 and started operations in 1946. I have
discussed the origins of these institutions in Rosa M Lastra, ‘The Bretton Woods Institutions
in the XXIst Century’ in Rosa M Lastra (ed), The Reform of the International Financial
Architecture (London: Kluwer Law International, 2001) 67–90.
9
The European Payments Union (EPU) was a clearing arrangement to which creditors and
debtors in the various countries participating in the arrangement could settle their claims
with one another without the use of foreign exchange reserves. A debtor to a foreign
creditor was able to pay in his local currency the equivalent of his foreign debt into an
account with his national central bank. At the same time, this process would be repeated in
the country in which the foreign debt was owed: ie, a local debtor paying an amount of local
currency that was the equivalent of his foreign debt into an account with his national
central bank. The upshot was that the national central banks would then satisfy the debts
owed to their respective local creditors, who tender to them their claims denominated in
foreign currencies while receiving in satisfaction the equivalent in local currencies. The two
central banks maintained accounts on their books in each other’s favour. In the EPU, any
foreign currency that one member country earned in transactions with another member
country could be utilized for payments to another member country. Each central bank had
an account with the EPU and debts had to be settled. The United States contributed,
through the Marshall plans, capital funds to facilitate the settlement of member country
debts to the EPU in gold and dollars.
See Robert Effros, ‘The Maastricht Treaty, Independence of the Central Bank and
Implementing Legislation’ in Tomás Baliño and Carlo Cotarelli (eds), Frameworks for
Monetary Stability. Policy Issues and Country Experiences (Washington, DC: IMF, 1994)
280–1.
10
The OEEC was formed to distribute Marshall Plan funds. By the end of the 1950s its
objectives had been largely achieved. The OEEC was succeeded by the OECD. The
convention establishing the OECD (Organisation for Economic Co-operation and
Development) was signed on 14 December 1961.
11
Treaty Establishing the European Community (Consolidated Version) (signed 25 March
1957) (hereinafter ‘Treaty of Rome’ or ‘EEC Treaty’). The Treaty of Rome was signed by
France, West Germany, Italy, and the three Benelux countries. For a description of the
Community monetary coordination during the Bretton Woods monetary order and its
reactions to the breakdown of the Bretton Woods system, see René Smits, The European
Central Bank—Institutional Aspects (The Hague: Kluwer Law International, 1997) 10–14.
René Smits emphasizes the reliance on the Bretton Woods regime of the EEC Treaty
negotiators and hence the scarce references to the concept of ‘money’ in the original EEC
Treaty.
12
Now renumbered Arts 126–151 TFEU included in Title VIII on Economic and Monetary
Policy.
13
See EEC Treaty, Art 2. EEC Treaty, Art 3 (abolished) further specified the activities and
policies to be carried out by the Community in the pursuit of its overarching objectives,
including ‘the abolition, as between Member States, of obstacles to freedom of movement of
goods, persons, services and capital’ and ‘the application of procedures by which the
economic policies of Member States could be co-ordinated and disequilibria in their
balances of payments remedied’.
14
According to EEC Treaty, Art 106 (now TFEU, Art 128), Member States were under the
obligation to grant any foreign exchange or other approvals required to authorize payments
in connection with supplies of goods, services, or capital by residents of other Member
States.
15
See EEC Treaty, Arts 67–73 (now TFEU Arts 82–93). See generally Sideek Mohamed,
European Community Law on the Free Movement of Capital and the EMU (The Hague:
Kluwer Law International, 1999) ch 2.
16
EEC Treaty, Art 67. The implementation of Article 67 was to be achieved by the Council
acting on a proposal from the Commission and after consultation with the Monetary
Committee.
17
For a legal analysis of these issues, which I further discuss in Chapter 13, see Cynthia
Lichtenstein, ‘International Jurisdiction over International Capital Flows and the Role of the
IMF: Plus ça change?’ in Mario Giovanoli (ed), International Monetary Law (Oxford: Oxford
University Press, 2000) 61–80. The IMF Articles of Agreement, Art XXX(d) defines
‘payments for current transactions’. However, the distinction between current and capital
transactions is ‘conceptually and operationally awkward’ according to the late Manuel
Guitián, ‘The Unique Nature of the Responsibilities of the International Monetary Fund’,
IMF Pamphlet Series No 46 (1 December 1996) 31, at <https://www.imf.org/external/pubs/
cat/longres.aspx?sk=113.0> (last visited 25 July 2014).
18
See Case 203/80 Re Casati [1981] ECR 2595.
19
See Case 9/73 Schlüter v HZA Lörrach [1973] ECR 1135.
20
See Charles Proctor, The Euro and the Financial Markets, The Legal Impact of EMU
(Bristol: Jordans, 1999) 6–7.
21
See Council Decision 64/300/EEC of 8 May 1964 on cooperation between the Central
Banks of the Member States of the European Economic Community, OJ 77 (21 May 1964)
(as amended in 1990). The Committee of Governors subsequently assumed responsibility
for the operation of the exchange rate and intervention mechanism upon the establishment
of the European Monetary System in 1979, and on 1 July 1990 became responsible for the
co-ordination of monetary policies of Member States until dissolved at the beginning of the
second stage of the EMU, as I explain in paras 6.32–6.35 below.
22
See Robert A Mundell, ‘The European Monetary System 50 Years after Bretton Woods: A
Comparison Between Two Systems’, Paper presented at Project Europe 1985–95, the tenth
edition of the Incontri di Rocca Salimbeni meetings, Siena (25 November 1994), at <http://
www.columbia.edu/~ram15/ABrettwds.htm> (last visited 25 July 2014); Juan Luis Millán
Pereira, ‘Economic Restructuring and the European Monetary Union’ (2001) 9 University of
Miami International and Comparative Law Review 45, 52–3.
23
See Mundell, above note 22.
24
See Roger J Goebel, ‘European Economic and Monetary Union: Will the EMU Ever
Fly?’ (1998) 4 Columbia Journal of European Law 249, 249–56.
25
Goebel, above note 24.
26
Goebel, above note 24.
27
See Pereira, above note 22.
28
See Pierre Werner, ‘Report to the Council and the Commission on the Realisation by
Stages of Economic and Monetary Union in the Community’, Bulletin the European
Communities, Suppl 11/1970 (8 October 1970), at <http://aei.pitt.edu/archive/00001002/01/
monetary_werner_final.pdf> (last visited 25 July 2014).
29
Werner, above note 28, 9.
30
Werner, above note 28, 12.
31
See Smits, above note 11, 15. A Council Decision adopted also on 22 March 1971
initiated the strengthening of the cooperation between the central banks. See Council
Decision 71/142/EEC of 22 March 1971 on the strengthening of co-operation between the
central banks of the Member States of the European Economic Community, OJ L 73/14 (27
March 1973).
32
Resolution of the Council and of the Representatives of the Governments of the Member
States of 22 March 1971 on the attainment by stages of economic and monetary union in
the Community, OJ C 28/1 (18 April 1972). This is often referred to as the ‘1971 EMU
Resolution’.
33
Resolution of the Council and of the Representatives of the Governments of the Member
States of 21 March 1972 on the application of the Resolution of 22 March 1971 on the
attainment by stages of economic and monetary union in the Community, OJ C 38/3 (18
April 1972).
34
Resolution of 21 March 1972, OJ C 38/3.
35
Resolution of 21 March 1972, OJ C 38/3.
36
See generally Proctor, above note 20.
37
See Regulation (EEC) No 907/73 of the Council of 3 April 1973 establishing a European
Monetary Cooperation Fund, OJ L 89/2 (5 April 1973).
38
See Smits, above note 11, 19. Smits recalls (above note 11, 12) that Jean Monnet, one of
the founding fathers of European integration, proposed a European Reserve Fund in the
late 1950s.
39
Regulation No 907/73, Art 2.
40
See Robert A Mundell, ‘Optimum Currency Areas’, extended version of a luncheon
speech presented at a ‘Conference on Optimum Currency Areas,’ Tel Aviv University (5
December 1997), at <http://www.columbia.edu/~ram15/eOCATAviv4.html> (last visited 25
July 2014).
41
See Loukas Tsoukalis, The New European Economy Revisited (Oxford: Oxford University
Press, 1997) 38.
42
See Joseph Gold, ‘Legal Models for the International Regulation of Exchange
Rates’ (1984) 82 Michigan Law Review 1533, 1546–8.
43
All Community currencies were represented in the basket until it was frozen on 1 August
1994. This explains why the currencies of the new Member States acceding on 1 January
1995 were not represented. The basket was revised at a five-year interval; the freezing of
its composition derives from EC Treaty, Art 118, inserted by the Maastricht Treaty. I am
grateful to René Smits for observations on this point.
44
See Smits, above note 11, 21.
45
See IMF Articles of Agreement, Art IV, s 2.
46
IMF Articles of Agreement, Art IV, s 1.
47
For the press notice of 18 September 1987 with regard to this Basle–Nyborg Agreement,
see the Bundesbank Annual Report 1987, 68. The Basle–Nyborg agreement is described at
67–72. See also Smits, above note 11.
48
Communiqué of the European Community, Brussels (2 August 1993). On 25 November
1996, the lira re-entered the ERM.
49
See EC Treaty, Art 121 (now TFEU, 140).
50
central banks of the Member States outside the euro area laying down the operating
procedures for an exchange rate mechanism in stage three of Economic and Monetary
Union, OJ C 345/05 (13 November 1998). This agreement was amended on 14 September
2000 with regard to the adoption of the single currency in Greece from 1 January 2001. See
central banks of the Member States outside the euro area amending the Agreement of 1
September 1998 laying down the operating procedures for an exchange rate mechanism in
stage III of economic and monetary union, OJ C 362/10 (16 December 2000). It was further
amended with a view to the new accession States in 2004. See the Agreement of 29 April
2004 between the European Central Bank and the national central banks of the Member
States outside the euro area on 1 May 2004 amending the Agreement of 1 September 1998
laying down the operating procedures for an exchange rate mechanism in stage three of
economic and monetary union, OJ C 135 (13 May 2004) 3.
51
See EC Treaty, Arts 121(1) and 122 (now TFEU, Art 140).
52
Single European Act (signed 17 February 1986, entered into force 1 July 1987), OJ L
169/1 (29 June 1987).
53
See Commission of the European Communities, One Market, One Money: An Evaluation
of the Potential Benefits and Costs of Forming an Economic and Monetary Union, European
Economy No 44 (October 1990), at <http://ec.europa.eu/economy_finance/publications/
publication7454_en.pdf> (last visited 25 July 2014).
54
This Directive 88/361/EEC of 24 June 1988 for the implementation of Article 67 of the
Treaty, OJ L 178 (8 July 1988), adopted the principle of liberalization of capital movements
both between Member States and with third countries (erga omnes liberalization).
Transitional arrangements were introduced for Spain, Portugal, Greece, and Ireland, which
were allowed to maintain restrictions until 31 December 1992. (An extension not exceeding
three years was granted to Portugal and Greece: the latter availed itself of this possibility
up to 16 May 1994.)
55
See Peter Kenen, EMU and ESCB after Maastricht (London: Financial Markets Group of
the London School of Economics, 1992) 15.
56
Kenen, above note 55.
57
Kenen, above note 55. See generally Tommaso Padoa-Schioppa, The Road to Monetary
Union in Europe: The Emperor, the Kings and the Genies (Oxford: Oxford University Press,
2000).
58
Hanover European Council, Conclusions on Presidency, SN 2683/4/88 (28 June 1988), at
<http://www.cvce.eu/content/publication/2002/9/25/70660e36-5c11-424e-
a6f8-9e9e4d0f9fa7/publishable_en.pdf> (last visited 25 July 2014).
59
The other members of the ‘Delors Committee’ were the governors of the national central
bank, a second Commissioner, and three outside experts: Niels Thygesen, Alexandre
Lamfalussy, and Miguel Boyer.
60
Committee for the Study of Economic and Monetary Union, Report on Economic and
Monetary Union in the European Community (12 April 1989), at <http://www.cvce.eu/
content/publication/2001/11/22/725f74fb-841b-4452-a428-39e7a703f35f/
publishable_en.pdf>.
61
Committee for the Study of EMU Report, above note 60, 21–2.
62
63
64
65
See Madrid European Council, Presidency Conclusions, DN DOC/89/1 (26–27 June
1989), at <http://www.cvce.eu/content/publication/2003/3/4/1f5fb0a0-6813-4573-
ac29-838acd4001b8/publishable_en.pdf> (last visited 25 July 2014).
66
See Charles A E Goodhart, ‘The Transition to EMU’ in Mads Andenas et al (eds),
European Economic and Monetary Union: The Institutional Framework (London: Kluwer
67
See Christos Hadjiemmanuil, ‘European Monetary Union, the European System of
Central Banks and Banking Supervision: A Neglected Aspect of the Maastricht
Treaty’ (1997) Tulane Journal of International and Comparative Law 105, 106–12.
68
See EC Treaty Arts 101, 102, and 116 (now TFEU, Arts 123, 124, and 139).
69
See EC Treaty, Arts 98 and 99 (now TFEU, Arts 120 and 121). The co-ordination of the
general economic policies of the Member States is the first task of the Council according to
EC Treaty, Art 99.
70
The Danish monetary opt-out already existed since Maastricht and was merely
confirmed in the Edinburgh European Council, Conclusions of Presidency (11–12 December
1992), OJ C 348/2 (31 December 1992). See Smits, above note 11, 137–8.
71
EC Treaty, Art 56 introduced the principle of full freedom of capital movements and
payments, both between Member States and between Member States and third countries.
EC Treaty, Art 57 introduced the possibility of maintaining certain existing restrictions vis-
à-vis third countries. EC Treaty, Art 58 set out the fields in which Member States can
maintain information, prudential supervision, and taxation requirements without capital
movements being hindered. EC Treaty, Art 59 provided for the possibility of taking
safeguard measures if movements of capital to or from third countries cause serious
difficulties for the operation of economic and monetary union. EC Treaty, Art 60 allowed the
Community or a Member State to take measures on movements of capital to or from third
countries for security or foreign policy reasons.
72
See Rosa M Lastra, ‘The Independence of the European System of Central Banks’ (1992)
33(2) Harvard International Law Journal 475, 503–6.
73
The Treaty provided that the transition to the third stage of EMU was to take place in
1997 if a majority of Member States fulfilled the convergence criteria. If by the end of that
year the date for the beginning of the third stage had not been set, the third stage was to
start on 1 January 1999 with those Member States which had achieved the degree of
convergence stipulated in the Treaty.
74
The Finnish markka joined the EMS exchange rate and intervention mechanism in
October 1996 and the Italian lira returned to the ERM in November 1996.
75
Council Regulation (EC) No 1103/97 of 17 June 1997 on certain provisions relating to
the introduction of the euro, OJ L 162/1 (19 June 1997).
76
Resolution of the European Council on the Stability and Growth Pact of 17 June 1997, OJ
C 236/1 (2 August 1997); see also Council Regulation 1466/1997 of 7 July 1997
Strengthening of the Surveillance of Budgetary Positions and the Surveillance and
Coordination of Economic Policies, OJ L 209/1 (2 August 1997), and Council Regulation
1467/97 of 7 July 1997 Speeding Up and Clarifying the Implementation of Excessive Deficit
Procedure, OJ L 209/6 (2 August 1997).
77
Work on the technical details and practical arrangements for the introduction of the
euro also made decisive headway, with the Commission setting up expert working groups to
discuss the various practical issues involved, such as bank charges for conversion, dual
price displays, and others.
78
Council Regulation (EC) No 974/1998 of 3 May 1998 on the introduction of the euro, OJ
L 139/1 (11 May 1998).
79
Council Regulation (EC) No 975/1998 of 3 May 1998 on denominations and technical
specifications of euro coins intended for circulation, OJ L 139/6 (11 May 1998).
80
Council Regulation (EC) No 2866/98 of 31 December 1998 on the conversion rates
between the euro and the currencies of the Member States adopting the euro, OJ L 359/1
(21 December 1998).
81
See eg Bertold Wahlig, ‘European Monetary Law: The Transition to the Euro and the
Scope of Lex Monetae’ in Mario Giovanoli (ed), International Monetary Law. Issues for the
New Millennium (Oxford: Oxford University Press, 2000) 126.
82
EC Treaty, Article 131 (now TFEU, Art 206). See also EC Treaty, Arts 25, 26 and 135
(now TFEU, Arts 30, 31, and 33 TFEU).
83
Apart from the free movement of goods, there was to be free movement of services, free
movement of workers and self-employed persons, freedom of establishment, and—first
limited, later unrestricted—free movement of capital with, as a corollary of the first four
freedoms, freedom of payments.
84
Under EC Treaty, Art 3(1)(c) (abolished), the internal market was characterized by the
abolition, as between Member States, of obstacles to the free movement of goods, persons,
services, and capital. Under EC Treaty, Art 14(2) (now TFEU, Art 26) the internal market
shall comprise an area without internal frontiers in which the free movement of goods,
persons, services, and capital is ensured.
85
See Comité Intergouvernemental Créé par la Conférence de Messine, ‘Rapport des chefs
de délégation aux Ministres des Affaires Étrangères’, Doc MAE 120 f/56 (Brussels, 21 April
1956) (hereinafter ‘Spaak Report’), at <http://aei.pitt.edu/archive/00000996/01/
Spaak_report_french.pdf> (last visited 25 July 2014).
86
The translation is from Kamiel Mortelmans, ‘The Common Market, the Internal Market
and the Single Market, What’s in a Market?’ (1998) 35 Canadian Modern Language Review
101, 102–3.
87
See Commission of the European Communities, Completing the Internal Market, White
Paper from the Commission to the European Council, COM(85)310 (1985). This White Paper
is also known as the ‘Cockfield Report’ as Lord Cockfield was the commissioner responsible
for the internal market directorate general at the time. The measures identified in this
White Paper gave rise to the adoption of a similar number of EEC Directives.
88
EC Treaty, Art 2 (amended) clearly stated that the overarching objectives of the
Community had to be achieved ‘by establishing a common market and an economic and
monetary union’.
89
See Case 15/81 Gaston Schul Douane Expediteur BV v Inspecteur der Invoerrechten en
Accijnzen [1982] ECR 1409.
90
Case 15/81 Gaston Schul Douane Expediteur [1982] ECR 1409, para 33.
91
EC Treaty, Art 3(1)(h) (abolished) counted among the activities of the Community ‘the
approximation of the laws of Member States to the extent required for the functioning of
the common market’. See also EC Treaty, Arts 94–95 (TFEU, Arts 114 and 115).
92
It adds references to the functioning of the internal market and clarifies that the term
‘agricultural’ also refers to ‘fisheries’.
93
Whether the term ‘common market’ is broader than the term ‘internal market’ is
debatable. There were instances in the EC Treaty where the two terms appear to be used
interchangeably. For example, EC Treaty, Art 94 (now TFEU, Art 115) referred to the
approximation of laws (by unanimity) with regard to ‘the establishment or functioning of the
common market’. In the TFEU, the term ‘common market’ has been replaced by ‘internal
market’, perhaps for the sake of clarity. EC Treaty, Art 95 (now TFEU, Art 114) refers to the
approximation of laws (by qualified majority) with regard to ‘the establishment and
functioning of the internal market’. In my opinion, there is an important chronological
element in this debate. EC Treaty, Art 94 is one of the original EEC provisions according to
the text of the 1957 Treaty of Rome. EC Treaty, Art 95 was introduced by the 1986 Single
European Act. In many ways, the ‘internal market’ project was a revamping of the ‘common
market’.
94
See Goebel, above note 24, 249–56.
95
See Treaty establishing a Constitution for Europe.
96
See Chapter 7 in this volume for an in-depth analysis of the institutional framework of
monetary union.
97
For an excellent analysis of the political economy of monetary union (including an
examination of this debate between ‘Monetarists’ and ‘Economists’), see Charles A E
Goodhart, The Central Bank and the Financial System (Cambridge: MIT Press, 1995) ch 8,
156–202.
98
See Smits, above note 11, 29, who quotes a speech by Chancellor Helmut Kohl referring
to Thomas Mann when stating the policy of keeping Germany firmly anchored in the
Community structure, striving for a ‘European Germany’ and not for a ‘German Europe’.
99
See eg entry ‘optimum currency areas’ in Peter Newman, Murray Milgate, and John
Eatwell (eds), New Palgrave Dictionary of Money and Finance (London: Macmillan Press
Ltd, 1992). The properties of an optimum currency area are: price and wage flexibility,
financial market integration, factor market integration, good market integration, and
macroeconomic policy co-ordination.
100
See Robert A Mundell, ‘A Theory of Optimum Currency Areas’ (1961) 51 American
Economic Review 657.
101
See Ronald McKinnon, ‘Optimum Currency Areas’ (1963) 53 American Economic
Review 717.
102
See Peter Kenen, ‘The Theory of Optimum Currency Areas: an Eclectic View’ in Robert
Mundell and Alexander Swoboda (eds), Monetary Problems of the International Economy
(Chicago: Chicago University Press, 1969).
103
See Goodhart, above note 97, 168. The three main criteria that define an OCA are: (1)
the openness of the economies involved to trade amongst themselves, an issue emphasized
by McKinnon; (2) the susceptibility of the participating members to asymmetric shocks, an
issue emphasized by Kenen; and (3) the flexibility to adjust to such shocks, an issue
emphasized by Mundell.
104
See Ronald McKinnon, ‘Mundell, the Euro and Optimum Currency Areas’ (22 May
2000), at <http://www-siepr.stanford.edu/workp/swp00009.pdf> (last visited 25 July 2014).
105
See Mundell, above note 100, 657–63. Mundell argues that if the world can be divided
into regions within each of which there is factor mobility and between which there is factor
immobility, then each of these regions should have a separate currency which fluctuates
relative to all other currencies. Mundell’s argument is based on the concept of ‘region’
which does not necessarily coincide with sovereign nations. A region may include
geographic areas cutting across more than one sovereign nation using as pertinent
criterion the similarities in the economic characteristics. After dismissing the case for a
global currency because the world is not a region and can never be an optimum currency
area, Mundell uses the following example: two countries, Canada and the United States
each have separate currencies. Suppose, however, that this particular continent is divided
into two regions which do not correspond to national boundaries: the East (comprising east
USA and Canada) and the West (comprising the west coast of the USA and Canada). The
East produces goods like cars and the West produces goods like timber. Let us suppose that
a shift in consumer tastes leads to increased demand for timber from the West and reduced
demand and excess supply of cars from the East. This will result in inflation in the West and
unemployment in the East. Mundell argues that the central banks of the two countries may
relieve the unemployment in the eastern regions by expanding the national money supplies
in the USA and Canada. Or to prevent inflation in the West, they may decide to contract the
money supply in the two countries. Thus, unemployment can be prevented in both
countries’ eastern regions, but only at the expense of inflation in the western regions. Or
inflation can be restrained in both countries’ western regions but at the expense of
unemployment elsewhere. Or the burden of economic adjustment can be shared between
East and West, with some unemployment in the East and some inflation in the West. ‘But
both employment and inflation cannot be escaped.’ He concludes that a flexible exchange
rate system does not serve to correct the balance of payments situation between the two
regions (which is the essential problem). Flexible exchange rates shall be based on regional
currencies, not on national currencies. Mundell argues that if regions cut across national
boundaries or if countries are multiregional then the argument for flexible exchange rates
is only valid if currencies are reorganized on a regional basis.
106
107
See McKinnon, above note 104, 3.
108
McKinnon, above note 104, 4.
109
110
See McKinnon, above note 104, 4–6.
111
McKinnon, above note 104, 4–6.
112
McKinnon, above note 104, 4–6.
113
See Eduard H Hochreiter and Pierre L Siklos, ‘From Floating to Monetary Union: The
Economic Distance between Exchange Rate Regimes’, SUERF Studies (2004), at <http://
www.suerf.org/download/studies/study20045.pdf> (last visited 25 July 2014).
114
José Ortega y Gasset, The Revolt of the Masses (New York: W W Norton & Co, 1932) ch
13 (‘The Greatest Danger, the State’).
115
See Iwa Akinrinsola, ‘Monetary Integration in West Africa’ (2003) 5 Journal of
International Banking Regulation 21.
116
See Patrick Honohan and Philip Lane, ‘Will the Euro Trigger More Monetary Unions in
Africa?’ in Charles Wyplosz (ed), The Impact of EMU on Europe and the Developing
Countries (Oxford: Oxford University Press, 2001).
117
Honohan and Lane, above note 116, 324.
118
See generally Benjamin J Cohen, ‘EMU and the Developing Countries’ in Charles
Wyplosz (ed), The Impact of EMU on Europe and the Developing Countries (Oxford: Oxford
119
See Smits, above note 11, 37, quoting Günter Hirsch.
120
European Union, ‘How the EU Works’, above note 1.
Part II Developments at the EU Level, 7 The Law of
the European Central Bank
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
International financial system — Monetary system — Monetary obligations — European Central Bank
(p. 247) 7 The Law of the European Central Bank
B. The European System of Central Banks 7.03
Primary and secondary EU law 7.05
The division of responsibilities between the ECB and the NCBs 7.10
C. Objectives of the ESCB 7.24

The primacy of price stability 7.25
D. Tasks of the ESCB 7.33

Basic tasks 7.35
Monetary policy 7.36
Monetary policy responses to the crisis: from standard to non-
standard 7.39
Securities Markets Programme 7.45
Long-term refinancing operations 7.46
Outright Monetary Transactions 7.47
Foreign exchange policy 7.51

Management of official foreign reserves 7.59
Promotion of the smooth operation of payment systems 7.60
Other tasks 7.62
Issue of banknotes 7.63
Prudential supervision and stability of the financial system 7.64
Advisory functions and collection of statistical information 7.66
International cooperation and ‘external operations’ 7.67
E. The Status of the European Central Bank 7.68

Special Status of the ECB 7.72
Independence 7.74
Accountability 7.86
F. Legal Provisions Regulating the Euro 7.92

The changeover to a single currency 7.93
Issue of banknotes and coins 7.99
The legal instruments regulating the euro 7.103
Regulation 1103/97 on certain provisions relating to the
introduction of the euro 7.105
Regulation 974/1998 on the introduction of the euro 7.108
Other instruments of secondary law relating to the euro 7.120
Technical specification of euro coins 7.121
Conversion rates 7.122
Counterfeiting 7.123
Reproduction, exchange, and withdrawal of euro banknotes 7.130

The legal status of the euro in non-EU Member States 7.131
G. The Future of the Euro 7.137
At midnight tonight, the twelve national currencies of the euro area will cease to be
legal tender. …[T]he citizens of the euro area have been…the key actors in this
major step in the history of European integration. The euro area economy will
undoubtedly build on this achievement in the months and years to come.
Willem F Duisenberg, ECB President, Press Release (28 February 2002)1
A. Introduction
7.01 The institutional foundations of monetary union are the euro and the European
Central Bank (ECB). The latter, together with the National Central Banks (NCBs) of the EU
(p. 248) Member States, forms the European System of Central Banks. The NCBs of the
Member States that have adopted the euro and the ECB constitute the Eurosystem.
According to its own website, ‘[t]he ECB is the central bank for Europe’s single currency,
the euro.’2
7.02 This chapter explores first the law applicable to the European System of Central
Banks (ESCB) and the division of responsibilities between the ECB and the NCBs. Secondly,
it analyses the objectives and tasks of the ESCB, providing a detailed study of the ECB
responses to the twin banking and sovereign debt crises in the Eurozone. Then, it examines
the status of the European Central Bank, its independence and accountability. Finally, it
presents a study of the legal provisions regulating the euro.
B. The European System of Central Banks

7.03 The ESCB is the central banking system of the European Union. The ESCB has a dual
structure with the ECB at the centre, headquartered in Frankfurt, and the NCBs at the
periphery. Since not all Member States have adopted the euro as their single currency, a
distinction is made between the ‘ins’ and the ‘outs’. The NCBs of the ‘ins’ and the ECB
constitute the Eurosystem. The ‘dualities’ inherent in the functioning of the ESCB are
examined in this section.
7.04 The complex structure of the ESCB is left unchanged by the Lisbon Treaty.3 Article
282(1) of the Treaty on the Functioning of the European Union (TFEU) states:
The European Central Bank, together with the national central banks, shall
constitute the European System of Central Banks. The European Central Bank,
together with the national central banks of the Member States whose currency is
the euro, which constitute the Eurosystem, shall conduct the monetary policy of the
Union.4
Primary and secondary EU law
7.05 The primary EU law applicable to the ESCB (the ECB and the NCBs) comprises
Articles 127–144 and Articles 282–284 TFEU5 plus the Statute of the European System of
Central Banks and of the ECB (the ESCB Statute), which is annexed to the Treaty as
Protocol No 4.
(p. 249) 7.06 Article 282 TFEU enshrines into EU law the term ‘Eurosystem’ (which was
not included in the EC Treaty) to refer to the ECB and the NCBs of the Member States
whose currency is the euro.6
7.07 The secondary legislation applicable to the ESCB comprises a few legal acts of the
Economic and Financial Affairs Council (ECOFIN) specifying the scope of the prohibition of
monetary financing and the ECB’s powers in respect of sanctions7 and establishing the
scope of its advisory function in respect of draft national legislation in its fields of
competence,8 plus a range of legal acts of the ECB (ECB regulations, decisions,
recommendations, and opinions)9 and intra-ESCB legal acts on internal matters (guidelines
and instructions).10 There is also important secondary EU law11 governing the ESCB,
notably the Regulation on the Single Supervisory Mechanism of 15 October 2013 (SSM
Regulation) which confers prudential supervisory tasks to the ECB.12
7.08 The ECB must be consulted (according to Art 127(4) TFEU) on any proposed Union
act in its fields of competence and on any draft legislative provision in its fields of
competence. The ECB may submit opinions to the appropriate Union institutions or bodies
or to national authorities on matters in its fields of competence.
7.09 The secondary law regarding the euro is surveyed in the last section of this chapter.
Article 133 TFEU states: ‘Without prejudice to the powers of the European Central Bank,
the European Parliament and the Council, acting in accordance with the ordinary legislative
procedure, shall lay down the measures necessary for the use of the euro as the single
currency. Such measures shall be adopted after consultation of the European Central Bank.’
A further competence for the Council to act in respect of the use of the euro as the single
currency derives from Article 140(3) TFEU in the context of the introduction of the euro in
a Member State acceding to monetary union.
The division of responsibilities between the ECB and the NCBs
7.10 The ESCB is a complex central banking system.13 This complexity is multi-layered.
First, there is the structural complexity, which is a permanent feature of the system. The
ESCB is (p. 250) composed of the ECB and the NCBs. The ECB is a creature of Community
(now: Union) law whereas the NCBs have been established as legal entities pursuant to
their own national law. The complex duality of the ESCB is further compounded—for a
transitional period of unknown duration—by the division between the ‘ins’ (ie, Member
States whose currency is the euro) and the ‘outs’ (ie, Member States not participating in
the single currency or ‘Member States with a derogation’ according to the language of the
Treaty).14 The NCBs of the ‘ins’ and the ECB constitute the Eurosystem. TFEU deals with
Member States whose currency is the euro in Articles 136–138 and with Member States
with a derogation in Articles 139–144.
7.11 The NCBs are also characterized by a duality. On the one hand they are an integral
part of the ESCB (operational arms of the ESCB), when carrying out operations that form
part of the tasks of the ESCB.15 On the other hand, they are also national agencies when
performing non-ESCB functions. For these reasons, while the law governing the ECB is
solely EU law, the laws governing the status of the NCBs emanate not only from EU
sources, but also from their respective national legislation (though such legislation needs to
be compatible with EU law before the adoption of the euro).16
7.12 Furthermore, there are substantial differences between the range of functions and
responsibilities assigned to each NCB in the various jurisdictions that comprise the euro
zone.
7.13 In terms of the ECB’s internal organizational structure, the Eurosystem is governed
by the Governing Council and the Executive Board.17 Only the NCBs of the Member States
whose currency is the euro are represented in the Executive Board and Governing Council.
A third organ represents all NCBs: the General Council, comprising the President and the
Vice President of the ECB and the Governors of all NCBs18.
7.14 According to Article 10.2 of the ESCB Statute: ‘Each member of the Governing
Council shall have one vote.’19 This so-called ‘Tietmeyer rule’ made the ECB a genuine
European, transnational institution.20
(p. 251) TFEU provides for a change in the appointment procedure for vacant seats in the
Executive Board of the ECB. Prior to Lisbon, the members of the Board were appointed by
common agreement of the government of the Member States at the level of Heads of State
or Government (EC Treaty, Art 112(2)). According to TFEU, the European Council is now
competent and decides by a qualified majority. Individual Member States thus lose the
possibility of blocking the appointment of the President or any other member of the
Executive Board of the ECB.
7.15 The fact that the ECB’s internal organizational structure is anchored in primary law
has had important implications in the design of the Single Supervisory Mechanism, as the
Supervisory Board—with responsibility for carrying out the ECB’s supervisory tasks—is a
creature of secondary law, while the Governing Council and the Executive Board were
created by primary law. Therefore the Supervisory Board proposes ‘complete draft
decisions’ for adoption by the ECB Governing Council.21
7.16 The NCBs of those Member States that do not participate in the Economic and
Monetary Union (EMU) (‘Member States with a derogation’) either because they have opted
out (the UK and Denmark), rejected membership through a referendum (Sweden),22 or have
not qualified yet (the new Member States23 have an obligation to join once the convergence
criteria are met) still participate in the third governing body of the ESCB, the General
Council, entrusted mostly with advisory functions (TFEU, Article 141).24 NCBs with a
derogation are members of the ESCB but not of the Eurosystem.
7.17 The tasks of the General Council can be classified into co-ordinating functions
(between the monetary policies of the ‘outs’ and that of the Eurozone) and preparatory
functions (helping the ‘outs’ prepare for eventual Eurozone membership). In accordance
with Article 44(2) of the ESCB Statute the General Council comprises all governors of the
national central banks and the President and Vice-President of the ECB. Article 46 of the
ESCB Statute grants the General Council the responsibility to perform the transition tasks
that in accordance with Article 43 of the ESCB Statute the ECB took over from the
European Monetary Institute (EMI).
7.18 It is worth recalling that neither the ESCB nor the Eurosystem have legal personality,
and that, therefore, they are not carriers of rights and obligations. The entities that do have
legal personality are the ECB25 and the NCBs. Only the ECB and the NCBs, but not the
ESCB, have the powers to sue and to be sued.26
(p. 252) 7.19 A claim against an NCB is not a claim against the ECB and certainly not
against the ESCB, since the latter does not have legal personality. A claim against an NCB
is not necessarily a claim against the Member State of that NCB nor against the EU. Article
35.6 of the ESCB Statute allows the ECB to bring a suit before the Court of Justice of the
European Union (CJEU) against an NCB if the latter does not comply with its obligations
under this Statute (though, interestingly, there is no corresponding provision allowing the
NCB to sue the ECB).27
7.20 The division of responsibilities between the ECB and the NCBs within the ESCB
resembles to some extent the structure of the US Federal Reserve System (the ‘Fed’).
Indeed, while the ESCB functionally is reminiscent of the pre-1999 Bundesbank,
geographically it resembles the Federal Reserve System. It is interesting to observe that in
the congressional debates that led to the establishment of the Federal Reserve System in
1913, there was a considerable discussion as to the use of the name ‘central bank’ and that
is why the name Federal Reserve System was adopted, to reflect the federal structure of the
USA, the balance of power between the Federal Government and the States.
7.21 The Federal Reserve System does not have legal personality. The entities with legal
personality are the Board of Governors and the Federal Open Market Committee (which are
both federal agencies and, as such, public legal persons) on the one hand, and the twelve
Federal Reserve Banks on the other. However, in contrast to the NCBs, which are typically
public legal persons (publicly managed and, for the most part, publicly owned), the Federal
Reserve Banks have private legal personality, with private ownership (wholly owned by the
member banks in each district) and private management.28 Nonetheless, the analogy
between the Federal Reserve System and the ESCB is useful in understanding the duality of
functions of the NCBs.29 In some instances, the NCBs act as a part of the ESCB, and in
other instances on their own, that is, separately and independently from the ECB. In terms
of its capital structure, it should be noted that the NCBs are the ECB’s sole shareholders.30
(p. 253) 7.22 The analogy with the Fed is also useful in understanding the process of
centralization that the Fed has experienced over the years in the field of monetary policy, as
illustrated by the fact that the discount rate, originally set by each Federal Reserve Bank,
became centralized. However, centralization of one function does not imply centralization of
all functions, as the example of the Federal Reserve Banks within the Federal Reserve
System clearly manifests. The Federal Reserve Banks are organically independent from the
Board of Governors in Washington, DC and from the US Government (each has its own
Board of Directors, a distinct legal personality, and private ownership) while, functionally,
they sometimes act in conjunction with the other components of the Federal Reserve
System in the implementation of monetary policy, at other times as agents of the US
Government (eg, when they act as fiscal agent or as an agent of the Treasury and the
Federal Open Market Committee in the conduct of foreign exchange interventions), and in
further instances as a corporate entity, performing corporate functions. The complexity of
the tasks assigned to the Federal Reserve Banks is a useful reference in understanding the
tasks assigned to the NCBs within the ESCB.31
7.23 A general principle applicable to the division of responsibilities between the ECB and
the NCBs is Article 12.1 paragraph 3 of the ESCB Statute, which sets out that ‘[t]o the
extent deemed possible and without prejudice to the provisions of this Article, the ECB shall
have recourse to the national central banks to carry out operations which form part of the
tasks of the ESCB.’
C. Objectives of the ESCB

7.24 The objectives and tasks of the ESCB are laid down in the TFEU (most notably in Art
127) and in the ESCB Statute.32
(p. 254) The primacy of price stability
7.25 The objectives of the ESCB are spelt out in Article 127(1) TFEU. The primary
objective of the European Central Bank is price stability. The ECB is heir to the stability
culture of the Bundesbank and a creature of its time: economic theory and evidence in the
late 1980s and early 1990s supported the case for a price-stability-oriented independent
central bank, as discussed in Chapter 2. The primary objective—the pursuit of the internal
aspect of monetary stability—is to be pursued without prejudice to the secondary objective,
the support of the general economic policies in the Union,33 which include a ‘high level of
employment’ and ‘sustainable and non-inflationary growth’.
7.26 The wording of Article 127(1) TFEU is heavily influenced by Article 12 of the 1957
Bundesbank Law, which was the subject of academic controversy in Germany, with one
author referring to it as the ‘squaring of the circle’34 (for hundreds of years it was
attempted to find a square of the same area as a circle, until in 1882 it was proved
impossible).
7.27 Price stability is not only the primary objective of the ESCB. It is also one of the
objectives of the Union, according to Article 119(2) TFEU and to Article 119(3) which states
that stable prices shall be one of the ‘guiding principles’ of the Union. It is interesting to
observe that Article 119(2) TFEU refers to price stability as being the primary objective
both for the ‘single monetary policy’ and for ‘exchange rate policy’.
7.28 The Treaty establishes a clear hierarchy and assigns overriding importance to the
objective of price stability, reflecting the consensus that stable prices are essential to
achieve a favourable economic environment and a high level of employment. As discussed in
Chapter 2, this is in line with the Tinbergen Rule,35 which states that for each and every
policy target there must be at least one policy tool.
7.29 However, in the aftermath of the twin banking and sovereign debt crises in the
Eurozone and in the light of serious deflationary concerns,36 attention has turned to the
objectives of growth and employment and to the importance of financial stability.
7.30 Financial stability was not considered at the time the Maastricht Treaty was signed as
relevant as the ‘primary’ goal of price stability.37 Indeed, while the wording of the latter is
crystal clear—‘The primary objective of the European System of Central Banks shall be to
maintain price stability’—the language of Article 127(5) is much less forceful: ‘The ESCB
shall contribute 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.’ Of course, the law simply reflected the division of responsibilities at that time. The
‘basic’ task conferred onto the ECB was monetary policy (one goal: price stability, one
instrument: monetary policy) while prudential supervision remained decentralized at the
level of the Member States.
(p. 255) 7.31 However, there is a now consensus that the neglect of financial stability
considerations in the years leading up to the crisis was one of its causes.38 In the European
context, financial stability is today a cornerstone of banking union, as further discussed in
Chapters 10 and 11. But the ECB’s role in financial stability (recognized in TFEU, Art 127(5)
TFEU and the ESCB Statute, Art 3.3) is not an exclusive role. Other national entities and
European committees and bodies also have an interest in financial stability.
7.32 The other condition mentioned in Article 127(1) TFEU, namely to act in accordance
with the principles of an open market economy with free competition and favouring an
efficient allocation of resources, and in compliance with the principles set out in Article 119
TFEU is a generic statement of respect for market economics in the workings of the
ESCB.39 Because of this ‘generic’ nature it is difficult to hold the ECB accountable for its
performance in the pursuit of this goal.
D. Tasks of the ESCB
7.33 The functions of the ESCB are divided into ‘basic tasks’, which are defined in Article
127(2) TFEU and reproduced in Article 3.1 of the ESCB Statute, and other functions (non-
basic tasks) that are scattered throughout other provisions. Though this distinction is not
always clear in my opinion (eg, why is the issue of banknotes not included in the
enumeration of basic tasks?), it is enshrined in the Treaty and, therefore, has legal
consequences.
7.34 While the language applicable in Article 127(2) TFEU refers to the ‘basic tasks to be
carried out through the ESCB’ (the ESCB being construed as the compound of its
constituent parts, ie, both the ECB and the NCBs), the language applicable to the other
tasks typically mentions the ECB and the NCBs separately (with the one significant
exception of Art 127(5) TFEU, which refers to the ESCB).
Basic tasks
7.35 There are four basic tasks ‘to be carried out through the ESCB’: (1) to define and
implement the monetary policy of the Community; (2) to conduct foreign exchange
operations consistent with the provisions of Article 219 TFEU; (3) to hold and manage the
official foreign reserves of the Member States; and (4) to promote the smooth operation of
payment systems.40
Monetary policy
7.36 The formulation and implementation of monetary policy is the first and most
important basic function to be ‘carried out through’ the ESCB. Responsibility for monetary
policy has been clearly transferred from the national arena to the supranational arena. In
this sense, it is both accurate and entirely appropriate to talk about a ‘single monetary
policy’ (for the Member States whose currency is the euro). Indeed, while the single market
is still yet to be completed, the idea of a single currency has been fully achieved through the
introduction of the euro on 1 January 1999. The transfer of monetary policy powers from
the national to (p. 256) the supranational arena signifies the surrender of one of the classic
attributes of sovereignty of the nation State.
7.37 Though the Maastricht Treaty and the ESCB Statute referred to the ‘monetary policy
of the Community’ in certain Articles (EC Treaty, Art 105(2) and the ESCB Statute, Arts
3(1), 12(1), and 31(2)), in such instances ‘the Community’ encompassed the Member States
that had adopted the single currency. This view has now been clarified by the TFEU, which
refers to the ‘monetary policy for the Member States whose currency is the euro’ in Article
3(1)(c) (an article which enumerates the areas of exclusive competence of the Union) and to
‘monetary policy of the Union’ in Article 127(2) TFEU (which enumerates the ESCB’s basic
tasks) and in Article 282. Article 282 states: ‘The European Central Bank, together with the
national central banks, shall constitute the European System of Central Banks (ESCB). The
European Central Bank, together with the national central banks of the Member States
whose currency is the euro, which constitute the Eurosystem, shall conduct the monetary
policy of the Union.’
7.38 Though monetary policy in the Eurosystem is ‘one and indivisible’, there still remains
an operational distinction between the ECB and the NCBs in the sense that while the
decision-making stage of monetary policy is fully centralized at the ECB, the
implementation stage is decentralized.41 It is the responsibility of the twelve NCBs to
conduct the monetary policy operations according to instructions set out by the Executive
Board. Article 14.3 clearly states that ‘[t]he national central banks are an integral part of
the ESCB and shall act in accordance with the guidelines and instructions of the ECB’.42
Accordingly, in the implementation of their ESCB tasks, that is, monetary policy and other
responsibilities resulting from the TFEU and the ESCB Statute, the NCBs act in their
capacity as a constituent part of the ESCB, and not as national agencies.
Monetary policy responses to the crisis: from standard to non-standard
7.39 As discussed in Chapter 2, conventional or standard instruments of a market-oriented
monetary policy are open market operations, discount policies (credit operations) and
reserve requirements.43 Non-standard or unconventional instruments include credit
support, (p. 257) credit easing, interventions in foreign exchange and securities markets,
provision of liquidity in foreign currency, forward guidance, and quantitative easing. The
crisis has changed the traditional understanding of the tools available to the monetary
authorities, with a resort to unconventional measures in an effort to revive moribund
markets and/or troubled economies.
7.40 The ECB has used both conventional and unconventional instruments of monetary
policy in response to the crisis. The ECB has faced a daunting challenge. To begin, the crisis
in Europe was not merely a financial crisis; it mutated into a sovereign debt crisis following
the problems in Greece in 2010. Secondly, though the ECB has ‘real power’, its room for
manoeuvre has been constrained by the Treaty provisions (in particular the no bail-out
clause and the prohibition to monetize public debt) and by the fact that fiscal policy remains
decentralized (albeit subject to increased co-ordination and conditionality). These
difficulties notwithstanding, the ECB has been creative in its responses to the crisis through
the adoption of programmes to restore the normal transmission of monetary policy. Though
the ECB has aimed to act within its Treaty mandate, there is no question that such mandate
has been stretched to the limit, with some questioning the legality of some of the ECB
responses.
7.41 In addition to reductions in interest rates (standard measures),44 the ECB has
provided ample market liquidity since the crisis commenced in 2007.45 The first measures
to combat the crisis—credit easing, swap arrangements with the Federal Reserve Bank of
New York46 and the relaxation of collateral requirements in its lending operations47—were
meant to be transitory and exceptional to address the paralysis in the interbank market.48
However, with the intensification of the financial crisis in September 2008 following the
collapse (p. 258) of Lehman Brothers, the ECB introduced a number of non-standard or
unconventional monetary policy measures that were unprecedented in nature, scope and
magnitude with the aim to safeguard the primary objective of price stability and ensure an
appropriate monetary policy transmission mechanism, such as enhanced credit support
(2008),49 the Covered Bonds Purchase Programme (2009),50 the Securities Markets
Programme (2010),51 the long-term refinancing operations or LTRO (2011) and the
expansion of the list of assets eligible for Eurosystem liquidity-provision operations.52 The
list of non-standard measures kept on expanding. The announcement of the yet-to-be-
activated Outright Monetary Transactions (OMT) in August 2012 has been the subject of
much controversy. The ECB has also resorted to ‘forward guidance’ (2013).53
7.42 On 5 June 2014, the ECB entered again into unchartered territory with the
announcement of negative interest rates, cutting the deposit rate from zero to minus 0.1
per cent, charging banks for the use of its overnight deposit facility.54 This ‘historic rate
cut’ (neither the Federal Reserve System, the Bank of Japan or the Bank of England have
attempted this so far) was accompanied by other measures to combat disinflation and
sluggish growth: a cut of its main refinancing rate from 0.25 per cent to 0.15 per cent,55
EUR 400 billion of cheap loans for Eurozone banks (targeted longer-term refinancing
operations, TLTROs) in order to boost lending to small businesses in the Eurozone Member
States, (p. 259) and a further exercise in forward guidance, announcing that the official
interest rates will remain lower for longer.56
7.43 On 5 June 2014 the ECB Governing Council also announced that it ‘had decided to
intensify preparatory work related to outright purchases’ of asset backed securities.57 This
would be a limited form of bond buying in accordance with Treaty rules (ie, it would not
contravene the monetary financing prohibition of Article 123 TFEU58).
On 4 September 2014, following an extended period of low inflation and stagnant growth,
the ECB Governing Council announced further interest rate cuts59 and a programme of
purchases of private-sector assets intended to help ease credit conditions in the Eurozone.
The Eurosystem will purchase a broad portfolio of simple and transparent asset-
backed securities (ABSs) with underlying assets consisting of claims against the
euro area non-financial private sector under an ABS purchase programme (ABSPP).
This reflects the role of the ABS market in facilitating new credit flows to the
economy and follows the intensification of preparatory work on this matter, as
decided by the Governing Council in June. In parallel, the Eurosystem will also
purchase a broad portfolio of euro-denominated covered bonds issued by MFIs
domiciled in the euro area under a new covered bond purchase programme
(CBPP3). Interventions under these programmes will start in October 2014. The
detailed modalities of these programmes will be announced after the Governing
Council meeting of 2 October 2014. The newly decided measures, together with the
targeted longer-term refinancing operations which will be conducted in two weeks,
will have a sizeable impact on our balance sheet.60
(p. 260) In response to the question of whether this programme amounted to QE, President
Draghi stated that their proposal ‘strikes the middle of the road’.61 No doubt this is a non-
conventional monetary policy measure (credit easing) that further stretches the ECB
mandate, and that leads to the expansion of the ECB’s balance sheet.
Concerns about a possible Japanese-style deflation spiral in the Eurozone have been behind
the monetary policy decisions of the ECB in June and September 2014.
7.44 In the ensuing paragraphs I discuss in further detail the Securities Markets
Programme (SMP), the long-term refinancing operations (LTRO), and the Outright
Monetary Transactions (OMT).
7.45 The SMP was put in place in May 2010 to address ‘the severe tensions in certain
market segments’.62 The objective of this temporary programme allowing the Eurosystem to
intervene into private and public debt securities markets was to address the malfunctioning
of securities markets and to restore an appropriate monetary policy transmission
mechanism.63 Under this programme, the ECB was able to buy large quantities of
government bonds of the distressed countries on the secondary market,64 with the notional
amount over 200 billion euros.65 Eser and Schwaab concluded in their paper that
government bond purchases under the SMP were effective in affecting yields despite the
severity of the sovereign debt crisis and the controversy which surrounded it.66 The
Securities Markets Programme was terminated on 6 September 2012, with the
announcement of the OMT decision.
(p. 261) Long-term refinancing operations
7.46 In December 2011, at a time when the problems had become significant in a number
of euro area Member States, the ECB announced additional enhanced credit support
measures to support bank lending and liquidity in the euro area money market.67 The ECB
Governing Council decided to conduct two LTROs at the rate of one per cent with a maturity
of 36 months and the option of early repayment after one year, and to increase collateral
availability by (i) reducing the rating threshold for certain asset-backed securities (ABS)
and (ii) allowing NCBs, as a temporary solution, to accept as collateral additional
performing credit claims (ie, bank loans) that satisfy specific eligibility criteria.68 The
allotment under the LTRO in December 2011 amounted to 489 billion euros in liquidity to
the banking sector and—in February 2012, an amount of 529 billion euros.69 These
operations met with great success among credit institutions, especially in peripheral
countries. The volume of deposits with the ECB increased. The increase of the liquidity
allowed financial institutions to buy sovereign bonds, which resulted in a significant drop in
their interest rate. As explained by Lastra and Louis, though this provision of liquidity to
financial institutions was useful in a period of paralysis of the interbank financing, the
contribution to lending to the economy was very limited.70 According to some
commentators, these actions further reinforced the vicious link between banks and
sovereigns.71
Outright Monetary Transactions
7.47 Following the ECB’s president, Mario Draghi’s, pledge ‘to do whatever it takes to
preserve the euro’ within the ECB mandate,72 in August 2012, the ECB Governing Council
announced its new bond purchasing programme—‘Outright Monetary Transactions’ which
was to replace the SMP. On 6 September 2012 the Governing Council of the ECB decided on
the technical features of the Eurosystem’s outright transactions in secondary sovereign
bond markets (OMT) and published a press release.73 This is the only legal document
available on the OMT so far.
(p. 262) 7.48 The OMT programme, based on Article 18.1 of the ESCB Statute,74 aims to
safeguard the monetary policy transmission mechanism in all countries of the euro area, to
preserve the singleness of the ECB’s monetary policy and to address severe distortions in
government bond markets which originate from the investors’ concerns about the
reversibility of the euro. The ECB felt that, if not addressed, these conditions would have
severe consequences for the maintenance of price stability. According to the ECB President,
the Governing Council decided to establish OMT by ‘almost unanimous decision’.75
(p. 263) 7.49 The launch of the OMTs will be subject to strict conditionality attached to an
appropriate EFSF/ESM programme with the involvement of the IMF. The Governing Council
will decide following a thorough assessment that implies a strict selection of the Member
States for the programme, ‘on the start, continuation and suspension of OMT in full
discretion and acting in accordance with its monetary policy mandate’. The specific details
remain to be seen once (and if at all) the programme is activated. However, the ECB has
pointed out that it will focus on the purchases of government bonds with one to three year
maturities, thereby underlining the close link to traditional monetary policy.76 Transparency
is an important element with regard to OMT as the ECB intends to publish aggregate data
on a weekly basis and country-specific breakdown on a monthly basis. There are no ex-ante
quantitative limits on the amount of OMT. The ECB intends to accept pari passu treatment
with other bondholders, unlike in the case of Greek government bonds purchased under the
SMP when the ECB refused to accept any losses as part of Greek debt exchange in
February 2012.77
7.50 The legality of OMT was challenged in the German Constitutional Court (GCC). The
GCC has referred the case to CJEU for preliminary ruling.78 It must be noticed that the
assessment of the compatibility of the ECB’s actions with the EU law is the exclusive
competence of the CJEU, though the GCC can only decide on whether the OMT is in line
with German constitution (Basic law). This is based on the ultra vires doctrine established
by the GCC in the Maastricht decision in 1993, according to which it is within the GCC
competence to examine whether ‘acts at the European level conform to the boundaries set
for the transfer of public powers to the EU’.79 The referral of the OMT case to the CJEU is
notable per se as it is the first time when the GCC refers a question about the interpretation
of the Treaty to the CJEU.80 In its request for a preliminary ruling the GCC has raised a
number of difficult questions about the compatibility of the ECB OMT programme with the
(p. 264) Treaty: (a) whether the ECB has exceeded its mandate by announcing the OMT; (b)
whether the OMT is incompatible with the prohibition of monetary financing;81 (c) whether
the Treaty allows Eurosystem central banks to make unlimited bond purchases under the
terms outlined in the OMT announcement. However, the way the questions to the CJEU are
structured also sheds light on the GCC’s own assessment of the OMT and raises the issue of
whether the GCC has raised real questions or whether it is merely seeking the CJEU’s
approval of its own interpretation.82 It is worth noticing that two GCC judges out of eight
dissented from the OMT decision.83
Foreign exchange policy
7.51 The second basic task of the ESCB according to Article 127(2) TFEU is ‘to conduct
foreign-exchange operations consistent with the provisions of Article 219’ TFEU. The
conduct of foreign exchange policy involves the determination of the exchange rate and the
exchange regime and the management of the official foreign reserves (both gold reserves
and foreign currency reserves). While the ECB has sole responsibility for monetary policy in
the euro area, the responsibility for exchange rate policy is divided between the Council
(primary role) and the ECB under a notoriously unclear set of Treaty provisions.84
7.52 TFEU does not alter the complex ‘institutional structure’ with regard to the conduct
of foreign exchange policy in the EU. The ‘actors’ in this field remain the same, as I further
explain in Chapter 9. TFEU introduces a new Article 138 with regard to ‘the euro’s place in
the international monetary system’. Paragraph 2 of this new Article specifically refers to the
need to ‘ensure unified representation within the international financial institutions and
conferences’.
7.53 Article 137 TFEU anchors the Euro Group in primary law giving it a degree of
‘institutional independence’ and formalizing a practice that has existed since 2005. There is
no doubt about the need for co-ordination between Eurozone countries, particularly in the
context of the global financial crisis. The French have called for the establishment of a
proper economic government as counterpart85 to the ECB.
7.54 The protocol86 on the Euro Group states in its Article 1 that the Euro Group is
composed of the Finance Ministers of the Member States whose currency is the euro
(ECOFIN Council). (p. 265) They meet informally and do not make binding decisions. It is
the ECOFIN Council (comprising Euro Group Member States and non-Euro Group Member
States) which makes the decision. The members of the Euro Group elect a president for a
two-and-a-half-year term (Art 2 of the Protocol).
7.55 Articles 138 and 219 TFEU (ex Art 111 EC Treaty) are cumbersome provisions in
legal and economic terms, the result of a calculated obfuscation for political purposes. As
René Smits, quoting the German commentator Stadler, emphasizes, ‘[t]he compromise
finally arrived at in the monstrous arrangements laid down in Article 111 EC Treaty, with
their attributions of competence and the participation in procedures in the area of external
monetary policy, unmistakably expresses the labour pains which accompanied the creation
of the provision.’87
7.56 Article 119 TFEU states that price stability is the primary objective both for ‘a single
monetary policy’ and for ‘exchange rate policy’.
7.57 The room for manoeuvre in the field of exchange rate policy—traditionally the domain
of the Treasury or Minister of Finance—varies from country to country, with most central
banks with freedom only to implement the foreign exchange policy formulated by the
government. Article 219 TFEU does allow a degree of ‘political meddling’ because of the
intergovernmental nature of the Council. Before the advent of EMU, governments or
Ministers of Finance in the Member States (with the exception of Sweden) had the last
word on exchange rate matters. Therefore, the agreement reached in Article 219 TFEU
reflected the status quo, that is, political responsibility for the external aspects of exchange
rate policy.
7.58 As acknowledged, the exchange rate has a dual dimension. On the one hand, it is the
external anchor of monetary stability (and in this respect the ECB has a vested interest in
safeguarding it) and—on the other hand—it is an instrument of the general economy policy
of a country, closely linked to its trade and employment objectives. For this reason,
independent central bankers committed to price-stability oriented monetary policy, but
deprived of parallel powers in the field of exchange rate policy, are likely to clash with
politicians who have other objectives to pursue besides price stability.
Management of official foreign reserves
7.59 The management and holding of the official foreign reserves of the Member States88
is one of the basic tasks to be ‘carried out’ through the ESCB according to Article 127(2)
TFEU. However, only part of the reserves have been transferred to the ECB (according to
Art 30 of the ESCB Statute), while part of the reserves are held by the NCBs (according to
Art 31 of the ESCB Statute). Further complexity is added by the fact that Member States
must comply with their international obligations and hold reserves with such organizations.
In particular, EU Member States are members of the International Monetary Fund, and, as
part of their membership responsibilities, they hold reserve positions with the IMF. Article
(p. 266) 30.5 of the ESCB Statute states that ‘[t]he ECB may hold and manage IMF reserve
positions and SDRs and provide for the pooling of such assets’.89
Promotion of the smooth operation of payment systems
7.60 According to Article 127(2) TFEU (Art 105 EC), the ESCB is entrusted with the
‘smooth operation of payment systems’.90 However, Article 22 of the ESCB Statute refers to
the constituent parts of the ESCB, that is, to both the ECB and the NCBs, when it states
that ‘[t]he ECB and national central banks may provide facilities, and the ECB may make
regulations, to ensure efficient and sound clearing and payment systems within the Union
and with other countries.’
7.61 The ECB and the NCBs are both competent to offer facilities for Union-wide payment
systems (typically through the Trans-European Automated Real-time Gross-settlement
Express Transfer system, TARGET2),91 but only the ECB—not the NCBs—is given
regulatory powers in this area.
Other tasks
7.62 There are four other ‘non-basic’ tasks (ie, not included under the umbrella of ‘basic
tasks’): (1) issue of banknotes, (2) prudential supervision and stability of the financial
system, (3) advisory functions and collection of statistical information, and (4) international
cooperation and ‘external operations’.
Issue of banknotes
7.63 According to Article 128(1) TFEU (formerly Art 106 EC Treaty), ‘the ECB shall have
the exclusive right to authorize the issue of euro banknotes within the Union’.92 The ECB
and the NCBs may issue such notes. The banknotes issued by the ECB and the national
central banks shall be the only such notes to have the status of legal tender in the Union.
Article 128 (2) TFEU further adds that ‘Member States may issue euro coins subject to
approval by the European Central Bank of the volume of the issue.’ Article 16 of the ESCB
Statute is the relevant provision in the ESCB Statute with regard to the issue of banknotes.
(This is further discussed in Section 7.E below when talking about the law of the euro.)
(p. 267) Prudential supervision and stability of the financial system
7.64 The Draft Statute of the ESCB—released by the Committee of Governors of the EC
Central Banks in November 1990—included prudential supervision amongst the basic tasks
of the ESCB. However, the opposition of some countries (notably Germany) to such an
inclusion means that the final version of the ESCB Statute and of the Treaty only referred to
supervision in a limited way, as a non-basic task, according to the language of Article 127
TFEU (Article 105 EC according to the Maastricht Treaty) and Article 25 of the ESCB
Statute. However, Article 127(6) TFEU (formerly Article 105.6 EC Treaty) left the door open
for a possible expansion of supervisory responsibilities following a simplified procedure.93 I
further discuss the new ECB’s responsibilities in banking supervision as part of a Single
Supervisory Mechanism following the entry into force of the SSM Regulation in Chapter 10.
(The conduct of macro prudential supervision—and the responsibilities of the ECB and
ESRB in this regard—are also further discussed in Chapters 10 and 11.)
7.65 Regrettably TFEU did not attempt to introduce substantial changes to this provision,
even though it is an anachronism to refer—as Article 127(6) TFEU does—to ‘prudential
supervision of credit institutions and other financial institutions with the exception of
insurance undertakings’. Financial developments combined with a global financial crisis
have rendered this exception meaningless, since nowadays financial conglomerates
encompass banking, securities, and insurance undertakings.
Advisory functions and collection of statistical information
7.66 According to Article 127 (4) TFEU, other Union institutions, bodies, and Member
State authorities are to consult with the ECB regarding any Union act or draft national
legislative provision within its field of competence. In addition, the ECB may ex officio
submit opinions to EU or national authorities on matters within its field of competence (Arts
4 and 34 ESCB Statute). Article 5 of the ESCB Statute refers to the collection of statistical
information by both the ECB and the NCBs. The additional ECB responsibilities with regard
to collection and sharing of statistical information resulting from the establishment of the
European System of Financial Supervision and the Single Supervisory Mechanism are
discussed in Chapters 10 and 11.
International cooperation and ‘external operations’
7.67 International cooperation is recognized by TFEU in Article 219 and in Article 138.
Articles 6 and 23 of the ESCB Statute are also relevant. A number of problems arise over
the tasks entrusted to the ESCB in this field and over the external representation of the EU
in EMU matters. These problems, resulting in a multiplicity of competent economic
authorities in various international forums and in friction points with regard to international
obligations, are further examined in Chapter 9.
(p. 268) E. The Status of the European Central Bank

7.68 The structural and functional duality of the ESCB, its organizational complexity and
the novelty of a truly ‘independent institution’ within the EU institutional structure
triggered a heated legal debate with regard to the constitutional position of the European
Central Bank.94
7.69 The OLAF case clarified the legal position of the European Central Bank. ‘[T]he ECB,
pursuant to the EC Treaty, falls squarely within the Community framework.’95 The proposed
EU Constitution considered that the European Central Bank was a ‘special’ institution in
charge of a major area of exclusive competence (Art I-30, para 3) endowed with legal
personality, but not included within the EU’s main core ‘institutional framework’, which
according to Art I-19 comprised the European Parliament, the European Council, the
Council of Ministers, the European Commission, and the Court of Justice.
7.70 The Lisbon Treaty goes further than the Proposed Constitution and assigns the ECB
the unrestricted status of an EU institution (Art 282 TFEU). Thus, since December 2009,
the ECB is one of the seven regular institutions of the Union: European Parliament,
European Council, Council of the EU, European Commission, Court of Justice of the EU, the
European Central Bank and European Court of Auditors. This status has only been assigned
to the ECB, not the ESCB.
7.71 The ESCB is the central banking system of the European Union (in the same way as
the Federal Reserve System is the central banking system of the USA) and the European
Central Bank is the institution at the heart of the ESCB in charge of the formulation of the
monetary policy of the Union. The legal personality of the ECB as a central bank is
‘derivative’.96
Special Status of the ECB
7.72 Despite the equalization of the ECB with other institutions, its status remains special
as the ECB is the only EU institution endowed with separate legal personality. This will no
doubt trigger jurisprudence to clarify such specialty.
The equalization of the ECB with other institutions seems to be the result of a cumbersome
process. Article 282 TFEU appears to be a kind of ‘puzzle’ constructed upon the existing (p.
269) provisions on monetary policy and adding little new to the chapter dedicated to
monetary policy (Arts 127–133 TFEU).
7.73 There have been some concerns in the literature regarding the ‘new institutional
position’ of the ECB. The second sentence of Article 13(2) TEU calls for mutual sincere
cooperation among all institutions. Furthermore, ‘Article 3(3) TEU requires the Union to
work for the sustainable development of Europe based on balanced economic growth and
price stability, a highly competitive market economy, aiming at full employment and social
progress; and a high level of protection and improvement of the quality of the environment’.
If the ECB was ‘forced’ to cooperate towards the Union’s aim—where price stability coexists
with other goals—the ECB’s strict mandate would likely lead to a legal debate. Article
127(1) clearly states that the ESCB and the ECB may support the general economic policies
in the Union in accordance with objectives of Article 3 TEU as long as this is ‘[w]ithout
prejudice to the objective of price stability’.
Independence
7.74 The independence from governmental direction of the ECB and the independence of
the National Central Banks constitute a key feature of the ESCB. Heir to the stability
culture of the Bundesbank and a child of the economic theories of its time, the ECB is a
highly independent institution. On the one hand, it is independent from the other
institutions and bodies of the EU and, on the other hand, it is independent from the national
authorities. This ‘dual independence’ is another expression of the duality that characterizes
the ESCB.97
7.75 The independence of the NCBs is a criterion of ‘legal convergence’ for any
prospective member of the euro area. As specified in Art 131 TFEU and the ESCB Statute
(Art 14(1)), any country wishing to join the euro area needs to ensure that its national
legislation including the statutes of its national central bank is compatible with the EC
Treaty and the ESCB Statute.
7.76 The independence of the ECB is enshrined in Art 130 TFEU. Article 130 TFEU
protects the independence of the ECB in very strong terms: ‘When exercising the powers
and carrying out the tasks conferred upon them by the Treaties and the Statute of the ECB
and the ESCB, neither the ECB, nor a national central bank nor any member of their
decision making bodies, shall seek or take instruction from Union institutions, bodies,
offices or agencies from any government of a Member State or from any other body.’
7.77 The ECB and the NCBs are independent in the exercise of their powers and in the
carrying out of their tasks and duties. Article 130 prohibits the ECB, the NCBs, and the
members of their decision-making bodies from seeking or taking any instruction from the
Union institutions or bodies, from any government of a Member State, or from any other
body, and also prohibits those Union institutions or bodies and the national governments
from (p. 270) seeking to influence the members of the decision-making bodies of the ECB
and the NCBs in the performance of their tasks.
7.78 The Court of Justice of the European Union has clarified the extent of the
independence of the ECB in the OLAF case.98 The Court further stated that ‘Article 108 EC
[now Art 130 TFEU] seeks, in essence, to shield the ECB from all political pressure in order
to enable it effectively to pursue the objectives attributed to its tasks, through the
independent exercise of the specific powers conferred on it for that purpose by the EC
Treaty and the ESCB statute.’99
7.79 It should also be remembered that although the Court ruled against the ECB on the
facts of this immediate dispute, the Court stated that ‘it is appropriate to state at the outset
that the draftsmen of the EC Treaty clearly intended to ensure that the ECB should be in a
position to carry out independently the tasks conferred upon it by the Treaty.’100 Moreover,
the economic and financial literature cited by Advocate General Jacobs observes that ‘[t]he
foremost argument put forward in favour of an independent monetary authority is that of
price stability’ because ‘governments are tempted to create money for their own ends and
in order to produce economic benefits in the short term, which eventually leads to an
increase in the rate of inflation’.101 Focusing on the point made earlier about the pursuit of
general economic policies being the ESCB’s objective, the Court seconded the Advocate
General.102
7.80 The Court is clearly in favour of a limited notion of independence, limited by the
functions, by the tasks and powers specifically conferred upon the ECB. The Court upheld a
concept of ‘independence within the Community structure’ (not independence from the
Community) that is reminiscent of the notion of ‘independence within government’.103 The
‘recognition that the ECB has such independence does not have the consequence of
separating it entirely from the European Community and exempting it from every rule of
Community law’.104
7.81 Article 282 TFEU states that the ECB ‘shall be independent in the exercise of its
powers and in the management of its finances. Union institutions, bodies, offices and
agencies and the governments of the Member States shall respect that independence’. It is
interesting to observe that the Lisbon Treaty introduces the notion of financial autonomy
(independent in the management of its finances) in this provision. Accordingly, the ECB is
independent both in the exercise of its powers and in the management of its finances.105
7.82 The ECB is independent ‘organically’, ‘functionally’, and ‘financially’.106 The ‘organic
independence’ is evidenced by a number of safeguards or guarantees such as the
appointment (p. 271) and removal procedures of the members of its governing bodies (eg,
Arts 11.2 and 11.4 of the ESCB Statute with regard to the Executive Board and Art 10
ESCB Statute with regard to the Governing Council).107
7.83 The ‘functional’ independence is enshrined in Article 130 TFEU (as recognized by the
Court of Justice in the OLAF case) and is also safeguarded by other provisions, such as
those dealing with the prohibition to finance public sector deficits via central bank credit
(eg, Art 21.1 ESCB Statute) or those dealing with the regulatory powers of the ECB. The
ECB regulatory role is rather extensive (though supervision can be separated from the
central bank, an independent central bank always keeps a regulatory role; this regulatory
role will be further strengthened with the assumption of supervisory responsibilities in
November 2014, as discussed in Chapter 10). The ‘financial autonomy’ is recognized in
Chapter 6 of the ESCB Statute (‘Financial Provisions of the ESCB’) and in Article 282(3)
TFEU.108
7.84 The new supervisory tasks of the ECB may lead to a rethink of the notion of
independence under EU law. While the degree of independence conferred onto the ECB by
Article 130 TFEU has served the institution well in the discharge of its monetary policy
responsibilities (with relatively limited mechanisms of accountability, including testimonies
before the European Parliament, publications, financial controls, interviews, and press
conferences), when it comes to supervision, the situation should be different and, in the
absence of a fiscal union, ‘supervisory independence’ should be construed in less strict
terms than the independence of the ECB in the conduct of monetary policy.
7.85 Article 19 of the SSM regulation and Recital 75 of its Preamble proclaim the
independence of the ECB in the exercise of prudential supervision.
Accountability
7.86 Since 1992, I have advocated the need for ‘accountable independence’.109 As
explained in Chapter 2 in this volume,110 an independent central bank is a particular kind of
institution that is independent in some respects, but highly constrained in others,
constrained (p. 272) by the goal, by the statutory objective, and by the demands of
democratic legitimacy and accountability.
7.87 Though a consensus has been reached on the definition and adequate quantum of
monetary independence, a debate is still going on regarding the definition and the adequate
quantum of accountability. The ECB has often been criticized for its alleged lack of
accountability and transparency. But what do we mean by accountability and transparency?
There are several paradigms and forms of accountability.111 And depending on which
paradigm one judges the institution (the ECB), one reaches different results. Amtenbrink112
argues that the existing democratic deficit of the European Central Bank is an expression of
the democratic deficit of the European Union at large, rather than a particular deficiency of
the institution. Zilioli113 argues that the ECB is accountable if we use a new ‘economic
paradigm of accountability’ rather than the traditional ‘formalistic’ notion of accountability
based on the theory of the division of powers and the existing system of checks and
balances.114 The economic notion of accountability (performance accountability)115 is based
on the assessment of the results achieved in relation to the specified statutory objective,
namely price stability. I would further suggest that the new paradigm is also based on
participation (consultation) and transparency (disclosure).116
7.88 The ECB is independent within the limits of the powers expressly conferred upon it by
the Treaty and the ESCB Statute. The ‘controls’ to which the ECB is subject constitute
another limit. The European Court of Justice in the OLAF case specifically mentioned the
review by the Court of Justice and the control by the Court of Auditors.117 These are, in fact,
important mechanisms of accountability.
7.89 Zilioli argues that the ECB is highly transparent.118 Even though it does not publish
the minutes of the deliberations of the meeting of the ECB Executive Council, the ECB
publicly announces a quantitative definition of price stability (despite the fact that the
Treaty does not set an obligation in this regard). Zilioli also explains that the ECB has
developed both an inter-institutional dialogue and a dialogue with financial markets,119 thus
facilitating the disclosure of information with regard to its activities and modus operandi.
(p. 273) 7.90 My own view of the accountability of the ECB reconciles some of the
arguments made by Amtenbrink with some of the arguments made by Zilioli. When it was
created, the ECB was influenced by the Bundesbank model of stability and independence.
The Bundesbank Law contained scarce provisions regarding the accountability of the
central bank, relying instead on the support of public opinion and the statutory objective to
legitimize its existence in a democratic society. This contributes to explain, in my opinion,
why accountability only played a ‘subsidiary role’ in the negotiations that led to the
establishment of the ECB (a point emphasized by Amtenbrink).120 But accountability can
only be judged through the life of the institution. Accountability cannot be guaranteed by
the fact that the initial stage of its creation is legitimate democratically. It is in its
continuing operations and policies that the institution must be subject to appropriate
mechanisms of accountability. And if the ECB gives ‘proper account’, explains and justifies
the actions or decisions taken (or omitted) in the exercise of its responsibilities, is subject to
judicial review and to audit control, and responds to Parliament through reports and
testimonies, then it can be judged to be sufficiently accountable.
7.91 As explained in Chapter 10 the accountability of the ECB in the exercise of
supervisory responsibilities under the SSM Regulation is a fundamental issue in its
institutional design.121 Concerns about accountability—the provisions in the SSM
Regulation dealing with accountability are Articles 20 and 21—should be continuously
voiced.
F. Legal Provisions Regulating the Euro

7.92 The euro is the currency that unifies Europe (even though it is not the currency of all
EU Member States). From the point of view of monetary law, the introduction of the euro
was a major historical development. Its symbolic value as a unifying force in the project of
European integration cannot be underestimated. Article I-8 of the Constitutional Treaty
proposed to include the euro (as ‘the currency of the Union’) amongst the ‘symbols of the
Union’. Although this article was abandoned in the TFEU, the euro currency has been
implemented into primary law. Article 3(1) TEU already mentions the establishment of ‘an
economic and monetary union whose currency is the euro’ as one of the aims of the Union.
Furthermore, Article 3(1)(c) TEU enumerates the ‘monetary policy for the Member States
whose currency is the euro’ as part of the exclusive competences of the Union. In addition,
TFEU states that the Union can ‘lay down the measures necessary for the use of the euro as
the single currency’.
The changeover to a single currency
7.93 As explained in Chapter 6, the birth of the single European currency was scheduled to
take place at the starting date of the third stage of EMU. The first concrete step towards
the introduction of the single currency was taken by the Commission in a green paper, ‘One
(p. 274) Currency for Europe’, on the practical arrangements for the introduction of the
single currency.122
7.94 At its meeting in Cannes in June 1995, the European Council requested the ECOFIN
Council to define, in consultation with the Commission and the EMI, a reference scenario
for the changeover to the single currency and to report back to the European Council at its
meeting in December 1995 in Madrid with a view to its adoption. The Presidency
Conclusions following the European Council held at Madrid in December 1995 included a
detailed framework for the changeover to the euro under the title ‘The Scenario for the
Changeover to the Single Currency’ as Annex 1 to those Presidency Conclusions.123
7.95 The financial markets wanted legislative certainty on key issues—such as the
continuity of contracts or the treatment of ecu-denominated obligations—at an early stage.
It was decided in Madrid that a Council regulation entering into force on 1 January 1999
would provide the legal framework for the use of the euro. As Proctor contends, this was
intended ‘to reassure financial markets that a complete legal framework would be put in
place well in advance of the birth of the single currency’.124
7.96 The naming of the single currency as ‘euro’ instead of ‘ecu’ (the name given to the
single currency in the Treaty) was also agreed at the Madrid summit.125 It was decided then
that no Treaty amendment was necessary to change the name, since ecu should be
regarded as a ‘generic term’ standing for European Currency Unit, while ‘euro’ was the
‘specific name’ for the generic term European currency unit.126 In the proposed EU
Constitution and the TFEU, the name ‘euro’ is the only name given to the single currency.
7.97 As stated earlier, TFEU provides distinct rules for members whose currency is the
euro (Arts 136–138) and for Member States with a derogation or ‘transitional
provisions’ (Arts 139–144). The Lisbon Treaty also updated the provisions of the Maastricht
Treaty (Arts 121–124 EC Treaty) on the procedure to integrate the euro in those Member
States (p. 275) with other currencies. TFEU adopted these provisions with no substantial
changes in content.
7.98 The economic and legal criteria are now to be found in Article 140(1) TFEU. However,
some changes have taken place at the procedural level. Article 122(2) EC stated that the
Council, after consulting the European Parliament and after discussion in the Council,
decided on the abrogation of the derogation and the introduction of the euro. According to
Article 140(2) TFEU the aforementioned discussions take place in the European Council.
Another procedural novelty is that the Council (all members eligible to vote) decides upon
recommendation of the representative of the Eurozone countries. As discussed earlier the
Euro group only has an advisory power, the Council takes the decision.
Issue of banknotes and coins
7.99 The European Central Bank has the exclusive right to authorize the issue of euro
banknotes in the Union (Art 128.1 TFEU), though both the European Central Bank and the
national central banks may physically issue such notes. Article 16 of the ESCB Statute
allocates the exclusive right to authorize the issue of euro banknotes to the Governing
Council of the European Central Bank. The prerogative of issuing currency (ius cudendae
monetae), which is a classic attribute of monetary sovereignty, has been transferred to the
supranational arena.
7.100 The legal tender status is also clear according to Article 128 TFEU. ‘The banknotes
issued by the ECB and the national central banks shall be the only such notes to have the
status of legal tender within the Union.’127
7.101 According to Article 128(2) TFEU, Member States retain the right to issue coins
subject to the approval by the ECB of the volume of the issue. The Council may also adopt
‘measures’ (according to the text of Art 128(2)) to ‘harmonise the denominations and
technical specifications of all coins intended for circulation to the extent necessary to
permit their smooth circulation within the Union’.128
7.102 The actual issue of euro notes is a competence shared by the ECB and the NCBs.129
Hence, notes can be printed and put into circulation by the ECB, the NCBs, or both the ECB
and the NCBs at the discretion of the Governing Council. Exercising this discretion, the
ECB decided that both the ECB and the NCBs can issue euro banknotes according to a
structured process for the even allocation of the total value of euro banknotes in circulation
to the ECB and NCBs.130
(p. 276) The legal instruments regulating the euro
7.103 The law of the euro is mainly secondary law. The Treaty only provided a blueprint
for the introduction of the euro, but not the detailed rules that were needed for the
substitution of the national currencies by the single currency. A comprehensive legal
framework for the euro is spelt out in several EU regulations. The legal bases for enacting
these euro regulations were Article 352 TFEU and Article 114 TFEU.
7.104 TFEU introduces a clear legislative competence with regard to the euro in Article
133: ‘the European Central Bank, the European Parliament and the Council, acting in
accordance with the ordinary legislative procedure, shall lay down the measures necessary
for the use of the euro as the single currency’.
Regulation 1103/97 on certain provisions relating to the introduction of the euro
7.105 Regulation 1103/97 was the first and most significant regulation governing the
introduction of the euro. It was adopted on 20 June 1997 and applied to all Member States.
It was often referred to as the Article 308 Regulation (now Art 352 TFEU).
7.106 The choice of Article 352 TFEU (Art 308 EC) as the legal basis for enacting this
Regulation indicates that the Maastricht Treaty had not specifically provided the necessary
powers for the adoption of all the measures needed for the changeover to the single
currency.131 Article 352 empowers the Council, acting unanimously, to take the necessary
measures only if ‘action by the Union should prove necessary, within the framework of the
policies defined in the Treaties, to attain one of the objectives set out in the Treaties, and
the Treaties have not provided the necessary powers, the Council, acting unanimously on a
proposal from the Commission and after obtaining the consent of the European Parliament,
shall adopt the appropriate measures.’
7.107 The key issues in this so-called ‘Article 308 Regulation’ were the continuity of
contracts, the treatment of ecu-denominated obligation and the issues of conversion and
rounding. The Regulation was based on the firm conviction that:132
• ‘it is a generally accepted principle of law that the continuity of contracts and other
legal instruments is not affected by the introduction of a new currency’;
• ‘the principle of freedom of contract has to be respected’;
• ‘the principle of continuity should be compatible with anything which parties might
have agreed with reference to the introduction of the euro’;
• ‘in order to reinforce legal certainty and clarity, it is appropriate explicitly to
confirm that the principle of continuity of contracts and other legal instruments shall
apply between (p. 277) the former national currencies and the euro and between the
ECU; this implies, in particular, that in the case of fixed interest rate instruments the
introduction of the euro does not alter the nominal interest rate payable by the
debtor, whereas the provisions on continuity can fulfil their objective to provide legal
certainty and transparency to economic agents, in particular for consumers, only if
they enter into force as soon as possible’;
• ‘the introduction of the euro constitutes a change in the monetary law of each
participating Member State’;
• ‘the recognition of the monetary law of a State is a universally accepted principle’;
and
• ‘the explicit confirmation of the principle of continuity should lead to the
recognition of continuity of contracts and other legal instruments in the jurisdictions
of third countries’.
Regulation 974/1998 on the introduction of the euro

7.108 Regulation 974/1998, the second euro regulation,133 purports to define the
‘monetary law provisions of the Member States which have adopted the euro’.134 While the
so-called Article 308 Regulation (now Art 352 TFEU) applied to all Member States, this
Regulation applied only to the Member States participating in EMU.135
7.109 The main issues covered were the replacement over a transitional period of the
national currencies by the euro, the gradual introduction of euro banknotes and coins, and
the full substitution of euro for national currency units at the end of the transitional period.
7.110 A transitional period was needed to prepare a smooth changeover, to allow for the
production and distribution of sufficient banknotes and coins, and to ‘educate’ the public
and the financial markets about the new currency. During this transitional period the
national currency units were defined as sub-divisions of the euro and thereby a ‘legal
equivalence’ was established between the euro unit and the national currency units.136 It
became clear that despite the lack of euro notes and coins during the transitional period,
the euro unit and the national currency units were in all effect units of the same
currency.137 Hence, in transactions which did not involve the physical exchange of notes
and coins there was no reason why the euro unit could not be used. In the same spirit, the
Regulation prescribed in the preamble that payments inside a participating Member State
by crediting an account could be made either in the euro unit or the respective national
currency unit and the same could apply to those cross-border payments which were
denominated in the euro unit or the national currency unit of the account of the creditor.138
(p. 278) 7.111 Article 2 of the Regulation 974/1998 (as amended by Regulation 2595/2000)
articulated what is probably the most important historical development in the European
monetary field for centuries: ‘As from 1 January 1999 the currency of the participating
Member States except Greece shall be the euro. As from 1 January 2001 the currency of
Greece shall be the euro. The currency unit shall be one euro. One euro shall be divided
into one hundred cents.’
7.112 Article 3 of the Regulation complemented the changeover. The euro was to be
substituted for the currency of each participating Member State at the ‘conversion rate’,
defined as the irrevocably fixed conversion rate adopted for the currency of each
participating Member State by the Council.
7.113 Pursuant to Article 4 of the Regulation, the euro became the unit of account of the
ECB and of the central banks of the participating Member States.
7.114 A contract expressed in the former currency of a participating Member State would
continue to create a valid and binding obligation of a monetary character. It was clear
under Article 7 of the Regulation that the substitution of the euro for the currency of each
participating Member State did not in itself have the effect of altering the denomination of
legal instruments in existence on the date of substitution. Acts to be performed under legal
instruments stipulating the use of or denominated in a national currency unit had to be
performed in that national currency unit; acts to be performed under legal instruments
stipulating the use of or denominated in the euro unit had to be performed in that unit,139
without prejudice to anything which the parties might have agreed.140
7.115 Any amount denominated either in the euro unit or in the national currency unit of a
given participating Member State and payable within that Member State by crediting an
account of the creditor, could be paid by the debtor either in the euro unit or in that
national currency unit. The amount had to be credited to the account of the creditor in the
denomination of his account, with any conversion being effected at the conversion rates.141
7.116 The Regulation contained further provisions which enabled participating countries
to re-denominate in the euro unit outstanding debt issued by that Member State’s general
government, denominated in its national currency unit and issued under its own law.142
7.117 Article 10 of the Regulation established the time-frame for the introduction of euro
notes and coins. From 1 January 2002, the ECB and the central banks of the participating
Member States were instructed to put into circulation banknotes denominated in euro.
These banknotes denominated in euro were to be the only banknotes with the status of legal
tender in all these Member States. Similarly for euro coins, as from 1 January 2002, the
participating Member States were empowered to issue coins denominated in euro or in
cents and complying with the denominations and technical specifications which the Council
may lay down in accordance with the Treaty.143 Again, these coins were to be the only coins
with the status of legal tender in all these Member States.144 Article 12 imposed on
participating Member States the responsibility to ensure adequate sanctions against
counterfeiting and falsification of euro banknotes and coins.
7.118 Banknotes and coins denominated in a national currency unit could remain legal
tender within their territorial limits until six months after the end of the transitional period
at the latest.145 This period could be shortened (but not extended) by national law.146 Each
participating Member State could for a period of up to six months after the end of the
transitional period, lay down rules for the use of the banknotes and coins denominated in its
national currency unit and take any measures necessary to facilitate their withdrawal.147
Finally, in accordance with the laws or practices of participating Member States, the
respective issuers of banknotes and coins would continue to accept, against euro at the
conversion rate, the banknotes and coins previously issued by them.148
7.119 During the transition period, national central banks were authorized by the ECB to
continue to issue national banknotes with the obligation to inform the ECB by the end of
February of each year of the amount of national banknotes issued during the preceding
year.149 This specific authorization was given in fulfilment of the requirements of the Treaty
which grants the ECB the exclusive right to authorize the issue of banknotes within the
Community (now Union) from the beginning of Stage Three.150
Other instruments of secondary law relating to the euro
7.120 The Council adopted other instruments of secondary law relating to the euro.
Technical specification of euro coins
7.121 The Regulation 975/98 on Denominations and Technical Specifications of Euro Coins
Intended for Circulation151 set out the denominations and technical specifications of euro
coins, such as diameter, weight, shape, colour, composition, and so on, fulfilling the
mandate given by the Treaty to the Council to adopt measures in order to harmonize the
denominations and technical specifications of all coins intended for circulation to the extent
necessary to permit their smooth circulation within the Community (now Union).152 It was
envisaged that the new European single coinage system should induce public confidence
and entail technological innovations that would establish it as a secure, reliable, and
efficient system.153 Other practical matters were also considered in the design. For
example, giving the coins one European and one national side is an appropriate expression
of the idea of European monetary union between Member States and could significantly
increase the degree of acceptance of the coins by European citizens.154
Conversion rates
7.122 The Regulation 2866/98 on the conversion rates between the euro and the
currencies of the Member States adopting the euro155 adopted the conversion rates at
which the currencies (p. 280) of the ‘Member States without derogation’ were irrevocably
fixed inter se and also the irrevocably fixed conversion rates at which the ecu (euro) was
substituted for those currencies.
Counterfeiting
7.123 Article 12 of the Regulation No 974/1998 on the introduction of the euro imposed on
participating Member States the responsibility to ensure adequate sanctions against
counterfeiting and falsification of euro banknotes and coins.
7.124 In its framework Decision of 29 May 2000 on increasing protection by criminal
penalties and other sanctions against counterfeiting in connection with the introduction of
the euro,156 the Council adopted provisions to ensure that the euro is protected in an
appropriate way by effective measures under criminal law. In June 2001, the Council
adopted the Regulation 1338/2001 of 28 June 2001 laying down measures necessary for the
protection of the euro against counterfeiting.157
7.125 The purpose of this Regulation 1338/2001 is to lay down measures necessary with a
view to uttering euro notes and coins in such a manner as to protect them against
counterfeiting.158 The Council regards the competence to adopt harmonized measures to
protect the euro against counterfeiting as part of its responsibility in respect of the single
currency.159 The Regulation is based on the assumption that the legal protection of the euro
cannot be (p. 281) satisfactorily ensured by the individual Member States alone, since euro
notes and coins will circulate beyond the territories of the participating Member States.160
7.126 For the purpose of applying this Regulation, ‘counterfeiting’ included the following
activities:161 (a) any fraudulent making or altering of euro notes or euro coins, whatever
means are employed; (b) the fraudulent uttering of counterfeit euro notes or counterfeit
euro coins; (c) the import, export, transport, receiving, or obtaining of counterfeit euro
notes or counterfeit euro coins with a view to uttering the same and with knowledge that
they are counterfeit; (d) the fraudulent making, receiving, obtaining, or possession of
instruments, articles, computer programs, and any other means peculiarly adapted for the
fraudulent making or altering of euro notes or coins, or holograms or other components
which serve to protect euro notes and coins against fraudulent making or alteration.
‘Counterfeit notes’ and ‘counterfeit coins’ shall mean notes and coins denominated in euro
or which have the appearance of euro notes or coins and which have been fraudulently
made or altered.162
7.127 Under Regulation 1338/2001, national authorities are obliged to gather and index
technical and statistical data relating to counterfeit notes and counterfeit coins discovered
in the Member States and to communicate such data to the European Central Bank for
storage and processing.163 The competent national authorities and, within its areas of
responsibility, the Commission, shall have access to the technical and statistical data held
by the European Central Bank. Europol shall have access to such data under an agreement
between it and the European Central Bank in accordance with the relevant provisions of the
Europol Convention and the provisions adopted on the basis of the latter.164
7.128 Regarding the role and contribution of the banking system, the Regulation
prescribes165 that credit institutions, and any other institutions engaged in the sorting and
distribution to the public of notes and coins as a professional activity, including
establishments whose activity consists in exchanging notes and coins of different
currencies, such as bureaux de change, were obliged to withdraw from circulation all euro
notes and coins received by them which they know or have sufficient reason to believe to be
counterfeit. They should immediately hand them over to the competent national
authorities.166 Further, Member States should take the necessary measures to ensure that
those undertakings which fail to discharge their obligations under the said paragraph are
subject to effective, proportionate, and deterrent sanctions.
7.129 The copyright on the designs of the euro bank notes was received by the ECB from
the EMI.167 The European Central Bank concluded that such copyright is administered and
enforced by all participating Member States according to their individual national legal (p.
282) systems.168 The ECB has established a Counterfeit Analysis Centre (CAC) in Frankfurt
to centralize the technical analysis and data relating to the counterfeiting of euro banknotes
issued by the ECB and the NCBs.169
Reproduction, exchange, and withdrawal of euro banknotes
7.130 An ECB decision of 20 March 2003170 amended by Decision ECB/2013/10171 deals
with the issues of withdrawal, reproduction, and exchange of damaged or mutilated euro
banknotes. According to this decision, the right of the ECB and of the NCBs to issue euro
banknotes includes the competence to take all necessary legal measures to protect the
integrity of the euro banknotes as a means of payment,172 such as rules on reproduction (to
provide for a minimum level of protection in all participating Member States in order to
ensure that the general public can distinguish genuine euro banknotes from reproductions),
rules regarding the exchange of damaged or mutilated banknotes,173 and rules with regard
to the withdrawal of euro banknotes.174
The legal status of the euro in non-EU Member States
7.131 The euro is not only the common currency of the twelve Member States of the
European Monetary Union, but has also been accorded legal tender status in certain States
and territories outside the European Union such as St Pierre et Miquelon and Mayotte, the
French overseas territories, San Marino, the Vatican City, and Monaco.175 This is a
consequence of various monetary relations which had been entertained traditionally by
certain Member States, such as France, Italy, Portugal, and Spain, with other States and
territories.
7.132 Following the introduction of the euro, the French franc ceased to be legal tender in
St Pierre et Miquelon and Mayotte. However, the respective European regulations on the
common currency did not automatically apply in those territories, as the institutions of the
European Union did not (and still do not) have any jurisdiction over these territories. Thus,
the Council authorized France to introduce the euro to St Pierre et Miquelon and to
Mayotte in 1999.176
(p. 283) 7.133 The French overseas territories use the franc of the Pacific Financial
Community (CFP) as legal currency. As the CFP franc was not identical with the French
franc, it was not automatically replaced by the euro. In the past France had guaranteed a
parity of 1 CFP franc against 0.005 French francs. This strict parity between the CFP franc
and the French franc had to be replaced by a corresponding parity between the CFP franc
and the euro. Although such parity between the euro and foreign currencies is normally a
matter for the EU, under Protocol No 13 annexed to the Treaty of Maastricht, France
explicitly reserved her right to monetary emissions in her overseas territories and her right
to determine the parity of the CFP franc. Hence, France was able to retain an exclusive
residual competence with respect to the CFP franc. The monetary relations between France
and her overseas territories have therefore been left unaffected by the introduction of the
euro.
7.134 The Republic of San Marino and the Italian Republic concluded a Monetary
Agreement in 2001.177 Under this agreement San Marino is entitled to use the euro as
official currency and legal tender status shall be accorded to euro banknotes and coins in
San Marino as from 1 January 2001. San Marino further undertakes to implement Union
rules on euro banknotes and coins in the territory and had to follow Italy’s timetable for the
withdrawal of San Marinese lira coins. Crucially, San Marino cannot issue any banknotes,
coins, or monetary surrogates denominated in euro unless the conditions for such issuance
have been agreed upon with the European Union.
7.135 Following a Council Decision of 1998,178 Italy, on behalf of the European
Community, concluded with the State of the Vatican City, which was represented by the
Holy See, a Monetary Agreement on 29 December 2000 on terms nearly identical to the
respective Agreement concluded with San Marino.179 The same terms were also applied in
the Monetary Agreement between France on behalf of the EU and the Principality of
Monaco.180
7.136 Interestingly, there are more States or territories in which the euro has now
obtained official tender status without a clear legal basis. It is argued for example that the
Principality of Andorra does not have any currency of its own, but has traditionally used
Spanish pesetas and French francs as legal tender up to 31 December 2001. In the course
of 2002, the euro was de facto introduced in Andorra.181 Also, the euro replaced the
German mark as the (p. 284) currency in circulation in Kosovo as of the beginning of 2002
without an express approval or authorization by the ECB or the ESCB.182
G. The Future of the Euro

7.137 Times have changed since the euro became a reality. Initial fears about continuity of
contracts and other issues failed to materialize. But it was a ‘black swan’ (borrowing the
expression from Nassim Nicholas Taleb’s acclaimed book183) that threatened to compromise
the very existence of the single currency. EMU’s history since 2009 has been so tumultuous
and the strains have been so severe that what seemed inconceivable in 2002 became
plausible in 2010. In this section we deal with the legal possibility of euro exit.
7.138 As the EU continued its expansion into Eastern Europe and the Baltics, with
newcomers (that entered the Union as ‘states with a derogation’) committing to an eventual
adoption of the euro (following the procedure set out in Art 140 TFEU),184 the EU also
entered into uncharted territory with the unfolding of the crisis. The financial/sovereign
debt/economic crisis not only delayed the adoption of the euro in some of these new
Member States but more fundamentally, it triggered some very existential issues about the
single currency.
7.139 Although optimism is what has characterized the founders of the European
integration project the Cassandras of the project could still have their omens realized. The
prospect that European monetary union might fall apart or that one country might wish to
exit from the Eurozone and recreate its own national currency has been seriously debated
during the Eurozone debt crisis.185
7.140 As I mentioned in Chapter 1, though there is no provision in the Treaty which
permits the revocation of EMU (no exit clause), the new Article 50 of the Lisbon Treaty
foresees the possibility of exiting the EU altogether.186 The wording ‘irrevocably fixed’
adopted (p. 285) by the Maastricht Treaty suggests that EMU is ‘a trip with no
return’ (irreversible).187 However, the Member States retain—as a residual attribute of their
sovereignty—the possibility of reversing the current status quo by unanimous agreement
(ie, by signing a new Treaty to that effect).188 Furthermore, in the exercise of sovereign
rights, individual Member States of the euro area may choose to ignore the obligations of
the Treaty (notwithstanding the illegality of this action) and abandon the monetary union.
Or they could try to negotiate an agreement to keep the euro.189 History teaches us that
countries have ignored and repudiated international obligations before. Revolutions and
coups d’état are notorious examples of such repudiation.190 We should not forget that laws,
treaties, and constitutions can change and do change, and that they need ‘societal
legitimacy’ for their long-term survival.
7.141 Furthermore, it has been argued there are legal mechanisms that already exist in
EU law for one or more Member States to leave the Eurozone under Article 352 TFEU (thus
the orderly consensual departure—or a ‘temporary exit’—of one or more periphery States
remains a legal possibility).191 I would like to finish this chapter however on a positive note
as regards the future of the euro. I do think that the euro will survive and that the changes
discussed in the second part of this book (notably on economic governance and banking
union) should strengthen the institutional foundations of monetary union.(p. 286)
Footnotes:
1
See European Central Bank, ‘The Euro Becomes the Sole Legal Tender in all Euro Area
Countries’, Press Release (28 February 2002), at <http://www.ecb.europa.eu/press/pr/date/
2002/html/pr020228.en.html> (last visited 25 July 2014).
2
See European Central Bank, ‘The ECB’, at <https://www.ecb.europa.eu/ecb/html/
index.en.html> (last visited 25 July 2014).
3
The Treaty of Lisbon Treaty of Lisbon Amending the Treaty on European Union and the
Treaty Establishing the European Community (signed 13 December 2007, entered into
force 1 December 2009), OJ C 306/01 (‘Lisbon Treaty’). See Consolidated versions of the
Treaty on European Union and the Treaty on the Functioning of the European Union, 2010
OJ C 83/01 vol 53 (30 March 2012) (hereinafter TFEU).
4
TFEU, Art 282(1) is in substance the same as Art I-30 of the proposed EU Constitution. As
discussed in Chapter 6, the Treaty establishing a Constitution for Europe (Rome, signed 29
October 2004), OJ C 310 (16 December 2004)—was thrown into a legal limbo following the
rejection of the Treaty in referenda in France (28 May 2005) and in the Netherlands (1 June
2005).
5
TFEU, Arts 127–144 were EC Treaty, Arts 105–124 before the entry into force of the
Lisbon Treaty. Doctrinal references to EU/ECB law before 2009 would cite the old
numeration. This is no doubt confusing for non-legal scholars. As mentioned in Chapter 6,
the Lisbon Treaty amends the Maastricht Treaty (known as the Treaty on European Union,
TEU) and the Treaty establishing the European Community, which has been renamed after
Lisbon as TFEU. References to the old numeration have been generally omitted in this 2nd
edition. For a comparative table, see Foreign and Commonwealth Office, A Comparative
Table of the Current EC and EU Treaties as Amended by the Treaty of Lisbon, Cm 7311
(January 2008), at <https://www.gov.uk/government/uploads/system/uploads/
attachment_data/file/228835/7311.pdf> (last visited 28 July 2014) (also published in [2010]
OJ C 89/361).
6
The term ‘Eurosystem’ was devised by the ‘in’ members of the ESCB as a way to
distinguish themselves as the monetary authority of the EU from the larger ESCB; this term
was then officially recognized in the Lisbon Treaty amendments to the original Treaties.
7
See Regulation (EC) No 985/2001 of the ECB of 10 May 2001 amending Regulation ECB/
1999/4 on the powers of the ECB to impose sanctions (ECB/2001/4), OJ L 137, (19 May
2001) 24.
8
Council Decision of 29 June 1998 on the consultation of the European Central Bank by
national authorities regarding draft legislative provisions, OJ L 189/42 (3 July 1998).
9
See TFEU, Art 132 and Statute of the European System of Central Banks and of the
European Central Bank, Art 34 (hereinafter ‘ESCB Statute’).
10
ESCB Statute, Art 14(3) refers to ‘guidelines and instructions’ of the ECB to the NCBs.
11
TFEU, Art 288 defines the legal acts of the Union: regulations, directives, decisions,
recommendations, and opinions. While directives (binding as to the result to be achieved
but leaving to the national authorities the choice of form and methods) have been the
preferred legislative instrument in the completion of the internal market, regulations
(binding in their entirety) are the appropriate legislative instrument when it comes to the
euro and the ECB.
12
Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on
the European Central Bank concerning policies relating to the prudential supervision of
credit institutions, OJ L 287/63 (29 October 2013) is analysed in Chapters 10 and 11.
13
See Rosa M Lastra, ‘The Division of Responsibilities between the European Central Bank
and the National Central Banks within the European System of Central Banks’ (2000) 6(2)
Columbia Journal of European Law 167.
14
See generally Chiara Zilioli and Martin Selmayr, The Law of the European Central Bank
(Oxford: Hart Publishing, 2001) ch 4.
15
ESCB Statute, Art 14(3).
16
See TFEU, Art 131: ‘The ESCB shall be governed by the decision-making bodies of the
European Central Bank which shall be the Governing Council and the Executive Board.’
17
See TFEU, Art 129.
18
ESCB Statute, Art 44; see further para 7.17 below.
19
However, in order to ensure efficiency in a growing Eurosystem, a rotation system of
voting rights in the Governing Council of the ECB was agreed in 2003, through an
amendment to Art 10.2 of the ESCB Statute. Nevertheless, the ECB Governing Council
decided on 18 December 2008 (Decision ECB/2008/29 (2009/5/EC), OJ L 3 (7 January 2009)
4) to postpone the start of the rotation system—as agreed by Council Decision of 21 March
2003 (Decision 2003/223/EC) on an amendment to Art 10.2 of the ESCB Statute based on
ECB Recommendation ECB/2003/1 OJ L 83 (1 April 2003) 66—and to continue with the
current voting regime until the number of NCB Governors in the Governing Council exceeds
eighteen. The Lithuanian accession will trigger the rotation system to start being applied.
There are two stages in this awkward rotation system. See Deutsche Bundesbank, ‘How
voting rights rotate on the ECB Governing Council’ (17 June 2014), at <http://
www.bundesbank.de/Redaktion/EN/Topics/2014/2014_06_17_rotation_system.html> (last
visited 27 July 2014). See also European Central Bank, ‘Rotation of Voting Rights in the
Governing Council of the ECB’, Monthly Bulletin (July 2009) 91–9, at <https://
www.ecb.europa.eu/pub/pdf/other/mb200907_pp91-99en.pdf> (last visited 27 July 2014).
20
This point was made by Manuel Conthe—who had been Spain’s representative to the
1991 Intergovernmental Conference on EMU—at a presentation at the ECB in Frankfurt on
15 November 2013.
21
This is further discussed in Chapter 10.
22
Under EU law the Swedish position is that of a Member State with a derogation; Sweden
does not fulfil two of the convergence criteria, ie on CB independence and on participation
of the krona in ERM-II. That Sweden itself considers that it requires a positive outcome of a
referendum and can stay aloof from EMU is irrelevant, strictly speaking, from a EU legal
perspective as tertium non datur: States have either an opt-out or the derogation status. I
am grateful to René Smits for observations on this point.
23
These are the countries that joined in 2004 (Cyprus, Czech Republic, Estonia, Hungary,
Latvia, Lithuania, Malta, Poland, Slovenia, and Slovakia), 2007 (Bulgaria and Romania), and
2013 (Croatia). See European Union, List of Countries, at <http://europa.eu/about-eu/
countries/index_en.htm> (last visited 27 July 2014).
24
TFEU, Art 141(1) refers to the General Council as the ‘third decision-making body of the
European Central Bank’. See also ESCB Statute, Arts 44–46.
25
As recognized in TFEU, Art 282.
26
ESCB Statute, Art 9.1 states that the ECB ‘shall enjoy in each of the Member States the
most extensive legal capacity accorded to legal persons under its law; it may, in particular,
acquire or dispose of movable and immovable property and may be a party to legal
proceedings’.
27
In his comments on this chapter, René Smits points out that this is the equivalent of Art
258 TFEU, under which the Commission can sue a State before the CJEU for neglecting
Community obligations, and a token of the independence of the NCBs since their actions as
ESCB members are no longer imputed to their State, but may come up for scrutiny before
the CJEU directly.
28
Not all NCBs are public legal persons: the Banque Nationale de Belgique, the Banca
d’Italia, the Bank of Greece, and De Nederlandsche Bank NV are public limited companies,
ie, firms with private legal personality.
29
The analogy between the Fed and the ESCB is helpful in casting some light on potential
developments within the Eurosystem. For instance, the influential role played by the
Federal Reserve Bank of New York (FRBNY) within the Federal Reserve System is an
interesting ‘precedent’ that suggests the possibility of one (or a few) of the NCBs playing a
predominant role within the ESCB in future. Because of its location in New York City, the
world’s leading financial centre, the FRBNY undoubtedly performs a major role within the
Federal Reserve System (as a part of the US central banking system) and in the
international banking community (as a corporate entity). In its capacity as a part of the US
central banking system, the FRBNY carries out a variety of functions, in some instances
independently of the Executive Branch of the US Government (eg, in regard to the
implementation of monetary policy) and in some others as an agent of the Government (eg,
when it acts as an agent of the Treasury in the carrying out of foreign exchange operations
or when it acts as a fiscal agent of the US Government in matters specified by the US
Treasury). In its corporate capacity, on the other hand, the FRBNY carries out corporate
activities, such as managing depository accounts for foreign central banks, including
custodian and investment services.
30
As mentioned in Chapter 2, in 1997–8 I participated in a very interesting case brought
against the FRBNY by Bank Markazi Iran, Case 823, Bank Markazi Iran v Federal Reserve
Bank of New York, presented before the Iran–United States Claims Tribunal at The Hague,
the Netherlands. Bank Markazi (BM) claimed an amount of principal as well as ‘unpaid
interest’ on the grounds that the FRBNY had breached the contractual obligations that it
had with respect to the investment of BM’s funds during the period of the freezing of the
Iranian assets (1979–81). BM also claimed that the FRBNY was ‘an agency, instrumentality
or entity controlled by the Government of the United States’. This was ‘the jurisdictional
issue of the case’ and it is with regard to this issue that I was asked by the FRBNY to assess
the independence of the Federal Reserve Bank of New York and of the Federal Reserve
System. I wrote an expert opinion on the nature, legal personality, independence, and
operations of the Federal Reserve System, including a comparison with other central banks.
The Tribunal reached its decision on 16 November 1999, Award No 595-823-3. The award
of the chamber (Chamber 3) dismissed the claim on its merits (concluding that the New
York Fed acted honourably and appropriately) but did not decide on the jurisdictional issue.
Judge Arangio-Ruiz wrote in the decision (para 34): ‘The issue of whether or not it [the
FRBNY] is an agency, instrumentality or entity controlled by the Government of the United
States is a complex one. Even the law in the United States as to the status of the Federal
Reserve Banks is arguably not consistent.’ Judge Richard Mosk concurred with Judge
Gaetano Arangio-Ruiz as to the merits, but thought that a decision on the jurisdictional
issue of ‘control’ would have been appropriate, since he argued that the FRBNY is not an
agency or instrumentality of the United States under the Claims Settlement Declaration.
(The Algiers Accords, an agreement to settle financial matters between the USA and the
Islamic Republic of Iran in the wake of the hostage-taking of diplomatic personal at the
American Embassy in Tehran during 444 days after the Islamic Revolution.)
31
For a recent analysis of the evolution of the independence of the Federal Reserve
System, see Peter Conti-Brown, ‘The Institutions of Federal Reserve Independence’, Rock
Center for Corporate Governance at Stanford University Working Paper No 139 (14 March
2014), at <http://ssrn.com/abstract=2275759> (last visited 27 July 2014).
32
TFEU, Protocol (No 4) on the Statute of the European System of Central Banks and the
European Central Bank.
33
See Niall J Lenihan, ‘The Price Stability Mandate of the European System of Central
Banks: A Legal Perspective’ in Current Developments in Monetary and Financial Law
(Washington, DC: International Monetary Fund, 2008) 7–9.
34
See Klaus Stern, Das Staatsrecht der Bundesrepublik Deutschland (Munich: C H Beck,
1980) vol 1, 463–508.
35
Jan Tinbergen, On the Theory of Economic Policy (Amsterdam: North Holland Publishing
Co, 1952).
36
See ‘Spain Looks to ECB to Avoid Deflation Trap’ Financial Times (2 April 2014), and
‘ECB Must Spend Big to Stop Deflation’ Financial Times (5 April 2014).
37
See Rosa M Lastra, ‘The Evolution of the European Central Bank’ (2012) 35 Fordham
International Law Journal 1265, 1260–81.
38
See generally Rosa M Lastra and Geoffrey Wood, ‘The Crisis of 2007–2009: Nature,
Causes, and Reactions’ (2010) 13(3) Journal of International Economic Law 531.
39
As it is for the Union and the Member States under TFEU, Arts 119 and 120.
40
TFEU, Art 127(2) and ESCB Statute, Art 3.1.
41
ESCB Statute, Art 12.1(3) states that ‘[t]o the extent deemed possible and without
prejudice to the provisions of this Article, the ECB shall have recourse to the national
central banks to carry out operations which form part of the tasks of the ESCB.’
42
43
The Governing Council of the ECB sets the three key interest rates: (1) the interest rate
on the main refinancing operations (MROs), which normally provide the bulk of liquidity to
the banking system. The Eurosystem may execute its tenders in the form of fixed rate or
variable rate tenders; (2) the rate on the deposit facility, which banks may use to make
overnight deposits with the Eurosystem; (3) the rate on the marginal lending facility,
offering overnight credit to banks from the Eurosystem. See European Central Bank,
Monetary Policy, at <http://www.ecb.int/mopo/html/index.en.html> (last visited 25 July
2014).
In October 1998, the ECB’s Governing Council agreed on a monetary policy strategy
consisting of three elements. First, price stability was defined as an annual rise in the
Harmonized Indices of Consumer Prices (HICP) below 2 per cent, to be achieved in a
medium-term context. Secondly, a prominent role was given to money, signalled by a
quantitative ‘reference’ value for the growth of a broad aggregate, derived in a manner
consistent with price stability. Thirdly, in parallel with an analysis of monetary growth, a
broadly based assessment of the outlook for future price developments is to be made using
a range of economic and financial indicators. In December 1998, the ECB announced that
the reference value for broad money growth would be 4.5 per cent. This reference value
does not apply to a specific time-frame, but is to be reviewed on a regular basis.
44
The Eurosystem’s monetary policy instruments and procedures—and the General
Documentation—were amended several times in response to the financial crisis. See
Guideline ECB/2009/1, Guideline ECB/2009/10, Guideline ECB/2010/1, Guideline ECB/
2010/13 all of them amending Guideline ECB/2000/7 on monetary policy instruments and
procedures of the Eurosystem.
45
The extent to which the ECB can act as lender of last resort (LOLR) is further discussed
in Chapter 10. As stated earlier, LOLR comes in two forms: market liquidity and individual
liquidity assistance. And while the ECB has legal authority to provide market liquidity
support (ESCB Statute, Art 18.1), because of its own restrictive interpretation of Art 14.4 of
the ESCB Statute, individual liquidity assistance (à la Thornton–Bagehot) remains a national
competence. This is bound to change in my opinion with banking union, since the conferral
upon the ECB of prudential supervisory responsibilities will lead to a different
interpretation of Art 14.4, one that puts the ECB firmly in charge. This would be possible in
accordance with Arts 18 and 20 of the ESCB Statute and the principle of subsidiarity.
46
European Central Bank, ‘Tender Procedure for the Provision of US Dollars to
Eurosystem Counterparties’ (6 December 2011), at <https://www.ecb.europa.eu/mopo/
implement/omo/pdf/EUR-USD_tender_ procedure.pdf?
4e46baa8a3c9fdb1ca472f35a83c5a42> (last visited 25 July 2014), and Annex I of Guideline
ECB/ 2007/7 of 31 August 2000 on monetary policy instruments and procedures of the
Eurosystem, OJ L 310/1 (11 December 2000).
47
See Guideline ECB/2008/18 and Guideline ECB/2009/24 on temporary changes to the
rules relating to the eligibility of collateral, temporarily widening the eligibility of collateral
admissible for Eurosystem credit operations.
48
For a detailed review and explanation of the measures adopted by the ECB between
2007 and 2009 see the article by the former president of the ECB, Jean-Claude Trichet,
‘State of the Union: The Financial Crisis and the ECB’s Response between 2007 and
2009’ (2010) 48 Journal of Common Market Studies 7.
See also European Central Bank, Monetary Policy Instruments, <http://www.ecb.europa.eu/
ecb/legal/1002/1014/html/index-tabs.en.html> (last visited 27 July 2014).
49
ECB, ‘Governing Council Decisions on Non-Standard Measures’ ECB Monthly Bulletin
(July 2009), at <http://www.ecb.europa.eu/mopo/decisions/html/mb200906_pp9_10.pdf>
50
The Covered Bonds Purchase Programme (CBPP) commenced in July 2009, both on the
primary market and on the secondary market. According to the Decision of the ECB of 4
July 2009 on the implementation of the covered bond purchase programme, ECB/2009/16
(2009/522/EC), OJ L 175/18 (4 July 2009), the CBPP had four objectives: (a) promoting the
on-going decline in money market term rates; (b) easing funding conditions for credit
institutions and enterprises; (c) encouraging credit institutions to maintain and to expand
their lending to clients; and (d) improving market liquidity in important segments of the
private debt securities market. The first programme covered 60 billion euros of bonds from
July 2009 to July 2010; the second programme—CBPP2 was launched in November 2011 for
one year and it covered eligible covered bond purchases for 40 billion euros. See John
Beirne et al, ‘The Impact of the Eurosystem’s Covered Bond Purchase Programme on the
Primary and Secondary Markets’, ECB Occasional Paper Series No 122 (January 2011), at
<http://www.ecb.europa.eu/pub/pdf/scpops/ecbocp122.pdf> (last visited 27 July 2014). See
also ECB, ‘The ECB’s Non-standard Measures—Impact and Phasing-Out’, ECB Monthly
Bulletin (July 2011) 55–69, at <https://www.ecb.europa.eu/pub/pdf/other/
art1_mb201107en_pp55-69en.pdf>.
51
See Decision of the ECB of 14 May 2010 establishing a Securities Markets Programme,
ECB/2010/5 (2010/281/EU), OJ L 124/8 (20 May 2010).
52
For an overview of the changes in the Eurosystem collateral framework during the
financial crisis see ECB, ‘The Eurosystem Collateral Framework Throughout the Crisis’,
ECB Monthly Bulletin (July 2013) 71–86, at <http://www.ecb.europa.eu/pub/pdf/mobu/
mb201307en.pdf> (last visited 27 July 2014). See also Decision of the ECB of 6 May 2010
on temporary measures relating to the eligibility of marketable debt instruments issued or
guaranteed by the Greek Government, ECB/2010/3 (2010/268/EU), OJ L 117/102 (11 May
2010).
53
Following its meeting on 4 July 2013, the Governing Council of the ECB communicated
that it expects the key ECB interest rates to remain at present or lower levels for an
extended period of time. See Marco Troiano, ‘ECB Meeting July 2013: ECB issues forward
guidance’, Euro-Banks.com (4 July 2013), at <http://euro-banks.com/ecb-meeting-july-2013-
forward-guidance> (last visited 27 July 2014).
54
See ECB, ‘ECB Introduces a Negative Deposit Facility Interest Rate’, Press Release (5
June 2014), at <http://www.ecb.europa.eu/press/pr/date/2014/html/pr140605_3.en.html>
(last visited 27 July 2014). See also ECB, ‘Why Has the ECB Introduced a Negative Interest
Rate?’, at <http://www.ecb.europa.eu/home/html/faqinterestrates.en.html> (last visited 27
July 2014).
55
See ECB, ‘Monetary Policy Decisions’, Press Release (5 June 2014), at <http://
www.ecb.europa.eu/press/pr/date/2014/html/pr140605.en.html> (last visited 27 July 2014).
56
See ECB, ‘ECB Announces Monetary Policy Measures to Enhance the Functioning of the
Monetary Policy Transmission Mechanism’, Press Release (5 June 2014), at <http://
www.ecb.europa.eu/press/pr/date/2014/html/pr140605_2.en.html> (last visited 27 July
2014):
In pursuing its price stability mandate, the Governing Council of the ECB has today
announced measures to enhance the functioning of the monetary policy
transmission mechanism by supporting lending to the real economy. In particular,
the Governing Council has decided: (1) To conduct a series of targeted longer-term
refinancing operations (TLTROs) aimed at improving bank lending to the euro area
non-financial private sector, excluding loans to households for house purchase, over
a window of two years; (2) To intensify preparatory work related to outright
purchases of asset-backed securities (ABS).
As reported by the Financial Times on 19 September 2014 (‘Draghi’s attempt to jump start
stuttering Eurozone falls flat’), the ECB’s first offer of cheap TLTROs fell short of
expectations.
57
ECB, Press Release (5 June 2014), above note 56:
The Governing Council has decided to intensify preparatory work related to outright
purchases in the ABS market to enhance the functioning of the monetary policy
transmission mechanism, given the role of this market in facilitating new credit
flows to the economy. Under this initiative, the Eurosystem will consider purchasing
simple and transparent ABS with underlying assets consisting of claims against the
euro area non-financial private sector, taking into account the desirable changes in
the regulatory environment, and will work with other relevant institutions to that
effect. The Eurosystem will work out the appropriate modalities for this policy
measure, including the key requirements that the ABS will have to meet in order to
be eligible. Further details of the initiative will be announced in due course.
58
As Jean-Victor Louis and myself pointed out in a joint contribution, this provision has
become a cause célèbre because it is the legal basis the ECB invokes in refusing to buy
sovereign bonds in the primary market. See Rosa M Lastra and Jean-Victor Louis, ‘European
Economic and Monetary Union: History, Trends and Prospects’ (2013) 32(1) Yearbook of
European Law 57, 98.
59
See European Central Bank, ‘Monetary Policy Decisions’, Press Release (4 September
2014), at <https://www.ecb.europa.eu/press/pr/date/2014/html/pr140904.en.html> (last
60
See Mario Draghi, President of the ECB, ‘Introductory Statement to the Press
Conference’, Frankfurt-am-Main (4 September 2014), at <https://www.ecb.europa.eu/press/
pressconf/2014/html/is140904.en.html> (last visited 5 September 2014). The operational
details were indeed announced on 2 October 2014. See European Central Bank, ‘ECB
Announces Operational Details of Asset-backed Securities and Covered Bond Purchase
Programmes’ (2 October 2014), at <http://www.ecb.europa.eu/press/pr/date/2014/html/
pr141002_1.en.html>.
Purchases of covered bonds commenced on 20 October 2014, while purchases of asset-
backed securities are expected later this year. See Financial Times, 21 October 2014, ‘ECB
bond-buying programme begins’.
61
Draghi, above note 60.
62
Decision ECB/2010/5, recital 2.
63
Decision ECB/2010/5, recital 3.
64
In this context, it is important to remember that such purchases could only be made in
the secondary market in accordance with the prohibition of monetary financing. See
generally Lastra and Louis, above note 58, 127. It is also important to mention that the
liquidity injected through the SMP was intended to be fully ‘sterilized’, ie, it is fully
absorbed from the market on a weekly basis ensuring that the net effect of bond purchases
on the overall liquidity in the interbank money market remains unaffected by the
programme (though the sterilization measures were not always successful).
65
See ECB, ‘Details on Securities Holdings Acquired under the Securities Markets
Programme’, Press Release (21 February 2013), at <http://www.ecb.europa.eu/press/pr/
date/2013/html/pr130221_1.en.html> (last visited 27 July 2014).
66
Fabian Eser and Bernd Schwaab, ‘Assessing Asset Purchases within the ECB’s Securities
Markets Programme’, ECB Working Paper Series No 1587 (September 2013) <https://
www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1587.pdf> (last visited 27 July 2014). The
authors of another paper argue that bond purchases by the ECB under the SMP mitigate
the negative crisis spill-overs among the distressed countries and reduce the ‘flight-to-
safety’ from the distressed countries to Germany. See Roel Beetsma, Frank de Jong,
Massimo Giuliodori, and Daniel Widijanto, ‘The Impact of News and the SMP on Realized
(Co)variances in the Eurozone Sovereign Debt Market’, ECB Working Paper Series No 1629
(January 2014), at <http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1629.pdf> (last visited
27 July 2014).
The controversy over the bond purchases allegedly led to the resignation of the two
members of the ECB Governing Council—Jürgen Stark and Axel Weber Reuters. See eg
Andreas Framke, Alexander Huebner, and Paul Carrel, ‘Stark to Leave ECB over Bond-
Buying Row—Sources’ (9 September 2011), at <http://uk.reuters.com/article/2011/09/09/
uk-ecb-stark-idUKTRE7883D720110909> (last visited 27 July 2014), the president of the
Bundesbank, Jens Weidmann, also made his descending views public.
67
See ECB, ‘ECB Announces Measures to Support Bank Lending and Money Market
Activity’, Press Release (8 December 2011), at <http://www.ecb.europa.eu/press/pr/date/
2011/html/pr111208_1.en.html> (last visited 27 July 2014).
68
Decision of the ECB of 14 December 2011 on additional temporary measures relating to
the Eurosystem refinancing operations and eligibility of collateral, ECB/2011/25 (2011/870/
EU), OJ L 341/65 (22 December 2011).
69
See ECB, Open Market Operations, Reference No 20110149, at <https://
www.ecb.europa.eu/mopo/implement/omo/html/20110149_all.en.html> (last visited 27 July
2014), and ECB, Open Market Operations, Reference No 20120034, at <https://
www.ecb.europa.eu/mopo/implement/omo/html/20120034_all.en.html> (last visited 27 July
2014). A number of operations came to maturity around this time, which reduced the net
liquidity supply to respectively 210 and 310 billion euros. These figures are given by José
Manuel González Paramo, then ECB Executive Board member, ‘De la crisis sub-prime a la
crisis soberana: el papel del BCE’, Speech, Madrid (5 March 2012).
70
Lastra and Louis, above note 58.
71
See ‘Definition of Long-Term Refinancing Operation—LTRO’ Financial Times Lexicon, at
<http://lexicon.ft.com/Term?term=long_term-refinancing-operation-_-LTRO> (last visited 27
July 2014). A large portion of the financing provided to Eurozone banks through LTRO was
used to buy periphery sovereign debt. This became known as the ‘Sarko trade’ after Nicolas
Sarkozy suggested that LTRO meant that the Italian and Spanish governments could
depend on their countries’ banks to buy their bonds.
72
Mario Draghi, President of the European Central Bank, Speech at the Global Investment
Conference, London (26 July 2012), at <https://www.ecb.europa.eu/press/key/date/2012/
html/sp120726.en.html> (last visited 27 July 2014).
73
ECB, ‘Technical Features of Outright Monetary Transactions’, Press Release (6
September 2012), at <http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html>
(last visited 27 July 2014):
As announced on 2 August 2012, the Governing Council of the European Central

Bank (ECB) has today taken decisions on a number of technical features regarding
the Eurosystem’s outright transactions in secondary sovereign bond markets that
aim at safeguarding an appropriate monetary policy transmission and the
singleness of the monetary policy. These will be known as Outright Monetary
Transactions (OMTs) and will be conducted within the following framework:
Conditionality
A necessary condition for Outright Monetary Transactions is strict and effective
conditionality attached to an appropriate European Financial Stability Facility/
European Stability Mechanism (EFSF/ESM) programme. Such programmes can
take the form of a full EFSF/ESM macroeconomic adjustment programme or a
precautionary programme (Enhanced Conditions Credit Line), provided that they
include the possibility of EFSF/ESM primary market purchases. The involvement of
the IMF shall also be sought for the design of the country-specific conditionality and
the monitoring of such a programme.
The Governing Council will consider Outright Monetary Transactions to the extent
that they are warranted from a monetary policy perspective as long as programme
conditionality is fully respected, and terminate them once their objectives are
achieved or when there is non-compliance with the macroeconomic adjustment or
precautionary programme.
Following a thorough assessment, the Governing Council will decide on the start,
continuation and suspension of Outright Monetary Transactions in full discretion
and acting in accordance with its monetary policy mandate.
Coverage
Outright Monetary Transactions will be considered for future cases of EFSF/ESM
macroeconomic adjustment programmes or precautionary programmes as specified
above. They may also be considered for Member States currently under a
macroeconomic adjustment programme when they will be regaining bond market
access.
Transactions will be focused on the shorter part of the yield curve, and in particular
on sovereign bonds with a maturity of between one and three years.
No ex ante quantitative limits are set on the size of Outright Monetary Transactions.
Creditor treatment
The Eurosystem intends to clarify in the legal act concerning Outright Monetary
Transactions that it accepts the same (pari passu) treatment as private or other
creditors with respect to bonds issued by euro area countries and purchased by the
Eurosystem through Outright Monetary Transactions, in accordance with the terms
of such bonds.
Sterilisation
The liquidity created through Outright Monetary Transactions will be fully
sterilised.
Transparency
Aggregate Outright Monetary Transaction holdings and their market values will be
published on a weekly basis. Publication of the average duration of Outright
Monetary Transaction holdings and the breakdown by country will take place on a
monthly basis.
Following today’s decision on Outright Monetary Transactions, the Securities
Markets Programme (SMP) is herewith terminated. The liquidity injected through
the SMP will continue to be absorbed as in the past, and the existing securities in
the SMP portfolio will be held to maturity.
74
ESCB Statute, Art 18.1: ‘In order to achieve the objectives of the ESCB and to carry out
its tasks, the ECB and the national central banks may: operate in the financial markets by
buying and selling outright (spot and forward) or under repurchase agreement and by
lending or borrowing claims and marketable instruments, whether in euro or other
currencies, as well as precious metals. …’
75
Mario Draghi, President of the ECB, Press Conference, Frankfurt am Main (6 September
2012), at <http://www.ecb.int/press/pressconf/2012/html/is120906.en.html> (last visited 27
July 2014).
76
ECB, ‘Compliance of Outright Monetary Transactions with the Prohibition on Monetary
Financing’, ECB Monthly Bulletin (October 2012) 8, at <http://www.ecb.europa.eu/pub/pdf/
mobu/mb201210en.pdf> (last visited 27 July 2014).
77
The ‘special treatment’ of the ECB raised concerns among the investors arguing that
this would create a de facto two-tier market on hand, and on the other hand had the ECB
accepted losses from its Greek debt holdings, this could have been treated as a violation of
monetary financing prohibition.
78
Referral for a preliminary ruling to the Court of Justice of the European Union by the
German Constitutional (Bundesverfassungsgericht) regarding the Decision of the Governing
Council of the European Central Bank of 6 September 2012 on Technical Features of
Outright Monetary Transactions (OMT Decision) lodged on 10 February 2014—Case
C-62/14 Peter Gauweiler and others, pending. See Federal Constitutional Court, Press
Release 9/2014 (7 February 2014), at <http://www.bundesverfassungsgericht.de/en/press/
bvg14-009en.html> (last visited 27 July 2014).
79
Franz C Mayer, ‘Rebels Without a Cause? A Critical Analysis of the German
Constitutional Court’s OMT Reference’ (2014) 15(2) German Law Journal 111, 116–17.
Mayer argues that this doctrine essentially empowers the GCC to independently interpret
EU law. Though the legal consequences of declaring a European act ultra vires would only
be binding in Germany, it gives the GCC a role of final arbiter which is not compatible with
the EU law. See also Russell Miller, ‘Germany vs. Europe: The Principle of Democracy in
German Constitutional Law and the Struggle for European Integration’, Washington and
Lee Public Legal Studies Research Paper Series No 2013/14 (13 August 2013), at <http://
ssrn.com/abstract=2309620> (last visited 27 July 2014). See also Samuel Dahan, Oliver
Fuchs, and Marie-Laure Layus, ‘Whatever it Takes? Regarding the OMT Ruling of the
German Federal Constitutional Court’ (3 October 2014). Available at SSRN: <http://
ssrn.com/abstract=2504976>
80
Udo Di Fabio, ‘Karlsruhe Makes a Referral’ (2014) 15(2) German Law Journal 107. As
explained in Mayer, above note 79, 112, the decision to separate the question about the
OMT from the ESM/Fiscal Compact case was made in December 2013,
Bundesverfassungsgericht [BVerfG—Federal Constitutional Court], 2 BvR 1390/12 (17
December 2013). The Constitutional Court issued an interim decision on the ESM Treaty
and Fiscal Treaty case on 12 September 2012, in which it effectively refused granting
interim measures blocking the Treaties. See BVerfG, 2 BvR 1390/12.
81
Samuel Dahan has argued that there is a mismatch between the Karlsruhe decision and
the Pringle case in that the CJEU implicitly approved the OMT in its argumentation on the
legality of the ESM. He contends that the teleological reading of Art 125 TFEU used in
Pringle—according to which ESM plans are legal only because of the conditionality—could
be applied to Art 123 TFEU. See Samuel Dahan, Olivier Fuchs, and Nancy Marie-Laure
Layus, ‘Whatever it takes? A propos de la décision OMT de la Cour constitutionnelle
fédérale d’Allemagne’ (2014) Actualité Juridique Droit Administratif.
82
For example, Mayer, above note 79, 119–20; Wolfgang Münchau, ‘Germany’s
Constitutional Court has Strengthened the Eurosceptics’ Financial Times (9 February
2014).
83
Dissenting Opinion of Justice Lübbe-Wolff on the Order of the Second Senate of 14
January 2013 and Dissenting Opinion of Justice Gerhardt on the Order of the Second Senate
of 14 January 2014, BVerfG, 2 BvR 2728/13 of 14 January 2014. Tolek Petch, in his article,
‘The Compatibility of Outright Monetary Transactions with EU Law’ (2013) 7 Law and
Financial Markets Review 1, 13–21, while generally concluding that the OMT is compatible
with the EU law, also stated that the argument about the potential loss incurred by the
taxpayers as a result of the implementation of the OMT is a political rather than legal
argument.
84
See also Jean-Victor Louis, ‘Monetary Policy and Central Banking in the Constitution’ in
Legal Aspects of the European System of Central Banks. Liber Amicorum Paolo Zamboni
Garavelli (Frankfurt: European Central Bank, 2005) 29–30.
85
See Polly Curtis, ‘Sarkozy and Merkel call for “True Economic Government” to Save
Eurozone’ The Guardian (16 August 2011).
86
Consolidated versions of the Treaty on European Union and the Treaty on the
Functioning of the European Union, Protocol (No 14) on the European Group, OJ C 115/283
(9 May 2008).
87
See René Smits, The European Central Bank: Institutional Aspects (The Hague: Kluwer
Law International, 1997) 375 n 40.
88
See René Smits, ‘Innovative Ways Out of the Crisis: Can Gold be Used as Collateral by
EU Member States?’ (31 October 2012), at <http://renesmits.eu/publications/emu-policy-
papers/academic-and-advisory> (last visited 27 July 2014).
89
TFEU, Art 138 states that the Council shall adopt ‘a decision establishing common
positions on matters of particular interest for economic and monetary union within the
competent international financial institutions and conferences’ (para 1) and that the Council
may ‘adopt appropriate measures to ensure unified representation within the international
financial institutions and conferences’ (para 2).
90
The establishment of the Single European Payments Area (SEPA) aims to improve the
efficiency of cross-border euro payments. See Regulation (EU) No 260/2012 of 14 March
2012 establishing technical requirements for credit transfers and direct debits in euro and
amending Regulation (EC) No 924/2009, OJ L 94/22 (30 March 2012) (hereinafter ‘SEPA
Regulation’).
91
TARGET2 replaced TARGET (Trans-European Automated Real-time Gross Settlement
Express Transfer System) in November 2007.
92
The right of issue is shared between the States and the ECB (8%) as far as banknotes is
concerned (see Decision of the ECB of 13 December 2010 on the issue of euro banknotes,
ECB/2010/29 (2011/67/EU) OJ L 5/26 (9 February 2011)). TFEU, Art 128 explains the
difference between the issue of banknotes and the issue of coins. Coins are issued by the
States but within the limits provided each year by the ECB. There are no such limits for the
issue of banknotes, as the issue is demand-driven. What is important is the transfer of
monetary policy competence to the ECB, not the right of issue. Anyway, this right is
controlled by the ECB. I am grateful to Jean-Victor Louis for observations on this point.
93
In his comments on this chapter, René Smits rightly pointed out that the European
Parliament’s (EP) assent required for the ‘kissing awake of the Sleeping Beauty provision’
was abolished by TFEU. TFEU, Art 127(6) permits the Council to confer tasks upon the ECB
by a regulation of the Council, after merely consulting the EP: ‘The Council, acting by
means of regulations in accordance with a special legislative procedure, may unanimously,
and after consulting the European Parliament and the European Central Bank, confer
specific tasks upon the European Central Bank concerning policies relating to the
prudential supervision of credit institutions and other financial institutions with the
exception of insurance undertakings.’
This provision—the legal basis of the SSM Regulation—is further discussed in Chapter 10 in
this volume.
94
Chiara Zilioli (now General Counsel of the ECB) and Martin Selmayr regarded the ECB
as ‘an independent specialised organisation of community law’. They first elaborated this
theory in Chiara Zilioli and Martin Selmayr, ‘The External Relations of the Euro Area: Legal
Aspects’ (1999) 36 Common Market Law Review 286, drawing on the previous work done
by Selmayr. They further polished their views in Chiara Zilioli and Martin Selmayr, ‘The
European Central Bank: An Independent Specialized Organization of Community
Law’ (2000) 37 Common Market Law Review 591 and Zilioli and Selmayr, above note 14,
29. Ramon Torrent argued that the ECB is the central bank of the European Community.
See Ramon Torrent, ‘Whom is the European Central Bank the Central Bank of? Reaction to
Zilioli and Selmayr’ (1991) 36 Common Market Law Review 1231. See also René Smits, The
European Central Bank in the European Constitutional Order (Utrecht: Eleven International
Publishing, 2003) 24–5.
95
See Case 11/00 Commission of the European Communities v European Central Bank
[2003] ECR I–7147, para 92 (commonly referred to as ‘the OLAF (European Anti-Fraud
Office) case’).
96
See Zilioli and Selmayr, ‘The External Relations of the Euro Area’, above note 94, 277.
They argue that central banks, unlike States, but similar to international organizations,
never have an originary, but only a derivative, international legal personality, the existence
of which always depends on the intention of their respective States or on recognition by
other subjects of public international law.
97
Case C-11/00 OLAF [2003] ECR I-7147, Advocate General Jacobs on 3 October 2002,
paras 150 and 155 (‘It is…clear that the independence thus established is not an end in
itself; it serves a specific purpose. By shielding the decision-making process of the ECB
from short-term political pressures the principle of independence aims to enable the ECB
effectively to pursue the aim of price stability and, without prejudice to that aim, support
the economic policies in the Community as required by Article 105(1) EC.’), and para 150 n
115 (‘[c]entral bank independence is thought to serve economic policy goals, notably to
reduce inflation and, perhaps, promote economic growth.’).
98
Case C-11/00 OLAF [2003] ECR I–7147, paras 130–5.
99
Case C-11/00 OLAF [2003] ECR I–7147, para 134.
100
101
Case C-11/00 OLAF [2003] ECR I–7147, Advocate General Jacobs on 3 October 2002,
paras 150 and 155 (citing Fabian Amtenbrink, The Democratic Accountability of Central
Banks: A ComparativeStudy of the European Central Bank (Oxford: Hart Publishing, 1999)
11–17 and 23–6).
102
Case C-11/00 OLAF [2003] ECR I–7147, paras 91–2.
103
See Federal Reserve System, Board of Governors, The Federal Reserve System
Purposes and Functions, 7th edn (Washington, DC, 1984) 2.
104
105
René Smits, ‘The European Constitution and EMU: An Appraisal’ (2005) 42 Common
Market Law Review 447, makes the following comment in this regard: ‘The special wording
of the Constitution devoted to the recognition of financial independence…is a welcome
sweetener after the OLAF debacle.’
106
107
P S Pollard, ‘A Look Inside Two Central Banks’, Federal Reserve Bank of St Louis
(January–February 2003) 13, at <https://research.stlouisfed.org/publications/review/03/01/
Pollard.pdf> (last visited 27 July 2014):
In Europe the governments of all the member states of the euro area must agree on
the appointments to the Executive Board. The process begins with a
recommendation by the Council of Economics and Finance Ministers (ECOFIN).
Since ECOFIN comprises the finance ministers of the member countries of the
European Union, its recommendations will reflect the consensus of the member
governments. Once ECOFIN makes its recommendation, the European Parliament
and the Governing Council of the ECB are consulted. Following these consultations
the appointments are confirmed by the heads of state or government of the euro
area members.
108
TFEU, Arts 282(3) and 130 do not contain any limitations. The obligation that binds EU
institutions to sincere mutual cooperation and the competence of the European Council to
‘define the general political directions and priorities’ could lead some to conclude that the
ECB has to comply with this obligation at the expense of price stability. However, the
specific provisions stipulated at TFEU, Arts 127(1) and 130 TFEU derogate the general
obligations of the institutions. Therefore, the ECB independence is not affected by its status
as an institution.
109
Rosa M Lastra, ‘The Independence of the European System of Central Banks’ (1992) 33
Harvard International Law Journal 475, 476–82.
110
See Rosa M Lastra and Geoffrey Miller, ‘Central Bank Independence in Ordinary and
Extraordinary Times’ in Jan Kleineman (ed), Central Bank Independence. The Economic
Foundations, the Constitutional Implications and Democratic Accountability (The Hague:
Kluwer Law International, 2001) 31–50.
111
See Chapter 2 in this volume. See also Rosa M Lastra, ‘How Much Accountability for
Central Banks and Supervisors?’ (2001) 12(2) Central Banking 69 and Rosa M Lastra and
Heba Shams, ‘Public Accountability in the Financial Sector’ in Eilis Ferran and Charles
Goodhart (eds), Regulating Financial Services and Markets in the Twenty First Century
(Oxford: Hart Publishing, 2001) 165.
112
See Amtenbrink, above note 101, 9.
113
See Chiara Zilioli, ‘Accountability and Independence: Irreconcilable Values or
Complementary Instruments for Democracy? The Specific Case of the European Central
Bank’ in Georges Vandersanden et al (eds), Mélanges en Hommage à Jean-Victor Louis
(Brussels: ULB, 2003) 402–5.
114
Compare Zilioli and Selmayr, above note 14, 1–35, especially 29–32, with Torrent,
above note 94, 1129–34.
115
116
Transparency became an issue during the financial crisis. For example, Bloomberg
News challenged the ECB in the CJEU over its refusal to make public the documents that
allegedly could shed light on how Greece managed to hide its growing debts. Though the
request was dismissed by the CJEU in C-28/13 P Thesing and Bloomberg Finance v ECB,
pending, it might demonstrate that the society is not necessarily satisfied with the level of
transparency of the ECB actions.
117
118
See Zilioli, above note 113, 408–9.
119
Zilioli, above note 113, 409.
120
See Amtenbrink, above note 101, 359–63.
121
See Rosa M Lastra, ‘Accountability and Governance—Banking Union Proposals’,
Duisenberg School of Finance, Policy Paper No 30 (November 2012), at <http://www.dsf.nl/
home/research/publications> (last visited 27 July 2014).
122
Commission Green Paper of 31 May 1995 on the practical arrangements for the
introduction of the single currency, COM (95) 333 final.
123
See Madrid European Council, Presidency Conclusions (15–16 December 1995) at
<http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/00400-c.en5.htm>
124
Charles Proctor, The Euro and the Financial Markets, The Legal Impact of EMU
(Bristol: Jordans, 1999) 87.
125
See Madrid European Council, Presidency Conclusions, above note 123, para 2:
The name of the new currency is an important element in the preparation of the
transition to the single currency, since it partly determines the public acceptability
of Economic and Monetary Union. The European Council considers that the name of
the single currency must be the same in all the official languages of the European
Union, taking into account the existence of different alphabets; it must be simple
and symbolize Europe. The European Council therefore decides that, as of the start
of Stage 3, the name given to the European currency shall be Euro. This name is
meant as a full name, not as a prefix to be attached to the national currency names.
126
This decision of the European Council is reflected in the preamble to Regulation (EC)
No 1103/97 of 17 June 1997 on certain provisions relating to the introduction of the euro,
OJ L 162/1 (19 June 1997) (as amended, <http://eur-lex.europa.eu/legal-content/EN/TXT/?
qid=1402931623778&uri=CELEX:01997R1103-20010101> (last visited 27 July 2014)) and
Regulation (EC) No 974/1998 of 3 May 1998 on the introduction of the euro, OJ L 139/1 (11
May 1998) (as amended <http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:
01998R0974-20140101&qid=1402931500196> (last visited 27 July 2014).
127
Regulation (EC) 974/1998 awards the same legal tender status to euro coins in Arts 10
and 11.
128
See Council Regulation (EC) No 975/98 of 3 May 1998 on Denominations and Technical
Specifications of Euro Coins Intended for Circulation, OJ L139/6 (11 May 1998), as
amended by Council Regulation (EC) No 423/1999 of 22 February 1999, OJ L 52/2 (27
February 1999).
129
ESCB Statute, Art 16 further specifies that the ECB ‘shall respect as far as possible
existing practices regarding the issue and design of banknotes’.
130
See Decision of the ECB of 6 December 2001 on the issue of euro banknotes, ECB/
2001/15 (2001/913/EC), OJ L 337/52 (20 December 2001), as amended by the Decision of
the ECB of 18 December 2003, ECB/2003/23 (2004/49/EC), OJ L 9/40 (15 January 2004). A
Decision of the ECB of 22 April 2004 amending Decision ECB/2001/15 of 6 December 2001
on the issue of euro banknotes, ECB/2004/9 (2004/506/EC), OJ L 05/17 (9 June 2004),
specifies the banknote allocation key as well as the obligations of the ECB and NCBs as
issuers of notes. The banknote allocation key means the percentages that result from taking
into account the ECB’s share in the total euro banknote issue and applying the individual
NCB’s shares in the ECB’s subscribed capital in accordance with the weightings in the key
referred to in ESCB Statute, Art 29.1. As acknowledged, each of the members of the
European System of Central Banks is assigned a weighting in the key for subscription to the
ECB’s capital which is based on the population and gross domestic product of each Member
State.
131
Though it was originally thought that EC Treaty, Art 123(4)—abrogated—would have
been the legal basis for the secondary law of the euro, the procedure established under
such article required that ‘the participating Member States’ were to vote on legislation.
However, since in 1997 the Council had not voted yet on which Member States were eligible
to participate in EMU and since a Regulation under this article would not have been
effective in the UK if it exercised the opt-out clause, it was decided to base the first of the
two euro regulations on EC Treaty Art 308 (formerly Art 235) (now TFEU, Art 352), the so-
called ‘flexibility clause’. See Clifford Chance, ‘European Monetary Union: the Legal
Framework’ (October 1997) 5–6. See also TFEU, Art 140.
132
Regulation (EC) 1103/97, Recital 8.
133
Council Regulation (EC) No 974/1998 as amended by Council Regulation (EC) No
2596/2000 of 27 November 2000, Council Regulation (EC) No 2169/2005 of 21 December
2005, Council Regulation (EC) No 1647/2006 of 7 November 2006, Council Regulation (EC)
No 835/2007 of 10 July 2007, Council Regulation (EC) No 836/2007 of 10 July 2007, Council
Regulation (EC) No 693/2008 of 8 July 2008, Council Regulation (EU) No 670/2010 of 13
July 2010.
Regulation 974/1998 (see above note 127) has also been adapted later with subsequent
accessions to the euro area: Latvia and Lithuania.
134
Regulation 974/1998, recital 1.
135
EC Treaty, Art 123(4) stipulated that the Council, acting by a qualified majority of the
Member States without a derogation on a proposal from the Commission and after
consulting the ECB, shall take the other measures necessary for the rapid introduction of
the ecu (euro) as the single currency of those Member States. See also TFEU, Art 140.
136
137
138
139
Regulation 974/1998, Art 8(1).
140
141
142
143
Regulation 974/1998, Art 11.
144
Regulation 974/1998, Art 11.(p. 279)
145
146
147
148
149
See the Guideline of the European Central Bank of 22 April 1999 on the authorisation
to issue national banknotes during the transitional period (ECB/1999/NP11), OJ L 55/71 (24
February 2001), Art 1.
150
TFEU, Art 128.
151
Council Regulation (EC) No 975/98, as amended.
152
Regulation (EC) No 975/98.
153
Regulation (EC) No 975/98, recital 5.
154
Regulation (EC) No 975/98, recital 10.
155
Council Regulation (EC) No 2866/98 of 31 December 1998 on the conversion rates
between the euro and the currencies of the Member States adopting the euro, OJ L 359/1
(21 December 1998), as amended by Council Regulation (EC) No 1478/2000 of 19 June
2000, OJ L 167/1 (7 July 2000); by Council Regulation (EC) No 1086/2006 of 11 July 2006 OJ
L 195/1 (15 July 2006); and by Regulations No 1134/2007 as regards the conversion rate to
the euro for Malta, OJ L 256/1 (2 October 2007) and No 1135/2007 of 10 July 2007 as
regards the conversion rate to the euro for Cyprus, OJ L 256/2 (2 October 2007), and by
Regulation (EU) No 671/2010 as regards the conversion rate to the euro for Estonia, OJ L
196/4 (28 July 2010). Latvia joined in 2013; see Council of the European Union, ‘Latvia to
adopt euro on 1 January 2014’, Doc No 12074/13 (9 July 2013), at <http://
www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/137884.pdf> (last
visited 27 July 2014). As for Lithuania, on 4 June 2014 the European Commission
recommended that the EU Council allow Lithuania to adopt the euro on 1 January 2015.
After the EU Council adopts a decision on the abrogation of a derogation and the
introduction of the euro in the Republic of Lithuania, Council Regulation (EC) No 974/98 of
3 May 1998 on the introduction of the euro will be amended, where the date of the euro
adoption and the date of the cash changeover in the Republic of Lithuania will be
determined, and it will be indicated whether a ‘phasing-out’ period is applied in the
Republic of Lithuania. The irrevocably fixed conversion rate of the litas to the euro will be
set by the Council Regulation (EC) amending Council Regulation (EC) No 2866/98 (National
Changeover Plan).
156
OJ L 140 (14 June 2000).
157
Regulation 1338/2001 of 28 June 2001, OJ L 181/6 (4 July 2001), as amended by
Regulation (EC) No 44/2009 of 18 December 2008 amending Regulation (EC) No 1338/2001
laying down measures necessary for the protection of the euro against counterfeiting, OJ
L17/131 (22 January 2009).
158
159
According to J A E Vervaele ‘Counterfeiting the Single European Currency (Euro):
Towards the Federalization of Enforcement in the European Union?’ (2002) 8 Columbia
Journal of European Law 151, 162:
The ECB has the exclusive right to authorise the issue of banknotes within the euro
area. It does not follow automatically, however, that imposing sanctions on the
counterfeiting of such banknotes would be a Community competence.
Counterfeiting provisions form part of criminal law, not monetary law. There is no
general competence of the Community in the field of criminal law, which is an area
falling within the competence of the Member States.
See also L Klimek, ‘Counterfeiting and Protection of the Euro: From Early Beginnings to the
Current Legislative Development’ (2012) Issues of Business and Law 4, 13:
The international dimension of the threat with respect to euro counterfeiting called
for and still calls for supranational co-ordination at the level of the EU. The Treaty
on the Functioning of the European Union lists the areas of particularly serious
crime with a cross-border dimension. Counterfeiting of means of payment is on that
list (Article 83(1) of the Treaty). In order to protect the euro against counterfeiting,
a legal framework for the protection of the euro has been developed in the EU.
160
See Regulation 1338/2001, recital 4.
161
162
Regulation 1338/2001, Art 2(a).
163
164
165
166
Decision of the ECB of 16 September 2010 on the authenticity and fitness checking and
recirculation of euro banknotes ECB/2010/14 (2010/597/EU), OJ L 267/1 (8 October 2010)
and Regulation (EU) No 1210/2010 of the European Parliament and of the Council of 15
December 2010 concerning authentication of euro coins and handling of euro coins unfit for
circulation, OJ L 339/1 (22 December 2010) establish common rules and procedures for
checking the authenticity of banknotes and coins, and withdrawal of counterfeit items.
167
As successor to the EMI, the ECB emphasizes that it holds the copyright on the designs
of the euro banknotes originally held by the EMI. See Decision of the ECB of 20 March 2003
on the denominations, specifications, reproduction, exchange and withdrawal of euro
banknotes, ECB/2003/4 (2003/205/EC), OJ L78/16 (25 March 2003), recital 3.
168
Guideline of the ECB of 7 July 1998 on certain provisions regarding euro banknotes, as
amended on 26 August 1999 (ECB/1999/3), OJ L 287 (14 November 2000), recital 1.
169
ECB Guideline of 7 July 1998, recital 2.
170
See ECB Decision of 20 March 2003 (ECB/2003/4) (replacing decisions of 1998 and
2001).
171
See Decision of the ECB of 19 April 2013 on the denominations, specifications,
reproduction, exchange and withdrawal of euro banknotes (ECB/2013/10), OJ L 118 (30
April 2013) 37.
172
ECB Decision of 19 April 2013 (ECB/2013/10), recital 4.
173
ECB Decision of 19 April 2013 (ECB/2013/10), Art 3.
174
ECB Decision of 19 April 2013 (ECB/2013/10), recital 12. The withdrawal of bank notes,
according to ECB Decision of 20 March 2003 (ECB/2003/4), Art 5 ( ECB Decision of 19 April
2013 (ECB/2013/10), Art 6) shall be regulated by a decision of the Governing Council
published for general information in the Official Journal of the European Union and other
media. This Decision shall cover, as a minimum, the euro banknote type or series to be
withdrawn from circulation, the duration of the exchange period, the date on which the
euro banknote type or series will lose its legal tender status, and the treatment of the euro
banknotes presented once the withdrawal period is over and/or they have lost their legal
tender status.
175
See generally Christoph A Stumpf, ‘The Introduction of the Euro to States and
Territories outside the European Union’ (2003) 28 European Law Review 283.
176
Council Decision 1999/95/EC of 31 December 1998 concerning the monetary
arrangements in the French territorial communities of Saint-Pierre-et-Miquelon and
Mayotte, OJ L 30/29 (4 February 1999); see also Opinion of the European Central Bank, OJ
C 127/5 (7 May 1999), and the original proposal for the Council Decision, COM 1999/10
[1999] OJ C 36/19.
177
Monetary Agreement between the Italian Republic, on behalf of the European
Community, and the Republic of San Marino [2001] OJ C 209/1. New ‘mini-State’
arrangements have been adopted, as we further discuss in Chapter 9. See Communication
from the Commission to the Council Report on the functioning of the Monetary Agreements
with Monaco, San Marino and Vatican, COM/2009/0359 final (14 July 2009). A Monetary
Agreement was concluded and signed between Andorra and the European Union in 2011
and it entered into force on 1 April 2012. See also Baudouin Lamine (Directorate-General
for Economic and Financial Affairs), ‘Monetary and Exchange-rate agreements between the
European Community and Third Countries’, European Commission Economic Papers No
255 (September 2006), at <http://ec.europa.eu/economy_finance/publications/
publication658_en.pdf> (last visited 27 July 2014).
178
Council Decision 1999/98/EC of 31 December 1998 on the position to be taken by the
Community regarding an agreement concerning the monetary relations with Vatican City,
OJ L 30/35 (4 February 1999). See COM/2009/0359 final (14 July 2009).
179
Monetary Agreement between the State of the Vatican City, represented by the Holy
See, and the Italian Republic on behalf of the European Community [2001] OJ C 299/1.
180
Monetary Agreement between the Government of the French Republic, on behalf of the
European Community, and the Government of His Serene Highness the Prince of Monaco
[2002] OJ L 142/59.
181
Stumpf, above note 175, 284. See also the ECB Opinion on Andorra, CON/2004/32, OJ
C 256 (16 October 2004) 9, at <http://www.ecb.int/ecb/legal/pdf/
c_25620041016en00090009.pdf> (last visited 27 July 2014). Since 2011 Andorra has a
monetary agreement with the EU allowing it to make the euro its official currency. The
agreement came into force on 1 April 2012.
182
Stumpf, above note 175.
183
Nassim Nicholas Taleb, The Black Swan (New York: Random House, 2007).
184
Slovenia (2007), Slovakia (2009), Estonia (2011), and Latvia (2014) already joined the
euro zone.
185
See also Barry Eichengreen, ‘Breakup of the Euro Area’ in Alberto Alesina and
Francesco Giavazzi (eds), Europe and the Euro (Chicago: University of Chicago Press, 2010)
11–51, at <http://www.nber.org/chapters/c11654>. See also Cinzia Alcidi, Paul De Grauwe,
Daniel Gros, and Yonghyup Oh, ‘The Future of the Eurozone and Gold’, CEPS Special
Reports (3 September 2010), at <http://www.ceps.eu/book/future-eurozone-and-gold> (last
186
Lisbon Treaty, Art 50 reads as follows:
1. Any Member State may decide to withdraw from the Union in accordance
with its own constitutional requirements.
2. A Member State which decides to withdraw shall notify the European
Council of its intention. In the light of the guidelines provided by the
European Council, the Union shall negotiate and conclude an agreement with
that State, setting out the arrangements for its withdrawal, taking account of
the framework for its future relationship with the Union. That agreement shall
be negotiated in accordance with Article 218(3) of the Treaty on the
Functioning of the European Union. It shall be concluded on behalf of the
Union by the Council, acting by a qualified majority, after obtaining the
consent of the European Parliament.
3. The Treaties shall cease to apply to the State in question from the date of
entry into force of the withdrawal agreement or, failing that, two years after
the notification referred to in paragraph 2, unless the European Council, in
agreement with the Member State concerned, unanimously decides to extend
this period.
4. For the purposes of paragraphs 2 and 3, the member of the European
Council or of the Council representing the withdrawing Member State shall
not participate in the discussions of the European Council or Council or in
decisions concerning it.
A qualified majority shall be defined in accordance with Article 238(3)(b) of the

Treaty on the Functioning of the European Union.
5. If a State which has withdrawn from the Union asks to rejoin, its request
shall be subject to the procedure referred to in Article 49.
For an analysis of Art 50 and other legal scenarios, see generally Phoebus Athanassiou,
‘Withdrawal and Expulsion from the EU and EMU; Some Reflections’, ECB Working Paper
No 10 (December 2009), at <http://www.ecb.int/pub/pdf/scplps/ecblwp10.pdf> (last visited
27 July 2014).
187
The Protocol (nowadays numbered No 24) attached to the EC Treaty on the irreversible
character of the Community’s movement to the third stage of economic and monetary
union, is a document that the authors of the proposed EU Constitution did not include
among the texts adopted. I thank René Smits for observations on this point.
188
See Christoph W Herrmann, ‘Monetary Sovereignty over the Euro and the External
Relations of the Euro Area: Competences, Procedures and Practice’ (2002) 7 European
Foreign Affairs Review 4.
189
See Charles Proctor, Mann on The Legal Aspect of Money, 6th edn (Oxford: Oxford
University Press, 2005) ch 32.
190
See Tullio Treves, ‘Monetary Sovereignty Today’ in Mario Giovanoli (ed), International
Monetary Law: Issues for the New Millennium (Oxford: Oxford University Press, 2000) 116,
cited in Chapter 1 in this volume. See also René Smits, ‘The European Constitution and
EMU: an Appraisal’ (2005) 42 Common Market Law Review 444, 465.
191
See Tolek Petch, Legal Aspects of the Eurozone Crisis (London: Slaughter and May,
2012) 158–9:
There are four cumulative requirements before recourse may be made to Article
352. First, action by the EU must be necessary. Secondly, that action must be within
the framework of the policies defined in the Treaties. Thirdly, it must be necessary
to attain one of the objectives set out in the Treaties. Finally, the Treaties must not
have provide the necessary powers (para 4.32).
René Smits, however, strongly disagrees that Art 352 can be used for this purpose.
Part II Developments at the EU Level, 8 Economic
Governance
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
(p. 287) 8 Economic Governance
B. Asymmetry of EMU 8.15
C. Primary Law Regarding ‘Economic Union’: From Maastricht to Lisbon 8.19
Coordination (‘positive integration’) 8.26
Prohibitions (‘negative integration’) 8.31
Prohibition of monetization of government debt 8.33
Prohibition of privileged access to financial institutions 8.36
No mutual guarantee of debts (the ‘no bail-out’ provision) 8.37
Prohibition of excessive deficits 8.50
The reference values 8.51
The excessive deficit procedure 8.58
D. Pre-crisis Secondary Law: The Stability and Growth Pact 8.63
History of the Stability and Growth Pact 8.66
Objectives of the SGP: From the ‘rigid SGP’ to the ‘flexible SGP’ 8.75
Regulation 1466/1997 as amended by Regulation 1055/2005 on the
strengthening of the surveillance of budgetary positions and the
coordination of economic policies 8.78
Council Regulation 1467/97 as amended by Regulation 1056/2005
on speeding up and clarifying the excessive deficit procedure 8.81
Practice of the Stability and Growth Pact 8.85

The case of Germany and the Judgment of the ECJ 8.86
E. The Fiscal Crisis and Lessons Thereof 8.95

From financial crisis to fiscal crisis 8.96
The roots of the Eurozone debt crisis 8.101
Fiscal Fatigue 8.106
Persistent internal and external macroeconomic imbalances 8.112
F. Strengthening Economic Governance Post Crisis 8.115

Fiscal policy coordination 8.121
Preventive rules: fiscal surveillance 8.123
Corrective rules 8.132
National frameworks 8.137
Sanctions and reverse voting 8.139
Preventing and correcting macroeconomic imbalances 8.147

Preventive arm: macroeconomic surveillance 8.149
Corrective arm: excessive imbalance procedure 8.152
Soft coordination of general economic policy 8.155

Europe 2020 8.156
The Euro Plus Pact 8.161
The TSCG and economic policy coordination 8.163
The European Semester: synchronization of governance mechanisms 8.165
G. Architecture to Deal with Sovereign Debt Problems in the Eurozone 8.167
Greek Loan Facility 8.169
EFSM 8.170
EFSF 8.172
ESM 8.173
The Pringle case 8.183
Validity of Decision 2011/199 8.185
Compatibility of the ESMT with EU treaties 8.188
Conclusion and ratification of the ESMT before the entry into force
of the Decision 2011/199 8.192
H. Genuine Economic and Monetary Union 8.193

I. Regional Adjustment 8.198
J. Concluding Observations 8.207
(p. 288)
The concern of the Bundestag to oppose any relaxation of the stability criteria
derives support from the Protocol on the Convergence Criteria. Without German
agreement, the convergence criteria cannot be relaxed.
Extract from the Judgment of the German Federal Constitutional Court, 18 October
1993, recital 861
We must not apply the treaty provisions on imposing [fiscal] mandatory

requirements and sanctions too mechanically. …More respect should be given to the
EU members’ primary competence over economic and fiscal policy.
Gerhard Schröder, former German Chancellor, on the reform of the Stability and
Growth Pact in ‘A Framework for a Stable Europe’ Financial Times (17 January
2005)
There is a need for more fiscal union in the eurozone…Stability is in everyone’s

interest. …What is needed now is more fiscal discipline with sanctions for countries
that fail to respect the rules.
Angela Merkel, German Chancellor, on the response to the sovereign debt crisis, in
her Speech at the Bundestag (2 December 2012)
A. Introduction
8.01 This chapter opens with three different epigraphs. The first represents the ‘official’
German view at the time when the Maastricht Treaty was ratified. As Samuel Brittan lucidly
put it: ‘Fiscal criteria are the German price for EMU’.2 The second quote represents the
German view following the costs of reunification, which had proven to be more onerous and
long-lasting than originally anticipated. The revised view was characterized by a desire to
relax the Stability and Growth Pact (SGP). (As examined in this chapter, the breach of the
budgetary rules both by Germany and France, seriously damaged the credibility of the
SGP3.) The third quote—in line with the first—represents the German view in response to
the Eurozone debt crisis. After a period of fiscal flexibility the traditional German view on
fiscal discipline is once again the foundation of German views on economic policy.
8.02 In the negotiations that led to the Maastricht Treaty, Germany was adamant that
fiscal sustainability was to be a key foundation for monetary stability and, accordingly, the
Community’s primary and secondary law enshrined numerical and quantitative criteria with
regard to the prohibition of ‘excessive’ deficits and the size of the public debt and
established procedures to enforce such rules. Germany was the main ‘architect’ of the SGP,
introduced in 1997 to ensure that the prohibition of excessive deficits could be enforced (p.
289) through strict rules and sanctions and to establish an EU-wide medium-term objective
of budgetary balance for the Member States.
8.03 The Eurozone debt crisis revived an old debate about the role of fiscal policy in
fighting recessions. More particularly, the rules and sanctions which constitute the
framework underpinning fiscal policy in the European Union, hailed by many as a guarantee
of restraint and a condition for the success of the euro, have come under intense scrutiny.
The automatic nature of the excessive deficit procedure has always been the subject of
much controversy (the words of the former President of the EU Commission, Romano Prodi,
still resonate: ‘stupid’ rules).4
8.04 The twin financial and sovereign debt crises in the Eurozone have triggered a
significant revision of the legal landscape of EU economic governance. The turmoil exposed
several shortcomings in the system. It became clear that the legal framework foreseen in
Title VIII of the Treaty and related secondary law was inadequate.
8.05 The need for large fiscal stimuli in numerous Member States led to the weakening of
their budgetary positions. As countries struggled to meet their obligations under Treaty
rules, while being penalized by the markets for their worsening public finances, the
inconsistency of the incomplete/asymmetric legal construction of Economic and Monetary
Union (EMU) with a centralized monetary policy and decentralized fiscal policy became
quite evident.
8.06 In some cases, the problems predated the crisis. Indeed, as a result of the
introduction of the euro, Eurozone members had enjoyed the benefits of the expansion of
trade and investment in an environment of low interest rates. The leniency of financial
markets combined with a lack of fiscal discipline at the national level led to a significant
deterioration of the fiscal position in Greece.5
8.07 There was also wide divergence in competitiveness and domestic demand within the
euro area. Policy makers have long underestimated these imbalances and their impact on
the fiscal framework. The financial crisis clearly demonstrated that these macroeconomic
and fiscal imbalances stemming from the so-called ‘monetary union without fiscal union’
had a destabilizing effect for the entire Eurozone. The financial markets’ loss of confidence
confronting certain euro area countries spread to other Member States and threatened the
stability of the euro area as whole.
8.08 The EU and the euro area have recently undertaken reforms to address the situation,
both in terms of a new architecture for the resolution of sovereign debt problems in the
Eurozone and in terms of the design of revamped fiscal rules. While 2010 was mainly
geared towards (p. 290) ad hoc emergency measures, the EU has taken permanent legal
measures to reinforce the economic dimension of EMU in 2011 and 2012.
8.09 A comprehensive set of rules entered into force on December 2011 to strengthen
fiscal and macroeconomic surveillance (the ‘Six Pack’ legislation). The Commission also
proposed two additional legislative texts to ensure even more rigorous budgetary
surveillance (the ‘Two Pack’ legislation, which came into force in 2013). In parallel to these
legal measures to strengthen governance, the European Semester has established a
timetable for all the governance mechanisms and the Euro Plus Pact (a soft law instrument)
which is built on the Europe 2020 strategy for ‘smart, sustainable and inclusive growth’.
8.10 Last but not least, in 2012, the EU Member States—except the United Kingdom and
the Czech Republic—concluded a new intergovernmental Treaty on Stability, Coordination
and Governance in the Economic and Monetary Union (TSCG—the fiscal part of the TSCG is
referred to as ‘Fiscal Compact’), while the Eurozone Member States signed a Treaty
establishing the European Stability Mechanism (ESMT).
8.11 The creation of new, intergovernmental institutions that lie outside the framework
currently provided in the EU treaties poses important constitutional law issues,6 and
introduces further elements of differentiation and conditionality in the process of European
economic integration.
8.12 This chapter examines the legal framework for economic governance according to
EU’s primary and secondary law with a particular emphasis on the post-crisis regulatory
framework.
8.13 The Treaty of Lisbon of December 2009 did not alter the primary law governing
economic and monetary policy. The post-crisis TSCG, however, modifies significantly fiscal
primary law (though its inter-governmental structure restricts its jurisdictional domain to
the signatory countries to that Treaty). As for secondary law, the euro debt crisis has
created a window of opportunity to highlight the shortcomings in the architecture of EMU
and to take several initiatives to reinforce the economic pillar of EMU. It is also interesting
to observe (with the Pringle case and the referral to the Court of Justice of the European
Union (CJEU) by the German Constitutional Court of the Outright Monetary Transactions
(OMT) decision) the new role of supreme judges in the formation of economic policy.
8.14 The need for economic and social cohesion is of great relevance for the success of
economic coordination, in particular in the light of the negative social consequences
resulting from the deregulatory pressure exerted on labour and social policy at the onset of
the crisis, an issue that is briefly discussed at the end of this chapter in the context of
‘regional adjustment’.
(p. 291) B. Asymmetry of EMU

8.15 The Treaty on the Functioning of the European Union (TFEU) came into force on 1
December 2009. However, the special asymmetric structure of EMU in which the legal
framework of the Economic Union totally differs from that of the Monetary Union was not
altered by the Lisbon Treaty. As mentioned in Chapter 6, the term ‘economic union’ is a
misnomer because, while Monetary Union conveys the reality of ‘oneness’, there is no
‘oneness’ with regard to the Member States’ primary competence over economic and fiscal
policy. The singleness of monetary policy contrasts with the multiplicity of fiscal policies.
The area of jurisdiction of fiscal policy is national. The area of jurisdiction of monetary
policy (for those countries which have adopted the euro) is supranational. In the words of
Alexandre Lamfalussy, ‘the greatest weakness of EMU is the E. The M Part is institutionally
well organised. We have a solid framework. We don’t have that for economic policy.’7
The term ‘economic’ is a broad concept that in other contexts also encompasses exchange
rate and monetary policies, trade policy, etc. In the EU context, however, the term
‘economic union’ refers mostly to the budgetary position and fiscal policies of the Member
States.
8.16 It should be noted that the EU budget is small and financed wholly from ‘own
resources’.8 Own resources account for 99 per cent of the budget. They are not allowed to
exceed 1.23 per cent of the EU’s gross national income (GNI).9 The EU budget is a ‘curious
hybrid’, since it is much more than the budget assigned to international organizations such
as the International Monetary Fund (IMF), but not comparable to the budget of ‘an
autonomous political entity which…has some direct link with a local electorate in relation to
fund-raising’.10
8.17 The advent of monetary union took place without a corresponding transfer of fiscal
powers to a supranational authority. As stated by Pascal Lamy, ‘we called economic and
monetary union a union that was extremely monetary and scarcely economic’.11 A
centralized monetary policy co-exists with decentralized fiscal policies, albeit subject to
significant procedural and substantive supranational constraints, in particular the
permanent obligation imposed upon Member States to avoid excessive deficits.12 ‘Economic
union’ is, in fact, (p. 292) economic policy coordination and, given the ‘enforcement deficit’
in the application of the fiscal rules, it has been so far a rather soft form of economic policy
coordination.
8.18 In the following section, an analysis of the legal provisions regulating economic policy
in the EU is presented, differentiating between pre-crisis and post-crisis law since the crisis
has created a window of opportunities to reform the legal framework for economic
governance in the EU.
C. Primary Law Regarding ‘Economic Union’: From Maastricht

to Lisbon
8.19 Article 119 TFEU defines the economic component of EMU as ‘the adoption of an
economic policy which is based on the close coordination of Member States’ economic
policies, on the internal market and on the definition of common objectives, and conducted
in accordance with the principle of an open market economy with free competition.’ Article
119 paragraph 3 spells out the guiding principles: ‘stable prices, sound public finances and
monetary conditions and a sustainable balance of payments’.
8.20 TFEU did not alter substantially the contents of the EC Treaty. The provisions on
economic policy coordination are inserted in Chapter 1 of Title VIII (‘Economic and
Monetary Policy’), comprising Articles 119–26.
8.21 Economic policy coordination is not included in the ‘areas of shared competences’
defined in Article 4 TFEU. Instead, the Lisbon Treaty introduces a specific provision, Article
5 to deal with ‘the co-ordination of economic and employment policies’, which reads as
follows:
1. The Member States shall coordinate their economic policies within the
Union. To this end, the Council of Ministers shall adopt measures, in
particular broad guidelines for these policies.
Specific provisions shall apply to those Member States whose currency is the
euro.
2. The Union shall take measures to ensure co-ordination of the employment
policies of the Member States, in particular by defining guidelines for these
policies.
3. The Union may take initiatives to ensure co-ordination of Member States’
social policies.
8.22 Article 2 TFEU, a provision dealing with ‘categories of competence’, refers to the co-
ordination of economic policies in its paragraph 3 (while para 1 deals with exclusive
competences and para 2 with shared competences). This has prompted some commentators
to argue that economic policy coordination is a ‘specific competence’.13 Jean-Victor Louis
maintains that the ‘compromise formula’ adopted tries to satisfy the viewpoint of those who
favoured a formula expressing that it was up to the Member States to coordinate their (p.
293) economic policy within the Union and the standpoint of those who favoured that it was
up to the Union to coordinate the economic policies of the Member States.14 The doctrinal
debate concerning what sort of category of competence economic policy coordination
reflects the uneasy cohabitation in the Treaty of a centralized monetary policy and an
essentially decentralized (albeit coordinated) fiscal policy.
8.23 The key primary law provisions regarding economic policy are Article 121 TFEU
regarding broad guidelines and multilateral surveillance and Article 126 TFEU regarding
excessive deficits and the excessive deficit procedure. These two provisions have been
further elaborated in the recent primary and secondary Union law acts (Six Pack, Two Pack,
and Euro Plus Pact) as explained in paragraph 8.58 below.
8.24 Article 121 TFEU is an element of ‘positive integration’.15 Positive integration
requires the coordination of Member State policies, as well as the approximation of laws
and regulations. A fundamental principle of the ‘economic’ component of EMU is that public
finances in individual Member States are a matter for common concern at the European
level and the subject of ‘positive integration’ with the adoption of common rules and
procedures.
8.25 Article 126 TFEU is an element of ‘negative integration’, which entails measures
which Member States should abolish and actions which they should refrain from taking (ie,
excessive deficits). There are other forms of negative integration besides the avoidance of
excessive deficits, such as the prohibition to finance government deficits.
Coordination (‘positive integration’)
8.26 ‘A coordinated economic policy is not a luxury for a monetary union. It may be
essential to its long-term survival.’16
According to 121(1) TFEU Member States shall regard their economic policies as a matter
of common concern and shall coordinate them with the Council. The main instruments to
achieve coordination are the setting out of broad guidelines—Article 121(2)—and a
mechanism for peer review—Article 122(3)—which is referred to as ‘multilateral
surveillance’.
8.27 The ‘broad economic policy guidelines’ (BEPG) are formulated once every three
years.17 The recommendations often resemble reports and economic surveys prepared by
the IMF or the Organisation for Economic Co-operation and Development (OECD). Their
content has, however, expanded considerably since their origin in 1993. Since 2005, the
BEPG and (p. 294) the employment guidelines were amalgamated in the integrated
guidelines and they have focused not just on macroeconomic policies but also on
microeconomic policies and employment policies.18 For instance, the 2008–10 BEGP contain
twenty-five guidelines, including guidelines on wage development, research and
development, information, communication and technology, sustainable development,
competiveness, small and medium-sized enterprises (SMEs), the inclusiveness of labour
markets and education and training cycles.19
8.28 Multilateral surveillance, according to Article 121(3) EC Treaty, refers to the
assessment of the economic policies of the Member States to ensure convergence and
consistency with the broad guidelines defined above. The Member States provide the
relevant information, the National Actions Plans, which set out how they will meet the
guidelines. The Commission then prepares the reports that it submits to the Council for the
purposes of ‘multilateral surveillance’.
8.29 Article 121(4) TFEU introduced an early warning right for the Commission within the
framework of multilateral surveillance. The Commission may address a warning if, under
the procedure of Article 121(3) TFEU, the assessment concludes that the economic policies
of the Member State/s are not consistent with the broad guidelines or that they risk
jeopardizing the proper functioning of economic and monetary union. The Council, acting
by a qualified majority on a recommendation from the Commission, is however, still
competent to make the necessary recommendations to the Member State/s concerned. It
may also decide to make its recommendations public, acting by a qualified majority on a
proposal from the Commission. The respective Member State/s can no longer take part in
the vote.
8.30 The Treaty of Lisbon also introduced the possibility for the guidelines to be applied
just for the Eurozone (Article 136(1) TFEU). This provision authorizes the Council to adopt
measures to ‘ensure the proper functioning of the economic and monetary union’. These
include measures ‘to strengthen the co-ordination and surveillance of [the] budgetary
discipline’ of the Member States as well as the setting out of ‘economic policy guidelines’ as
long as ‘they are compatible with those adopted for the whole of the Union. According to
Article 136(2) TFEU, Member States with derogation will not be eligible to vote in that
respect’.
Prohibitions (‘negative integration’)
8.31 There are strong reasons to restrict the fiscal behaviour of governments in the
Member States that have adopted the euro. TFEU contains a number of prohibitions
intended to reinforce market discipline and to impose an official level of fiscal restraint.20
The philosophy behind these prohibitions is that borrowing and spending decisions by the
government (p. 295) in one Member State have negative influences in the whole
Eurozone.21 The crisis provided ample evidence of these negative effects.
8.32 These provisions (in particular Arts 123 and 125 TFEU)—which acted as a
‘straightjacket’ in trying to solve the Eurozone debt problems22—have been the subject of
much controversy when assessing the legality of some of the actions undertaken to combat
the crisis, such as the Securities Markets Programme and the announcement of the OTM by
the European Central Bank (ECB).
Prohibition of monetization of government debt
8.33 In accordance with the provisions of Article 123(1) TFEU, overdraft facilities, or any
other type of credit facility with the ECB or with the central banks of the Member States in
favour of Union institutions, bodies, offices or agencies, central governments, regional,
local or other public authorities, other bodies governed by public law, or public
undertakings of Member States, are prohibited. The same applies for the purchase directly
from these public organizations by the ECB or national central banks (NCBs) of debt
instruments. The prohibition does not apply to publicly owned credit institutions which, in
the context of the supply of reserves by central banks, are given the same treatment by
national central banks and the ECB as private credit institutions.
8.34 As Jean-Victor Louis and myself point out in a joint contribution, this provision has
become a cause célèbre because it is the legal basis the ECB invokes in refusing to buy
sovereign bonds in the primary market.23
8.35 The rule prohibiting government financing is repeated in Article 21 of the Statute of
the European System of Central Banks and of the European Central Bank (ESCB Statute)
which concerns operations of the European System of Central Banks (ESCB) with public
entities. While Article 21 TFEU allows the ECB and NCBs to perform functions as fiscal
agents for governments, it prohibits the financing of governments.
Prohibition of privileged access to financial institutions
8.36 In accordance with Article 124 TFEU, any measure, not based on prudential
considerations, establishing privileged access by Union institutions or bodies, offices or
agencies, central governments, regional, local or other public authorities, other bodies
governed by public law, or public undertakings of Member States to financial institutions,
shall be prohibited.
No mutual guarantee of debts (the ‘no bail-out’ provision)
8.37 According to Article 125(1):
The Union shall not be liable for or assume the commitments of central
governments, regional, local or other public authorities, other bodies governed by
public law, or public undertakings of any Member State, without prejudice to
mutual financial guarantees for the joint execution of a specific project. A Member
State shall not be liable for or assume the commitments of central governments,
regional, local or other public authorities, other bodies (p. 296) governed by public
law, or public undertakings of another Member State, without prejudice to mutual
financial guarantees for the joint execution of a specific project.
8.38 Article 125 TFEU is effectively the ‘no mutual guarantee of debts’ provision. The
colloquial term ‘no bail-out’, even if legally inaccurate, remains in use. However, the
provision does not forbid the voluntary assistance to a troubled country. It does forbid
implicit and explicit guarantees.24
8.39 Smits insightfully pointed out that ‘financial markets are hereby warned that each
Member State is “on its own” and not backed by implicit guarantees from the Community or
from fellow Member States.’25 The rationale of this provision is that governments whose
behaviour is financially irresponsible are not allowed to ‘free ride’ on the credit-worthiness
of other Member States and should pay the risk premiums for their own individual
circumstances. A default by a Member State is therefore considered to be an internal
problem of the affected State and its respective creditors.
8.40 However, the crisis forced national and European authorities to intervene in favour of
Member States in great need. So what could they do? The instruments at their disposal
were limited.26
8.41 Article 143 TFEU set up a medium-term balance of payment (MTBoPA) facility
available only for non Eurozone members. When a ‘Member State with a derogation’ is in
difficulties or seriously threatened with difficulties as regards its balance of payments the
Council can eventually grant ‘mutual assistance’ and ‘appropriate methods’.27
8.42 Under this MTBoPA facility, financial assistance was provided to Hungary, Latvia and
Romania at the beginning of the crisis.28 The funds in this MTBoPA facility are raised by the
European Commission on behalf of the EU in international financial markets. For each
programme, there is a planned disbursement schedule agreed by all programme partners
according to the estimated financing need of the country. The total outstanding amount of
loans to be granted to Member States under the medium-term financial assistance facility is
limited to EUR 50 billion. The maximum amount was increased in response to the financial
crisis, by EUR 25 billion in December 2008 and a further EUR 50 billion in May 2009.29
8.43 A limited scope for exercising financial solidarity is foreseen in Article 122(2) TFEU
but only under extraordinary circumstances. Article 122(2) TFEU addresses situations in
which a Member State ‘is in difficulties or is seriously threatened with severe difficulties
caused by natural disasters or exceptional occurrences beyond its control’. But it does not
establish a claim, not even an obligation to assist. It is up to the discretion of the Council to
grant the aid: ‘Where a Member State is in difficulties or is seriously threatened with severe
(p. 297) difficulties caused by natural disasters or exceptional occurrences beyond its
control such aid may be provided.’
8.44 In May 2010, financial aid was given to Greece because of the imminent danger that
the country could not refinance its outstanding debt and because its budget deficit reached
a two digit number. The aid was granted as credit guarantees on a bilateral basis.30 Article
122(2) TFEU was the legal basis for the assistance since the situation of the Greek finances
was considered to be an ‘exceptional occurrence beyond the control’ of Greece.31 The
controversy surrounding this case is examined in paragraphs 8.98–8.99 below.
8.45 Member States’ government bonds had benefitted—regardless of the state of their
public finances—from the Eurozone’s single interest rate until 2009.32 The financial crisis,
however, triggered a new dynamic. From late 2009, the markets started to exert their
discipline upon ‘weaker governments’ (ie, upon members running large deficits and
accumulated public debt) by widening the yield spreads—risk premium—on their
government bonds and lowering their credit ratings.33 Fears of a sovereign debt crisis
developed among investors as a result of the rising government debt levels in certain
European countries along with a wave of downgrading of government debt in some
European States.34 While problems were confined to a few Eurozone countries, the crisis
became an existential issue for the Eurozone as a whole, leading to speculation about a
possible breakup of the euro.35
8.46 Before the Eurozone debt crisis, the European Central Bank had set minimum credit
standards defining the limits on what it would accept as adequate collateral in its credit
operations.36 Former ECB President Jean-Claude Trichet had said that the ECB would
refuse to accept as collateral government bonds rated below A–, which has been interpreted
as a reminder to Member States that serious ‘market penalties’ await countries that exhibit
fiscal indiscipline.37 In March 2011 and September 2012, ‘the Governing Council of the
ECB…decided to suspend the application of the minimum credit rating threshold in the
collateral eligibility requirements for the purposes of the Eurosystem’s credit operations in
the case of marketable debt instruments issued’ by Member States that are ‘eligible for
Outright Monetary Transactions or are under an EU–IMF programme and comply with the
attached conditionality as assessed by the Governing Council’.38 The ECB also decided to
expand the list of assets eligible to be used as collateral until further notice.
(p. 298) 8.47 As explained in Chapter 7, the ECB decided to help keep down the borrowing
costs of crisis-hit countries through the Securities Markets Programme (a bond-purchasing
programme) in 2010 in order to ‘restore an appropriate transmission mechanism of
monetary policy’,39 and then by announcing, in August 2012, the OMTs.40 Mario Draghi, the
ECB president, publicly proclaimed that the central bank would do ‘whatever it takes’ to
ensure the future stability of the euro.41
8.48 Along similar lines, some economists argued—long before the Eurozone debt crisis—
that a single monetary area would require financial transfers from one region to another to
absorb cyclical problems or to deal with other problems.42 The crisis has given the green
light for a ‘fiscal integration’ road map, notably with the publication of the Commission
Green Paper on Stability Bonds of 23 November 2011. It is commonly agreed that deeper
fiscal integration is necessary to overcome the structural defects that have hindered the
Eurozone efforts to tackle the euro debt crisis.
8.49 However, TFEU does not include any provision regarding the possibility of fiscal
transfers to deal with cyclical problems or to offset regional/national imbalances, and the
debate over Eurobonds always comes back to the same point. Germany has been reluctant
to share the debt burden of stressed Eurozone peers.43
Prohibition of excessive deficits
8.50 The prohibition in Article 126(1) TFEU (ex Article 104(1) EC Treaty) is a firm rule:
‘Member States shall avoid excessive government deficits.’
It is for the Commission to monitor the budgetary situation in the Member States and for
the Council to decide whether an excessive deficit exists and, if necessary, to compel the
Member State to reduce the deficit identified.
The reference values
8.51 Under Article 126(2) TFEU, the Commission examines compliance with budgetary
discipline on the basis of the following two criteria:
(a) whether the ratio of the planned or actual government deficit to gross
domestic product exceeds a reference value, unless either the ratio has
declined substantially and continuously and reached a level that comes close
to the reference value, or, alternatively, the excess over the reference value is
only exceptional and temporary and the ratio remains close to the reference
value; and
(b) whether the ratio of government debt to gross domestic product exceeds
a reference value, unless the ratio is sufficiently diminishing and approaching
the reference value at a satisfactory pace.
(p. 299) 8.52 The reference values are specified in the Protocol on the excessive deficit
procedure annexed to TFEU.44 According to Article 1 of the Protocol, the reference values
referred to in Article 126(2) TFEU are: (a) 3 per cent for the ratio of the planned or actual
government deficit to gross domestic product at market prices and (b) 60 per cent for the
ratio of government debt to gross domestic product at market prices.
8.53 The Treaty provides some room for interpretation and a degree of discretion in the
application of the reference values. The definition of an excessive deficit entails a
judgement. A current deficit, for instance, exceeding the reference value of 3 per cent does
not constitute a lack of budgetary discipline if ‘the ratio has declined substantially and
continuously and reached a level that comes close to the reference value’ or, alternatively,
the excess over the reference value is ‘only exceptional and temporary and the ratio
remains close to the reference value’. Similarly, the total stock of government debt may be
in excess of 60 per cent of the gross domestic product (GDP) without leading to the finding
of budgetary imbalance provided that ‘the ratio is sufficiently diminishing and approaching
the reference value at a satisfactory pace’.
8.54 Under Article 126(3) EC Treaty, the Commission prepares a report if a Member State
does not fulfil the requirements under one or both of these criteria. But the two criteria are
not the only ones to be taken into account. The Commission must also take into account
‘whether the government deficit exceeds government investment expenditure’ (which
reflects the golden rule that only investment can be financed through deficits) and ‘all other
relevant factors, including the medium-term economic and budgetary position’ of the
Member State in question.
8.55 The Protocol on the Excessive Deficit Procedure further defines the technical terms
used in Article 126 TFEU.45 Hence, for the purposes of the excessive deficit procedure,
‘government’ means ‘general government’, that is, central government, regional or local
government, and social security funds, to the exclusion of commercial operations, as
defined in the European System of Integrated Economic Accounts; ‘deficit’ means net
borrowing as defined in the European System of Integrated Economic Accounts;
‘investment’ means gross fixed capital formation as defined in the European System of
Integrated Economic Accounts; and ‘debt’ means total gross debt at nominal value
outstanding at the end of the year and consolidated between and within the sectors of
general government as defined in the first indent.
8.56 Under Article 3 of the Protocol, the governments of the Member States are deemed
responsible for the deficits of general government as defined above. Further, the Member
States must ensure that national procedures in the budgetary area enable them to meet
their obligations for the purposes of the excessive deficit procedures and must report their
planned and actual deficits and the levels of their debt promptly and regularly to the
Commission. But crucially, it is the statistical data provided by the Commission and not the
statistical data provided by Member States which are decisive for the purposes of the
excessive deficit procedure.46
(p. 300) 8.57 The crucial reference values of 3 per cent and 60 per cent and the remaining
provisions of the Protocol can be replaced by appropriate provisions adopted by the
Council, acting unanimously on a proposal from the Commission and after consulting the
European Parliament and the ECB.47
The excessive deficit procedure
8.58 The excessive deficit procedure is a procedure in stages. Article 126 TFEU specifies
the manner in which it is carried out and the respective roles and powers of the
Commission, the Council, and the Member States. Since these are provisions of primary
law, they can only be altered by a revision of the Treaty.
• The Commission monitors the budgetary position of the Member States and
the compliance with the reference values of 3 and 60 per cent of government
deficit and total government debt to GDP with a view to identifying gross
errors (Art 126(2) TFEU).
• According to Article 126(3) TFEU, if a Member State does not fulfil the
requirements under one or both of the criteria, or if the Commission is of the
opinion that there is a risk of an excessive deficit in a Member State, the
Commission prepares a report. The Commission has the right of initiative in
the excessive deficit procedure. 48
• The Commission Report is discussed in the Economic and Financial
Committee, which formulates an opinion (Art 126(4) TFEU).
• Should the Commission consider that an excessive deficit in a Member
State ‘exists’ or ‘may occur’, the Commission addresses an opinion to Member
States (Art 126(5) TFEU). So far this authorization was not provided by Article
104(5) EC Treaty. That Commission could only consult the Council and
recommend measures.
• The Council decides after an overall assessment whether an excessive
deficit ‘exists’, acting by a qualified majority on a proposal from the
Commission, and having considered any observations which the Member
State concerned may wish to make (Art 126(6) TFEU). Before the Lisbon
Treaty, the Council could decide on the existence of an exercise deficit only on
a recommendation (as provided by Art 104(6) EC Treaty). This means that the
Council may now deviate from the Commission proposal only by a unanimous
vote. This modification also strengthens the position of the Commission
towards the Council which is now left with a ‘take it or leave it’ position.
• Article 126(7) TFEU introduces a new obligation on the Council to make
recommendation without undue delay to the Member State concerned with a
view to bringing the situation to an end within a given period. This first set of
recommendations must not be made public.
• The recommendations can only be made public after a separate decision to
that effect by the Council, if the Council establishes that there has been no
effective action in response to its recommendations within the period laid
down (Art 126(8) TFEU).
• If, however, a participating Member State persists in failing to put into
practice the recommendations of the Council, the Council may decide to give
notice to the Member State to take, within a specified time limit, measures for
the deficit reduction which is judged necessary by the Council in order to
remedy the situation, and to submit reports on its proposed adjustment efforts
(Art 126(9) TFEU). Responsibility for making the Member States observe
budgetary discipline lies essentially with the Council. (p. 301)
• According to Article 126(11) TFEU, as long as a participating Member State
fails to comply with the decision of the Council, the Council may decide to
apply or, as the case may be, intensify one or more of the following measures:
(1) to require the Member State concerned to publish additional information,
to be specified by the Council, before issuing bonds and securities; (2) to
invite the European Investment Bank to reconsider its lending policy towards
the Member State concerned; (3) to require the Member State concerned to
make a non-interest-bearing deposit of an appropriate size with the
Community until the excessive deficit has, in the view of the Council, been
corrected; and (4) to impose fines of an appropriate size. All these measures
must be made public, alerting of course investors in financial markets. The
President of the European Council must also inform the European Parliament
of the decisions taken.
8.59 The Lisbon Treaty reinforces the differentiation between the ‘ins’ and the ‘outs’.
According to Article 139(1) TFEU ‘Member States with a derogation’ are ineligible to vote
in the Council in certain decision regarding Eurozone countries.49
8.60 It must be noted that the normal provisions of securing a State’s compliance with the
Treaty (Arts 258 and 259 TFEU) do not apply in the excessive deficit procedure. And any
decision to impose a sanction or not to impose a sanction is, of course, subject to judicial
review.
8.61 Once an excessive deficit has been corrected, the Council is obliged to make a public
statement that an excessive deficit in the Member State concerned no longer exists (Art
126(12) TFEU).
8.62 Regarding the voting arrangements in the Council, the Member State concerned
cannot take part in the Council vote. So far this has been already applied to any further
action taken after the initial assessment of the deficit situation. Article 126(13)(2) TFEU
now excludes the vote of the representation of the member Sate concerned from the
decision according to paragraph 6. This reduces the possibility of blocking that vote, even
though it can be assumed that a group of Member States under an excessive deficit
procedure could come to each other’s defence.
D. Pre-crisis Secondary Law: The Stability and Growth Pact

8.63 Pre-crisis secondary law concerning economic policy coordination comprises a
number of regulations of which the most significant ones are those that form the core of the
Stability and Growth Pact.
8.64 Following one of the recommendations of the Delors Report, on 12 March 1990, the
Council adopted the Council Decision 90/141/EEC on the attainment of progressive
convergence of economic policies and performance during stage one of economic and
monetary (p. 302) union.50 In that decision, the Council officially acknowledged that
progress towards economic and monetary union required a high degree of convergence of
economic performances between Member States through greater compatibility and closer
coordination of economic policies.51
8.65 The Council laid down detailed rules and definitions for the application of the
provisions of the Protocol on the Excessive Deficit Procedure annexed to the EC Treaty in
Council Regulation (EC) No 3605/93 of 22 November 1993, as amended.52 Council
Regulation (EC) No 3603/93 of 13 December 1993 specified definitions for the application
of the prohibition to finance government deficits via central bank credit.53 For example, the
term ‘overdraft facilities’ is defined as any provision of funds to the public sector resulting
or likely to result in a debit balance.54 ‘Public sector’ meant Community (Union) institutions
or bodies, central governments, regional, local, or other public authorities, other bodies
governed by public law, or public undertakings of Member States.55 Council Regulation
(EC) No 3604/93 of 13 December 1993 elaborated on the concept of ‘privileged access’.56
History of the Stability and Growth Pact
8.66 In November 1995, Theo Waigel, then German Minister of Finance, put forward the
idea of adopting a scheme which would ensure stricter budgetary discipline for the Member
States acceding to monetary union. Though the Maastricht Treaty had already been
criticized (p. 303) by many for defining fiscal policy sustainability in quantitative terms,57
Germany felt that more clearly defined rules on prevention and deterrence (of excessive
deficits) were needed to strengthen the ‘economic’ component of EMU and to achieve
sustained and lasting convergence of the economies of the Member States belonging to the
euro area.
8.67 However, the amendment of the Protocol on the Excessive Deficit Procedure would
have required unanimity within the Council, and few countries wanted to renegotiate the
agreement reached at Maastricht. Instead, the European Council favoured the adoption of
rules by way of a Council Resolution.
8.68 Following the agreement reached at the Dublin European Council in December 1996,
the Resolution on the Stability and Growth Pact was adopted by the Amsterdam European
Council in June 1997.58
8.69 The SGP initially consisted of the Resolution of the European Council of 17 June 1997
(which reflected a political commitment to ensure fiscal discipline) and of two Regulations:
the Council Regulation (EC) No 1466/1997 of 7 July 1997 on the strengthening of the
surveillance of budgetary positions and the coordination of economic policies59 and the
Council Regulation (EC) No 1467/97 of 7 July 1997 on speeding up and clarifying the
excessive deficit procedure.60 The SGP fully entered into force on 1 January 1999.
8.70 The term ‘pact’ is misleading in that the rules (with preventive and corrective
elements) are not a separate agreement. They have been adopted in the form of regulations
under the provisions of the Treaty. The rules apply to all Member States, but the strict
enforcement of budgetary discipline pursuant to the excessive deficit procedure apply only
to the States which have adopted the euro.
8.71 According to some commentators, the problem with the 1997 SGP is that it was more
about stability than growth.61 In September 2004, the Commission issued a Communication
on ‘strengthening economic governance and clarifying the implementation of the Stability
and Growth Pact’.62 Following this communication, on 20 March 2005, the ECOFIN Council
adopted a report on ‘Improving the implementation of the Stability and Growth Pact’,63
which was endorsed by the European Council meeting in Brussels on 22 and 23 March
2005. The ministers of finance agreed to ‘rewrite the SGP’, with more flexible fiscal (p. 304)
rules, thus lending some credence to the allegation that political pressures had prevailed
over economic considerations.
8.72 Former Chancellor Schröder wrote at the beginning of 2005 that ‘the goal of
consolidating public budgets may well conflict in the short term with the goal of enhancing
the potential for economic growth’.64 Further, Schröder argued that the complexities of
fiscal policy cannot be adequately captured by quantitative limits: ‘Whether a fiscal policy is
“right” and promotes stability and growth equally cannot be measured solely by compliance
with the deficit reference value of 3 per cent of gross domestic product. This indicator is
inadequate to deal with the complex realities of fiscal policy.’
8.73 The rewriting of the SGP took place through the adoption on 27 June 2005 of two
Regulations (Council Regulation 1055/2005 and Regulation 1056/2005) on the basis of the
ECOFIN Council Report mentioned above, and bearing in mind that the EC Treaty stands,
with the main elements of the Excessive Deficit Procedure and the qualitative and
quantitative reference values—3 per cent and 60 per cent—unaltered. Regulation
1055/2005 amended Regulation 1466/1997 on the strengthening of the surveillance of
budgetary positions and the surveillance and coordination of economic policies.65
Regulation 1056/2005 amended the Regulation 1467/97 on the excessive deficit procedure
(Regulation 1467/97).66
8.74 Some of the changes that were agreed by the European Council did not require
amendments to Regulation 1466/1997 and resulted in a Code of Conduct on the Content
and Format of the Stability and Convergence Programmes67 that was endorsed by the
ECOFIN Council on 11 October 2005. This code of conduct incorporated the essential
elements of Council Regulation 1466/1997 into guidelines to assist the Member States in
drawing up their programmes. It also aimed at facilitating the examination of the
programmes by the Commission, the Economic and Financial Committee, and the Council.68
Objectives of the SGP: From the ‘rigid SGP’ to the ‘flexible SGP’
8.75 One of the major novelties of the SGP as designed in 1997 was the commitment to
budgetary balance over time (which goes one step further than ‘simply’ avoiding excessive
deficits). This commitment has been weakened in the ‘flexible SGP’. This is one of the most
visible differences between the 1997 SGP and the 2005 SGP.
8.76 In the reformed SGP, the obligation for Member States to adhere to the medium-term
objective for their budgetary positions of close to balance or in surplus ‘should be
differentiated for individual Member States, to take into account the diversity of economic
and budgetary positions and developments’ in the light of the economic and budgetary
heterogeneity in the Union.69(p. 305) Furthermore, the reformed SGP was more ‘growth-
oriented’ than the old one and considered the impact of long-term structural reforms.
Structural reforms, such as the introduction of a multi-pillar system for pension fund
reform, which can entail a short-term deterioration of public finances during the
implementation period, had to be taken into account when defining the adjustment path to
the medium-term budgetary objective, so as to safeguard the sustainability of public
finances in the long run and to avoid imposing excessive burdens on future generations.70
The term ‘national ownership’ (an expression which had become ‘fashionable’ in many
contexts: law reform, IMF conditionality, implementation of soft law standards) recurs in
the new version of the SGP.71
8.77 The ‘flexible’ SGP did not alter the main organizational divide between monetary and
fiscal policy: ‘Member States remain responsible for their national budgetary policies,
subject to the provisions of the Treaty; they will take the necessary measures in order to
meet their responsibilities in accordance with those provisions.’72
Regulation 1466/1997 as amended by Regulation 1055/2005 on the strengthening of
the surveillance of budgetary positions and the coordination of economic policies
8.78 For the purposes of the multilateral surveillance foreseen by Article 121 TFEU,
Member States (then Article 99 EC Treaty) had to prepare ‘stability’ or ‘convergence
programmes’ in conformity with Regulation 1466/1997 as amended by Regulation
1055/2005. The Member States of the euro area had to present annual ‘stability
programmes’ to the Commission and to the Council, while the Member States with a
derogation had to present annual ‘convergence programmes’.
8.79 The Member States had to draw the programmes in accordance with the Regulation
and along the guidelines set in the Code of Conduct on the content and format of the
stability and convergence programmes.73 These programmes were supposed to present a
medium-term objective for the budgetary position, as well as the main assumptions about
expected economic developments (growth, employment, inflation, and others), a description
of the budgetary and other economic policy measures being taken or proposed to achieve
the objectives of the programme, and an analysis of how changes in the main economic
assumptions would affect the budgetary and debt positions, bearing in mind the reference
values of 3 per cent and 60 per cent. Convergence programmes had also to present the
medium-term policy objectives and the relationship of those objectives to price and
exchange rate stability.
(p. 306) 8.80 The programmes were assessed by the Council and the European and
Financial Committee, through a process of multilateral surveillance, which had a
preventative function, with the aim to identify problems early on (checking that budget
deficits do not exceed the 3 per cent reference value). The Regulation also foresaw the
establishment of an ‘early warning procedure’ in the event of an imminent breach of the
rules (ie, before an excessive deficit as defined in the Treaty has actually occurred).74
Council Regulation 1467/97 as amended by Regulation 1056/2005 on speeding up and
clarifying the excessive deficit procedure
8.81 Regulation 1467/97 has been rightly considered as the cornerstone of the original
SGP. This regulation defined more precisely and strengthens the Treaty rules relating to the
excessive deficit procedure. Its objective is ‘to deter excessive general government deficits
and, if they occur, to further their prompt correction’ (Art 1(1) of the Regulation).
Regulation 1467/97 established a system of sanctions to penalize the country if there was a
breach of the rules.
8.82 In the words of Lorenzo Bini Smaghi (former member of the ECB’s Executive Board),
While the Treaty aimed at achieving budgetary discipline through a procedure (the
so-called excessive deficit procedure), the SGP is based on a set of specific rules for
national policies. According to the Treaty, the identification of an excessive deficit
should be the result of a judgement…The SGP marked a drastic change in
philosophy. …The drafters of the SGP did not intend the Treaty’s Excessive Deficit
Procedure as a procedure but as a rule.75
8.83 Regulation 1056/2005 introduced some changes that ‘relax’ the rigidity of some of the
rules of Regulation 1467/97, in particular with regard to the concept of exceptional excess,
the medium-term budgetary position, and the nature of the assessment. The assessment by
the Commission moved towards more ‘qualitative terms’ according to the amended Article
2(3) of the Regulation:
The Commission shall give due consideration to any factors which, in the opinion of
the Member State concerned, are relevant in order to comprehensively assess in
qualitative terms the excess over the reference value. …In that context, special
consideration shall be given to budgetary efforts towards increasing or maintaining
at a high level financial contributions to fostering international solidarity and to
achieving European policy goals, notably the unification of Europe [a veiled
reference to the costs of German reunification, which have turned Germany from a
saint to a sinner in budget management] if it has a detrimental effect on the growth
and fiscal burden of a Member State.
8.84 Article 5 as amended by Regulation 1055/2005 stated that the Council could also take
into account whether a higher adjustment effort is made in ‘economic good times’, whereas
the effort may be more limited in ‘economic bad times’. The reference to good and bad
economic times allowed for a greater degree of discretionary judgement in the assessment
of the budgetary position of a Member State than under Regulation 1667/1997.76
(p. 307) Practice of the Stability and Growth Pact
8.85 Until the crisis, the EU rules on economic policy coordination appeared to have had
little effect on the fiscal behaviour of several Eurozone countries. Breaches of the SGP
became a recurrent feature in the life of the ‘Pact’.77
The case of Germany and the Judgment of the ECJ
8.86 The credibility of the excessive deficit procedure (EDP) was seriously damaged when
Germany—the very bastion of stability—was brought to the European Court of Justice (ECJ)
by the Commission for failing to comply with it. This made other countries that had
breached the rules such as Portugal, Italy, the Netherlands, Greece, France, Malta, Cyprus,
Czech Republic, Poland, Slovakia, Hungary, etc, feel that somehow they were too strict even
for the main architect of such rules.
8.87 In February 2002, upon examining Germany’s proposed stability programme, the
Commission proposed to the ECOFIN Council to give Germany an early warning on the
basis of Regulation 1466/1997 of the Stability and Growth Pact. The Council, however, did
not follow the Commission’s recommendation for an early warning. Germany’s budget
deficit and projected government debt in 2002 exceeded the reference values of 3 and 60
per cent (reaching 3.7 and 60.9 per cent, respectively). The Commission adopted a report
on the budgetary situation in Germany. The report stated that the excessive deficit did not
result from an unusual event outside the control of Germany or from a severe economic
downturn. The Commission recommended to the Council that it should decide that there
was an excessive deficit in Germany.
8.88 On 21 January 2003, the Council adopted a decision on the existence of an excessive
deficit in Germany78 and a recommendation on action to be taken to correct it. The Council
informed the German Government that it should bring the excessive deficit situation to an
end as rapidly as possible in accordance with Article 3(4) of Regulation 1467/97 (ie, within
four months). According to the Commission’s forecast of the German finances, the deficit
for 2003 was over 4 per cent of GDP. In view of this budgetary development, the
Commission declared that Germany was not in compliance with the Council
recommendation issued in January 2003.
8.89 The Commission further declared that Germany should put an end to the excessive
deficit situation by 2004 as required by the Council. The Commission proposed that the
Council should adopt two recommendations in relation to the excessive deficit procedure
for Germany (as well as for France). The first recommendation stating that the actions
taken by Germany in 2003 had proved inadequate to bring the excessive deficit to an end in
2004. The second requesting Germany to bring the government deficit below 3 per cent by
2005.
8.90 However, on 25 November 2003, the Council of Ministers did not adopt the two
Commission recommendations (it did not achieve the required majority). Instead, it merely
adopted a set of conclusions stating that it had decided to hold the excessive deficit
procedure in abeyance with regard to Germany (and also to France) and addressed
recommendations (p. 308) to Germany (and to France) for correcting the excessive deficit
in the light of the earlier commitments made by each of them.
8.91 On 27 January 2004, the Commission brought an action before the European Court of
Justice challenging (1) the Council’s failure to adopt the decisions recommended by the
Commission under Articles 104(8) and 104(9) EC which, if adopted, would have ordered
France and Germany to put an end to their excessive deficits by 2005 and to achieve a
reduction of the deficit in 2004; and (2) the conclusions adopted by the Council. On
application by the Commission, the President of the Court ordered on 13 February 2004
that the case be determined in accordance with an expedited procedure.
8.92 The Court of Justice did react speedily and on 13 July 2004 its judgment was
published.79 The Court found that failure by the Council to adopt the decisions
recommended by the Commission did ‘not constitute an act challengeable by an action for
annulment’ and that, therefore the action (for annulment) brought by the Commission
against the Council was inadmissible.
8.93 The Court also ruled that the conclusions of the Council holding the excessive deficit
procedures in abeyance and modifying the recommendations that it had previously adopted
were unlawful. The Court clarified that, though the Council has a discretion in this field, it
cannot depart from the rules laid down by the Treaty or those which it set for itself in
Regulation 1467/97. Accordingly, the Court stated that once the Council has adopted
recommendations for the correction of the excessive deficit, the Council cannot modify such
recommendations without being prompted again by the Commission, which has the right of
initiative in the excessive deficit procedure. The Court also found that the recommendations
contained in the Council’s conclusions were adopted in accordance with the voting rules
prescribed for a decision to give notice, which are different from those prescribed for the
adoption of the recommendations for correcting the excessive deficit. The Court therefore
annulled the Council’s conclusions of 25 November 2003.
8.94 The ECJ’s judgment of 13 July 2004 focused on procedural issues. The nature of the
fiscal rules and budgetary policy was left at the time to politicians to renegotiate. The
amendments in 2005 did not restore credibility to the SGP. Breaches of the fiscal rules
continued with a growing deterioration of the budgetary positions in several Member
States. While policy makers and mainstream economists acknowledged that the euro debt
crisis had been triggered first by the financial crisis, excessive fiscal profligacy and the
flexibility of the SGP and by the same token the asymmetric construction of EMU were at
the root of the Eurozone debt crisis.
E. The Fiscal Crisis and Lessons Thereof

8.95 While European decision makers had expressed concerns about fiscal profligacy and
excessive borrowing in Europe before the crisis,80 it was commonly argued that the 2008
crisis (p. 309) was a financial American/Anglo-Saxon concern. European economies (at least
the large countries, ie France or Germany) were considered to be built on a strong export
industry and therefore could absorb the economic shocks generated by the financial crisis.
In fact, many Member States (especially weaker economies) turned out to be very
dependent on cheap capital. Under this borrowing-based system, the financial crisis
triggered an adjustment process which ultimately led to a weakening of domestic demand
and a reduction in the current account deficits at the cost of slowdown in growth.
From financial crisis to fiscal crisis
8.96 In response to the economic shocks generated by the financial crisis some Eurozone
governments also had to take significant fiscal measures in order to contain the recession.
Impressive recovery plans supplemented the automatic stabilizers to prevent the collapse of
economic activity.
8.97 In certain countries, especially Ireland, where the financial sector was particularly
exposed to risks, the government had to intervene to support banks. More specifically, the
Irish economy expanded rapidly during the ‘Celtic Tiger’ years (1994–2007) mainly due to a
low corporate tax rate and low ECB interest rates.81 This led to an expansion of credit and
included a property bubble which burst in 2007. Irish banks, already over-exposed to the
Irish property market, came under severe pressure in September 2008 due to the financial
crisis. Irish banks’ foreign borrowings rose from EUR 15 billion to EUR 110 billion in 2004–
8.82 Much of this was borrowed on a three-month rollover basis to fund building projects.
When the properties could not be sold due to oversupply, the result was a classic asset–
liability mismatch.83 On 29 September 2008, the government issued an unlimited bank
guarantee in favour of six banks that was to cost much more than the government
estimated.84 The banking sector, at its peak had assets five times Ireland’s annual GDP.85 As
a result, the recapitalization of Irish banks had a dramatic impact on the budget position.
This was to result in the EU–IMF intervention in late 2010.
8.98 For other countries, notably Greece, the main problem was not the banking sector
(although the financial crisis was the immediate trigger) but unsustainable fiscal behaviour
which was possible via cheap borrowing. According to many economists, notably IMF and
Commission officials, since EMU accession in 2001 the country has experienced
consistently higher inflation than the EMU average, resulting in pronounced (p. 310)
competitiveness losses and record current account deficits.86 In December, Greece
admitted that its debts had reached EUR 300 billion, the highest in modern history. Greece
was burdened with debt amounting to 113 per cent of GDP, nearly double of the Eurozone
limit of 60 per cent. In January 2010, an EU report condemned ‘severe irregularities’ in
Greek accounting procedures. Greece’s budget deficit in 2009 was revised upwards to 12.7
per cent, from 3.7 per cent, and more than four times the maximum allowed by EU rules. As
a result, there was a significant widening of the spreads on the public debt in Greece in
relation to the German Bonds, against the backdrop of mounting concerns about the
reliability of the statistics and the sustainability of the Greek public debt. In February 2010,
Greek borrowing costs reached yet further record highs and the EU announced that the
Greek deficit was even worse than thought after reviewing its accounts—13.6 per cent of
GDP, not 12.7 per cent.
8.99 The nervousness then spread to other vulnerable Eurozone countries which in varying
degrees combined high public debt with chronic current account deficits. Notably, concerns
start to build about all the heavily indebted countries in Europe—Portugal, Ireland, and
Spain. The yields on government bonds from Spain and Italy rose sharply—while Germany’s
fell to record lows—as investors demanded very high returns to borrow. On 7 August
2011,87 the European Central Bank announced the active implementation of the Securities
Market Programme, adopted on 14 May 2010,88 and that accordingly it would buy Italian
and Spanish government bonds in order to bring down their borrowing costs, as concern
grew that the debt crisis may spread to the larger economies of Italy and Spain.
8.100 It is worth noting that the crisis spread beyond the periphery of the Eurozone. The
global financial crisis also caused several eastern European States to take a direct hit. The
economic downturn was generated from the easy credit market burst, resulting in an
unemployment crisis, along with the bankruptcy of many companies.89 Specifically, it can be
argued that the global crisis caused financial markets to re-evaluate risk. Increased risk
aversion and the decline in global liquidity changed the risk ratings of the emerging
markets, leading to an appraisal of the eastern European assets as more risky based on an
identification of some vulnerabilities specific to the domestic economy.90 Estonia and Latvia
were hit first by the crisis. In 2008, after years of booming economic success, these two
countries experienced a total fall in GDP from peak to trough of 20 per cent and 24 per
cent, respectively.91 In February 2009, the Latvian government asked the IMF and the
European Union for an (p. 311) emergency bailout loan of EUR 7.5 billion, which was
completed on 19 January 2012.92 Latvia was subject to post-programme surveillance until a
large part of the EU-funded loans were repaid and Estonia even adopted the euro in 2011.
Hungary and Romania experienced much smaller declines in output, respectively 7 per cent
and 9 per cent. Yet, they had sluggish growth of 1.6 per cent and 2.5 per cent, respectively,
in 2011. And GDP fell in Hungary in 2012 and was close to stagnant in Romania. These two
countries adopted IMF programmes at the height of the global financial crisis in 2008 and
2009, respectively, and Hungary became subject to a post-surveillance programme.
The roots of the Eurozone debt crisis
8.101 The causes of the Eurozone debt crisis were not only confined to unsustainable
public finances; there were also significant doubts about the functioning of EMU itself. The
financial crisis revealed the pitfalls of an asymmetric EMU and that one country’s instability
could rapidly spread to others, thus damaging the cohesion and stability of the entire euro
area.
8.102 According to the European Commission, there are many causes of the Eurozone
debt crisis:
Some of them were related to external factors: a global economic slowdown and
growing risk aversion in the financial markets had direct impact on growth
prospects in the EU. Other causes were related to the build-up in some EU countries
of fiscal and macroeconomic imbalances, such as large government debt and trade
deficits. The combination of high government debt, weakened competitiveness and
poor economic growth led financial markets to increasingly question the fiscal
sustainability of some euro area countries.93
8.103 Although the lawyers’ role is to pinpoint pitfalls and loopholes in the EMU
institutional framework lawyers should nevertheless investigate what is believed to be the
economic root of the crisis in order to understand and design the appropriate legal
responses.94
8.104 The Eurozone debt crisis constitutes an opportunity to confirm the logic underlying
Maastricht—namely, that there was a need to watch over the sustainability of public
finances and to arrange binding economic policy coordination. In the unfolding of the debt
crisis it has also become obvious that there were serious issues with the asymmetric legal
construction of EMU: the original mix of fiscal rules and market discipline did not suffice to
ensure sound fiscal policy across the EMU.
8.105 As mentioned earlier, the institutional organization of EMU is unique in that it
combines monetary policy centralization with fiscal policy decentralization. While there was
some policy coordination in this sphere, it was a ‘soft’ form of coordination.
Fiscal Fatigue
8.106 In principle, fiscal discipline was to be reinforced once the euro was introduced. Yet
the reality was very different. Breaches of the SGP became commonplace, as mentioned
earlier.
(p. 312) 8.107 More recently, the costs to governments of bank bailouts and the
subsequent efforts to achieve fiscal restraint, have resulted in widespread fiscal fatigue
(albeit with few exceptions, notably Germany).
8.108 Marco Buti, Director General for Economic and Financial Affairs at the European
Commission, has found several explanations for the failure to apply the fiscal rules.95 A first
explanation is the lack of national ownership of the collective fiscal framework. There were
recurring gaps between budgetary projections reported in national stability and
convergence programmes and the actual implementation of the plan. There was a tendency
to underperform.
8.109 Secondly, the new ‘flexibility’ of the SGP was amply exploited. The financial
penalties available under the rules were not even mentioned for any of the Member States.
In addition, the Council decision in November 2003 to suspend the excessive deficit
procedure, under the pressure of Germany and France, discredited the disciplinary
framework of Maastricht. The budget position of most of the Eurozone countries was
therefore not very strong at the start of the Great Recession. In 2007, the average cyclically
adjusted budget deficit in the euro area countries was 1.9 per cent of GDP, while the
average public debt still stood at around 66 per cent of GDP.96
8.110 It is not surveillance (‘carrots’) that deters countries from misbehaving; it is the
effective application of sanctions that is the true deterrent (‘sticks’). By analogy with the
IMF functions of surveillance and conditional financial assistance (surveyed in Chapter 13),
it is not IMF surveillance that makes countries comply with their self-imposed reform
programmes, but the ‘conditionality’ that governs the access to and use of IMF resources
(conditionality as a ‘stick’). Under this test of ‘carrots and sticks’, it can be said that if the
sanctions or penalties foreseen in the excessive deficit procedure when the budgetary rules
are breached are not applied, the ‘deterrent effect’ of the SGP disappears, ‘inviting’ other
Member States to be ‘fiscal delinquents’ too. The ‘non-application’ of the excessive deficit
procedure in the cases of Germany and France damaged the credibility of the SGP and
distorted the incentives to comply with its rules. The SGP (as any other rule) cannot survive
without societal legitimacy. The widespread breach of the fiscal rules damaged the
credibility of the commitment of the Eurozone Member States to fiscal discipline. However,
the constraints imposed by the demands of primary law remain. Only a Treaty change could
alter them.97
8.111 Finally, there had been a rapid disappearance of market signals on sovereign
borrowers in the early years of the euro. Financial markets did not make a difference
between sovereign assets across EMU.98 The adoption of the euro led to many Eurozone
countries of different credit worthiness receiving similar and very low interest rates for
their bonds during years (p. 313) preceding the crisis. However, market discipline
eventually came full to the fore with the financial crisis that commenced in 2007.
Persistent internal and external macroeconomic imbalances
8.112 The Commission recognizes that fiscal profligacy is neither the sole nor the main
origin of Europe’s fiscal crisis.99 For example, in Ireland and Spain, the public debt was well
below the reference value in 2007.100 Nonetheless, there were macroeconomic imbalances
in those countries, often arising from excessive private sector indebtedness.
8.113 According to the Commission, since the introduction of the euro, unit labour costs
had risen sharply in relative terms, gradually eroding those countries’ competitiveness. At
the same time, a strong expansion of lending to households and a surge in household debt
against the background of soaring house prices triggered a marked rise in domestic
demand (particularly in Ireland, Spain, and Greece). Furthermore, financial institutions
often underestimated the credit risks; for instance in Ireland, the banking system had
become very fragile. On the other hand, countries like Germany, recorded substantial
competitiveness gains, while the growth of domestic demand and household lending had
remained very moderate. These divergences of competitiveness in the Eurozone can have
more or less persistent side effects on current accounts.
8.114 Fiscal surveillance mechanisms were incapable of preventing or correcting these
serious internal and external macroeconomic imbalances. The assessment of public finances
was confined to traditional indicators of sustainability, and did not make room for
contingent liabilities emanating from non-fiscal agents. According to the Commission,
indicators of fiscal vulnerability incorporating variables for financial and competitiveness
developments would give a better picture of the risk of fiscal crisis than purely fiscal
indicators.101
F. Strengthening Economic Governance Post Crisis

8.115 The economic and financial crisis has revealed the weaknesses of the economic
governance of the Union and has called for a comprehensive and decisive strengthening of
its legal framework. At the end of 2010, the European Commission had already formulated
six legislative proposals (five regulations and one directive)102 subsequently (p. 314) known
as the ‘Six Pack’. On the basis of those proposals and the final report of the Van Rompuy
task force, and following intense negotiation between the EC, the Council and the European
Parliament (the ‘trialogue’), the European Parliament approved the new ‘Six-Pack’
legislation on 28 September 2011. Formal approval by the Council followed on 8
November.103
8.116 In November 2011, the Commission proposed two new legislative texts (the ‘Two
Pack’) for further strengthening budgetary surveillance in the euro area, which entered into
force in 2013.104
8.117 In addition, the EU Member States, with the exception of the United Kingdom and
the Czech Republic, concluded a new intergovernmental treaty:105 the Treaty on Stability,
Coordination and Governance in the Economic and Monetary Union. The TSCG intends to
strengthen fiscal discipline further by introducing more automatic sanctions and stricter
surveillance (the fiscal part of the TSCG is referred to as ‘Fiscal Compact’)106 and to
reinforce the coordination of economic policies. The TSCG was signed on 2 March 2012 and
entered into force on 1 January 2013 following ratification by twelve Eurozone Member
States (as prescribed in its Art 14.2 TSCG).
8.118 By March 2011, Member States also reached an agreement on the Euro Plus Pact
aimed at improving the quality of Economic Governance. The Euro Plus Pact is a soft law
instrument which complements/overlaps with certain aspects of the Europe 2020 growth
strategy (notably the Integrated Guidelines).
8.119 Finally, the Union has introduced a new mechanism for economic policy coordination
under the recommendation of the Van Rompuy task force: the European Semester.107 This
comprehensive reporting process ensures that all the elements of economic policy
surveillance conducted annually are synchronized in a common process.
(p. 315) 8.120 The new economic governance is a continuation of the former economic
policy design where Member States keep their sovereignty in economic policy but goes
further in three areas: (1) fiscal policy coordination is strengthened via a more stringent
SGP and the new ‘Fiscal Compact’ (the fiscal part of the TCSG); (2) macroeconomic
surveillance mechanism is introduced via a target-based mechanism underpinned by
sanctions; (3) general economic policy is coordinated via the EU 2020 growth strategy and
the Integrated Guidelines; (4) a new extensive reporting system (ie the European Semester)
now synchronizes all the mechanisms of economic policy coordination.
Fiscal policy coordination
8.121 Four of the six legislative texts introduced by the ‘six pack’ deal with public finances
as does the ‘Fiscal Compact’ (the fiscal part of the TCSG), and the ‘two pack’ legislation.
8.122 The ‘six-pack’ brings about fundamental changes to both the preventive rules and
the corrective measures specified by the SGP. Furthermore, the decision-making procedures
have been modified and minimum requirements have been imposed regarding the EU
Member States’ budgetary frameworks.
Preventive rules: fiscal surveillance
8.123 Regulation 1175/2011 amending Regulation 1466/97 is geared towards enhancing
the surveillance of budgetary positions, and the surveillance and coordination of economic
policies as foreseen in Article 121 TFEU.
8.124 First, the amending regulation attempts to address the main problem which
emerged in the implementation of the SGP, that is the lack of incentive generated by the
‘medium-term objective’ (MTO, since 2005). The MTO refers to the structural budgetary
balance and varies—depending on the assumed trend growth and debt level—between a
surplus of 1 per cent and a deficit of 1 per cent (relative to GDP). The obligation to achieve
a ‘safe’ MTO and to submit stability and convergence programmes to that effect. However,
from now on, progress towards the MTO will be assessed in a broader framework (‘overall
assessment’) in which, though the structural balance remains the reference point,
expenditure growth will also be taken into account.
8.125 The expenditure benchmark evaluates public expenditure growth against potential
growth, also taking account of discretionary revenue measures. According to the
Commission, ‘the structural balance has in practice proved an insufficient measure of a
country’s underlying fiscal position’.108 This may have resulted in the past in a distorted
picture of a Member State’s budgetary situation. They both share the same roots but the
latter reflects more accurately discretionary decisions where the estimate of the structural
balance may be blurred by windfall revenues or other uncertainties.
8.126 It seems important to note that the expenditure concept is defined in restrictive
terms. It takes no account of the interest charges, the cyclical component of unemployment
expenditure, or all the spending relating to the European programmes financed by EU
funds. In principle, any deviation from the adjustment path towards the attainment of the
MTO could trigger a warning and, if necessary some sanctions but only if the deviation (p.
316) is significant. A significant deviation is a deviation of at least 0.5 per cent of GDP over
a given year or at least 0.25 per cent of GDP per annum average over two consecutives
years (in the case of deviations concerning the reduction in the structural deficit or
expenditure growth) while leaving some scope for interpretation.109
8.127 While this new preventive system is very stringent, the deviation will not be
considered significant in unusual events beyond the Member State’s control having a major
impact on the budget positions, and for severe economic recession. Furthermore, the new
preventive rules will not apply if the budget position was already better than the MTO and if
the attainment of that objective at the end of the period covered by the stability or
convergence programmes is not compromised. Finally, the amended regulation offers some
leniency if the Member States undertook structural reforms which, in the short term, have a
negative impact on budget position but which, on the long term, improve sustainable public
finance. Special attention is paid to pension reforms (eg, the switch to funded schemes) and
on reforms designed to enhance potential economic growth.
8.128 In line with the preventive arm of the reinforced SGP, the Fiscal Compact (the fiscal
part of the TSCG), also states that the MTO must be evaluated on the basis of an ‘overall
assessment’ with the structural balance as a reference, including an analysis of expenditure
net of discretionary revenue measures. The Fiscal Compact demands a ‘rapid convergence’
towards the MTO, while the timeframe will be further specified in a proposal by the
Commission which shall take account of the country-specific sustainability risks. A new
component of the Fiscal Compact is that within one year after entering into force, the
contracting parties must write debt brakes into their national legislation, preferably at the
constitutional level.110
8.129 There is an indirect threat of sanction as one or more of the contracting parties can
call upon the CJEU to verify the transposition of the balanced budget rule and the
correction mechanism into national law. The Court’s ruling is binding and the affected
country must take the necessary measures to comply with the judgment within a specified
period. Another key element of the Fiscal Compact is that the Commission is invited to
publish common principles on the role and independence of the institutions responsible at
the national level for monitoring compliance with all the provisions of the balanced budget
rules. Finally Article 6 of the TSCG states: ‘With a view to better coordinating the planning
of their national debt issuance, the Contracting Parties shall report ex-ante on their public
debt issuance plans to the Council of the European Union and to the European
Commission’.
8.130 The associated ‘Two Pack’ aimed at strengthening fiscal surveillance in the euro
zone (Art 136 TFEU) comprises two regulations.111 The first regulation establishes a
common (p. 317) budgetary timeline within EMU to synchronize key steps in the
preparation of national budgets. Budgetary plans encapsulated in annual national laws are
to be examined in the autumn at the European level so as the check their consistency with
the fiscal requirements of the SGP and the guidance agreed in the spring as part of the
European Semester.
8.131 The second regulation lays out a closer surveillance regime in euro area countries
which requested financial assistance from the European emergency funds (Greece, Ireland,
Portugal, Spain, Cyprus). This Regulation institutionalizes financial assistance mechanisms.
Article 6(6) stipulates that any ‘Member State subject to an adjustment programme
experiencing insufficient administrative capacity or significant problems in the
implementation of its adjustment programme shall seek technical assistance from the
Commission’. These regulations limit economic sovereignty. And as we have seen with the
EU/IMF financial assistance programmes, seeking assistance means that ‘lenders of last
resort’ (the expression here is used in a broad sense not in the technical sense analysed in
Chapters 2 and 10) can impose a variety of structural reforms in return for financial aid.
Corrective rules
8.132 The excessive deficit procedure has also been strengthened. Similarly to the old
framework, the EDP is launched if a country’s general government deficit exceeds 3 per
cent of GDP or if it is established that public debt is being insufficiently reduced towards 60
per cent of GDP. At first glance, the new framework does not seem to change much as the
debt criterion was already part of the government criterion under the Treaty on the
European Union. In principle, the deficit procedure could be initiated against Member
States which did not satisfy this criterion. However, this never really happened in practice
as the criterion remained unworkable.
8.133 Two amendments are most notable with Regulation 1177/2011 (amending regulation
1467/97): the ‘operationalization’ of the debt criterion and the application on ‘interest-
bearing deposit’ under the excessive deficit procedure. With regard to the former, the new
rules place the debt requirement on an equal footing with the deficit criterion. Also, the
ratio of the government debt to GDP shall be considered sufficiently diminishing and
approaching the reference value at a satisfactory pace in accordance with Article 126(2)(b)
TFEU. This reduction must take place either during the last three years for which data are
available, or during the latest year for which data are available and during the two
subsequent years (according to the Commission estimates).
8.134 However, failure to respect this figure does not automatically trigger the EDP. The
EDP is only launched by a decision of the ECOFIN Council (under qualified majority) upon
recommendation of the Commission. The Commission has to produce a report assessing the
situation. A ‘list of factors’ is taken into account, explicitly referring to such aspects as the
adjustment path followed in order to achieve the MTO, the primary balance, the
sustainability of the public debt, the quality of the national budgetary framework, the
existing guarantees, and the level of the financial assets. However, when the EDP is
launched most steps in the procedure will be implemented via reverse voting quasi-
automatically.
8.135 The numerical benchmark for reduction of government debt in excess of the
reference value of 60 per cent of GDP, included in the corrective arm of the SGP, is now also
enshrined in the fiscal compact. However, two elements are new with the Fiscal Compact.
First, the rules of the EDP have been tightened up for the euro area Members in breach of
the (p. 318) deficit criterion. Member States undertake to support any recommendation
submitted by the Commission concerning the existence of excessive public deficit unless
that recommendation is opposed by qualified majority (reverse voting system).
8.136 Secondly, Member States subject to an EDP procedure must set a fiscal and
economic partnership programme comprising the measures to be implemented in order to
ensure the lasting correction of their excessive deficit. In practice, countries under
partnership programmes will likely have to implement reforms similar to structural reforms
implemented by countries under EU/IMF financial adjustment programmes.112
National frameworks
8.137 Experience in the past with unreliable economic data and over-optimistic growth
forecasts by Member States (notably in Greece) in the context of the multilateral
surveillance and excessive deficit procedure has resulted in the adoption of new EU
Directive imposing certain minimum requirements on national budgetary frameworks.113
The objective is to achieve greater consistency between national and European rules such
as multi-annual planning, numerical fiscal rules, etc.
8.138 First, fiscal planning by Member States must be ‘based on realistic macroeconomic
and budgetary forecasts using the most up-to-date information’ and ‘fiscal data for all
subsectors of general government’ must be made public.114 Secondly, Member States must
introduce ‘appropriate’ numerical rules concerning the deficit and the debt, with provision
for corrective mechanism if the rules are broken. Those rules should be based on reliable
and independent bodies endowed with function autonomy vis-à-vis the fiscal authorities of
the Member States.115 Member States must also draw up detailed plans for the attainment
of the MTO specified in the stability and convergence programmes.116 The Directive also
lays down detailed rules concerning the characteristics of the budgetary frameworks for the
Member States (public accounting systems, which include elements such as bookkeeping,
internal control, financial reporting, and auditing): ‘Complete and reliable public accounting
practices for sub-sectors government are a precondition for the production of high quality
statistics that are comparable across Member Sates.’117
Sanctions and reverse voting
8.139 Apart from the content of the preventive and corrective arms of the SGP, the
decision- making and sanctions were also adjusted to improve the application of the rules.
For the Commission, the main problem with the SGP was not the inadequacy of the fiscal
rules but the shortcomings in their application.
8.140 The new fiscal surveillance framework sets out the rules concerning the preventive
arm, that is the submission, the examination and the monitoring of the stability and
convergence programmes as part of the multilateral surveillance framework so as to
prevent, at an early stage, the occurrence of excessive deficit. Starting in 2011, a new
process has been followed (p. 319) with the ‘European Semester’ (also formalized as part of
the Six-Pack): the Union and member States discuss economic and budgetary policies in the
first half of the year before countries submit their stability and convergence programmes by
April; the Commission then evaluates these programmes and ECOFIN issues guidance on
them (in June). If the plans in the programmes of the EMU countries do not fit with the
opinions of the Commission, non-complying countries face the risk of sanctions.
8.141 The aim of the new governance framework is to make the procedures more
automatic. For this purpose, the new framework also amends the old multilateral
surveillance regime with the introduction of reversed voting and financial sanctions (for
both the preventive and corrective arm of the SGP).
8.142 The reverse qualified majority voting appears once in the preventive arm of the pact
and in two provisions of its corrective arm.118 According to these provisions, if the Council
does not make a decision on the basis of this Commission recommendation, the Commission
will make a new recommendation to the Council which is ‘deemed to be adopted by the
Council unless it decides by a qualified majority to reject the Commission’s
recommendation within 10 days of the Commission’s adoption thereof’.119 The reversed
voting procedure is aimed to prevent the Council remaining inactive despite clear
indications of a failure to comply with the Commission recommendations.
8.143 Financial sanctions for euro-area Member States are imposed in a gradual way, from
the preventive arm to the latest stages of the EDP, and may eventually reach 0.5 per cent of
GDP. It is now possible to impose effective sanctions on Member States that do not respect
the rules set out in the preventive arm, which was not the case before. This is provided in
Regulation 1173/2011 on budgetary surveillance of the Eurozone. In principle, the
imposition of any sanctions under the preventive arm (Regulation 1175/2011) starts with
Commission early warning (Art 121(4) TFEU),120 if the Commission decides that
convergence towards the MTO is inadequate. According to Article 6(2) of Regulation
1175/2011, when a Member State to which the Council has addressed recommendation in
accordance with Article 121(4) TFEU fails to take action, the Commission must immediately
recommend to the Council to adopt, by qualified majority, a decision establishing that no
effective action has been taken. Then, the ECOFIN Council has to examine this warning and
make a recommendation to the Member State concerned within one month. If it is not the
case, the Commission will make another recommendation to the Council no effective action
has been taken by the concerned Member State. The Council can only reject this second
recommendation by reversed qualified majority. If the Council does not reject the
recommendation, the Commission has twenty days to recommend that the Council imposes
a sanction in the form of an interest-bearing deposit equal to 0.2 per cent of the previous
year’s GDP. Here again, the Council can only reject that recommendation by reversed
qualified majority.121 It may also amend the recommendation by qualified majority.122
(p. 320) 8.144 As regards the corrective arm, the sanctioning system has also been
adjusted. Until recently this was only possible at a late stage in the procedure and in
practice had never occurred.123 According to Regulation 1173/2011 on the effective
enforcement of budgetary surveillance in the Eurozone, the sanction may range from a non-
interest-bearing deposit at the time of the decision on the existence of an excessive deficit
to an actual fine in a later stage of the process.124
8.145 Where an interest-bearing deposit has been imposed upon a Member State under
the preventive arm of the SGP, the Commission can recommend to impose a non- interest-
bearing deposit within a maximum of twenty days of the Council’s decision that there is a
excessive deficit. In that case, the interest-bearing deposit is converted into a non-interest-
bearing-deposit (once again, reversed voting applies). The procedure for imposing a
subsequent fine has not changed significantly. The major difference is that, with regard to
the actual imposition of the fine on the Commission’s recommendation, there is provision
for another qualified majority vote.
8.146 The governance framework introduces another new sanction: the fine for statistics
that misrepresent the data on the budget deficit of the public debt. In principle, serious
negligence may lead to a fine. The budget figures need not to have been manipulated.
These fines are imposed via the old voting procedure, ie not via reversed majority voting.
Preventing and correcting macroeconomic imbalances
8.147 In order to prevent and correct macroeconomic imbalances in the EU, the economic
legal framework, which used to be geared towards fiscal policy, had to be broadened to
include a new surveillance framework. As part of the Economic Six Pack, the new
macroeconomic imbalance procedure is based on two of the six legislative texts, one
concerning the identification of the imbalances,125 and the other concerning a system of
sanctions.126 These regulations supplement the multilateral surveillance procedure referred
to in Article 121(3) and (4) TFEU.
8.148 The imbalance procedure is scheduled as follows: first, the identification of
imbalances (alert mechanism) and preventing measures to avoid a serious imbalance; and
next, if serious imbalances nevertheless develop, corrective measures can be taken via the
excessive imbalance procedure. If necessary, sanctions may be imposed.
Preventive arm: macroeconomic surveillance
8.149 The early identifications of imbalances operated via an indicator-based warning
mechanism. The Commission publishes an annual alert mechanism report which is
discussed by the ECOFIN Council and the Eurogroup as part of the annual multilateral
surveillance (Art 121 TFEU) under the European Semester.
(p. 321) 8.150 The Commission reports contain an economic and financial evaluation of the
Member States based on a macroeconomic scoreboard comprising indicative thresholds in
order to detect ‘severe imbalances, including imbalances that jeopardise or risk
jeopardising the proper functioning of the economic and monetary union’.127 The list of
indicators reads like a listing of the macroeconomic deficiencies currently found in the
Eurozone,128 including internal imbalances (such as public and private indebtedness,
financial and assets market developments in areas such as housing, as well as
developments in private sector credit flow and unemployment) and external imbalances
(such as those relating to movements in the balance of payment current account, the net
investment position, the real effective exchange rate, export markets shares and
competitiveness).129
8.151 If the thresholds have been breached, then the Commission performs a more
detailed analysis. In doing so, it also takes into account other ECOFIN recommendations,
National Reform Programme (NRP) and Stability and Convergence Programme (SCP)
targets as well as warnings and recommendation issued by the European Systemic Risk
Board (ESRB).130 If the Commission concludes that the situation is unproblematic, then no
further action is taken.
Corrective arm: excessive imbalance procedure
8.152 If in its analysis, the Commission concludes that excessive imbalances are
developing in a Member State, it informs the European Parliament, ECOFIN and the
Eurogroup. The Council then makes its recommendation131 establishing the existence of an
excessive imbalance and advocating corrective action as well as a deadline by which the
Member State must submit its corrective action plan (Art 121(2) TFEU).132
8.153 Following the submission of the plan, the Council has two months to assess it on the
basis of the report of the Commission. If the plan is satisfactory, it is approved and the
surveillance timetable is drawn up. However, if the Council decides that the measures or
the implementation periods are not satisfactory, the Member State has to submit another
plan within two months.
8.154 If the Member State fails to take corrective action, the Council—on the basis of the
Commission’s recommendation—can impose sanctions to the concerned Member State. As
in the EDP, the decision is taken by reverse majority voting. Specifically, the Council can
impose the following sanction: (1) an interest bearing deposit for Member States that do
not comply with the recommendation to take corrective action;133 (2) this deposit can turn
into a fine in the case of continued non-compliance with the recommendation to address
excessive (p. 322) macroeconomic imbalances with the same imbalances procedure; (3)
finally, repeated failures of the Member State to draw up a correction action plan to address
the Council recommendation should also be subject to an annual fine until the Council
establishes that the Member has provided a corrective action plan that sufficiently
addresses its recommendation. To ensure equal treatment among the Member States, the
interest-bearing deposit and the fine should be equal to 0.1 per cent of the GDP of the
Member State concerned in the preceding year.
Soft coordination of general economic policy
8.155 The final pillar of economic governance concerns general economic policy of the
EU-27. It is not underpinned by sanctions, but is based on non-legally binding agreement
(Euro Plus Pact) and extensive reporting by the Member States and recommendations from
the ECOFIN Council and the Commission (the Europe 2020 Strategy).
Europe 2020
8.156 ‘Europe 2020 Strategy’ was adopted by EU leaders at the European Council meeting
of June 2010. This is the Union’s strategy for creating jobs and promoting growth through
economic and social reforms, while respecting environmental limitations. Under the three
headings of smart, sustainable and inclusive growth, the strategy consisting of ‘seven
flagship initiatives’ covers policy actions at both national and EU level aimed at enhancing
the welfare of European citizens.134 This is to be achieved by pursuing the following five
quantified headlines targets: (1) raising the employment rate for those aged 20–64 to 75 per
cent; raising combined public and private R&D investment to 3 per cent of GDP; (2)
reducing greenhouse gas emission by 20 per cent compared to 1990 levels; (3) reducing
school drop-out rates to less than 10 per cent; (4) increasing the share of 30–34-year-olds
having completed tertiary or equivalent education to at least 40 per cent; and (5) reducing
the number of people suffering or at risk of poverty and social exclusion by at least 20
million.135 The Europe 2020 Strategy is a follow-up to the Lisbon Strategy, which has been
only moderately successful.136 The Europe 2020 Strategy attempts to correct Lisbon
weaknesses, mainly by giving the European Council a strong role in steering the
implementation of the reform agenda.
8.157 As the successor of the Lisbon Strategy, the Europe 2020 Strategy is implemented
via two processes spelled out in Articles 121 and 148 TFEU that apply to all 27 EU Member
States and operationalize the five headline targets of the strategy: the Broad Economic and
Policy Guidelines and the Employment Guidelines which have been proposed by the
European Commission and cover macroeconomic, microeconomic, and employment policies.
As mentioned above, the two sets of guidelines have been brought together under the single
heading of the Integrated Guidelines. They were revised in July 2010 as part of the adoption
of the Europe 2020 Strategy and also contain a specific guideline for the euro area.
(p. 323) 8.158 Having analysed the progress towards achieving Europe 2020 targets the
Commission published a communication and announced the launch of a public consultation
on the planned mid-term review of the strategy scheduled for March 2015, taking into
account the practicalities of its implementation during the first four years.137 In its
communication, the Commission concluded that Europe 2020 ‘targets has inevitably been
mixed’. Mainly due to the impact of the financial crisis and also because of discrepancies in
performance between Member States, the advancement on employment, research and
development and poverty reduction goals has been hindered whereas the outlook on
reaching other targets was positive.138
8.159 The coordination process takes place in four stages also within the European
Semester:139 (1) the Integrated Guidelines are formulated by the European Council on the
recommendation of the Commission and based on the Conclusions of the ECOFIN Council
and are then approved by the ECOFIN in March; (2) on the basis of the guidelines, each EU
country draws up its National Reform Programme setting out in detail the economic
reforms it will take under the new strategy, with a particular emphasis on efforts to meet
the national targets and to remove the bottlenecks that constrain sustainable growth at
national level;140 (3) in accordance with the guidelines, the Commission evaluates the
NRPs; (4) the European Councils issues recommendation based on ECOFIN’s assessment of
the NRPs (endorsement, mid-June).
8.160 In this context it is also worth mentioning the importance of the legislative package
known as Two Pack141 (explained in paras 8.116 and 8.130 above) which came into force in
2013. According to Regulation 473/2013, euro area Member States must submit their draft
budgets for the following year by 15 October annually, to the Commission for an assessment
and, on which basis it will issue respective opinions. Further, they will be discussed by the
Eurogroup along with the Commission’s overall assessment on the budgetary situation and
prospects in the euro area as a whole.142 Regulation 472/2014 requires the Commission to
increase the frequency of periodic reviews for the Member States subject to excessive
deficit or excessive macroeconomic adjustment procedure or financial assistance
programme.143 As discussed above, the Two Pack complements Six Pack and the SGP, thus
playing an (p. 324) important role in ensuring consistency between budgetary and other
economic policy processes and decisions.
The Euro Plus Pact
8.161 In March 2011, the heads of States or Government of the euro area and of six other
EU Member States reached an agreement on the Euro Plus Pact.144 This Pact aims to
strengthen further the economic pillar of EMU and enhance the quality of economic policy
coordination.145 The Pact’s main objective is to boost competitiveness in order to minimize
the long-term macroeconomic imbalances and achieve growth and convergence. The
common policy objectives are: fostering competitiveness and employment, contributing
further to the sustainability of public finances and reinforcing financial stability.146
8.162 While the Euro Plus Pact is only a soft law instrument the Member States which
signed the pact agree to take concrete measures every year which will be implemented in
the subsequent twelve months. The choice of actions to achieve the common objectives
remains the responsibility of each country. The measures are reported in the SCPs and
NRPs and monitored by euro area governments and contracting parties on the basis of
series of indicators. Then the Commission, the Council and the European Council assess the
NRPs and SCPs in the spring as part of the European Semester. In February 2012, the
ECOFIN adopted conclusions on the future of Euro Plus Pact, stating that (1) the
commitments under the Pact must be integrated into the NRPs and SCPs; (2) the Pact
should be used as an effective complementary instrument in implementing high impact
measurer aiming to substantially improving growth and employment; (3) these aims must
be targeted in both, short and long term perspectives; and (4) further coordination in the
area of tax policy is envisaged.147
The TSCG and economic policy coordination
8.163 As mentioned above, the TSCG not only reinforces fiscal discipline (via the Fiscal
Compact), but also provides new elements for economic policy coordination.148 The
contracting parties commit to strengthening the economic pillar of EMU ‘by adopting a set
of rules intended to foster budgetary discipline through a fiscal compact, to strengthen the
coordination of their economic policies and to improve the governance of the euro area,
thereby supporting the achievement of the European Union’s objectives for sustainable
growth, employment, competitiveness and social cohesion’.149 The contracting parties can
make use of Article 136 TFEU ‘whenever appropriate and necessary’ to achieve closer
economic policy coordination.150 The contracting parties also (p. 325) agree to discuss ex
ante all major economic policy reforms planned at the national level ‘with a view to
benchmarking best practices and working towards a more closely coordinated economic
policy’.151
8.164 The TSCG reaffirms that economic policy making remains a national competence
while adding certain elements on competitiveness and convergence. Although these
commitments overlap with Euro Plus Pact, the TSCG fails to mention it explicitly and to
make it a legally binding instrument. Furthermore, the TSCG does not mention any new
instruments enabling the Union to impose on countries specific reforms.
The European Semester: synchronization of governance mechanisms
8.165 On the recommendation of the Van Rompuy task force, the European Council of 17
June 2010 agreed to reinforce the ex ante dimension of economic coordination by
introducing the European Semester on January 2011. This new extensive coordination
process ensures that all elements of surveillance, including fiscal, macroeconomic and
structural policies are synchronized in a common process. The synchronization of the
processes does not, however, mean that their elements and objective are combined. Their
timetables are now harmonized but they remain legally separated.
8.166 The European Semester timetable is organized as follows:
• The process starts in January with the Publication of the ‘Annual Growth Survey’,
which intends to identify the mutual economic challenges and determines the
strategic policy stance.
• In February, the Commission publishes its ‘Alert Mechanism Report’ as part of the
new macroeconomic imbalance procedure. At the same time, the Economic Policy
Committee (EPC) prepares the discussion to be conducted in the Council.
• As part of the Europe 2020 Strategy, an annual economic and social summit of the
European Council in March provides for strategic guidance via the Integrated
Guidelines.
• In the spring, the Member States draw up their SCPs as part of the preventive arm
of the SGP and Fiscal Compact (fiscal coordination above). 152 At the same time they
draft their NRPs taking into account the objective of the Integrated Guidelines and
the Euro Plus Pact.
• These programmes are submitted in April to the Commission.
• In May/June, the Commission assesses these programmes and provides country-
specific recommendations on SCPs, NRPs, and macroeconomic surveillance.
• Finally, at the end of June or in early July, the Council formally adopts the country-
specific recommendations. The European Semester harmonizes the Council voting on
the different element of economic policy coordination, including fiscal,
macroeconomic and structural developments. For instance, the EU-23 vote on the
NRPs (addressing the objectives of Europe 2020 Strategy and the Euro Plus Pact), but
also the EU-25 vote on the SCPs (addressing the objective of the SGP and Fiscal
Compact). These are held in a single meeting.
(p. 326) G. Architecture to Deal with Sovereign Debt Problems

in the Eurozone
8.167 The Maastricht Treaty did not foresee the establishment of mechanisms or
programmes to provide emergency financial assistance to Eurozone Member States
suffering from sovereign debt troubles. Article 143 TFEU only included a mechanism of
balance of payments assistance for non-euro area countries.
8.168 When the euro crisis erupted in 2009 there was no institutional mechanism to
withstand the economic shock which certain Member Sates underwent. In the face of
severe market pressures, a new architecture to deal with sovereign debt problems has
emerged since 2010. This architecture comprises the European Financial Stabilisation
Mechanism (EFSM), the European Financial Stability Facility (EFSF), bilateral loans for the
euro countries, and lastly the European Stability Mechanism (ESM).
Greek Loan Facility
8.169 In April 2010, when Greece seemed to be in dire need of financial assistance, the
Eurozone countries, alongside the IMF,153 agreed to grant Greece several bilateral loans.
Greece was granted financial assistance equalling EUR 110 billions, in return for the
adoption of an austerity package. On 2 May 2010, the euro area Member States first
established a Greek Loan Facility (GLF).
EFSM
8.170 In response to the acute problems in Greece and the fear of cross-border contagion,
on 9 May 2010, during the extraordinary ECOFIN meeting, the ministers decided to
establish two emergency funds: the European Financial Stabilisation Mechanism and the
European Financial Stability Facility.154 The former was established by Council Regulation
407/2010 on the basis of the emergency clause of Article 122 TFEU.155 The latter was
designed as a public limited company governed by the laws of Luxembourg.156
8.171 Article 122(2) TFEU, the legal basis of the EFSM, allows EU financial assistance to
be granted to a Member State facing ‘severe difficulties caused by natural disasters or
exceptional occurrences beyond its control’. The ‘exceptional occurrence’ in this case is the
international financial crisis, although doubts were expressed about whether the debt crisis
of Member States like Greece have indeed been beyond their control. The maximum lending
capacity of the EFSM was determined in Article 2(2) and amounted to EUR 60 billion. The
(p. 327) EFSM was activated for up to EUR 22.5 billion for Ireland, and for up to EUR 26
billion for Portugal (in total for up to EUR 48.5 billion).
EFSF
8.172 The EFSF was established on 7 June 2010 as a public limited liability company
under Luxembourg law (société anonyme).157 The EFSF became operational on 4 August
2010 following its ratification by Member States. The total lending capacity of the EFSF
amounts to EUR 440 billion. Six months after the entry into force, on 30 November 2010,
the Commission published a report reviewing whether the exceptional circumstances which
justified the establishment of the EFSM are still present. It concluded that the exceptional
events and circumstances still existed and that the EFSM should therefore be
maintained.158,159
158 159
ESM
8.173 According to the Eurogroup statement of 28 November 2010 the finance ministers
agreed on the future European Stability Mechanism to replace the EFSF as of mid-2013.
This strategy was approved by the Council on 16–17 December 2010.160
8.174 In July 2012, the Eurogroup approved the financial assistance package for Spain of
up to EUR 100 billion.161 This became the catalyst for the relatively quick adoption of
banking union, as discussed in Chapter 10.
8.175 On 14 March 2012, euro area finance ministers approved financing of the Second
Economic Adjustment Programme for Greece amounting to EUR 164.5 billion in total. Euro
area Member States’ commitment was EUR 144.7 billion to be provided via the EFSF, while
the IMF contributes EUR 19.8 billion. The financial assistance was released in instalments
(p. 328) subject to the satisfaction of requirements and criteria detailed in the Council
Decision 2011/734/EU.162
8.176 Cyprus lodged an official request for assistance on 25 June 2012. On 25 March
2013, it was agreed by the euro area Member States163 that the ESM will provide EUR 9
billion of financial assistance to Cyprus whereas EUR 1 billion will be provided by the IMF
as a part of ESM/IMF package of EUR 10 billion assistance.164
8.177 The temporary measures to provide financial assistance to Greece, Ireland,
Portugal, and Spain’s ailing banking sector understandably proved to be controversial.
Concerns about the ‘no bail-out’ clause of Article 125 TFEU which prohibits financial aid
among Eurozone States,165 the limited nature of Article 122(2) TFEU, which provided that
the Council could provide financial assistance to Member States in case of exceptional force
majeure type circumstances, such as natural disaster or comparable events beyond the
control of Member States (though it is questionable whether Greece’s public debt should
count as an event beyond its control), and the legal uncertainty surrounding these
temporary solutions, led the European Council to take the initiative at its meeting of
December 2010 to create a permanent crisis mechanism through a simplified revision
procedure (SRP)166 on the basis of Article 48(6) TEU.167 On 25 March 2011, the European
Council adopted Decision 2011/199, adding a third paragraph to Article 136 TFEU. This
paragraph authorizes euro area Member States to establish a permanent stability
mechanism that would operate under strict conditionality.
8.178 Besides this simplified Treaty amendment, the Member States also negotiated an
international treaty governing the ESM which was originally signed on 11 July 2011.168
However, the European Stability Mechanism Treaty (ESMT) was renegotiated in order to
provide more flexibility and the new version was concluded in Brussels on 2 February 2012.
The ESMT entered into force on 27 September 2012 and the ESM was inaugurated on 8
October 2012 following the ratification by all the Eurozone Members. The ESM has a
lending capacity of EUR 500 billion, backed up by an authorized capital of 700 billion.169(p.
329) The ESM like the EFSF, is established to provide financial assistance to euro area
Member States experiencing or threatened by financing difficulties.
8.179 On 1 July 2013, the EFSF was replaced by the ESM—the sole and permanent
mechanism for responding to new requests for financial assistance by euro area Member
States.170 The EFSF may no longer engage in new financing programmes or enter into new
loan facility agreements but it remained active in financing the on-going programmes. The
ESM raises funds by issuing money market instruments and medium and long-term debt
with maturities of up to thirty years, which are backed by a paid-in capital of EUR 80 billion
and the irrevocable and unconditional obligation of ESM Member States to provide their
contribution to ESM’s authorized capital stock.171
8.180 ESM Members can apply for several financial assistance mechanisms, subject to
strict conditionality, if they are experiencing serious financial difficulties.172 These
conditions are implemented through a Memorandum of Understanding (MoU) reflecting a
macroeconomic adjustment programme concluded with ESM Members concerned.173
8.181 On 10 June 2014, euro area Member States reached a political understanding on the
operational framework of the ESM direct recapitalization instrument.174 Following the
relevant national procedures and the formal adoption by the ESM Board of Governors, the
instrument is expected to be added to the toolkit of the ESM by the start of the SSM
supervision in November 2014. The instrument may be activated in case a bank fails to
attract sufficient capital from private sources and if the ESM Member concerned is unable
to recapitalize it, including through the instrument of indirect recapitalization of the ESM.
For a transitional period until 31 December 2015, a bail-in of 8 per cent of all liabilities will
be a precondition for using the instrument, as well as the use of the resources available in
the ESM Member’s national resolution fund. From 1 January 2016, bail-in in line with the
rules of the Bank Recovery and Resolution Directive will be required. The financial
assistance will (p. 330) be provided in accordance with EU State aid rules and the ESM
Member will be asked to invest alongside the ESM.
8.182 The ESMT has been subject to constitutional review in several Member States. In
Estonia, a constitutional complaint was rejected.175 Germany, Europe’s main paymaster,
delayed the entry into force since the ESMT could only take effect once the instruments of
ratification were deposited by signatories whose initial capital subscriptions represented no
less than 90 per cent of the ESM’s authorized capital stock.176 Given that Germany’s
subscription is more than 27 per cent, the ESMT could not enter into force without
Germany’s consent, which was eventually possible on 11 September 2012 when the German
Federal Constitutional Court gave the green light for ratification under several
conditions.177
The Pringle case
8.183 In Ireland, Thomas Pringle, an independent member of the Parliament, introduced a
challenge against the legality of the ESMT on the grounds that it was incompatible with the
Irish Constitution and the EU Treaties.178 Pringle requested a preliminary reference to the
European Court of Justice.179 On 17 July 2012, the Irish High Court held that the Treaty
was compatible with the Irish Constitution and the Irish Constitution did not require a
referendum prior to the Irish government’s ratification of the EMST. On July 2012, the Irish
Supreme Court rejected Mr Pringle’s constitutional challenge under Irish law and refused
to grant the injunction sought.180 However, the Supreme Court upheld the preliminary
reference to the CJEU.
8.184 The Irish Supreme Court sought clarification on three aspects:
(1) whether the Council Decision of 25 March 2011 amending Article 136 TFEU
under the SRP is valid;
(2) whether the provisions of the ESMT are compatible with Member States’
obligations under the Treaties; and
(3) whether the entry into force of the ESM was subject to prior entry into force of
the European Council Decision authorizing Member States to establish the ESM.
Validity of Decision 2011/199

8.185 After dismissing challenges to the admissibility of the case,181 the CJEU
demonstrated that Decision 2011/199 complied with the conditions of the SRP laid down in
Article 48(6) TEU: first, that the Treaty amendment concerned only Part III of TFEU (ie,
internal policies and actions of the EU); and secondly, that the amendment does not
increase the competences of the EU.
(p. 331) 8.186 In defining whether the amendment only concerned Part III of the TEFU,
the court attempted to examine how the ESMT could infringe the Union’s competence in
the fields of monetary and economic policy. Regarding the EU’s exclusive monetary
competence, the CJEU argued that the objectives and instrument of a stability mechanism,
of the kind envisaged by Decision 2011/199 do not fall in the realm of monetary policy. The
objective of the ESM is ‘to safeguard the stability of the euro area as a whole, that is clearly
distinct from the objective of maintaining price stability, which is the primary objective of
the Union’s monetary policy’.182 Even though the Court admits that the activities of the
ESM may have repercussions on the stability of the euro, the ESM is only competent to take
economic policy measures, which cannot be treated as equivalent to monetary policy
measures. As far as economic policy is concerned, the CJEU held that the Decision did not
encroach upon the EU’s competences in economic policy.183 More specifically, the Court
argued that the Union only has shared competence in the field of economic policy and
therefore cannot establish a permanent stability mechanism like the one envisaged by
Article 136(3) TFEU. As argued above, the legal basis in the Treaty that enables the Union
to grant financial assistance is Article 122(2) TFEU. However, this provision only allows a
temporary ad hoc mechanism, which is very distinct from the ESM. The CJEU concluded
therefore that, the Decision did not affect the Union’s economic competence. However, the
Court noted that the ESM could not disregard EU law when exercising its competence in
that area. And this is the reason why financial assistance is subject to strict conditionality:
‘to ensure that the mechanism will operate in a way that will comply with EU Law’.184
8.187 With regard to the increase of the competences conferred upon the Union, the Court
claimed that Article 136(3) was not the legal basis for the establishment of the ESM. The
Member States always had the competence to create the ESM and therefore the
amendment does not entail transfer of power to the Union. The ECJ concluded that the
conditions for validity of the Decision 2011/199 have been fulfilled.
Compatibility of the ESMT with EU treaties
8.188 With its second question, the CJEU examined first the ESMT in light of several
provisions on monetary and economic policy. Regarding the former, the Court reaffirms that
the ESM did not concern monetary policy.185 As for economic policy, the Court assessed
whether the ESMT encroached upon the Union’s coordinating competences laid down in
Articles 2(3), 119–21, and 126 TFEU. The CJEU held that the ESM is only concerned with
financial assistance and therefore does not affect the coordinating competence of the
Union.186 While strict conditionality imposed by the ESM shall ensure consistency with
coordination measures, these conditions are not instruments for coordination of economic
policy.187 Regarding the Union’s competence to grant assistance, the Court reiterated its
statement earlier that Article 122(2) TFEU was not a sufficient legal basis for the
establishment of a Union’s permanent stability mechanism.188 Accordingly, the ESMT does
not encroach upon the Union’s competence to provide ad hoc emergency funding.
(p. 332) 8.189 The compatibility of the ESMT with the ‘no bail-out’ clause seemed to be the
most complex obstacle for the Court. It argued that Article 125 does not cover every form of
financial assistance and held that this reading of Article 125 is supported by Articles 122
and 123 TFEU. According to the Court, if the Treaty had prohibited any forms of assistance
then Article 122(2) would have had to state that it constitutes a derogation from this
prohibition. Furthermore, the Court noted that the wording of Article 123 TFEU on
monetary financing is much stricter than the language used in Article 125 TFEU and as a
result, any support granted on the ground of the ‘no bail-out’ clause is not automatically
prohibited.
8.190 In order to define which forms of financial aid are compatible with the Treaty, the
Court presented a teleological interpretation of Article 125 TFEU. Investigating the
preparatory work of the Maastricht Treaty, the CJEU claimed that the aim of Article 125 is
to ensure fiscal discipline and that Member States submit themselves to the logic of the
markets. Article 125 contributes to the attainment of a higher objective, namely the
maintenance of the financial stability of the monetary union.189
8.191 In light of this interpretation, the Court held that the financial assistance provided
by the ESM is compatible with the Treaty because it is subject to strict conditionality and
does not reduce the incentive for Member States to conduct sound fiscal policies.
Furthermore, the Court added that financial aid cannot be granted as soon as a Member
State suffers impaired market access. Stability support must be indispensable to safeguard
the stability of the Europe area as a whole.190 The Court also held that if financial
assistance is granted the recipient remains responsible to its creditors provided that the
conditions attached to such assistance will not reduce the incentive to conduct sound fiscal
policies. On the basis of this reasoning the CJEU ruled that the provisions of the ESMT did
not breach EU law.
Conclusion and ratification of the ESMT before the entry into force of the Decision
2011/199
8.192 Finally, the third reference on whether the ESMT could be legally concluded and
ratified before the entry into force of the amendment to TFEU was briefly treated. Given
this question is closely related to the first question on the power, the Court reiterated that
Article 136(3) only confirms already existing power of the Member States to conclude and
ratify an international agreement and therefore the conclusion of the ESMT did not depend
on the entry into force of Decision 2011/199.191
H. Genuine Economic and Monetary Union
8.193 The President of the European Council was tasked by the European Council in May
2012 with creating a Genuine Economic and Monetary Union (GEMU). The European
Commission’s 2012 report,192 ‘A Blueprint for a Deep and Genuine Economic and Monetary
(p. 333) Union (GEMU)’ and the 2012 report by the President of the European Council,
Herman Van Rompuy,193 ‘Towards a Genuine Economic and Monetary Union’ set out the
four building blocks for the future of EMU, namely an integrated financial framework, an
integrated budgetary framework, an integrated economic policy framework, and
strengthened democratic legitimacy and accountability.194
8.194 Significant progress has been made on the integrated financial framework (banking
union) and discussions are on-going on what this may entail on the economic, fiscal and
political front. At the same time, EU countries continue to grapple with how to ensure long-
term sustainable growth and what role the EU level should play in supporting this.195
8.195 The ‘remorseless logic’ of fiscal union in a monetary union (in order to ensure the
survival and long term success of the euro) and the inadequacy of the framework for
financial supervision and resolution have been evidenced by the twin financial and
sovereign debt crises and their aftermath. The fiscal backstop of one of the pillars of the
banking union plan—resolution—suggests that a lot of work still remains to be done. The
plans for GEMU increase coordination and surveillance of fiscal policies, enhance discipline
with the creation of a Finance Minister and the contested ‘federalism by exception’ which
would allow a central authority to have powers vis-à-vis Member States which do not
comply with the rules (conditionality adds an element of diktat over fiscally ‘irresponsible’
countries), but still fall short of full fiscal union.
8.196 We must address the legal and constitutional challenges that stem from the
increasing design of a ‘double treaty structure’—EU treaties on the one hand and
intergovernmental treaties, such as the ESMT or the TSCG (Fiscal Compact), on the other
hand. EU institutions are relied upon for the effective working of the institutions—such as
the ESM—created by such intergovernmental treaties. Though the European Court of
Justice is satisfied with the legality of the ESM in the Pringle case, this double treaty
structure requires further legal consideration. It is interesting to note that progressively the
Commission takes over elements of budgetary discipline covered by the TSCG into genuine
EU law. Binding contracts, known as ‘Convergence and Competitiveness Instruments’, have
been proposed as part of the plans for GEMU to encourage structural reforms through
rewards or sanctions.
8.197 Only a treaty change could alter the existing framework. A true fiscal union requires
an automatic system of fiscal transfers (fiscal stabilizers), a substantial central budget
based on an autonomous power of taxation and the possibility to issue EU sovereign bonds
(with joint liability).
(p. 334) I. Regional Adjustment

8.198 Effective economic coordination at the macroeconomic level (through fiscal rules
and multilateral surveillance) needs to be accompanied by the economic development of the
EU Member States. Regional disparity and regional imbalances have been a permanent
feature in the history of the European Union. Hence the importance of microeconomic
policies and regional adjustment.
8.199 Although the European Union is one of the richest parts of the world, there are
striking internal disparities of income and opportunity between its regions. Regional
policy196 transfers resources from affluent to poorer regions. It is both an instrument of
financial solidarity and a powerful force to promote economic and social cohesion. The need
to promote balanced development by reducing the gap between the different regions and
helping the poorest regions to catch up was recognized in the preamble to the Treaty of
Rome in 1957. The EEC Treaty also provided for the establishment of the European
Investment Fund.
8.200 Article 3 TEU states that one of the Union’s tasks is to ‘work for the sustainable
development of Europe based on balanced economic growth and price stability, a highly
competitive social market economy, aiming at full employment and social progress, and a
high level of protection and improvement of the quality of the environment. …It shall
promote economic, social and territorial cohesion, and solidarity among Member States.’
More specifically, Articles 174–8 TFEU, on ‘Economic, social and territorial cohesion’,
explain that the Union aims to reduce disparities between the development of various
regions and the backwardness of the least favoured regions or islands, including rural
areas.
8.201 The European Union grants financial assistance under multi-annual regional
development programmes negotiated between the regions, the Member States, and the
Commission, as well as under specific Union initiatives and schemes, through four
‘Structural Funds’:197 the European Regional Development Fund (ERDF); the European
Social Fund; the European Agricultural Guidance and Guarantee Fund (EAGGF); and the
Financial Instrument for Fisheries Guidance (FIFG) which provides financial support for
fishing communities as part of the common fisheries policy.198 In addition to these four
‘structural funds’, a special solidarity fund, the Cohesion Fund, was set up in 1993 to
finance transport and environment infrastructure in Member States with a GDP of less than
90 per cent of the Union average at the time (at that time, Greece, Ireland, Spain, and
Portugal).199
(p. 335) 8.202 To address the substantial needs of the Member States that joined the EU in
May 2004 (with regard to the development of their infrastructure, transport, agriculture,
environment, and other areas), two facilities were established: (1) the Instrument for
Structural Policies for Pre-Accession (ISPA), to finance transport and environment
projects,200 and (2) the Special Accession Programme for Agriculture and Rural
Development (SAPARD), to help the countries prepare for the Common Agricultural
Policy.201 In January 2007, these programmes were replaced by the Instrument for Pre-
Accession Assistance (IPA)202 for candidate countries (Croatia,203 Turkey, and the former
Yugoslav Republic of Macedonia) or potential candidate countries (Albania, Bosnia-
Herzegovina, Montenegro, Serbia, and Kosovo under UN Security Council Resolution
1244/99).
8.203 In order to make cohesion policy more efficient and sustainable the special support
instruments were adopted as a part of 2007–13 programming framework. The European
Commission in cooperation with the European Investment Bank group and other financial
institutions developed four joint initiatives: two of them refer to the promotion of financial
engineering instruments (JEREMIE204 and JESSICA205), and the other two (JASPERS206 and
JASMINE207) operate as technical assistance facilities. While according to the 2014–20
Cohesion Policy, it is intended to invest EUR 325 billion in Member States, their regions and
cities to deliver the EU-wide goals of growth and jobs, tackle climate change, energy
dependence and social exclusion, the overall impact is expected to exceed EUR 500 billion
taking into account the contribution from the Member States and the leverage effect of
financial instruments.208 The funding for regional and cohesion policy available in 2014–20
amounts to EUR 351.8 billion.
8.204 The European Council adopted in its session of 7–8 February 2013 a Common
Strategic Framework, a project designed to bring together all cohesion and structural funds
with the European Agricultural Fund for Rural Development (AFRD) and the European
Maritime (p. 336) and Fisheries Fund (EMFF) and establish a closer link between cohesion
policy and the economic governance of the Union.209
8.205 The new multi-annual framework adopted for 2014–20 acknowledging the benefits
of the use of financial instruments as a more efficient and sustainable alternative to
complement traditional grant-based financing providing a greater degree of flexibility for
Member States, encourages further expansion and strengthens their use, and provides a
range of the new implementation options compared to 2007–13 framework.210
8.206 Economic development in the poorer regions of Europe is necessary for the success
of economic policy coordination in the EU and the periodic review of the methods used to
achieve this goal cannot be underestimated. Solidarity and cohesion imply prosperity for all.
This is one of the premises upon which the project of European integration rests.
J. Concluding Observations

8.207 The weakness of the ‘E’ of EMU became apparent with the twin banking and
sovereign debt crisis in Europe. A flurry of EU and Eurozone initiatives has tried to
strengthen this weak pillar in the last few years. However, the asymmetric institutional
structure combining centralized monetary policy combined with decentralized fiscal policy
remains. This chapter has analysed the primary and secondary law (a veritable patchwork
of rules) governing the ‘E’ of EMU before and after the crisis.
8.208 Europe is again at a crossroads between those who want deeper integration and
those who would prefer a more decentralized approach. Greece returned to international
bond markets in April 2014,211 following a period of fiscal austerity, social unrest and the
biggest debt restructuring in history. Other Eurozone Member States that were at the heart
of crisis are now doing (p. 337) better, too.212 However, much still remains to be done in
terms of structural reforms. There should be little room for complacency. There is a growing
disconnection between the elites that drive the process of integration and the general
public, where discontent on a number of issues has led to the rise of anti European or
extreme right wing parties in the May 2014 elections to the European Parliament.
8.209 Reflecting on the current ‘patchwork’ of fiscal rules, Jean-Victor Louis and myself
concluded in a recent paper:
Going forward, we need to reconcile the interests of the citizens of the EU with the
grand plans and small patches that the Union institutions have devised and
continue to devise—in a frenzy of legislative and policy initiatives—to combat the
twin sovereign debt and financial crisis and to ensure the survival of the euro.213
Texts have been added on top of another in order to respond to pressures from the
market. The result is a complex system of EU secondary law, international treaties,
and soft law or political agreements…‘an intergovernmental bricolage’. The number
of addresses varies from one text to another and it is difficult to identify who is in
charge and what is the specific legal value of the respective commitments.
Procedures intertwine with each other. …The euro area has a fragmented
governance which could not replace a true government.214
8.210 A permanent and coherent framework for GEMU would require a Treaty revision. As
we embark on banking union (in particular the Single Resolution Mechanism (SRM) pillar,
discussed in Chapter 10), fiscal union looms in the background.
8.211 From a legal perspective it is also interesting to observe (with the Pringle case and
the referral to the ECJ by the German Constitutional Court of the OMT decision) the new
role of supreme judges in the formation of economic policy. Before Pringle, the only two
material ECJ decisions215 related to EMU were the 2003 OLAF case clarifying the status
and independence of the ECB (discussed in Chapter 7) and the 2004 judgment on the
Stability and Growth Pact (discussed at para 8.63 above). Pringle marks the beginning of a
period of ‘judicial activism’ in the field of economic policy.(p. 338)
Footnotes:
1
See Judgment of the German Federal Constitutional Court (Bundesverfassungsgericht) of
12 October 1993 in the case of Brunner v The European Union Treaty, published in (1993)
12 Recht der Internationalen Wirtschaft, Suppl 5. An English translation was published in
(1994) 1 Common Market Law Review 57.
2
See Samuel Brittan, ‘EMU in Perspective’ in Mads Andenas et al (eds), European
Economic and Monetary Union: The Institutional Framework (The Hague: Kluwer Law
International, 1997) 118.
3
See Case C-27/04 Commission of the European Communities v Council of the European
Union [2004] ECR I–06649, concerning the action of the Commission and the conclusions of
the Council with regard to the excessive deficits of France and Germany. See also the
European Court of Justice, ‘Judgment of the Court of Justice in Case C-27/04’, Press Release
No 57/04 (13 July 2004), <http://curia.europa.eu/en/actu/ communiques/cp04/aff/
cp040057en.pdf> (last visited 7 August 2014).
4
See ‘Row Over “Stupid” EU Budget Rules’ BBC News (17 October 2002). According to
Mario Monti,
[I]t would have been far preferable for the EU to have adopted a more rational pact
from the start, or to have modified it only after the completion of a full first round of
enforcement. Instead, the imperfect pact was applied rigorously to two small
member states—Ireland and Portugal—then suspended and changed when France
and Germany, the same countries that originally opposed the adoption of a lax pact,
ran into difficulty. In the process, the fundamental principle of equality of treatment
has been violated and the EU’s credibility damaged.
See Mario Monti, ‘Toughen Up the Reform Agenda and Make it Count’ Financial Times (22
March 2005).
5
Klaus Armingeon and Lucio Baccaro, ‘Political Economy of the Sovereign Debt Crisis: The
Limits of Internal Devaluation’ (2012) 41 Industrial Law Journal 254.
6
See Angelos Dimopoulos, ‘The Use of International Law as a Tool for Strengthening
Economic Governance in the EU and its Implications on EU Institutional Integrity’ in
Maurice Adams, Federico Fabrinni, and Pierre Larouche (eds), The Constitutionalisation of
EU Budgetary Constraints (Oxford: Hart Publishing, 2014). Dimopoulos points out (at 42–3):
As the ESM and the Fiscal Compact introduce international law obligations in an
area covered largely by EU law, it is, at least, questionable how these international
agreements fit within the existing Union legal framework…and [they] cast doubt on
the credibility of the EU governance model.
7
See Mark Milner, ‘Europe’s Financial Architect. Interview: Alexandre Lamfalussy’ The
Guardian (16 August 2003), at <http://www.theguardian.com/business/2003/aug/16/3> (last
visited 7 August 2014).
8
See Consolidated versions of the Treaty on European Union and the Treaty on the
Functioning of the European Union, 2010 OJ C 83/01 vol 53 (30 March 2012), Art 311
(hereinafter TFEU).
9
The Council adopted the regulation laying down the EU’s multiannual financial
framework for 2014–20 in November 2013. See European Commission, ‘Council Adopts the
Multiannual Financial Framework 2014–20’, at <http://ec.europa.eu/budget/mff/
index_en.cfm> (last visited 7 August 2014). The EU’s Multiannual Financial Framework
2014–20 allows the EU to invest up to EUR 960 billion in commitments (1.00% EU GNI) and
EUR 908.4 billion in payments (0.95% EU GNI). See also European Commission, Financial
Programming and Budget, ‘Where does the money come from?’, at <http://ec.europa.eu/
budget/explained/budg_system/financing/fin_en.cfm> (last visited 7 August 2014).
10
Iain Begg, ‘Future Fiscal Arrangements in the European Union’ (2004) 41 Common
Market Law Review 781.
11
The French version reads as follows: ‘on a appelé union économique et monétaire une
union qui était en réalité très monétaire et guère économique’. See Pascal Lamy and Henri
Busson, ‘Pourquoi l’euro?’ (2012) 11(12) Regards croisés sur l’économie 1.
12

EMU essentially rests on an asymmetric two-pillar structure, splitting competences

between the Community and the Member States. The competence for the execution
and, to a considerable extent, also for the formulation of economic policy has been
left with the Member States. Arguably, at the time of the drafting of the provisions
on EMU this not only reflected the diversity between the Member States’ economic
structures and economic developments and the different beliefs of what economic
policy can and cannot achieve, but also the political conviction of the Member
States at large that fiscal policy should essentially remain a national competence.
See Fabian Amtenbrink and Jakob De Haan, ‘Economic Governance in the European Union:
Fiscal Policy Discipline versus Flexibility’ (2003) 40 Common Market Law Review 1078.
13
See Dominique Servais and Rodolphe Ruggeri, ‘The EU Constitution: its Impact on
Economic and Monetary Union and Economic Governance’ in Legal Aspects of the
European System of Central Banks, Liber Amicorum Paolo Zamboni Garavelli (Frankfurt:
European Central Bank, 2005) 50.
14
Jean-Victor Louis, ‘The Economic and Monetary Union: Law and Institutions’ (2004) 41
Common Market Law Review 582.
15
See also René Smits, The European Central Bank. Institutional Aspects (The Hague:
Kluwer Law International, 1997) 55. In the view of Smits, ‘this positive integration does not
entail material norm-setting as in the area of competition policy or in the harmonization of
legislation for the full exercise of market freedoms or the proper supervision of market
participants…Yet…the economic policies in the Community are to be geared towards
objectives specified in the Treaty and embedded in the framework of an open market with
free competition. In this respect, economic policy co-ordination is norm-bound.’
16
Wolfang Munchau, ‘Eurozone Faces Risks if Inflation Rates Stay Out of Line’ Financial
Times (31 May 2004). Munchau suggested that ‘the trouble with the eurozone is that the
ECB is the only genuine “pan-European player” in the entire game. Fiscal policy is
determined by national governments, labour markets are organised on national lines and
people and companies still form their price expectations on a national basis. The idea that
you can run autonomous national policies in a monetary union seems increasingly
unrealistic.’
17
TFEU, Article 121(2).
18
See Council Recommendation 2010/410/EU of 13 July 2010 on broad guidelines for the
economic policies of the Member States and of the Union, OJ L 191/28 (23 July 2010); and
Council Decision of 6 May 2014 on guidelines for the employment policies of the Member
States for 2014, OJ L 165/49 (4 June 2014).
See Servaas Deroose, Dermot Hodson, and Joost Kuhlmann, ‘The Broad Economic Policy
Guidelines: Before and After the Re-launch of the Lisbon Strategy’ (2008) 46 Journal of
Common Market Studies; European Commission, ‘Integrated Guidelines 2005–2008
including a Commission Recommendation on the Broad Economic Policy Guidelines’,
COM(2005) 141 final (12 April 2005), at <http://ec.europa.eu/economy_finance/
publications/publication6410_en.pdf> (last visited 7 August 2014).
19
Council Recommendation 2008/390/EC of 14 May 2008 on the broad guidelines of the
economic policies of the Member States and the Community (for the 2008–2010 period), OJ
L 137/13 (27 May 2008).
20
Council Recommendation 2008/390/EC, 74–9. Smits provides an insightful discussion of
these prohibitions.
21
Smits, above note 15, 74.
22
See Rosa Lastra and Jean-Victor Louis, ‘European Economic and Monetary Union:
History, Trends and Prospects’ (2013) 32(1) Yearbook of European Law.
23
24
Lastra and Louis, above note 22, 43–4: ‘Voluntary financial support should not be
considered as the indirect takeover of obligations of another Member State.’
25
26
27
TFEU, Art 143(1) subpara 2 and 143(2).
28
See European Commission, ‘Balance of Payments’, at <http://ec.europa.eu/
economy_finance/eu_ borrower/balance_of_payments/index_en.htm> (last visited 7 August
2014).
29
European Commission, ‘Balance of Payments’, above note 28.
30
See Jean-Victor Louis, ‘The No-Bailout Clause and Rescue Packages’ (2010) 47 Common
Market Law Review 971
31
The temporary and permanent support mechanisms that Member States agreed to set
up in order to offer financial assistance to troubled Eurozone countries are discussed in
para 8.98 below.
32
See ‘ECB Shows its Hand’, Editorial, Financial Times (20 November 2005): ‘[T]here has
been little differentiation [so far] in a market that has tended to believe that there is an
implicit guarantee of all euro-zone government debt.’
33
See ‘Bond Yields Widen as Greek Talks Begin’ Financial Times (1 April 2010): ‘In a sign
that markets are waiting for Athens to ask for assistance the yield on 10-year government
bonds climbed 42 basis points to 8.28 per cent.’
34
Gavin Hewitt, ‘The Downgrading of Europe’ BBC News Europe (14 January 2012).
35
See ‘How the Euro Became Europe’s Greatest Threat’ Der Spiegel (20 June 2011).
36
See European Central Bank, ‘The Implementation of Monetary Policy in the Euro
Area’ (February 2005) ch 6, at <http://www.ecb.int/pub/pdf/other/gendoc2005en.pdf> (last
37
‘ECB Shows its Hand’, above note 32. See also Joanna Chung and Ralph Atkins, ‘ECB
Sends Powers Signal on Debt’ Financial Times (10 November 2005).
38
See European Central Bank, ‘Measures to Preserve Collateral Availability’, Press
Release (6 September 2012), at <http://www.ecb.int/press/pr/date/2012/html/
pr120906_2.en.html> (last visited 7 August 2014).
39
Decision of the ECB of 14 May 2010 establishing a Securities Markets Programme, ECB/
2010/5 (2010/281/EU), OJ L 124/8 (20 May 2010).
40
See European Central Bank, ‘Technical Features of Outright Monetary Transactions’,
Press Release (6 September 2012), at <http://www.ecb.int/press/pr/date/2012/html/
pr120906_1.en.html> (last visited 7 August 2014).
41
‘Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And
believe me, it will be enough.’ See Mario Draghi, President of the European Central Bank,
Speech at the Global Investment Conference in London (26 July 2012), at <http://
www.ecb.europa.eu/press/key/date/2012/html/sp120726.en.html> (last visited 7 August
2014).
42
Indeed, this is one of the tenets of fiscal federalism.
43
Chris Giles, Peter Spiegel, and Quentin Peel, ‘Germany Rules Out Common Euro Bonds’
44
This protocol is also annexed (as Protocol 12) to TFEU.
45
See Protocol on the Excessive Deficit Procedure annexed to TFEU, Art 2.
46
Protocol on the Excessive Deficit Procedure annexed to TFEU, Art 4. Statistical data
collection became a critical issue with the Eurozone debt crisis since a Member State (ie,
Greece) provided incorrect data.
47
TFEU, Art 126(14).
48
The powers of the Commission and the Council were clarified by the European Court of
Justice in its judgment of 13 July 2004, Case C–27/04 Commission v Council [2004] ECR I–
06649.
49
Before Lisbon, EC Treaty, Art 122(3) and Protocol (No 25) on certain provisions relating
to the United Kingdom of Great Britain and Northern Ireland (1992), annexed to the Treaty
establishing the European Community, para 5 (hereinafter UK Opt-out Protocol) authorized
the derogation only for Art 104(9) and (11) EC Treaty, but did not mention paras 6, 7, 8, and
12. This meant that Member Sates with a derogation had the right to vote on Council
proposals according to Article 104(6), (7), (8), and (12) EC Treaty. Since the Lisbon Treaty,
Article 139(4)(1) lit b provides for the suspension for the voting rights of Members of the
Council representing member States with a derogation for all measures against member
States with euro currency as laid down in TFEU, Article 126 (6), (7), (8), (12), and (13).
50
Council Decision 90/141/EEC of 12 March 1990 on the attainment of progressive
convergence of economic policies and performance during stage one of economic and
monetary union, OJ L 78 (24 March 1990) 23. This Council Decision repealed the Council
Decision 74/120/EEC of 18 February 1974 on the attainment of a high degree of
convergence of the economic policies of the Member States of the European Economic
Community, OJ L 63 (5 March 1974) as well as the Council Directive 74/121/EEC of 18
February 1974 on stability, growth, and full employment in the Community, OJ L 63/16 (5
March 1974).
51
Council Decision 90/141/EEC, Art 3. According to Council Decision 90/141/EEC, Art 1,
the Council was empowered to undertake ‘multilateral surveillance’ in order to help to
achieve sustained non-inflationary growth in the Community, together with a high level of
employment and the degree of economic convergence necessary for the success of Stage
One of Economic and Monetary Union.
52
Council Regulation (EC) No 3605/93 of 22 November 1993 on the application of the
Protocol on the excessive deficit procedure annexed to the Treaty establishing the
European Community, OJ L 332 (31 December 1993) 7. Under Council Regulation 3605/93,
Art 4, from the beginning of 1994, Member States shall report to the Commission their
planned and actual government deficits and levels of government debt twice a year, the first
time before 1 March of the current year (year n) and the second time before 1 September of
year n. Regulation 3605/93 was last amended by Regulation 351/2002 of 25 February 2002,
OJ L 55 (26 February 2002) 23.
53
Council Regulation (EC) No 3603/93 of 13 December 1993 specifying definitions for the
application of the prohibitions referred to in Articles 104 and 104b (1) of the Treaty, OJ L
332 (31 December 1993) 1.
54
Council Regulation (EC) No 3603/93, Art 1(a).
55
Council Regulation (EC) No 3603/93, Art 3.
56
Council Regulation (EC) No 3604/93 of 13 December 1993 specifying definitions for the
application of the prohibition of privileged access referred to in Article 104a of the Treaty,
OJ L 332 (31 December 1993) 4. The Regulation was adopted under the enabling provisions
of Art 102(2) EC. Article 1 of the Regulation defines privileged access as any law, regulation
or any other binding legal instrument adopted in the exercise of public authority which:
• Obliges financial institutions to acquire or to hold liabilities of Community

institutions or bodies, central governments, regional, local or other public
authorities, other bodies governed by public law or public undertakings of
Member States (hereinafter referred to as ‘public sector’), or
• Confers tax advantages which may benefit only financial institutions or
financial advantages which do not comply with the principles of a market
economy, in order to encourage the acquiring or the holding by those
institutions of such liabilities.
57
See ‘Editorial Comments: Whither the Stability and Growth Pact?’ (2004) 41(5) Common
Market Law Review 1197.
58
Resolution of the European Council on the Stability and Growth Pact of 17 June 1997, OJ
C 236/1 (2 August 1997).
59
See Council Regulation 1466/1997 of 7 July 1997 on strengthening of the surveillance of
budgetary positions and the surveillance and coordination of economic policies, OJ L 209/1
(2 August 1997).
60
See Council Regulation 1467/97 of 7 July 1997 speeding up and clarifying the
implementation of excessive deficit procedure, OJ L 209/6 (2 August 1997). The Regulation
provides a clear method for proposing and implementing prompt corrective actions within a
year of the reporting of the excessive deficit.
61
See Lorenzo Bini Smaghi, ‘What Went Wrong with the Stability and Growth Pact’ in
Peter Sørensen (ed), Monetary Union in Europe. Essays in Honour of Niels Thygesen
(Copenhagen: DJØF Publishing Copenhagen, 2004) 169.
62
Communication from the Commission to the Council and the European Parliament on
strengthening economic governance and clarifying the implementation of the Stability and
Growth Pact, COM (2004) 581 final (3 September 2004).
63
See ECOFIN Council, ‘Improving the Implementation of the Stability and Growth Pact’,
Report 7435/05 (21 March 2005), at <http://www.eu2005.lu/en/actualites/
documents_travail/2005/03/21stab/stab.pdf> (last visited 7 August 2014).
64
Gerhard Schröder, ‘A Framework for a Stable Europe’ Financial Times (17 January
2005).
65
Council Regulation (EC) No 1055/2005 amending Regulation (EC) No 1466/1997 on the
strengthening of the surveillance of the budgetary positions and the surveillance and
coordination of economic policies, OJ L 174 (7 July 2005) 1–4.
66
Council Regulation (EC) No 1056/2005 amending Regulation (EC) No 1467/97 on
speeding up and clarifying the implementation of the excessive deficit procedure, OJ L 174
(7 July 2005) 5–9.
67
See European Commission, European Economy No 3/2005 (2006) 79–80, at <http://
ec.europa.eu/economy_finance/publications/publication421_en.pdf> (last visited 15
September 2014).
68
See European Commission, Economic and Financial Affairs, ‘The Stability and Growth
Pact’, at <http://ec.europa.eu/economy_finance/economic_governance/sgp/index_en.htm>
(last visited 7 August 2014).
69
See Regulation 1055/2005, recital 5 and Art 2(a).
70
See Regulation 1055/2005, recitals 2 and 8 and Art 5 as amended. See Regulation No
1056/2005, Art 2 as amended, paras 3–5.
71
See ECOFIN Council, Report 7435/05, above note 63, 4. The Council, in reviewing the
SGP provisions, detected mainly five areas where improvements could be made: (i) enhance
the economic rationale of the budgetary rules to improve their credibility and ownership;
(ii) improve ‘ownership’ by national policy makers; (iii) use more effectively periods when
economies are growing above trend for budgetary consolidation in order to avoid pro-
cyclical policies; (iv) take better account in Council recommendations of periods when
economies are growing below trend; (v) give sufficient attention in the surveillance of
budgetary positions to debt and sustainability.
72
Resolution on the Stability and Growth Pact of 17 June 1997.
73
See European Commission, Economic and Financial Affairs, ‘Multilateral Economic
Coordination and Surveillance’, at <http://ec.europa.eu/economy_finance/
economic_governance/sgp/convergence/index_en. htm> (last visited 15 September 2014).
74
Regulation 1466/1997, Art 6(2). As of 7 July 2004, there were four on-going procedures
with regard to this ‘early warning mechanism’ (concerning Portugal, Germany, France, and
Italy). See Council of the European Union, Press Release 10888/04 (Presse 213) (5 July
2004), at <http://www.consilium.europa.eu/ueDocs/cms_Data/docs/pressData/en/ecofin/
81342.pdf> (last visited 15 September 2014).
75
Bini Smaghi, above note 61, 171 (emphasis added).
76
Gerhard Schröder, former German Chancellor, above note 64, referred to ‘cyclical
incentives’. He complained about ‘the mechanistic application of the pact’ which had led the
EU to recommend further restrictive measures (in a downturn, albeit not a ‘severe
economic downturn’), which had delayed recovery (in the country affected).
77
For an analysis of these breaches see Chapter 8 of the first edition of this book, Legal
Foundations of International Monetary Stability, 265–70. See also Sideek M Seyad,
‘Destabilisation of the European Stability and Growth Pact’ (2004) 19 Journal of
International Banking Law and Regulation 239, 242–4.
78
Above note 77. Council Decision 2003/89/EC of 21 January 2003 on the existence of a
government deficit in Germany—Application of Article 104(6) of the EC Treaty, OJ L 034 (11
February 2003) 16–17.
79
See Case C–27/04 Commission v Council [2004] ECR I–06649, concerning the action of
the Commission and the conclusions of the Council with regard to the excessive deficits of
France and Germany. See also the European Court of Justice, Press Release No 57/04,
above note 3.
80
Fritz Scharpf, ‘Monetary Union, Fiscal Crisis and the Pre-emption of Democracy’, LEQS
Paper No 36 (May 2011), at <http://ssrn.com/abstract=1852316> (last visited 7 August
2014); Ludger Schuknecht, Jürgen von Hagen, and Guido Wolswijk, ‘Government Bond Risk
Premiums in the EU Revisited: The Impact of the Financial Crisis’ (2011) 27 European
Journal of Political Economy 36–43; Stephen Cecchetti, Deepak Mohanty, and Fabrizio
Zampolli, ‘The Future of Public Debt: Prospects and Implications’, BIS Working Paper No
300 (March 2010), at <http://www.bis.org/publ/work300.pdf> (last visited 7 August 2014).
81
Antoin Murphy, ‘The “Celtic Tiger”—An Analysis of Ireland’s Economic Growth
Performance’, EUI Working Paper, RSC No 2000/16 (April 2000), at <http://cadmus.eui.eu/
bitstream/handle/ 1814/1656/00_16.pdf?sequence=1> (last visited 7 August 2014).
82
‘Timeline: The Unfolding Eurozone Crisis’ BBC News (13 June 2012), at <http://
www.bbc.co.uk/news/business-13856580> (last visited 7 August 2014).
83
Karen E Naylor and Claire Robert, ‘Assessing Asset-Liability Mismatch Risk in Covered
Bonds: Revised Methodology and Assumptions for Target Asset Spreads’, Standard & Poor’s
(24 April 2012), at <http://www.standardandpoors.com/spf/upload/Ratings_EMEA/
AssessingAsset-LiabilityMismatch_24Apr2012.pdf> (last visited 7 August 2014).
84
Lisa O’Carroll, ‘European Commissioner Says Lenihan Bank Guarantee Was Mistake’,
The Guardian: Ireland Business Blog (17 June 2011).
85
See Philip Coggan, ‘The IMF and the Euro Crisis: Less Cash, More Impact’ The
Economist (6 October 2012), at <http://www.economist.com/node/21564254> (last visited 7
August 2014).
86
Michael Georgiou Arghyrou and Georgios Chortareas, ‘Current Account Imbalances and
Real Exchange Rates in the Euro Area’ (2008) 16 Review of International Economics 747.
87
European Central Bank, ‘Statement by the President of the ECB’, Press Release (7
August 2011), at <http://www.ecb.europa.eu/press/pr/date/2011/html/pr110807.en.html>
88
Decision of the ECB of 14 May 2010 establishing a Securities Markets Programme.
89
Anders Åslund, ‘How Latvia Can Escape from the Financial Crisis’, Presentation to the
Annual Conference of the Bank of Latvia, Riga (1 October 2009) 2.
90
Julius Horvath, ‘2008 Hungarian Financial Crisis’ CASE Network E-brief No 2009/1,
(2009). Certain economist argue that the root cause of the Romania crisis is the
‘unsustainable economic growth before 2008, based mainly on the consumption of imported
goods, financed by cheap foreign money. The global crisis only hastened the inevitable
domestic crisis and raised its costs by adding to the pre-existing problems.’
91
See ‘Latvia’s Economy Shrinks Rapidly’ BBC News (27 February 2009), at <http://
news.bbc.co.uk/2/hi/business/7879529.stm> (last visited 7 August 2014).
92
See European Commission, ‘Balance-of-Payment Assistance to Latvia’ (23 October
2012), at <http://ec.europa.eu/economy_finance/assistance_eu_ms/latvia/index_en.htm>
93
European Commission, ‘Stronger Economic Rules to Manage the Euro and Economic
and Monetary Union’ (July 2013), <http://ec.europa.eu/economy_finance/publications/
general/pdf/eu_economic_governance_en.pdf> (last visited 7 August 2014).
94
See generally Rosa M Lastra and Lee Buchheit, Sovereign Debt Management (Oxford:
95
Marco Buti and Nicolas Carnot, ‘The EMU Debt Crisis: Early Lessons and
Reforms’ (2012) 50 Journal of Common Market Studies 899.
96
Maria Grazia Attinasi, Nadine Leiner-Killinger, and Michal Slavík, ‘The Crisis and the
Sustainability of Euro Area Public Finances: What can go Wrong?’ European Central Bank
(29 January 2010).
97
Eijffinger has pointed out that ‘in the end only a higher degree of fiscal integration
would remove the inflexibility inherent in the recourse to predefined budgetary rules’. See
Sylvester Eijffinger, ‘How Can the Stability and Growth Pact be Improved to Achieve
Stronger Discipline and Higher Flexibility’ (2003) 38(1) Intereconomics 10.
98
Paul De Grauwe and Yuemei Ji, ‘Mispricing of Sovereign Risk and Multiple Equilibria in
the Eurozone’, Centre for European Policy Working Paper 61 (20 January 2012), at <http://
ceps.eu/book/mispricing-sovereign-risk-and-multiple-equilibria-eurozone> (last visited 7
August 2014).
99
European Commission, ‘Stronger Economic Rules’, above note 93.
100
See Eurostat, ‘General Government Gross Debt’, at <http://epp.eurostat.ec.europa.eu/
tgm/table.do? tab=table&plugin=0&language=en&pcode=teina225> (last visited 7 August
2014).
101
European Commission, ‘Report on Public Finances in EMU’ European Economy No
3/2011 (2011), at <http://ec.europa.eu/economy_finance/publications/european_economy/
2011/pdf/ee-2011-3_en.pdf> (last visited 7 August 2014).
102
The five Regulations and one Directive were all published in OJ 2011 L 306 (23
November 2011): Regulation 1173/2011 on the effective enforcement of budgetary
surveillance in the euro area, OJ 2011 L 306/1; Regulation 1174/2011 on enforcement
measures to correct excessive macroeconomic imbalances in the euro area, OJ 2011 L
306/8; Regulation 1175/2011 amending Council Regulation (EC) No 1466/97 on the
strengthening of the surveillance of budgetary positions and the surveillance and
coordination of economic policies, OJ 2011 L 306/12; Regulation 1176/2011 of the European
Parliament and of the Council of 16 November 2011 on the prevention and correction of
macroeconomic imbalances, OJ 2011 L 306/25; Council Regulation 1177/2011 amending
Regulation (EC) No 1467/97 on speeding up and clarifying the implementation of the
excessive deficit procedure, OJ 2011 L 306/33; Council Directive 2011/85/EU on
requirements for budgetary frameworks of the Member States, OJ 2011 L 306/41.
103
It is worth noting that the Council significantly watered down the proposals during the
lengthy negotiation process.
104
Regulation (EU) No 473/2013 of the European Parliament and of the Council of 21 May
2013 on common provisions for monitoring and assessing draft budgetary plans and
ensuring the correction of excessive deficit of the Member States in the euro area, OJ L 140
(27 May 2013) and Regulation (EU) No 472/2013 of the European Parliament and of the
Council of 21 May 2013 on the strengthening of economic and budgetary surveillance of
Member States in the euro area experiencing or threatened with serious difficulties with
respect to their financial stability, OJ L 140 (27 May 2013).
105
As two Member States were not willing to commit to the TSCG, it took the form of an
intergovernmental agreement among contracting parties, raising constitutional law
concerns. See Dimopoulos, above note 6.
106
Treaty on Stability, Coordination and Governance in the Economic and Monetary Union
(TSCG), at <http://european-council.europa.eu/media/639235/st00tscg26_en12.pdf> (last
visited 7 August 2014). The ‘fiscal compact’ refers to the fiscal part of the Treaty
(title III of the Treaty). According to TSCG, Art 1.1:
By this Treaty, the Contracting Parties agree, as Member States of the European
Union, to strengthen the economic pillar of the economic and monetary union by
adopting a set of rules intended to foster budgetary discipline through a fiscal
compact, to strengthen the co-ordination of their economic policies and to improve
the governance of the euro area, thereby supporting the achievement of the
European Union’s objectives for sustainable growth, employment, competitiveness
and social cohesion.
107
An idea already accepted by the European Council at its meeting of 17 June 2010 and
decided by the ECOFIN Council of 7 September 2010 which adopted the ‘Specifications on
the implementation of the Stability and Growth Pact and the Guidelines on the format and
content of Stability and Convergence Pacts’. This allowed the start of the first European
semester after 1 January 2011. See Lastra and Louis, above note 22, 66 and footnote 173.
108
Regulation (EU) No 473/2013.
109
110
See TSCG, Art 3.2: ‘The rules set out in paragraph 1 shall take effect in the national law
of the Contracting Parties at the latest one year after the entry into force of this Treaty
through provisions of binding force and permanent character, preferably constitutional, or
otherwise guaranteed to be fully respected and adhered to throughout the national
budgetary processes.’ See above note 106.
111
Regulation (EU) No 473/2013 and Regulation (EU) No 472/2013. When the Commission
published the proposals in November 2011, they were accompanied by a Green Paper on
the feasibility of introducing Stability Bonds, COM (2011) 818 final. On 28 February 2013,
when the Council announced that it had reached an agreement with the European
Parliament on the ‘two pack’ legislation, the compromise included a number of
commitments by the Commission. The most important one provided that ‘the Commission
will set up a group of experts to analyse the possible merits, risks, requirements and
obstacles in relation to a partial substitution of national debt issuance by joint issuance in
the form of debt redemption fund and eurobills’. See Lastra and Louis, above note 22, 147.
112
As stated by German Chancellor Angela Merkel at a press conference following the
European Council on December 9, at <http://youtu.be/Op1UdzUwWBc> (last visited 7
August 2014).
113
Council Directive 2011/85/EU, Art 1.
114
Council Directive 2011/85/EU, Arts 4(1) and 3(2).
115
Council Directive 2011/85/EU, Art 6(1)(b).
116
Council Directive 2011/85/EU, Art 14(1).
117
Council Directive 2011/85/EU, Preamble 3.
118
Regulation 1173/2011, Arts 4(2), 5(2), and 6(2), respectively.
119
See Regulation 1173/2011, Arts 4(2), 5(2), and 6(2).
120
See Regulation 1175/2011.
121
122
123
See TFEU, Art 126(11).
124
In his comments on this chapter, René Smits noted:
One may question the legality of the EU legislator changing the order which
primary law sets for the adoption of sanctions: it is an open question whether the
EU legislator was competent to make the Council competent to impose a fine before
it has issued a ‘notice’ pursuant to Article 126(9) TFEU (the new rule permits action
based on Article 126(8) TFEU).
125
126
127
128
Fabian Amtenbrink, ‘Legal Developments’ (2012) 50 Journal of Common Market
Studies 132, 136.
129
Regulation 1176/2011, Art 4(3); for more detail, see European Commission,
‘Scoreboard for the Surveillance of Macroeconomic Imbalances’, European Economy
Occasional Paper 92 (February 2012).
130
A new EU financial supervisions architecture was launched in early 2011, comprising
three European supervisor agencies and the European Systemic Risk Board (ESRB). In
particular, the ESRB monitors system-wide risks from a macro-prudential perspective,
acknowledging the need to prevent excessive risk-taking and leverage and overcome the
possible reluctance of national supervisors to pursue counter-cyclical actions.
131
132
The corrective plan corresponds to the budgetary and economic partnership
programmes that are required under the corrective arm of the SGP as amended by the
Fiscal Compact.
133
134
See European Commission, ‘Europe 2020: Country-Specific Recommendations 2014’,
<http://ec.europa.eu/europe2020/index_en.htm> (last visited 7 August 2014).
135
See European Council, ‘Conclusions’, EUCO 13/10 (17 June 2010), at <http://
ec.europa.eu/eu2020/pdf/council_conclusion_17_june_en.pdf> (last visited 7 August 2014).
136
According to the ECB and European Commission, the ‘Lisbon failure’ is related to weak
governance arrangements, a lack of clear focus and deficiencies in communication. For
more detail, see European Central Bank, ‘The Lisbon Strategy—Five Years On’, Monthly
Bulletin (July 2005).
137
European Commission, ‘Public Consultation on the Europe 2020 Strategy’ (5 May
2014), at <http://ec.europa.eu/europe2020/public-consultation/index_en.htm> (last visited 7
August 2014), which opens the strategy and its role in fostering growth to public scrutiny,
and it will also serve as a basis for the Commission’s proposals for the further development
of the strategy.
138
European Commission, ‘Taking Stock of the Europe 2020 Strategy for Smart,
Sustainable and Inclusive Growth’, Communication to the European Parliament, the
Council, the European Economic and Social Committee of the Regions COM(2014) 130 final
(5 March 2014). The annual statistics on each target including country specific data is
published by Eurostat, at <http://epp.eurostat.ec.europa.eu/portal/page/portal/
europe_2020_indicators/headline_indicators> (last visited 7 August 2014).
139
See para 8.165 below.
140
In principle, national parliaments, social partners, and civil society are invited to
participate in the formulation of the programme. This is intended to improve the national
‘ownership’ of the structural reform agenda of each Member State. See European
Commission, ‘EU 2020: European Institutions and Bodies’, at <http://ec.europa.eu/
europe2020/who-does-what/eu-institutions/index_en.htm> (last visited 7 August 2014).
141
Regulation (EU) No 472/2013 and Regulation No 473/2013, both adopted on the basis
of TFEU, Art 136.
142
143
Regulation 472/2013, Arts 2 and 3.
144
The Pact was not signed by the Czech Republic, Hungary, Sweden, and the UK.
145
See Conclusions of the Heads of State or Government of the Euro Area, ‘A Pact for the
Euro. Stronger Economic Policy Coordination for Competitiveness and Convergence’ (11
March 2011), at <http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/
ecofin/119810.pdf> (last visited 7 August 2014).
146
Three of these goals—competiveness, employment, and sustainability of public finances
—overlap with three of the ten integrated guidelines.
147
Council of the European Union, ‘EuroPlus Pact—The Way Forward—Conclusions of
Member States Participating in the Euro Plus Pact’, 3148th Economic and Financial Affairs
Council meeting (21 February 2012), at <http://www.consilium.europa.eu/uedocs/cms_data/
docs/pressdata/en/ecofin/128095.pdf> (last visited 7 August 2014).
148
See TSCG, Title IV.
149
TSCG, Art 1.
150
TSCG, Art 10.
151
TSCG, Art 11.
152
The corrective arms of the SGP and Macroeconomic Imbalance Procedure are not
included in the European Semester since these procedures are always initiated solely on an
ad hoc basis. See above note 102. Regulation 1173/2011 established the ‘European
Semester’ for economic policy co-ordination. See also above note 106.
153
See IMF, ‘IMF Approves EUR 30bn Loan for Greece on Fast Track’, IMF Survey Online
(9 May 2010), at <http://www.imf.org/external/pubs/ft/survey/so/2010/new050910a.htm>
154
Council of the European Union, ‘Extraordinary Council Meeting’, Press Release
9596/10 (9–10 May 2010), at <http://www.consilium.europa.eu/uedocs/cms_data/docs/
pressdata/en/ecofin/114324.pdf> (last visited 7 August 2014).
155
Council Regulation 407/2010 establishing a European financial stabilization
mechanism, OJ L 118/1 (12 May 2010).
156
Registered as a société anonyme, having a registered office 43, Avenue John F.
Kennedy, L-Luxembourg, RCS Luxembourg B n 153.414.
157
EFSF, Articles of Association, at <http://www.efsf.europa.eu/attachments/
EFSFStatusCoordonnes %2023AVRL2014.pdf> (last visited 7 August 2014). The
intergovernmental agreement on the terms and procedures are set in the Framework
Agreement between Euro Area Member States, at <http://www.efsf.europa.eu/attachments/
20111019_efsf_framework_agreement_en.pdf> (last visited 7 August 2014).
158
European Commission, ‘Communication from the Commission to the Council and the
Economic and Financial Committee on the European Financial Stabilisation Mechanism’,
COM (2010) 713 final (30 November 2010), at <http://eur-lex.europa.eu/LexUriServ/
LexUriServ.do?uri=COM:2010:0713:FIN:EN:PDF> (last visited 7 August 2014).
159
See EFSF, ‘Maximising the Capacity of the EFSF: Terms and Conditions’ (29 November
2011), at <http://www.efsf.europa.eu/attachments/
efsf_terms_of_reference_maximising_the_capacity.pdf> (last visited 7 August 2014). The
EFSF also published the following guidelines: (1) on Primary Market Purchases, at <http://
www.efsf.europa.eu/attachments/efsf_guideline_on_primary_market_purchases.pdf> (last
visited 7 August 2014); (2) on Interventions in the Secondary Market, at <http://
www.efsf.europa.eu/attachments/
efsf_guideline_on_interventions_in_the_secondary_market.pdf> (last visited 7 August 2014);
(3) on Precautionary Programmes, at <http://www.efsf.europa.eu/attachments/
efsf_guideline_on_precautionary_ programmes.pdf> (last visited 7 August 2014). The
Guidelines on Recapitalisation of Financial Institutions were published on 21 July 2011, at
<http://www.efsf.europa.eu/attachments/
efsf_guideline_on_recapitalisation_of_financial_institutions.pdf> (last visited 7 August
2014).
160
European Council, ‘Conclusions of the European Council Meeting of 16–17 December
2010’, Press Release (25 January 2011) 1, at <http://www.consilium.europa.eu/uedocs/
cms_data/docs/pressdata/en/ec/118578.pdf> (last visited 7 August 2014).
161
See Eurogroup Statement (20 July 2012), at <http://www.eurozone.europa.eu/media/
367880/eg_statement_spain_20_july.pdf> (last visited 7 August 2014). The assistance of up
to EUR 100 billion earmarked for the Spanish banking sector—granted by the Eurogroup on
20 July 2012—was first disbursed by the EFSF but was transferred to the ESM on 2009
November 2012. The ESM financial assistance programme for Spain expired on 31
December 2013.
162
Council Decision 2011/734/EU of July 2011 addressed to Greece with a view to
reinforcing and deepening fiscal surveillance and giving notice to Greece to take measures
for the deficit reduction judged necessary to remedy the situation of excessive deficit, OJ L
295/38 (15 November 2011) as amended.
163
See Eurogroup Statement on Cyprus (25 March 2013), at <http://
www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ecofin/136487.pdf> (last
164
To date, eight countries—including Greece, which also received financial assistance
before the establishment of EFSM via bilateral loans—have received financial assistance
under the various support mechanisms and have agreed with the Commission on a macro-
economic adjustment programme. These countries are Hungary, Romania, Latvia (these
three under the medium term balance of payments assistance), Portugal, Greece, Ireland
(under the EFSM/EFSF/bilaterally), Cyprus, and Spain (ESM). The programme for Hungary
expired in 2010, while the programme for Latvia expired in early 2012.
165
Alicia Hinarejos, ‘The Euro Area Crisis and Constitutional Limits to Fiscal
Integration’ (2012) 14 Cambridge Yearbook of European Legal Studies 243; Mark
Hallerberg, ‘Fiscal Federalism Reforms in the European Union and the Greek Crisis’ (2011)
12 European Union Politics 127.
166
To avoid protracted ratification process involving referenda in certain Member States.
167
See European Council, Conclusions of 16–17 December 2010, above note 160.
168
The amendment was sought to clear the way for this ESM Treaty which is outside the
Union legal framework.
169
See Treaty Establishing the European Stability Mechanism (ESM) (2 February 2012),
OJ L 91/1 (6 April 2011), Art 41(2) and Annex II (hereinafter ESMT), at <http://
www.esm.europa.eu/pdf/ESM%20Treaty%20consolidated%2013-03-2014.pdf> (last visited
7 August 2014).
170
Lastra and Louis, above note 22, 44: ‘Paradoxically, before the…adoption of the ESM
Treaty it was easier for Member States to get help through the IMF and the EBRD than
through the EU available mechanisms.’
171
See ESMT, Annex I (‘Contribution Key of the ESM’). The ESM has adopted a set of
guidelines for:
• ESM Guideline on Loans, at < http://www.esm.europa.eu/pdf/

ESM%20Guideline%20on%20loans.pdf > (last visited 7 August 2014);
• ESM Guideline on Primary Market Support Facility, at < http://
www.esm.europa.eu/pdf/ESM%
20Guideline%20on%20the%20primary%20market%20support%20facility.pdf
> (last visited 7 August 2014);
• ESM Guideline on Secondary Market Support Facility, at < http://
www.esm.europa.eu/pdf/
ESM%20Guideline%20on%20the%20secondary%20market%20support%20facility.pdf
> (last visited 7 August 2014);
• ESM Guideline on Precautionary Financial Assistance, at < http://
ESM%20Guideline%20on%20precautionary%20financial%20assistance.pdf >
(last visited 7 August 2014);
• ESM Guideline on Recapitalisation of Financial Institutions, at < http://
ESM%20Guideline%20on%20recapitalisation%20of%20financial%20institutio
ns.pdf > (last visited 7 August 2014).
172
ESMT, Art 12.
173
ESMT, Art 13(3).
174
Eurogroup Statement, ‘ESM Direct Recapitalisation Instrument’ (10 June 2014), at <htt
p://www.eurozone.europa.eu/media/533095/20140610-eurogroup-president-direct-
recapitalisation.pdf> (last visited 7 August 2014).
175
Riigikohus [Supreme Court Republic of Estonia], Case No 3-4-1-6-12, 12 July 2012, at
<http://www.nc.ee/?id=1347> (last visited 7 August 2014).
176
ESMT, Art 48.
177
Bundesverfassungsgericht [BVerfG—Federal Constitutional Court], Case No 2 BvR
1390/12, 12 September 2012 (2012) Neue Juristische Wochenschrift (NJW) 3145
(Germany).
178
Case C-370/12 Thomas Pringle v The Government of Ireland, Ireland and the Attorney
General, Judgment, 27 November 2012 (challenging the legality of the ESM).
179
C-370/12 Pringle, 27 November 2012, para 1.
180
Pringle v Ireland [2012] IESC 47, para 5 (SC) (Ireland).
181
Pringle [2012] IESC 47, para 43.
182
183
184
185
Pringle [2012] IESC 47, paras 95–6.
186
187
188
189
190
191
192
José Manuel Barroso, President of the European Commission, ‘The Commission
Presents a Blueprint for a Deep and Genuine Economic and Monetary Union’, at <http://
ec.europa.eu/commission_2010-2014/president/news/archives/
2012/11/20121128_2_en.htm> (last visited 7 August 2014).
193
Herman Van Rompuy, European Council, ‘Towards A Genuine Economic And Monetary
Union’ (5 December 2012) 4, at <http://www.consilium.europa.eu/uedocs/cms_Data/docs/
pressdata/en/ec/134069.pdf> (last visited 7 August 2014).
194
See European Commission, Communication on ‘A Blueprint for a Deep and Genuine
Economic and Monetary Union’ (GEMU), COM (2012) 777 final (28 November 2012) 40.
195
For a recent review of the UK position with regard to GEMU, see HM Treasury,
Economic and Monetary Policy, Call for Evidence (March 2014), at <https://www.gov.uk/
government/uploads/system/uploads/attachment_data/file/297996/
PU1634_Economic_and_monetary_policy_final.pdf> (last visited 7 August 2014). Chancellor
George Osborne stated in 2011 that ‘the remorseless logic’ of monetary union was greater
fiscal union. See The Sunday Times, 20 May 2011, and The Financial Times, 20 July 2011.
196
European Commission, Regional Policy, at <http://ec.europa.eu/regional_policy/
index_en.cfm> (last visited 7 August 2014).
197
See Council Regulation (EC) No 1260/99 of 21 June 1999 laying down general
provisions on the Structural Funds and the Council Regulation (EC) No 1083/2006 of 11
July 2006 laying down general provisions on the European Regional Development Fund, the
European Social Fund and the Cohesion Fund and repealing Regulation (EC) No 1260/1999,
OJ L 210/25 (31 July 2006) (repealed by Regulation (EU) No 1303/2013).
198
These funds paid out about EUR 213 billion for the existing fifteen members, roughly
one-third of total EU spending, between 2000 and 2006, and EUR 22 billion for the new
Member States between 2004 and 2006. See European Commission, Regional Policy:
History of the Policy 2000–2006, at <http://ec.europa.eu/regional_policy/what/milestones/
index_en.cfm#4> (last visited 7 August 2014).
199
European Commission, History of the Policy 2000–2006, above note 198. A further 18
billion for the period 2000–6 is allocated to the Cohesion Fund and EUR 15.9 billion for the
years 2004–6, while EUR 8.49 billion was reserved for the new Member States.
200
Council Regulation (EC) No 1267/1999 of 21 June 1999 establishing an Instrument for
Structural Policies for Pre-accession, OJ L 161/73 (26 June 1999).
201
Council Regulation (EC) No 1268/1999 of 21 June 1999 on Community support for pre-
accession measures for agriculture and rural development in the applicant countries of
central and eastern Europe in the pre-accession period, OJ L 161/87 (26 June 1999).
202
Council Regulation (EC) No 1085/2006 of 17 July 2006 establishing an Instrument for
Pre-Accession Assistance (IPA) OJ L210/82 (31 July 2006), as amended by Regulation (EU)
No 540/2010 and Regulation (EU) No 153/2012.
203
Croatia successfully joined the EU in 2013.
204
Joint European Resources for Micro to Medium Enterprises—aims to promote the use
of financial engineering instruments to improve access to finance for SMEs via Structural
Funds interventions.
205
Joint European Support for Sustainable Investment in City Areas—supports sustainable
urban development and regeneration through financial engineering mechanisms.
206
Joint Assistance to Support Projects in European Regions—a technical assistance
facility for the twelve Member States which joined the EU between 2004 and 2007,
provides the support to prepare high quality major projects, which will be co-financed by
EU funds.
207
Joint Action to Support Micro-finance Institutions in Europe—provides technical
assistance and financial support to non-bank micro-credit providers and assists them to
improve the quality of their operations, expansion and sustainability, while also promoting
good practices in the field of microcredit and drafting codes of good conduct for micro-
credit institutions.
208
For the key elements of the reform ‘Refocusing EU Cohesion Policy for Maximum
Impact on Growth and Jobs’ see European Commission, ‘Refocusing EU Cohesion Policy for
Maximum Impact on Growth and Jobs: The Reform in 10 points’, Memo (19 November
2013), at <http://europa.eu/rapid/press-release_MEMO-13-1011_en.htm> (last visited 7
August 2014).
209
See European Council, ‘Conclusions of the European Council Meeting of 7–8 February’
EUCO 37/13 (8 February 2013) points 76 ff, at <http://www.consilium.europa.eu/uedocs/
cms_data/docs/ pressdata/en/ec/135344.pdf> (last visited 15 September 2014). The
Common Strategic Framework Funds ‘can, if necessary, be redirected to addressing the
economic problems a country is facing. For this reason a gradual macroeconomic
conditionality will be established in the Common Strategic Framework regulation. If
recommendations of the Commission (under the BEPG, employment, excessive deficit
procedure, etc) are not followed, part or all or payments or commitments or both should be
suspended. The suspension could be lifted by the Council upon a proposal by the
Commission (for details, see European Council, Conclusions EUCO 37/13, points 79–83).
210
Regulation (EU) No 1303/2013 of the European Parliament and of the Council of 17
December 2013 laying down common provisions on the European Regional Development
Fund, the European Social Fund, the Cohesion Fund, the European Agricultural Fund for
Rural Development and the European Maritime and Fisheries Fund and laying down
general provisions on the European Regional Development Fund, the European Social
Fund, the Cohesion Fund and the European Maritime and Fisheries Fund and repealing
Council Regulation (EC) No 1083/2006, OJ L 347/320 (20 December 2013).
For the information on Member State and category specific allocation of funds see
European Commission, ‘EU Cohesion Funding—Key Statistics: Available Budget 2014–
2020’, at <http://ec.europa.eu/regional_policy/thefunds/funding/index_en.cfm> (last visited
7 August 2014).
211
See ‘Greece Comes Out of Bond Exile’ Financial Times (10 April 2014) (investors
placed EUR 11 billion of orders for the five year government bonds governed by UK law)
and ‘Greece’s Long Road to Recovery’, Editorial, Financial Times (11 April 2014) (The
outlook for Greece is subdued. Equally uncertain is the sustainability of Greece’s mountain
debt pile).
212
See ‘Special Report on the Future of the European Union’ Financial Times (9 May
2014):
Judging by the eurozone’s bond markets, which just 18 months ago served as the
most important globally watched gauge of the European project’s health, the EU
should be cruising through its most contented period in years. Spain and Italy have
seen borrowing costs on their benchmark bonds fall to levels not seen since the
heady days before Lehman Brothers collapsed. Ireland—the first eurozone member
officially to exit its international financial rescue programme—is borrowing in the
private market at the cheapest rates on record. Portugal auctioned its first 10-year
bond in three years. Even the eurozone’s perpetual problem child, Greece, has been
able to dip into the private markets and raise €3Bn on its own.
213
Lastra and Louis, above note 22, 71.
214
Lastra and Louis, above note 22, 140–1.
215
There were also cases in the context of the euro, as well as numerous cases on the free
movement of capital. See Case 11/00 Commission of the European Communities v European
Central Bank [2003] ECR I–07147, para 92; Case C–27/04 Commission v Council [2004]
ECR I–06649; C–359/05 Estager SA v Receveur principal de la recette des douanes de
Brive, unreported, Judgment of 18 January 2007.
Part II Developments at the EU Level, 9 External
Aspects of EMU
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
International financial system — Monetary system — Monetary obligations — European Central Bank —
International Monetary Fund (IMF)
(p. 339) 9 External Aspects of EMU
B. Exchange Rate Policy 9.07
Who is ‘Mr Euro’? 9.12
Primary law regarding exchange rate policy 9.18
Monetary policy lato sensu 9.22
Monetary policy stricto sensu 9.24
The jurisprudence of the ECJ: The doctrine of parallelism 9.27
C. Detailed Analysis of Articles 219 and 138 TFEU 9.30

Formal exchange rate agreements 9.31
Floating exchange rates 9.35
International agreements on monetary matters 9.38
The international role of the euro 9.42
The residual role of the Member States 9.43
D. International Relations 9.45

The Union 9.46
The European Central Bank 9.50
The national central banks 9.56
The EU Member States: IMF membership 9.58
Implications for IMF surveillance 9.63
Implications for the SDR 9.64
Implications for the holding and management of foreign reserves 9.65
The problems of relying upon multiple external actors under a multi-

layered system of representation 9.67
The intricate nature of Article 111 [now Articles 219 and 138 TFEU] and its
convoluted language reflect the difficult birth of this provision. The compromise
arrived at in the monstrous arrangements laid down in Article 111 EC Treaty…
unmistakeably expresses the labour pains which accompanied the creation of the
provision.1
René Smits, The European Central Bank. Institutional Aspects (1997) 375, quoting
Rainer Stadler, Der rechtliche Handlungsspielraum des Europäischen Systems der
Zentralbanken (1996) 172
A. Introduction
9.01 The European System of Central Banks (ESCB) is entrusted by the Treaty on the
Functioning of the European Union (TFEU) with sole responsibility for monetary policy,
which is an exclusive Union competence (albeit geographically limited to the Member
States that have adopted the euro). Despite the indissoluble link that exists between a
single monetary policy (geared towards internal price stability) and external monetary
relationships, in the euro area the responsibility for the latter is divided between the
Council (primary role) and the European Central Bank (ECB) under a notoriously unclear
set of Treaty provisions.
(p. 340) 9.02 This EU arrangement reflects, nonetheless, the norm in many countries,
where the conduct of external monetary affairs involves an uncomfortable dialogue between
the central bank and the Treasury or Ministry of Finance. Politicians are typically involved
in tactical decisions concerning the exchange rate regime, while central banks are involved
in operational issues. The problem at the European level is that while the voice of the ECB
with regard to monetary policy is a ‘single voice’, the Council represents many voices, the
views of all the Member States. This adds an extra layer of complexity to the conduct of
exchange rate policy in Europe.
9.03 Article 111 of the EC Treaty was a cumbersome provision in legal and economic
terms, the result of a calculated obfuscation for political purposes. Its contents have
remained under TFEU. Article 111 EC Treaty (paras 1–3) has become Article 219 TFEU
(Title V ‘International Agreements’), while Article 111 EC Treaty (para 4) has become
Article 138 TFEU (Title VII ‘Economic and Monetary Policy’, ch 4 ‘Provisions Specific to
Member States whose Currency is the Euro’).
9.04 There is a degree of inconsistency, and possibly conflict, in giving the ECB
independence of political control in the conduct of a price stability oriented monetary policy
while leaving the determination of the exchange rate and the exchange regime (pegged,
floating, or managed float) in the hands of the political authorities.
According to Article 119.2 TFEU, the primary objective of both the single monetary policy
and the exchange rate policy is price stability.
9.05 It is interesting to observe that, while Article 138 TFEU is inserted within the EU
Treaty’s monetary policy provisions (ch 4 of Title VIII ‘Economic and Monetary Policy’),
Article 219 is inserted in a chapter on International Agreements included in Title V (‘The
Union’s External Action’) of the Treaty. An important consequence of this repositioning is
that, while the relations between the Member States that have adopted the euro and those
that have a derogation are considered to be an element of the differentiated integration
existent with regard to monetary policy, the relations between Member States and third
States (non EU) and international organizations are considered to be the true ‘external
aspects of EMU’ in the Lisbon Treaty.
9.06 I dealt in Chapter 7 of this volume with the complexities involved in the
‘differentiated integration’ within the EU with regard to monetary policy, and I referred to
the different provisions applicable to the Member States that have adopted the euro and to
the ‘Member States with a derogation’. The focus of this chapter is the exchange rate policy
of the euro area, the external representation of the euro, and other external aspects.2
B. Exchange Rate Policy

9.07 Before the advent of economic and monetary union (EMU), governments or Ministers
of Finance in the EU Member States typically had the last word on exchange rate matters.
Therefore, the agreement reached in Article 219 TFEU reflected the status quo, that is, (p.
341) political responsibility for the external aspects of exchange rate policy, which resides
at the EU level since the beginning of Stage 3, ie as of 1 January 1999.
9.08 The stability of exchange rates (the exchange rate being the price of a currency in
another currency) and the issue of which is the best exchange rate arrangement for a given
country (fixed, floating, or some version of managed float) remain a matter of great
controversy in the economic literature. This means that the law tends to refer to the
external dimension of monetary stability (the stability of the currency) in rather ambiguous
terms.
9.09 There is no reference in the EU Treaty to ‘exchange rate stability’. Hence, it can be
inferred that exchange rate movements will be the object of ‘benign neglect’ by the ECB
(and the Council) unless they negatively affect or threaten to affect the price stability
objective.
9.10 As acknowledged, the exchange rate has a dual dimension. On the one hand, it is the
external anchor, the external dimension of monetary stability (and, in this respect, the ESCB
has a vested interest in safeguarding it, since exchange rate fluctuations influence price
stability). On the other hand, it is an instrument of the general economic policy of a country,
closely linked to its trade and employment objectives.3 For this reason, independent central
bankers committed to price-stability-oriented monetary policy (interest rate policy), but
deprived of parallel powers in the field of exchange rate policy, are likely to clash with
politicians who have other objectives to pursue besides price stability.
9.11 Given the intergovernmental character of the EU Council, as representative of the
Member States, one is inclined to think that a degree of ‘political meddling’ may go into the
decision-making. National politicians in the euro area appear to be somehow reluctant to
release completely their powers over exchange rate issues. This may help explain the
proposals put forward by the former German Minister of Finance, Oskar Lafontaine, with
regard to the adoption of target zones for the euro, the US dollar and the Japanese yen in
order to diminish the volatility of exchange rate movements.4 It also explains why, more
recently, the French Prime Minister, Mr Manuel Valls, stated that France would push for
action to lower the value of the euro.5 The depoliticization of monetary policy (in the hands
of an independent central bank) contrasts with the possible politicization of exchange rate
policy. However, this is not necessarily a bad thing, since important strategic decisions
concerning the exchange rate (such as a hypothetical scenario in which the euro were to be
pegged to the US dollar) need to be subject to democratic, that is, political, control, since
such decisions should not be taken against the wishes of democratically elected
governments.
(p. 342) Who is ‘Mr Euro’?
9.12 As a result of the sharing of competences between the Council and the ECB in the
field of exchange rate policy, the answer to this question is not clear. McNamara and
Meunier argue that a single external voice for the euro is needed both to defend its value on
international exchange markets and to influence decisions on a wide range of international
macroeconomic policy issues (normally in the G7 or the International Monetary Fund
(IMF)), such as international policy coordination on fiscal, monetary, and exchange rate
policy, the construction of a new international financial architecture, and the management
of international financial crises.6
9.13 The Treaty introduces a new Article 138 (which replaced Art 111(4) EC Treaty) with
regard to the international role of the euro. It empowers the Council (though only the
members of the Council representing the Member States of the euro area) to adopt
European decisions ‘in order to secure the euro’s place in the international monetary
system’ (para 1) and to adopt ‘appropriate measures to ensure unified representation within
the international financial institutions and conferences’ (para 2). In both cases (European
decisions and ‘appropriate measures’), the Commission has the right of initiative and the
European Central Bank must be consulted.
9.14 Some have spoken of the President of the Eurogroup as Mr Euro,7 and this
denomination has also been appropriated on some occasions by the President of the ECB.8
9.15 The Eurogroup is formally recognized in Article 137 of the Treaty and in the Protocol
on the Euro Group (Protocol No 14 of the Lisbon Treaty) as an informal meeting of the
ministers of finance of the Member States whose currency is the euro together with the
Commission to discuss ‘questions related to the specific responsibilities they share with
regard to the single currency’. The European Central Bank ‘shall be invited’ to attend the
meetings. The President of the Eurogroup is selected by a majority of the ministers of
finance for a period of two and a half years. The Eurogroup is meant to enhance the
dialogue and to develop closer coordination of economic policies within the euro area.
9.16 Smits points out:
The Eurogroup president may strive to call himself ‘Mr Euro’—an epithet that only
comes naturally for the ECB President in view of the central competences for the
management of the euro with which the central bank is entrusted, certainly in the
absence of formal exchange-rate agreements or formal orientations from the
Council.9
(p. 343) 9.17 The press has echoed the uncertainty that surrounds this important issue:
Who exactly speaks for Europe’s single currency? We do, says the European Central
Bank, because we run monetary policy and are therefore the guardians of its worth.
We do, say the governments whose countries make up the European Union, because
we created the euro, and the unelected people who run the central bank should
have a vocal political counterweight. Too many people already speak for it, mutter
currency traders.10
Under TFEU both the ECB and the Council speak for the euro. The former is a single voice,
the latter represents the voices of all Member States.
Primary law regarding exchange rate policy
9.18 The second basic task of the ESCB according to Article 127 (2) TFEU and Article 3 of
the ESCB Statute is ‘to conduct foreign-exchange operations consistent with Article 219’.
9.19 The conduct of foreign exchange policy involves the determination of the exchange
rate and the exchange regime and the management of the official foreign reserves (gold
reserves, foreign currency reserves, and reserve positions at the IMF, including Special
Drawing Rights (SDRs)). Article 219 TFEU deals with the division of responsibilities with
regard to the determination of the exchange rate and the exchange regime. The
management and holding of the official foreign reserves of the Member States is one of the
basic tasks to be ‘carried out’ through the ESCB according to Article 127(2) TFEU, as I
explained in Chapter 7.11
9.20 Though the proposed Treaty does not include the conduct of exchange rate policy
under the areas of exclusive competence (Art 3 TFEU), there is no doubt that the area of
jurisdiction of the euro is supranational. In an ECB opinion of 4 November 2004, it is clearly
stated that ‘the euro area’s exchange rate policy is an exclusive Community competence’.12
9.21 The language of the treaty provisions regarding exchange rate policy remains
somewhat confusing. In particular, should the concept of monetary policy be understood
stricto sensu or lato sensu?13
Monetary policy lato sensu
9.22 Among the EU exclusive competences, Article 3 TFEU lists the area of ‘monetary
policy for the Member States whose currency is the euro’. Zilioli considers that the term
‘monetary policy’ as used in Article 3 TFEU refers to monetary policy lato sensu
(comprising internal and (p. 344) external aspects), as opposed to the term ‘monetary
policy’ as used in Article 127(2) TFEU which refers to monetary policy stricto sensu.14 The
same view is held by Smits, who considers that exchange rate policy, as an integral part of
monetary policy lato sensu, is an exclusive Union competence.15
9.23 Though Article 219 TFEU is included in the chapter on international agreements,
Article 138 TFEU remains within the provisions specific to Member States whose currency
is the euro, and Articles 127–33 are included in a chapter entitled ‘Monetary Policy’ of Title
VIII (‘Economic and Monetary Policy’). This is in line with the contents of the previous EC
Treaty, where Articles 105–11 were included in a chapter entitled ‘Monetary Policy’ (ch 2 of
Title VII), thus lending support to a broad interpretation of the term ‘monetary policy’.
There is one more provision in the Lisbon Treaty which could shed some light (or further
darkness, depending on one’s viewpoint) on this complex debate. Article 2 TFEU states that
‘[t]he scope of and arrangements for exercising the Union’s competences shall be
determined by the provisions of the Treaties relating to each area.’ Accordingly, it could be
inferred that the reference to monetary policy in Article 3 TFEU should include the
competences provided in Articles 127–33 TFEU.
Monetary policy stricto sensu
9.24 Article 3 TFEU only refers to ‘monetary policy’ (no mention of exchange rate policy)
in its enumeration of the areas where the Union shall have exclusive competence.
9.25 Article 127(2) TFEU differentiates again between monetary policy and foreign
exchange operations. The TFEU does not place exchange rate policy (Art 219) within the
chapter on economic and monetary policy as the EC Treaty did (Art 111 EC Treaty is
inserted in ch 2 of Title VII on Monetary Policy) but within the chapter on international
agreements (Title V of the Treaty).
9.26 In short, both the internal and the external competences regarding the management
of the euro lie with the EU alone. This notwithstanding, I understand the term ‘monetary
policy’ in a narrow sense, in line with established economic theory. While the ESCB has
exclusive responsibility for ‘internal’ monetary policy, there is a sharing of responsibilities
between the Council (with a primary role) and the ECB (with an important operational role)
with regard to exchange rate policy.16
The jurisprudence of the ECJ: The doctrine of parallelism
9.27 The European Court of Justice (ECJ), relying upon the theory of implied powers, has
developed the doctrine of parallelism between internal and external competences. In the
ERTA case,17 the Court ruled that the authority of the Union to conclude international (p.
345) agreements (external competence) was inferred from the internal attribution. Applying
the doctrine of parallelism to EMU, some authors have concluded that the external aspects
of monetary management fall within the community competence to protect the effet utile of
its internal exclusive competence.18 ‘The logic behind the doctrine of parallelism is to avoid
internal competences being circumvented by the conflicting exercise of external
competences.’19
9.28 According to the jurisprudence of the ECJ, the Union’s competence to conclude
international agreements arises not only from an express conferment by the Treaty but may
equally flows from other provisions of the Treaty and from measures adopted, within the
framework of those provisions, by the Union institutions. In practice, the Member States
lose their right, acting individually or even collectively, to undertake obligations towards
non-member countries, from the moment that the Union adopts provisions laying down
common rules (whatever form these may take) with a view to implementing a common
policy envisaged by the Treaty. As and when such common rules come into being, the Union
alone is in a position to assume and carry out contractual obligations towards non-member
countries affecting the whole sphere of application of the Union legal system. According to
Smits,20 even in the absence of internal common rules, the Union may be competent to act
externally, should the international act be necessary for the attainment of one of the
objectives of the Union.21
9.29 Herrmann observes that the doctrine of implied external competences, which mirror
explicit internal competences, can only be applied if no explicit external competences are
laid down in the Treaty. The Treaty provisions should be the starting point of any analysis in
this field.22
C. Detailed Analysis of Articles 219 and 138 TFEU

9.30 As stated at the beginning of the Chapter, Article 111 of the EC Treaty governed the
exchange rate policy of the euro and other external aspects of EMU. In the Lisbon Treaty,
Article 111 is replaced by Article 219 TFEU (with regard to Article 111(1), (2), (3), and (5))
and by Article 138 TFEU (with regard to para 4).
(p. 346) Formal exchange rate agreements
9.31 Formal exchange rate agreements between the euro and one or more currencies of
third States are the responsibility of the Council in accordance with the first indent of
Article 219(1) TFEU.23 The Council, acting by unanimity, on a recommendation from the
ECB or the Commission, and after consulting the European Parliament, in an endeavour to
reach a consensus consistent with the objective of price stability, may conclude formal
agreements on an exchange rate system for the euro in relation to currencies of third
States.
9.32 This means that any formal agreement related to the choice of exchange regime vis-à-
vis the dollar or other currencies is the responsibility of the Council. The language,
however, is convoluted and the reference to the procedure in paragraph 3, analysed in
paragraph 9.08 above, complicates an already cumbersome provision.
9.33 The Annexed Declaration on Article 219 (ex Article 111) clarified that the words
‘formal agreements’ as used in paragraph 1 of that provision was not intended to create a
new type of international agreement in Community law.24 Smits observes that only ‘Bretton
Woods-type arrangements’ were intended in paragraph 1, while less formal exchange rate
arrangements, such as those which emanated from the so-called Plaza and Louvre accords,
would only give rise to the ‘general orientations’ that are mentioned in Article 219(2).25
9.34 While Smits argues that the difference between Article 219(1), which provides for
‘formal agreements establishing exchange rate systems’, and Article 219(3), which provides
for ‘agreements concerning monetary and foreign exchange regime matters’, is one of
procedure,26 Zilioli and Selmayr consider that Article 219(3) EC includes not only
procedural aspects by also the Union’s explicit external competence to enter into public
international law agreements on monetary and exchange regime matters.27
In my opinion, the real difference between Article 219(1) and Article 219(3) is substantive.
Article 219(1) is the provision applicable to ‘formal’ exchange rate arrangements (ie, formal
arrangements concerning the exchange rate regime between the euro and other currency
or currencies), whereas Article 219(3) is the provision applicable to ‘informal’ exchange
rate arrangements and other agreements concerning monetary or foreign exchange regime
matters that the Union negotiates with third States or international organizations.
Floating exchange rates
9.35 The provisions of Article 219(1) TFEU have yet to be used. The euro floats freely in
international financial and money markets in conformity with current obligations under the
(p. 347) IMF’s Articles of Agreement, which no longer prescribe fixed exchange rate
arrangements, as I further explain in Chapter 12. In the present situation, the provisions of
Article 219(2) are of major practical importance. In a situation where no formal exchange
rate agreements have been concluded in relation to one or more non-Union currencies, the
Council may ‘formulate general orientations for exchange-rate policy in relation to these
currencies’.
9.36 As to the legal nature of these ‘general orientations’ for exchange rate policy, the
term ‘orientations’ does not refer to any established legal instruments and, according to
Smits, lacks legal binding force.28 During its Luxembourg summit on 12–13 December
1997, the European Council adopted a Resolution29 in which it stated that ‘in general,
exchange rates should be seen as the outcome of all other economic policies’. General
orientations may be adopted by the Council only ‘in exceptional circumstances, for example
in the case of a clear misalignment’. Even in this case, ‘such general orientations should
always respect the independence of the ECB and be consistent with the primary objective of
the ESCB to maintain price stability’.30
9.37 As I mentioned in paragraph 9.27 above, the ESCB is responsible for the conduct of
foreign exchange operations (according to Art 127(2) TFEU, consistent with Art 219 TFEU)
and for the management of the Union’s foreign reserves. That is, under the present regime,
the ESCB is operationally responsible for exchange rate policy, even though the Council
could at any time issue ‘general orientations’.
International agreements on monetary matters
9.38 Article 219(3) TFEU contains an explicit external competence of the Union with
regard to the negotiation of international agreements concerning monetary matters and
foreign exchange regime matters, which constitutes a derogation from the normal treaty-
making procedures between the Union and third countries or international organizations.31
9.39 Article 219(3) TFEU states:
[W]here agreements concerning monetary or foreign exchange regime matters need

to be negotiated by the Union with one or more third States or international
organisations, the Council, on a recommendation from the Commission and after
consulting the European Central Bank, shall decide the arrangements for the
negotiation and for the conclusion of such agreements. These arrangements shall
ensure that the Union expresses a single position. The Commission shall be fully
associated with the negotiations.
9.40 ‘Monetary matters’ under Article 219(3) TFEU refer to situations in which the
monetary regime of the euro is extended to a third country, for example, if a third country
wants to use the euro as its currency under a currency board arrangement, or as parallel
legal tender on its territory and is allowed to do so by the Union.32 ‘Foreign exchange
regime matters’ under (p. 348) Article 219(3) TFEU cover issues not included in Article
219(1) TFEU, such as informal—or less formal—public international law agreements
regarding the exchange rate regime of the euro. In terms of procedure, the one described in
paragraph 3 also applies to the conclusion of the ‘formal exchange rate arrangements’
referred to in Article 219(1).
9.41 The use of the verbs ‘need’ and ‘shall’ in Article 219(3) is more forceful than the use
of ‘may’ in Article 219(1) TFEU. According to Zilioli and Selmayr,33 the explicit external
competence attributed to the Union (treaty-making powers) by Article 219(3) TFEU is
limited by two restrictions: by the residual competence of the Member States to negotiate
and conclude international agreements regarding economic and monetary union under
Article 219(4) TFEU, and by the external competence of the ECB in monetary matters.
The international role of the euro
9.42 As I have already pointed out in paragraphs 9.03 and 9.22 above, Article 138 TFEU
deals with the need to ‘secure the euro’s place in the international monetary system’. The
increased use of the euro in global markets as a reserve currency, second only to the US
dollar, is a significant development, in line with the economic prowess of the eurozone
(three eurozone Member States are part of the G-7) and the strength of its legal and
institutional foundations, notwithstanding the problems experienced during the last few
years. The Eurosystem neither hinders nor promotes the international use of the euro.34
The residual role of the Member States
9.43 Article 219(4) TFEU refers to the residual role of the Member States to negotiate in
international bodies (international organizations and other groupings) and to conclude
agreements as regards economic and monetary union. It states: ‘Without prejudice to Union
competence and Union agreements as regards economic and monetary union, Member
States may negotiate in international bodies and conclude international agreements.’
9.44 In the following sections, I further discuss the obligations of IMF membership for the
individual Member States of the euro area.
D. International Relations

9.45 An entity needs legal personality in order to act in international relations, to create
rights and obligations under international law.35 Neither the European System of Central
Banks, nor the Eurosystem/Eurogroup have legal personality.36 Therefore they do not have
the (p. 349) capacity to enter into international legal relations. The entities with legal
personality are the ECB and the NCBs, the Union, and the Member States.37
The Union
9.46 The European Union has been awarded legal personality by Article 47 TEU, which
states that ‘the Union shall have legal personality’.38 The legal power of the Union to act
internationally with regard to monetary matters is governed by Article 219 TFEU.
9.47 The Union is typically represented externally by its institutions (notably by the
Council and the Commission),39 which themselves are not endowed with legal personality.40
The procedures for the conclusion of international agreement foreseen in Article 218
TFEU41 do not apply in the case of external monetary relations, which are governed by
Article 219 TFEU. This provision (Art 219 TFEU) gives the Council a prominent role with
regard to the negotiation and conclusion of formal and informal arrangements in monetary
and foreign exchange regime matters.
9.48 The euro area as such has no legal personality.42
9.49 Herrmann contends that all the fundamental decisions a monetary sovereign can take
from the perspective of international law are to be taken by the Council (entering into
formal exchange rate systems like Bretton Woods, restricting the flow of capital and
payments, or entering into monetary or foreign exchange regime agreements) not by the
ECB.43 Slot also considers that the Council is in the driver’s seat.44
(p. 350) The European Central Bank
9.50 In the field of international monetary cooperation the European Central Bank is
entrusted with competences by the EC Treaty and the ESCB Statute. It is important to bear
in mind that though the ECB is an institution endowed with separate legal personality, it is
enshrined in the Community framework (as the Court of Justice recognized in the OLAF
case that I examined in Chapter 7), and in the conduct of its monetary policy
responsibilities it exercises an exclusive Union competence.
9.51 The European Central Bank governs the ESCB through its decision-making bodies
(Art 129(1) TFEU). In particular, the decision on external representation of the ESCB is
centralized in the hands of the Governing Council of the ECB.45 According to Article 6(1) of
the ESCB Statute, ‘in the field of international cooperation involving the tasks entrusted to
the ESCB, the ECB shall decide how the ESCB shall be represented.’ Moreover, under
Article 6(2) of the Statute, ‘the ECB and, subject to its approval, the national central banks
may participate in international monetary institutions.’ For instance, the ECB has
participated in the Bank for International Settlements (BIS) since 1999.
9.52 The international legal personality of the ECB is limited to the specific fields of tasks
entrusted to the ECB by the Treaty. It should be noted that, in the absence of formal
exchange rate arrangements or general orientations, the operational management of the
exchange rate is the responsibility of the European Central Bank.
9.53 Article 23 of the ESCB Statute lists the ‘external operations’ (explicit external
competences) which the ECB and the national central banks may conduct:
• establish relations with central banks and financial institutions in other countries
and, where appropriate, with international organizations;
• acquire and sell spot and forward all types of foreign exchange assets and precious
metals; the term ‘foreign exchange asset’ shall include securities and all other assets
in the currency of any country or units of account and in whatever form held;
• hold and manage the assets referred to in this Article;
• conduct all types of banking transactions in relations with third countries and
international organizations, including borrowing and lending operations.
9.54 In addition to Article 23, there are other provisions in the ESCB Statute that also
refer to ‘external operations’. According to Article 22 of the ESCB Statute, the role of the
ECB in the promotion of the smooth operation of payment systems also includes an external
aspect. The ECB is competent to ‘make regulations, to ensure efficient and sound clearing
and payment systems within the Union and with other countries’. This regulatory
competence implies a parallel external competence to negotiate and conclude, if necessary,
international agreements on payment systems.46 For technical reasons, some of these
agreements ought to involve also national central banks in the case where the ECB relies on
the payment facilities and infrastructure of national central banks. This is what happened
with the Agreement on a Trans-European Automated Real Time Gross-Settlement Express
Transfer System, concluded by both the ECB and the euro-NCBs with the NCBs outside the
euro area. (TARGET2 replaced TARGET in November 2007, as noted in paragraphs 7.61 and
10.73.)
(p. 351) 9.55 The ECB also has the powers to conclude international administrative
agreements, particularly with the country of its seat (Art 24 ESCB Statute).
The national central banks
9.56 The NCBs of the Member States that have adopted the euro are an integral part of
the ESCB (operational arms of the ESCB) when carrying out operations that form part of
the tasks of the ESCB.47 They are also national agencies when performing non-ESCB
functions.48
9.57 According to Article 6(2) of the ESCB Statute, the national central banks may
continue to participate in international monetary institutions, such as the Bank for
International Settlements. (Though the ECB has been a member of the BIS since 1999, the
individual NCBs retain their participation as members.49) Article 31(1) of the ESCB Statute
further enables the NCBs to perform transactions in fulfilment of their obligations towards
international organizations in accordance with Article 23.
According to Article 42(2) of the ESCB Statute, the national central banks of the Member
States with a derogation shall retain their powers in the field of monetary policy according
to national law, despite their participation in the ESCB.
The EU Member States: IMF membership
9.58 The transfer of monetary powers from the national to the Union level has reduced the
legal capacity of the Member States to act on the international level.50 The external
competences of the Members States of the euro area have a residual character,51 as
recognized in Article 219(4) TFEU.
9.59 However, EU Member States must still comply with their international obligations. In
the following paragraphs the consequences of IMF membership for the Member States in
the euro area are briefly examined.
(p. 352) 9.60 Under the Fund’s Articles of Agreement (Art II, s 2), only ‘countries’ are
allowed membership. Member States that have adopted the euro remain individual
members of the IMF, despite the fact that the area of jurisdiction of the euro is clearly
supranational. The membership of the Union (or of the ECB) would need an amendment to
the Articles.52
9.61 The euro area as such is not able to appoint a Governor or appoint or elect Executive
Directors in the IMF, even though, in December 1998, the ECB was granted observer status
at selected Executive Board meetings.53
9.62 The national–supranational dichotomy presents a challenge for the Member States of
the euro area. The differentiated integration with regard to monetary policy and to
exchange rate policy and the asymmetries between monetary and fiscal policy further
complicate the obligations of IMF membership.
Implications for IMF surveillance
9.63 Article IV consultations (analysed in Chapter 13 in this volume) continue to be held
with each individual Member State. However, these consultations also require the
involvement of representatives of the relevant EU institutions, given the Union competence
with regard to monetary and exchange rate policies, and the need to take into account the
regional perspective with regard to fiscal policy and other economic policies. In addition to
its bilateral Article IV consultations with the 18 eurozone Member States, IMF staff also
hold consultations annually for the euro area as a whole.54 The IMF work in Europe
intensified with the onset of the global financial crisis and was further stepped up since
2010 as a result of the sovereign debt crisis in some eurozone Member States.55
Implications for the SDR
9.64 Since the advent of EMU, the euro has replaced the Deutschmark and the French
franc in the SDR valuation basket. The value of the SDR is now determined daily on the
basis of four currencies: the US dollar, the yen, the euro, and the pound sterling.
Implications for the holding and management of foreign reserves
9.65 As part of their membership responsibilities, Member States hold reserve positions
with the IMF. Article 31 of the ESCB Statute allows Member States of the euro area to hold
some reserves so that they can fulfil their obligations towards international organizations.
(p. 353) However, the discretion that a Member State of the euro area retains in managing
its foreign reserve assets is limited since part of the assets have been transferred to the
ECB (according to Art 30 of the ESCB Statute), and ‘transactions above certain limits
involving foreign assets that are retained by a country are subject to ECB approval’.
9.66 According to Article 30(5) of the ESCB Statute, ‘[t]he ECB may hold and manage IMF
reserve positions and special drawing rights and provide for the pooling of such assets.’
Notwithstanding the existing institutional limitations (IMF Articles of Agreement and
others), some significant developments have taken place in terms of direct IMF–EU
consultations. In March 2013, the IMF published its first EU-wide Financial Sector
Assessment Program (FSAP).56 And since the sovereign debt crisis in the Eurozone, the IMF
is firmly inserted in the EU process.
The problems of relying upon multiple external actors under a multi-layered
system of representation
9.67 The European Union is competent to speak and act in international fora whenever the
external competences of the Union are involved.57 The ECB is competent to speak and act
in international fora whenever the tasks entrusted to the ESCB are involved. The Member
States of the euro area (the ‘ins’) have a residual competence and also have the
responsibilities of their ‘individual’ membership in international monetary organizations.
The national central banks of the Member States that have adopted the euro remain
competent to act in the field of financial supervision and in the exercise of the other
responsibilities assigned to them by national law as national agencies, that is, when
performing non-ESCB tasks.58 They also continue to participate in international
organizations, such as the BIS. The Member States with a derogation (the ‘outs’) retain
their monetary sovereignty, internally and externally, and their competence to speak and act
in international fora, though they need to comply with a number of treaty provisions.59 The
national central banks of the Member States with a derogation retain the competences
attributed to them by national law. They act as national agencies, not as an integral part of
the ESCB, as opposed to the national central banks of the Member States that have adopted
the euro.60
9.68 The problems of relying upon multiple actors and the existence of a multi-layered
complex system of representation in the Union with regard to EMU matters present a
picture of bewildering complexity. Smits pointedly remarks: ‘If unchecked, [the] panoply of
uncoordinated provisions on external action, may lead, in the field of EMU, to an hexagonal
representation of the Union’, comprising the President of the European Council, President
(p. 354) of the Commission, Ministers of Finance, President of the EU Council, ECB
President, and the President of the Eurogroup.61 This ‘spreading of internal and external
power’62 does not augur well for ‘unity’ with regard to the external representation of the
euro.
9.69 The current structure is far too complex and should be simplified.
E. Concluding Observations
9.70 Responsibility for the conduct of exchange rate policy in the euro area is a task which
is divided between the Council and the ECB under a notoriously unclear set of treaty
provisions. Article 219 TFEU (and Art 138 TFEU) is cumbersome in legal and economic
terms, the result of a calculated obfuscation for political purposes.
9.71 Despite the convoluted language of Article 219 TFEU, it can be inferred from the
treaty provisions and from the doctrine of parallelism developed by the case law of the ECJ
that the conduct of exchange rate policy in the euro area is an exclusive Union competence.
9.72 Though the Council has the primary role according to the language of Article 219, in
the absence of formal exchange rate arrangements or general orientations, the
management of the exchange rate is the operational responsibility of the European Central
Bank.
9.73 The external representation of the euro is complicated by the existence of multiple
actors with external competences and by a multi-layered system of representation at the EU
level.
9.74 From the point of view of monetary law, the relations between the Member States of
the euro area and the International Monetary Fund are of particular relevance. Under
Article II, section 2 of the current Articles of Agreement, only countries can be members of
the IMF. This raises important challenges in terms of international monetary cooperation,
since the area of jurisdiction of the euro is clearly supranational, while IMF membership
remains nationally based.
Footnotes:
1
The contents of Treaty Establishing the European Community, 2006 OJ C 321 E/37, Art
111 (hereinafter EC Treaty) are now included in Consolidated versions of the Treaty on
European Union and the Treaty on the Functioning of the European Union, 2010 OJ C 83/01
vol 53 (30 March 2012), Arts 219 and 138 (hereinafter TFEU).
2
My analysis in this chapter focuses on the external aspects of monetary policy, leaving
aside external aspects of other elements of EMU (payments and capital and economic
union).
3
See Rosa M Lastra, Central Banking and Banking Regulation (London: London School of
Economics/Financial Markets Group, 1996) 276 n 454, for a quote of former German
Chancellor Helmut Schmidt who had stated in his memoirs that he ‘regarded exchange rate
policies…as an important part of general foreign and strategic policy’. See also Chapter 2 in
this volume and Anna Maria Viterbo, International Economic Law and Monetary Measures:
Limitations to States’ Sovereignty and Dispute Settlement (Cheltenham: Edward Elgar,
2012) 24–5.
4
See Peter Norman, ‘Finance Minister in Waiting’ Financial Times (4 October 1998);
Wolfgang Münchau, ‘Return to Keynes’ Financial Times (26 October 1998). See also eg Fred
Bergsten, ‘How to Target Exchange Rates’ Financial Times (20 November 1998), for a more
academic explanation with regard to the proposed adoption of target zones.
5
See ‘France to Seek Euro Devaluation’ Financial Times (30 April 2014).
6
See Kathleen R McNamara and Sophie Meunier, ‘Between National Sovereignty and
International Power: What External Voice for the Euro’ (2002) 78 International Affairs 849,
851.
7
See René Smits, ‘The European Central Bank’s Independence and its Relations with
Economic Policy Makers’ (2007) 31(6) Fordham International Law Journal 1629. Smits
recalls the spat between Jean Claude Juncker and Jean Claude Trichet on external
representation. It also provides further evidence of the difficult demarcation line between
politicians and the ECB.
8
See eg ‘Jean-Claude Trichet, ECB President Said Last Weekend: “As far as the currency is
concerned, I am evidently Mr Euro”’ Financial Times (17 September 2004).
9
See René Smits, ‘The European Constitution and EMU: An Appraisal’ (2005) 42 Common
Market Law Review 425, 455.
10
‘Euroshambles’ The Economist (16 September 2000).
11
Only part of the reserves have been transferred to the ECB (according to Statute of the
European System of Central Banks and of the European Central Bank, Art 30 (hereinafter
ESCB Statute)), while part of the reserves are held by the national central banks (NCBs)
(according to ESCB Statute, Art 31). The distribution among the members of the ESCB is
irrelevant for the communal holding and managing of the reserves that no longer are for
the Member States to own and decide upon. See the ECB Opinion CON/2004/6 of 13
February 2004 on cover for exchange losses by the Banque de France, at <http://
www.ecb.int/ecb/legal/pdf/en_con_2004_6_f_sign.pdf> (last visited 10 August 2014). I am
grateful to René Smits for observations on this point.
12
See the ECB Opinion CON/2004/34 of 4 November 2004 at the request of the Belgian
Ministry of Finance on a draft law introducing a tax on exchange operations involving
foreign exchange, banknotes, and currency, para 13, at <https://www.ecb.europa.eu/ecb/
legal/pdf/en_con_2004_34_f_sign.pdf> (last visited 10 August 2014).
13
For a discussion on this issue, see Jean-Victor Louis, ‘Monetary Policy and Central
Banking in the Constitution’ in Legal Aspects of the European System of Central Banks,
Liber Amicorum Paolo Zamboni Garavelli (Frankfurt: European Central Bank, 2005) 29–30.
14
In private correspondence, Chiara Zilioli suggested that while Art 3 TFEU (then Treaty
Establishing a Constitution for Europe, OJ C 310/1 (29 October 2004), Art I-13 (hereinafter
EU Constitution)) refers to monetary policy lato sensu, in German, Währungspolitik
(literally currency policy), Art 127(2) TFEU (then EU Constitution, Art III-185(2) and EC
Treaty, Art 105(2)) refers to monetary policy in a narrower sense, in German, Geldpolitik.
15
Smits, above note 9.
16
And with the TFEU injunction to the Council to endeavour to reach consensus with the
ECB when ‘formal’ exchange rate policy (Art 219(1)) is concerned and to respect the
ESCB’s price stability objective (‘without prejudice to’) when general orientations are
adopted (Art 219 (2) TFEU). I am grateful to René Smits for observations on this point.
17
Case 22/70 Commission v Council (‘ERTA’) [1971] ECR 263.
18
See Chiara Zilioli and Martin Selmayr, ‘The External Relations of the Euro Area: Legal
Aspects’ (1999) 36 Common Market Law Review 273, and René Smits, The European
Central Bank. Institutional Aspects (The Hague: Kluwer Law International, 1997) 369.
19
Zilioli and Selmayr, above note 18, 292. They further contend, that ‘the ECB is the
natural bearer of external competences in the field of monetary policy’. As regards the
external competence of the Union and the ECB in monetary matters, Zilioli and Selmayr
(294) make the following distinctions: first, the explicit external competences of the
Community, exercised normally by the Council, as laid down in Art 218(1) and (3), and Art
138 TFEU; secondly, the explicit external competences of the European Central Bank laid
down in the provisions of Art 127(2) TFEU and Art 21 of the ESCB Statute, and, thirdly, the
implicit external competences of the ECB which mirror the internal tasks of the ESCB
without explicit reference in the legal texts.
20
Smits, above note 18, 369–70.
21
ECJ Opinion 1/76 European Laying-up Fund for Inland Waterway Vessels [1977] ECR
741, para 4.
22
See generally Christoph W Herrmann, ‘Monetary Sovereignty over the Euro and
External Relations of the Euro Area: Competences, Procedures and Practice’ (2002) 7
European Foreign Affairs Review 1, 6–7.
23
The second indent of Art 219(1) TFEU deals with the adoption, adjustment, or
abandonment by the Council of the central rates of the euro within the exchange rate
system, following a procedure similar to the one the Council must comply with in the case
of the adoption of formal exchange rate arrangements.
24
Declaration on Article 111 of the Treaty establishing the European Community (Treaty
of Nice), OJ C 80/78 (10 March 2001): ‘The Conference agrees that procedures shall be
such as to enable all the Member States in the euro area to be fully involved in each stage
of preparing the position of the Community at international level as regards issues of
particular relevance to economic and monetary union.’ Under the Treaty on European
Union (signed 7 February 1992, entered into force 1 November 1993), OJ C 325/5 (24
December 2002) (hereinafter Maastricht Treaty or TEU), this was the Declaration on the
then Article 109 of the Treaty Establishing the European Community, OJ C 191/99 (29 July
1992).
25
26
27
Zilioli and Selmayr, above note 18, 296.
28
29
Resolution of the European Council on economic policy coordination in Stage III of EMU
and on Articles 109 and 109b of the EC Treaty, OJ C 35/1 (2 February 1998).
30
EC Resolution, OJ C 35/1 (2 February 1998).
31
EC Treaty, Art 300 and EU Constitution, Art III-325.
32
The agreements with the principality of Monaco, the Republic of San Marino, the
principality of Andorra, and Vatican City with regard to the use of the euro in their
territories are included under this category of ‘monetary matters’. See eg Manuel López
Escudero, El Euro en el Sistema Monetario Internacional (Madrid: Tecnos, 2004) 57. See
also Communication from the Commission to the Council Report on the functioning of the
Monetary Agreements with Monaco, San Marino and Vatican, COM/2009/0359 final (14 July
2009). A Monetary Agreement was concluded and signed between Andorra and the
European Union in 2011 and it entered into force on 1 April 2012. See Baudouin Lamine
(Directorate-General for Economic and Financial Affairs), ‘Monetary and Exchange-rate
Agreements Between the European Community and Third Countries’, European
Commission Economic Papers No 255 (September 2006), at <http://ec.europa.eu/
economy_finance/publications/publication658_en.pdf> (last visited 10 August 2014).
33
Zilioli and Selmayr, above note 18, 297–303.
34
See ‘The International Role of the Euro’, ECB, July 2014 at <http://www.ecb.europa.eu/
pub/pdf/other/euro-international-role-201407en.pdf?
456475aa49c78ac8f912d9828d374c52> According to Article 138(2) TFEU, the Council may
‘adopt appropriate measures to ensure unified representation within the international
financial institutions’.
35
See Ziloli and Selmayr, above note 18, 274.
36
Ziloli and Selmayr, above note 18, 275–6.
37
Ziloli and Selmayr, above note 18, 276–86. Zilioli and Selmayr provide an analysis of the
actors in the external relations of the euro area (the Member States, the national central
banks, the Community, and the European Central Bank).
38
The explicit recognition of the European Union’s legal personality in the Treaty of the
European Union abolished ‘pillar’ structure where only the European Community and the
European Atomic Energy Community had legal personality. See also Declaration concerning
the legal personality of the European Union, OJ C 306/258 (17 December 2007).
39
But, in the case of the monetary agreements with Monaco and Vatican City, by France,
respectively Italy, and the Commission. See Monetary Agreement between the European
Union and the Principality of Monaco, OJ C 310/01 (31 October 2012) and Monetary
Agreement between the European Union and the Vatican City State, OJ C 28/05 (4 February
2010). The Monetary Agreement between the European Union and the Republic of San
Marino, OJ C 121/5 (26 April 2012), was directly between the EU and San Marino.
40
See Zilioli and Selmayr, above note 18, 281–2 and 282 n 42. See also Joined Cases 7/56
and 3/57–7/57 Algera and others v Common Assembly of the European Coal and Steel
Community [1957] ECR 81. As discussed in Chapter 7 in this volume, according to TEU, Art
13, the Union’s institutions are the European Parliament, the European Council, the
Council, the European Commission, the Court of Justice, the European Central Bank, and
the Court of Auditors. The ECB does have legal personality as I have already pointed out. Its
legal personality is recognized in Art 282(3) TFEU.
41
TEU, Article 218 refers to the procedure for the conclusion of international agreements
between the Union and third countries or international organizations.
42
This point is made by Zilioli and Selmayr, above note 18, 274–5.
43
Herrmann, above note 22, 6.
44
Piet Jan Slot, ‘The Institutional Provisions of the EMU’ in Deirdre Curtin and Ton
Heukels (eds), Institutional Dynamics of European Integration. Essays in Honour of Henry
G. Schemers (Dordrecht: Martinus Nijhoff Publishers, 1994) vol II, 241.
45
See ESCB Statute, Arts 6 and 12(5).
46
47
ESCB Statute, Arts 12(1) and 14(3).
48
49
López Escudero, above note 32, 121.
50
Member States, as a rule, remain externally competent in the field of economic (fiscal)
policy provided (1) that they regard their economic policies as a matter of common concern
and (2) any international agreements do not circumvent the prohibitions laid down in the
Treaty regarding economic policy. For example, Member States shall not enter into
international agreements which would require them to grant public authorities privileged
access to financial institutions. See Zilioli and Selmayr, above note 18, 290. In his comments
on this chapter, René Smits contends that Member States’ obligations extend further than
this: they may not, via G8 or G10 arrangements, preclude the internal coordination of
economic policies and should at the very least consult their counterparts on possible
positions in these contexts, as well as in IMF affairs.
51
See generally Zilioli and Selmayr, above note 18, 317–32. According to Art 127(3) TFEU
the competence of the ECB to hold and manage the official foreign reserves of the Member
States ‘shall be without prejudice to the holding and management by the governments of
Member States of foreign-exchange working balances’. There is also a rather limited
external competence of Member States for international agreements with regard to coins,
which remain largely a national competence. There are also a number of Protocols and
Declarations attached to the Treaty which reserve external competences to specific
Member States and thus enable them to continue their public international law relationship
with specific countries and territories such as the Republic of San Marino, Vatican City, and
the Principality of Monaco. René Smits observes (in private correspondence) that even
though France or Italy may act, it is the Community which enters into international
relations with these ‘mini-States’.
As noted in paras 9.40 and 9.46 above, the new monetary agreements have been concluded
by either France/Italy and the Commission acting for the EU, or directly EU–mini-State
(Monetary Agreement between the EU and San Marino, OJ C 121/5 (26 April 2012)).
52
The alternative reading, namely that the Articles of Agreement should be interpreted in
conformity with a new legal reality, not foreseen at the time of their conclusion when only
‘countries’ had currencies and currency unions were always between sovereign States, and
that for the purposes of the IMF Articles of Agreement, the Union is a ‘country’ has been
advocated by René Smits, as he pointed out in his comments on this chapter.
53
See IMF, ‘The IMF & the European Economic and Monetary Union’ (March 1999), at
<http://www.imf.org/external/np/exr/facts/emu.htm> (last visited 10 August 2014). On the
EU single seat, see European Commission, Communication on ‘A Blueprint for a Deep and
Genuine Economic and Monetary Union—Launching a European Debate’, COM (2012) 777
final/2 (30 November 2012), Annex 2 (‘External Representation of the Euro Area’) 46–8. See
also Ariel Buira (ed), Reforming the Governance of the IMF and the World Bank’ (New York:
Anthem Press, 2005) and Lorenzo Bini Smaghi, ‘A Single EU Seat in the International
Monetary Fund?’ in Knud Eric Jørgensen (ed), The European Union and International
Organizations (London: Routledge, 2009) 61.
54
See IMF ‘Executive Board Concludes 2014 Article IV Consultation on Euro Area
Policies’, Press Release No. 14/341, 14 July 2014, at <http://www.imf.org/external/np/sec/pr/
2014/pr14341.htm>. See also ‘The IMF and Europe’ (factsheet), International Monetary
Fund, 18 September 2014, at <https://www.imf.org/external/np/exr/facts/europe.htm>.
55
The first-ever EU wide Financial Sector Assessment Program (FSAP) was concluded in
March 2013. See <https://www.imf.org/external/np/sec/pr/2013/pr1379.htm>. See also ‘The
IMF and Europe’, above note 54.
56
See IMF, ‘IMF Assessment of Financial Stability in Europe: Much Achieved to Address
the Crisis but Vulnerabilities Remain and Intensified Efforts Needed’, Press Release (15
March 2013), at <https://www.imf.org/external/np/sec/pr/2013/pr1379.htm> (last visited 10
August 2014).
57
58
Though subject to the constraints imposed by Art 14(4) of the ESCB Statute, which
reads as follows: ‘National Central Banks may perform functions other than those specified
in this Statute unless the Governing Council finds, by a majority of two thirds of the votes
cast, that these interfere with the objectives and tasks of the ESCB. Such functions shall be
performed on the responsibility and liability of national central banks and shall not be
regarded as being part of the functions of the ESCB.’
59
See eg TFEU, Art 142.
60
However, these NCBs of the Member States with a derogation participate in the General
Council, the third governing body of the ESCB. See TFEU, Art 141(1) and ESCB Statute, Art
46.
61
See Smits, above note 9, 455–6.
62
Smits, above note 9, 455–6.
Part II Developments at the EU Level, 10 Banking
Union
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
Deposit protection schemes — International financial system — Monetary system — Monetary obligations
— European Central Bank
(p. 355) 10 Banking Union
B. The Rationale of Banking Union 10.07
A flawed institutional design 10.10
The financial trilemma 10.11
The vicious link 10.12
Independent supervision and adequate conditionality 10.14
C. The Three Pillars of Banking Union 10.16

Single Supervisory Mechanism 10.18
The SSM Regulation—a brief analysis 10.20
Governance 10.29
Preparatory work 10.34
Single Resolution Mechanism 10.36
Legal basis of the SRM Regulation 10.41
The content of the SRM Regulation 10.44
Common deposit protection 10.65
D. The ‘Missing Pillar’: Lender of Last Resort 10.69

Crisis in the payments system 10.73
General market liquidity crisis 10.74
The ‘classic’ individual liquidity crisis 10.75
Fiscal assistance and State aid rules 10.81
A. Introduction
10.01 Banking union is the most important development in the EU since the launch of the
euro. In 1999, Tommaso Padoa-Schioppa famously pointed out that the abandonment of the
coincidence between the area of jurisdiction of monetary policy and the area of jurisdiction
of banking supervision was a major novelty brought about by the advent of the economic
and monetary union (EMU).1 This has now been reversed. Banking union signifies a further
transfer of sovereign powers from the national to the supranational arena.
10.02 Banking union is based upon three pillars. The first pillar is ‘single supervision’, with
the establishment of the Single Supervisory Mechanism (SSM). ‘Single supervision’ in the
context of banking union means European supervision (conferred upon the European
Central Bank (ECB)) for credit institutions of Eurozone Member States and of non-Eurozone
EU Member States that choose to become part of the SSM. The second pillar is ‘single
resolution’, with a Single Resolution Mechanism (SRM)2—which should be aligned with the
EU (p. 356) Bank Recovery and Resolution Directive (BRRD)3—and a Single Resolution
Fund. The third pillar is ‘common deposit protection’.
10.03 Underpinning these three pillars is the concept of a common supervisory rule book,
laying down uniform terms for the authorization and withdrawal of credit institutions, for
the conduct of micro-prudential supervision over credit institutions, for the resolution of
non-viable credit institutions and for the operation of deposit guarantee schemes.4
Banking union co-exists with the single market in financial services. From an institutional
perspective this means that the expanded mandate of the ECB—the entity at the centre of
the SSM—will impact upon the work of the European Banking Authority (EBA), whose
jurisdiction is the EU at large.5
10.04 The first pillar of banking union, single supervision, has become a reality through
the adoption on 15 October 2013 of the Single Supervisory Mechanism Regulation (SSM
Regulation).6 The SSM Regulation entered into force on 3 November 2013. It becomes
operative on 4 November 2014.7 The so-called ‘SSM Framework Regulation’ was
subsequently adopted on 16 April 2014.8
10.05 This chapter discusses the history, rationale, and pillars of banking union, and
briefly analyses each of the three pillars, as well as the implications of a ‘fourth’ pillar (the
missing pillar) that should be an intrinsic part of the banking union edifice: lender of last
resort (LOLR).
(p. 357) 10.06 In 2006, in the first edition of this book, I proposed the creation of a
European Standing Committee for Crisis Management to alleviate the shortcomings of the
then existing system. By the time this second edition gets published, the ECB will be the
key supervisory authority in the Eurozone, while the institutional arrangements for crisis
management will still be the subject of considerable discussion.
B. The Rationale of Banking Union

10.07 Before the SSM Regulation, prudential supervision in the Eurozone remained
decentralized at the level of the Member States, based upon the principle of home State
control, combined with mutual recognition on the basis of prior regulatory harmonization,
and subject to cooperation and coordination. (How this cooperation and coordination
evolved from the so-called Lamfalussy process to the De Larosière framework, culminating
in the establishment of EU-wide supervisory arrangements aimed at the Single Market in
Financial Services, is discussed in Chapter 11.9)
10.08 Though the Draft Statute of the European System of Central Banks (ESCB) had
included prudential supervision as a fifth basic task of the ESCB, the final version of the
Statute (Art 25) and Article 127 of the Treaty on the Functioning of the European Union
(TFEU) (then Art 105 EC Treaty) only granted the ECB a limited supervisory role owing to
opposition from some countries—including Germany—to such an inclusion. As a
compromise solution, Article 127(6) TFEU left the door open for a possible future expansion
of such supervisory role, following a simplified procedure.10
10.09 Article 127(6) TFEU—the so-called ‘enabling clause’—reads as follows:
The Council, acting by means of regulations in accordance with a special legislative

procedure, may unanimously, and after consulting the European Parliament and the
European Central Bank, confer specific tasks upon the European Central Bank
concerning policies relating to the prudential supervision of credit institutions and
other financial institutions with the exception of insurance undertakings.
The rationale of banking union in general and of the SSM in particular can be explained by
the confluence of a number of factors: a flawed institutional design combining a strong
monetary pillar with weak economic and supervisory pillars in the design of EMU, the
relevance of the so-called financial ‘trilemma’ (which also justifies the federalization of EU-
wide supervision further discussed in Chapter 11, as well as the case for international
regulation and supervision), the ‘vicious link’ between banking debt and sovereign debt, (p.
358) and the need for ‘independent supervision’ and adequate conditionality. Let us
examine in turn each of these arguments.
A flawed institutional design
10.10 The financial crisis that commenced in the United States in August 2007 and that
became a global financial crisis in 2008 following the demise of Lehman Brothers had a
profound effect in the EU. In the euro area, the financial crisis mutated into a sovereign
debt crisis in 2010.11 At the root of the euro area problems lay a fundamental inconsistency
between a relatively strong monetary pillar (with the euro and ECB) and weak economic
and supervisory pillars (the weak ‘E’ and ‘S’). Each of the weak pillars of the economic and
monetary union—the economic one and the supervisory one—proved not only weak on their
own; they also proved weak in their inter-linkages.12 The inadequacy of the principle of
decentralized supervision in a monetary union became all too evident; existential doubts
about the very sustainability of the euro led to a frenzy of legislative and policy reforms. In
the words of Veron, banking union is ‘the most consequential policy initiative since the start
of its financial crisis’.13
The financial trilemma
10.11 One of the main economic arguments in favour of European Monetary Union was
the need to solve the ‘inconsistent quartet’ of policy objectives: free trade, full capital
mobility, pegged (or fixed) exchange rates, and independent national monetary policies.14
The only long-term solution to this inconsistency was to complement the internal market
with monetary union,15 thus abandoning national control over domestic monetary policies.
A similar argument was made with regard to financial supervision by Niels Thygesen and
Dirk Schoenmaker. Thygessen pointed out that it is difficult to achieve simultaneously a
single financial market and financial stability while preserving a high degree of nationally
based supervision.16 Schoenmaker referred to these inconsistent objectives as the
‘trilemma (p. 359) in financial supervision’: a stable financial system, an integrated financial
market, and national financial supervision.17 The trilemma is an argument also used to
justify the need for EU wide (and not simply euro area) supervisory arrangements as well as
international solutions.18 The dichotomy between national laws and policies and
international or supranational institutions and markets remains a daunting challenge.
The vicious link
10.12 The twin financial and sovereign debt crises in the Eurozone have evidenced the
interdependence between the national governments issuing sovereign debt and the banks
purchasing such debt. This doomed loop, vicious link, or fatal embrace between banks and
sovereigns got exacerbated because many banks relied upon restructuring and resolution
frameworks—at times a full ‘bail-out’—backed by national budgets. Bank rescue packages
compromise the fiscal position of the government and increase national indebtedness, while
in turn the sustainability of sovereign debt threatens the stability of the banks that hold
such sovereign debt.19
10.13 This doomed loop was the catalyst for the quick political agreement that was forged
in 2012 to move swiftly towards a banking union.
Independent supervision and adequate conditionality
10.14 European supervision was identified as a necessary precondition for access to
European Stability Mechanism (ESM) funding. In June 2012, the Euro Area Summit decided
that the European Stability Mechanism should get an instrument to recapitalize banks
directly in order to relieve troubled Eurozone Member States from the substantial rise of
their national indebtedness due to the need to finance the restructuring of their banks:
‘When an effective single supervisory mechanism is established, involving the ECB, for
banks in the Euro area the ESM could, following a regular decision, have the possibility to
recapitalise banks directly.’20 On 10 June 2014, euro area Member States reached a
political understanding on the operational framework of the ESM direct recapitalization
instrument, which is expected to be added to the toolkit of the ESM by the start of the SSM
supervision in November 2014.21
(p. 360) 10.15 European supervision by definition can distance itself from a purely
domestic or national approach to supervision where politics or national economic priorities
may lead to regulatory forbearance.22 Banking union should help prevent that the financial
consequences of improper or delayed national supervisory measures be transferred to the
European level, and thereby, to taxpayers of other Member States.23 This issue is of great
concern to Germany and other countries. European supervisors can provide a more
independent and objective assessment of the problems identified in the course of the
supervisory process than national supervisors. Supranational supervision can also facilitate
the imposition of adequate conditionality if European funds are to be disbursed to help
recapitalize failing or troubled institutions.
C. The Three Pillars of Banking Union

10.16 What is in a name?24 The name ‘banking union’ is a bit of a conceptual accordion,
with different layers. Arguably, the first layer of a banking union has already been achieved
via European regulation, namely the Directives and Regulations that form the corpus of
common rules under which banks operate in the EU/European Economic Area (EEA). Of
course, this first layer, this ‘narrow’ banking union, was incomplete—as evidenced by the
financial crisis—due to the lack of effective rules on cross-border crisis management and
insolvency. The 2010 innovations under de De Larosière reform, introducing three
authorities (European Banking Authority (EBA), European Securities Market Authority
(ESMA), and European Insurance and Occupational Pensions Authority (EIOPA)) with some
override powers over national supervisors, did not have sufficient effect. The ‘banking
union’ that the European Commission advocated in September 201225 goes beyond
regulation and coordination ‘with bite’, and encompasses micro prudential supervision,
some macro-prudential supervisory powers (which are now included in Art 5 of the SSM
Regulation) and crisis management—including resolution and deposit insurance. A
‘broader’ and full banking union should encompass all these elements plus lender of last
resort (what I refer to as the fourth ‘missing pillar’ in this chapter).
(p. 361) 10.17 Nicolas Veron has defined banking union as ‘the transfer of banking sector
policy from the national to the European level’.26
Single Supervisory Mechanism
10.18 The idea of a single European authority for banking supervision is not new, neither
doctrinally27 nor from a policy perspective.28 However, concrete steps towards its
realization are very recent.29 The report of the president of the European Council, Herman
Van Rompuy in May 2012, acknowledged that EMU was ‘facing a fundamental challenge’
and that it needed ‘to be strengthened to ensure economic and social welfare’.30 According
to the Van Rompuy report, the achievement of closer EMU integration was to be based on
four building blocks: an integrated financial framework, an integrated budgetary
framework, an integrated economic policy framework, and democratic legitimacy and
accountability.
10.19 A political consensus to advance towards banking union was agreed by the
European Council on 29 June 2012:31
We affirm that it is imperative to break the vicious circle between banks and
sovereigns. The Commission will present Proposals on the basis of Article 127(6) for
a single supervisory mechanism shortly. We ask the Council to consider these
Proposals as a matter of urgency by the end of 2012. When an effective single
supervisory mechanism is established, involving the ECB, for banks in the euro area
the ESM could, following a regular decision, have the possibility to recapitalize
banks directly. This would rely on appropriate conditionality, including compliance
with state aid rules, which should be institution-specific, sector-specific or economy-
wide and would be formalised in a Memorandum of Understanding. The Eurogroup
will examine the situation of the Irish financial sector with the view of further
improving the sustainability of the well-performing adjustment programme. Similar
cases will be treated equally.
We urge the rapid conclusion of the Memorandum of Understanding attached to the
financial support to Spain for recapitalisation of its banking sector. We reaffirm that
the (p. 362) financial assistance will be provided by the EFSF until the ESM
becomes available, and that it will then be transferred to the ESM, without gaining
seniority status.
We affirm our strong commitment to do what is necessary to ensure the financial
stability of the euro area, in particular by using the existing EFSF/ESM instruments
in a flexible and efficient manner in order to stabilise markets for Member States
respecting their Country Specific Recommendations and their other commitments
including their respective timelines, under the European Semester, the Stability and
Growth Pact and the Macroeconomic Imbalances Procedure. These conditions
should be reflected in a Memorandum of Understanding. We welcome that the ECB
has agreed to serve as an agent to EFSF/ESM in conducting market operations in
an effective and efficient manner.
We task the Eurogroup to implement these decisions by 9 July 2012.
The SSM Regulation—a brief analysis

10.20 The Single Supervisory Mechanism is composed of the ECB and the national
competent authorities, with the ECB in charge of its effective and consistent functioning
(Art 6.1 SSM Regulation).
10.21 The scope of application of the SSM Regulation comprises all euro area Member
States on a compulsory basis and also non-euro area Member States that voluntarily enter
into a ‘close cooperation’ with the ECB (Art 7 SSM Regulation).32
10.22 The SSM Regulation confers ‘specific tasks’ related to the prudential supervision of
credit institutions to the ECB.33 Drawing upon the stages of the supervisory process
outlined in Chapter 3 in this volume, these ‘specific’ tasks: comprise authorization and
withdrawal of authorization (Art 4.1.a SSM Regulation), a broad range of micro-supervisory
responsibilities (Art 4.1.b–4.1.h SSM Regulation) for which it receives investigative and
supervisory powers (Arts 9–16 SSM Regulation), macro-prudential supervisory powers (Art
5 SSM Regulation), early intervention and recovery plans (Art 4.1.i SSM Regulation) and
sanctioning powers (Art 18 SSM Regulation).34
(p. 363) 10.23 The SSM Regulation has given competences to the ECB to supervise
directly ‘significant’ institutions and indirectly35 the other ‘less significant’ institutions.36
The test of significance is open-ended (and indeed the ECB can also supervise non-
significant institutions) though some criteria are established in Article 6.4 of the SSM
Regulation: if the balance sheet total exceeds either 20 per cent of the gross domestic
product (GDP) of its Member State or EUR 30 billion, if the entity is of significant relevance
for the domestic economy, if the credit institution has received financial assistance from the
ESFS and ESM. The procedures for classifying entities as ‘significant’ are outlined in
Articles 43–44 of the SSM Framework Regulation.37
10.24 The powers of home and host authorities have been the subject of considerable
debate in the aftermath of the financial crisis.38 With the advent of the SSM, the balance of
powers between home and host has different dimensions, which have been clarified with
the passage of the SSM Framework Regulation: (1) for Eurozone Member States, home/host
is no longer a matter of controversy for the tasks that have been transferred to the ECB; (2)
for SSM participating Member States which are not part of the Eurozone, as long as the
close cooperation arrangement with non Eurozone Member States participating in the SSM
remains in place, the balance also gravitates to the centre, for those tasks that have been
transferred to the ECB; (3) for non-SSM EU Member States, the single market rules apply,
bearing in mind the transfer of tasks to the ECB; (4) for non-EU Member States, the
transfer of tasks from the national authorities to the ECB signifies that the latter is the
institution in charge, but the pre-existing home–host balance remains.
10.25 The ECB takes over the supervisory responsibilities of both home and host
supervisors for the significant credit institutions located in the participating Member
States.39 The traditional single market divide that gives prevalence to home State control
will continue to apply to those tasks that have not been conferred to the ECB by Article 4.40
The ECB acts as the host supervisor for credit institutions in non SSM EU Member States
that provide banking services in participating Member States through branches or cross-
border services.41
(p. 364) 10.26 Article 17.2 of the SSM Regulation says that the provisions relating to
supervision on a consolidated basis shall not apply to the extent that the ECB is the only
competent authority.42 Paragraph 3 of Article 17 states that in those supervisory tasks that
have been transferred to the ECB the ECB shall respect ‘a fair balance’ between all
participating Member States and shall in relationship with non-participating Member States
respect the balance between home and host Member States established in relevant Union
law.
10.27 The so-called ‘SSM Framework Regulation’ of 16 April 2014 lays down the main
rules for the proper functioning of the SSM, including (1) the practical arrangements for
cooperation within the SSM (implementing Art 6(7) SSM Regulation); (2) the methodology
for assessing ‘significance’ (implementing Art 6(4) SSM Regulation); (3) the procedures for
supervising significant and less significant supervised entities; (4) the cooperation with
regard to the exercise of macro prudential tasks (Art 5 SSM Regulation); (5) the procedures
for ‘close cooperation’; and (6) the procedures applicable to sanctioning powers.
10.28 Articles 3–6 of the SSM Framework Regulation deal with the establishment of ‘joint
supervisory teams’; Articles 7–10 clarify the supervisory arrangements for colleges of
supervisors and consolidated supervision. Article 49 requires the ECB to publish a list of the
entities it supervises directly and a list of the entities supervised by a NCA (national
competent authority). Such list was published on 4 September 2014.43
Governance
10.29 In terms of the governance structure of the SSM, a new internal body called the
‘Supervisory Board’ is established according to Article 26 of the SSM Regulation. The
Supervisory Board is composed of a Chair and Vice Chair, four representatives of the ECB—
who may not be charged with any tasks directly linked to the monetary policy tasks of the
ECB—and one representative of the national authority competent for the supervision of
credit institutions in each participating Member State (Art 26.6 SSM Regulation). Decisions
of the Supervisory Board shall be taken by a simple majority of its members and each
member shall have one vote (Art 26.8 SSM Regulation).
10.30 The Supervisory Board shall carry out preparatory works regarding supervisory
tasks conferred on the ECB and propose complete draft decisions to the Governing Council
of the ECB. These decisions are adopted by the Governing Council as the decision-making
body of the ECB recognized in the Treaty (primary law), whose competences cannot be
restricted by secondary law. A draft decision of the Supervisory Board shall be deemed
adopted unless the Governing Council objects within a certain period (Art 26.8 SSM
Regulation). According to this ‘non-objection procedure’ the Governing Council can adopt
or object a draft decision of the Supervisory Board (‘take it or leave it’). In case of an
objection by the Governing Council, the matter can be referred to a Mediation Panel (Art
25.5 SSM Regulation).
10.31 As explained in Chapter 7 in this volume, the decision-making structures of the ECB
were designed primarily for monetary policy. This poses challenges with regard to the
actual conduct of supervision by the ECB. Supervision, let us not forget, is by definition
resource and personnel intensive, very litigious, prone to reputational damage, and,
generally, a ‘thankless task’ in which failures are magnified and successes are often hidden.
(p. 365) 10.32 The conferral of supervisory responsibilities onto the ECB also poses
challenges for its cherished independence. The creation of ‘Chinese walls’ within the ECB,
in order to ensure the effective separation of its monetary responsibilities from its
supervisory tasks is a key challenge for the ECB. The possibility of conflict is recognized in
Article 25 of the SSM Regulation, which establishes a ‘mediation panel’.44 Furthermore,
every transfer of a new task to the ECB raises concerns about democratic legitimacy. These
issues have, however, been addressed in arrangements between the ECB and the European
Parliament on the one hand, and between the ECB and the Council45 on the other, which
provide for extensive reporting and accountability mechanisms.
10.33 Article 24(1) of the SSM Regulation establishes an Administrative Board of Review
for the purposes of carrying out an internal administrative review of the decisions taken by
the ECB in the exercise of its supervisory powers.
The coexistence between the SSM and the Single Market is a further challenge for the
effectiveness of both realities (banking union and single market). Though it is stated in the
SSM Regulation that the inclusion of the ‘single supervisory mechanism’ in the European
System of Financial Supervision (ESFS) will not affect the current tasks of the European
Banking Authority, this remains to be tested.
Preparatory work
10.34 The ECB has been conducting a comprehensive assessment of the credit institutions
(128 institutions) that it will directly supervise prior to assuming full responsibility for
supervision under the SSM in November 2014.46 This comprehensive assessment consists
of three elements:
(i) ‘Asset Quality Review’ to enhance the transparency of bank exposures by

reviewing the quality of banks’ assets, including the adequacy of asset and collateral
valuation and related provisions;
(ii) ‘Stress test’ to examine the resilience of banks’ balance sheet to stress scenarios.
This exercise will be performed in collaboration with EBA;
(iii) ‘Supervisory Risk Assessment’ to review, quantitatively and qualitatively, key
risks, including liquidity, leverage, and funding.
10.35 The goals of the comprehensive assessment (in particular the asset quality review
(AQR),47 which is the key part of the assessment) are three: (1) transparency, (2) repair,
identifying (p. 366) and implementing any necessary corrective actions, and (3) confidence
building. As Veron points out, the context of this review is different from the stress tests
conducted by EBA, which were ‘widely seen as policy failures, as they gave a clean bill of
health to banks that collapsed shortly afterwards’.48 The AQR is considered essential in
order to avoid that hidden legacy assets in the balance sheets of the banks may undermine
the credibility and reputation of the ECB. The results of the AQR were published on 26
October 2014 (see <https://www.ecb.europa.eu/press/pr/date/2014/html/
pr141026.en.html>). The Member States are responsible and liable for the risks in the
balance sheets of the financial institutions that have arisen while such institutions have
been under the supervision of their national authorities.
Single Resolution Mechanism
10.36 The establishment of an SRM is a logical complement to the creation of the SSM. As
explained in Part I of this book, supervision and crisis management are part of a seamless
process.
10.37 Banking union requires a centralized approach to crisis management. The Single
Resolution Mechanism aims to ensure that financial institutions in the SSM area can be
resolved according to common rules and pre-established procedures. The SRM framework,
based on Regulation (EU) No 806/2014, and the Bank Recovery and Resolution Directive is
considered to be more efficient than the existing network of the national resolution
authorities.
10.38 On 10 July 2013, the Commission presented a proposal for a Regulation establishing
investment firms in the framework of a Single Resolution Mechanism and a Single Bank
Resolution Fund.49 Following the political agreement between the Parliament and the
Council, the text of the Regulation was adopted by the European Parliament on 15 April
2014. The final text of the Regulation was adopted on 15 July 2014.50 Some of the
provisions of the SRM Regulation (those related to the powers of the Board to collect
information and cooperate with the national resolutions authorities for the elaboration of
resolution (p. 367) planning) are expected to enter into force on 1 January 2015, while
others (including the bail-in tool) shall apply from 1 January 2016 (Art 88 SRM Regulation).
10.39 The SRM Regulation is complemented by an Intergovernmental Agreement (IGA)
between Member States that participate in the SSM on the transfer and mutualization of
contributions into the Single Resolution Fund (SRF).51 The rationale for establishing this
SRF on the basis of a separate, IGA instead of secondary legislation based on TFEU52 was
due to concerns about the legality of this latter method.53
10.40 A single resolution fund is foreseen as a common financial backstop. During the
build-up period of this fund, bridge financing will be available from national sources,
backed by bank levies, or from the European Stability Mechanism, in accordance with
agreed procedures. Lending between the national compartments of the fund shall also be
possible.
Legal basis of the SRM Regulation
10.41 Article 114 of the Treaty on the Functioning of the European Union is the legal basis
for the SRM Regulation.54 Article 114 allows the EU to adopt measures for the
approximation of national provisions laid down by law, regulation or administrative action
aiming at the establishment and functioning of the Internal Market of the European Union.
This legal basis is controversial and has been criticized by some as insufficient (given that it
deals with the needs of the internal market), with some arguing that a treaty revision is
needed.
10.42 In the Meroni judgment of 1958,55 the European Court of Justice (ECJ) declared
inadmissible under EU law the delegation of discretionary powers to bodies that are not
established under the (now defunct) European Coal and Steel Community (ECSC) Treaty. (p.
368) New bodies with discretionary powers can only be established by the Member States
by a transfer of competences in the way of a Treaty amendment but not by normal
secondary legislation. Therefore, the Meroni doctrine requires a basis in primary law for
authorities with discretionary powers.56 It has been argued that Article 114 TFEU in
principle does not provide for such a basis. Although the establishment of the three
European Supervisory Authorities (ESAs) was also based on Article 114 TFEU, the
establishment of an SRM, including a Single Resolution Fund, is substantially different from
the ESAs. While the core decision-making competences remain at the national level in the
case of the ESAs, with regard to the Single Resolution Mechanism, the core decision-
making competences are transferred to the European level, to European ‘authorities’.57
10.43 Bearing in mind the aforementioned legal limitations, the SRM regulation creates a
Mechanism instead of a new authority (with a Single Resolution Board) and gives a key role
to the European Commission. However, the resulting decision-making mechanism is
complex and has been criticized by some as inefficient.
The content of the SRM Regulation
10.44 The jurisdictional scope of the SRM Regulation is aligned with the SSM Regulation,
ie the participating Member States in the SSM will be also subject to the SRM regulation.58
However, the SRM shall not be limited to the ‘significant’ institutions which are directly
supervised by the ECB; ‘less significant’ institutions shall also fall under the scope of the
SRM.59
10.45 The SRM will apply to the resolution of: (1) credit institutions; (2) parent
undertakings established in one of the participating Member States, including financial
holding companies and mixed financial holding companies when subject to consolidated
supervision carried out by the ECB; (3) investment firms and financial institutions
established in participating Member States when they are covered by the consolidated
supervision of the parent undertaking carried out by the ECB.60
10.46 According to the estimations of the European Commission, the SRM will be directly
responsible for about 6,000 banks.61
(p. 369) 10.47 The SRM shall supplement the Bank Recovery and Resolution Directive,
which must be implemented in all EU Member States. The jurisdictional domain of the
BRRD is the EU/single market.
10.48 On the basis of the harmonization of the national legal frameworks on the
restructuring and resolution of financial institutions (BRRD), the SRM Regulation
establishes the Single Resolution Board (SRB) based in Brussels,62 which will be a
European Union agency with legal personality.63 The SRB is established with the view of
ensuring a coherent and uniform approach to the operation of the resolution rules under
the SRM and it will be responsible for the effective and consistent functioning of the SRM64
and for undertaking an assessment of an individual institution and to which extent it is
resolvable.65
10.49 The SRB established under the SRM Regulation shall comprise: (1) a full-time chair
(assisted by a vice-chair), (2) four full-time members,66 and (3) a member appointed by each
participating Member State, representing the national resolution authorities,67 where each
member shall have one vote.68 The ECB and the European Commission will each designate
a permanent representative entitled to participate in executive and plenary sessions of the
SRB as an observer only.69 The chair of the SRB will be responsible for convening and
chairing its meetings, management and day-to-day administration, including the
implementation of the Board’s annual work programme, and preparing the work of the
Board, in its plenary and executive sessions.70 The operations of the agency will be funded
by a levy imposed on the banking industry which will be raised separately from the
contributions required from banks for the SRF.71
10.50 Resolution decisions will be taken at the European level. According to Article 18
(‘Resolution Procedure’) of the SRM Regulation, before an institution is placed under
resolution the following resolution conditions must be satisfied: (a) the entity in question is
failing or likely to fail; (b) it is unreasonable to expect that any alternative private sector
measures, or supervisory action, taken in respect of the entity, would prevent its failure
within a reasonable timeframe; (c) resolution action is necessary in the public interest.72
The ECB will determine whether an institution is failing or likely to fail, ie, it will pull the
trigger for the resolution process. The Single Resolution Board shall adopt the resolution
schemes and determine the (p. 370) application of resolution tools and the use of the single
resolution fund on its own initiative or if it is notified by the ECB that a bank is failing or
likely to fail.73,74
73 74
10.51 If the Single Resolution Board considers that all the resolution conditions are met, it
will adopt a resolution scheme and transmit such scheme to the European Commission.75
The Commission can then (1) either endorse the resolution scheme within 24 hours, or
object to it, and/or (2) propose to the Council within 12 hours that it should object to the
resolution scheme.76 This means that the Council will only be involved in considering a
resolution plan if the European Commission submits such request. If any objections to the
scheme are raised, the SRB shall have eight hours to adjust its resolution scheme. And if no
objections are expressed by the European Commission or the Council, the scheme enters
into force 24 hours after it has been transmitted to the Commission.77
10.52 The resolution scheme adopted by the SRB also determines which resolution tools
should be deployed and how the Single Resolution Fund should be used to support the
resolution action. According to the European Commission, the timeframe for the agreement
about the resolution scheme is expected to take place within 32 hours, thus allowing a
failing entity to be resolved over a weekend.78
10.53 The national resolution authorities shall be responsible for executing the decisions
of the SRM. However, the Single Resolution Board has the power to address decisions to
the national resolution authorities for the execution at the national level in accordance with
the SRM Regulation. The Board shall also monitor the execution by the national resolution
authorities of its decisions at the national level and can directly address decisions to banks,
if a national resolution authority does not comply with its decision.
10.54 The SRB will operate in ‘plenary sessions’ and ‘executive sessions’. The former are
conducted to consider general issues relating to the operation of the SRM as specified in
Articles 49–52, and these will consist of all the members of the SRB board (that is, the chair,
the full-time members and the representatives of participating Member States). In the
latter, executive sessions, the SRB will consider decisions relating to the resolution, or
potential resolution, of individual institutions. In executive sessions, the SRB will consist of
the chair four independent full-time members, who shall act independently and objectively
in the interest of the Union as a whole.79 A member representing from the national
resolution authority of the Member State in which the institution in question is established
will also (p. 371) take part in the decision-making process, as will members representing
Member States in which this institution has subsidiaries.80 In case a decision by consensus
cannot be reached, the chair and the full-time members will take a decision by a simple
majority, with the chair having a casting vote.81
10.55 The financing of resolution measures shall be carried out through the Single
Resolution Fund. The SRB will be the owner of the SRF and it will be responsible for its
administration under the delegated acts to be adopted by the European Commission.82 The
SRF shall be financed through contributions by the financial institutions which are subject
to the SRM. The target size of the fund should be at least 1 per cent of covered deposits in
the banking system of the participating Member States. During the ten-year initial build up
period of the Fund, the contributions of the financial institutions shall be raised at the
national level and flow into ‘national compartments’ of the Single Resolution Fund, which
shall be used only for the resolution of banks in the respective Member State. This means
that during the build-up period, the Single Resolution Fund consists of national
compartments. These national compartments shall be gradually merged. While the cost of
resolving banks would mainly come from the ‘national compartments’, during the first years
this national share would gradually decrease as the contribution from other countries’
compartments increases.83
10.56 The purposes for which the SRF can be used are strictly limited to: (1) guarantee
the assets or the liabilities of the institution under resolution, its subsidiaries, a bridge
institution or an asset management vehicle; (2) make loans to the institution under
resolution, its subsidiaries, a bridge institution or an asset management vehicle; (3)
purchase assets of the institution under resolution; (4) make contributions to a bridge
institution or an asset management vehicle; (5) pay compensation to shareholders or
creditors should they incur greater losses than they would have incurred, in a winding up
under normal insolvency proceedings; (6) make a contribution to the institution in lieu of
the contributions that would have been achieved by the write down of certain creditors, had
the bail-in tool been applied in accordance with Article 27 of the SRM Regulation.
10.57 The funding for the SRF will be formed from the ex ante contributions made by all
banks established in participating Member States;84 the amount of their contributions will
(p. 372) depend on their size and business model.85 The calculations for the yearly
contributions (a ‘flat contribution’ and a ‘risk-adjusted contribution’) by the individual
institutions will be made by the SRB after consulting the ECB and the national competent
authority. However, the cumulative contributions by all institutions cannot exceed annually
12.5 per cent of the target funding level.86 The ex-ante contributions raised during the
transitional period under the BRRD will be required to be transferred to the SRF under the
Intergovernmental Agreement87 once the SRM becomes operational.88 In addition to the ex-
ante contributions, the SRF can also raise extraordinary ex-post contributions89 and raise
funds through (a) the voluntary borrowing from resolution financing arrangements in non-
participating Member States, or (b) by approaching the financial institutions or other third
parties for loans.90
10.58 Neither the Commission, nor the Council nor the Single Resolution Board shall have
the power to require Member States to provide extraordinary public financial support to the
Single Resolution Fund. However, as the Fund may not have enough financial means at the
beginning of its functioning, it has to be ensured that the national budgets of the Member
States are not used to finance resolution measures. Thus, the Council also agreed on the
design of a backstop to the Single Resolution Fund.
(p. 373) 10.59 Under Article 45(1) of the SRM Regulation, the SRB is made accountable to
the European Parliament, the Council and the European Commission for its decisions. The
accountability mechanism embedded into the Regulation requires the SRB to submit an
annual report on the execution of its role to the European Parliament, the national
parliaments of participating Member States, the Council, the Commission, and the
European Court of Auditors. In addition, the national parliaments may also request written
responses from the SRB to their questions and observations in accordance with Article
46(1).91 This, of course, remains a thorny issue in the absence of a fiscal union.
10.60 Another controversial issue concerns the relationship between the ECB/SSM and the
SRM at the critical point of early intervention (which is a task conferred upon the ECB) and
how to move from early intervention and recovery plans to resolution plans. According to
Article 7(2) of the SRM Regulation, the SRB will be responsible for drawing up resolution
plans and adopting resolution decisions for those institutions that are directly supervised by
the ECB under the SSM Regulation, while the national resolution authorities will remain
responsible for other entities, except where the resolution scheme is expected to use the
Single Resolution Fund.92 However, this does not prevent the SRB from intervening when it
is ‘necessary to ensure consistent application of high resolution standards’.93 The SRB shall
also have certain investigatory powers that it can exercise either directly or through the
ECB or the national authorities. For example, the SRB is empowered: (1) to request
information form the institutions subject to the SRM Regulation, their employees, and third
parties to whom these entities outsourced functions or activities;94 (2) conduct all necessary
investigations (including access to all necessary documents and records, and the possibility
to obtain explanations from the employees);95 and (3) conduct on-site inspections.96 The
SRB shall also have limited powers to penalize institutions to address infringements and
non-compliance with the SRB decisions. In this regard the SRB can take decision to either
impose fines or periodic penalty payments.97
10.61 The SRB and the European Commission will be ‘mirroring’ the resolution tools
available to national resolution authorities under the BRRD.98 The resolution framework
includes: (1) preparatory and preventative measures, such as recovery plans and resolution
plans; (2) early intervention measures; (3) resolution tools (including bail-in). According to
Article 31 BRRD, there are four main resolution tools at the disposal of the resolution
authorities: (a) the sale of business tool; (b) the bridge institution tool; (c) the asset
separation tool; (d) the bail-in tool. First, a sale of business tool allows resolution authorities
to (p. 374) sell all or part of the failing entity to another entity under the conditions set out
in Articles 38 and 39 of the Directive. Secondly, bridge institution tool requires to identify
the ‘good’ assets or essential functions of the failing entity and separate them into a new
entity (‘bridge bank’) that, in turn, could be sold to another entity. The remaining failing
entity labelled as ‘bad bank’ would then be liquidated under normal insolvency
proceedings.99 The third resolution tool—asset separation tool regulated by Article 42,
needs to be used in conjunction with another resolution tool, as it requires that the bad
assets of an entity must be transferred to an asset management vehicle.100 The fourth tool
is a ‘bail-in tool debt’ which empowers the resolution authorities to write off (1) all equity of
the firm, (2) subordinated debt (or convert it into equity).101 As explained elsewhere, bail-in
by definition, addresses capital rather than liquidity problems. Hence, to ensure its
efficiency this tool needs to be complemented with liquidity provision by the central
bank.102
10.62 The relevant national resolution authorities will be responsible for executing the
resolution scheme devised by the SRB. Under Article 28 of the SRM Regulation, the SRB
will be monitoring the resolution of an entity and may give instructions on any aspect of the
resolution. However, if the national resolution authority does not comply with the resolution
scheme, the SRB can also exercise its powers to make instructions directly to the entity
subject to resolution.103
10.63 The involvement of the European Commission in the resolution procedure under the
SRM Regulation is also justified given the Commission’s role in controlling State aid under
Articles 107 to 109 TFEU.104
(p. 375) 10.64 When it comes to the external aspects of the SRM and its relations with
non-participating EU Member States—in the case of cross-border resolution of entities
operating outside banking union—the BRRD will govern the interaction between the SRB
and national resolution authorities in non-participating Member States, and EBA will have a
mediation role.105
Common deposit protection
10.65 The creation of a Single Deposit Guarantee Scheme (SDGS) is the third pillar of
banking union. However, there is no political agreement yet on how to advance to a SDGS.
Common deposit protection is discussed in terms of principles and ‘high-level politics’ but
no specific regulatory proposals have been tabled by the European Commission yet. Article
127(6) TFEU—the primary law basis for the SSM—could also be the legal basis for the
SDGS, since a broad interpretation of this ‘enabling clause’ could lead to the conclusion
that deposit protection falls under the ‘policies relating to the prudential supervision of
credit institutions’.
10.66 The rationale for a common deposit insurance scheme is clear: with perfect capital
mobility, in order to prevent a flight of deposits from troubled countries to countries
perceived to be ‘safe’, one needs to convince ordinary citizens that a euro in a bank account
in one euro area Member State is worth the same and is as secure as a euro in a bank
account in another euro area Member State. This is a real challenge, as the experience in
Cyprus evidenced.106
10.67 Although a SDGS shall not be established for the time being (we will continue to rely
upon the existing networks of national deposit guarantee schemes), a new Directive on
Deposit Guarantee Schemes (DGS), repealing Directive 94/19/EC,107 was adopted by the
Council and the European Parliament in April 2014.108 This Directive further harmonizes
rules governing national deposit guarantee schemes across the whole EU (with EEA
relevance, too), with a view to strengthening the single banking market, particularly as
regards swift payout if a scheme’s intervention is triggered.109
10.68 Some other key elements of the Directive are: the possibility of voluntary borrowing
between DGS (Art 12 SDGS), the possibility of merging DGS or establishing cross-border
DGS on a voluntary basis, (Art 4.1, Art 4.7, and recital 4 SDGS), the possibility of using the
financial means of a DGS for the resolution of credit institutions (Art 11 SDGS), enhanced
cooperation between home and host authorities (Art 14 SDGS) and greater depositor
information (Art 16 SDGS).
(p. 376) D. The ‘Missing Pillar’: Lender of Last Resort

10.69 Though LOLR is not included as a pillar of the current banking union plan, in my
opinion it is clearly the fourth ‘missing pillar’. LOLR is the first line of defence in a crisis.
Central banks provide liquidity when no other sources of liquidity are readily available (or
at least are not available at ‘reasonable market prices’).
10.70 LOLR comes—as we have discussed in Part I of this book—in two forms: market
liquidity assistance and individual liquidity assistance. The ECB has clear competence—a
competence which it has exercised widely—when it comes to the first form, while—due to
its own restrictive interpretation of Article 14.4 of the ESCB Statute—it does not have so far
competence with regard to the latter. This subject has always triggered much
controversy.110
10.71 The situation, however, is bound to change with banking union. That the ECB should
formally be the ultimate provider of liquidity in the euro area, both in cases of market
liquidity and in cases of individual liquidity assistance, is a necessary consequence of the
transfer of supervisory powers from the national to the European level.111 Emergency
liquidity assistance links together monetary policy and prudential supervision, evidencing
the complementarity of central banking functions.
10.72 In any case, let us examine the status quo and the legal basis for the ECB to act as
LOLR in the three types of liquidity crises presented below.
Crisis in the payments system
10.73 If a crisis originates in the payments system, the ECB has competence to act as
lender of last resort according to Art 127(2) TFEU, which states that the ESCB is entrusted
with the ‘smooth operation of payment systems’. This point is actually borne out by the fact
that the Bank of England had to put up substantial collateral with the ECB to take part in
TARGET (Trans-European Automated Real-time Gross-settlement Express Transfer)
whereas this was not the case for the national central banks (NCBs) of the Eurosystem
participating in TARGET. (TARGET was subsequently replaced by TARGET2.112)
(p. 377) General market liquidity crisis
10.74 In the case of a general liquidity dry-up, for example, in the wake of a dramatic fall
in stock prices or a complete loss of market confidence (a Lehman Brothers type of
collapse) leading to a widespread and generalized questioning of the liquidity of different
sorts of financial institutions, the ECB is entitled to provide market liquidity according to
Article 18 of the ESCB Statute.
The ECB can carry out open market operations and discount policies (credit operations)
according to Article 18 of the ESCB Statute.
The ‘classic’ individual liquidity crisis
10.75 This is the ‘traditional’ understanding of LOLR assistance,113 that is, collateralized
lines of credit to an individual financial institution which becomes illiquid, but not
necessarily insolvent, and whose illiquidity threatens to spread to other institutions and to
other markets (the problem of contagion). Though the ECB is competent to provide liquidity
assistance to ‘financially sound’ banks,114 the classic LOLR assistance (collateralized loans
to troubled illiquid but solvent banks) remains a national competence (unless the problems
originate in the payment system) because it has not been specifically transferred.115
10.76 The ESCB adopted in 1998 a restrictive reading of the ECB competences,
concluding that the provision of lender of last resort assistance to specific illiquid individual
institutions was a national task of the NCBs in line with Article 14.4 of the ESCB Statute (a
provision which allows NCBs to perform non-ESCB tasks on their own responsibility and
liability).116(p. 378) Therefore the classic collateralized lines of credit to individual
institutions remain the responsibility of the national central banks, at their own cost, but
with the fiat of the ECB. This interpretation is somewhat awkward, though it has been
reaffirmed in 2013.117
When prudential supervision was at the national level, it was perhaps logical to assume that
the national authorities had the adequate expertise and information to assess the problems
of banks within their jurisdictions. But with the advent of banking union and, in accordance
with Article 18 of the ESCB Statute, Article 127 of TFEU, and the principle of subsidiarity,
the ECB should be in all effect lender of last resort for all those institutions it now
supervises.
10.77 Even before banking union, Article 18 provided a perfectly valid legal basis for the
ECB to provide the two forms of emergency liquidity assistance (ELA)/LOLR. And the case
for having the ECB in charge can also be justified on the basis of the principle of
subsidiarity. Article 5.3 TEU states: ‘In areas which do not fall within its exclusive
competence, the Union shall act only if and insofar as the objectives of the proposed action
cannot be sufficiently achieved by the Member States, either at central level or at regional
and local level, but can rather, by reason of the scale or effects of the proposed action, be
better achieved at Union level.’
10.78 In a crisis, action by the ECB is more effective than action by a national central bank
or national authority. National supervisory authorities do not have the ability, authority, or
inclination to deal effectively with externalities with cross-border effects. The ECB is able to
better judge the risk of contagion.
10.79 Some commentators have argued that a degree of ‘constructive ambiguity’ is
desirable in the case of crisis management. Ambiguity provides scope for different—or even
contrasting or possibly conflicting—interpretations. However, in my opinion, ambiguity is
never constructive. The only ‘ambiguity’ that can be constructive in crisis management and
LOLR is the discretionary component in the provision of such assistance, in the sense that
there is no obligation for the central bank to provide LOLR loans. There needs to be
transparency and publicity about crisis management procedures. This will in turn facilitate
accountability. Indeed, ambiguity and uncertainty as to the procedures and loci of power
are not constructive. What is needed is discretion (in this case, no guarantee as to whether
the assistance will be provided, so as to avoid moral hazard). It is this discretionary nature,
this uncertainty that reduces the moral hazard incentives inherent in any support
operation.118
(p. 379) 10.80 Table 10.1 summarizes the three cases just presented and the principle and
legal basis that at the time of completing this manuscript still apply in each of them.
Table 10.1 Centralization or decentralization in the allocation of LOLR responsibilities?
Case Principle Legal basis
Payment systems gridlock Centralization Art 127(2) TFEU
General liquidity dry-up Centralization Art 18 ESCB Statute
Emergency credit lines Decentralization Art 127(5) and (6) TFEU, Art 18 ESCB Statute, MoUs,
Subsidiarity, Art 5 TEU
Ambiguity
Fiscal assistance and State aid rules

10.81 The problem with having the ECB as LOLR is, of course, the ‘fiscal backstop’, when
the institution receiving the assistance is no longer illiquid, but insolvent.119 Drawing on the
terminology used by Tommaso Padoa-Schioppa,120 a most contentious issue is whether the
LOLR assistance to troubled institutions, that is, a ‘central bank money solution’—as
opposed to a ‘taxpayers’ money’ solution or a ‘private money solution’—is solely to illiquid,
but solvent institutions.
10.82 Goodhart points out that ‘a central bank can create liquidity, but it cannot provide
for new injections of equity capital. Only the fiscal authority can do that.’121 The central
bank should not lend over an extended period of time, committing taxpayers’ money,
without the explicit approval of the fiscal authority.122 Any extended lending becomes the
responsibility of the fiscal authority.
10.83 In practice, the central bank and the Treasury/Ministry of Finance (MoF) need to
work together in the case of a support operation. This can be arranged at the national level
relatively easily. The problem at the EU level—as the recent financial crisis amply
demonstrated—is that the relevant fiscal authorities are by definition national. Indeed,
while the Bank of England is ultimately backed by the fiscal resources of the UK Treasury
(though it must comply with the EU rules on State aid and the prohibition of monetary
financing) and the Federal Reserve System is ultimately backed by the fiscal resources of
the US Treasury, the ECB does not have a European fiscal counterpart yet.123
(p. 380) 10.84 The ECB is therefore ‘sui generis’ because of the ‘fiscal constraint’ and the
TFEU provisions (in particular Arts 123 and 125).124 The ECB did indeed provide hugely
expanded liquidity operations during the crisis125 and made ample use of the considerable
set of operational tools at its disposal to handle a liquidity crisis.126 The problem is that
what constitutes ‘ordinary’ liquidity assistance as opposed to ‘emergency’/LOLR liquidity
assistance becomes blurred during a crisis, since the drying of the inter-bank market gives
the central bank a primary role in the provision of liquidity.
10.85 A further twist is provided by the need to comply with the EU rules on State aid. As
we discussed in Chapter 4, because an inherent subsidy exists whenever the central bank
lends to an insolvent institution, under the EU rules on State aid, the granting of emergency
aid to banking institutions can be considered illegal in some cases. The Luxembourg Court
of Justice recognized in a groundbreaking decision, the Züchner case, that EC competition
rules are also applicable to the banking sector.127
10.86 On 5 December 2007, the EU Commission in its approval of the rescue aid package
for Northern Rock concluded ‘that the emergency liquidity assistance provided by the Bank
of England on 14th September 2007, which was secured by sufficient collateral and was
interest-bearing, did not constitute state aid’.128 The Commission Communication of 13
October 2008 further reiterated this point:129 In establishing a single market in financial (p.
381) services, it is important that the Treaty’s State aid rules are applied consistently and
equally to the banking sector, though with a regard to the peculiarities and sensitivities of
the financial markets.130
10.87 In August 2013, the Commission published another Communication extending the
‘crisis rules’ for banks.131 According to paragraph 53 of this August 2013 communication:
Liquidity support and guarantees on liabilities temporarily stabilise the liability side
of a bank’s balance sheet. Therefore, unlike recapitalisation or impaired asset
measures which in principle must be preceded by the notification of a restructuring
plan by the Member State concerned and approval by the Commission before they
can be granted, the Commission can accept that Member States notify guarantees
and liquidity support to be granted after approval on a temporary basis as rescue
aid before a restructuring plan is approved.
10.88 And paragraph 62 further clarifies:
The ordinary activities of central banks related to monetary policy, such as open
market operations and standing facilities, do not fall within the scope of the State
aid rules. Dedicated support to a specific credit institution (commonly referred to as
‘emergency liquidity assistance’) may constitute aid unless the following cumulative
conditions are met:
(a) the credit institutions is temporarily illiquid but solvent at the moment of
the liquidity provision and is not part of a larger aid package;
(b) the facility is fully secured by collateral to which appropriate haircuts are
applied, in function of its quality and market value; (p. 382)
(c) the central bank charges a penal interest rate to the beneficiary;
(d) the measure is taken at the central bank’s own initiative, and in particular
is not backed by any counter-guarantee of the State.
10.89 It is rather interesting that the Thornton–Bagehot doctrinal principles find their way
into a legal text.
10.90 Paragraph 63 of this 2013 Communication further specifies that: ‘interventions by
deposit guarantee funds to reimburse depositors in accordance with Member States’
obligations under Directive 94/19/EC on deposit-guarantee scheme do not constitute state
aid’.

10.91 The global financial crisis and the ensuing sovereign debt crisis in the Eurozone
fundamentally rattled the existing wisdom about what constituted effective supervision and
crisis management in the EU. The case for centralized supervision and crisis management
became overwhelming for the reasons explored in this chapter. Banking union is a
fundamental milestone in the history of the EU. Primary law (Art 127.6 TFEU) did provide a
clear legal basis for the first supervisory pillar. Ideally, the Treaty should have foreseen the
possibility of transferring resolution and other crisis management powers from the national
to the European level, through the establishment of an agency or institution akin to the
FDIC in the USA.132 It is worth remembering that it took twenty years in the US to advance
from the federalization of liquidity assistance and supervision with the establishment of the
Federal Reserve System in 1913 to the federalization of bank insolvency (today we call it
resolution) and deposit insurance with the establishment of the FDIC in 1933. In the same
way as in supervision we went in Europe from Lamfalussy to De Larosiere to SSM, when it
comes to resolution, SRM may be just a first step on the way towards the design of an
adequate resolution framework. Time will tell, but crisis management must be predictable,
clear, and speedy. Of course, political realities and Treaty constraints cannot and should not
be neglected. As for the fourth ‘missing pillar’, lender of last resort there is sufficient legal
basis in the Treaty and ESCB Statute for the ECB to formally assume such role.
10.92 In Chapter 11, we discuss further the uneasy co-existence between banking union
and single market in the light of different jurisdictional domains (Eurozone, SSM, EU, EEA,
and the international dimension). We also touch upon the problems of coordination amongst
different authorities (ECB and EBA, ESM and Single Resolution Board, European
Commission and national resolution authorities, ESFS and others) and the underlying need
for legitimacy and accountability in the design of the European financial architecture.
Footnotes:
1
Tommaso Padoa-Schioppa, ‘EMU and Banking Supervision’ [Lecture at the London School
of Economics, 24 February 1999], in Charles A E Goodhart (ed), Which Lender of Last
Resort For Europe? (London: Central Banking Publications, 2000).
2
Regulation (EU) No 806/2014 of the European parliament and of the Council of 15 July
institutions and certain investment firms in the framework of a Single Resolution
Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/2010, OJ
L 225/1 (30 July 2014) (hereinafter SRM Regulation).
3
See Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014
establishing a framework for the recovery and resolution of credit institutions and
investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC,
2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/
EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament
and of the Council, OJ L 173/190 (12 June 2014) (hereinafter BRRD).
4
See Rosa Lastra, Bernd Krauskopf, Christos Gortsos, and René Smits, ‘European Banking
Union’, MOCOMILA Report/European Center of Economic and Financial Law Working
Paper No 9 (April 2014), at <http://www.ecefil.eu//UplFiles/wps/
WORKING%20PAPER%20SERIES%202014_9.pdf> (last visited 11 August 2014).
A key element in the single rulebook is the regulation on capital requirements. Regulation
(EU) No 575/2013 of the European Parliament and the Council of 26 June 2013 on
prudential requirements for credit institutions and investment firms and amending
Regulation (EU) No 648/2012, OJ L 176/1 (27 June 2013) (hereinafter CRR). The concept of
‘single rulebook’ encompasses both Regulations and the Technical Standards of EBA, but
not Directives. However, Directive 2013/36/EU of the European Parliament and of the
Council on access to the activity of credit institutions and the prudential supervision of
credit institutions and investment firms, amending Directive 2002/87/EC and repealing
Directives 2006/48/EC and 2006/49/EC, OJ L 176/338 (27 June 2013) (hereinafter CRD IV)
is a fundamental piece of secondary law.
5
See Regulation (EU) No 1022/2013 of the European Parliament and of the Council of 22
October 2013 amending Regulation (EU) No 1093/2010 establishing a European
Supervisory Authority (European Banking Authority) as regards the conferral of specific
tasks on the European Central Bank pursuant to Council Regulation (EU) No 1024/2013, OJ
L 287/5 (29 October 2013).
6
Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on
the European Central Bank concerning policies relating to the prudential supervision of
credit institutions, OJ L 287/63 (29 October 2013) (hereinafter SSM Regulation).
7
As indicated in SSM Regulation, Art 33.2: ‘The ECB shall assume the tasks conferred
upon it by this Regulation on 4 November 2014.’
8
Regulation (EU) No 468/2014 of the European Central Bank of 16 April 2014,
establishing the framework for cooperation within the Single Supervisory Mechanism
between the European Central Bank and national competent authorities and with national
designated authorities, OJ L 141/1 (14 April 2014) (hereinafter SSM Framework
Regulation).
9
This European System of Financial Supervision (ESFS)—comprising the three European
Supervisory Authorities: European Banking Authority (EBA), European Securities Market
Authority (ESMA), and European Insurance and Occupational Pensions Authority (EIOPA)—
fully came into effect on 1 January 2011. The establishment of the ESFS was initially
proposed in Jacques De Larosière, Chair, Report of the High-Level Group on Financial
Supervision in the EU (25 February 2009), at <http://ec.europa.eu/internal_market/
finances/docs/de_larosiere_report_en.pdf> (last visited 11 August 2014) (hereinafter De
Larosière Report).
10
See Rosa M Lastra, ‘The Division of Responsibilities Between the European Central
Bank and the National Central Banks Within the European System of Central Banks’ (2000)
6(2) Columbia Journal of European Law.
11
For a timeline of the Greek sovereign debt crisis, which commenced in 2009 when the
new government of George Papandreou announced that the public deficit would be much
larger than the figures that had been submitted to Brussels, see Breugel, ‘Euro Crisis
Timeline’, at <http://www.bruegel.org/blog/euro-crisis-timeline> (last visited 11 August
2011). See also Jean Pisani-Ferry, André Sapir, and Benedicta Marzinotto, ‘Two Crises, Two
Responses’, Breugel (22 March 2010), at <http://www.bruegel.org/publications/publication-
detail/publication/392-two-crises-two-responses/> (last visited 11 August 2011).
12
Banking crises often require the involvement of the fiscal authority. Hence, a full
banking union needs some degree of fiscal union (the issue of burden sharing of the
potential fiscal costs of bank recapitalization remains a thorny one). For a recent study of
the economic governance challenges and proposals to address the weakness in the
economic pillar, see generally Rosa M Lastra and Jean-Victor Louis, ‘European Economic
and Monetary Union: History, Trends and Prospects’ (2013) 32(1) Yearbook of European
Law 199. See also Chapter 8 in this volume.
13
See Nicolas Veron, ‘European Banking Union: Current Outlook and Short-Term Choices’,
Testimony on Banking Union at the Portuguese Parliament (26 February 2014), at <http://
piie.com/publications/papers/veron20140226.pdf> (last visited 11 August 2011).
14
Others refer to the ‘trilemma’ in macroeconomic policy of three desirable yet
contradictory or inconsistent policy objectives: fixed exchange rates, capital mobility, and
independent monetary policy. See eg Andrew Rose, ‘Explaining Exchange-Rate Volatility: An
Empirical analysis of the “Holy Trinity” of Monetary Independence, Fixed Exchange Rates
and Capital Mobility’ (2003) 15 Journal of International Money and Finance 925.
15
See generally Tommaso Padoa-Schioppa, The Road to Monetary Union in Europe: The
Emperor, the Kings and the Genies (Oxford: Oxford University Press, 2000).
16
See Niels Thygesen, ‘The Political Economy of Financial Harmonisation in Europe’ in
Jeroen Kremer, Dirk Schoenmaker, and Peter Wierts (eds), Financial Supervision in Europe
(Cheltenham: Edward Elgar, 2003) 145.
17
See Dirk Schoenmaker, ‘Financial Supervision: from National to European?’ (2003) 22(1)
Financial and Monetary Studies.
18
See generally Dirk Schoenmaker, Governance of International Banking. The Financial
Trilemma (Oxford: Oxford University Press, 2013).
19
However, banking union is not enough to break this vicious link. We also need to address
—as Jens Weidman suggested in ‘Stop Encouraging Banks to Buy Government Debt’
Financial Times (1 October 2013)—the regulatory treatment of sovereign exposures and
end the ‘fiction of risk-free assets’, which receive favourable ratings by credit rating
agencies.
20
See European Council, Euro Area Summit Statement (29 June 2012), at <http://
www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131359.pdf> (last visited
11 August 2014). See also Treaty Establishing the European Stability Mechanism (ESM) (2
February 2012), OJ L 91/1 (6 April 2011) (hereinafter ESMT), para 6, at <http://
www.esm.europa.eu/pdf/ESM%20Treaty%20consolidated%2013-03-2014.pdf> (last visited
11 August 2014).
21
Eurogroup Statement, ‘ESM Direct Recapitalisation Instrument’ (10 June 2014), at <htt
p://www.eurozone.europa.eu/media/533095/20140610-eurogroup-president-direct-
recapitalisation.pdf> (last visited 11 August 2014):
Following the relevant national procedures and the formal adoption by the ESM
Board of Governors, the instrument is expected to be added to the toolkit of the
ESM by the start of the SSM supervision in November 2014. The instrument may be
activated in case a bank fails to attract sufficient capital from private sources and if
the ESM Member concerned is unable to recapitalise it, including through the
instrument of indirect recapitalisation of the ESM. For a transitional period until 31
December 2015, a bail-in of 8% of all liabilities will be a precondition for using the
instrument, as well as the use of the resources available in the ESM Member’s
national resolution fund. From 1 January 2016, bail-in in line with the rules of the
Bank Recovery and Resolution Directive will be required. The financial assistance
will be provided in accordance with EU State aid rules and the ESM Member will be
asked to invest alongside the ESM.
Under its original set of instruments, the ESM could only give financial assistance to its
Member States, which could then use such assistance to recapitalize their banks.
22
Nicolas Veron, ‘Tectonic Shifts’ (2014) 51(1) Finance and Development (IMF) 18, at
<http://www.imf.org/external/pubs/ft/fandd/2014/03/veron1.htm> (last visited 11 August
2014): ‘Most countries were deeply reluctant to identify weak banks for fear of putting their
banking sector at a disadvantage.’
23
See Lastra et al, above note 4.
24
See generally Rosa M Lastra, ‘Banking Union and Single Market: Conflict or
Companionship?’ (2013) 36(5) Fordham International Law Journal 1190.
25
European Commission, ‘Communication from the Commission to the European
Parliament and the Council: A Roadmap towards a Banking Union’, COM (2012) 510 Final
(12 September 2012) (hereinafter A Roadmap towards a Banking Union), at <http://eur-
lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:52012DC0510:EN:NOT> (last visited
11 August 2014).
26
See Veron, above note 13.
27
As early as 1989, an academic group proposed draft statutes for the European System of
Central Banks with a prudential control mission for the ECB; see Jean-Victor Louis et al,
Vers un système de banques centrales: projet de dispositions organiques (Brussels: Éditions
de l’Université de Bruxelles, 1989).
28
According to the SSM Regulation, recital 8:
The European Parliament has called on various occasions for a European body to be
directly responsible for certain supervisory tasks over financial institutions, starting
with its resolutions of 13 April 2000 on the Commission communication on
implementing the framework for financial markets: Action Plan and of 21 November
2002 on prudential supervision rules in the European Union.
29
In May 2012, the European Commission voiced the need for integrated financial
supervision and, in June 2012, José Manuel Durão Barroso, the president of the European
Commission, in his speech before the European Parliament, confirmed that creating a
banking union must be a priority as this is an ‘area where major progress could be made
quickly, and without Treaty changes’. See José Manuel Durão Barroso, President of the
European Commission, ‘Joint European Parliament Debate on the Forthcoming European
Council Meeting and the Multiannual Financial Framework’ (13 June 2012), at <http://
europa.eu/rapid/press-release_SPEECH-12-440_en.htm> (last visited 11 August 2014).
30
Herman Van Rompuy, European Council, ‘Towards A Genuine Economic And Monetary
Union’ (May 2012) 4, at <http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/
en/ec/134069.pdf> (last visited 11 August 2014).
31
European Council, Euro Area Summit Statement (29 June 2012), above note 20.
32
According to SSM Regulation (above note 6), Art 7.2, this close cooperation will be
established by a decision adopted by the ECB and can be terminated or suspended by a
decision of the ECB if the member does not fulfil its obligations (Art 7.5) or terminated by a
request by the Member State after a lapse of at least three years (Art 7.6).
See also SSM Framework Regulation (above note 8).
33
For a detailed analysis of the SSM Regulation, see Lastra, above note 24.
34
See also Regulation (EU) No 469/2014 of the European Central Bank of 16 April 2014
amending Regulation (EC) No 2157/1999 on the powers of the European Central Bank to
impose sanctions (ECB/1999/4) (ECB/2014/18), OJ L 141/51 (14 May 2014).
The position with respect to sanctioning powers provides a telling illustration of the
complexities of the ECB/NCA [National Competent Authority] interface. When there
is a breach of directly applicable Union law, the ECB can open infringement
proceedings against and impose administrative penalties on supervised entities.
Where there is a breach of national law, the ECB cannot impose administrative
pecuniary penalties, but can required NCAs to open proceedings that can lead to
the imposition of sanctions on supervised entities.
See Eilis Ferran, ‘European Banking Union: Imperfect, But It Can Work’, University of
Cambridge Faculty of Law Research Paper No 30/2014 (17 April 2014), at <http://ssrn.com/
abstract=2426247> (last visited 11 August 2014).
35
But it controls access to and exit from the market for all credit institutions and oversees
their ownership (‘fit & proper’ test for shareholders); see SSM Regulation, Arts 6(4) and
4(1)(a) and (c)—this aspect is often overlooked.
36
See European Central Bank, ‘The List of Significant Supervised Entities and the List of
Less Significant Institutions’ (4 September 2014), at <http://www.ecb.europa.eu/pub/pdf/
other/ssm-listofsupervisedentities 1409en.pdf> (last visited 10 September 2014).
37
See in particular SSM Framework Regulation, Arts 11–18.
38
The key provision to understand the division between home and host country
responsibilities in the SSM Regulation is 17. Also important are: SSM Regulation, Art 4,
which defines the tasks conferred on the ECB, Art 7, which deals with close cooperation
between Eurozone and Member States whose currency is not the euro, and Art 8, which
deals with international relations.
39
For the non-significant banks that are not directly supervised by the ECB, the balance of
powers between home and host authorities remains unchanged.
40
See SSM Regulation, Art 17.1.
41
SSM Regulation, Art 4.2:
For credit institutions established in a non-participating Member State, which

establish a branch or provide cross-border services in a participating Member
State, the ECB shall carry out, within the scope of paragraph 1, the tasks for which
the national competent authorities are competent in accordance with relevant
Union law.
42
See also SSM Regulation, Art 4.1.g and 4.1.h.
43
See ECB Press Release of 4 September 2014 at <http://www.ecb.europa.eu/press/pr/
date/2014/html/pr140904_2.en.html>.
44
See the ECB decision on the implementation of separation between the monetary policy
and supervision functions of the European Central Bank (ECB/2014/39) adopted on 17
September 2014, available at <https://www.ecb.europa.eu/ecb/legal/pdf/
en_ecb_2014_39_f_sign.pdf>.
45
Interinstitutional Agreement between the European Parliament and the European
Central Bank on the practical modalities of the exercise of democratic accountability and
oversight over the exercise of the tasks conferred on the ECB within the framework of the
Single Supervisory Mechanism, OJ L 320/1 (30 November 2013). See also Council of the
European Union and the European Central Bank, ‘Memorandum of Understanding between
the Council of the European Union and the European Central Bank on the cooperation on
procedures related to the Single Supervisory Mechanism (SSM)’ (December 2013), at <http
://www.ecb.europa.eu/ssm/pdf/memorandum-ssm-eucouncil-ecb.pdf> (last visited 11 August
2014).
46
European Central Bank, ‘Comprehensive Assessment’, at <http://www.ecb.europa.eu/
ssm/assessment/ html/index.en.html> (last visited 11 August 2014). The results of the
comprehensive assessment—which joined up the AQR and the stress test components—
were published on 26 October 2014. The 130 banks that were examined accounted for
assets of €22 trillion, which represents 82 per cent of total banking assets in the euro area.
See <https://www.ecb.europa.eu/ssm/assessment/html/index.en.html>.
47
See Danièle Nouy, ‘Launch of the SSM—What Will Change in Banking Supervision and
What are the Imminent Impacts on the Banking Sector?’, Speech at Third FIN-FSA
Conference on EU Regulation and Supervision, Helsinki (5 June 2014), at <http://
www.ecb.europa.eu/press/key/date/2014/html/sp140605.en.html> (last visited 11 August
2014):
The actual execution of the AQR is on track—more than 6,000 supervisors and
auditors are now working on the AQR. If banks face a capital shortfall arising from
the AQR or the baseline stress test scenario, they will be asked to restore their
capital position within six months; for shortfalls arising from the adverse stress test
scenario, they will have up to nine months. The SSM is working on harmonised
reporting templates based on Common Reporting (COREP) and Financial Reporting
(FINREP) data that will ultimately reduce the reporting burden on pan-European
banks, by eliminating different reporting standards across European countries, and
will help to foster a level playing field.
48
See Veron, above note 13.
49
European Commission, ‘Proposal for a Regulation of the European Parliament and of the
Council establishing uniform rules and a uniform procedure for the resolution of credit
Mechanism and a Single Bank Resolution Fund and amending Regulation (EU) No
1093/2010 of the European Parliament and of the Council’, COM(2013) 520 final (10 July
2013), at <http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:
2013:0520:FIN:EN:PDF> (last visited 11 August 2014).
50
Regulation (EU) No 806/2014 of the European Parliament and of the Council of 15 July
Mechanism and a Single Resolution Fund and amending Regulation (EU) No 1093/2010 OJ
L 225, (30 July 2014), 1–90. The SRM Regulation entered into force on 19 August 2014.
51
The Intergovernmental Agreement (IGA) on the Transfer and Mutualisation of
Contributions to the Single Resolution Fund, Doc 8457/14 (signed 21 May 2014), at <http://
register.consilium.europa.eu/doc/srv?l=EN&f=ST%208457%202014%20INIT> (last visited
11 August 2014). See also Council of the European Union, ‘Member States Sign Agreement
on Bank Resolution Fund’, Press Release No 302 (21 May 2014), at <http://
See ECOFIN 342 (8457/14), 14 May 2014 for the publication of this IGA in the website of
the EU Council. The IGA was signed by all EU Member States, except Sweden and the UK.
See also European Commission, ‘A Single Resolution Mechanism for the Banking Union—
Frequently Asked Questions’, MEMO/14/295 (15 April 2014), at <http://europa.eu/rapid/
press-release_MEMO-14-295_en.htm> (last visited 11 August 2014):
The IGA scope is strictly limited: it will cover the transfer of the contributions raised
by the national resolution authorities to the national compartments (which will be
merged after a transitional phase of 8 years) of the Single Fund; the mutualisation
(60% over the first two years and 6.7% in each of the remaining six years) of the
funds available in the national compartments;…the bail-in conditionality; and the
compensation provisions to the benefit of those Member States which do not
participate in the SRM. All other aspects of the SRM are dealt with in the
Regulation.
52
Council of the European Union, ‘Council agrees general approach on Single Resolution
Mechanism’, Press Release No 564 (18 December 2013), at <http://
53
European Commission, ‘Commissioner Barnier Welcomes the Signature of the
Intergovernmental Agreement (IGA) on the Single Resolution Fund’, STATEMENT/14/165
(21 May 2014), at <http://europa.eu/rapid/press-release_STATEMENT-14-165_en.htm> (last
54
See Lastra et al, above note 4.
55
Joined Cases 9/56 and 10/56 Meroni v High Authority [1957–8] ECR 133.
56
Under Joined Cases 9/56 and 10/56 Meroni [1957–8] ECR 133 and Case 98/80, Romano
v Institut National d’Assurance Maladie Invalidité [1981] ECR 1241, ECJ’s two main
concerns were the attribution of discretionary powers to an entity not foreseen in the
Treaty and the absence of judicial review of its acts.
57
In this context, the recent judgment of the Court of Justice of the European Union in a
case on the implementing powers of the ESMA—in relation to the UK challenge against the
short-selling prohibition powers of ESMA—may be relevant (Case C-270/12 United Kingdom
v Parliament and Council, 22 January 2014, unreported) by providing a ‘mellowing’ of the
Meroni doctrine and perhaps opening up new possibilities. See Court of Justice of the
European Union, ‘The Power of the European Securities and Markets Authority to Adopt
Emergency Measures on the Financial Markets of the Member States in Order to Regulate
or Prohibit Short Selling is Compatible with EU Law’, Press Release No 7/14 (22 January
2014), at <http://curia.europa.eu/jcms/upload/docs/application/pdf/2014-01/
cp140007en.pdf> (last visited 11 August 2014). The word mellowing is used by Jacques
Pelkmans and Mara Simoncini, ‘Mellowing Meroni: How ESMA Can Help Build the Single
Market’, CEPS Commentary (18 February 2014), at <http://www.ceps.eu/system/files/
JP%20&%20MS%20Mellowing%20Meroni.pdf> (last visited 11 August 2014).
58
Article 4 SRM Regulation. According to Art 4(2), Member States that decide to join
banking union need to have the respective ‘close cooperation’ agreement discussed above.
59
See generally Lastra et al, above note 4.
60
SRM Regulation, Art 2.
61
See European Commission, MEMO/14/295, of 15 April 2014 at <http://europa.eu/rapid/
press-release_MEMO-14-295_en.htm>. See also <http://ec.europa.eu/internal_market/
finances/docs/banking-union/banking-union-memo_en.pdf>.
62
SRM Regulation, Art 48.
63
SRM Regulation, Art 42(1).
64
65
66
In accordance with SRM Regulation, Art 56(6), the full-time members of the SRB
including the chair and vice-chair will be appointed for a five-year term which is not
renewable with the derogation for the first chair, who will be initially appointed for three
years and whose tenure can be renewed once under SRM Regulation, Art 56(7). The full-
time members of the board will be appointed by the Council after the candidates are
approved by the European Parliament on the basis of the proposal of the European
Commission.
67
SRM Regulation, Arts 43(1c). The national resolution authorities can also appoint an
additional member who shall have an observer status with no voting rights.
68
69
70
71
The European Commission will later adopt the delegated acts specifying the calculation
of the amount of contributions. On 21 October 2014, the European Commission adopted
detailed rules on contribution of banks to resolution funds. It adopted a delegated act and a
draft proposal for a Council implementing act to calculate the contributions of banks to the
national resolution funds and to the Single Resolution Fund (IP/13/674). See <http://
europa.eu/rapid/press-release_IP-14-1181_en.htm>.
72
See Ferran, above note 34.
73
The SRB can also commence the process on its own initiative if according to its
assessment all three resolution conditions are met. See SRM Regulation, Art 18(6) and (6c).
74
Some Members of the European Parliament argued that the ECB must be the only
authority to decide whether a bank is ‘failing or likely to fail’ without limiting the possibility
for other institutions to voice their concerns in this regard. See European Parliament,
‘MEPs Lay Out Final Offer on Bank Single Resolution Mechanism’, Press Release (5 March
2014), at <http://www.europarl.europa.eu/pdfs/news/expert/infopress/
20140305IPR37601/20140305IPR37601_en.pdf> (last visited 11 August 2014).
75
The SRB may take individual resolution decisions involving the use of the SRF under
EUR 5 billion. Any use of the SRF above this threshold requires a decision taken by the SRB
in plenary session.
76
In case the Council objects to the resolution scheme, an entity will be simply wound up
in accordance with the national law of the Member State.
77
See SRM Regulation Article 18(7b). The twenty-four-hour-long period given to the
European Commission to object the decision of the SRB is also important to ensure
compliance with the Meroni doctrine (Joined Cases 9/56 and 10/56 Meroni [1957–8] ECR
133).
78
See European Commission, ‘A Single Resolution Mechanism’, above note 61.
79
SRM Regulation, recital 31 and Arts 53–55.
80
SRM Regulation, Art 53(1) and (4).
81
SRM Regulation, Arts 52(3) and 55(3).
82
SRM Regulation, Art 65(1), (3), and (5). See above note 71.
83
In its initial proposal the Commission suggested that the target size of the SRF must be
EUR 55 billion. The initial aim was that this target will be reached within eight years from
the adoption of the SRM Regulation, although the SRB is empowered to extend the
transitional period if the SRF makes disbursements up to 0.5 per cent of the target funding
figure. The ultimate goal of the SRF is to ensure that the funds are available while an
institution is being restructured, though costs and other expenses incurred in the resolution
process should be borne by shareholders and creditors as the fund will not bail-out an
institution subject to the resolution proceedings. Moreover, it is clearly stated in the SRM
Regulation that under no circumstances the DRF expenses or losses can be incurred by the
national or Union budgets. See SRM Regulation, Arts 67(2) and 71(1). The SRM is
anticipated to be applied from 1 January 2016, therefore the target date must be 1 January
2024. By that time the SRF must replace the national resolution funds of the Member States
participating in banking union.
84
85
The exact criteria for the contributions payable by the financial institutions will be
specified by the Single Resolution Board after consulting the ECB or the national competent
authority and in close cooperation with the national resolution authorities, in accordance
with SRM Regulation, Arts 65(5) and 66(3).
86
See SRM Regulation, Art 70(2)(b) in connection with Art 70(2).
87
As Ferran, above note 34, states: ‘The high political salience of burden sharing risks
helps also to explain the bifurcated approach to the establishment of the SRF, which is
effected in part by means of the SRM Regulation (working in conjunction with the BRRD)
and in part by the SRF-IGA.’ Ferran also points out that certain passages in the IGA ‘are
designed to insulate the arrangements from the type of legal challenge that the ESM (also
established by an intergovernmental agreement) faced’.
Participating Member States committed to approve an IGA on the SRF formalizing the
transfer and mutualization of contributions to the SRF and the contributions raised at the
national level. During an eight-year-long transitional phase these will be gradually merged
over. The European Commission stated in its Memo of 15 April 2014 (European
Commission, ‘A Single Resolution Mechanism’, above note 50) that the mutualization of
paid-in funds will be front-loaded, starting with 40 per cent in the first year and a further 20
per cent in the second year, while continuously increasing by equal amounts over the
coming six years until the SRF is fully mutualized. At the moment of writing the IGA was
under negotiation and a final version has not yet been published. In the Cover Note
18134/13, the Council has set out the details of the decision taken by participating
Members States on the IGA and the terms of reference for this agreement. See Council of
European Union, ‘Single Resolution Mechanism’, Cover Note 18134/13 (20 December
2013), at <http://register.consilium.europa.eu/doc/srv?
l=EN&t=PDF&gc=true&sc=false&f=ST%2018134%202013% 20INIT> (last visited 11
August 2014). According to the European Commission’s Memo (European Commission, ‘A
Single Resolution Mechanism’, above note 50) the Member States had made a political
commitment to ratify the IGA ‘without delay’. The statement on behalf of the Council
annexed to the resolution of the European Parliament on the SRM Regulation it is stated:
Regarding the ratification of the IGA, I can confirm on behalf of the Council that
‘The signatories to the Intergovernmental Agreement on the transfer and
mutualisation of contributions to the Single Resolution Fund are ready to declare
that they will strive to complete its process of ratification in accordance with their
respective national legal requirements in due time so as to permit the Single
Resolution Mechanism to be fully operational by the 1st January 2016’.
88
SRM Regulation, Art 65(5c).
89
SRM Regulation, Art 71. Extraordinary ex-post contributions by the institutions subject
to the SRM Regulation are levies raised by the SRB in cases where the funds available
through the SRF are not sufficient to cover its losses, costs or other expenses.
90
SRM Regulation, Art 60(1c).
91
In addition, the European Commission is required to publish a report by 31 December
2018, and then every five years, on the application of the SRM Regulation under Art 94(1).
92
SRM Regulation, Arts 7(2) and 8(6).
93
94
SRM Regulation, Art 34(1)(c).
95
SRM Regulation, Art 8(9)(m).
96
97
The detailed limits for each type of infringement depending on its gravity are
determined in SRM Regulation, Art 38, and the guidelines on the imposition on the periodic
penalty payments are set out in SRM Regulation, Art 39.
98
When acting under the BRRD mandate, the SRB will ‘step into the shoes’ of the national
resolution authorities and when exercising the powers that are given under the BRRD, the
SRB will be considered the relevant national resolution authority or (if applicable) the
relevant group national resolution authority (See SRM Regulation, Art 5(1)).
99
See BRRD, Arts 40 and 41.
100
See BRRD, Art 42. This resolution tool must be used alongside another resolution tool,
as otherwise, an entity will benefit from the competitive advantage.
101
See BRRD, Arts 43–58. The concept of ‘bail-in’ which is opposite to the concept of ‘bail-
out’, allows to impose losses directly on certain stakeholders of the failing entity either by
writing down their claims or by converting them to equity. As explained by the European
Commission in its Explanatory Memorandum to the Proposal for the BRRD, in order to
apply the bail-in tool it is necessary to insure that an institution has a sufficient amount of
liabilities in their balance sheet that could be bailed in. According to the European
Commission’s estimates based on the evidence from the recent financial crisis and
respective model simulations, an appropriate percentage of total liabilities which could be
bailed-in could be equal to 10 per cent of total liabilities (excluding regulatory capital).
Article 39 requires that the minimum amount must be proportionate and adapted for each
category of entity taking into account their risk or the composition of their sources of
funding. See European Commission, Proposal for a Directive of the European Parliament
and of the Council establishing a framework for the recovery and resolution of credit
institutions and investment firms and amending Council Directives 77/91/EEC and 82/891/
EC, Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC and 2011/35/
EC and Regulation (EU) No 1093/2010, at <http://ec.europa.eu/internal_market/bank/docs/
crisis-management/2012_eu_framework/COM_2012_280_en.pdf> (last visited 11 August
2014) (hereinafter Proposal for the BRRD).
102
Rosa M Lastra, ‘Written Evidence on Banking Standards to the House of Lords’ (26
October 2012), at <http://www.publications.parliament.uk/pa/jt201314/jtselect/jtpcbs/
27/27vi20.htm> (last visited 11 August 2014).
103
104
SRM Regulation, Arts 18(9) and 19(1). If the SRB considers that the resolution
measures could constitute State aid under Art 107(1) TFEU, the SRB will invite the
participating Member States concerned by the scheme to notify the envisaged measures
immediately to the European Commission. The European Commission in turn will consider
whether the resolution action envisaged under the SRM is compatible with State aid
provisions and take a decision on State aid or on the use of the SRF before the SRB adopts
the resolution scheme and transmits it to the European Commission in accordance with the
SRM Regulation.
105
SRM Regulation, Art 32. Article 32(1) specifies that the SRB, the ECB, and the
resolution authorities, and competent authorities of the participating Member States, shall
conclude Memoranda of Understanding describing how they will cooperate under the
BRRD.
The recognition and enforcement of third country resolution proceedings is governed by Art
33(1) of the SRM Regulation, which refers to the international agreements with third
countries provided in Art 93(1) of the BRRD.
106
107
Directive 94/19/EC of the European Parliament and of the Council of 30 May 1994 on
deposit- guarantee schemes, OJ L 135/5 (31 May 1994).
108
Directive 2014/49/EU of the European Parliament and of the Council of 16 April 2014
on deposit guarantee schemes, OJ 173/149 (12 June 2014).
109
Payment within seven working days according to Directive 2014/49/EU, Art 8. The
harmonized coverage level of EUR 100,000 is per depositor not per deposit (Directive
2014/49/EU, Art 6 and recital 22). See also SRM Regulation, Art 79 (‘Use of deposit
guarantee schemes in the context of resolution’).
110
See eg Goodhart, above note 1; Jeroen Kremers, Dirk Schoenmaker, and Peter J Wierts
(eds), Financial Supervision in Europe (Cheltenham: Edward Elgar Publishing, 2001) chs 4
and 5; Tommaso Padoa-Schioppa, Regulating Finance (Oxford: Oxford University Press,
2004) chs 7 and 8; and Xavier Freixas, ‘Crisis Management in Europe’ in Kremer et al (eds),
Financial Supervision in Europe 110. For a critique of the ECB’s interpretation of its powers
in respect of ELA, see René Smits, ‘European Supervisors in the Credit Crisis: Issues of
Competence and Competition’ in Mario Giovanoli and Diego Devos (eds), International
Monetary and Financial Law—The Global Crisis (Oxford: Oxford University Press, 2010)
310–11.
111
This Notwithstanding, the European Central Bank reiterated its restrictive
interpretation in ‘ELA Procedures’ (17 October 2013), at <http://www.ecb.europa.eu/pub/
pdf/other/201402_elaprocedures.en.pdf> which assigns ‘responsibility for the provision of
ELA’ to the ‘NCB(s) concerned’, further specifying that ‘[t]his means that any cost of, and
the risks arising from, the provision of ELA are incurred by the relevant NCB.’
112
The second generation of TARGET (Trans-European Automated Real-time Gross
settlement Express Transfer system)—TARGET2—was launched on 19 November 2007. See
ECB, ‘TARGET2 Successfully Launched’, Press Release (19 November 2007), at <http://
www.ecb.europa.eu/press/pr/date/2007/html/pr071119_1.en.html> (last visited 11 August
2014). The Bank of England decided not to participate in TARGET2.
113
As discussed in Part I of this book, the theoretical foundations of the lender of last
resort doctrine were first set by Henry Thornton in 1802 and then by Walter Bagehot in
1873. See Henry Thornton, An Enquiry into the Nature and Effects of the Paper Credit of
Great Britain (Fairfield, NJ: AM Kelley, 1991 [1802]); Walter Bagehot, Lombard Street. A
Description of the Money Market (New York: Wiley, 1999 [1873]). Such doctrine is based
upon four doctrinal principles. To begin, the central bank—acting as lender of last resort—
should prevent temporarily illiquid but solvent banks from failing. (This type of lending is by
nature short-term.) Secondly, the central bank should be able to lend as much as is
necessary (only the ultimate supplier of high-powered money has this ability), but charge a
high rate of interest. Thirdly, the central bank should accommodate anyone with good
collateral, valued at pre-panic prices. Finally, the central bank should make its readiness to
lend clear in advance.
114
See ECB, ‘The Implementation of Monetary Policy in the Euro Area’ (November 2008)
11, at <http://www.ecb.europa.eu/pub/pdf/other/gendoc2008en.pdf> (last visited 11 August
2014).
115
René Smits has always held a different opinion, regarding this LOLR responsibility as
an exclusive EU competence. See René Smits, ‘The role of the ESCB in Banking
Supervision’ in Legal Aspects of the European System of Central Banks, Liber Amicorum
Paolo Zamboni Garavelli (Frankfurt: European Central Bank, 2005) 211–12.
116
ESCB Statute, Art 14.4 reads as follows:
National central banks may perform functions other than those specified in this
Statute unless the Governing Council finds, by a majority of two thirds of the votes
cast, that these interfere with the objectives and tasks of the ESCB. Such functions
shall be performed on the responsibility and liability of national central banks and
shall not be regarded as being part of the functions of the ESCB.
The ECB can assess whether a given LOLR operation by a national central bank interferes
with monetary policy and, if so, either prohibit it or subject it to conditions. To this effect,
the ECB has some internal rules (memorandum of understanding (MoU)) requiring ex ante
notification to the Governing Council of such LOLR operation (ESCB Statute, Art 14.4). I
thank Antonio Sainz de Vicuña for observations on this point. The following is an excerpt
from the ECB Annual Report 1999 (p 98), at <https://www.ecb.europa.eu/pub/pdf/annrep/
ar1999en.pdf> (last visited 11 August 2014):
The institutional framework for financial stability in the EU and in the euro area is
based on national competence and international cooperation. …Co-ordination
mechanisms are primarily called for within the Eurosystem. This is the case for
emergency liquidity assistance (ELA), which embraces the support given by central
banks in exceptional circumstances and on a case-by-case basis to temporarily
illiquid institutions and markets. …If and when appropriate, the necessary
mechanisms to tackle a financial crisis are in place. The main guiding principle is
that the competent NCB takes the decision concerning the provision of ELA to an
institution operating in its jurisdiction. This would take place under the
responsibility and at the cost of the NCB in question. …The agreement on ELA is
internal to the Eurosystem and does not affect the existing arrangements between
central banks and supervisors at the national level or bilateral or multilateral co-
operation among supervisors and between the latter and the Eurosystem.
117
See ECB, ‘ELA Procedures’, above note 111.
118
The ambiguity in some Treaty provisions is the result of a calculated obfuscation for
political purposes, which expresses the labour pains that accompanied the drafting of some
of these provisions. Padoa-Schioppa in the first public statement by an ECB official on this
controversial subject—above note 1—dismissed the concerns about the lack of a clearly
defined lender of last resort role for the ESCB on three counts: it reflected an outdated
notion of LOLR, it underestimates the Eurosystem’s capacity to act, and it represented too
mechanistic a view of how a crisis is actually managed.
119
I have argued elsewhere that LOLR operations often provide assistance to insolvent
institutions. See eg, Rosa M Lastra, ‘Lender of Last Resort, an International
Perspective’ (1999) 48(2) International and Comparative Law Quarterly 340.
120
Padoa-Schioppa, above note 1.
121
See Charles A E Goodhart, ‘Foreword’ in Padoa-Schioppa, above note 110, xvii.
122
In the EU, the prohibition of monetization of government debt, also known as ‘monetary
financing’, in accordance with the provisions of Art 123 TFEU, applies.
123
Alexandre Lamfalussy remarked in an interview: ‘The great weakness of EMU is the E.
The M part is institutionally well organized. We have a solid framework. We don’t have that
for economic policy.’ See Mark Milner, ‘Europe’s Financial Architect. Interview: Alexandre
Lamfalussy’ The Guardian (16 August 2003), at <http://www.theguardian.com/business/
2003/aug/16/3>.
124
This has cast some legal doubts on the yet-to-be-activated OMT programme (for the
referral by the German Constitutional Court to the ECJ of the legality of the OMT decision,
see Federal Constitutional Court, Press Release No 9/2014 (7 February 2014), at <http://
www.bundesverfassungsgericht.de/pressemitteilungen/bvg14-009en.html> (last visited 11
August 2014)) and has also raised concerns about the possibility of using quantitative
easing (QE) programmes to stimulate the Eurozone economy, even though Art 123 TFEU
only forbids the ESCB from giving credit to or purchasing sovereign debt directly from EU
Member States but there is no ban on purchases of government bonds on the secondary
markets, which the ECB has been doing since May 2010, when it began buying the
government debt of Greece.
125
For a summary of significant liquidity provision measures adopted during the crisis, see
Jean-Claude Trichet, ‘The ECB’s Response to the Crisis’, Statement at the European
American Press Club, Paris (20 February 2009), at <http://www.ecb.int/press/key/date/
2009/html/sp090220.en.html> (last visited 11 August 2014). As regards the Outright
Monetary Transactions, see ECB, ‘Technical features of Outright Monetary Transactions’,
Press Release (6 September 2012), at <http://www.ecb.europa.eu/press/pr/date/2012/html/
pr120906_1.en.html> (last visited 11 August 2014). For unconventional ECB monetary
policies, see also Philippine Cour-Thimann and Bernhard Winkler, ‘The ECB’s Non-standard
Monetary Policy Measures. The Role of Institutional Factors and Financial Structure’, ECB
Working Paper Series No 1528 (April 2013), at <https://www.ecb.europa.eu/pub/pdf/
scpwps/ecbwp1528.pdf> (last visited 11 August 2014).
126
ECB open market operations are described in ECB, ‘The Implementation of Monetary
Policy in the Euro-area’ (November 2008) ch 3, at <http://www.ecb.europa.eu/pub/pdf/
other/gendoc2008en.pdf> (last visited 11 August 2014).
127
See Case 172/80 Züchner v Bayerische Vereinsbank [1981] ECR 2021.
128
Northern Rock’, Press Release IP/07/1859 (5 December 2007), at <http://europa.eu/rapid/
pressReleasesAction.do? reference=IP/
07/1859&format=HTML&aged=1&language=EN&guiLanguage=en> (last visited 11
August 2014). ‘However, the guarantee on deposits granted by the Treasury on 17th
September, as well as the measures granted on 9th October, which provided further
liquidity and guarantees to Northern Rock and were secured by a Treasury indemnity, do
constitute state aid.’ On 17 March 2008, six months after the first State aid measures
(‘rescue aid’) took place, the UK authorities submitted to the Commission a restructuring
plan. The Commission then launched an in-depth investigation into this ‘restructuring aid’.
See European Commission, ‘State Aid: Commission Launches In-depth Investigation into UK
Restructuring Aid Package for Northern Rock’, Press Release IP/08/489 (2 April 2008), at
<http://europa.eu/rapid/pressReleases Action.do?reference=IP/08/489> (last visited 11
August 2014).
129
European Commission, ‘Communication of 13 October 2008 on the Application of State
Aid Rules to Measures Taken in Relation to Financial Institutions in the Context of the
Current Global Financial Crisis’, OJ C 270 (25 October 2008) para 51, at <http://
ec.europa.eu/competition/state_aid/legislation/banking_crisis_paper.pdf> (last visited 11
August 2011):
[T]he Commission considers for instance that activities of central banks related to
monetary policy, such as open market operations and standing facilities, are not
caught by the State aid rules. Dedicated support to a specific financial institution
may also be found not to constitute aid in specific circumstances. The Commission
considers that the provision of central banks’ funds to the financial institution in
such a case may be found not to constitute aid when a number of conditions are
met, such as: the financial institution is solvent at the moment of the liquidity
provision and the latter is not part of a larger aid package; the facility is fully
secured by collateral to which haircuts are applied, in function of its quality and
market value; the central bank charges a penal interest rate to the beneficiary; the
measure is taken at the central bank’s own initiative, and in particular is not backed
by any counter-guarantee of the State.
130
From the beginning of the global financial crisis in the autumn of 2008 to December
2010, the Commission issued four communications which provided detailed guidance on the
criteria for the compatibility of State support to financial institutions with the requirements
of Article 107(3)(b) of TFEU: (1) Communication on the application of State aid rules to
measures taken in relation to financial institutions in the context of the current global
financial crisis (Banking Communication); (2) Communication on the recapitalisation of
financial institutions in the current financial crisis: limitation of aid to the minimum
necessary and safeguards against undue distortions of competition (Recapitalisation
Communication); (3) Communication from the Commission on the treatment of impaired
assets in the Community banking sector (Impaired Assets Communication); and (4)
Communication on the return to viability and the assessment of restructuring measures in
the financial sector in the current crisis under the State aid rules (Restructuring
Communication). See European Commission, State Aid Temporary Rules Established in
Response to the Economic and Financial Crisis, at <http://ec.europa.eu/competition/
state_aid/legislation/temporary.html> (last visited 11 August 2014).
131
European Commission, Communication on the Application, from 1 August 2013, of
State Aid Rules to Support Measures in Favour of Banks in the Context of the Financial
Crisis (‘Banking Communication’), OJ C 216/01 (30 July 2013), at <http://eur-lex.europa.eu/
legal-content/EN/ALL/?uri=CELEX:52013XC0730(01)> (last visited 11 August 2014).
132
A similar observation is made by Ferran, above note 34.
Part II Developments at the EU Level, 11 European
Financial Architecture
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
(p. 383) 11 European Financial Architecture
B. Models of Integration 11.07
Single European supervisor 11.07
Multiple European supervisors 11.08
Centralization in one sector 11.09
C. History of the Legislative Processes to Adopt Financial Regulation in the EU 11.13
The Lamfalussy procedure 11.18
From Lamfalussy to De Larosière 11.25
D. The European System of Financial Supervision 11.28

The European Systemic Risk Board and macro-prudential supervision 11.30
The European Supervisory Authorities and micro-prudential supervision 11.46
Coordination between EBA and ECB—Single Market and Banking Union 11.59
A. Introduction
11.01 This chapter examines the governance structure for financial regulation and
supervision in the EU, and the relationship between banking union and the single market.
The jurisdictional domain explored in this chapter is that of the EU at large (bearing in
mind the needs of the single market in financial services, with European Economic Area
(EEA) relevance too). The existence of concentric circles of integration: Eurozone, Single
Supervisory Mechanism (SSM)/Single Resolution Mechanism (SRM),1 EU and EEA creates
coordination problems and challenges, both in terms of the competent authorities involved
and in terms of the issues at stake with regard to the effective supervision of the financial
sector and the pursuit of financial stability.
(p. 384) 11.02 The goal of creating an internal market in financial services was given fresh
impetus with the 1999 Financial Services Action Plan,2 which contained forty-two legislative
measures intended to remove barriers so as to speed the integration of EU financial
markets. The main strategic objectives of the Financial Services Action Plan were the
creation of a single wholesale market for financial services, an open and more secure
financial retail market, and the implementation of prudential rules and supervision. It also
aimed at the wider conditions for a functioning single market, including measures on
taxation and the creation of an efficient and transparent legal system for corporate
governance.
11.03 While the Financial Services Action Plan responded to the question of ‘what to
regulate’, the issues of ‘who and how to regulate’, in particular with regard to securities
markets, were addressed in the so-called Lamfalussy Report,3 published in February 2001
and adopted by the European Council in its Resolution of 23 March 2001 in Copenhagen.
Since then we have witnessed a process of federalization of financial supervision in the EU,
which culminated—following the adoption of the recommendations of the De Larosière
Report—in the establishment of the European System of Financial Supervision (ESFS).
11.04 The ESFS is not only relevant for the single market in financial service at large but
also for the supervision of insurance and securities markets in both Eurozone/SSM and
other EU Member States, since banking union—as the name indicates—centralizes banking
policy only, while securities and insurance remain decentralized.
11.05 The needs of a single market and the ‘trilemma in financial supervision’ to which I
referred in Chapter 10 (the inconsistency of pursuing at the same time a stable financial
system, an integrated financial market, and national financial supervision)4 suggest that a
greater degree of supervisory convergence is needed in the EU and that the current
structure evolving towards greater integration, federalization, or even centralization is
inevitable.
11.06 In the ensuing paragraphs, we briefly consider three different models to advance in
this direction: ‘single European supervisor’, ‘multiple European supervisors’, and
centralization of one sector.
B. Models of Integration

Single European supervisor
11.07 The possibility of establishing a European Financial Services Authority (EFSA) had
been suggested in the past as a possible way of advancing towards effective European
financial (p. 385) supervision.5 However, the wisdom of such an authority is doubted by
many academics and policy makers and, as the UK experience with the FSA suggests, does
not necessarily guarantee better supervisory outcomes. Arguments against the creation of
such an authority at the EU level rest on the grounds of excessive concentration of power
and potential lack of accountability and transparency.6
Multiple European supervisors
11.08 The SSM Regulation gives the European Central Bank (ECB) responsibility for
banking supervision. Though the ECB as the European supervisory authority for banking
now co-exists with national authorities for the supervision of securities and insurance we
could possibly conceive a system in which European Securities Market Authority (ESMA),
and European Insurance and Occupational Pensions Authority (EIOPA) (discussed at paras
11.46, 11.54, and 11.64 below) could evolve into true pan-European supervisory agencies,
with rule-making and enforcement powers.
Centralization in one sector
11.09 It is possible to centralize the supervision of one sector of the financial industry
while the supervision of other sectors of the financial system remain decentralized. Indeed,
this is what banking union does.
11.10 The US model of financial supervision is a mix of centralized and decentralized
elements. Banking in the USA is supervised by federal and state authorities; the securities
industry is mainly subject to the supervision of a federal agency, the Securities and
Exchange Commission (SEC) (though self-regulation and, to a lesser extent, state law also
play a role), and insurance remains a matter of state law.
11.11 The possibility of establishing a European Securities and Exchange Commission,
modelled upon the US Securities and Exchange Commission, was proposed by some
commentators at the turn of the century.7
11.12 Gilles Thieffry had argued that Art 352 TFEU (previously Article 308 EC) could
serve as the legal basis for the creation of such a European SEC.8
(p. 386) C. History of the Legislative Processes to Adopt
Financial Regulation in the EU
11.13 A single market in financial services does not need a single supervisor (though it
needs a logical, coherent, and integrated structure) but it does need some common rules.
However, the process of adopting common rules does not require per se the existence of a
centralized authority. Common rules can also be adopted through the adoption of a Treaty
or a model law, through the adoption of harmonized principles, through the adoption of
standards (‘soft law’ as in the case of the Basel Committee on Banking Supervision), and
through other regulatory techniques. Common rules can (and do) coexist with different
national systems of financial legislation.
11.14 A bit of history helps explain the evolution of the legislative processes for adopting
financial regulation in the EU.9 The approximation of legislations in the field of banking and
finance as required by Article 100 of the original Treaty establishing the European
Economic Community (EEC Treaty) had been difficult before 1985. Indeed, while the
Commission had succeeded in the approximation of laws (mainly through regulations) in the
fields of quality, composition, labelling and control of goods, industrial property rights,
public procurement, technical or administrative barriers to trade, industrial safety and
hygiene, and so on, the Commission had failed to approximate laws in other fields such as
banking and financial services, transport, energy, telecommunications, and the like, owing
to stark differences across Member States in the structure of their services industry, owing
to the political implications of the liberalization of some ‘key’ services, and owing to the
existence of exchange controls.10 A new strategy was needed, with new political initiatives
and more flexible techniques for integration.
11.15 The new strategy first envisaged in the 1985 White Paper on the Internal Market
and legally enshrined in the 1986 Single European Act was rooted in the generalization of
the concept of mutual recognition on the basis of prior minimum harmonization (rather than
full or detailed harmonization) and on the principle of home State control.11 Directives
became the preferred legislative instrument for achieving financial integration.12 The use
(p. 387) of directives is consistent with the principles of minimum harmonization and
mutual recognition. Regulations, as opposed to directives, are consistent with the principle
of full or detailed harmonization. And regulations leave no freedom to Member States with
regard to their national transposition.
11.16 Despite the relative success of the new strategy in advancing the Community’s goal
of creating a single market, it had also limitations. These limitations became apparent in
the process of integrating capital markets in Europe, where the legislative process was
often criticized for being too slow and rigid to adapt to market developments.13 On past
experience, the adoption of directives in the field of financial regulation takes two to three
years, followed by a one- to two-year period for national implementation. In the absence of
other legislative instruments, directives often dealt with both broad framework principles
on the one hand and very technical issues on the other hand. This resulted in a mix of
ambiguity in some cases and excessive prescription in some others. The legislative process
also proved inadequate to deal with the needs and concerns of market participants.
11.17 Though bank-dominated systems have traditionally prevailed in Europe (with the
exception of the UK), the development of capital markets in recent years has required a
greater deal of dialogue, consultation, and cooperation between the many parties involved:
lawmakers, supervisors, self-regulatory organizations, market intermediaries, issuers, and
investors.14 The techniques needed to regulate securities markets (disclosure requirements,
fiduciary rules) have a much larger component of market discipline and consultation than
the regulatory techniques typically applied to lending and deposit taking (mandatory rules,
capital requirements).
The Lamfalussy procedure
11.18 In response to criticisms about an inefficient EU process for regulating capital
markets, in July 2000 the European Council set up the Committee of Wise Men on the
Regulation of European Securities Markets under the chairmanship of Alexandre
Lamfalussy. The mandate given to the Wise Men was confined to the workings of the law-
making process concerning securities markets regulation in Europe, with the aim of
speeding it up and making it more flexible in order to respond to market developments. The
Wise Men were asked to identify the imperfections of this process and to come up with
recommendations for change. The mandate of the Wise Men was not to identify what should
be regulated, nor to look at other relevant issues such as international implications or
prudential considerations.
11.19 The Final Report of the Committee of Wise Men on the Regulation of European
Securities Markets15 was published on 15 February 2001 and the European Council in its
Resolution of 23 March 2001 adopted some of the proposals recommended in the Report.
(p. 388) The Report focused on the question of ‘how’ to speed up reform, that is, on the
processes and legal procedures needed to reform securities markets regulation, rather than
on the question of ‘what’ needs to be reformed. Thus, the Lamfalussy Report had a
procedural character.
11.20 It is interesting to observe that though the Lamfalussy approach started as a
‘regulatory issue’ (confined to the workings of the law-making process concerning
securities markets regulation in Europe), it soon became a ‘supervisory matter’, leading to
an overhaul of the institutional design of supervision and not only for securities, but also for
banking and insurance (as well as financial conglomerates).
With the publication of the Lamfalussy Report and the subsequent establishment of the
Committee of European Securities Regulators (CESR) in 2001 and the European Securities
Committee (ESC) in 2002, the dual structure that emerged was referred to as the
‘Lamfalussy framework’ (see Figure 11.1). It comprised: four level-2 committees (the
European Securities Committee, the European Banking Committee, the European Insurance
and Occupational Pensions Committee, and the Financial Conglomerates Committee),
chaired by the European Commission and based in Brussels; and three level-3 committees
(the Committee of European Securities Regulators, located in Paris; the Committee of
European Securities Supervisors, located in London; and the Committee of European
Insurance & Occupational Pensions Supervisors, located in Frankfurt). The ‘Lamfalussy
framework’ did not imply the centralization of supervisory and regulatory responsibilities.
There was no transfer of competencies from the national to the supranational arena. The
level-2 and level-3 committees were a form of supervisory cooperation.
11.21 The aim of the four-level regulatory Lamfalussy approach (framework principles in
level 1, implementing technical measures in level 2, cooperation in level 3, and enforcement
in level 4)—namely to speed up the legislative process for the regulation of securities
markets—implies a ‘governance change’, a bottom-up approach, rather than top-down, also
applicable to other areas of European integration.16
11.22 The distinction between ‘core principles’ in level 1 and non-essential ‘technical
implementing matters’ in level 2 mirrors, at the EU level, what happens at the national level
with the distinction between primary legislation and secondary regulation.
11.23 There is an inevitable tension between the quality and the democratic nature of the
legislative output and the need for speed and flexibility. At the national level, this tension,
this trade-off has been solved through the distinction between primary and secondary law.
By definition, primary law—the legislative process—is rigid and slow, but ‘democratically
accountable’, while secondary law—the regulations and rules issued by regulatory agencies
—is flexible and quick, but less ‘democratically accountable’.
11.24 The Resolution of the European Council of 23 March 2011 also invited the
Commission to use regulations instead of directives, whenever this is ‘legally possible’. The
move towards maximum harmonization has been a feature of the EU legislative process in
financial regulation and supervision ever since.
(p. 389) From Lamfalussy to De Larosière
11.25 The financial crisis highlighted a number of weaknesses in the EU financial
supervision framework, which remained decentralized and fragmented at the national level
despite the changes in the EU financial architecture explained earlier in this chapter.17 In
his speech on October 2008, José Manuel Durão Barroso, as President of the European
Commission, called for a coordinated response to the crisis while criticizing Member States
for the lack of ‘real effort at co-ordination’ ensuring cooperation among the national
authorities and the EU-level institutions.18 While praising the efficiency of Member States
actions during the financial crisis, Barroso stated their actions must be based on the
common principles and taken within a commonly agreed framework, and that the cross-
border effects of such actions must be taken into account.
11.26 Barroso also announced the Commission’s decision to set up a high level group of
experts in financial services chaired by Jacques de Larosière, to advise on the future of
European financial regulation and supervision and to make recommendations laying ‘the
ground for building consensus on crossborder supervision’. As it stems from the text of the
De Larosière group mandate, the European Commission did not see the evolutional nature
of the Lamfalussy committees as an appropriate framework to combat the constantly
changing and cross-border nature of the financial crisis.
11.27 The aim of the De Larosière group mandate was to provide a report on the
establishment of ‘a more efficient, integrated and sustainable European system of
supervision’.19 The report (De Larosière Report) with thirty-one recommendations was
presented to the European Commission in February 2009.20 These recommendations called
for the creation of an EU-level body to oversee risk in the financial system as a whole;
stronger system in place to reduce the risk and severity of future crises; convergence of
technical rules across Member States; a mechanism for ensuring agreement and
coordination among supervisors of cross-border financial institutions (including those in
colleges of supervisors); a rapid and effective mechanism to ensure the consistent
application of EU rules; and coordinated decision-making in emergency situations.(p. 390)
View full-sized figure
Figure 11.1 European financial architecture—Lamfalussy.
(p. 391) D. The European System of Financial Supervision

11.28 Following the recommendations of the De Larosière Report, the European System of
Financial Supervision was established in 2010. The new regime came into force on 1
January 2011.
11.29 The ESFS is an integrated network of national and EU supervisors which comprises
three European supervisory authorities (ESAs): (1) a European Banking Authority (EBA),21
(2) a European Insurance and Occupational Pensions Authority (EIOPA),22 and (3) a
European Securities and Markets Authority (ESMA),23 as well as the Joint Committee to
foster cross-sectoral coordination amongst ESAs, a European Systemic Risk Board
(ESRB),24 and the national supervisory authorities.
The European Systemic Risk Board and macro-prudential supervision
11.30 The ESRB is responsible for the macro-prudential oversight of the EU financial
system in order to contribute to the prevention or mitigation of systemic risks to financial
stability,25 which directly contributes to the smooth functioning of the internal market. As
explained elsewhere,26 this initiative was a response to a necessity underscored by the G20
London meeting of April 2009 which, inter alia, led to the transformation of the Financial
Stability Forum into a Financial Stability Board (FSB), to the creation in the USA of the
Financial Stability Oversight Council (FSOC), as part of the Dodd–Frank (p. 392) reform in
summer 2010,27 and to the establishment of financial stability councils or central bank
committees in charge of macro-prudential supervision, as discussed in Chapter 3.28
11.31 The scope of the ESRB mandate is very broad, as the ‘financial system’ is defined
Article 2(b) of the ESRB Regulation as all financial institutions, markets, products and
market infrastructures. The notion of ‘systemic risk’ is also defined very broadly in Article
2(c) as a risk of disruption in the financial system, irrespectively of the sector or type of
entity, with the potential to have serious negative consequences for the internal market and
the real economy.
11.32 In identifying, analysing, and monitoring systemic risks, the ESRB relies on
information provided by the ESAs, the European System of Central Banks (ESCB), the
European Commission, national supervisory authorities, and the national statistics
authorities with whom the ESRB closely cooperates to fulfil its tasks.29 The ESRB can ask
for information in aggregate form, so that individual firms cannot be identified, or request
data about individual institution. However, in this latter case it must justify why such data is
deemed to be systemically relevant and necessary.30
11.33 The ESRB receives data in aggregated form on a regular basis from the ECB and
ESAs, and can also make ad hoc requests.31
In practice, the legal framework for provision of information to the ESRB has proven to be
relatively weak leading to delays, irregular and partial provision of data.32
11.34 The ESRB’s instruments are limited to warnings of systemic risks that are deemed
to be significant and recommendations for the remedial action that should be taken to
address the risks identified.33 The recommendations can be either of a general or a specific
(p. 393) nature,34 and may be addressed to the EU as a whole, the European Commission
(in relation to EU legislation), Member States, ESAs, and national supervisory authorities.
11.35 The ESRB has no legally binding powers35 and no powers to intervene or decide on
emergencies.36 The ESRB does not have legal personality.37 Both ESRB warnings and
recommendation can be kept confidential or made public; the ESRB decides this on a case-
by-case basis.38 The institutions to which the ESRB recommendations are addressed should
implement them and report to the ESRB and the Council on the actions undertaken, and
provide adequate justification for any inaction. The ESRB monitors compliance with its
recommendations, based on reports from the addressees. If the ESRB considers that a
reaction is inappropriate, it informs the addressees, the Council and, where appropriate,
the ESAs concerned, but it does not have any enforcement tools to ensure compliance.
11.36 In terms of governance, the ESRB consists of a General Board, a Steering
Committee, a Secretariat, an Advisory Scientific Committee and an Advisory Committee.39
The General Board, which meets at least four times a year,40 takes the decisions necessary
to ensure the performance of the tasks entrusted to the ESRB. This decision-making organ
brings together central bank governors, high-level representatives of the financial
supervisory authorities from all EU Member States, the president and vice-president of the
ECB,41 a member of the European Commission and the chairs of each ESA, the chair and
the vice-chair of the Advisory Scientific Committee (ASC), and the chair of the Advisory
Technical Committee (ATC), as well as some members without voting rights—the president
of the Economic and Financial Committee (EFC) and high-level representatives from the
national competent authorities.42 As explained elsewhere,43 the question of having the ECB
President as the ESRB chair was the result of a compromise which proved inefficient,
leading the European Parliament to recommend the appointment of an ‘independent’ chair
who is not the ECB President.44
(p. 394) 11.37 The role of the Steering Committee is to ensure that the ESRB operates
efficiently and to assist the ESRB decision-making process by preparing the Board’s
meetings, reviewing the documents to be discussed and monitoring the progress of the
ESRB’s on-going work.45
11.38 The ESRB Secretariat, which is provided and supported by the ECB,46 is responsible
for the day-to-day business of the ESRB. It provides high quality analytical, statistical,
administrative, and logistical support to the ESRB, and it draws on technical advice from
the ESAs, national central banks (NCBs), and national supervisory authorities. The head of
the Secretariat is appointed by the ECB, in consultation with the General Board of the
ESRB.47
11.39 The Advisory Technical Committee’s responsibility is to provide advice and
assistance on issues relevant to the work of the ESRB by bringing technical expertise on
issues which might go beyond the support provided by the Secretariat.48 The ATC consists
of representatives of the ESAs, each NCB, the ECB, the European Commission, and national
supervisors, among others.49 The Advisory Scientific Committee provides advice and
assistance on issues relevant to the work of the ESRB. The ASC consists of fifteen experts
representing a wide range of skills and experiences, including the chair of the ATC and they
are appointed ‘on the basis of general competence and their diverse experience in academic
fields or other sectors’.50 According to the review of the ESRB work by the European
Parliament pursuant to Article 20 of the ESRB Regulation, the ATC’s key role in prioritizing
risks has been ‘inhibited by national position-taking by members from national central
banks and national supervisory authorities’ thus hindering the ESRB’s ability to focus on
controversial issues.
11.40 Article 19 of the ESRB Regulation sets extensive accountability and reporting
requirements for the ESRB. It must report to the European Parliament and the Council at
least once a year. The chair of the ESRB will appear in an annual hearing in the European
Parliament, marking the publication of the ESRB’s annual report to the European
Parliament and the Council.51 In the event of widespread financial distress the meetings
with the European Parliament and the Council can be held more frequently. In addition, (p.
395) the chair of the ESRB may be asked to attend hearings of the competent committees of
the European Parliament.
11.41 The ESRB is expected to coordinate its activities with the international financial
organizations to contribute to a stronger international framework for risk monitoring, and
more stable global financial markets. In particular, the ESRB has established contact with
the International Monetary Fund (IMF), the US Financial Stability Oversight Council
(FSOC), and the FSB, but no extensive cooperation has taken place yet in this format. This
can be explained by the fact that some representatives are already members of the FSB
which is an international forum for the matters related to macro-prudential oversight.52 The
ESRB also cooperates with the relevant bodies in countries outside the EU on issues
relating to macro-prudential oversight.
11.42 As mentioned in paragraph 11.39 above, an extensive review of the ESRB work and
its governance arrangements was undertaken pursuant to Article 20. In general, the report
of 2013 concluded that the ESRB played a significant role in the macro-prudential
supervision and legislative process, but it was also stated that it is too early to assess the
ESRB’s policy outputs. It is also important to notice that the significant changes in the
structure of the European financial supervision discussed in the previous chapter, as well as
the new responsibilities of the ESRB under the CRD IV package are altering the role of the
ESRB. An important observation in the report refers to the ESRB’s potential to act as ‘a
shield against groupthink’.53
11.43 Being part of the ESFS, the ESRB is required to work closely with the ESAs and the
Joint Committee. The ESRB and the ESAs are jointly developing a common set of
quantitative and qualitative indicators for identifying and measuring systemic risk, known
as the ‘risk dashboard’.54 They are also working together on an adequate stress-testing
regime to help identify firms that may pose systemic risk.
11.44 With the SSM Regulation, responsibility for macro-prudential supervision is to be
shared between the ESRB, the ECB (Article 5 of the SSM Regulation grants the ECB some
macro-prudential powers) and national authorities, while responsibility for lender of last
resort in the euro area—a classic macro-prudential tool—is currently divided between the
ECB (when it comes to ‘market’ liquidity assistance) and the national central banks (when it
comes to collateralized lines of credit to individual illiquid but solvent banks, according to
the ECB’s own restrictive interpretation of Article 14.4 of the ESCB Statute).55
(p. 396) 11.45 The ESRB has not been very effective so far. The advent of powerful
European banking supervision (ECB–SSM) together with the lack of effective legal powers
and legal personality of the ESRB may limit further the impact of the ESRB, possibly
rendering it irrelevant in the long run. Of course, it can still play a useful role as a kind of
observatory of systemic risk for the EU at large.
The European Supervisory Authorities and micro-prudential supervision
11.46 On 1 January 2012, the level-3 committees were replaced by the European
Supervisory Authorities (EBA, EIOPA, and ESMA) which are sector-specific EU micro-
prudential supervisors (see Figure 11.2). Unlike the ESRB, they have separate legal
personalities and autonomous budgets. Their organizational structure and their
competencies are similar with some deviations.56 The ESAs’ aim is to ‘protect the public
interest by contributing to the short, medium and long-term stability and effectiveness of
the financial system, for the Union economy, its citizens and businesses’.57 To achieve this
objective, the ESAs contribute to: (1) improving the functioning of the internal market
including, (including efficiency and consistency of regulation and supervision); (2) ensuring
the integrity, transparency, efficiency and orderly functioning of financial markets; (3)
strengthening international supervisory coordination; (4) preventing regulatory arbitrage;
(5) promoting equal conditions of competition; (6) ensuring the appropriate regulation and
supervision of credit and other risks; and (7) enhancing consumer protection.
11.47 Though the ESAs have wider tasks and more powers than their predecessors (level-3
Lamfalussy committees), including the power to make binding decisions in relation to
specific firms and to individual supervisors, the scope of their competencies is strictly
defined in the relevant EU legal acts. For example, they are expressly prohibited from
taking any decisions with the impact on the fiscal responsibilities of Member States. ESAs
carry out several key tasks in order to meet their objectives.
11.48 First, they contribute to the establishment of the high-quality common regulatory
and supervisory standards and practices within the ESFS, and ensure the common, uniform
and consistent application of the EU law. The ESAs are responsible for developing draft
binding technical standards (BTS)58 to ensure harmonization of standards, and to create a
single financial services rulebook. It is important to notice that this does not empower ESAs
to take any policy decisions. In general, draft BTS are adopted in the form of European
Commission regulations or decisions with some exceptions. There is a no-objection
procedure for the RTS which enter into force only if the European Parliament and the
Council do not object within three months of notification. The (p. 397) ITS can in some
cases enter into force as soon as they are adopted by the European Commission.59
11.49 Secondly, the ESAs issue guidelines and recommendations addressed to the national
supervisors and firms on the application of the relevant EU law. These recommendations
and guidelines are not legally binding, but the addressees of these acts need to explain the
reasons for non-compliance. This information can be made public by the ESAs.
11.50 Thirdly, the ESAs acting as independent bodies, can provide opinions to the
European Parliament, the Council, the European Commission and national competent
authorities on all issues relating to their areas of competence.
11.51 Fourthly, the ESAs are required to foster a coordinated approach among supervisors
by stimulating and facilitating the exchange of information and agreements among national
supervisors at an earlier stage.
11.52 Fifthly, the ESAs play an important role as mediators by mediating and settling the
disputes between the national supervisors (including within colleges of supervisors), in
areas that require cooperation, coordination, or joint decision-making by supervisors of
more than one Member State. For this purposes ESAs can adopt decisions which are
binding to all parties to the dispute.
11.53 Finally, the ESAs are actively involved in building a common supervisory culture in
the EU by monitoring how the EU legal acts of all levels are being applied and enforced by
national supervisors to ensure their consistent application. The regular peer reviews of
some or all of the activities of national supervisors carried out by the ESA Review Panels
also enable improving the consistency of supervision across the EU. If a supervisor is failing
to apply EU legal acts properly, the ESAs can investigate non-compliance on its own
initiative, or following the request from the supervisors, the European Parliament, the
Council and the European Commission. It is then within ESAs’ competence to issue a
recommendation to the relevant supervisor setting out the action that is required in order
to comply with EU law. The second step in ensuring compliance can be made by the
European Commission which can adopt a formal opinion requiring the supervisor to take
necessary actions. If the national supervisor still does not follow the directions given, as a
last resort, the ESA may adopt a decision addressed directly to the individual firms to
ensure that they comply with EU law.60 The precondition for such action is that the national
supervisor failed to comply and that it has received an ESA decision in this regard. Finally,
the decisions addressed to the individual firms must be made in relation to EU law that is
directly applicable to these firms. This mechanism allows the ESAs to overcome non-
compliance by the national supervisor.
11.54 The ESAs can also put pressure on the institutions acting against formal opinions
and decisions by including information on them in their annual reports. It must be noted
that, (p. 398) generally, ESA Regulations do not grant them direct supervisory powers over
the financial institutions. They merely open the possibility of further centralization under
the legislation to be adopted in future to grant supervisory powers for the specific types of
institutions. The only exception is ESMA, as it has been granted with the exclusive direct
supervisory powers over the EU credit rating agencies (CRAs) under the CRA Regulation.61
Another category of institutions that are directly supervised by ESMA are trade
repositories.62
11.55 The ESAs also have powers enabling them to temporarily ban or restrict certain
financial activities that threaten the orderly functioning and integrity of financial markets
or the stability of the whole or part of the EU financial system (such actions must be
foreseen in the relevant legislation).63 The ESAs like the ESRB, also have power to take
these actions in emergency situations as declared by the Council. In practice, the efficiency
of ESA powers will depend on the conditions set out in the relevant underlying legislation.64
The ESAs also have an important coordinating role among the national supervisors in
emergency situations. Thus the powers of ESAs in emergency situations are strictly limited.
11.56 Another important power in the ESAs’ toolkit is the power to initiate and coordinate
EU-wide stress testing to assess the resilience of financial institutions to adverse market
developments, and evaluate the potential for the increase of systemic risk. As explained
earlier, the stress-testing regime is developed by ESAs and the ESRB.65 The ESAs can also
carry out an inquiry into a particular type of firm, product or conduct to assess potential
threats to the stability of the financial system either at the request of the European
Parliament, the (p. 399) Council or the European Commission, or at their own initiative, and
make recommendations for action to the relevant supervisors.
11.57 As regards their governance structure, the ESAs have the following organs: board of
supervisors, management board, review panel, stakeholder group, and the board of appeal.
The board of supervisors is the main decision-making body of the ESA which is responsible
for taking all policy decisions. It comprises the representatives of all Member State national
supervisors and observers including representatives of the European Commission, the
ESRB, the ECB, and the other ESAs. The management board is composed of the chair, six
representatives of national supervisors and a representative of the European Commission.
This organ sets the regulatory agenda for the agency and ensures that an ESA performs its
tasks and functions.66 The chair, who must be a full-time independent professional, is
responsible for preparing the work of the board of supervisors, chair the meetings of the
board of supervisors and the management board. ESA’s executive director, must also be a
full-time independent professional, responsible for managing an ESA an preparing the work
of the management board.
11.58 Each ESA has a stakeholder group composed of thirty members with various
backgrounds, representing academics, firms, consumers and other users of financial
services. The Group’s role is to help facilitate consultation with stakeholders in areas
relevant to the ESA’s tasks. It will be consulted on actions concerning technical standards,
guidelines, and recommendations, and their implementation, to the extent that they do not
relate to individual firms. The Group may also submit opinions and advice to the ESA on any
issue related to the ESA’s tasks. In addition, the Group may submit requests to the ESA to
investigate alleged breaches or non-application of EU law.
Coordination between EBA and ECB—Single Market and Banking Union67
11.59 Issues of ‘jurisdictional domain’ haunt the design of banking union as stated at the
beginning of this chapter. The euro area, the SSM area, the EU and the EEA represent
concentric circles of integration, subject to differentiation and conditionality. And then of
course we also have the international dimension since global institutions also expand
beyond the contours of Europe.
11.60 A major challenge for the EU is that the needs of a well functioning single market in
financial services cannot be disentangled from the design of the supervisory pillar. The
Communication of 12 September 2012 (A Roadmap to banking union) addressed the
conundrum of the uneasy co-existence between a banking union and the single market. It
stated:
The single market for financial services is based upon common rules which ensure
that banks and other financial institutions…are subject to equivalent rules and
proper supervision across the EU. The creation of the banking union must not
compromise the unity and integrity of the single market which remains one of the
greatest achievements of European (p. 400) integration. …The single market and
the banking union are thus mutually reinforcing processes.68
The SSM co-exists with the European Supervisory Authorities and the European Systemic
Risk Board. Of the three ESAs, of course, it is the European Banking Authority that will
most ‘suffer’ from the establishment of a powerful European supervisory authority: the
ECB.
11.61 The existence of two ‘banking authorities’, EBA and ECB, is a reflection of the co-
existence of the Single Market and the Banking Union. These two realities have different
jurisdictional domains though some of their needs intersect. From an institutional
perspective, EBA is not as powerful—has never been, will never be—as the ECB. EBA is a
product of the gradual federalization of financial law in the EU.69 The ECB, on the other
hand, is a proper European institution. The ECB is governed by primary law, while EBA is a
product of secondary law.
11.62 According to recital 11 of the SSM Regulation:
A banking union should therefore be set up in the Union, underpinned by a

comprehensive and detailed single rulebook for financial services for the internal
market as a whole and composed of a single supervisory mechanism and new
frameworks for deposit insurance and resolution. In view of the close links and
interactions between Member States whose currency is the euro, the banking union
should apply at least to all euro area Member States. With a view to maintaining
and deepening the internal market, and to the extent that this is institutionally
possible, the banking union should also be open to the participation of other
Member States.
11.63 The problems of coordination amongst different banking authorities—in the case of
the EU, the ESRB, EBA, and ECB, as well as ESM—are real, as the tripartite arrangement in
the UK showed during the Northern Rock episode (and then, there are also the colleges of
supervisors and crisis management groups). The European Banking Authority will remain in
charge of the single rulebook (ie regulations and technical standards) and will be guardian,
with the Commission, of the single market. But the ECB will be a very powerful institution.
EBA’s existence and powers (strengthened by the EBA regulation) are justified because of
the different jurisdictional domain EU/euro area, but add a layer of complexity to the
supervisory picture.
11.64 Recital 31 of the SSM Regulation emphasizes the need for cooperation not only with
EBA, but also with ESMA and EIOPA, as well as with the relevant resolution authorities and
facilities (reference to ESFS and ESM) financing direct or indirect public financial
assistance. But this is likely to be very complicated. As stated earlier, the move from early
intervention to resolution and crisis management must be crystal clear.
11.65 Resolution, lest we forget, is a highly legal, highly technical, highly complicated
task, very resource-intensive. It requires legal certainty and clear powers. In terms of
problems of coordinating different authorities, the second pillar of banking union, single
resolution, (p. 401) faces its own challenges (challenges that go beyond the move from
supervision to resolution and crisis management), given the powers of the European
Commission, the ESM, the Single Resolution Board and the national resolution authorities
when it comes to dealing with failing institutions. Resolution is even more thankless than
supervision. And the cross-border dimension is not simply European, but also international
since the major Eurozone credit institutions also have branches, subsidiaries and operations
in other parts of the World and have to form cross-border Crisis Management Groups
(CMGs). (As for cross-border resolution, as Charles Randell says, ‘it is all about funding and
burden sharing’.70)
11.66 Issues of jurisdictional domain have characterized the design of financial regulation
and supervision in the United States, with a mix of federal and state powers as discussed in
paragraph 11.10. Federal law prevails in securities, while insurance has traditionally been a
matter of state law and banking offers a mix of federal and state powers. Over the years,
however, there has been a process of federalization in the supervision and crisis
management of financial institutions, with the latest addition, the Dodd–Frank Act,
substantially increasing federal powers for any financial institution that is deemed to be
systemically significant. Lender of last resort was federalized in 1913 with the Federal
Reserve Act, while the Federal Deposit Insurance Corporation (FDIC) was established in
1933. FDIC has three hats as receiver of failed or failing banks (and now also financial
institutions under the Orderly Liquidation Authority), deposit insurer, and supervisor.
11.67 For the UK, the challenge lies in that while the strengthening of the economic and
supervisory pillars responds to the needs of the euro area (Chancellor Osborne referred to
the ‘inexorable logic’ of fiscal union), the efficient functioning of the single market in
financial services is essential for the City of London as a leading financial centre. The single
market, the great achievement of the EU as a whole, is what the UK most wishes to
preserve. But the agenda of further integration is moving ahead with or without the UK.
11.68 The creation of the Single Supervisory Mechanism and the Single Resolution
Mechanism coexists with the existing architecture for competition and State aid. The
European Commission (Directorate-General for Competition) remains in charge of watching
over the compliance of State aid with EU rules.71 State aid rules are a fundamental
component of the Single Market, and are intrinsically related to the area of resolution.
11.69 There are a number of other underlying challenges in the reform plan. To begin,
legitimacy (to avoid a growing disconnection between the intellectual elite and the general
population),72 then the underlying problem of stagnant growth and finally the recognition
that supervision can have negative reputational effects in the discharge of the European
Central (p. 402) Bank’s main responsibility: the conduct of monetary policy. The issue of
sufficiency of ESM resources is, of course, a major concern (as it has always been for the
International Monetary Fund). The European Central Bank, on the other hand, does have
the capacity to print money.73
Before concluding this chapter, let us consider in some greater detail the role of EBA
following the advent of banking union.
11.70 EBA retains its existing powers and tasks within the single market in banking
services and receives further powers when it comes to resolution. However, the
establishment of a true powerful European supervisor obviously required that some
amendments be made to the EBA Regulation to reflect the enhanced role of the ECB in the
SSM.
The revision of the EBA Regulation74 is related to the voting modalities and the composition
of the EBA management board. The new status of the ECB as a competent authority for the
purposes of the EBA regulation is reflected in Article 1(1) of the EBA Amending Regulation.
11.71 The EBA Amending Regulation seeks to ensure that there are at least two members
of the EBA management board who are representatives from the Member States not
participating in the banking union.
11.72 The EBA Regulation currently provides for decisions concerning regulatory matters
(ie technical standards, guidelines, and recommendations) to be taken by the EBA board of
supervisors on the basis of a qualified majority of its members. Other decisions are taken by
a simple majority of the voting members. The EBA Amending Regulation adjusts voting
mechanisms to reflect the role of the ECB in coordinating the position of the Member States
participating in the banking union and to safeguard the interests of non-participating
Member States. The EBA Amending Regulation establishes a ‘reverse voting mechanism’
intended to ensure that any proposal prepared by the independent panel is supported by
the Member States both participating and non-participating in the banking union. Article
1(7) of the EBA Amending Regulation, which replaces Article 44(1) of the existing EBA
Regulation, reads as follows:
[T]he Board of Supervisors shall take decisions on the basis of a qualified majority
of its members…which shall include at least a simple majority from members of
participating Member States [in the SSM]…and simple majority from members of
non participating [in the SSM] Member States.
11.73 Though non-participating Member States can block decisions that do not command
a simple majority this rule may be revisited if fewer than five Member States are outside
the SSM.

11.74 This chapter has addressed the ‘uneasy’ co-existence between banking union and
the single market in financial services. The former will be geographically restricted to the
countries in (p. 403) (p. 404) the euro area and to those Member States that choose to
participate in the SSM (via ‘close cooperation’ arrangements) and SRM.
View full-sized figure
Figure 11.2 European financial architecture for the Single Market—De Larosière.
11.75 Banking union as the name indicates centralizes banking policy but responsibility
for other sectors of the financial system (securities, insurance) remains decentralized albeit
subject to increasing ‘federalization’ through ESMA and EIOPA. Though much progress has
been achieved in a relatively short period of time a lot remains to be done, in particular
when it comes to the development of a true ‘capital markets union’, which is the next
regulatory frontier in the completion of the single market in financial services.75 The
complexity of the still evolving European financial architecture is a major challenge for the
future of European financial markets. And complexity frustrates accountability, which
brings us to the end of Part II of this book.
11.76 It is fitting to finish this chapter and this part with one more reflection about the
important issues of legitimacy and accountability. As explained earlier, legitimacy pre-exists
and is a prerequisite of accountability. In the European Union, the formal legitimacy of the
integration process rested initially on the Member States’ ratification of the foundational
Treaties (and subsequent amendments), while its social legitimacy—its ‘popular appeal’—
rested upon the benefits in terms of peace and welfare that it promised to deliver to its
citizens.76 (Of course, the direct European legitimacy has been increased since the 1950s
with ever-expanding powers for the European Parliament and its direct elections since 1979
plus transparency requirements for the Council as co-legislator.)
11.77 The need to combine efficiency (to avoid a cumbersome and unduly complicated
decision- making process and excessive bureaucracy) with democratic legitimacy (the
interest of the citizens of the twenty-five EU Member States) is fundamental for the future
of Europe. And since democracy is considered the sole legitimate form of government in the
EU, legitimacy equates to democratic legitimacy.
11.78 The creation of any agency or authority (be it a central bank, or any other type of
governmental or intergovernmental entity) must be the fruit of a democratic act (an act of
the legislator, a constitutional decision, or a treaty provision). This first source of
legitimization is essential in a democratic society. It is then in the continuing life of that
entity that accountability becomes necessary: the process of bringing back (by giving
account, explaining, justifying, or taking measures of amendment or redress) that entity to
the procedures and processes of a democratic society.77 The more complex the activity, the
more difficult it is to establish clear standards of conduct and specific outcomes—in which
case accountability becomes ever more evasive.78
Footnotes:
1
See Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks
on the European Central Bank concerning policies relating to the prudential supervision of
credit institutions, OJ L 287/63 (29 October 2013) (SSM Regulation) and Regulation (EU)
No 806/2014 of the European parliament and of the Council of 15 July 2014 establishing
investment firms in the framework of a Single Resolution Mechanism and a Single
Resolution Fund and amending Regulation (EU) No 1093/2010, OJ L 225/1 (30 July 2014).
See also Directive 2014/59/EU of the European Parliament and of the Council of 15 May
2014 establishing a framework for the recovery and resolution of credit institutions and
investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC,
2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/
EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament
and of the Council, OJ L 173/190 (12 June 2014).
2
See European Commission, Communication on Financial Services—Implementing the
Framework for Financial Markets: Action Plan, COM (1999) 232 (11 May 1999), at <http://
ec.europa.eu/prelex/detail_dossier_real.cfm?CL=en&DosId=145237> (last visited 16
September 2014). In May 2005, the Commission published a ‘Green Paper on Financial
Services Policy (2005–2010)’, COM (2005) 177, 1–13, at <http://ec.europa.eu/
internal_market/finances/docs/actionplan/index/green_en.pdf> (last visited 11 August
2014). See also Lamfalussy Committee of Wise Men, Final Report of the Committee of Wise
Men on the Regulation of European Securities Market (2000), at <http://ec.europa.eu/
internal_market/securities/lamfalussy/report/index_en.htm> (last visited 15 September
2014) (hereinafter Lamfalussy Report).
3
See Lamfalussy Report, above note 2.
4
See Dirk Schoenmaker, ‘Financial Supervision: from National to European?’ (2003) 22(1)
Financial and Monetary Studies. See also Niels Thygesen, ‘The Political Economy of
Financial Harmonisation in Europe’ in Jeroen Kremer, Dirk Schoenmaker, and Peter Wierts
(eds), Financial Supervision in Europe (Cheltenham: Edward Elgar, 2003) 145.
5
Indeed, the Lamfalussy Report, above note 2, stated: ‘[I]f the full review were to confirm
in 2004 (or earlier as the case may be) that the approach did not appear to have any
prospect of success, it might be appropriate to consider a Treaty change, including the
creation of a single EU regulatory authority for financial services generally in the
Community.’
I had the opportunity of asking Baron Lamfalussy whether the wording of this statement
was intentional when he spoke in London on 3 May 2001, and his answer was positive: the
choice of words ‘single EU regulatory authority for financial services in the Community’ was
intentional. Hence, this wording indicated a preference for the conceivable creation of a
European FSA rather than for the creation of a European Securities and Exchange
Commission (SEC).
6
The consolidated versions of the Treaty on European Union and the Treaty on the
Functioning of the European Union, 2010 OJ C 83/01 vol 53 (30 March 2012), Art 127.6
(TFEU) left the door open for the transfer to the ECB of tasks related to the prudential
supervision of credit institutions and other financial institutions, with the exception of
insurance undertakings. It did not consider the potential transfer of resolution powers.
7
Committee of European Securities Regulators (CESR), ‘Preliminary Progress Report—
which supervisory tools for the EU securities market? An analytical paper by CESR’, CESR/
04-333f (October 2003) (hereinafter ‘Himalaya Report’). See CESR, Press Release, CESR/
04-570 (25 October 2004).
8
See Gilles Thieffry, ‘After the Lamfalussy Report: The First Steps Towards a European
Securities Commission’ in Mads Andenas and Yannis Avreginos (eds), Financial Markets in
Europe. Towards a Single Regulator? (The Hague: Kluwer Law International, 2003) 197.
Besides Art 352 TFEU, other articles could be considered, such as Art 114 TFEU (ex Art 95
EC Treaty). Article 308 was Art 235 before the renumbering of the EC Treaty provisions by
the Treaty of Amsterdam amending the Treaty on European Union, the Treaties establishing
the European Communities and certain related acts—Final Act, OJ C 340/115 (10 November
1997) (hereinafter Amsterdam Protocol).
9
See Rosa M Lastra, Central Banking and Banking Regulation (London: London School of
Economics/Financial Markets Group, 1996) 215–23.
10
The Single European Act also gave momentum to the liberalization of capital
movements, one of the four freedoms of a true single market and a precondition for the full
liberalization of financial services. In his comments to this chapter, René Smits remarked
that he counts five freedoms: (i) goods, (ii) services, (iii) workers and self-employed persons,
(iv) freedom of establishment, and (v) capital, with payments the corollary sixth freedom.
11
The principle of home country control and the limitations of the divide between home
and host country responsibilities have become a matter of concern for financial supervisors
in the EU, particularly in the new members in Central and Eastern Europe. See eg
European Shadow Financial Regulatory Committee, ‘Challenges to Financial Regulators in
Accession Countries’, Statement No 18 (17 May 2004), at <http://www.esfrc.eu/id76.html>
12
The Single European Act in its Declaration on Article 100a of the EEC Treaty stated
that: ‘[T]he Commission shall give precedence to the use of the instrument of a directive if
harmonisation involves the amendment of legislative provisions in one or more Member
States.’ The Amsterdam Protocol, above note 8, also states in its point 6: ‘[D]irectives
should be preferred to regulations.’
13
See Rosa M Lastra, ‘Regulating European Securities Markets: Beyond the Lamfalussy
Report’ in M Andenas and Y Avreginos (eds), Financial Markets in Europe: Towards a Single
Regulator? (The Hague: Kluwer Law International, 2003) 211.
14
See Karel Lannoo (Rapporteur), ‘Updating EU Securities Market Regulation. Adapting to
the Needs of a Single Capital Market’, Report of a CEPS Task Force (1 March 2001), at <htt
p://ceps.eu/system/files/book/30.pdf> (last visited 11 August 2014).
15
Lamfalussy Report, above note 2.
16
See Alexandre Lamfalussy, ‘Reflections on the Regulation of European Securities
Markets’, Société Universitaire Européenne de Recherches Financières (SUERF) Studies,
Vienna (2001) 16–17, at <http://www.suerf.org/download/studies/study14.pdf> (last visited
11 August 2014).
17
See the European Commission, ‘High Level Expert Group on EU Financial Supervision
to Hold First Meeting on 12 November’, Press Release IP/08/1679 (11 November 2008)
Annex ‘Mandate for the High Level Expert Group on EU financial supervision’, at <http://
europa.eu/rapid/press-release_IP-08-1679_en.htm> (last visited 11 August 2014).
18
José Manuel Durão Barroso, Speech, SPEECH/08/509 (8 October 2008), at <http://
europa.eu/rapid/press-release_SPEECH-08-509_en.htm> (last visited 11 August 2014).
19
Report of the High-Level Group on Financial Supervision in the EU chaired by Jacques
de Larosière (25 February 2009) 6 (hereinafter De Larosière Report), at <http://
ec.europa.eu/internal_market/finances/docs/de_larosiere_report_en.pdf> (last visited 11
August 2014).
For a critical analysis of the De Larosière Report, see René Smits, ‘Europe’s Post-crisis
Supervisory Arrangements—A Critique’ (2010) 1(2) C&R Revista de Concorrência &
Regulaçao 125, at <renesmits.eu/index.php/download_file/view/33/> (last visited 11 August
2014).
20
De Larosière Report, above note 19. The Report is divided into four chapters covering
the analysis of the causes of the financial crisis, policy and regulatory issues, supervisory
framework in the EU, and the global dimension and cooperation on international level. The
De Larosière Report was endorsed by the European Commission in May 2009 and by the
Council in June 2009. See European Commission, ‘Consultation on Commission
Communication of 27 May 2009 on European Financial Supervision’ (May–July 2009), at <h
ttp://ec.europa.eu/internal_market/consultations/2009/fin_supervision_may_en.htm> (last
visited 11 August 2014). In September 2009, the European Commission presented
legislative proposals to implement its recommendations: see European Commission,
‘Commission Adopts Legislative Proposals to Strengthen Financial Supervision in Europe’,
Press Release IP/09/1347 (23 September 2009), at <http://europa.eu/rapid/press-
release_IP-09-1347_en.htm> (last visited 11 August 2014). In September 2010, the
European Parliament, following agreement by the Council, adopted the new supervisory
framework. See European Parliament, ‘Parliament Gives Green Light to New Financial
Supervision Architecture’, Press Release (22 September 2010), at <http://
www.europarl.europa.eu/news/en/news-room/content/20100921IPR83190/html/Parliament-
gives-green-light-to-new-financial-supervision-architecture> (last visited 11 August 2014).
21
EBA replacing CEBS, based in London, was established under Regulation (EU) No
1093/2010 of the European Parliament and of the Council of 24 November 2010
establishing a European Supervisory Authority (European Banking Authority), amending
Decision No 716/2009/EC and repealing Commission Decision 2009/78/EC, OJ L 331/12 (15
December 2010) (hereinafter EBA Regulation) as amended by Regulation (EU No
1022/2013 of 22 October 2013, OJ L 287/5 (29 October 2013) (hereinafter EBA Amending
Regulation).
22
EIOPA, the successor of CEIOPS, based in Frankfurt, was established by the Regulation
(EU) No 1094/2010 of the European Parliament and of the Council of 24 November 2010
establishing a European Supervisory Authority (European Insurance and Occupational
Pensions Authority), amending Decision No 716/2009/EC and repealing Commission
Decision 2009/79/EC, OJ L 331/48 (15 December 2010) (hereinafter EIOPA Regulation).
23
ESMA, which replaced CESR, based in Paris, was established by Regulation (EU) No
1095/2010 of the European Parliament and of the Council of 24 November 2010
establishing a European Supervisory Authority (European Securities and Markets
Authority), amending Decision No 716/2009/EC and repealing Commission Decision
2009/77/EC, OJ L 331/84 (15 December 2010) (hereinafter ESMA Regulation).
24
ESRB, the new body responsible for macro-prudential oversight and based in Frankfurt,
was established under the Regulation (EU) No 1092/2010 of the European Parliament and
of the Council of 24 November 2010 on European Union macro-prudential oversight of the
financial system and establishing a European Systemic Risk Board, [2010] OJ L 331/1 (15
December 2010) (hereinafter ESRB Regulation) and Council Regulation (EU) No 1096/2010
of 17 November 2010 conferring specific tasks upon the European Central Bank concerning
the functioning of the European Systemic Risk Board, OJ L 331/162 (15 December 2010).
25
ESRB Regulation, Art 3(1).
26
Rosa M Lastra and Jean-Victor Louis, ‘European Economic and Monetary Union: History,
Trends, and Prospects’ (2013) 32(1) Yearbook of European Law 57, 85.
27
See also the Council of Financial Regulation and Systemic Risk established in France in
October 2010, the Interim Financial Policy Committee (FPC) established within the Bank of
England in February 2011 and the Council of Cooperation on Macro-prudential Policy
created by the Sveriges Riksbank and the Finansinspektionen at the beginning of 2012,
mentioned in Michaela Posch and Remco Van der Molen, ‘The Macro-prudential Mandate of
National Authorities’ (2012) 2 Macro-prudential Commentaries 5, at <https://
www.esrb.europa.eu/pub/pdf/commentaries/ESRB_commentary_1203.pdf> (last visited 11
August 2014).
28
This was stressed, in particular, in the De Larosière Report, above note 19, paras 146,
153, and 173.
29
30
31
See generally, Decision of the European Systemic Risk Board of 21 September 2011 on
the provision and collection of information for the macro-prudential oversight of the
financial system within the Union (ESRB/2011/6), OJ C 302/3 (13 October 2011). This
decision was drafted as an interim solution and therefore the data was provided on ‘best-
effort basis’ which was not sufficient.
32
This problem was acknowledged by the High-Level Group on the ESRB Review (March
2013) 16–17, at <https://www.esrb.europa.eu/pub/pdf/other/
130708_highlevelgroupreport.pdf> (last visited 11 August 2014). In this report, it was
suggested granting more powers to the ESRB to request data on a permanent and on an ad
hoc (aggregate or firm-specific) basis.
This probably explains the reason why certain notification requirements were embedded in
CRD IV, Art 133 and CRR, Art 458 which also require the ESRB to provide opinions and
issue recommendations on specific national macro-prudential policy measures. See also
Decision of the European Systemic Risk Board of 27 January 2014 on a coordination
framework regarding the notification of national macro-prudential policy measures by
competent or designated authorities and the provision of opinions and the issuing of
recommendations by the ESRB (ESRB/2014/2), at <http://www.esrb.europa.eu/pub/pdf/
2014-01-27-Decision_ESRB_2014-2.pdf> (last visited 11 August 2014).
33
ESRB Regulation, Art 16.
34
See European Systemic Board, Recommendations, at <http://www.esrb.europa.eu/pub/
recommendations/ html/index.en.html> (last visited 11 August 2014).
35
Lastra and Louis, above note 26, 86–7.
36
When the ESRB determines that an emergency situation may occur it must promptly
issue a confidential warning to the Council and provide their assessment of the situation.
Pursuant to ESRB Regulation, Art 3(2)(e), it is for the Council, not the ESRB, to adopt a
decision addressed to the ESAs determining the existence of an emergency situation.
37
See also Deutsche Bundesbank, ‘The European Systemic Risk Board: from institutional
foundation to credible macro prudential oversight’, Monthly Report (April 2012), at <https:/
/www.bundesbank.de/Redaktion/EN/Downloads/Publications/Monthly_Report_Articles/
2012/2012_04_esrb.pdf> (last visited 11 August 2014).
38
ESRB Regulation, Arts 3(2)(c)–(d) and 18(3).
39
40
In addition to ordinary meetings Art 9(1) also allows to hold extraordinary meetings at
the request of the Chair or at least of one third of General Board members with voting
rights.
41
Their presence and the role of the ECB President as chairman for the first five years (Art
5(1) ESRB Regulation) and the ECB’s permanent role as secretariat (ECB Regulation,
Article 127(6) in respect of ESRB Regulation, Article 2 ) makes for very significant ECB
influence on the ESRB.
42
ESRB Regulation, Art 6. The General Board currently includes sixty-five members,
thirty-seven voting members and twenty-eight non-voting members.
43
44
Several arguments were put forth for changing the existing arrangements: greater
independence of the ESRB and autonomy from the ECB, which is especially important
taking into account the key role of the ECB within the SSM (see Chapter 10 in this volume);
the European Parliament also highlighted the importance of high dedication of the chair to
the ESRB work. See European Parliament, ‘Review of the New European System of
Financial Supervision. Part 2: The Work of the European Systemic Risk Board’ (2013) 61
and 86, at <http://www.europarl.europa.eu/RegData/etudes/etudes/join/2013/507490/IPOL-
ECON_ET(2013)507490_EN.pdf> (last visited 11 August 2014).
45
46
Regulation (EU) No 1096/2010, Arts 2 and 3.
47
European Commission, Proposal for a Council Decision entrusting the European Central
Bank with specific tasks concerning the functioning of the European Systemic Risk Board,
COM(2009) 499 final, COM(2009) 501 final, COM(2009) 502 final, COM(2009) 503 final,
SEC(2009) 1234, SEC(2009) 1235 (23 September 2009), Art 3(2), at <http://eur-
lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52009PC0500&from=EN> (last
48
See ESRB, ‘Mandate of the Advisory Technical Committee of the European Systemic
Risk Board’ (20 January 2011), at <https://www.esrb.europa.eu/pub/pdf/ATC-mandate.pdf>
49
50
ESRB Regulation, Art 12(1). See also Decision of the European Systemic Risk Board of
20 January 2011 on the procedures and requirements for the selection, appointment and
replacement of the members of the Advisory Scientific Committee of the European Systemic
Risk Board (ESRB/2011/2) [2011] OJ C 39/10.
51
See ESRB Regulation, Art 19.
52
European Parliament, ‘Review of the New European System of Financial Supervision.
Part 2’, above note 44, 49.
53
Part 2’, above note 44, 10.
54
ESRB Regulation, Art 3(1)(g).
55
As pointed out in Chapter 10 in this volume, one wonders if this situation could change
now, once the ECB will be in charge of prudential supervision of credit institutions. In these
new circumstances, nothing should prevent the ECB giving emergency liquidity assistance
(ELA) to the institutions it supervises—in the sense of temporary help to illiquid but solvent
institutions at a higher interest than they would pay otherwise, for collateral—that could be
different from the one that is required for monetary policy operations. The ‘own restrictive
interpretation’ of the beginning of the monetary union, according to which ELA is a
national, non-Eurosystem, task appears to have been mainly based on the link between the
central bank granting ELA and the supervisor, whose task is to assess, and confirm, that the
credit institution in trouble is illiquid but solvent (therefore taking some responsibility for
the ensuing risk for the central bank), supervisor that remained at that point in time a
national supervisory authority. In future, for the credit institutions for which the supervisory
responsibility is moved to the ECB, it would make full sense that the decision whether or
not to grant ELA is taken by the ECB.
56
The governance of EBA has changed since its establishment and differs from the other
two ESAs due to the new supervisory arrangements imposed by the creating of the SSM. As
explained in Chapter 10 in this volume, the ECB will assume supervisory from November
2014 responsibilities over the credit institutions and act as home or host supervisor.
Reference to the national supervisor or the national competent authority will also refer to
the ECB acting as such authority, depending on the financial sector and jurisdiction.
57
EBA Regulation, Art 1(5); EIOPA Regulation, Art 1(5); ESMA Regulation, Art 1(6).
58
These include regulatory technical standards (RTS) under Art 290 TFEU and
implementing technical standards (ITS) under Art 291(2) TFEU.
59
The European Commission has power to adopt BTS for four years until the end of 2014.
On the basis of the European Commission’s report to be presented by the end of this term,
this power will be automatically extended for a further four-year term unless the European
Parliament and the Council decide to revoke it.
60
The ESAs can adopt binding decisions addressed directly to the national supervisors if:
(a) supervisors are involved in the supervision of a cross-border group need to agree or
coordinate their position; (b) where a supervisor is in breach of, or incorrectly applying, EU
law; and (c) in case of emergency situations as declared by the Council.
61
See Article 21 of the Regulation (EC) No 1060/2009 of 16 September 2009 on credit
rating agencies, OJ L 302/1 (17 November 2009) as amended by Regulation (EU) No
513/2011 of the European Parliament and of the Council of 11 May 2011, OJ L 145/30 (31
May 2011).
62
The details for the supervisory arrangements are set out in Title VI of the Regulation
(EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC
derivatives, central counterparties and trade repositories, OJ L 201/1 (27 July 2011)
(hereinafter EMIR). Under this Regulation ESMA also plays an important role in the process
of authorization and supervision of central counterparties (CCPs). In particular, ESMA has a
seat on all CCP colleges but without voting rights. There is a further potential for
broadening the scope of ESMA’s supervisory responsibilities to ‘highly integrated entities,
activities or financial instruments’ such as CCPs, central securities depositories (CSDs), or
index providers, according to the European Parliament’s report. However, further
centralization of supervision in this area is deemed problematic based on the experience
with centralizing banking supervision within the SSM. For further discussion see European
Parliament, ‘Review of the New European System of Financial Supervision, Part 1: The
Work of the European Supervisory Authorities (EBA, EIOPA and ESMA)’ (2013), at <http://
www.europarl.europa.eu/RegData/etudes/etudes/join/2013/507446/IPOL-
ECON_ET(2013)507446_EN.pdf> (last visited 11 August 2014).
63
In a landmark decision of 22 January 2014, the Court of Justice of the European Union
dismissed the UK’s challenge to the Short-Selling Regulation. The UK was challenging the
power of ESMA to adopt emergency measures under the Short-Selling Regulation, which in
their view went against general EU principles. The ECJ rejected the plea finding that the
Short-Selling Regulation and the powers given to ESMA are compatible with EU law. See
Case C-270/12 United Kingdom v Parliament and Council, 22 January 2014, and Court of
Justice of the European Union, ‘The power of the European Securities and Markets
Authority to adopt emergency measures on the financial markets of the Member States in
order to regulate or prohibit short selling is compatible with EU law’, Press Release No 7/14
(22 January 2014), at <http://curia.europa.eu/jcms/upload/docs/application/pdf/2014-01/
cp140007en.pdf> (last visited 11 August 2014).
64
For example, with regard to ESMA, see Article 28 of Regulation (EU) No 236/2012 of the
European Parliament and of the Council of 14 March 2012 on short selling and certain
aspects of credit default swaps, OJ L 86/1 (24 March 2012).
65
As explained in Chapter 10 in this volume, an EU-wide stress-testing for banks is a part
of the ECB’s comprehensive assessment prior to assuming full responsibility for their
supervision under the SSM in November 2014.
66
The members of the management board must act independently and objectively in the
sole interest of the Union as a whole. ESMA Regulation, Art 45.
67
See generally Rosa M Lastra, ‘Banking Union and Single Market: Conflict or
Companionship?’ (2013) 36(5) Fordham International Law Journal 1190.
See also Eilis Ferran, ‘European Banking Union and the EU Single Financial Market: More
Differentiated Integration, or Disintegration?’, University of Cambridge Faculty of Law
Research Paper No 29/2014 (18 April 2014), at <http://ssrn.com/abstract=2426580> (last
68
See European Commission, ‘Communication from the Commission to the European
Parliament and the Council: A Roadmap towards a Banking Union’, COM (2012) 510 Final
(12 September 2012) (hereinafter A Roadmap towards a Banking Union), at <http://eur-
lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:52012DC0510:EN:NOT> (last visited
11 August 2014).
69
See Takis Tridimas, ‘EU-Financial Regulation: From Harmonisation to the Birth of EU
Federal Financial Law’ in Harold James, Hans-W Micklitz, and Heike Schweitzer (eds), EUI
Working Papers 2010/05: Impact of the Financial Crisis on the European Economic
Constitution (Fiesole: European University Institute, 2010) 3, 14.
70
See generally Charles Randell, ‘European Banking Union and Bank Resolution’ (2013) 7
Law and Financial Markets Review 30.
71
See European Commission, Communication from the Commission on the application,
from 1 August 2013, of State aid rules to support measures in favour of banks in the context
of the financial crisis (‘Banking Communication’), C 216/01 (30 July 2013), at <http://eur-
lex.europa.eu/legal-content/EN/ALL/?uri=CELEX:52013XC0730(01)> (last visited 11
August 2014).
72
The tension between the ‘single rulebook’ and national supervisory discretion is another
issue that touches on accountability and legitimacy. This potentially poses a considerable
problem for the United Kingdom. The size of the UK financial sector could justify additional
measures (ring-fencing, additional loss-absorbing capital) to secure the safety and
soundness of banks, but the maximum harmonization approach of a single rulebook set by
the EBA could make it impossible for the UK authorities to impose such measures. One size
is unlikely to fit all in Europe for some time to come, given its very divergent national
economies (even within the euro area).
73
Indeed, the very announcement of the ECB’s bond purchasing programme: ‘Outright
Monetary Transactions’—discussed in Chapter 7—was sufficient to halt the crisis in 2012.
See European Central Bank, Technical features of Outright Monetary Transactions Press
Release ‘Technical Features of Outright Monetary Transactions’, Press Release (6
September 2012), at <http://www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html>
74
See EBA Amending Regulation.
75
See the ‘Mission letter’ of 10 September 2014 written by Jean Claude Juncker, as
President-elect of the European Commission, to Jonathan Hill as incoming Commissioner for
‘Financial Stability, Financial Services and Capital Markets Union’, available at <http://
ec.europa.eu/about/juncker-commission/docs/hill_en.pdf>.
76
Verhoeven, above note 75, 63–5.
77
In addition to the institutional/formal articulation of accountability, new mechanisms of
accountability (such as advisory panels of practitioners and consumers) ought to be
established to channel the representation of the interests of financial market participants. A
fine balance must be established though between consulting the private sector and being
captured by it.
78
See Rosa M Lastra and Heba Shams, ‘Public Accountability in the Financial Sector’ in
Eilis Ferran and Charles A E Goodhart (eds), Regulating Financial Services and Markets in
the 21st century (Oxford: Hart Publishing, 2001) 165. See also Chapter 2 in this volume.
Part III Developments at the International Level, 12
History of International Monetary Cooperation
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
Bank for International Settlement (BIS) — International financial system — Monetary system —
Monetary obligations — International Monetary Fund (IMF)
(p. 407) 12 History of International Monetary Cooperation
B. The International Gold Standard 12.06
C. The Inter-war Period 12.09
D. The Keynes and White Plans 12.15
E. The Bretton Woods Conference 12.22
F. The Bretton Woods Regime 12.26
The par value regime and the original IMF Articles of Agreement 12.28
The economic analysis of the collapse of the par value regime 12.35
The ‘life’ of the par value regime 12.39
Gold, reserves, and liquidity 12.40
Devaluations, revaluations, and floating rates 12.45
The US dollar 12.49
A note on the notion of reserve currency 12.52
G. The Second Amendment to the IMF Articles of Agreement 12.55

The choice of exchange regime in the absence of an international legal
obligation to ‘maintain’ exchange rate stability 12.63
H. Concluding Observations 12.69
Perhaps the most difficult question is how much to decide by rule and how much to
leave to discretion.
John Maynard Keynes, ‘Proposals for an International Currency (Clearing) Union’,
1942
A. Introduction
12.01 Central bank cooperation on a bilateral and multilateral basis already existed in the
nineteenth and early twentieth centuries.1 The Bank for International Settlements (BIS)
(the oldest international financial institution) was established in 1930 in the context of the
German reparations after the First World War, to act as a centre for central bank
cooperation. However, the history of the BIS before and during the Second World War was a
troubled one; the Bretton Woods conference even called for its liquidation.
12.02 An institutional system of intergovernmental economic relations sanctioned by law
was not established until Bretton Woods.2 The Bretton Woods system foresaw the setting up
(p. 408) of three international organizations: the International Monetary Fund (IMF) for the
purposes of international monetary cooperation; the International Bank for Reconstruction
and Development (IBRD) for the purposes of international development assistance
(investment); and an International Trade Organization (ITO) for the purposes of
international trade cooperation. However, while the IMF and the IBRD (World Bank) came
into existence in the 1940s, the fate of the ITO—which should have played the role of the
necessary ‘third leg’ of the Bretton Woods system—was quite different. Though a charter
for the International Trade Organization was concluded in Havana in 1948, the project for
its creation died because of the rejection by the US Congress. Instead, the General
Agreement on Tariffs and Trade (GATT) was signed in 1947 and entered into force (through
a Protocol for Provisional Application) in 1948. Only in 1995 did a ‘permanent’ international
trade organization—the World Trade Organization (WTO)—finally come into existence.3
12.03 The Bretton Woods system was conceived with the bitter memories of high
unemployment, hyperinflation, recession, and fluctuating exchange rates still fresh. The
inter-war period had not been properly handled by the international community. In
particular, many commentators argue that the harsh reparations policy towards Germany
had proven to be very damaging.4 Both John Maynard Keynes of the UK and Harry Dexter
White of the USA referred in their proposals to the need to ‘win the peace’.
12.04 The challenges that the Bretton Woods institutions face in the twenty-first century
are very different from the challenges these two institutions—the Fund and the World Bank
—confronted when they started operations in Washington, DC in May 1946. These
challenges, particularly the ones encountered by the International Monetary Fund are
examined in Part III of this book. Chapter 12 is largely a historical chapter. Chapter 13
focuses on the law of the IMF according to the Articles of Agreement, and Chapter 14
studies the rule-making aspects of the international financial architecture and the
framework for the prevention and resolution of international financial crises.
(p. 409) 12.05 Andreas Lowenfeld points out in his treatise on international economic law
that though the International Monetary Fund and the World Bank seemed ‘strong’ in the
1950s and 1960s, while the agreement on trade issues—the GATT—seemed ‘vulnerable’, at
the beginning of the twenty-first century the situation is the reverse.5 The GATT has grown
into the World Trade Organization, with enforcement powers and an agenda that extends
beyond trade in goods to include services and others.
B. The International Gold Standard

12.06 Gold, silver, and other metals have been used as money (coins minted by sovereigns)
throughout history. However, the term ‘international gold standard’ has a specific meaning
in the economic literature.6 The international gold standard (sometimes simply referred to
as the gold standard), with gold as the principal reserve asset, was a monetary arrangement
amongst the major countries in the world during the last part of the nineteenth century and
lasted until 1914.7 According to this arrangement, each participating country committed to
guaranteeing the free convertibility of its currency into gold at a fixed price. As Paul de
Grauwe explains,8 the fact that each currency was convertible into gold at a fixed price also
made it possible that each currency was convertible into all others also at a fixed price.9
12.07 Gold was the anchor of the system. Countries fixed the value of their currencies
against gold and central banks held gold in their reserves to defend that fixed price. The
gold standard provided the underlying monetary stability until the beginning of the First
World War. However, the gold standard was not based on any formal international
agreement and did not impose any international legal obligation upon the countries that
adopted it.10
12.08 From an economic point of view, a key difference between the gold standard and the
Bretton Woods regime, discussed in detail below, is the choice of assets into which national
currencies could be convertible. As the name indicates, the international gold standard
relied on gold, while the Bretton Woods regime was to rely upon a two-tier system of
convertibility based upon gold and the fixed US dollar value of gold, that is, a system in
which the key (p. 410) currency—the US dollar—would be convertible into gold and the
other currencies into the key currency.11 The reasons for the choice of this two-tier system
of convertibility rather than reverting to the gold standard were the following: (1) the
distribution of gold after the Second World War was uneven, with the US monetary
authorities holding around 70 per cent of the gold reserves, (2) the belief at the time that
the existing gold reserves were insufficient to cope with the needs for international
liquidity.12
C. The Inter-war Period

12.09 The aftermath of the First World War was characterized by acrimony. Though the
Paris Peace Conference in 1918, following Germany’s unconditional surrender on 11
November 1918, made an attempt to focus on restoring prosperity and peace, a few months
later, the Treaty of Versailles of 28 June 1919 imposed a policy of reparations against
Germany. However, the Treaty of Versailles was not ratified by the US Congress.13 The
history of the inter-war period is a history of failures. After the First World War there were
attempts to reintroduce a system similar to the gold standard (eg, the 1922 Genoa
Conference14), and some of the features of the gold standard were re-established by some
countries (acting unilaterally and sequentially) between 1925 and 1931. The system was
ultimately abandoned in 1931 and the inter-war period was to be characterized by rising
international tension and great instability.15
12.10 The disastrous experience of hyperinflation in Germany in 1923, in an economy
already overburdened with onerous war debts and reparations as well as high
unemployment, created enormous popular discontent. This paved the way for the rise of
National Socialism, with its dire consequences for the German nation. Keynes’s argument
that the reparations (p. 411) policy towards Germany after the First World War was not a
way of winning the peace16 was sadly confirmed by history.
12.11 The Bank for International Settlements was set up in 1930 in the context of the
Young Plan17 which dealt with the issue of the reparation payments imposed on Germany by
the Treaty of Versailles following the First World War. The BIS took over the functions
previously performed by the Agent General for Reparations in Berlin: collection,
administration, and distribution of the annuities payable as reparations. The BIS was also
created to act as a trustee for the Dawes and Young Loans (international loans issued to
finance reparations).18 Although the settlement of the reparations was the causa proxima
for setting up the BIS (indeed, the Bank’s name is derived from this role), the objectives of
the BIS were defined more broadly by its statutes,19 and the BIS was to act as a centre for
international central bank cooperation. But by the time the BIS started operations, the
world was sliding into depression. The Great Depression, that is, the economic contraction
from 1929 to 1933, was the most severe and widely diffused international contraction in
modern times and an unprecedented financial catastrophe. ‘Though sharper and more
prolonged in the United States than in most other countries, it [the Great Contraction] was
worldwide in scope.’20 Between 1929 and 1932 industrial production in the USA contracted
by 47 per cent. By March 1933, there were at least fourteen million unemployed.21
12.12 The United States rejected a proposed dollar–franc–pound stabilization plan at the
London International and Monetary Conference of 1933, a conference which ‘broke up in
disarray’.22 The demise of the gold standard, the end of reparations in 1933–4,23 and the
failures in international economic cooperation affected the role and relevance of the BIS.24
12.13 The political tensions in the 1930s spilt over domestic economic policy
considerations. As Harold James explains, ‘the depression also acted internally to destroy
the stability of democratic regimes. Throughout Europe and Latin America, parliamentary
regimes disintegrated in the face of their inability to deal with the economic crisis. At the
same time, the collapse of international collaboration reduced the incentive for states to
behave (p. 412) responsibly.’25 Everything that States did in the international economy
(trade policy, currency policy, and others) aimed at maximizing their own wealth and power,
driven by national considerations. ‘The country that excelled in trade and currency
manipulation of the international system for its own ends was National Socialist
Germany.’26
12.14 The economic breakdown was a contributing factor to the breakdown of peace.
D. The Keynes and White Plans

12.15 Any serious analysis of the origins of the Bretton Woods institutions must trace back
to the original proposals of the two men who drafted their foundations: Harry Dexter White
and John Maynard Keynes.27
12.16 Harry Dexter White joined the staff of the US Treasury in 1934 and resigned on 1
May 1946, to take up the post of US Executive Director of the Fund. He died in 1948. John
Maynard Keynes (later Baron Keynes of Tilton) combined a multifaceted career with the
position, from July 1940 until his death on 21 April 1946, of Honorary Advisor to the British
Treasury.
12.17 Both men firmly believed that the economic distress of the inter-war period could be
avoided after the end of the Second World War only by international economic cooperation.
Their proposals were drafted in 1941 and 1942, negotiated in 1943,28 and adopted at the
International Monetary and Financial Conference of the United and Associated Nations in
Bretton Woods, New Hampshire, in July 1944.
12.18 White’s proposal was greatly influenced by the experience of the Great Depression
in the USA, following the stock market crash of 1929. The prime objective of White’s
proposal was the establishment of a mechanism—‘a stabilization fund’ in his own words—
that would ensure the stability of currencies and avoid the recurrence of competitive
devaluations and of the restrictions on payments, as well as the setting up of a ‘bank for
reconstruction and development’. In the introduction to his plan, entitled ‘Preliminary Draft
Proposal for a United Nations Stabilization Fund and a Bank for Reconstruction and
Development of the United and Associated Nations’ and dated April 1942,29 he stated:
No matter how long the war lasts nor how it is won, we shall be faced with three
inescapable problems: to prevent the disruption of foreign exchanges and the
collapse of monetary (p. 413) and credit systems; to assure the restoration of
foreign trade; and to supply the huge volume of capital that will be needed virtually
throughout the world for reconstruction, for relief, and for economic recovery. If we
are to avoid drifting from the peace table into a period of chaotic competition,
monetary disorders, depressions, political disruptions, and finally into new wars
within as well as among nations, we must be equipped to grapple with these three
problems and to make substantial progress toward their solution.
12.19 Keynes’s proposal was inspired by a different set of events: an analysis of Britain’s
post-war prospects. Demand for imports would rise with the end of wartime austerity, while
Britain’s future capacity to export would be cut because of the wartime conversion of
industries to military manufacture and the difficulties of reconversion.30 Keynes proposed
the establishment of an international clearing union, aimed at avoiding balance of payments
imbalances through a set of rules governing the overdrafts on the Union accumulated by
debtors (such as the UK) and the positive balances acquired by creditors (such as the USA).
Keynes’s plan was entitled: ‘Proposals for an International Currency (or Clearing) Union’.31
12.20 Keynes spelt out his concerns for the UK economy after the Second World War:
This [an international clearing union] would give us, and all others, the great
assistance of multilateral clearing, whereby (for example) we could offset
favourable balances due to the United States or South America or elsewhere. How
indeed can we hope to afford to start up trade with Europe (which will be of vast
importance to us) during the relief and reconstruction period on any other terms?32
Keynes further regarded that an international currency (clearing) union—which in his

original plan also included the creation of a new international currency that he named
bancor—would support other international policies regarding, for example, trade (whose
importance was also emphasized by White), investment, and development,33 though he did
not design a specific institutional framework to deal with such other issues.
12.21 While the British proposal focused mainly on the work of the International Monetary
Fund, which Keynes referred to as the International Currency (or Clearing) Union, the US
proposal focused on the establishment of both a stabilization fund and a bank for
reconstruction and development. With regard to the stabilization fund, the system would be
tied to gold, not to the new international money proposed by Keynes, though by a kinder
and gentler tie than the gold standard. With regard to the bank for reconstruction and
development, Harry Dexter White was certainly the central figure in the birth of the World
Bank,34 though Keynes and other UK experts eventually became major enthusiasts for the
Bank, acknowledging that loans from creditor countries to debtor countries in the early
post-war period were essential to avoid economic chaos and that without them no
international monetary plan could have a fair start.35(p. 414) The World Bank,36 or more
properly speaking, the International Bank for Reconstruction and Development, had—as its
name indicated—two main goals, though the ‘development’ goal would eventually become
the primary one. The sequencing of these two goals was summarized by Lord Keynes in his
opening remarks at the first meeting of the Bretton Woods Commission on the Bank:
It is likely, in my judgement, that the field of reconstruction from the consequences

of war will mainly occupy the proposed Bank in its early days. But, as soon as
possible, and with increasing emphasis as time goes on, there is a second primary
duty laid upon it, namely to develop the resources and productive capacity of the
world, with special reference to the less developed countries.37
E. The Bretton Woods Conference

12.22 The International Monetary and Financial Conference of the United and Associated
Nations, commonly referred to as the Bretton Woods Conference, was held in Bretton
Woods, New Hampshire in July 1944. Delegates from forty-five nations (including the Soviet
Union, which, nevertheless, never became a signatory)38 as well as representatives of
international organizations attended the conference. As acknowledged, the world was still
at war in July 1944. And yet, the delegates at Bretton Woods were talking about, and indeed
were erecting a framework for, future international economic cooperation.
12.23 Though the role of the BIS as an existing international institution could have been
enhanced in the Bretton Woods Conference, instead, the Conference called for the
liquidation of the BIS. This was in part due to US hostility towards the institution, in the
light of its ‘blunders before and during the war’.39 (With the start of the Second World War,
the BIS had adopted a policy of neutrality in 1939,40 which was to be questioned by the
Allies.41) The Resolution calling for the liquidation of the BIS was included in its Final Act of
the Conference.42(p. 415) However, the institution was not dissolved and today plays an
important role as a centre for central bank cooperation and as an ‘umbrella organization’
for a panoply of committees involved in the process of setting international financial
standards, as I further explain in Chapter 14.
12.24 The setting up of the International Monetary Fund was the primary focus of the
Bretton Woods Conference, while the World Bank was—in the words of some commentators
—something of an ‘afterthought’.43
12.25 When the war was over, it was the Marshall Plan rather than the World Bank that
played the major role in the reconstruction and recovery of war-torn European economies.
As acknowledged, US Secretary of State George Marshall unveiled the ‘European Recovery
Program’ (which became known as the Marshall Plan) in his famous Harvard
commencement speech in June 1947, where he announced a programme of massive
financial assistance to Europe.44 As explained in Chapter 6, the Marshall Plan, which was
supervised by the US Economic Cooperation Administration (ECA), also created the
Organisation for European Economic Cooperation (OEEC) and contributed to the
establishment of a multilateral system of European payment: the European Payments Union
(EPU) (1949–50).45
F. The Bretton Woods Regime

12.26 The Bretton Woods regime can be characterized as the first international legal
system to govern the monetary relations of States.46 In contrast to the gold standard, the
IMF Articles of Agreement did impose legal obligations upon Member States.47 Though
these obligations have changed over time, the principles embodied in the IMF Articles of
Agreement still provide the legal basis for economic governance in the monetary field at the
international level.
12.27 The Articles of Agreement of the International Monetary Fund, adopted on 22 July
1944, came into force on 27 December 1945.
(p. 416) The par value regime and the original IMF Articles of Agreement
12.28 The International Monetary Fund began operations in Washington, DC in May 1946.
The first meeting of the Governors of the Fund and of the World Bank had taken place in
March 1946 at the General Oglethorpe Hotel, Wilmington Island, Savannah, Georgia. At
Savannah, the Governors agreed that the headquarters of the new institution should be in
Washington. Though the obvious original choice as Managing Director was an American,
Harry Dexter White, his reputation was tainted by allegations of involvement with the
Soviet cause. In May 1946, Camille Gutt, then Belgian Finance Minister, became the Fund’s
first Managing Director. ‘As a consequence, the President of the World Bank could only be
an American, and Eugene Meyer, a distinguished but elderly public servant, was appointed.
With these two men began a tradition of non-American (and in practice, at least until the
present, European) IMF Managing Directors, and American World Bank Presidents.’48
12.29 The par value regime, often referred to as the Bretton Woods regime, was a two-tier
system of convertibility, also known as the gold–dollar standard. According to this par value
regime, the value of currency of each participating member was defined in terms of gold or
alternatively in terms of the US dollar of 1 July 1944, which had a fixed gold value (one
ounce of gold was equal to USD 35).49
12.30 Article IV, section 1(a) of the original Articles of Agreement clearly stated:
The par value of the currency of each member shall be expressed in terms of gold as
a common denominator or in terms of the United States dollar of the weight and
fineness [sic] in effect on July 1, 1944.50
12.31 The US monetary authorities guaranteed the convertibility of the dollar into gold at
the fixed price of USD 35 per ounce of gold. The monetary authorities of the participating
countries committed themselves to convert their currency into dollars at a fixed price,
which was called the official exchange rate or the parity rate.51
The original Articles of Agreement foresaw the possibility of adjusting the rate of an
individual currency if it fell into a ‘fundamental disequilibrium’, a term which despite its
importance was not defined.52 Article IV, section 5 (a) concerning ‘changes in par values’
stated:(p. 417)
A member shall not propose a change in the par value of its currency except to
correct a fundamental disequilibrium.
12.32 The original Articles of Agreement also foresaw the possibility of readjusting all
currencies through the ‘uniform changes in par values’. For instance, if the world stock of
gold at USD 35 per ounce became too small for a growing world economy. According to
Article IV, section 7:
[T]he Fund by a majority of the total voting power may make uniform proportionate
changes in the par values of the currencies of all members, provided each such
change is approved by every member which has ten percent or more of the total of
the quotas.
12.33 The IMF’s mandate was to maintain the good order of this predictable and relatively
‘stable’ international monetary system, by enforcing rules about adjustment in international
monetary relations and by providing temporary resources to deal with short-term balance of
payments problems.
12.34 However, the faults in the system would soon become apparent. In the following
paragraphs the economic rationale behind the eventual abandonment of the system is
discussed first and, then, the ‘life’ of the system is reviewed.
The economic analysis of the collapse of the par value regime
12.35 The collapse of the Bretton Woods regime is often explained in economic terms by
the so-called Triffin dilemma, developed by Robert Triffin in 1960.53 Triffin argued that the
demands of a growing world economy would imply an increase in the demand for dollar
reserves. Though the US could supply these desired dollars by running balance of payment
deficits, the problem would arise because the supply of gold is more or less fixed (and
guided by new discoveries, technological developments in mining gold, and other factors).
In this scenario, if the US accommodated the increased demand for dollar reserves, it
condemned the system to its inevitable demise (by undermining confidence in the
convertibility of the dollar into gold, leading to a rush to convert dollars into gold and
eventually producing the collapse of the system); if it resisted those demands, it condemned
the world to deflation. Officials as well as academic economists came to accept Triffin’s
diagnosis.54 Concerns about liquidity in the international monetary system led to the
establishment of the Special Drawing Right (SDR) as a reserve asset in addition to gold and
dollars.
12.36 De Grauwe elaborates on the Triffin dilemma.55 He argues that the move from a
gold–dollar standard to a dollar standard can be further explained in economic terms by
Gresham’s law. The law applies to every monetary system based on the use of two
currencies where the monetary authorities fix an official price between the two and where,
in addition, they are willing to buy and sell the currencies at that price. If one of the two
currencies becomes relatively abundant, its private market price will tend to decline.
Economic agents will then buy it cheaply in the private market and sell it in the official
market at a higher official (p. 418) price. The scarce currency is taken out of the monetary
circuit and used for non-monetary purposes. The opposite occurs with the abundant
currency. In the case of the gold–dollar standard, gold (‘the good money’) was driven out of
the international monetary circuit to be used for private purposes (jewellery, art, dentistry,
etc), while dollars took the place of gold in the vaults of central banks.56
12.37 The reason why the Triffin problem was not handled quite simply by revaluing the
price of gold, as could have been done under Article IV, section 7 of the Articles of
Agreement, was political. The main beneficiaries would have been Russia, South Africa
(with gold mines), and the countries which were seeking to destabilize the United States by
holding their reserves in gold rather than in US dollars. Politically, it became effectively
impossible to revalue gold.57 According to Joseph Gold: ‘An increase in the price of gold, for
which the Articles [Art IV, section 7] make provision, was…rejected for various reasons, one
of which was that the direct benefit of the increase would be enjoyed only by those
members that held gold.’58
12.38 De Grauwe points out that the collapse of the Bretton Woods regime has some
characteristics that are repeated again and again in the history of the international
monetary system. He explains this recurring feature as follows: Central banks commit
themselves to defending a given exchange rate. After some time, they realize that it is no
longer in their interest to continue their commitment, because the exchange rate has
become ‘out of touch with reality’.59 Private speculators often anticipate that policy makers
will renege on their commitment, and precipitate its abandonment. By its very definition a
system of fixed exchange rates is vulnerable to speculative attacks and the credibility of
such a system is eroded when those attacks take place.60 The crisis in the exchange rate
and intervention mechanism (ERM) of the European Monetary System in September 1992 is
another example of this recurrent history.
The ‘life’ of the par value regime
12.39 Though the IMF was founded in 1944 and started operations in 1946, the ‘proper’
Bretton Woods regime did not start functioning till 1959, once European countries achieved
convertibility of their currencies.61 Since the Bretton Woods regime was abandoned at the
(p. 419) beginning of the 1970s, the ‘life’ of the par value regime was short and, as I explain
in this subsection, problematic.
Gold, reserves, and liquidity
12.40 The gold–dollar two-tier system of convertibility had an inherent flaw in that the
United States was willing to convert gold balances of dollars held by the monetary
authorities of other members, while private gold markets were permissible and were in
operation.62
12.41 In the beginning of the 1960s, it became clear that the gold reserves were
insufficient for the growing demands of the international monetary system. In order to
avoid the private price of gold increasing above the official price (USD 35 per ounce), the
central banks of Belgium, France, Germany, Italy, the Netherlands, Switzerland, the United
Kingdom, and the United States decided to form in 1961 a ‘gold pool’ to intervene in the
London gold market (the leading gold bullion market) to keep the price of gold at its official
level.63 The gold pool was a cooperative arrangement
whereby central banks sought to share the cost of maintaining the London price of
gold at $35 an ounce rather than depleting US gold reserves. It encouraged
collective action by establishing an understanding of how the costs of these
operations would be divided, that is, of what share of the gold that needed to be
sold in London in order to stabilize the market price would be provided by each
participating central bank.64
12.42 In 1967 and in 1968, the demand for gold became so great that the central banks
decided to abolish the ‘gold pool’.65 In March 1968, the authorities announced that the
price of gold in the private market would henceforth be determined by supply and demand
and that they would no longer intervene in the private gold market. From then on the price
of gold started to climb.66
12.43 Concerns about liquidity and the shortage of reserves led to the creation of the SDR,
as a supplementary reserve asset in the late 1960s (the first amendment to the IMF Articles
of Agreement).67
12.44 At the end of the 1960s, the gold–dollar ratio had declined so much that the US was
forced to suspend the convertibility of dollars into gold. According to De Grauwe, the gold
exchange standard ended de facto in 1968 with the collapse of the gold pool, though it was
formally abandoned on 15 August 1971 when US President Nixon ended the American
commitment to sell gold at a fixed price to foreign central banks.68 The major central banks
in turn ceased to guarantee the convertibility of their currencies into dollars at a fixed
price.
(p. 420) Devaluations, revaluations, and floating rates
12.45 Though the possibility of changes in the par value was foreseen in the original
Articles of Agreement and the procedure ‘to correct a fundamental disequilibrium’—Article
IV, section 5—was meant to be an orderly resolution of a problem or crisis,69 the reality of
the international monetary system turned out to be different. Crises are seldom—if ever—
orderly and their workout is seldom an orderly process. A sense of urgency prompts
countries (or individuals) to forego procedures and rules. Forbearance leads to lack of
credibility and lack of credibility may lead to the collapse of the system and/or to a
rewriting of the rules.
12.46 In the United Kingdom, domestic economic problems in the immediate post-war
period led to the adoption of a 30 per cent devaluation of the pound sterling on 19
September 1949. Other continental countries also devalued their currencies.70
Germany in the late 1950s and early 1960s presented a different set of circumstances:
economic growth and surpluses. This led the German cabinet to vote for a small revaluation
of the mark by 5 per cent in February 1961 to correct a disequilibrium in international
payments.71 The revaluation of the mark was followed by a revaluation of the Dutch guilder
in March 1961.72
12.47 Canada adopted a floating rate in 1950. Though the float was seen as a violation of
the par value principle, it actually allowed Canada to make the transition to external
convertibility at an early stage. In 1952, Canada accepted the obligations of Article VIII
(current account convertibility) under the IMF Articles of Agreement.73
(p. 421) In the United Kingdom, the second half of the 1960s was a difficult period for the
UK economy. Large current account deficits and a drain on British reserves forced the
devaluation of the British pound by 14.3 per cent in November 1967.74
12.48 The economic difficulties in France in 1968, following the student unrest and
widespread industrial strikes (eventually settled by large wage rises), led to the devaluation
of the French franc by 11 per cent in August 1969.75 Soon after the French devaluation, in
October 1969, a new parity was adopted for the Deutschmark, with a revaluation of 9.3 per
cent against the US dollar.76
The US dollar
12.49 The role of the dollar as the only currency expressly linked to gold succeeded only
while the US had a dominant economy and a dominant currency. The immediate post-war
period has been described as the period of ‘dollar hegemony’.77 But with the economic
recovery in Japan and Germany, the situation of the dollar became untenable. The US
position shifted from one of being a creditor country to one of being a debtor country,
running persistent deficits in its balance of payments. When the dollar had been perceived
as good as gold, countries had been happy to keep dollar reserves, but when the situation
reversed, the US authorities restricted the conversion of dollars into gold.
12.50 Amongst the ‘manifold and cumulative’ causes that put unsustainable pressure on
the dollar, Lowenfeld cites the following: the war in Vietnam, which affected the US budget
and the payments position; the rise in imports from Japan; the continuing direct foreign
investment by corporations based in the United States; and a very different overall
economic climate from that of the early post-war period.78
12.51 In the spring of 1971 the IMF Managing Director suggested the devaluation of the
dollar, which the United States rejected. In May 1971 the German Government unilaterally
decided to float the mark upwards. Subsequently, the Dutch guilder was also floated
upwards against the dollar. ‘The German float suddenly transferred the force of global
speculative pressures against the dollar to Japan.’79 The yen was not permitted to float, but
the Bank of Japan had to acquire billions of US dollars to maintain the par value of the
yen.80 Sunday, 15 August 1971 marks the day on which the ‘gold window’ was closed.
Moreover, the US would not intervene in exchange markets to defend the par value of the
dollar against other currencies. The measures announced by President Nixon in a televised
address signified the end of the Bretton Woods par value regime. The faults of the system,
though, had been in evidence for some time.
A note on the notion of reserve currency
12.52 A national currency can be used as an ‘international currency’ if there is confidence
that it will maintain a stable purchasing power. If a country is a major participant in world
trade (p. 422) and a major source of capital, residents and central banks of other countries
will find it convenient to hold balances of its currency.81 With the demise of gold as the
main reserve asset of the international monetary system, the notion of ‘reserve currency’
became more relevant.
12.53 The characteristic of becoming a ‘reserve currency’ is typically associated with the
feature of being a ‘vehicle currency’, that is, a currency used to denominate international
trade and capital transactions.82 Confidence in the value of the currency, convertibility,
political stability, and liberalized financial markets are conditions typically associated with
vehicle currencies.83 The dollar emerged as a major international currency at the end of the
First World War, and after the Second World War it became the main ‘reserve currency’ and
‘vehicle currency’.84 Frankel explains why the US dollar is the most important vehicle
currency, reserve currency, and all-round international currency.85 He mentions historical
considerations, patterns of trade and finance, well-developed financial markets, and
confidence in the value of the currency. The US dollar thus fulfils a dual role: that of being
the national currency of the US, and the ‘world’s currency’ of choice. McKinnon had
predicted that a move to floating rates would not reduce the private demand for US dollars
(only the official demand).86 This is indeed what happened following the collapse of the
Bretton Woods regime.
12.54 Being a ‘reserve currency’ has both advantages and shortcomings. General de
Gaulle famously spoke of the ‘exorbitant privilege’ of the United States of being able to
acquire investments abroad with its own currency.87 However, the position of the pound
sterling as a reserve currency became a burden for the UK in the 1960s and ‘the instability
caused by the sterling balance overhang and the danger of liquidation in fact lay behind
each of the major British crises of the second half of the 1960s.’88
In recent years, other currencies such as the euro and the Japanese yen have been
increasingly used in international transactions and as reserves.
(p. 423) G. The Second Amendment to the IMF Articles of
Agreement
12.55 In the beginning of the 1970s, the par value regime was de facto abandoned.
Attempts at repairing the collapsed system, such as the Smithsonian Agreement of 18
December 1971, failed. Speculative pressures in 1972 and 1973 led some members to
abandon the fixed exchange rates for their currencies. ‘On February 12, 1973, the United
States announced that it intended to propose a further devaluation in the par value of the
US dollar. This change became effective on October 18, 1973.’89
12.56 The worldwide change from fixed to floating exchange rates triggered the second
amendment to the IMF’s Articles of Agreement, which was adopted on 30 April 1976 and
which came into effect on 1 April 1978, allowing members to choose their exchange
arrangement and to determine the external value of their currency. Sir Joseph Gold, then
General Counsel of the IMF, wrote in 1976:
On August 15, 1971, the United States, having decided to free itself from certain
constraints that had become unacceptable and to exercise greater autonomy for
national policies, suspended the convertibility into gold or other reserve assets of
balances of US Dollars held by the monetary authorities of the other members of
the Fund. This action made it clear that certain fundamental assumptions on which
the Articles had been agreed at the Bretton Woods conference in July 1944 were
now disputable or even untenable. In due course, the Committee of Board of
Governors of the Fund on Reform of the International Monetary System and Related
Issues (the Committee of Twenty)…was appointed to negotiate reform of the
International Monetary System. …On March 31, 1976, the Executive Board agreed
on the modifications of the Articles that it would recommend, and sent to the Board
of Governors a Report entitled ‘Proposed Second Amendment to the Articles of
Agreement of the International Monetary Fund’. The Board of Governors approved
the proposed second amendment on April 30, 1976.90
12.57 The Second Amendment sanctioned de jure what was already the actual behaviour
of the IMF Member States.
The key amendment was Article IV, concerning the ‘obligations regarding exchange
arrangements’, which I further discuss in Chapter 13. The new Article IV, section 2(b),
which allows members freely to choose their exchange arrangement, reads as follows:
Under an international monetary system of the kind prevailing on January 1, 1976,

exchange arrangements may include (i) the maintenance by a member of a value for
its currency in terms of the special drawing right or another denominator, other
than gold, selected by the member or (ii) cooperative arrangements by which
members maintain the value of their currencies in relation to the value of the
currency or currencies of other members or (iii) other exchange arrangements of a
member’s choice.
12.58 Since the entry into force of the Second Amendment, the Fund has had no
substantive legal rights with respect to the choice of exchange rate arrangements of its
members. Members, though, must behave in the manner prescribed by the amended
Articles. However, the obligations of Article IV, section 1, are rather generic in their
formulation (‘endeavour (p. 424) to…’, ‘seek to promote…’), with the exception of Article IV,
section 1(iii), which specifically requests members to ‘avoid manipulating exchange rates…
to gain an unfair competitive advantage over other members’.
12.59 Nonetheless, Sweden flouted this ‘specific’ obligation in 1982, when Prime Minister
Olaf Palme announced a devaluation of the Swedish krona by 16 per cent to improve
conditions for Swedish industry. The IMF Executive Board, following the complaints of the
other Nordic countries that Sweden was seeking an unfair advantage, met to discuss
Sweden’s action, but took no specific formal decision nor imposed any sanction against
Sweden.91
12.60 The Second Amendment places the functions of surveillance at the centre of the
Fund’s activities.92 From being a virtually self-enforcing arrangement, surveillance now
becomes a function in which judgement is of the essence.93 According to Article IV, section
3(a),
The Fund shall oversee the international monetary system in order to ensure its
effective operation, and shall oversee the compliance of each member with its
obligations under Section 1 of this Article.
12.61 Article IV, section 3(b) further states:
[T]he Fund shall exercise firm surveillance over the exchange rate policies of
members, and shall adopt specific principles for the guidance of all members with
respect to those policies.94
12.62 The members are obliged to cooperate with the Fund by supplying all the
information necessary to allow the Fund to perform effective bilateral surveillance. Apart
from the changes inherent in the adoption of flexible exchange rates, surveillance of
national policies becomes more complex when countries embark on programmes of trade
and financial liberalization, as I further discuss in Chapter 13. The opening up of the
economy raises important challenges and sets into motion a process of regulatory reform.
The choice of exchange regime in the absence of an international legal
obligation to ‘maintain’ exchange rate stability
12.63 Countries face a wide variety of options regarding the choice of exchange regime,
since they are under no international legal obligation to ‘maintain’ a given exchange rate or
exchange regime.95 A country can let market forces determine the exchange rate (flexible
rates, freely (p. 425) floating according to market discipline) or can control its exchange
rate through some form of official rules. Countries can achieve the fixity of rates through
the establishment of a common central bank, by adopting a common monetary standard (eg,
the gold standard), or through some other monetary arrangement (eg, a currency board).
However, according to Sam Cross, ‘fixity’ is a thing that either you have or you do not. It is
a matter of ‘yes or no’, and not a ‘matter of degree’. ‘There seems to be a kind of Murphy’s
law of exchange markets, which says that any exchange rate that can change eventually will
change and that there are speculators who will bet that way.’96
12.64 The reality of exchange markets is that exchange rates do fluctuate. Under a system
of flexible exchange rates, such variations (appreciation or depreciation of the currency vis-
à-vis other currencies) are triggered by market forces. Under a system of government-
controlled exchange rates, such variations (devaluation or revaluation) are officially
imposed decisions.97 According to Gold: ‘These formal distinctions [pegged or floating
currencies] may be misleading. The exchange rate for a floating currency may be managed
in order to make it hover more or less around a desired level. The peg for a pegged
currency may be changed so often that the exchange rate fluctuates almost as much as one
that floats.’98
12.65 Pegging is often used as a policy tool of stabilization. The credibility of the ‘peg’ is
conditional upon the rules adopted by the countries under a bilateral or multilateral
pegging arrangement. Two historical examples of multilateral pegging are the Bretton
Woods regime and the experience of the ERM of the European Monetary System before the
advent of economic and monetary union (EMU). As for bilateral pegging there are multiple
examples in Asia and Latin America.99
12.66 A government can peg its exchange rate to a single currency or to a basket of
currencies, let the rate ‘crawl’, adopt a dual exchange rate (eg, a fixed rate for current
account transactions and a floating rate for capital account transactions), or conduct a
managed float. Target zones suggest that exchange rates can vary within given bands
(narrow or wide, soft or hard).100 There is a strong body of economic analysis and theory
that believes that (p. 426) an intermediate regime, with some kind of peg, is unsustainable
under conditions of free capital movements (the ‘Walters critique’ of all pegged but
adjustable exchange rates).101 Following the experience of the ERM in 1992 and 1993, that
viewpoint is widely shared. If one cannot easily maintain a peg, then the alternatives are
either a fixed rate system or a relatively free floating one.
12.67 Some economists, such as Steve Hanke, differentiate between pegged and fixed
exchange rates.102 Pegged rates (adjustable pegs, bands, crawling pegs, managed floats,
etc) require the monetary authority to manage the exchange rate and monetary policy
simultaneously. With a fixed rate, a monetary authority sets the exchange rate, but has no
monetary policy. The same actually happens with a ‘clean’ floating, when the monetary
authority sets only monetary policy, but leaves the determination of the exchange rate to
market forces. Hanke points out that if a country adopts a fixed exchange rate regime such
as an orthodox currency board or official dollarization, it must give up its autonomy in
monetary policy. If a country has a pegged exchange rate it must restrict capital mobility to
avoid balance of payments and currency crises.103
12.68 Whether a country should fix the external value of its currency to another currency
(or to a basket of currencies) or whether it should let it be freely determined in the foreign
exchange market is a hotly debated issue in the economic literature.104 The case for
floating exchange rates was clearly made by Milton Friedman in his seminal paper ‘The
Case for Flexible Exchange Rates’.105
Exchange rate stability remains something to be ‘promoted’ according to Article I of the
IMF Articles of Agreement, but there is no international legal obligation to ‘maintain’
exchange rate stability.106
H. Concluding Observations

12.69 This chapter—bringing together legal, economic, and political considerations—has
analysed the history of international monetary cooperation in the twentieth century. The
Bretton Woods institutions created in 1944 have survived the passage of time, though the
role of the IMF has been substantially altered with the abandonment of the par value
regime at the beginning of the 1970s and the worldwide change from fixed to floating
exchange rates.
12.70 At the international level, there is no central authority with the ability to issue a
‘global currency’ (Keynes’s proposal in this regard was rejected). Since it is highly unlikely
that such a world authority will emerge in the near future (or that the IMF will be entrusted
with such (p. 427) a role), one has to conclude that the supply of currencies at an
international level will remain a competitive business, even though regional currency blocs
are likely to emerge. Indeed, this is the case already with the Eurozone.
Though the International Monetary Fund was conceived as an international monetary
institution (and such a feature remains part of its idiosyncrasy), its role has expanded over
the years, as I further discuss in Chapters 13 and 14. The challenges faced by the
institution have changed over the years: stabilization in the late 1940s; convertibility in the
1950s; liquidity in the 1960s; flexibility in the 1970s with the abandonment of the par value
regime and the new economic circumstances; international debt crises in the 1980s;
transition to a market economy in the former communist countries in the beginning of the
1990s; financial crises in South-East Asia, Russia, Brazil, and elsewhere in the late 1990s;
the global financial crisis (2007–9) and sovereign debt crisis in the Eurozone (2010–12) at
the beginning of the twenty-first century. The IMF has become an international financial
institution (IFI) dealing with a wide variety of financial issues: financial reform, capital
markets, financial crises, financial stability and sovereign debt crises.
12.71 As we move into the second part of the first decade of the twenty-first century, the
words of Henry Morgenthau, in the opening remarks at the 1944 Bretton Woods conference
still resonate. Indeed, they seem appropriate to describe the challenges that the IMF and
the international community currently face and are likely to face in years to come:
Prosperity has no fixed limits. It is not a finite substance to be diminished by

division. On the contrary the more of it that other nations enjoy, the more each
nation will have for itself…Prosperity like peace is indivisible. We cannot afford to
have it scattered here or there among the fortunate or to enjoy it at the expense of
others. Poverty, where it exists, is menacing to us all and undermines the well-being
of each of us. It can no more be localized than war (emphasis added).107
(p. 428)
Footnotes:
1
See Gianni Toniolo, Central Bank Co-operation at the Bank for International Settlements:
1930–1973 (Cambridge: Cambridge University Press, 2005) ch 1. See also Marc Flandreau,
‘Central Bank Co-operation in Historical Perspective: a Sceptical View’ (1997) 4 Economic
History Review 735, for an analysis of the pre-1914 period, and Barry Eichengreen, ‘Central
Bank Co-operation and Exchange Rate Commitments: The Classical and Inter-war Gold
Standards Compared’ (1995) 2 Financial History Review 99.
2
There are three dimensions to the economic relations between States: trade, money, and
investment. These relations can be cooperative, conflicting, or non-existent. In the latter
case, the State retrenches to an inward-looking economic policy of isolationism and
protectionism. Conflicts—of any sort—are unavoidable; however, the existence of a rule-
based framework for the resolution of international economic conflicts can help promote
cooperation. If such a framework does not exist, or if it is not respected, economic conflicts
will either lead to the deterioration (or rupture) of economic relations between the States
involved or will turn into a political conflict with the possibility of severance of diplomatic
ties or, even worse, of a military backlash.
3
An excellent historical account of the ITO (in the context of the Bretton Woods system),
GATT, and WTO is provided by John Jackson, The World Trade Organization: Constitution
and Jurisprudence (London: Royal Institute of International Affairs, 1998) ch 2. Despite the
provisional character of GATT, it proved to be a rather permanent institution nevertheless,
playing a significant role in international trade for almost five decades. Jackson points out
(15–16) that the Bretton Woods conference was held under the jurisdiction of ministries of
finance, while trade was under the competence of different ministries. However, he also
notes that ‘the 1944 conference is on record as recognising the need for a comparable
institution for trade, to complement the monetary institutions.’ A succinct summary can be
read at Richard N Gardner, ‘The Bretton Woods–GATT System After Sixty-Five Years: A
Balance Sheet of Success and Failure’ (2008) 47 Columbia Journal of Transnational Law 31.
4
In John Maynard Keynes, The Economic Consequences of the Peace (London: Macmillan,
1919) (cited by Arminio Fraga, German Reparations and Brazilian Debt: a Comparative
Study (Princeton, NJ: Princeton University Press, 1986)) Keynes had forcefully argued that
the reparations payments discussed in Versailles were far too high. He also argued that
post-war prosperity required a lower level of reparations and a cancellation of inter-ally
indebtedness incurred during the war.
5
See Andreas Lowenfeld, International Economic Law (Oxford: Oxford University Press,
2002) 18.
6
See generally Michael Bordo, ‘The Gold Standard: the Traditional Approach’ in Michael
Bordo and Anna J Schwartz (eds), A Retrospective on the Classical Gold Standard 1821–
1931 (Chicago: Chicago University Press, 1984). For a brief explanation, see Marcello de
Cecco, ‘Gold Standard’ in Peter Newman, Murray Milgate, and John Eatwell (eds), Palgrave
Dictionary of Money and Finance (London: Macmillan Press Ltd, 1992).
7
England was the first country to adopt a de facto gold standard in 1717. By 1870, most
countries had abandoned bimetallism and opted for gold. See Michael Bordo, ‘Gold
Standard: Theory’ in Newman et al (eds), above note 6.
8
See Paul de Grauwe, International Money: Post-War Trends and Theories (Oxford: Oxford
University Press, 1990) 11.
9
De Grauwe, above note 8, 16, provides an interesting three-stage story of international
money and the shift from a metallic currency to paper money. In the first stage (gold
standard), the gold was deposited in the vaults of the banks. In the second stage (Bretton
Woods regime), the gold was centralized in the central bank, and the private banks replaced
the gold convertibility by the convertibility of their liabilities into currency (the liability of
the central bank). In the third stage (breakdown of Bretton Woods regime), the central
banks abolished the gold convertibility of their national currencies. This leads De Grauwe to
conclude: ‘the history of international money is to a certain extent a rerun of the history of
national moneys’.
10
Lowenfeld, above note 5, 500. ‘No international legal obligation required adherence to
the gold standard, and it collapsed almost overnight at the start of World War I.’
11
De Grauwe, above note 8, 15.
12
De Grauwe, above note 8, 15. With regard to the difference between the ‘pure’ gold
standard and the ‘gold exchange’ standard, Geoffrey Wood explains:
The gold exchange standard evolved from the gold standard to economise on gold.
Some central banks held gold in their reserves, but others held not gold but the
currency of countries whose reserves did comprise gold. These central banks which
held all or large part of their reserves in the currency of a country whose reserves
were comprised entirely of gold were said to be on a gold exchange standard.
Before World War I, if a currency was held as a reserve, it was primarily sterling;
that system is often described as a sterling–gold exchange system. Under the
Bretton Woods system after World War II, the currency held as a reserve was
primarily the US dollar and the system was accordingly described as a dollar–gold
exchange standard.
See Geoffrey Wood, ‘Gold Exchange Standard’ in Newman et al (eds), above note 6.
13
See Toniolo, above note 1, ch 2. Toniolo’s book provides an excellent study of the history
of the BIS from its inception until 1973.
14
Toniolo, above note 1, 20. With regard to the Genoa conference, Toniolo recalls that
Benjamin Strong (of the Fed) opposed the conference knowing that the British intended to
discuss the gold standard. A resolution of the Genoa conference declared that the re-
establishment of a stable value of money was essential for the economic reconstruction of
Europe. The Genoa conference resolutions mark ‘the first uncompromising international
recognition of the desirability of formal co-operation among central banks’. Toniolo (19) also
refers to an economic conference in Brussels in 1920 where loans for the reconstruction of
the European economies and calls for central bank independence were discussed.
15
See generally Barry Eichengreen, Golden Fetters: The Gold Standard and the Great
Depression, 1919–1939 (New York: Oxford University Press, 1992). With regard to the end
of the ‘inter-war gold standard’, see Toniolo, above note 1, ch 5.
16
Keynes, above note 4.
17
See Toniolo, above note 1, 33–4. The Young Plan was named after Owen D Young, an
American Banker who presided over a Committee of Experts convened to work out a final
settlement on German reparations. I further refer to the BIS in Chapter 14 in this volume.
18
See Bank for International Settlements website, at <http://www.bis.org> (last visited 12
August 2014). The BIS was to take over the functions previously performed by the Agent
General for Reparations in Berlin: collection, administration, and distribution of the
annuities payable as reparations. The Bank’s name is derived from this original role. The
BIS was also created to act as a trustee for the Dawes and Young Loans (international loans
issued to finance reparations) and to promote central bank cooperation in general.
19
BIS Statutes (20 January 1930; as amended on 27 June 2005), Art 3, at <http://
www.bis.org/about/statutes-en.pdf> (last visited 12 August 2014) states: ‘The objects of the
Bank are: to promote the cooperation of central banks and to provide additional facilities
for international financial operations, and to act as trustee or agent in regard to
international financial settlements entrusted to it under agreements with the parties
concerned.’
20
See Milton Friedman and Anna Schwartz, The Great Contraction 1929–1933 (Princeton:
Princeton University Press, 1965) 3.
21
See J Keith Horsefield, The International Monetary Fund 1945–1965. Vol I: Chronicle
(Washington, DC: IMF, 1969) 5.
22
Lowenfeld, above note 5, 500. See also Toniolo, above note 1, 144–9.
23
Toniolo, above note 1, ch 5.
24
Toniolo, above note 1, 167–75, also refers to the American misgivings towards the BIS,
which would turn into outright hostility.
25
See Harold James, International Monetary Cooperation since Bretton Woods
(Washington, DC/Oxford: IMF/Oxford University Press, 1996) 26.
26
James, above note 25, 32.
27
This section of the chapter draws on Rosa M Lastra, ‘The International Monetary Fund
in Historical Perspective’ (2000) 3 Journal of International Economic Law 507, 507–23 and
Rosa M Lastra, ‘The Bretton Woods Institutions in the XXIst Century’ in Rosa M Lastra (ed),
The Reform of the International Financial Architecture (London: Kluwer Law International,
2001) 67–90. For a recent extended analysis on the topic see the recent publication by Benn
Steil, The Battle of Bretton Woods. John Maynard Keynes, Harry Dexter White, and the
Making of a New World Order (Princeton, NJ: Princeton University Press, 2013).
28
Their proposals were presented to the public in April 1944 as ‘The Joint Statement of
Experts on the Establishment of an International Monetary Fund’. See Toniolo, above note
1, 260.
29
This proposal is reproduced in J Keith Horsefield, The International Monetary Fund
1945–1965. Vol III: Documents (Washington, DC: IMF, 1969) 37–82 (though it omits the
Articles for the Bank). The final version of Mr White’s plan was issued by the US Treasury
in printed form on 10 July 1943, and is reproduced in Horsefield, vol III, 83–96.
30
See James, above note 25, 35.
31
John Maynard Keynes, ‘Proposals for an International Currency (or Clearing) Union’,
fourth draft (1942) is reproduced in Horsefield, above note 29, 3–18. The final draft which
was issued by the British Government in April 1943 as a White Paper (Cmd 6437) is
reproduced in Horsefield, above note 29, 19–36. The title of the final British draft dropped
the word currency and was simply entitled: ‘Proposals for an International Clearing
Union’ (hereinafter Keynes, Proposals).
32
See Keynes, Proposals, above note 31, para 10.
33
See Keynes, Proposals, above note 31, para 54.
34
Indeed, as Mason and Asher recall, ‘the Bank was essentially a U.S. proposal’. See
Edward S Mason and Robert E Asher, The World Bank since Bretton Woods (Washington,
DC: The Brookings Institution, 1973) 13.
35
See James, above note 25, 52.
36
Nowadays, the name World Bank is given both to the International Bank for
Reconstruction and Development and to the World Bank Group. The World Bank Group
comprises five institutions: the International Bank for Reconstruction and Development (set
up in 1944, the original Bretton Woods institution), the International Development
Association (set up in 1960 to deal with the world’s poorest countries), the International
Finance Corporation (set up in 1956, as the private-based arm of the World Bank Group),
the Multilateral Investment Guarantee Agency (set up in 1988 to provide insurance against
political risk), and the International Centre for the Settlement of Investment Disputes (set
up in 1966 for the resolution of investment conflicts).
37
See Mason and Asher, above note 34.
38
James, above note 25, 70, recalls the considerations that led the Soviet Union not to sign
the Bretton Woods agreements. The decision not to subscribe to the IMF Articles of
Agreement was first presented by the then Soviet Finance Minister, Molotov, as a
postponement. Interestingly, James points out that ‘[t]he Soviet postponement of a decision
on membership of the Bretton Woods institutions is a useful chronological mark of the
beginning of the Cold War.’ At a meeting of the General Assembly of the United Nations in
1947, the Soviet representative charged that the Bretton Woods Institutions were merely
‘branches of Wall Street’ and that the Bank was ‘subordinated to political purposes which
make it the instrument on one great power’. The incident is recalled by Mason and Asher,
above note 34, 29 (n 46).
39
See Toniolo, above note 1, 259 and 279–80: ‘Hostility towards the BIS at Bretton Woods
was rooted in a number of factors. One of these was the vague, if pervasive feeling that the
Bank was surreptitiously siding with Germany. …That aside, there were two political
reasons why the US Treasury…was opposed to the very existence of the BIS. There seemed
to be no place for the BIS in the framework envisaged at Bretton Woods. …Domestic
political considerations also played a role.’
40
Toniolo, above note 1, 215.
41
Toniolo, above note 1, 216 and generally ch 7 (‘Wartime’).
42
Toniolo, above note 1, 260 and 271.
43
See Mason and Asher, above note 34, 2.
44
See James, above note 25, 74:
In 1946, the Western European trade deficit with the United States had been $2,356
million, and in 1947 it rose to $4,742 million. In its first year of operation (April
1948–June 1949), the European Recovery Program, ERP, made $6,221 million
available, and then $4,060 million in 1949–50 and $2,254 in 1950–51.
45
The formal proposal for an EPU came in December 1949 from the ECA. It was designed
as a provisional measure until it is possible to establish, by other methods, a multilateral
system of European payments. See James, above note 25, 76.
46
See Lowenfeld, above note 5, 500: ‘Prior to the close of World War II no international
legal regime governed the conduct of states with respect to monetary affairs.’ See also
James, above note 25, 57: ‘The Bretton Woods meeting was the first conference to establish
a permanent institutional and legal framework for ensuring cooperation between states,
requiring commitments by states to limit their sovereignty for the sake of cooperation and
to observe specified rules in economic intercourse.’
47
See Manuel Guitián, ‘The Unique Nature of the Responsibilities of the International
Monetary Fund’, IMF Pamphlet Series No 46 (1 December 1996) 2, at <https://
www.imf.org/external/pubs/cat/longres.aspx?sk=113.0> (last visited 12 August 2014):
‘Bretton Woods constituted the first formal international agreement applicable for economic
transactions among the countries that had subscribed to it.’
48
49
Lowenfeld, above note 5, 524:
For original parties to the IMF whose territory had not been under enemy
occupation, the par value was required to be based on the exchange rate prevailing
on the sixtieth day before the agreement entered into force, which turned to be
December 27, 1945, subject to negotiation between the Fund and the member state
within 90 days [Original IFM Articles, Art XX(4)(a)]. Other States could set their
own par values, but they were required to do so and to notify the Fund.
50
The original IMF Articles of Agreement can be found at <http://imfsite.org/origins/
original/> (last visited 12 August 2014) (hereinafter original IMF Articles).
51
See De Grauwe, above note 8, 15.
52
Harry Dexter White, in an unpublished memorandum of August 1946, reproduced in
Joseph Gold, ‘The Legal Structure of the Par Value System’ (1973) 5 Law and Policy
International Business 155, 161, explains why such a term was not defined:
In the drafting of the Articles of Agreement, no attempt was made to define

fundamental disequilibrium. This, as we know, was not oversight. It was generally
agreed that a satisfactory definition would be difficult to formulate. A too rigid or
narrow interpretation would be dangerous; one too loose or general would be
useless in providing a criterion for changes in currency parities. It was felt that the
matter was so important, and the necessity for crystallization of a harmonious view
so essential that it was best left for discussion and formulation by the Fund.
Because of the key position of the term and the importance attached to its precise
meaning, it would be desirable, if possible, to reach agreement on a tentative
formulation before any definitive position to be taken by any of the officials of the
Fund.
53
Robert Triffin, Gold and the Dollar Crisis (New Haven, CT: Yale University Press, 1960).
54
Wood, above note 12.
55
De Grauwe, above note 8, 22–6.
56
57
I thank Charles Goodhart for observations on this point.
58
Joseph Gold, ‘Law and Reform of the International Monetary System’ (1975) 10 Journal
of International Law and Economics 371, 385. Others solutions which were rejected were
the general abandonment of par values, and general increases in quotas (Gold, 386).
59
60
61
After the Second World War, the European countries which had taken part in the war (as
well as Japan) were devastated and in desperate need of imports of machinery and essential
consumer goods, many of them coming from the United States. If a free market had been
allowed, the US dollar would have risen to very high levels. Exchange controls were
therefore introduced. But, shortly thereafter, a recovery and continuing fast rate of growth
of productivity in continental Europe (and Japan) meant that the currencies in these
countries became increasingly competitive against the US dollar, and the balance of trade
moved in favour of continental Europe and Japan. I thank Charles Goodhart for observations
on this point. As I explained in Chapter 6 in this volume, the European Payments Union was
established in 1950 as a mechanism for settling payments amongst European countries. By
1958–9, member currencies became de facto fully convertible, ie, transferable between
each other, and de jure in 1961, on formal acceptance of the obligations of Art VIII of the
IMF Articles of Agreement (which I further discuss in Ch 13). See also De Grauwe, above
note 8, 19.
62
This point is made by Gold. See Joseph Gold, ‘Gold in International Monetary Law:
Change, Uncertainty and Ambiguity’ (1981) 15 Journal of International Law and Economics
323, 338.
63
Gold, above note 62, 338–41, explains the history of the ‘gold pool’.
64
See Barry Eichengreen, ‘The Dollar and the New Bretton Woods System’, Henry
Thornton Lecture, delivered at the Cass School of Business (15 December 2004) 5, at
<http://eml.berkeley.edu/~eichengr/policy/cityuniversitylecture2jan3-05.pdf> (last visited
12 August 2014).
65
Eichengreen, above note 64, 5: ‘It collapsed in 1968 after French gold purchases
became known and was followed by a short-lived Gentleman’s Agreement that collapsed in
1970.’ See also Norman Humphreys, Historical Dictionary of the International Monetary
Fund, 2nd edn (Lanham, MD: The Scarecrow Press, 1999), entry ‘gold pool’.
66
67
68
69
Original IMF Articles, Art IV, s 5(b)–(f) specified the procedure to follow to change the
par value in the case of a fundamental disequilibrium. Because of its significance, I
reproduce in this note the whole text of Article IV, s 5:
a. A member shall not propose a change in the par value of its currency
except to correct a fundamental disequilibrium.
b. A change in the par value of a member’s currency may be made only on the
proposal of the member and only after consultation with the Fund.
c. When a change is proposed, the Fund shall first take into account the
changes, if any, which have already taken place in the initial par value of the
member’s currency as determined under Article XX, Section 4. If the proposed
change, together with all previous changes, whether increases or decreases,
i. does not exceed ten percent of the initial par value, the Fund shall
raise no objection;
ii. does not exceed a further ten percent of the initial par value, the
Fund may either concur or object, but shall declare its attitude within
seventy-two hours if the member so requests;
iii. is not within (i) or (ii) above, the Fund may either concur or object,
but shall be entitled to a longer period in which to declare its attitude.
d. Uniform changes in par values made under Section 7 of this Article shall
not be taken into account in determining whether a proposed change falls
within (i), (ii), or (iii) of (c) above.
e. A member may change the par value of its currency without the
concurrence of the Fund if the change does not affect the international
transactions of members of the Fund.
f. The Fund shall concur in a proposed change which is within the terms of (c)
(ii) or (c) (iii) above if it is satisfied that the change is necessary to correct a
fundamental disequilibrium. In particular, provided it is so satisfied, it shall
not object to a proposed change because of the domestic social or political
policies of the member proposing the change.
70
71
James, above note 25, 114–15.
72
73
74
75
76
77
James, above note 25, 90. See generally Richard Gardner, Sterling-Dollar Diplomacy:
The Origins and Prospects of Our International Economic Order (New York: McGraw-Hill,
1969).
78
Lowenfeld, above note 5, 526.
79
80
Lowenfeld, above note 5, 526.
81
See Jacques J Polak, ‘Reserve Currency’ in Newman et al (eds), above note 6. The IMF
Articles of Agreement, Art XXX(f) define a ‘freely usable currency’:
A freely usable currency means a member’s currency that the Fund determines (i)
is, in fact, widely used to make payments for international transactions, and (ii) is
widely traded in the principal exchange markets.
82
See George Tavlas, ‘Vehicle Currency’ in Newman et al (eds), above note 6.
83
Tavlas, above note 82.
84
See generally Peter Kenen, ‘The Role of the Dollar as an International Currency’, Group
of Thirty Occasional Paper No 13 (1983).
85
See Jeffrey Frankel, ‘Dollar’ in Newman et al (eds), above note 6.
86
See Ronald McKinnon, Private and Official International Money: The Case for the Dollar
(Princeton, NJ: International Finance Section, Dept of Economics, Princeton University,
1969).
87
Polak, above note 81:
The mythical ‘advantages; of being a reserve centre are mostly based on a

misconception. French President Charles de Gaulle spoke of the ‘exorbitant
privilege of the United States’ of being able to acquire investments abroad with its
own currency. …Both the United Kingdom and the United States have at times felt
constrained in the pursuit of domestic monetary policy, by the international
‘overhang’ of foreign holdings of currency that holders might liquidate in their
currency markets.
88
James, above note 25, 186. James also notes (188) that ‘[f]or the Americans the attack
on one reserve centre [British sterling] appeared to be a dangerous anticipation of the
vulnerability of the other.’
89
Gold, above note 58, 392.
90
See Joseph Gold, A Report on Certain Legal Developments in the International Monetary
Fund (Washington, DC: World Association of Lawyers, 1976) 1–4.
91
The incident is recalled by Lowenfeld, above note 5, 536–7.
92
The function of surveillance is further discussed in Chapter 13 in this volume.
93
See Manuel Guitián, ‘The IMF as a Monetary Institution: The Challenge Ahead’ (1994)
31(3) Finance and Development 38.
94
On 29 April 1977, the Fund adopted a decision entitled ‘Surveillance over Exchange
Rate Policies’, which was replaced by a new Decision on ‘Bilateral Surveillance of Member
Policies’ on 15 June 2007. Later, in order to expand the key modalities of bilateral
surveillance to multilateral surveillance, the Fund issued a new Decision on ‘Bilateral and
Multilateral Surveillance’ or Integrated Surveillance Decision (ISD) on 18 July 2012. I
further refer to these decisions in detail in Chapter 13 in this volume.
95
See Charles Proctor, Mann on the Legal Aspect of Money, 6th edn (Oxford: Oxford
University Press, 2005) 564: ‘A clearly defined and self-standing legal duty to maintain
stable currencies [stability of exchange rates] does not at present exist.’ With regard to the
lack of an legal obligation to maintain exchange rate stability, it is worth considering the
following observations by Joseph Gold, A Third Report on Some Recent Legal Developments
in the International Monetary Fund (Washington, DC: World Association of Lawyers, 1978)
7–8:
Under the Second Amendment, the Fund has clear authority to concern itself with
the domestic policies of members because only orderly underlying conditions can
promote a system of stable exchange rates. The objective, however, is not exchange
stability, because the accusation is made that it did degenerate into exchange
rigidity, but a stable system of exchange rates. Stability is not incompatible with
flexible exchange rate arrangements provided that a member’s policies produce
orderly underlying conditions (emphases added).
96
See Sam Cross, ‘Thoughts on the International Monetary System and the Future of the
IMF’, Background Paper prepared for the Bretton Woods Commission, Bretton Woods:
Looking into the Future, Washington, DC (April 1994) C-34. Cross also points out that there
is an element of contradiction in the phrase ‘fixed but adjustable’ or any ‘fixed-but formula’
since they are ‘fixed but not fixed’ arrangements, and, in terms of market credibility, they
become not fixed.
97
For a legal interpretation of the notions of ‘depreciation’ and ‘devaluation’ see Proctor,
above note 95, 504–6. Proctor differentiates between the (nominal) par of exchange and the
(real) rate of exchange (469–75). The former—of virtually no modern significance since the
collapse of the Bretton Woods regime—is ‘the equation between two money units, each
based on a fixed standard’. ‘The par of exchange is independent of the rate of exchange of
the day’ (Proctor, above note 95, 470). The (real) rate of exchange refers to the market rate
or commercial rate of exchange. The most frequently quoted rate of exchange is the spot
rate though more sophisticated contracts often involve a forward exchange rate.
98
99
See Giorgia Giovannetti, ‘Pegged Exchange Rates’ in Newman et al (eds), above note 6.
100
See generally Jacob Frenkel and Morris Goldstein, ‘A Guide to Target Zones’, IMF Staff
Papers No 33 (December 1986), at <http://www.nber.org/papers/w2113> (last visited 12
August 2014). The terms ‘hard’ and ‘soft’ are used to distinguish bands that must never be
breached from bands that may be breached occasionally. Bands may be ‘loud’ or ‘quiet’ in
that they are known to market participants also or known only to the government involved.
101
See Alan Walters, ‘Walters’ Critique’ in Newman et al (eds), above note 6. See also Alan
Walters, Sterling in Danger: The Economic Consequences of Pegged Exchange Rates
(London: Institute of Economic Affairs, 1986).
102
See Steve H Hanke, ‘International Economic and Exchange Rate Policy Hearings’,
Statement before the Banking, Housing, and Urban Affairs Committee of the United States
Senate (1 May 2002).
103
Hanke, above note 102.
104
See generally Peter B Kenen, Managing Exchange Rates (London: Routledge, 1988).
105
Milton Friedman, ‘The Case for Flexible Exchange Rates’ in Milton Friedman, Essays in
Positive Economics (Chicago: University of Chicago Press, 1953).
106
Proctor, above note 95.
107
Address by Henry Morgenthau, Jr (US Treasury Secretary and Permanent Secretary of
the Conference) at the Inaugural Plenary Session, 1 July 1944, United Nations Monetary
and Financial Conference, Bretton Woods, New Hampshire, July 1 to July 22, 1944: Final
Act and Related Documents (Washington, DC: US Government Printing Office, 1944).
The Law of the International Monetary Fund
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
International financial system — Monetary system — Monetary obligations — International Monetary
Fund (IMF)
(p. 429) 13 The Law of the International Monetary Fund
B. The Role and Purposes of the IMF 13.05
C. Organizational Issues 13.11
Membership 13.11
Management 13.14
D. Financial Issues 13.22

Quotas and subscriptions 13.23
Financial structure 13.32
Borrowing by the Fund 13.45
E. Special Drawing Rights 13.54

F. Current Account Convertibility and the Control of Capital Movements 13.63
Current account convertibility 13.65
Control of capital movements 13.72
G. IMF Functions 13.79

Surveillance 13.84
The legal basis of surveillance 13.86
Types of surveillance 13.92
The obligations of members 13.94
Surveillance in practice 13.102
From macro-surveillance to micro-surveillance 13.104
Financial Assistance 13.112

Some introductory notions 13.115
Stand-by arrangements 13.123
Extended arrangements 13.136
Conditionality 13.137
The history of conditionality 13.140
The legal basis of conditionality 13.147
The rationale of conditionality 13.153
The critique of conditionality 13.154
Conditionality in practice 13.165
Principles underlying the Guidelines on Conditionality 13.176
The provision of information and consequences of ‘misreporting’ 13.180
‘Hard conditionality’ versus ‘soft conditionality’ 13.184
Technical assistance 13.189
H. The Evolution of IMF Financial Facilities and Policies 13.194

Taxonomy 13.197
Concessional facilities: financial assistance to low-income countries 13.200
Structural Adjustment Facility 13.205
Enhanced Structural Adjustment Facility 13.207
Poverty Reduction and Growth Facility 13.209
Poverty Reduction and Growth Trust 13.213
Other forms of financial assistance to low-income developing countries 13.217

Debt relief and the HIPC Initiative 13.217
The Multilateral Debt Relief Initiative and the Post-Catastrophe
Debt Relief Trust 13.223
Special policies 13.224

Emergency assistance (natural disasters and post-conflict situations) 13.225
Extended Fund Facility 13.230
Other facilities/policies/mechanisms 13.232
Defunct facilities 13.236

Terms applicable to the facilities and access limits 13.238
I. Concluding Observations 13.240
International Monetary Law in a sufficiently comprehensive and systematic form to

justify recognition of it as a separate province of public international law came into
existence on December 27, 1945.
Joseph Gold, ‘Gold in International Monetary Law: Change, Uncertainty and
Ambiguity’ (1981) 15 Journal of International Law and Economics 323.
(p. 430) A. Introduction

13.01 It is fitting to start this chapter on the law of the International Monetary Fund (IMF)
with some words by the late Sir Joseph Gold,1 since his writings have greatly contributed to
the development of the public international law of money and have acted as a source of
inspiration for many legal scholars specializing in this field.2
13.02 The law of the IMF must be analysed in the context of its Articles of Agreement, its
By-Laws, Rules, and Regulations and the decisions, interpretations, and resolutions of the
Executive Board and the Board of Governors of the International Monetary Fund.3
13.03 The Articles of Agreement of the IMF were adopted at the United Nations Monetary
and Financial Conference, Bretton Woods, New Hampshire, on 22 July 1944 and entered
into force on 27 December 1945. They are the constitutional charter of the IMF. They have
been amended six times. (An amendment, which must be approved by the Board of
Governors, becomes effective when it is ratified by three-fifths of the members, having 85
per cent of the total voting power.4) The First Amendment, approved by the Board of
Governors in Resolution No 23–5, adopted on 31 May 1968 and effective 28 July 1969,
established the Special Drawing Rights (SDRs) account in the Fund, provided for the
allocation of SDRs, and improved the characteristics of the ‘gold tranche’ as a reserve
asset. The Second Amendment, approved by the Board of Governors in Resolution No 31-4,
adopted on 30 April 1976 and effective 1 April 1978, dealt mostly with the reform of the
international (p. 431) monetary system following the worldwide shift from fixed to floating
exchange rates. The Second Amendment also modified and expanded the role of the SDR
and reduced the role of gold in the international monetary system. The Third Amendment,
approved by the Board of Governors in Resolution No 45-3, adopted on 28 June 1990 and
effective 11 November 1992, provided for the suspension of voting and related rights of
members that do not fulfil their obligations under the Articles of Agreement. The Fourth
Amendment, approved by the Board of Governors in Resolution No 52-4, adopted on 23
September 1997 and effective on 10 August 2009, addressed the reform for a special one-
time allocation of SDRs to allow all participants in the Special Drawing Rights Department
to receive an equitable share of cumulative SDR allocations. The Fifth Amendment,
approved by the Board of Governors in Resolution No 63-3, adopted on 5 May 2008 and
effective 18 February 2011, provided for the expansion of the investment authority of the
IMF. Finally, the Sixth Amendment approved by the Board of Governors in Resolution No
63-2, adopted on 28 April 2008 and effective 3 March 2011, dealt with the reform of quotas
and voice of the members in the IMF.
13.04 This chapter aims to explain in clear language the workings of the Fund, its
organization and functions.5 It focuses on issues of public international monetary law
(where States are the main actors and sovereign relations are to be considered), leaving
aside specific questions of private international monetary law (conflict of laws, involving the
contractual obligations and relations of private parties—natural or juridical persons—
residing in different States).6 The boundaries between the two are not always clearly
defined though. There are ‘shades of grey’ and areas of intersection. Some issues belong to
the private law arena to start with and then turn into public law issues. In a way the
private–public divide in the legal field resembles the micro–macro divide in the economic
field.7
B. The Role and Purposes of the IMF

13.05 The International Monetary Fund, the international monetary institution par
excellence, is a cooperative intergovernmental organization which comprises 188 members
(as of 2014). The objectives of the IMF, which are to guide all its policies and decisions, are
defined in Article I of its Articles of Agreement:
(i) To promote international monetary cooperation through a permanent

institution which provides the machinery for consultation and collaboration on
international monetary problems. (p. 432)
(ii) To facilitate the expansion and balanced growth of international trade,
and to contribute thereby to the promotion and maintenance of high levels of
employment and real income and to the development of productive resources
of all members as primary objectives of economic policy.
(iii) To promote exchange rate stability, to maintain orderly exchange
arrangements among members, and to avoid competitive exchange
depreciation.
(iv) To assist in the establishment of multilateral system of payments in
respect of current transactions between members and in the elimination of
foreign exchange restrictions which hamper the growth of world trade.
(v) To give confidence to members by making the Fund’s resources available
to them under adequate safeguards, thus providing them with the opportunity
to correct maladjustments in their balance of payments without resorting to
measures destructive of national or international prosperity.
(vi) In accordance with the above, to shorten the duration and lessen the
degree of disequilibrium in the international balances of payments of
members.
13.06 This broad enumeration of goals has allowed the institution to survive over the
years, adjusting and re-adjusting its role in response to diverse economic circumstances.
The worldwide change from fixed to floating exchange rates, following the collapse of the
par value regime, also signified a more profound change in the nature of the IMF. There has
been a shift in emphasis from being primarily an international monetary institution focusing
on issues such as exchange rate stability and convertibility, to becoming an international
financial institution with a broader array of responsibilities, encompassing not only
monetary issues, but also other financial issues, such as the regulation and supervision of
banking and capital markets, financial reform, debt restructuring and others.
13.07 The Fund played a leading role in the sovereign debt restructuring of the less
developed countries (LDC) in the 1980s (a financial role), in the transition to market
economies of formerly communist countries (a financial and advisory role), in the financial
crises in the 1990s (a financial role), in the 2007–9 global financial crisis, and in the ensuing
Eurozone sovereign debt crisis (a financial role and an advisory role).8
13.08 These changes have undoubtedly influenced the work of the Fund and, in particular,
the way it carries out its main functions: surveillance, financial support, and technical
assistance. Surveillance these days focuses as much on financial sector issues and policies,
including the regulation and supervision of banks and other financial institutions, legal and
institutional reform, bank restructuring, financial reform, etc, as it does on macroeconomic
policies. Financial assistance to members experiencing balance of payments difficulties is
typically made conditional upon the fulfilment of some financial sector policy or objective
(in addition to macroeconomic considerations). Technical assistance in banking and (p. 433)
financial regulation has been one of the areas where the Fund has been most active in
recent years. I further discuss in Section 13.G the changing nature of the Fund’s
responsibilities.
13.09 On 22 February 2010, the IMF published a document entitled ‘The Fund’s Mandate
—The Legal Framework’ to accompany an earlier document, ‘The Fund’s Role and Mandate
—An Overview’, published on 22 January 2010.9 The aim of this February 2010 document
was to survey the constraints and flexibilities that exist under the current legal framework
to enhance the role of the Fund in promoting global stability through its surveillance,
lending and to confer upon it a clear mandate for ‘systemic surveillance’, as a form of
‘multilateral surveillance’ advisory functions.10
13.10 The Fund somehow appears to be struggling to try to sort out how the international
financial system relates to the international monetary system (as well as differentiating
between what is public and what is private).11 The February 2010 document claims that the
Articles provide sufficient flexibility to accommodate reforms (with the limits imposed by
Articles 31–33 of the Vienna Convention of the Law of Treaties12) and that the drafters of
the Articles conferred upon the Fund ‘enabling authority’ in key areas that can facilitate an
updated or expanded mandate for the Fund with regard to financial sector issues (‘…the
operational content of the Fund’s mandate has been updated over time by Executive Board
decision’).13 The document also acknowledges that the option of amending the Articles of
Agreement would be a difficult one.
C. Organizational Issues
Membership
13.11 Article II of the IMF Articles of Agreement deals with ‘Membership’. Section 1 of
that Article specifies that the ‘original members’ were the countries represented at the
Bretton Woods conference, whose governments accepted membership before 31 December
1945 (p. 434) (the former Soviet Union was represented at the Bretton Woods conference
but declined to become a signatory to the agreements, as explained in Chapter 12).
13.12 Section 2 of Article II specifies that ‘membership shall be open to other countries’,
thus restricting membership to sovereign nation States.14 The limitation of this approach in
terms of the representation of the European Central Bank (ECB) and the interests of the
Eurozone in the IMF were discussed in Chapter 9. The IMF accepts members regardless of
their political system and human rights record. Democracy is not a requirement to become
(or to remain) a member of the Fund.
13.13 The Articles of Agreement consider the possibility of ‘withdrawal from membership’
in Article XXVI. Section 1 deals with the ‘right of member of members to withdraw’. There
have been three instances of voluntary withdrawal: Poland (1950), Cuba (1964), and
Indonesia (1965).15 Section 2 deals with ‘compulsory withdrawal’. If a member fails to fulfil
its obligations under the Agreement, the Fund will first declare the member ‘ineligible to
use its general resources’. If the member persists in its failure then the Fund may (by a 70
per cent majority of the voting power) suspend the voting rights of the member, and,
eventually, require the member to withdraw from membership (by a majority of the Board of
Governors having 85 per cent of the total voting power). There has been only one case of
compulsory withdrawal: Czechoslovakia (1954).
Management
13.14 Article XII of the IMF Articles of Agreement deals with ‘organization and
management’. The decision-making organs of the International Monetary Fund are the
Board of Governors, the Executive Board, and the Managing Director.16 Gianviti compares
this structure to that of a company, with its shareholders’ meetings, board of directors, and
chairman of the board.17
13.15 The Board of Governors of the IMF consists of one Governor and one alternate
Governor appointed by each member country.18 The Board of Governors normally meets
once a year (p. 435) at the IMF–World Bank Annual Meetings. Resolutions by the Board of
Governors may be adopted during meetings of the Board of Governors or by letter.19
13.16 Article XII, section (2)(j) confers upon the Board of Governors and the Executive
Board the power to appoint ‘committees as they deem advisable’. On 2 October 1974, the
Board of Governors established the Interim Committee of the Board of Governors on the
International Monetary System and the Joint Ministerial Committee of the Board of
Governors of the Bank and the Fund on the Transfer of Real Resources to Developing
Countries. In September 1999, the Interim Committee was renamed as the International
Monetary and Financial Committee or IMFC (made up of twenty-four of the Governors who
meet twice a year). The Joint Ministerial Committee of the Board of Governors of the Bank
and the Fund on the Transfer of Real Resources to Developing Countries was renamed as
the IMF–World Bank Development Committee.
13.17 The day-to-day work of the Fund is conducted at its Washington, DC headquarters
by its Executive Board. The Board of Governors at its first meeting in 1946 made a broad
delegation of powers to the Executive Board, in accordance with the possibility foreseen in
Article XII, section 2(b). According to the current text of section 15 of the IMF’s By-Laws:
‘The Executive Board is authorised by the Board of Governors to exercise all the powers of
the Board of Governors, except for those conferred directly by the Articles of Agreement on
the Board of Governors.’20 The work of the Executive Board is guided by the IMFC and
supported by the Fund’s professional staff. The Executive Board usually meets three times a
week, in full-day sessions, and more often if needed, at the organization’s headquarters in
Washington, DC.21 The member countries select the Executive Directors who form the
Executive Board (currently twenty-four Directors). The IMF’s five largest shareholders—the
United States, Japan, Germany, France, and the United Kingdom appoint their own
Executive Directors (ie, each of these countries has its own ‘seat’ on the Board).22 The other
nineteen Executive Directors are elected for two-year terms by single members (currently
China, Russia, and Saudi Arabia) or groups of countries, known as ‘constituencies’.23
13.18 The decisions adopted by the Executive Board must be consistent with the
provisions of the Articles and the resolutions of the Board of Governors. The members of
the Executive Board have a fiduciary duty to the IMF in the discharge of their obligations
(which means that they may be in breach of that duty if they disregarded their obligations
to the IMF and acted only in accordance with instructions received from their countries or
constituencies).24
(p. 436) 13.19 The Executive Board selects the Managing Director, who serves as
Chairman of the Executive Board and as Head of the staff of the IMF.25 The Managing
Director is assisted by four Deputy Managing Directors (Office of the Managing Director). I
explained in Chapter 12 the historical circumstances that led to the appointment of a
European, and not an American, as the first Managing Director of the IMF, a ‘tradition’—not
a written rule—which has been rightly criticized in recent years, since the best person for
the post should be considered, regardless of nationality.
Both the Managing Director and the staff in the discharge of their functions shall owe their
duty entirely to the Fund, and not to national authorities, according to Article XII, section
4(c).26
13.20 With regard to the internal organization of the Fund, there are several departments,
four institutes, offices in Paris, Geneva, Tokyo, and at the United Nations, and resident
representatives located in various member countries.27 Currently there are five ‘area
departments’ (African, Asia and Pacific, European, Middle East and Central Asia, and
Western Hemisphere) in addition to the ‘functional and special services departments’.28 The
latter include the Institute for Capacity Development, the finance, fiscal affairs, legal,
monetary and capital markets, strategy, policy and review, research and the statistics, and
communications departments. The General Counsel29 and the Legal Department of the IMF
perform an important role in advising the Executive Board, management, and others on the
interpretation of the law of the Fund.30
13.21 With regard to the organizational chart of the IMF,31 a mention must be made of the
Independent Evaluation Office (IEO), which was established by the Executive Board in July
2001.32 The IEO operates autonomously from IMF management and aims to provide
objective and independent assessment of various aspects of the IMF’s work.
(p. 437) D. Financial Issues

13.22 The various issues related to the finances of the Fund are intricate. They are
discussed in part in this section and in part below, when I analyse the financial assistance
the Fund provides to its members and the facilities and policies through which financing is
made available. These issues are further complicated by the specialized and idiosyncratic
terminology that surrounds the Fund’s operations.
This section covers subscriptions and quotas (composition, assignment, adjustment), the
accounting structure of the Fund (the accounting entities: the General Department, the
SDR Department, and the administered accounts), and borrowing by the Fund (powers of
the IMF to borrow and the practice in the exercise of those powers).
Quotas and subscriptions
13.23 On joining the Fund, each member is assigned a quota, which determines its
subscription to the capital of the IMF. The quota is an amount calculated by the IMF and
expressed in Special Drawing Rights. What the member pays to the IMF is the
subscription.33 The subscription of each member is equal to its quota and has to be paid in
full to the IMF. Article III, section 1 of the Articles of Agreement states:
Each member shall be assigned a quota expressed in special drawing rights. …The
subscription of each member shall be equal to its quota …
13.24 Members pay an amount not exceeding 25 per cent of the quota in reserve assets
(Special Drawing Rights or currencies specified by the Fund),34 and the rest in the
member’s own currency.35 This first 25 per cent segment is known as the reserve asset
portion. The remainder is the non-reserve asset portion. Payment of the non-reserve asset
portion of the quota subscription is normally made in the form of promissory notes or by
crediting the Fund’s account with the member’s central bank in the member’s own
currency.36
13.25 A member that provides reserve assets to the IMF as part of its quota subscription
receives a liquid claim on the IMF (‘reserve tranche position’) which is made instantly (p.
438) available to that member, on demand, to obtain reserve assets to meet a balance of
payments financing need.37 Reserve tranche positions are, on the one hand, a part of the
Fund’s resources (monetary liabilities) and also part of the members’ international reserve
assets.38 The ‘reserve tranche position’ of a member at any time is equivalent to the amount
by which that member’s quota exceeds the IMF’s holdings of the member’s currency.39
The reserve tranche can be considered a ‘facility of first resort’. It stands apart from
the credit tranches and the various facilities in that a member’s reserve tranche
position is part of its own foreign exchange reserves. Purchases in the reserve
tranche do not therefore constitute use of IMF credit. …Reserve tranche purchases
are not subject to conditionality, charges or repurchase expectations and
obligations.40
13.26 A ‘freely usable currency’ is one that the IMF determines is widely used to make
payments for international transactions and is widely traded in the principal exchange
markets.41 Presently, the euro, Japanese yen, pound sterling, and US dollar are classified as
freely usable currencies by the IMF. A freely usable currency serves as a reserve asset,
though freely usable currencies are not the only ones regarded as reserve assets.
13.27 The sum of all the quotas represents the capital base of the Fund. Quotas are the
primary source of IMF resources. The quotas form a pool of money that the Fund can draw
from to provide financing to members in balance of payment difficulties, as I explain in
paragraph 13.28. A member’s share of general SDR allocations is established in proportion
to its quota. Quotas are also the basis for determining how much a country can
‘borrow’ (draw) from the Fund and they determine their voting rights. Unlike some
international organizations that operate under a one-country-one-vote principle (such as the
United Nations General Assembly), the IMF has a weighted voting system: the larger a
country’s quota in the IMF the more votes it has. With regard to the voting procedures, any
decision of the IMF that requires 70 per cent or 85 per cent of the voting power gives a de
facto veto to countries with large quotas (the USA in the case of the 85 per cent ‘super
majority’) or to a sufficiently large constituency of smaller members.
(p. 439) 13.28 The original formula for the determination of the quotas, introduced by
Raymond Mikesell,42 was criticized for being a rather ‘unscientific exercise’, and for being
influenced by political considerations.
13.29 Today, a member’s quota is broadly based on its relative size in the world economy,
determined by various economic factors, including gross domestic product (GDP),
openness, economic variability and international reserves. In response to the widespread
dissatisfaction with the formulae used to determine the quotas, the IMF established in 1999
an external panel of independent experts, the Quota Formula Review Group, chaired by
Professor Richard Cooper.43 The report of the panel was presented to the Executive Board
and published on the IMF’s website.44 However, no formal change was introduced to the
way the quotas are determined until the Executive Board approved a new quota formula in
April 2008.45 The Fourteenth General Review included an extensive review of the current
formula in January 2013. The outcome of this review will form a basis for the Executive
Board to agree on a new quota formula as part of the Fifteenth General Review.46
13.30 Article III, section 2(a) deals with the ‘adjustment’ of quotas, a procedure which can
take place at intervals of no more than five years, following a ‘general review’ of quotas by
the Board of Governors. There have been fourteen ‘general reviews of quotas’ in the history
of the Fund so far, with the Fifteenth General Review scheduled to take place in January
2015.47 Any change in quotas requires a majority of 85 per cent of the total voting (p. 440)
power.48 There are two main issues addressed in a ‘general review’: the size of a possible
overall increase and the distribution of the increase among the members. There were
increases in quotas following reviews in 1958–9, 1965, 1970, 1976, 1978, 1983, 1998, and
2010. The Fourteenth General Review (in 2010) was the last time that an increase in quotas
was proposed. This proposal, once approved by the member countries, will result in an
exceptional 100 per cent increase in the IMF’s total quota resources with a 6 per cent shift
of quota shares from over-represented to under-represented member countries that will
reflect better the changing relative weights of the IMF’s members in the global economy (as
a result, China will become the third largest member and Brazil, India and Russia will be
amongst the first ten).49
13.31 There are also ‘ad hoc’ adjustments of quotas outside the context of the General
Reviews which are also possible at the request of the member concerned;50 for instance, in
the case of China in 2001, Saudi Arabia in 1981, China, South Korea, Mexico, and Turkey in
2006, and of fifty-four member countries in 2011.51 Total quotas as of June 2013 were USD
360 billion.52
Financial structure
13.32 The IMF operates its financial functions through three separate accounting entities:
the General Department, the SDR Department, and the Administered Accounts. These
accounting entities are not organizational units; the division between the General
Department and the SDR Department (Arts XVI and XXI of the IMF Articles of Agreement)
is an accounting division. The financial functions of the IMF are discharged by the Finance
Department (known as the Treasurer’s Department until 2003), which is an organizational
unit of the Fund.
13.33 The IMF publishes an Annual Report containing audited statements of its accounts.
The balance sheet of the General Department shows assets and liabilities of the IMF. The
assets held in the General Department comprise currencies of members (‘usable’ and ‘non-
usable’) and the Fund’s own holdings of SDRs and gold. The balance sheet of the SDR
Department shows assets and liabilities of its participants and other holders of SDRs.
Article XVI, section 2 refers to the separation of assets and property of the two
departments.
(p. 441) 13.34 The General Department has three accounts: the General Resources
Account (the principal account of the IMF), the Special Disbursement Account (whose
resources have been used in the context of the Poverty Reduction and Growth Trust and the
Heavily Indebted Poor Countries Initiative, which I further discuss in Section 13.H), and the
Investment Account.53
13.35 The bulk of transactions between member countries and the Fund take place
through the General Resources Account (GRA), which is the principal account of the IMF.
13.36 Quota subscriptions are the primary source of financing for the GRA. However, not
all the currencies are ‘usable’, which means that the pool of resources available to the Fund
from quota subscriptions is not all used for financing. The IMF may supplement its quota
resources by borrowing (as I further discuss below) and through additions to its
‘precautionary balances’. The IMF’s precautionary balances consist of retained earnings
(the IMF’s general and special reserves) that are not linked to the profits from the recent
gold sales as well as resources that have been set aside in the so-called first Special
Contingent Account (SCA-1) of the GRA to protect against the risk of overdue financial
obligations (‘arrears’) to the IMF. A main source of these precautionary balances is the
‘surcharge income’ (ie, the rate above the basic rate of charge applicable to some IMF
financial facilities such as the Supplemental Reserve Facility)54,55
13.37 The resources of the GRA are used in the IMF’s regular financing operations, and
are available to all members in case of balance of payments difficulties. ‘The Fund’s
assistance in the GRA is not provided in the form of loans, but rather in the form of
exchanges between the requesting member’s currency and an equivalent amount of either
another member’s currency or SDRs. …These swaps, which are called “purchases” by the
Articles are often referred to as “drawings” in Fund’s parlance.’56
The extension of regular Fund financing via is often referred to as access in the ‘credit
tranches’, reflecting the notion that IMF credit is traditionally provided in tranches
(segments) equivalent to 25 per cent of quota.57
(p. 442) 13.38 The Executive Board adopts a ‘Financial Transactions Plan’ (previously
known as the operational budget) for each forthcoming quarter to specify the amounts of
SDRs and selected member currencies to be used in purchases and repurchases expected to
be conducted through the GRA during that period.58 The purchase–repurchase technique
explains why, from an accounting perspective, the GRA resources do not vary as a result of
the IMF’s financial assistance, only the composition of its assets changes.59
13.39 The GRA does not include resources from the Trust Fund, the Poverty Reduction and
Growth Trust (PRGT), the PRG–HIPC (Heavily Indebted Poor Countries initiative) Trust, the
MDRI-I and MDRI-II (Multilateral Debt Relief Initiative) Trusts, and the PCDR (Post-
Catastrophe Debt Relief) Trust. These ‘trusts’ are ‘administered accounts’, used in the
IMF’s concessional lending, which are further in paragraph 13.197.60
13.40 The SDR Department (created through the First Amendment) extends unconditional
liquidity to its participants.61 The Fund has the authority to create unconditional liquidity
through allocations of SDRs to participants in the SDR Department (participation by IMF
members in the SDR Department is voluntary) in proportion to their quotas (IMF Articles of
Agreement, Art XV, s 1). The IMF may also prescribe non-members as holders (‘prescribed
holders’, see IMF Articles of Agreement, Art XVII, s 3 for details). The SDR Department is
an accounting entity rather than an organizational unit of the Fund’s staff and it records
and administers operations and transactions in SDRs.
13.41 Article XIX, section 5 provides for a ‘designation mechanism’ for the use of SDRs.
Under this mechanism, the IMF ‘designates’ certain participants, whose external positions
are deemed sufficiently strong, to receive specified amounts of SDRs from other
participants and, in exchange, to provide the latter with equivalent amounts of freely usable
currencies (p. 443) (ie, US dollars, euros, Japanese yen, and pounds sterling). The
designation mechanism aims to ensure that in case of need, participants can use SDRs to
obtain foreign currency reserves at short notice.
13.42 The financial structure of the IMF is complex and the different accounts and
departments make the understanding of the transactions of the Fund opaque. In the words
of Jacques Polak (who was a delegate at the Bretton Woods conference, a senior official of
the staff of the IMF, and an Executive Director of the organization), ‘the Fund’s financial
operations are still shrouded in clouds of specialized terminology’,62 thus hindering the
transparency of the Fund’s activities. ‘The Fund must be the only financial organization in
the World for which the balance sheet contains no information whatever on the magnitudes
of its outstanding credits or of its liquid liabilities.’63 He further pointed out that ‘the
cumulative weight of the Fund’s jerry-built structure of financial provisions has meant that
almost nobody outside, and indeed few inside, the Fund understand how the organization
works, because relatively simple economic relations are buried under increasingly opaque
layers of language.’64 He suggested that ‘a number of esoteric terms’ such as ‘reserve
tranche’, ‘reserve position in the Fund’, and others, should disappear (though, of course,
that would require an Amendment to the Articles of Agreement; reserve tranche purchase is
defined in IMF Articles of Agreement, Art XXX, para (c)).
13.43 Polak also proposed that the SDR and General Departments be merged into one and
that the Articles of Agreement be amended to reflect this. (The Fund is prevented by Art
XVI from consolidating the balance sheets of the General and SDR Department.) Polak’s
proposal, however, has two major flaws. First, it would change the nature of SDRs. At
present, SDRs are allocated, not issued, by the Fund.65 Secondly, from a practical point of
view, how would the Fund operate without currencies? How would it pay salaries and other
expenditure which cannot be discharged in SDRs? How would the Fund provide currencies
to members that hold SDRs but cannot use them in payment? This would require a new
system in which the Fund would have to turn to its members to receive currencies needed
for its operations and transactions not conducted in SDRs. This would place the Fund at the
mercy of members who refuse to cooperate, which is the reason why the Fund has not been
made dependent on ad hoc contributions from its members and has thus avoided the
problems faced, for instance, by the United Nations.
(p. 444) 13.44 Though the IMF’s external website contains information on all the financial
activities of the Fund66 and though IMF financial statements conform to International
Accounting Standards, Polak’s critique remains generally valid in my opinion (though I do
not support his case for the consolidation of the General and SDR Departments for the
reasons mentioned above).
Borrowing by the Fund
13.45 The ‘capital base’ of the Fund, that is, the sum of the quota subscriptions, is by
definition limited. Since increases in quotas are difficult to negotiate (and an increase might
not be sufficient to cope with the needs of members experiencing difficulties), it has become
commonplace that the Fund needs to rely upon borrowed resources to supplement its
subscribed resources in order to perform its financial functions effectively.
13.46 The Fund has the power to borrow under Article VII of the Articles of Agreement.67
13.47 The first credit lines established by the Fund to supplement its quota-based
resources were the General Arrangements to Borrow (GAB). This was an agreement
negotiated by the Fund with eight of the major industrial countries (United States, United
Kingdom, France, Japan, Italy, Canada, Netherlands, Belgium) and the central banks of two
others (Deutsche Bundesbank and Sveriges Riksbank) in 1962.68 (As acknowledged, the
G10, or Group of Ten, refers to the group of countries that agreed to participate in the
GAB.) Under this agreement, the members would consider supplementing the Fund’s
resources if further resources were necessary in order to finance the transactions of any of
them with the Fund.69 The GAB have been activated ten times since 1964.
13.48 The Swiss National Bank became a participant in the GAB with effect from 10 April
1984. Saudi Arabia provided supplementary resources in association with the GAB with
effect from 26 December 1983.70
13.49 Though the General Arrangements to Borrow were conceived as stand-by
arrangements amongst the participant Member States and the IMF, in 1983 they were
amended to permit the Fund to make calls under the GAB for ‘non-participant’ Member
States in ‘exceptional (p. 445) situations’ in which the ‘inadequacy’ of the Fund’s resources
could ‘threaten the stability of the international monetary system’.71 Using this authority, in
July 1998, the GAB were activated for an amount of SDR 6.3 billion in connection with the
financing of an Extended Arrangement for Russia. Of that amount, SDR 1.4 billion was
used.72
13.50 The New Arrangements to Borrow (NAB) were set up in 199773 with twenty-five
participating countries and institutions because of concerns about the adequacy of the
existing resources of the Fund to deal with the financing needs of members experiencing
financial crises of the magnitude of that in Mexico in 1994–5. The NAB came into effect in
November 1998. The line was first activated in the extended arrangement offered to Brazil
in December 1998, when the IMF called on funding of SDR 9.1 billion, of which SDR 2.9
billion was used. The activations for both Russia and Brazil were cancelled in March 1999,
when the Fund repaid the outstanding amounts following payments of quota increases
under the Eleventh General Review of Quotas.74 All the participants in the GAB became
participants in the NAB, together with Australia, Austria, Denmark, Finland, Korea, Kuwait,
Luxembourg, Malaysia, Norway, Singapore, Spain, Thailand, and the Hong Kong Monetary
Authority. The Banco Central de Chile became a new participant in the NAB in February
2003 and in April 2010, the IMF Executive Board approved the addition of 13 new
participating countries and institutions.75 The National Bank of Poland joined the NAB as a
new participant in November 2011.76
(p. 446) 13.51 Within the efforts to overcome the global financial crisis, the IMF endorsed
in April 2009 the G-20 call to increase the resources available to the IMF, including an
expanded and more flexible NAB. The amended NAB became effective in March 2011, with
an increase in the maximum amount of resources available to the IMF under the NAB to
SDR 367.5 billion (about USD 560 billion), from the SDR 34 billion under the original NAB.
Also, the loan-by-loan activation under the original NAB was replaced by the establishment
of general activation periods of up to six months, in order to make the extended NAB a
more effective tool in the prevention and management of crisis. The activation periods
depend on a specified maximum level of commitments. The new participants can be
admitted at any time subject to the approval of participants representing 85 per cent of the
total credit arrangements.77
13.52 In addition to the GAB and the NAB (which are examples of ‘joint lending’) the Fund
has access to other special programmes in connection with its ‘special facilities’ as I further
discuss at paragraph 13.224.
13.53 The power to perform technical and financial services under Article V, section 2(b)
has been used in the creation of concessional facilities.78 Concessional operations are
conducted under administered accounts (‘trusts’) with the Fund acting in the capacity of
‘trustee’ of the resources.79 For instance, the Enhanced Structural Adjustment Facility
(ESAF) was introduced in 1987 in the form of a ‘trust’ to provide loans on concessional
terms, ‘trust loans’.80 The ESAF was replaced by the Poverty Reduction and Growth Facility
(PRGF) in 1999 (also in the form of a trust). The PRGF aimed at making poverty reduction
efforts among low-income members a key and more explicit element of a renewed growth-
oriented economic strategy.81 In July 2009, the Executive Board approved widespread
reforms of the concessional facilities, in which the Poverty Reduction and Growth Trust
replaced the PRGF.82
E. Special Drawing Rights

13.54 Since the Fund is responsible for the smooth functioning of the international
monetary and payment system, it is also concerned about international liquidity, that is,
about the level and composition of reserves available to members to meet their trade and
payment (p. 447) obligations.83 As discussed in Chapter 12 in this volume, concerns about
liquidity in the international monetary system led to the creation of the Special Drawing
Rights through the First Amendment to the IMF Articles of Agreement, which became
effective on 28 July 1969.84 Though SDRs were created to supplement existing reserve
assets, they were only officially recognized as a reserve asset with the Second
Amendment.85
13.55 The Fund can allocate and cancel SDRs to members that participate in the Special
Drawing Rights Department (formerly called Special Drawing Account) ‘to meet the need,
as and when it arises, for a supplement to existing reserve assets’.86 Though, in the 1960s,
the Fund considered other solutions to deal with the concerns about inadequate reserves
and liquidity in the international monetary system (such as the abandonment of the par
value regime, or an increase in the price of gold, or general increases in quotas),87 in the
end, the creation of official liquidity by the IMF, through the allocation of SDRs, was
considered to be the most appropriate response to deal with the problem. Article XVIII,
section 1(a) explains the rationale for the ‘allocation’ and ‘cancellation’ of SDRs in the
following terms:
In all its decisions with respect to the allocation and cancellation of SDRs, the Fund
shall seek to meet the long-term global need, as and when it arises, to supplement
existing reserve assets in such manner as will promote the attainment of its
purposes and will avoid economic stagnation and deflation as well as excess
demand and inflation in the world.
13.56 Since 1969, the primary sources of international liquidity have been gold, foreign
exchange reserves, and allocations of SDRs by the IMF. ‘For increases in global reserves,
members need rely no longer on the uncertain production and destination of gold and the
unwelcome deficits of the issuers of reserve currencies.’88 It can be argued that the
introduction of the SDR came too late to be able to save the par value regime and did not go
far enough to make a considerable impact in the international monetary system.
13.57 The value of this synthetic international reserve asset was first determined in terms
of gold or its US dollar equivalent, with one SDR equal to the value of the US dollar at its
official rate of USD 35 per ounce. With the abandonment of the par value regime, a new
method of (p. 448) valuation was needed. An interim system of valuation on the basis of a
composite basket of sixteen currencies was adopted by the Executive Board in 1974.89 This
interim system was replaced in 1980 by a basket of five currencies90 that determined the
value of the SDR: the US dollar, the Japanese yen, the German mark, the French franc, and
the British pound. With the introduction of the euro on 1 January 1999, the IMF replaced
currency amounts of the German mark and the French franc with equivalent amounts of
euros, based on the fixed conversion rates announced on 31 December 1998. The valuation
of the SDR is now determined daily on the basis of the US dollar, the Japanese yen, the
euro, and the British pound. (The SDR currency basket thus comprises the currencies of the
four largest exporting Fund members or monetary unions that have been determined by the
Fund to be freely usable currencies.91)
13.58 The SDR is the unit of account of the IMF and the SDR interest rate provides the
basis for calculating the interest charged on regular IMF financing. However, the use of the
SDR is rather restricted. To begin, holders of SDRs are only prescribed holders, such as
multinational central banks and other official entities, and some international and regional
organizations.92 In addition, the frequency and size of SDR allocations has been rather
limited (allocations can only be made to participants, ie to members). Three general
allocations of SDRs have been made, in the period from 1970 to 1972, from 1979 to 1981,
and in 2009. The first two allocations resulted in cumulative SDR allocations of SDR 21.4
billion. The third general SDR allocation was of SDR 161.2 billion and intended to mitigate
the effects of the global financial crisis. In addition to the general allocations of SDR, in
2009 the Fourth Amendment approved a special one-time allocation of SDR 21.5 billion. The
purpose of this special allocation of SDR was to allow all IMF members to join the SDR
system on an equitable basis and to correct the fact that countries that joined the IMF after
1981 had never received an SDR allocation.93
13.59 In an excellent study on the nature of the SDR, Gianviti explains that a country’s
reserve assets now include four categories: gold, foreign currencies, reserve positions in
the Fund, and SDRs. A reserve position in the Fund gives a member the right to draw all or
part of (p. 449) its so-called ‘reserve tranche’ unconditionally. Gianviti recalls that, in the
discussions that led to the eventual creation of the SDR, the search for a name was
lacklustre and unimaginative and that ‘by analogy with the drawing rights on the Fund and
because the new instrument was designed essentially as a credit line among participants,
the new instrument was called the special drawing right.’94 The name SDR would surely
have been criticized by Keynes as ‘Cherokee language’. (Keynes derided the language used
in the American drafts—a language that in many instances was adopted in the final version
of the Articles of Agreement—as ‘Cherokee’, in contrast with the ‘Christian English’ of his
own writings.95) In an attempt to explain it in simple terms, Gianviti says:
The closest analogy to SDRs is Monopoly money. It is distributed at the beginning of

the game to all players, because without money there is no game, and it is returned
at the end. The difference is that in the SDR department the ‘play money’ can be
used to buy real assets and discharge real liabilities and, at the end, real money
must be returned if the allocated SDRs have been spent.96
13.60 The SDR is not a currency, nor is it a liability of the IMF.97 It is an official reserve
asset. The SDR derives its value from the readiness of participants to convert it into freely
usable currencies. At the international level, there has been a conspicuous absence of a
central authority with the ability to monopolize the issue of currency. As discussed in
Chapter 12, at the Bretton Woods conference, Keynes included in his proposals the
establishment of an international currency, that he called ‘bancor’, which would have been
a true medium of exchange. White referred in his proposals to a unit of account, that he
called ‘unitas’ which was only a unit of account, not a medium of exchange. In the end, no
new international unit of account was adopted in Bretton Woods. Instead, the 1944 Bretton
Woods agreement stressed the importance of the US dollar, thus satisfying the US
negotiators, who privately favoured a post-war world economy centred around the US
dollar.98 The IMF took a limited step towards the establishment of an international unit of
account with the creation of the Special Drawing Rights. Over the years, several proposals
to ‘harden’ the SDR (so that it could become a medium of exchange) have also been
unsuccessful.
13.61 In the early 1990s, there were discussions with regard to the need for a new
allocation of SDRs, either through a general allocation (as foreseen in the Articles of
Agreement) or through a targeted allocation to new members, since SDRs can only be
allocated to those members that are participants in the SDR department at the time of the
allocation on the basis of their quotas. (If a member joins the SDR department after an
allocation it will receive SDRs only prospectively in future allocations.) This meant that
some members had not received allocations at all until 2009, while other members had very
small quotas at the time the allocations had been made, and consequently received very
small SDR allocations.
(p. 450) 13.62 To remedy these ‘inequities’ with regard to the allocation of SDRs, an
amendment to the Articles of Agreement was approved by the Board of Governors in 1997
and ratified later on by the Fourth Amendment to the Articles of Agreement which became
effective in 2009.99 The allocation of SDRs under the fourth amendment levelled the
distribution of overall allocations among the membership bringing each member’s
cumulative allocation of SDRs to the same percentage of its quota as of 19 September
1997.100 As Polak explains, the proposed special allocation (which would double the amount
of SDRs outstanding) required an amendment because the Articles of Agreement stipulated
that allocations, and not cumulative allocations, should be proportional to quotas, and
because the criterion for an allocation required a finding that there was a ‘long-term global
need’ to supplement reserves, a condition that most industrial country members believed
had not been met.101
F. Current Account Convertibility and the Control of Capital

Movements
13.63 The Articles of Agreement impose upon Member States a set of obligations of
varying nature. The Fund’s regulatory powers comprise both Article VIII, section 2 and
Article IV. Article IV (as amended in 1976, effective 1978) refers to the ‘obligations
regarding exchange arrangements’, which form the basis of the exercise of surveillance by
the Fund as further explained below. Article VIII (which remains unaltered since its original
formulations) imposes some ‘general obligations’ upon member countries with regard to
avoiding restrictions in current international transactions.
13.64 According to Article VIII, section 2, the jurisdiction of the Fund extends only to
payments and transfers for current international transactions, not to capital transactions
(the regulation of capital movements is left to the Member States). This distinction in the
Articles of Agreement between current and capital transactions—largely due to historical
considerations—is considered by some experts to be ‘conceptually and operationally
awkward’.102 Indeed, in a world where private capital movements have acquired increasing
importance, this international code of conduct (freedom of payments and transfers for
current international transactions but not for capital transactions) has been often criticized
as obsolete. The critique has not resulted yet in any amendment to the Articles of
Agreement but has generated, in the (p. 451) aftermath of the global financial crisis, a
paper summarizing the IMF institutional view (‘institutional view’) on the topic.103
Current account convertibility
13.65 Article VIII, section 2 of the IMF Articles of Agreement imposes an obligation upon
members to avoid restrictions on current payments and transfers (ie, unrestricted access to
foreign exchange to conduct trade in goods and services). This obligation is often referred
to as an obligation to maintain ‘current account convertibility’. Article VIII, section 2 reads
as follows:
(a) Subject to the provisions of Article VII Section 3(b) [‘scarce currency’
provisions] and Article XIV Section 2 [transitional arrangements], no member
shall, without the approval of the Fund, impose restrictions on the making of
payments and transfers for current international transactions.
(b) Exchange contracts which involve the currency of any member and which
are contrary to the exchange control regulations of that member maintained
or imposed consistently with this Agreement shall be unenforceable in the
territories of any member. In addition, members may, by mutual accord,
cooperate in measures for the purpose of making the exchange control
regulations of either member more effective, provided that such measures
and regulations are consistent with this Agreement.
13.66 The Fund has designed policies on approving restrictions that are otherwise subject
to Article VIII, section 2(a). One aspect of that policy, which has been widely used by
members, refers to the imposition of restrictions for reasons of national or international
security.104 In these cases, the member notifies the Fund prior to the imposition of such
restrictions, whenever possible, or as promptly as circumstances permit and, unless the
Fund objects within a specified period, the member may assume that the Fund has no
objections to the imposition of such restrictions.
13.67 The interpretation of Article VIII, in particular section 2(b), has given rise to an
abundant legal literature and to a large body of jurisprudence, where the lack of uniformity
of interpretation among the courts of some major countries is noticeable.105 Since Article
VIII, (p. 452) section 2(b) is a rule of private international law/conflict of laws, and since my
analysis focuses on public international law, I will not discuss it further in this chapter.106
13.68 Article XXX(d) explains the meaning of the term ‘payments for current transactions’.
The definition of ‘payments for current transactions’ is broader than the statistical
definition of ‘current transactions’ used by economists. Also, it is not limited to transactions
in goods, which is used by the General Agreement on Tariffs and Trade. It includes
transactions in services, now covered by the General Agreement on Trade in Services. It
also includes some transfers from capital transactions, such as amortization of loans.107
13.69 IMF members are to avoid restrictions on payments and transfers for current
international transactions, but remain free to impose restrictions or controls on capital
transfers. However, members not ‘prepared to accept the obligations of Article VIII Sections
2, 3 and 4’ are allowed to operate under the transitional arrangements foreseen in Article
XIV. (Under Art VIII, s 3, multiple currency practices and discriminatory currency
arrangements are prohibited, unless they are approved by the Fund. Article VIII, s 4 refers
to the ‘convertibility of foreign-held balances’.)
13.70 The transitional regime foreseen in Article XIV allows members to maintain and
adapt restrictions that were in effect when they joined the Fund. Only about twenty
members continue formally to avail themselves of Article XIV status. However, these
members have an obligation to consult annually with the IMF concerning the retention of
the restrictions on payments and transfers for current international transactions. Article
XIV also requires members to withdraw such restrictions as soon as they are satisfied they
will be able, without such restrictions, to settle their balance of payments in a manner that
will not unduly encumber the Fund’s general resources.108 In addition, if the Fund finds
that a member persists in maintaining restrictions that are inconsistent with the purposes
of the Fund, the member would be subject to sanctions under Article XXVI, section 2(a),
which refers, inter alia, to the ineligibility to use the general resources of the Fund.
(p. 453) 13.71 From the point of view of restrictions on international transfers and
payments, IMF members can be divided into three groups:
(1) members that embrace both current account convertibility (the

obligations of Art VIII) and capital account convertibility (no IMF obligation);
(2) members that adopt current account convertibility only (the obligations of
Art VIII);
(3) members that still operate with restrictions on current account
convertibility (operating under the transitional arrangements of Art XIV, or
members that maintain restrictions subject to Art VIII, that have either been
approved by the Fund, or that are maintained in breach of the Articles, ie,
without Fund approval).
Control of capital movements

13.72 Under the law of the IMF, member countries can impose restrictions on capital
movements, without the Fund’s approval. Article VI, section 3 allows members to exercise
‘controls of capital transfers as necessary to regulate international capital movements’. The
extension of the Fund’s jurisdiction109 over capital movements would therefore require an
amendment of the Articles of Agreement granting the Fund an explicit mandate in this
regard.110 However, the ‘institutional view’ states that ‘…member’s rights to regulate
international capital movements are not unlimited’ and points that ‘…the Fund’s legal
framework for surveillance has long recognized the importance of capital flows and policies
to manage them.’111
13.73 Both White and Keynes favoured the control of capital movements. Capital
movements in the 1920s and 1930s (in particular short-term capital flows) were considered
a fundamental ill of the inter-war economy. According to Keynes: ‘It is widely held that
control of capital movements, both inward and outward, should be a permanent feature of
the post-war system. …If control is to be effective, it probably involves the machinery of
exchange control for all transactions, even though a general open licence is given to all
remittances in respect of current trade.’112 White noted that each member country should
‘subscribe to the general policies of permitting foreign exchange trading in an open, free
and legal market, and to abandon, as rapidly as conditions permit, all restrictions or
controls by which various classes of foreign exchange transactions have been prohibited or
interfered with’. However, he also pointed out that, in practice, there are situations ‘that
make inevitable the adoption of controls’ on movements of capital.113
(p. 454) 13.74 A lot has changed since 1944 in terms of volume and composition of capital
flows. However, the law of the IMF has not changed in this respect, even though in recent
years a number of voices within the Fund, as well as outside it, have advocated the need to
extend convertibility to capital account,114 since international capital flows have made
national boundaries increasingly porous.115 Private capital flows constitute today a main
source of financing for developed as well as developing countries (middle-income
developing countries). In the European Union, and in developed countries generally, capital
account liberalization is the norm. Also, some relevant emerging economies as India and
China have plans to promote openness.116 As noted by the ‘institutional view’, in the
aftermath of the global financial crisis the trend toward liberalization slowed down a little,
but the tendency worldwide continues to be one of promoting liberalization of capital
flows.117
13.75 In its meeting of 28 April 1997, the Interim Committee of the IMF ‘agreed that the
Fund’s Articles of Agreement should be amended to make the promotion of capital account
liberalization a specific purpose of the Fund and to give the Fund appropriate jurisdiction
over capital movements’.118
13.76 However, following the financial crises in East Asia in the late 1990s—crises which
arose from disturbances to the capital account—the momentum to push forward such an
amendment has been lost and it is unlikely that ‘capital account convertibility’ will be
adopted de jure by the Fund in the near future. Some economists have argued that free
capital mobility does not lead to an optimal allocation of resources especially when
significant domestic distortions exist.119 Controls on short-term capital inflows, as in Chile,
have been appraised on the grounds that countries imposing such controls are subject to
less volatility than countries with unrestricted capital mobility; if speculators cannot bring
money into the country, then capital will not flow out when market sentiment changes.
13.77 There are certainly dangers in liberalizing capital movements in an economy in
which the macroeconomic framework and the financial sector are weak. Before adopting
such liberalization a country needs to prepare its financial sector, often through the
restructuring of the financial industry (adequate sequencing of reforms), the strengthening
of the capital base of the financial institutions, and the replacement of capital controls by
effective prudential regulation and supervision.120
(p. 455) 13.78 In the absence of a formal mandate to promote open capital accounts, the
Fund has not always provided consistent policy advice to its members. This is the finding of
a report on the Fund’s approach to capital liberalization released in May 2005 by the
Independent Evaluation Office.121 For instance, Russia was encouraged to open its
government bond market to help finance its deficit through foreign borrowing, while the
Fund was more cautious in its recommendations to other countries. In China, on the other
hand, support for the country’s ‘gradual’ approach to capital account liberalization (given
the ‘structural weakness’ of the financial sector) was reflected in the public information
notice (PIN) issued after the conclusion of the 2003 Article IV consultation.122 The IEO
report recommended a clarification by the Executive Board of the elements of agreement on
capital controls. The ‘institutional view’, as a response to this issue, aims to provide a
consistent, even-handed and flexible basis for the Fund to provide policy advice on the topic
upon request by a member.123
G. IMF Functions

13.79 The main functions performed by the IMF in relation to its members are surveillance
(IMF Articles of Agreement, Art IV), financial assistance (Art V, s 3), and technical
assistance (Art V, s 2(b)).
13.80 The Fund uses surveillance, financial assistance, and technical assistance as
instruments to accomplish its objectives or purposes as defined in Article I. From the point
of view of the Member States, they constitute the main ‘services’ that the Fund provides to
them. From the Fund’s perspective, its powers can be broken down into three categories: (i)
regulatory (jurisdiction), comprising Article VIII, section 2 and Article IV; (ii) financial (Art
V, s 3), and (iii) advisory (technical assistance, Art V, s 2(b)).
13.81 The authority of the IMF to perform for members specific services that are not
mentioned in the Articles but are sufficiently related to the purposes of the institution is
made explicit by the Second Amendment, Article V, section 2(b).
13.82 While surveillance applies to all members, conditional financial assistance and
technical assistance apply only to the members that request such assistance. The
mandatory nature of surveillance contrasts with the voluntary nature of technical
assistance. I explain below the sui generis nature of IMF financial assistance.
13.83 Article V, section 1 specifies that members will deal with the Fund ‘only through its
Treasury, central bank, stabilization fund or other similar agency’. Hence the legal study of
these activities generally falls within the realm of public international law.
(p. 456) Surveillance
13.84 In the words of the late Manuel Guitián, ‘[t]he IMF is primarily a surveillance
institution’,124 in charge of the oversight of an international financial ‘code of conduct’. This
‘code of conduct’ is a set of obligations that members must comply with according to the
Articles of Agreement.
13.85 Surveillance is a jurisdictional function, which traditionally focused on the
assessment of the exchange arrangements, the exchange rate, and the balance of
payments,125 and which today focuses upon a wide range of economic and financial policies,
encompassing not only exchange rate, monetary, and fiscal policies, but also financial sector
issues, structural issues, and institutional developments.126 Surveillance entails a
judgement on the part of the Fund, and as with any judgement, a degree of discretion is
always involved. In the case of surveillance, the exercise of this ‘judgement’ is particularly
complex, because of the interconnectedness between domestic and foreign economic policy,
the interdependence amongst countries, and the political and social consequences of some
sensitive economic decisions.
The legal basis of surveillance
13.86 The legal basis of surveillance is Article IV, sections 1 and 3, as amended. Article IV,
section 1 imposes a set of obligations upon members, which I discuss further in paragraphs
13.94–13.96 below. To make these obligations effective, the Fund is granted powers to
oversee, to monitor the compliance of each member with these obligations.
13.87 Article IV, section 3(a) confers upon the IMF a clear role in this regard:
The Fund shall oversee the international monetary system in order to ensure its
effective operation, and shall oversee the compliance of each member with its
obligations under Section 1 of this Article.
13.88 Article IV, section 3(b) further states:
[T]he Fund shall exercise firm surveillance over the exchange rate policies of
members, and shall adopt specific principles for the guidance of all members with
respect to those policies.
13.89 The principles of surveillance were set out in further detail in a 1977 decision127
which was replaced by a new decision of 2007.128 The Decision of 15 June 2007 covered
exchange rate policies and also relevant domestic economic and financial policies. External
stability in (p. 457) this Decision of 2007 encompassed both the current account and the
capital account of the balance of payments, consistent with the members’ obligations under
Article IV.129 A new decision on ‘Bilateral and Multilateral Surveillance’, also know as
Integrated Surveillance Decision (ISD), was adopted by the Executive Board on 18 July
2012. This new decision maintains the key modalities for surveillance established in the
2007 decision and defines the substance and modalities of multilateral surveillance.130 The
ISD also defines—for the first time—the substance/focus of multilateral surveillance, and
includes a definition of the ‘international monetary system’.
13.90 Following the abandonment of the par value regime, the Second Amendment placed
the function of surveillance at the centre of the Fund’s operations, at the core of the
international monetary system. From being a virtually self-enforcing arrangement subject to
strict rules, surveillance now becomes a function in which judgment is of the essence.
Surveillance is no longer a rules-based regime but a ‘discretion based regime’.131
13.91 This broad scope of economic situations and policies has facilitated the evolution of
surveillance over the years, the most interesting development in the last decade being the
emphasis given to financial stability and financial sector policies.
Types of surveillance
13.92 The Fund carries out surveillance mainly through its so-called ‘Article IV
consultations’ with each individual member country. In addition to this ‘bilateral
surveillance’, there is also ‘multilateral surveillance’, with the publication by the Fund of a
World Economic Outlook Report and a Global Financial Stability Report twice a year.132
Another form of (p. 458) surveillance is ‘regional surveillance’, under which the IMF also
examines developments in regional areas, such as the European Union and the euro area;
the activity often referred to as ‘regional surveillance’.133
13.93 The purpose of surveillance is to evaluate the appropriateness of a country’s existing
policies and at the same time to encourage the country to adjust the existing or adopt new
policies that enhance the smooth functioning of the international monetary system. IMF
surveillance integrates the bilateral aspects of analysing the policies of individual countries
with the multilateral aspects of examining the consequences of these policies for the
operation of the system as a whole.
The obligations of members
13.94 Article IV, section 1 of the IMF Articles of Agreement reads as follows:
Recognizing that the essential purpose of the international monetary system is to

provide a framework that facilitates the exchange of goods, services and capital
among countries and that sustains sound economic growth, and that a principal
objective is the continuing development of the orderly underlying conditions that
are necessary for financial and economic stability, each member undertakes to
collaborate with the Fund and other members to assure orderly exchange
arrangements and to promote a stable system of exchange rates. In particular, each
member shall:
(i) Endeavor to direct its economic and financial policies toward the objective
of fostering orderly economic growth with reasonable price stability, with due
regard to its circumstances;
(ii) Seek to promote stability by fostering orderly underlying economic and
financial conditions and a monetary system that does not produce erratic
disruptions;
(iii) Avoid manipulating exchange rates or the international monetary system
in order to prevent effective balance of payments adjustment or to gain an
unfair competitive advantage over other members; and
(iv) Follow exchange policies compatible with the undertakings of this
Section.
13.95 Article IV, section 1 imposes obligations upon its members that are both positive and
negative in character. The positive obligations are the ones described in Article IV, section
1(i), (ii), and (iv). The negative obligation is the one described in Article IV, section 1(iii),
which is written in rather forceful terms: ‘avoid manipulating exchange rates’.
13.96 The first two obligations of Article IV, section 1—(i) and (ii)—are formulated in soft
terms. As Proctor points out, ‘an obligation to co-operate with a view to achieving a
particular (p. 459) objective, does not impose an obligation to achieve that objective’.134
Gianviti considers that these first two obligations—(i) and (ii)—are ‘soft obligations’, as
opposed to the obligations in (iii) and (iv), which are ‘hard obligations’, even though the
language of section 1(iv) is rather generic.135 While the obligations in section 1(iii) and (iv)
relate to external policies, where the Fund has greater jurisdiction, the obligations in
section 1(i) and (ii) relate to domestic policies, where members have greater sovereignty.136
13.97 The members are obliged to cooperate with the Fund by supplying all the
information necessary to allow the Fund to perform effective bilateral surveillance,
according to Article IV, section 3(b). The obligation to furnish information to the Fund ‘as it
necessary for its activities’, is also recognized in Article VIII, section 5.
13.98 Despite the emphasis that Article IV places upon exchange rate policies, in recent
years, the practice of surveillance has given greater emphasis to domestic policies (the ‘soft
obligations’ of Art IV, s 1(i) and (ii)), than to exchange rate policies (the ‘hard obligations’ of
Art IV, s 1(iii) and (iv)).137
13.99 Since Article IV imposes obligations upon members, sanctions can be applied in the
case of breach of these obligations. However, ‘there has not been a single instance in which
sanctions have been applied or a report has been made for breach of obligation under
Article IV. This de facto transformation of Article IV section 1 into a “soft law provision” is
reflected in the description of Article IV consultation with members as “policy advice”…or
“policy dialogue”.’138
13.100 Gianviti discusses the nature of the obligation of members under Article IV and the
ambiguities in Article IV, sections 1 and 3. The focus of the obligation relates to exchange
rate policies; other policies (such as trade and investment policies) do not constitute ‘an
obligation under Article IV’ even if they are an important element with which to assess
exchange rate policies.139 However, he acknowledges that the practice of surveillance is
expanding beyond the actual obligations of Article IV through the conduct of Article IV
consultations.140 He warns against an undue extension in this practice: if surveillance is
perceived more as a form of peer pressure than as a means of monitoring compliance (p.
460) with obligations specified in the Articles of Agreement, this may lead to a dilution of its
objectives.141
13.101 The language of Article IV, section 1 reflects the ‘labour pains’ of the origins of this
provision, which came to replace the legal certitude and simplicity of the original par value
regime.142 The choice of verbs (endeavour, seek to promote, fostering, follow), the
introduction of a preamble, and what I would describe as a ‘hesitant tone’ in the new
mandate, suggest that the drafters of the provision were unsure about the direction that the
new regime would follow and did not want to preclude an eventual return to the regime
that they had just abandoned.
Surveillance in practice
13.102 In accordance with Article IV of the IMF Articles of Agreement, IMF staff hold
annual bilateral meetings with officials from the member country. When an ‘Article IV
consultation’ takes place, a Fund staff team (called an IMF ‘mission’) visits the country to
collect information about macroeconomic policies (fiscal, monetary, and exchange rate), the
soundness of the financial system, and other relevant issues such as social and labour
policies as well as institutional developments. Following the review of these policies, the
Fund team holds discussions with the authorities regarding the effectiveness of their
economic policies as well as prospective changes for the domestic economy and the
member’s balance of payments positions. At the conclusion of these discussions, and prior
to the preparation of the staff’s report to the Executive Board,143 the IMF mission often
provides the authorities with a statement of its preliminary findings. Once the IMF’s
Executive Board has discussed the staff report, thereby concluding the consultation, they
forward a summary of the discussion to the country’s government. The conclusions of the
report are only published if the country consents. However, with the increased transparency
of the IMF and its work in recent years, the summary of the Executive Board discussions for
many Article IV consultations are published in Public Information Notices, which are
available on the IMF website.
13.103 The evolving nature of the practice of surveillance has been made possible thanks
to the ample room for interpretation granted to the Fund in the exercise of surveillance.
Every two (or, more recently, three) years, the IMF reviews the principles and procedures
that guide its surveillance.144
(p. 461) From macro-surveillance to micro-surveillance
13.104 IMF surveillance has evolved significantly over the last decades, with the increased
attention to financial sector issues and policies being the main development in recent years.
While surveillance in the past was typically focused on the exchange arrangements and
exchange rate policies of members and macroeconomic policies, surveillance nowadays also
takes into account other issues, often involving the workings of the private sector (‘micro’
issues), such as good governance, legal and institutional reform, bank restructuring,
financial reform, and so on. There is a widespread recognition in the aftermath of the global
financial crisis that surveillance must be strengthened to increase the Fund’s ability to
detect incipient financial tensions and vulnerabilities in international capital markets. The
Fund often has access to information about vulnerabilities in each country and therefore is
in a unique position via the exercise of its functions (in particular surveillance and technical
assistance) to monitor that members have adequate supervision, regulation and resolution
procedures and tools. If we need a global institution that can safeguard international
financial stability, the Fund is best suited to undertake such role. I further discuss this issue
in Chapter 14 with regard to the role of the IMF in the resolution of international financial
crises.
13.105 The need to provide effective surveillance of the financial system (a need which
became pressing following the crises in the late 1990s) has given rise to the Financial
System Stability Assessments (FSSAs), which the Fund carries out as part of the Financial
Sector Assessment Program (FSAP), a joint IMF–World Bank initiative which was
introduced in May 1999 and reviewed after ten years in September 2009.145 In an FSSA,
IMF staff address issues of relevance to the function of surveillance, including risks to
macroeconomic stability stemming from the financial sector and the capacity of the sector
to absorb macroeconomic shocks.
13.106 The FSAP has been characterized by its voluntary nature and its joint Bank–Fund
character. The voluntary participation has resulted in greater country ‘ownership’.146 In
September 2010, the IMF made the stability assessments under the FSAP a mandatory part
of bilateral surveillance for twenty-five jurisdictions with systemically important financial
sectors.147 (This was increased to twenty-nine jurisdictions in December 2013.)148
(p. 462) 13.107 In addition to the FSSAs, a key component of the FSAP are the Reports on
Observance of Standards and Codes (ROSCs) which summarize the extent to which
countries observe certain internationally recognized standards and codes.149 The IMF has
recognized twelve areas and associated standards as useful for the operational work of the
Fund and the World Bank. These comprise accounting, auditing, anti-money laundering and
countering the financing of terrorism (AML/CFT), banking supervision, corporate
governance, data dissemination, fiscal transparency, insolvency and creditor rights,
insurance supervision, monetary and financial policy transparency, payment systems, and
securities regulation.
13.108 ROSCs provide a focus to surveillance, and also facilitate performance
accountability. ROSCs also provide a direction to programmes of technical assistance by
identifying the areas that the country must aim to improve or strengthen.150
13.109 While FSAPs and ROSCs inform Fund surveillance, they are, as a legal matter,
performed as technical assistance.151 Such activities are voluntary for both the member and
the Fund, with the exception of surveillance for the list of jurisdictions with systemically
important financial sectors as noted above. According to Gianviti, ‘FSAP reports and ROSCs
are not by themselves an exercise of surveillance.’152 (‘The Fund cannot expand the scope
of its surveillance beyond the provisions of Article IV. A finding of non compliance with
standards and codes would not constitute a breach of obligation under the Articles.’153) The
FSAP reports and ROSCs, however, ‘feed into surveillance, ie provide material which
deepens the Fund’s understandings of the member’s circumstances’. He concluded: ‘While
expanding the sources of information available to the Fund in the exercise of surveillance,
FSAP reports and ROSCs illustrate the evolution of surveillance from an assertion of
jurisdictional powers as contemplated by the Fund’s Articles to a policy dialogue coupled
with peer pressure.’154
13.110 Surveillance of national policies becomes more complex when countries embark on
programmes of trade and financial liberalization.155 The opening up of the economy raises
important challenges and sets into motion a process of regulatory reform. In the 1970s, the
emphasis of surveillance was on the traditional macroeconomic policies, such as exchange
rate, monetary, and fiscal policies. In the 1980s, structural policies became more relevant,
particularly in the aftermath of the debt crisis. At the beginning of the 1990s, the transition
from centrally planned to market economies in countries in Eastern Europe and the former
Soviet Union moved surveillance in the direction of further structural reforms, with
emphasis on legal and institutional reform. In the late 1990s, the financial crises in South
East Asia, Russia, and other emerging economies, suggested that financial reform (p. 463)
and financial law reform should be the object of IMF surveillance. Following the global
financial crisis and the recognition of the pernicious link between bank debt and sovereign
debt, the IMF encourage—through the exercise of conditionality and surveillance—the
strengthening of members’ banking and financial systems and the design of appropriate
tools and frameworks for the resolution of crises, on a cross-border basis.
13.111 Continuous concerns about poverty and the response of the international
community to the financial needs of countries which are both poor and heavily indebted
remain among the greatest challenges the institution must confront. The social and
economic injustice of impoverished Africa, the troubled Middle East, and the populist
policies that can appeal to many in developing countries are a reminder that the economic
foundations of peace (with shared prosperity) are a necessary complement of the political
foundations of peace. This implies a renewed attention on institutional issues, given that an
adequate legal and institutional framework is fundamental for successful economic
development.156 The IMF functions of surveillance, technical assistance, and financial
assistance can be used to this end.
Financial Assistance
13.112 IMF financial assistance (support to members experiencing temporary balance of
payments problems) is generally conditional on the adoption and implementation of
adjustment policies. IMF financing is typically available through ‘stand-by
arrangements’ (or extended arrangements). Though these arrangements are not technically
nor legally loans, however, they are the ‘functional equivalent’ of loans.157
13.113 In this section, after a few introductory notions (a bit of ‘Cherokee language’), I
discuss the nature of stand-by arrangements and then I dissect the notion of conditionality,
taking into account its history and legal basis. In the following section, I survey the various
financial facilities and instruments that the Fund has developed over the years to deal with
‘special’ balance of payments problems and with the needs of developing countries
(concessional lending).
13.114 The terminology applicable to the Fund’s financial operations is cumbersome (a
point which is emphasized throughout this chapter) and for those not familiar with Fund
jargon it makes understanding the Fund’s activities rather difficult.
Some introductory notions
13.115 All members are in principle eligible to use the Fund’s general resources in
proportion to their quota.158 A member is entitled to ‘purchase’ the currencies of other
members in exchange for an equivalent amount of its own currency, subject to the four
conditions (p. 464) established in Article V, section 3(b). These four conditions are: (i) the
use must be consistent with the Articles of Agreement; (ii) the member makes a declaration
(‘representation’) of balance of payments need; (iii) the proposed purchase does not raise
the Fund’s holdings of the member’s currency above 200 per cent of the member’s quota;
and (iv) the member has not been declared ineligible to use those resources. The third and
fourth requirements can be waived.159
13.116 ‘Purchases’ (drawings in Fund’s parlance) are the financial transactions foreseen
in Article V, section 3(b). ‘Outright purchases’ are purchases outside an arrangement.
13.117 Arrangements are commitments of resources by the Fund under which purchases
may be made by a member. There are two types of arrangements: stand-by arrangements
under the credit tranche policies, and extended arrangements under the Extended Fund
Facility (EFF). The Flexible Credit Line and the Precautionary and Liquidity Line
arrangements are also arrangements in the credit tranches. Thus, the IMF has now four
types of arrangements in the GRA.
13.118 ‘Credit tranche policies’ are defined in the Glossary of Selected Financial Terms as
‘policies under which members may make use of IMF credit’.160 The amount of such use is
governed by the member’s quota; uniformity of treatment for IMF members does not mean
equal access to Fund resources but access in proportion to quotas.
13.119 Under the credit tranche policies, both direct requests for purchases (ie, outright
purchases under the Rapid Financing Instrument (RFI)) and requests for stand-by, FCL, and
PLL arrangements can be made.
13.120 The ‘credit tranche policies’ are generally for short-term adjustment purposes,
‘with a lower conditionality when total outstanding purchases do not exceed 25 per cent of
the quota (which, added to a prior use of the reserve tranche, would raise the Fund’s
holding to 125 per cent of the quota) and a higher conditionality for additional purchases.
Hence, the distinction between “first credit tranche conditionality” and “upper credit
tranches conditionality”.’161
13.121 The Fund’s attitude to drawings in the ‘first credit tranche’ is rather liberal,
provided that members demonstrate reasonable efforts to overcome their balance of
payments difficulties. In contrast, requests beyond this ‘first credit tranche’, that is
requests for access to ‘upper credit tranches’—normally via stand-by arrangements—
require substantial justification (conditionality).162
13.122 According to Gianviti:
Once the reserve tranche has been fully drawn and replaced with the purchasing
member’s currency, the Fund’s holdings of the member’s currency stand at 100
percent of quota. (p. 465) Beyond that, the member is using the Fund’s financial
assistance, and the use of Fund’s general resources will continue as long as the
Fund’s holdings of the member’s currency are not reduced to 100 per cent or below.
Above 100 percent of quota, the Fund’s conditions for the use of its resources
gradually tighten, and these conditions may also vary with the type of problem
faced by the member. …Between 100 percent and 200 percent of quota, a member
is ‘entitled’ to use the Fund’s resources. …[W]hen the Fund’s holding of the
member’s currency reach 200 percent of quota, the entitlement ceases, and, for any
additional assistance, a waiver must be obtained by the Fund.163
Stand-by arrangements
13.123 The history of stand-by arrangements (SBAs) is inextricably linked to the history of
conditionality. Conditionality is made ‘specific’ through a stand-by arrangement (or other
‘arrangements’). Conditionality ends when an arrangement ends.
13.124 IMF members have always been able to draw on the Fund’s pool of resources ‘to
correct maladjustments in their balance of payments’ (original IMF Articles of Agreement,
Art I). According to Article V of the original Articles of Agreement, a member had the right
to purchase the currency of another member in exchange for gold or its own currency.164
13.125 The stand-by arrangement, the quintessential financial instrument of the Fund,
was not foreseen in the original Articles of Agreement. In 1952, the then Managing
Director, Ivar Rooth, stated the desirability of a means by which a country would not
necessarily make an immediate drawing but would receive from the Fund the assurance
that it would be able to make a drawing within a prescribed period (originally six months)
should the need arise.165 The Fund, Rooth stated, should help members that need
‘temporary help’ and the Fund should assess ‘whether the policies the members will pursue
will be adequate to overcome the problems within such a period’.166 The new instrument,167
which was initially named ‘stand-by agreement’ but would soon thereafter be called ‘stand-
by arrangement’, has been refined and expanded since it was formalized in 1953.168
(p. 466) 13.126 Stand-by arrangements were originally conceived as precautionary
arrangements. It was thought that the right to purchase would by itself be sufficient to
satisfy the member’s requirements without a purchase actually being made.169
Precautionary arrangements have remained an important instrument over the years even
though the ‘typical’ stand-by arrangement is one in which members meet their immediate
balance of payments needs by actually ‘drawing’ resources.
13.127 The exercise of the member’s ‘right to purchase’ gradually became subject to
‘conditions’, thus linking the history of stand-by arrangements to the history of
conditionality.
13.128 The Second Amendment in 1978 introduced a definition of the stand-by
arrangement in Article XXX(b):
Stand-by arrangement means a decision of the Fund by which a member is assured

that it will be able to make purchases from the General Resources Account in
accordance with the terms of the decision during a specified period and up to a
specified amount.
13.129 Stand-by arrangements are the main instrument or vehicle for disbursing credit
tranche resources. According to the IMF Glossary of Selected Financial Terms, a stand-by
arrangement is a decision of the IMF by which a member is assured that it will be able to
make purchases (drawings) from the General Resources Account up to a specified amount
and during a specified period of time, usually one to two years, provided that the member
observes the terms set out in the supporting arrangement.170
13.130 A stand-by arrangement is therefore not a contract or an agreement but a decision
of the Fund. This is important to understanding its legal nature.171 The letter of intent
(signed by the applicant member and outlining ‘its’ programme) and the decision of the
Executive Board of the IMF announcing that a stand-by arrangement has been approved do
not constitute together an international legally binding agreement (hence the name
‘arrangement’ instead of ‘agreement’).
Fund arrangements are not international agreements and therefore language

having contractual connotations will be avoided in arrangements and in program
documents.172
13.131 Stand-by arrangements are not technically or legally loans, but purchase and
repurchase arrangements. However, they are the functional equivalent of a loan. The
‘revolving character’ is a basic feature of the stand-by arrangement. Purchases (drawings)
have to be reversed by repurchases (or repayments).
13.132 The Fund offers its general resources available to members through stand-by, FCL,
PLL in the GRA and extended arrangements under the EFF. Member countries use the
general resources of the IMF by making a purchase (drawing) of other members currencies
or SDRs with an equivalent amount of their own currencies. The IMF levies charges on
these (p. 467) drawings and requires that members repurchase (repay) their own
currencies from the IMF with other members’ currencies or SDRs over a specified time.
13.133 On 25 September 2002, the Fund published new guidelines on conditionality. The
2002 guidelines are supplemented by a statement to staff with the principles underlying the
guidelines on conditionality and an operational guidance.173 There is also a decision on
stand-by arrangements,174 which refers to Article V, section 3(a), (b), and (c) (‘Use of Fund’s
Resources, Credit Tranche Policies, Stand-By Arrangements, Extended, Flexible Credit Line
and Precautionary Credit Line Arrangements’), and which states the following:
1. A representation of need by a member for a purchase requested under a

stand-by arrangement will not be challenged by the Fund.
2. The normal period for a stand-by arrangement will range from 12 to 18
months. If a longer period is requested by a member and is considered
necessary by the Fund to enable the member to implement its adjustment
program successfully, the stand-by arrangement may extend beyond this
range, up to a maximum of three years.
3. Phasing and performance clauses will be omitted in stand-by arrangements
within the first credit tranche. They will be included in all other stand-by
arrangements but will apply only to purchases outside the first credit tranche.
For an arrangement within the first credit tranche, a member may be required
to describe the general policies it plans to pursue, including its intention to
avoid introducing or intensifying exchange and trade restrictions.
13.134 Financial assistance through an arrangement (stand-by, FCL, and PLL
arrangements in the credit tranches or extended arrangement under the Extended Fund
Facility) is the instrument typically used in the non-concessional facilities the Fund offers to
its members to help them remedy their balance of payments difficulties.
13.135 In March 2009, the IMF further modernized its conditionality framework175 in the
context of a comprehensive reform to strengthen its capacity to prevent and resolve crises.
The revised operational guidance to staff stipulates that structural conditions should be
focused and tailored to member countries’ different policies and economic starting points.
Moreover, structural performance criteria requiring formal waivers were abolished, and
structural reforms are covered by reviews of overall programme performance.
Extended arrangements
13.136 An extended arrangement (under the Extended Fund Facility, discussed in paras
13.230–13.231 below) is similar in nature to a traditional stand-by arrangement, though the
assistance is given for a longer period (typically three years)176 and in amounts larger in
relation to (p. 468) quotas than ordinary stand-by arrangements, and repayment of the
currencies the member draws is to be made within four to ten years of the drawing.
Extended arrangements are not defined in the Articles but they are regarded as
‘similar’ to stand-by arrangements for purposes of Article V, Section 3(a). There are
certain differences between the two instruments because they are used under
different policies, but the source and nature of the commitment are the same as for
stand-by arrangements. Therefore, the same definition applies to them and their
legal nature is identical.177
Conditionality
13.137 Conditionality refers to the policies and procedures developed by the Fund to
govern the access to and the use of its resources by member countries. Since these
resources exist for the benefit of the entire membership and are finite, their use needs to be
temporary and consistent with the purposes of the Fund.
13.138 Conditionality can be defined as the link between the approval or continuation of
the Fund’s financing and the implementation of specified elements of economic policy by
the country receiving the financing, that is, the link between the adjustment effort by the
country and the financing by the Fund.178 Ross Leckow defines conditionality as ‘those
features of a member country’s program of economic reform whose successful
implementation is expressly established by the IMF as a condition for the availability of IMF
financial assistance’.179
13.139 The 2002 ‘Guidelines on Conditionality’ present some elements for a definition:
Conditionality—that is program-related conditions—is intended to ensure that Fund

resources are provided to members to assist them in resolving their balance of
payments problems in a manner that is consistent with the Fund’s Articles and that
establishes adequate safeguards for the temporary use of the Fund’s resources.180
Conditionality is one element in a broad strategy for helping members strengthen
their economic and financial policies.181
Program-related conditions may contemplate the members meeting particular
targets or objectives (outcomes-based conditionality) or taking (or refraining from
taking) particular actions (actions-based conditionality).182
(p. 469) The history of conditionality
13.140 The word conditionality did not appear in the original Articles of Agreement. John
Maynard Keynes had advocated in his proposals that Member States should have ‘an
automatic entitlement’ to draw on the resources of the Fund, while Harry Dexter White had
urged that the resources only be made available if the country met the ‘conditions’ set down
by the Fund.183 In the end, Keynes’s case for unconditional access would apply only to the
‘gold tranche’ (now the ‘reserve tranche’), while White’s proposals influenced the original
text of Article V, section 3 of the Articles of Agreement, which established a set of
‘conditions governing the use of the Fund’s resources’. However these ‘conditions’ did not
amount to the current notion of ‘conditionality’.
13.141 The original Articles of Agreement contained no explicit statement that the Fund
had to adopt policies on the use of its resources.184 The First Amendment to the Articles of
Agreement introduced clear language that required the Fund to have policies on the use of
its resources.
13.142 Though the word ‘conditionality’ was first used in the 1964 IMF Annual Report,185
two decisions of the Executive Board of 10 March 1948186 and 13 February 1952187 already
anticipated the concept. The 1952 decision is of particular importance in the Fund’s history,
since it also set the basis for the creation of the stand-by arrangement.
13.143 The reference to stand-by arrangements in the IMF Articles of Agreement was
introduced by the Second Amendment, Article V, section 3(a) and Article XXX(b).
Conditionality evolved through the life and practices of the institution. Sir Joseph Gold188
once wrote that ‘the dynamism of the Fund has been particularly apparent in the
development of new policies and practices connected with the use of its resources in order
to meet the changing needs of the international monetary system.’189 It is in this context
that conditionality needs to be understood.
13.144 In 1968, the Fund published some guidelines on conditionality190 that were revised
and expanded in 1979.191 Though those guidelines were useful at the time, they became
obsolete with the passage of time. In September 2000, the then Managing Director, Horst
Köhler, issued an Interim Guidance Note on Streamlining Structural Conditionality to staff,
indicating that he viewed streamlining and focusing conditionality as well as ‘strengthening
(p. 470) national ownership’ as a priority. Accordingly, IMF staff embarked on a review of
various issues associated with conditionality. This review gave rise to a number of
papers,192 which were then discussed by the Executive Board.193 The comprehensive
review resulted in the adoption of a new set of conditionality guidelines by the Executive
Board on 25 September 2002, replacing the 1979 guidelines.
13.145 These 2002 guidelines were prepared by the Legal and Policy Development and
Review Department in consultation with other departments, and comprise two decisions.
Decision No I is entitled ‘Guidelines on Conditionality’ and Decision No II is entitled ‘Stand
By Arrangements’.194 In considering the new ‘Guidelines on Conditionality’, the Board also
discussed and approved a statement to staff, providing additional explanation and context
with regard to the principles underlying the guidelines on conditionality.
13.146 On 8 May 2003, a note entitled ‘Operational Guidance on the New Conditionality
Guidelines’ was published.195 This guidance elaborated upon the operational implications of
the new guidelines, covering three areas: (i) negotiation and programme design progress;
(ii) design of conditionality; and (iii) the presentation of conditionality in Board papers.
Since its first issuance in 2003, the guidance note was reviewed in three opportunities. A
first revision carried out following the 2005 review of the guidelines emphasized the
importance (p. 471) of ownership in the success of IMF-supported programmes and
provided enhanced guidance on the design of conditionality. (A ‘staff statement’ was revised
in January 2006). A further revision in 2008 applied the Board’s recommendation to achieve
prudence by requiring rigorous justification of conditionality. A new revision in 2009
reflects the reform of the Fund’s conditionality framework, and a revised operational
guidance to staff was published in 2010.196 In 2012 the IMF Executive Board concluded a
discussion reviewing conditionality during the period from 2002 to 2011 based on staff
papers.
The legal basis of conditionality
13.147 The word ‘conditionality’ does not have a precise legal meaning under the IMF
Articles of Agreement. This lack of clearly defined legal contours helps explain why
conditionality has changed over the years.197 The interpretation of conditionality is not
independent of the international economic regime in place.198
13.148 In the words of the late Sir Joseph Gold in 1979: ‘[T]he word conditionality…is not
a legal term of art. …There is no absolute standard on conditionality. The [IMF] Articles [of
Agreement] give no express guidance on what policies the Fund should encourage members
to follow under its policies of conditionality’.199
13.149 The word conditionality is currently interpreted by the Fund according to Article V,
section 3(a) as amended in 1978, which reads as follows:
The Fund shall adopt policies on the use of its general resources, including policies
on stand-by or similar arrangements, and may adopt special policies for special
balance of payment problems, that will assist members to solve their balance of
payments problems in a manner consistent with the provisions of this Agreement
and that will establish adequate safeguards for the temporary use of the general
resources of the Fund.
13.150 In addition to Article V, section 3(a), the interpretation of conditionality must also
take into account Article I, paragraph (v) which refers to the need for ‘adequate safeguards’
in the temporary provision of resources by the Fund.200 As Gianviti points out, ‘[t]he broad
definition of its purposes in Article I gives the IMF a large degree of latitude in the
formulation of policies on the use of its resources, and over the years, has allowed the IMF
to adapt its policies and expand the scope of conditionality in the light of experience.’201
13.151 The guidelines on conditionality are not legally binding principles in the way the
Articles of Agreement are. A decision of the Executive Board can be repealed or amended
by a (p. 472) subsequent decision. Indeed, the decision regarding the 1979 guidelines was
repealed by the 2002 decision adopting the new guidelines.
13.152 According to Gianviti, conditionality consists of ‘three layers of conditions’.202 He
explains that the first layer consists of the Articles of Agreement and the policies adopted
by the Fund under the Articles. The second layer consists of the stand-by or other
arrangements, which specify the particular conditions applicable to the assistance provided
under that arrangement (in particular, performance criteria and reviews). The third layer of
conditionality is based upon the recommendations by the Managing Director and the staff
with regard to the approval of an arrangement (prior actions and benchmarks).203 Four
types of ‘conditions’ are identified: performance criteria, reviews, prior actions, and
benchmarks, in addition to the ‘conditions’ imposed by the IMF Articles of Agreement.
The rationale of conditionality
13.153 Conditionality has served a variety of purposes over the years:204
(1) It is a filter to channel financial assistance. The provision of financial assistance to

countries in need is not automatic, but conditional (only the reserve tranche can be
accessed unconditionally). IMF financial assistance (support to members experiencing
balance of payments problems) is conditional on the adoption and implementation of
adjustment policies. The logic behind the conditionality requirements is that a country
with external payments problems is spending more than it is taking in. Unless
economic reform takes place, it will continue to spend more than it takes in. This filter
function is clearly manifested in the ‘phasing out’ technique of conditionality:
successive tranches of financing are delivered only if key objectives remain
attainable.
(2) Conditionality represents the essence of the ‘adequate safeguards’ of Fund
resources prescribed in Article 1(v) of the Articles of Agreement: ‘[T]o give confidence
to members by making the general resources of the Fund temporarily available to
them under adequate safeguards.’ Conditionality is consistent with the nature of the
IMF resources, which are finite and exist for the benefit of the entire membership.
Conditionality protects the quality of the IMF asset portfolio, as Manuel Guitián
emphasized. 205 Access limits, phasing of purchases, and repurchase policies 206
constitute important safeguards for the temporary use of such resources.
In recent years, the Fund has developed other safeguards207 both to protect outstanding
credit (such as ‘safeguards assessments of central banks’, which aim at preventing the
misuse (p. 473) of Fund resources and the misreporting of information208) as well as to
assist members in clearing ‘arrears’ (ie, overdue financial obligations) to the Fund.
(3) It is a tool to promote ‘good policies’. Countries seeking IMF financial assistance
know that only good policies will ‘earn’ them a programme. This knowledge makes
the ‘ownership’ issue all the more difficult. This issue is addressed by the 2002
guidelines (principle 7), which aims to circumscribe the scope of conditionality: 209
Program-related conditions governing the provision of Fund resources will be

applied parsimoniously. …Conditions will normally consist of macroeconomic
variables and structural measures that are within the Fund’s core areas of
responsibility. Variables and measures that are outside the Fund’s core areas
of responsibility may also be established as conditions but may require more
detailed explanation of their critical importance. The Fund’s core areas of
responsibility in this context comprise: macroeconomic stabilization;
monetary, fiscal, and exchange rate policies, including the underlying
institutional arrangements and closely related structural measures; and
financial system issues related to the functioning of both domestic and
international financial markets.
(4) It serves as a substitute for collateral. Banks require collateral in commercial

lending. Conditionality operates as a substitute for collateral in lending to sovereign
borrowers. 210
(5) It signals policy credibility to the markets. The existence of an IMF-supported
programme encourages private investment into the country. This explains why
countries are ready to tighten their belts (and the belts of their citizens) in order to
get and maintain an ‘IMF-supported programme’. The eagerness to get or maintain a
programme may also help explain why, in some instances, specific measures in a
programme have been proposed, without a full awareness or analysis of their
potentially negative social implications. The importance attached by countries to IMF
conditionality goes beyond the importance they attach to the fulfilment of other
obligations undertaken as members of international organizations. In an explicit
acknowledgement of the need to take into account the circumstances of members,
principle 4 of the 2002 guidelines states: 211
In helping members to devise economic and financial programs, the Fund will
pay due regard to the domestic social and political objectives, the economic
priorities, and the circumstances of members, including the causes of their
balance of payments problems and their administrative capacity to implement
reforms.
(6) It is an instrument to reduce moral hazard. In the words of Guitián:
The availability of IMF financial assistance provides a measure of insurance

against adverse shocks and the emergence of external imbalances. In common
with all insurance activities, it raises the spectre of moral hazard in the form
of less determination on the part of the member countries toward the
adoption or maintenance of appropriate policies. By making its resources
conditional on the implementation of adjustment measures, the risk of moral
hazard is thus contained (emphasis added). 212
(p. 474) The critique of conditionality

13.154 Conditionality has been the subject of fierce opposition and criticism through the
years. The Meltzer Report concluded that ‘the use of IMF resources and conditionality to
control the economies of developing nations often undermines the sovereignty and
democratic processes of member governments receiving assistance.’213 A report produced
by an independent task force within the Council on Foreign Relations stated that ‘[t]he IMF
should limit the scope of its conditionality to monetary, fiscal, exchange rate, and financial-
sector policies.’214
13.155 In part in response to some of these criticisms, the IMF undertook its own review
of conditionality (which led to the 2002 guidelines and subsequent guidance) in order to
identify a number of issues that ought to be revised and that constituted an agenda for
reform of conditionality.
13.156 With regard to the policies that ought to be covered by conditionality, a
considerable broadening in the scope of IMF-supported programmes was identified as a
problem. The expansion of conditionality into the ‘structural’ area has been the
consequence of a number of factors. First, it reflects the increasing emphasis on growth as
a policy objective, driven by the view that demand management alone is inadequate to
address the pressing economic problems of member countries and, thus, that supply-side
measures and institutional policies are necessary. Secondly, it is a result of the IMF’s
involvement with low-income countries (LICs) (suffering from structural imbalances), with
transitional economies (where structural reforms have been essential), and with countries
experiencing financial crises, where ‘structural weaknesses’ in the financial sector have
been at the root of the problem. Thirdly, the very success of macroeconomic policies
depends on structural reforms (hence the name ‘structural conditionality’), including the
removal of market distortions and the establishment of the institutional underpinnings for
effective policy making in a market economy. The broadening of conditionality into areas
like legal reform is a recognition that durable capital flows these days take the form of
equity investments and that those investors are at much greater risk of weaknesses in the
local legal system.
13.157 The problem with the broadening scope of these programmes is that structural
reforms in areas outside the Fund’s core of expertise, such as public enterprise
restructuring, privatization, and social security reform, have also grown, on the
consideration that they are linked to fiscal adjustment. Against this broadening scope of
conditionality, the Board rightly recommended the need to streamline and focus it. The
Fund cannot overstep its mandate.
13.158 Another area of streamlining identified by the Board referred to the monitoring of
programmes. An excessive degree of detail in programme monitoring may create the
impression that the Fund is trying to ‘micro-manage’ the authorities’ policy programme.
Performance criteria, programme reviews, prior actions, indicative targets and structural
benchmarks (p. 475) are the tools of monitoring subject to review.215 While the first three
techniques were mentioned in the 1979 guidelines, structural benchmarks were not.
Structural benchmarks, however, have become increasingly used in the last decade as a
monitoring technique, owing to the fact that structural reforms are often difficult to
characterize through quantifiable objective performance criteria. This proliferation in the
use of structural benchmarks,216 however, is one of the factors contributing to the excessive
expansion of conditionality, and therefore has been criticized by the IMF Board.
Interestingly, a great number of these structural benchmarks are legal measures, reflecting
the demand by investors for a reliable local legal infrastructure. The Board also expressed a
concern that excessively detailed conditionality may undermine the national ownership of a
policy programme and strain the country’s administrative capacity.
13.159 The Board recommended that letters of intent (LOIs) should make a clearer
distinction between the authorities’ overall policy programme and the part of that
programme that is subject to the Fund’s conditionality. IMF-supported programmes have
sometimes ‘short-circuited’ national decision-making processes and failed to take adequate
account of the authorities’ ability to muster public support for the policies envisaged, as
well as their administrative capacity to implement these policies. This was identified as a
serious problem, one which undermined the nature of conditionality. Governments
frequently outlined in LOIs their broader policy agenda—including reforms agreed with
other institutions such as the World Bank—to reaffirm their agenda before domestic and
international audiences. Such broad policy agendas often become untenable objectives both
to carry out and to monitor: hence the need to streamline the contents of the LOIs.
13.160 The conditionality framework has evolved substantially over the years, as
discussed in paragraphs 13.144 to 13.146, and, since the adoption of the 2002 guidelines of
conditionality, there have been a number of revisions and reviews of policies and practice.
13.161 In March 2009, the IMF adapted and modernized its conditionality framework to
reinforce its competence in crises prevention and resolution. The revised operational
guidance to staff requires the focusing and tailoring of the structural conditions to the
different policies and economic starting points of the member countries. In addition, a
couple of new facilities were introduced that rely heavily on ex-ante conditionality217 as part
of the reforms on the IMF lending toolkit. This includes the Flexible Credit Line, which
relies on rigorous pre-qualification criteria or ex-ante conditionality. In situations where a
full-fledged economic programme is either not necessary or not feasible, the Fund can
provide financial support to meet urgent balance of payments needs under the Rapid
Financing Instrument and Rapid Credit Facility (RCF),218 as described in paragraph 13.214
below. The Precautionary and Liquidity Line, introduced in 2011, combines elements of both
ex-ante and ex-post conditionality.
(p. 476) 13.162 The FCL created in 2009 is a type of ‘insurance policy’ for strong
performers, mainly emerging market countries. Access to the FCL is restricted to countries
that meet strict qualification criteria. But once a credit line has been approved, a country
can draw on it without having to meet specified policy goals,219 as is normally the case for
IMF loans. The new framework ensures that structural conditions linked to disbursements
of IMF financing are sufficiently focused and adequately tailored to member countries’
different policies and economic starting point.220
13.163 The PLL replaced the Precautionary Credit Line (PCL, introduced in 2010),
building on its strengths and enhancing its flexibility. The PLL can be used for both crisis
prevention and crisis resolution purposes by countries with sound fundamentals and
policies, and a track record of implementing such policies. PLL eligible countries may face
moderate vulnerabilities and may not meet the FCL qualification standards, but they do not
require the same large-scale policy adjustments normally associated with SBAs. The PLL
combines qualification (similar to the FCL) with focused ex-post conditions that aim at
addressing the identified vulnerabilities in the context of semi-annual monitoring.221
13.164 Later on, in September 2012, the IMF Executive Board concluded a discussion on
the 2002 guidelines on conditionality.222 This discussion was focused on a debate of the
staff papers discussing the guidelines on conditionality and on the design and effects of
IMF-supported programmes during the period from 2002 to September 2011. The 2011
review emphasizes the IMF efforts to learn lessons from previous crises and to provide
more flexible and tailored lending to its members needs. Although this latest review found
that the IMF’s conditionality guidelines were generally appropriate, it also drew attention
to the main areas where additional reinforcement in implementation of underlying policies
might be required, including as challenges remained especially in some recent high-debt
crisis programmes. These areas comprise:223
(i) keeping conditionality focused;

(ii) enhancing risk diagnostics underpinning programme design;
(iii) considering macro-social issues in IMF-supported programmes; (p. 477)
(iv) enhancing programme ownership and transparency;
(v) leveraging economic surveillance to increase contingency planning; and
(vi) improving partnerships with other institutions.
Conditionality in practice
13.165 So, how does conditionality work in practice? Along with the request for financial
assistance, the member presents to the IMF a plan of reform (a ‘programme’) typically
outlined in a letter of intent or a memorandum on economic and financial policies (MEFP)
that may be accompanied by a technical memorandum of understanding (TMU).224
13.166 In the programme documents, the member sets out some macroeconomic (fiscal,
monetary, and exchange rate), financial, institutional, or closely related structural
objectives or policies. The specifics of the programme are selected by the member, not by
the Fund.
13.167 Indeed, the primary responsibility for the design of the programme lies with a
member’s authorities. ‘The letter of intent is a statement of intention, not the undertaking
of obligations.’225
13.168 The issue of the national ‘ownership’ of the programme remains a thorny one. The
truth is that in the past the Fund has exerted a very influential role in the design of these
programmes. On the one hand, this is a result of its surveillance function, as the Fund
identifies problems through its Article IV consultations. On the other hand, this is a result of
the members’ eagerness to get the assistance; countries know what the Fund likes and
dislikes—often referred to as ‘the Washington consensus’—and are unlikely to choose
policies or objectives that run against that consensus. In addition, the countries know that
the Executive Board will judge the sufficiency of the reform measures and whether the IMF
can reasonably expect payment before giving the green light to the approval of the
assistance.
13.169 A member’s programme is the member’s unilateral commitment to policies, as set
forth in the LOI or MEPF. This unilateral character is important for legal purposes, because
if it formed part of an ‘agreement’ between the Member and the Fund, then failure to fulfil
the letter of intent could be seen as giving rise to a breach of an international obligation. It
is important to make a distinction between a member’s ‘programme’ and the ‘Fund
arrangement’.
13.170 A Fund arrangement is a decision by the Fund to provide financing to the member,
subject to certain conditions. These conditions are merely elements of the member’s
programme that the Fund finds particularly important, but they are always derived from the
member’s programme. From a conditionality perspective, the programme sets forth the
design of policies, while the arrangement provides the basis for monitoring the
implementation of those policies.
A Fund arrangement is a decision by the Executive Board by which a member is

assured that it will be able to make purchases or receive disbursements from the
Fund in accordance with the terms of the decision during a specified period and up
to a specified amount. Fund (p. 478) arrangements are not international
agreements and therefore language having a contractual connotation will be
avoided in arrangements and in program documents. Appropriate consultation
clauses will be incorporated in all arrangements.226
13.171 The monitoring of performance, assessing the implementation of the member’s

understandings with the Fund (the programme), is carried out through performance criteria
(key measures under Fund-supported programmes), prior actions, programme, or other
reviews, and other variables and measures established as structural benchmarks or
indicative targets.227 Since 2009, the structural performance criteria are no longer used in
order to avoid an excessively narrow or rigid focus on a specific criterion.228
13.172 A performance criterion is defined as a variable or measure whose observance or
implementation is established as a formal condition that must be met for the Fund’s
financing to continue, unless the IMF Executive Board grants a waiver. The availability of
further instalments or purchases under the arrangement (phasing out) is made conditional
on the member’s observance of those variables or measures. Non-observance leads to the
interruption of the financing. The ‘phasing out technique’ is at the core of IMF
conditionality and remains an essential component in the new guidelines. If the money were
to be disbursed in one single lump instalment, members would not be motivated to continue
reform, and, thus, the very logic of conditionality would be distorted.
13.173 Prior actions are measures that the Fund expects the member to adopt in some
cases (eg, before approving an arrangement or completing a review).
Programme reviews are typically held every six months to provide a framework for
assessing whether the programme is on track or whether modifications are necessary. In
addition to programme reviews, the Fund also conducts ‘financing assurances reviews’ in
the case of members that have ‘outstanding sovereign external payments to private
creditors, or that by virtue of the imposition of exchange controls, has outstanding non-
sovereign external payments arrears’ so as ‘to determine whether adequate safeguards are
in place’.229
13.174 Indicative targets are variables that ‘cannot be established as performance criteria
because of substantial uncertainty about economic trends’ or quantitative indicators
introduced in addition to performance criteria to assess the progress of the member in
meeting the objectives of a programme.230
Structural benchmarks are defined in rather vague terms and comprise a variety of
measures not included in the other categories of monitoring techniques.231 A structural
benchmark is different from a performance criterion in that failing to achieve it would not,
by itself, interrupt the Fund’s financing. The revised operational guidance to staff stipulates
that the structural benchmarks should be critical for the achievement of the programme
objectives.232
(p. 479) 13.175 The Executive Board reviews the performance of the member under
programmes supported by use of the Fund’s resources in connection with Article IV
consultation and in connection with further requests for assistance.233 This review by the
Executive Board is typically informed by the staff’s appraisal of such performance.234
Principles underlying the Guidelines on Conditionality
13.176 A staff statement attached to the 2002 Guidelines explains the key principles that
should guide the Fund in designing and implementing conditionality.235 Chief among these
‘principles underlying the guidelines on conditionality’ are: (i) national ownership of reform
programmes, (ii) parsimony in the application of programme-related conditions; (iii)
tailoring of programmes to the member’s circumstances; (iv) effective coordination with
other multilateral institutions; and (v) clarity in the specification of conditions.
13.177 National ownership refers to a willing assumption of responsibility for a
programme of policies, by country officials who have the responsibility to formulate and
carry out those policies. National ownership along with the member’s administrative
capacity to implement reforms is identified as the key element for the success of the reform
programme. However, as mentioned above, the issue of national ownership remains a
thorny one. Indeed the operational guidance on the new conditionality guidelines236
acknowledges the limitations of national ownership when it admits that ‘the [national]
authorities might have limited capacity or inclination to draft program documents.’ In this
respect, technical assistance might be needed to enable those authorities to make ‘informed
choices’.
13.178 Programme conditions should not be too numerous, hence the principle of
parsimony. Tailoring of programmes is the recognition that each programme is different,
since the specific circumstances (causes of balance of payment difficulties), priorities, and
time framework in each country are different. Fund policies must be applied consistently
though, so as to maintain the uniform treatment of members.
Coordination with other multilateral institutions, in particular with the World Bank (and I
would also add interdepartmental coordination), addresses the need to avoid overlaps,
unnecessary duplications, as well as the need to have a lead agency in terms of
responsibility and accountability. The guidelines specify in principle 8 (Decision I) that
‘[t]here will be no cross-conditionality.’ In the 2011 Review of Conditionality, the Executive
Board Directors pointed out the importance of coordination and collaboration with other
international institutions and donors to ensure adequate financing and coherent
conditionality while avoiding duplication, giving especial attention to recent programmes
for countries part of a currency union such as the countries pertaining to the Eurozone.237
(p. 480) 13.179 Clarity is related to transparency and also to the principles of parsimony
and tailoring. The authorities must clearly distinguish what is the specific domain of
conditionality (ie, the parts of the reform agenda upon which continued access to Fund
resources depend) and what is the broader policy agenda which they wish to set out for
national and international audiences (but which is not a condition for the use of Fund
resources).238
The provision of information and consequences of ‘misreporting’
13.180 The effectiveness of conditionality is also dependent upon the provision of accurate
information by the member with regard to the design and implementation of the
programme.239 Article VIII, section V imposes a legal obligation upon members with regard
to the reporting of information to the Fund.
13.181 There have been cases in recent years in which countries receiving financial
assistance have ‘misreported’ economic data to the Fund.240 Misreporting has major
consequences under the Fund’s policies on use of its resources and may constitute a breach
of Article VIII, section 5. Failure to report at all or to do so in a timely manner, or to report
inaccurate information, can lead to the imposition of the sanctions specified in Article XXVI
(including, ultimately, the compulsory withdrawal from membership of the Fund if the
member persistently fails to fulfil the obligation).241
In January 2004 the Executive Board adopted a decision to strengthen the effectiveness of
Article VIII, section 5.242
13.182 In 1984, the IMF put in place a separate framework of guidelines on misreporting
to deal with cases in which members fail accurately to report information associated with
the provision of IMF financial assistance, such as information regarding the observance of
performance criteria.243 The guidelines specify the corrective actions or remedies to be
taken in the case of misreporting.244
(p. 481) 13.183 A decision of the Executive Board of 27 July 2000 on the ‘Establishment of
General Policy to Condition Decisions in the General Resources Account on Accuracy of
Information Regarding Implementation of Prior Actions’, reads as follows:
Any decision on the use of resources in the General Resources Account (including
decisions approving an arrangement or an outright purchase, completing a review,
or granting a waiver either of applicability or for the non-observance of a
performance criterion) will be made conditional upon the accuracy of the
information provided by the member regarding implementation of prior actions
specified in the decision.245
‘Hard conditionality’ versus ‘soft conditionality’

13.184 Since the interpretation of conditionality is not independent of the international
economic regime in place,246 and since there is no absolute standard in the IMF Articles of
Agreement concerning its understanding, it is possible to talk about different types of
conditionality. Today, ‘hard’ or ‘strict’ conditionality co-exists with ‘milder’ or ‘softer’
conditionality in some cases and with ‘stricter’ conditionality in some other cases.
13.185 The Fund has tried over the years to apply more lenient standards in special cases.
The lower the conditionality, the higher the degree of automaticity.
The Second Amendment to the IMF Articles of Agreement introduced the word ‘special’ in
Article V, section 3(a), to ‘adopt special policies for special balance of payments problems’.
This is the legal basis for the creation over the years of special policies.247 Article V, section
3(a) thus enables the Fund to establish different terms, different facilities, different
mechanisms to respond to diverse needs. Special policies are often more attractive because
they have more favourable terms, such as longer repurchase periods (eg, the EFF).
(However, in some cases the terms are more severe; for example the surcharge—higher
rate of interest—that applied in the case of the now defunct Supplemental Reserve Facility,
SRF.)
13.186 The controversy that surrounds the relaxation of conditionality is not new. Sir
Joseph Gold already pointed out in 1979 some of the problems of ‘milder conditionality’:
The contention that conditionality should be milder creates a dilemma. …If the
Fund’s standards of conditionality were lowered, the change would become known
and probably the Fund would have less influence on other potential lenders. …The
dilemma would not be so grave for some members because they do not have access
to other means of financing. …For these members, the provision of larger resources
by the Fund on the basis of milder conditionality than at present would be a net
financial benefit in the short run. Lower standards of conditionality, however, could
be detrimental to all members in a difficult balance of payments or reserve position
if this relaxation were to discourage some members from agreeing to increase the
Fund’s resources by the adjustment of quotas or by loans to it. Some members
argue that milder conditionality would not result in the neglect of adjustment but
would only extend it over a longer period.248
(p. 482) 13.187 From a legal point of view, the co-existence of different types of
conditionality can be justified through the principle of uniformity in combination with the
legal objective of symmetry. The principle of uniformity, embodied in the IMF Articles of
Agreement, provides that policies adopted by the Fund in the exercise of its functions must
not discriminate against or in favour of a particular member.249 It is reminiscent of the
doctrine of the equality of States in international law.250 However, the uniformity of rights
and obligations, and the uniform application of the policies of the Fund, require that
members be treated alike if they are in the same circumstances.
13.188 Symmetry focuses on the treatment of members in different circumstances. Unlike
uniformity, the objective of symmetry does not aim at ensuring equality of treatment (of
members in the same circumstances), but focuses instead on the comparability of the
treatment of members in different circumstances, which involves in turn, a subjective
judgement.251 Circumstances create different types of countries: debtor and creditor
countries, deficit and surplus countries, developed and developing countries, reserve and
non-reserve centres, countries that adopt the obligations of Article VIII and countries that
operate under the transitional arrangements of Article XIV. The rights and obligations of
different types of countries are not the same. Countries of the same type, however, must
have the same rights and obligations. The symmetrical effects of rights and obligations on
the different classes of members is an important consideration in the Fund’s operations.252
Technical assistance
13.189 The third main function performed by the IMF is technical assistance (Art V, s 2(b)
of the IMF Articles of Agreement). This task has grown in importance in recent years. The
IMF provides technical assistance to its members on their request. However, technical
assistance is not a right of a member, and requests are sometimes turned down or
discouraged because of tight resources or for other reasons.253
13.190 The IMF began providing technical assistance in the mid 1960s, when many newly
independent countries sought the advice of the IMF to set up their central banks and
ministries of finance.254 Technical assistance and training in banking and monetary policy,
foreign exchange, fiscal policy and statistics became a major function of the International
Monetary Fund in the early 1990s, particularly in the transition from centrally planned
economies to market economies in the formerly communist countries of Eastern Europe and
the Former Soviet Union. More recently, as is further discussed in Chapter 14, the IMF’s
technical assistance function has focused on strengthening the international financial
architecture and the financial and fiscal problems caused by the global financial crisis have
given rise to additional demands for IMF technical assistance.255
(p. 483) 13.191 The Legal Department of the IMF offers ‘legal technical assistance’ in the
areas of banking and finance, central banking, taxation, foreign exchange, secured
transactions, resolution, insolvency, AML/CFT, and others.256 This assistance includes
drafting and reviewing legislation and implementing regulations and providing other legal
advice.
13.192 Though the IMF ‘competes’ in the provision of technical assistance with other
private institutions, members may often find it to their advantage to receive advice from the
IMF, particularly if they have also requested conditional financial assistance from the Fund.
In this sense, these two functions are mutually reinforcing. Furthermore, through its
surveillance function, the Fund can identify weaknesses in the economy and in the financial
system, which can be corrected through adequate advice. The interplay between
surveillance, conditionality, and technical assistance is a feature of the operations of the
Fund.
13.193 In October 2005, the Fund approved a proposal establishing Policy Support
Instruments to provide policy support to low-income countries that do not want—or do not
need—financial assistance from the IMF, but still want the Fund to support, monitor, and
endorse their policies.257 This is in fact a form of technical assistance.
H. The Evolution of IMF Financial Facilities and Policies

13.194 This section surveys the various facilities, policies, and procedures that the Fund
has devised over the years to channel financial resources to its members.
13.195 The term ‘facilities’ lacks conceptual precision in the Fund jargon (and in Fund
publications), encompassing facilities, policies, instruments, procedures, and even
accounts.
13.196 Though the Fund has been often criticized on the grounds that it prescribes the
‘same medicine’ no matter what the malaise may be, this criticism is not always justified, as
the evolution of IMF facilities throughout its almost seventy years of existence evidences.
Taxonomy
13.197 IMF financial facilities and policies for the use of its resources can be classified
according to different criteria. The first criterion is the concessional–non-concessional
divide. Non-concessional financing is typically offered on a revolving basis, through the
purchase and re-purchase technique that characterizes stand-by arrangements, drawing on
the Fund’s general resources.258 Concessional facilities are generally offered via loans. The
(p. 484) resources available for concessional financing have been provided in part by
members voluntarily and independently from their quota subscriptions and in part by the
IMF itself. These resources are administered by trust funds (currently the PRGT, the PRG-
HIPC, MDRI-I and MDRI-II Trusts, and the PCDR Trust) for which the IMF acts as a trustee
(administered accounts).259
13.198 The mandatory policies referred to in Article V, section 3(a) are the credit tranche
policies, including first credit tranche policies. The optional ‘special policies’ referred to in
the same provision refer to those facilities that either (i) have a special repurchase period
under Article V, section 7(d) or (ii) have a special rate of charge under Article V, section
8(d). These special policies include the EFF and the now defunct Compensatory Financing
Facility (CFF), SRF, Currency Stabilization Funds, and Contingent Credit Line (CCL).260
13.199 The unduly complex structure of the facilities and policies adopted by the Fund
with regard to the provision of financial assistance to members, the intricate and
idiosyncratic terminology, and the lack of conceptual precision of the very term ‘facilities’ is
acknowledged by the Fund in the review it conducted of its own (non-concessional)
facilities. For the sake of ‘presentational simplicity’, the review states that ‘the paper refers
collectively to the various policies on the use of Fund resources as facilities’.261
Concessional facilities: financial assistance to low-income countries
13.200 The Fund is a monetary institution, not a development organization. However, the
Fund has over the years addressed the ‘special’ needs of developing countries in various
ways. As mentioned in paragraphs 13.230–13.231 below, the creation of the Extended Fund
Facility in 1974 took account of the needs of these countries, since short-term balance of
payments assistance is not the solution to remedy longer-term structural problems.
13.201 Low-income developing countries (which often lack access to private international
capital markets) need a different set of responses to help them address their problems.
They need lending over an extended period of time (or grants, with no expectation of
repayment), and they need concessional terms regarding repayment, rate of charge, and
access policy.
13.202 The Fund has created over the years several lending facilities to help the poorest
countries in the world address their problems. In 1976, the IMF established the Trust Fund
which drew upon the profits generated from the sale of part of the IMF’s gold holdings and
provided concessional loans to low-income developing countries.262 In 1986, the Fund
established the Structural Adjustment Facility to provide concessional loans by recycling
resources lent under the Trust Fund. In 1987, the Fund established the Enhanced
Structural Adjustment Facility. In October 1999 the ESAF was renamed as Poverty
Reduction and Growth Facility. In July 2009, the Executive Board approved widespread (p.
485) reforms of the concessional facilities, in which the Poverty Reduction and Growth
Trust replaced the PRGF.263
13.203 Concessional facilities are made available via loans, and not through purchase and
repurchase arrangements.
13.204 The resources used in concessional lending are separate from the IMF’s general
resources generated from quota subscriptions (GRA) and are typically provided through
voluntary contributions by a large number of IMF members as well as by the IMF itself.
These resources are administered under Trusts (currently the PRGT and PRG–HIPC Trusts)
for which the Fund acts as a Trustee.
Structural Adjustment Facility
13.205 The Fund established the Structural Adjustment Facility (SAF) within the Special
Disbursement Account, in 1986 to provide all low-income developing countries eligible for
International Development Association (IDA) resources with concessional loans in support
of medium-term macroeconomic adjustment policies and structural reforms. It is interesting
to point out that ‘structural benchmarks’ were first introduced in the context of the SAF in
1986.
13.206 Under the SAF, the member, with the help of the Fund and the World Bank,
developed a medium term policy framework for a three-year period, with loan
disbursements made annually, an applicable rate of interest of 0.5 per cent, and repayment
due in five and a half to ten years. In November 1993, the IMF’s Executive Board agreed
that no new commitments would be made under the SAF.
Enhanced Structural Adjustment Facility
13.207 The ESAF was established in 1987264 and enlarged in 1994. Under the ESAF, loans
were disbursed semi-annually at an interest rate of 0.5 per cent, and repayment was due in
five and a half to ten years.
13.208 An eligible member (low-income) that sought to use ESAF resources developed,
with the assistance of the IMF and World Bank, a policy-framework paper (PFP) for a three-
year adjustment period. The resources available under the ESAF were provided primarily
by bilateral contributions.
Poverty Reduction and Growth Facility
13.209 In 1999, the IMF transformed the ESAF and ESAF Trust into the more positively
named Poverty Reduction and Growth Facility and the PRGF Trust,265 and expanded the
facility’s objectives to support programmes that substantially strengthen balance of
payments positions and make them sustainable, while fostering durable growth, leading to
a reduction of poverty. Uganda became the first recipient of the new facility on 10
December 1999.
(p. 486) 13.210 To determine eligibility for PRGF loans, the Fund had in practice relied
upon the level of per capita income and eligibility under the International Development
Association (IDA) (the part of the World Bank that helps the earth’s poorest countries).266
However, there was no automatic link between PRGF and IDA eligibility and it was up to the
IMF Executive Board to establish the list of PRGF-eligible countries. The PRGF Trust (which
was administered by the Fund as a trustee) borrowed resources from central banks,
governments, and official institutions generally at market-related interest rates, and lent
them on a pass-through basis to PRGF-eligible countries. The difference between the
market-related interest rate paid to PRGF Trust lenders and the rate of interest of 0.5 per
cent per year paid by the borrowing members was financed by contributions from bilateral
donors and the IMF’s own resources.267 PRGF operations were conducted through three
accounts within the PRGF Trust: the Loan Account, Reserve Account, and Subsidy
Account.268
13.211 PRGF loans were provided under three-year PRGF arrangements (with the
possibility of one-year extension), with annual programmes for each of the three years.
Disbursements under PRGF arrangements were typically tied to performance criteria and
semi-annual reviews (conditionality).269
13.212 The access limits were changed in 2009 when the LIC reforms were adopted. The
PRGT instrument provides that the overall access of each eligible member to the resources
of the Trust under all facilities of the Trust as specified in section I, paragraph 1(a) shall be
subject to: (i) an annual limit of 100 per cent of quota; and (ii) a cumulative limit of 300 per
cent of quota, net of scheduled repayments. The Fund may approve access in excess of
these limits in cases where the member is experiencing an exceptionally large balance of
payments need, has a comparatively strong adjustment programme and ability to repay the
Fund, does not have sustained past and prospective access to capital markets, and has
income at or below the prevailing operational cut-off for assistance from the IDA; provided
that access shall in no case exceed (i) a maximum annual limit of 150 per cent of quota, and
(ii) a maximum cumulative limit of 450 per cent of quota, net of scheduled repayments.
Furthermore, specific access limits—not discussed above—apply for access under the
concessional RCF and under the Standby Credit Facility (SCF). PRGF-supported
programmes were framed around Poverty Reduction Strategy Papers (PRSP) which were
prepared by the borrowing country.270
Poverty Reduction and Growth Trust
13.213 In 2009, the IMF reformed the concessional lending facilities for low-income
countries and installed a new architecture of facilities that intended to be more flexible and
tailored to the increasing diversity of LICs and their needs. Also, as part of this reform, the
IMF’s Executive Board approved a new concessional financing framework, and converted
(p. 487) the PRGF–Exogenous Shocks Facility Trust to the new Poverty Reduction and
Growth Trust.271
13.214 Under the umbrella of the PRGT, three new concessional facilities became effective
in January 2010 and refined in April 2013: the Extended Credit Facility (ECF) to provide
flexible medium-term support; the Standby Credit Facility for addressing short-term actual
or potential needs;272 and the Rapid Credit Facility to provide emergency support. These
concessional loans carry zero interest rates until the end of 2014. The IMF reviews the level
of interest rates for all concessional facilities under the new PRGT every two years.273
13.215 The ECF replaced the PRGF as the Fund’s main instrument for providing medium-
term support to LICs with protracted balance of payments problems. The SCF offers
financial assistance to LICs with short-term balance of payments needs. The SCF
substitutes the High-Access Component of the Exogenous Shocks Facility, and can be used
in different circumstances, including on a precautionary basis. The RCF provides rapid
financial assistance with limited conditionality to LICs facing an urgent balance of
payments need. The RCF make more efficient the Fund’s emergency assistance for LICs,
and can be used flexibly in a wide range of circumstances.274
13.216 Furthermore, as part of the 2009 reform package, the resources available to low-
income countries were expected to grow to USD 17 billion during 2009–14. To meet these
new financing commitments, additional loan and subsidy resources were needed to be
mobilized through bilateral contributions. However, most of the needed subsidy resources
were to come from the IMF’s internal resources and the use of resources linked to windfall
profits from gold sales.
The PRGT Trust has more accounts today; there are loan accounts to finance each PRGT
facility (an ECF loan account, an SCF loan account, and an RCF loan account) and a general
loan account that may finance any of the facilities. Similarly, there are subsidy accounts to
finance subsidies for interest payments under each PRGT facility: ie, ECF, SCF, and RCF
subsidy accounts, and a general subsidy account that can subsidize any of the facilities.
In April 2014, an IMF policy paper on the Update of the Financing of the IMF concessional
assistance was published.275
Other forms of financial assistance to low-income developing countries
Debt relief and the HIPC Initiative
13.217 In addition to concessional loans, financial assistance for low-income developing
countries is also provided through grants and through debt relief. Debt relief under the
Heavily (p. 488) Indebted Poor Countries Initiative,276 which was jointly launched by the
IMF and the World Bank in 1996, was linked to the PRGF in 1997,277 with the setting up of
an HIPC–PRG Trust in February 1997 with resources administered by the IMF.
13.218 An increasing recognition by the international community that the external debt
levels of a number of countries—mostly in Africa—have become unsustainable and that a
concerted effort is needed (through debt relief, concessional financing, institutional reform,
and pursuit of sound economic policies) to place those countries on the road to sustainable
development culminated in an enhanced HIPC in September 1999. The objective of this
enhanced HIPC initiative is to provide faster and deeper and broader debt relief to help
countries reach and maintain a sustainable debt position.
13.219 The IMF provides its share of assistance under the HIPC Initiative to eligible
members typically in the form of grants which are used to help meet debt service
payments.278
13.220 As of October 2013, of the thirty-nine countries that are eligible or potentially
eligible for the HIPC Initiative assistance, thirty-five are receiving full debt relief from the
IMF and other creditors after reaching their completion points. One country, Chad, has
benefitted from interim debt relief. Three countries, which have been identified as
potentially eligible for HIPC Initiative assistance, have not yet reached their decision points
(Eritrea, Somalia, and Sudan). The members that currently benefit from HIPC debt relief
are: Afghanistan, Benin, Bolivia, Burkina Faso, Burundi, Cameroon, Central African
Republic, Comoros, Republic of Congo, Democratic Republic of Congo, Ivory Coast,
Ethiopia, Gambia, Ghana, Guinea, Guinea-Bissau, Guyana, Haiti, Honduras, Liberia,
Madagascar, Malawi, Mali, Mauritania, Mozambique, Nicaragua, Niger, Rwanda, São Tomé
and Príncipe, Senegal, Sierra Leone, Tanzania, Togo, Uganda, and Zambia.279
13.221 The IMF and the World Bank introduced the Poverty Reduction Strategy approach
in 1999 to strengthen their approach to providing assistance to low-income countries,
including both new financial assistance and debt relief under the enhanced HIPC
Initiative.280 Poverty Reduction Strategy Papers describe the macroeconomic, structural,
and social policies and programmes that a country will pursue over several years to
promote broad-based growth and reduce poverty, as well as external financing needs and
the associated sources of financing.281
(p. 489) 13.222 The PRSPs aim to provide the crucial link between national public actions,
donor support, and the development outcomes needed to meet the United Nations’
Millennium Development Goals, centred on halving poverty between 1990 and 2015.282
The Multilateral Debt Relief Initiative and the Post-Catastrophe Debt Relief Trust
13.223 In 2005, to help speed up progress toward the United Nations Millennium
Development Goals (MDGs), the HIPC Initiative was complemented by the Multilateral Debt
Relief Initiative (MDRI). The MDRI allows for 100 per cent relief on eligible debts by three
multilateral institutions—the IMF, the World Bank, and the African Development Fund
(AfDF)—for countries completing the HIPC Initiative process.283 In 2007, the Inter-
American Development Bank (IaDB) also decided to provide additional (‘beyond HIPC’) debt
relief to the five HIPCs in the Western Hemisphere.284 Finally, the IMF launched a Post-
Catastrophe Debt Relief Trust in 2010, which allows the IMF to join international debt relief
efforts for very poor countries that are hit by the most catastrophic of natural disasters.
This enabled the IMF to eliminate Haiti’s entire outstanding debt to the IMF following the
devastating earthquake in January 2010.285
Special policies
13.224 Over the years the Fund has developed ‘special policies’ and facilities to address
special balance of payments problems according to Article V, section 3(a). Some of those
facilities have been allowed to lapse (since they were designed to address a particular
problem, once the problem was solved the facility was no longer needed). Others still
remain in operation.286
(p. 490) Emergency assistance (natural disasters and post-conflict situations)
13.225 Emergency assistance was a concept introduced by the IMF in 1962 to help
member countries with urgent balance of payments financing needs in the wake of natural
disasters such as floods, earthquakes, hurricanes, or droughts. Its scope was expanded in
1995 to deal with post-conflict situations, that is, the aftermath of armed conflicts.287
13.226 The idea of quick disbursement which is inherent in the provision of emergency
financial assistance is an element which has been adopted in the facilities that have been
devised over the last decade to deal with crises stemming from international capital
markets (in particular the now defunct Supplemental Reserve Facility and the Contingent
Credit Line) and with the accelerated procedures that were introduced following the
Mexican crisis in 1995 (the so-called ‘emergency financing mechanism’, which is still in
effect).
13.227 While emergency assistance following natural disasters is aimed at meeting
immediate foreign exchange financing needs arising from shortfalls in export earnings and/
or increased imports, to avoid a serious depletion of a country’s external reserves, in the
case of post-conflict situations, the assistance is aimed at rebuilding the capacity for
developing and implementing an economic programme, as a catalyst for support from other
sources, as part of an international concerted effort to address the aftermath of an armed
conflict.288 Emergency assistance was converted into a special policy in 2000.289
13.228 As part of the reforms implemented on the IMF lending facilities in the aftermath
of the last global financial crisis, two main instruments for emergency assistance were
introduced, the Rapid Credit Facility on concessional terms for LICs and the Rapid
Financing Instrument for all members on non-concessional terms.290 These new
instruments replaced and widen the previous emergency assistance facilities. The RCF, as it
was explained earlier, provides rapid financial assistance with limited conditionality to LICs
facing an urgent balance of payments need. The RFI provides rapid financial (p. 491)
assistance with limited conditions to all members facing an urgent balance of payments
need.291
13.229 Consequently, the emergency financing at present includes: (i) on non-concessional
terms and available to all members, the RFI, the Flexible Credit Line and the Precautionary
and Liquidity Line292—pending of qualification, or under an existing stand-by arrangement
or Extended Fund Facility—as an augmentation. These facilities are subject to the IMF’s
market-related interest rate, and (ii) on concessional terms the LICs may borrow under the
PRGT through the RCF, the Extended Credit Facility or the Standby Credit Facility, as an
augmentation. These new facilities for LICs are subject to zero rates until the end of
2014.293
Extended Fund Facility
13.230 The Fund established the EFF in 1974 to assist members (in particular, developing
countries) to meet balance of payment difficulties that stem from structural problems and
require a longer period of adjustment. The IMF Executive Board in its decision on the
Extended Fund Facility explained that the purpose of ‘extended arrangements’ is to support
‘comprehensive programs that include policies of the scope and character required to
correct structural imbalances in production, trade and prices’.294
13.231 Thus, the EFF is a financing facility (window) under which the IMF supports
economic programmes aimed at overcoming balance of payments difficulties which require
a longer period of time for their resolution. Such medium-term assistance (under the EFF)
is given through an ‘extended arrangement’ which can be defined as a decision of the IMF
under the Extended Fund Facility that gives a member the assurance of being able to
purchase (draw) resources from the General Resources Account in accordance with the
terms of the decision during a specified period, usually three years, and up to a particular
amount.295 Typically, the member’s economic programme states the general objectives for
the three-year period and the specific policies for the first year; policies for subsequent
years are spelled out at the time of programme reviews (see Table 13.1).
Other facilities/policies/mechanisms
13.232 In 1989, the Fund designed policies to support Debt and Debt Service Reduction
(DDSR) operations aiming to provide financing in conjunction with the World Bank and
other official sources for the advance costs of members’ DDSR operations with commercial
banks. Fund support for such operations is provided under a stand-by or extended
arrangement or (since 1997) an ESAF–PRGF arrangement (now PGRT).296(p. 492)
Table 13.1 General Terms of IMF Financial Assistance
Facility or Policy Charges Duration Repayment Instalments
Standby Basic rate1 plus 1–2 years 3¼–5 Quarterly

Arrangement (SBA) surcharge2
Flexible Credit Line Basic rate plus 1–2 years3 3¼–5 Quarterly
(FCL) surcharge
Precautionary and Basic rate plus 6 months to 2 3¼–5 Quarterly

Liquidity Line (PLL) surcharge years
Extended Fund Basic rate plus 3–4 years4 4½–10 Semi-annual

Facility (EFF) surcharge
Rapid Financing Basic rate plus 3¼–5 Quarterly

Instrument (RFI) surcharge
Extended Credit Zero Rate5 3 years 5½ years grace N/A

Facility (ECF) extendable to 5 period and 10
years years of final
maturity
Standby Credit Zero Rate 1–2 years 4 years grace N/A

Facility (SCF) period and 8 years
of final maturity
Rapid Credit Facility Zero Rate N/A (one-off 5½ years grace N/A
(RCF) disbursements) period and 10
years of final
maturity
Policy Support N/A 1–3 years N/A N/A

Instrument (PSI) extendable to 4
years
Memorandum Items6 50 basis points N/A N/A N/A

Service Charge
Commitment Fee7 15 basis points for N/A N/A N/A

committed amounts
up to 200 per cent of
quota, 30 basis
points on committed
amounts above 200
per cent and up to
1,000 per cent of
quota and 60 basis
points on amounts
exceeding 1,000 per
Facility or Policy Charges Duration Repayment Instalments
cent of quota points

thereafter
1
The basic rate of charge is linked directly to the SDR interest rate by a fixed margin that
is set each financial year. The basic rate of charge therefore fluctuates with the market rate
of the SDR, which is calculated on a weekly basis. The basic rate of charge is adjusted
upward for burden sharing to compensate for the overdue charges of other members.
2
The surcharge on high levels of credit outstanding under SBA and the EFF is 200 basis
points, paid on the amount of credit outstanding above 300 per cent of quota. If credit
remains above 300 per cent of quota after three years, this surcharge rises to 300 basis
points, and is designed to discourage large and prolonged use of IMF resources.
3
The FCL works as a renewable credit line, which at the country’s discretion could initially
be for either one- or two-years with a review of eligibility after the first year.
4
Interest rates on concessional loans under the PRGT (ECF, SCF, and RCF) were reduced
to zero for one year and subsequently extended until the end of 2014. The interest rate is
reviewed every two years henceforth.
5
The surcharge on the SRF is 300–500 basis points, with the initial surcharge of 300 basis
points rising by 50 basis points after one year and each subsequent six months. The
surcharge increases over time in order to provide an incentive for repurchases ahead of the
obligation schedule.
6, 7
These charges do not apply to PRGT facilities.
Source: International Monetary Fund, IMF Lending—Factsheet, September 2013, available
at <http:// www.imf.org/external/np/exr/facts/howlend.htm>
(p. 493) 13.233 In 1995, the Fund established the Currency Stabilization Funds as an
element within a standby or extended arrangement to provide additional, precautionary
balance of payments support in the initial stage of an exchange rate based stabilization.
However, no member has made use of this policy yet.297
13.234 Though it is not a facility, a mention ought to be made of the Trade Integration
Mechanism (TIM) established by the IMF Executive Board in April 2004.298 The TIM allows
the IMF to stand ready to provide resources, as necessary, to assist member countries in
meeting balance of payments shortfalls that might result from multilateral trade
liberalization. The TIM is not a new lending facility, but rather a policy aimed at making
Fund resources more predictably available to qualifying member countries under existing
IMF facilities. The establishment of a Trade Integration Mechanism within the Fund’s
existing lending facilities clarifies further how the Fund stands ready to help its members
mitigate short-term balance of payments pressures stemming from trade liberalization. The
TIM is designed to mitigate concerns among some developing countries that their balance
of payments positions could suffer, albeit temporarily, as liberalization changes their
competitive position in world markets.299
13.235 Also, not providing direct financing, the Policy Support Instrument (PSI) gives the
LIC members an explicit Fund endorsement of their economic policies. As a non-lending
arrangement, the PSI provides policy support and highlights for LICs that have made
significant progress toward economic stability in recent years and no longer require IMF
financing.300
Defunct facilities
13.236 The Fund identified in the 2000 review of its own facilities a number of
instruments that should be eliminated or allowed to lapse. The purpose of this so-called
‘housecleaning’ and ‘renovation’ was to facilitate the understanding of the financial
assistance offered by the Fund to its members.301 The following facilities (special policies,
typically with less stringent conditionality) are now defunct:
(i) The Buffer Stock Financing Facility was created in 1969 and eliminated in
2000. It provided financing to members to help finance their contributions to
approved commodity price stabilization funds.
(ii) The first Oil Facility was created in June 1974 in response to the oil price
shock, and lapsed in December 1974. It was designed to help members
finance deficits related to oil import price increases following the
Organization of Petroleum Exporting Countries’ (OPEC’s) decision in 1973;
only two conditions were required: (a) to consult with the IMF on balance of
payments needs; (b) to avoid enacting restrictions on international
transactions. A second Oil Facility was created in April 1975 (through the
establishment of a Subsidy Account) to provide additional financing, and
lapsed in March 1976. (p. 494)
(iii) An oil import element was added to the Compensatory and Contingency
Financing Facility in November 1990, when oil prices rose sharply during the
Gulf War. It was allowed to lapse at the end of 1991.
(iv) The Systemic Transformation Facility (STF) was created in April 1993 302
and allowed to lapse in April 1995. It provided support for the early stages of
transition from centrally planned to market economies, in relatively small
amounts and with relatively low conditionality. Former communist countries in
Eastern Europe and the former Soviet Union temporarily suffered sharp drops
in exports and permanent increases in import costs, particularly for energy
products, because of the shift to market prices, thus creating severe balance
of payments problems. The STF was used by twenty countries from 1993 to
1995. It was designed to pave the way for these countries to move to regular
IMF facilities. 303
(v) The contingency element of the Compensatory and Contingency Financing
Facility, created in 1988 and eliminated in 2000, which provided additional
access under arrangements, according to pre-specified calculations, in the
event of unanticipated adverse current account developments.
(vi) The Y2K Facility was created in September 1999, to deal with possible
strains resulting from the Y2K computer bug. It has not been used, and lapsed
at the end of March 2000.
(vii) The Contingent Credit Lines, created in 1999, was allowed to expire in
November 2003, on its scheduled sunset date. 304 The CCL had been intended
for members concerned with potential vulnerability to contagion, but not
facing a crisis at the time of commitment. Financing under the CCL was to be
provided if a member experienced exceptional payments difficulties resulting
from unforeseen ‘adverse developments in international capital markets’. 305
However, this precautionary line of defence was never used for various
reasons. For a start, ‘potentially eligible countries may have lacked confidence
that a CCL would be viewed as a sign of strength rather than weakness’;
furthermore, ‘there had been some uncertainty about whether Fund resources
under a CCL would in fact be readily available in the event of need, as the
release of funds would require Executive Board approval’. Finally, ‘many
potentially eligible countries had reduced their vulnerability to external
shocks through…reforms, thus reducing the perceived demand for insurance
in the form of a CCL’.
(viii) The Supplemental Reserve Facility was created in 1997 as a facility
intended to provide financial assistance to a member country experiencing
exceptional balance of payments difficulties due to a large short-term
financing need resulting from a (p. 495) sudden and disruptive loss of market
confidence reflected in the pressure on the capital account and member’s
reserves.
(ix) The Compensatory Financing Facility was established in 1963 to assist
commodity exporter countries experiencing a sudden shortfall in export
earnings arising from events beyond their control (fluctuating world
commodity prices).
13.237 Additionally, in 2009 by Decision No 14282-(09/29), the Fund decided to eliminate

the following special facilities.306 The Short-Term Liquidity Facility was created in 2008 to
establish quick-disbursing financing for countries with strong economic policies that were
facing temporary liquidity problems in the global capital markets. In 1989, the Fund
designed policies to support Debt and Debt Service Reduction operations (no longer in
effect) which aimed to provide financing in conjunction with the World Bank and other
official sources for the advance costs of members’ DDSR operations with commercial banks.
Fund support for such operations was provided under a stand-by or extended arrangement
or (since 1997) an ESAF–PRGF arrangement (now PGRT).307
In 1995, the Fund established the Currency Stabilization Funds (no longer in place) as an
element within a stand-by or extended arrangement to provide additional, precautionary
balance of payments support in the initial stage of an exchange rate based stabilization.
However, no member made use of this policy.308
Terms applicable to the facilities and access limits
13.238 The amount that a country can borrow from the Fund, referred to as ‘access limit’,
is typically a multiple of the country’s quota subscription.309 In February 2008 (revised
again in 2009, 2010, and 2011), the Fund approved a decision on access limits, establishing
that access by a member to the Fund’s general resources in the credit tranches and under
the Extended Fund Facility shall be subject to an annual limit of 200 per cent of quota and a
cumulative limit of 600 per cent of quota, net of scheduled re-purchases, provided that
these limits will not apply in cases where a member requests an FCL arrangement in the
credit tranches, although outstanding holdings of a member’s currency arising under such
arrangements will be taken into account when applying these limits in cases involving
requests for access under other Fund facilities.310 These limits shall not be regarded as
targets. The Fund may approve access in excess of these limits only in exceptional
circumstances.311 Under the (p. 496) PRGT, the total access to concessional financing is
limited to 100 per cent of quota per year, and total outstanding concessional credit of 300
per cent of quota. These limits can be exceeded in exceptional circumstances.312,313
312 313
In the
PRGT, there is a maximum limit of 150 annually, and 450 cumulative.
Access under an ECF arrangement is subject to a limit of 120 per cent of quota and an
exceptional maximum annual cumulative limit of 300 per cent of quota.314
13.239 Except for the PRGT, all facilities are subject to the IMF’s market-related interest
rate, known as the ‘rate of charge’, and some large loans carry an interest rate premium or
‘surcharge’.315 The rate of charge is based on the SDR interest rate, which is revised
weekly to take account of changes in short-term interest rates in the major international
money markets. (The surcharge had been introduced with the advent of large financing
packages to help members weather capital account crises, supplementing the general
policy on early repurchases.316)
I. Concluding Observations

13.240 The study of the law of the IMF is a fascinating and complex subject which has
appealed to me ever since I worked in the Legal Department of the IMF in the early 1990s.
The institution is at the centre of the international monetary system and at the centre of the
so-called international financial architecture.
13.241 The interplay between law and economics is a constant in the history of the Fund,
with economics taking a leading role. However, economists within the Fund (as well as
outside it) have grown accustomed to the use of references to key provisions of the Articles
of Agreement, in particular Article IV; Article VIII, section 2; and Article V, sections 2 and 3.
Economists need to be conversant with the key legal principles that apply to the Fund.
There are some official histories commissioned by the Fund, which include some legal
citations,317 and there are plenty of economic studies dealing with the various issues that
fall within the mandate of the Fund’s responsibilities. Lawyers have also produced a
number of studies on the international monetary system, in particular two former General
Counsels of the institution: the late Sir Joseph Gold and François Gianviti and the current
General Counsel, Sean Hagan. The originality of this chapter is that it provides a
comprehensive yet succinct legal analysis of the workings of the Fund that is accessible for
both economists and legal practitioners.
13.242 A recurring feature in this chapter is the complexity of the Fund’s operations and
financial structure, ‘shrouded in clouds of specialized terminology’.318 Complexity and
opacity tend to frustrate accountability and transparency. This is a challenge that IMF must
confront. (p. 497) The Fund has over the last few years made a conscious effort to become
more transparent, and its website and publications are a valuable source of information.
However, the language applicable to the Fund operations is often esoteric for those not
familiar with the institution. In this chapter, I have endeavoured to explain the workings of
the Fund in plain terms in the light of the law applicable to it. It is no easy task and only the
reader can judge whether I have succeeded in my endeavour.
13.243 Despite the abandonment of the par value regime in the 1970s, the importance of
the IMF has remained undiminished. Over the last few decades, the IMF’s mandate has
been broadened: from being primarily an international monetary institution to becoming an
international financial institution, encompassing not only monetary issues but also other
financial issues (capital markets, payments systems, etc). The IMF played a leading role in
the sovereign debt restructuring of the less-developed countries in the 1980s, in the
transition to a market economy of formerly communist countries in the early 1990s, in the
resolution of financial crises in Mexico and Asia in the mid- to late-1990s, and in the 2007–9
global financial crisis and the ensuing sovereign debt crisis in the Eurozone, though its
handling of such crises has been the subject of much controversy. The domain of
surveillance has extended beyond macroeconomic policies to encompass financial sector
and structural issues.
13.244 From the Fund’s point of view, surveillance is the key function. From the member
countries’ point of view, financial assistance is the key. Countries in need (of balance of
payments support) subject themselves to conditionality, surveillance, and technical
assistance as the ‘price’ that must be paid to obtain financial support. Members are not
always keen to tighten their belts or the belts of their citizens to obtain the resources they
need to address balance of payments difficulties, but they are well aware that non-
observance of their financial obligations with the Fund will lead them into further trouble.
13.245 One feature of the international monetary system, which is unsettled, concerns the
law governing international capital transfers. The extension of the Fund’s jurisdiction from
current account to capital account convertibility is a matter of great controversy. The
wisdom of capital account liberalization remains contested in the aftermath of the financial
crises in East Asia in the late 1990s (capital account driven crises). The economic literature
on the issue is still divided, with some distinguished economists favouring such
liberalization and some other equally distinguished economists opposing it. As a result, no
amendment to the IMF Articles of Agreement is foreseeable in the near future.
13.246 The evolution of the role of the Fund over the last few decades has affected the
practice of conditionality, that is, the policies and procedures developed by the Fund to
govern the access to, and the continuing use of, its resources by members. Though the
institution continues to focus on macroeconomic management, growing emphasis has been
placed over the last decade on efficiency issues, microeconomic measures, structural
policies, and financial sector reforms. This shift in emphasis has contributed to the
broadening scope of conditionality, which has become increasingly attached to structural
reforms including legal and institutional reforms. In response to these changes, the IMF
Executive Board conducted a review of conditionality which ended in the adoption of new
guidelines (replacing the 1979 decision) in September 2002. This chapter provided an
analysis of these guidelines in particular and of conditionality generally.
(p. 498) 13.247 Two of the major challenges confronted by the Fund in the twenty-first
century are the effective prevention and resolution of international financial crises, on the
one hand, and the financial support to the poorest countries in the world, on the other. The
former is further analysed in Chapter 14. The latter, which would deserve another volume,
has been the subject of some consideration in this chapter. And it is with reference to the
goal of poverty reduction that I conclude this chapter.
13.248 The position and reputation of the IMF in the international financial community
make it a particularly suitable actor in the process of financing development in the world’s
poorest countries. The Fund has the instruments that can make financial assistance through
debt relief and concessional lending effective, in particular, technical assistance
(fundamental for legal and institutional reform), surveillance, and conditionality, keeping a
vigilant eye on the temptation of corruption. Poverty alleviation is a daunting task, but one
that the international community ‘cannot afford’ to neglect.
Footnotes:
1
I had the privilege of getting to know Sir Joseph Gold in Washington, DC in 1992–3, when
I was working as a consultant in the legal department of the IMF. He impressed me as a
great thinker, a great lawyer, and a great person. Sir Joseph Gold had joined the Legal
Department of the International Monetary Fund in 1946 and served as the Fund’s General
Counsel from 1960 until 1979 when he retired from active service to become Senior
Consultant. He died in the year 2000. Sir Joseph Gold was the main draftsman of the First
and Second Amendments to the IMF Articles of Agreement and a prolific writer.
2
Public international monetary law is still a rather novel legal field. Recent references
include: Dominique Carreau and Patrick Juillard, Droit international économique (Paris:
Dalloz, 2003) paras 1453–514; Andreas Lowenfeld, International Economic Law (Oxford:
Oxford University Press, 2008) chs 16–17; Mario Giovanoli and Diego Devos (eds),
International Monetary and Financial Law: The Global Crisis (Oxford: Oxford University
Press, 2010); Charles Proctor, Mann on the Legal Aspect of Money, 7th edn (Oxford: Oxford
University Press, 2012) chs 19–23 (in particular, ch 22); Annamaria Viterbo, International
Economic Law and Monetary Measures: Limitations to States’ Sovereignty and Dispute
Settlement (Cheltenham: Edward Elgar, 2012); Thomas Cottier, John H Jackson, and Rosa M
Lastra (eds), International Law in Financial Regulation and Monetary Affairs (Oxford:
Oxford University Press, 2012); Thomas Cottier, Rosa M Lastra, and Christian Tietje (eds),
The Rule of Law in Monetary Affairs (Cambridge: Cambridge University Press, 2014);
François Gianviti, ‘Evolving Role and Challenges for the International Monetary Fund’ in
Mads Andenas and Joseph Norton (eds), International Monetary and Financial Law Upon
Entering the New Millennium. A Tribute to Sir Joseph and Ruth Gold (London: The British
Institute of International and Comparative Law, 2002) 29–70; François Gianviti, ‘The
International Monetary Fund and the International Monetary System. Decision Making in
the International Monetary Fund’ in Current Developments in Monetary and Financial Law
(Washington, DC: IMF, 1999) 31–67; and François Gianviti, ‘The Reform of the International
Monetary Fund (Conditionality and Surveillance)’ in Rosa M Lastra (ed), The Reform of the
International Financial Architecture (London: Kluwer Law International, 2001) 93–106.
3
A volume of Selected Decisions and Selected Documents of the International Monetary
Fund is published annually. The 36th issue, updated as of 31 December 2011, is available at
<http://www.imf.org/external/pubs/ft/sd/index.asp> (last visited 12 August 2014).
4
See Articles of Agreement of the International Monetary Fund (Bretton Woods, NH,
adopted 22 July 1944, entered into force 27 December 1945, as amended), Art XXVIII(a)
(hereinafter IMF Articles of Agreement).
5
Regular information on the Fund can be obtained from the IMF’s website <http://
www.imf.org>, the Annual Report, the bi-weekly survey, fact sheets, pamphlets, and other
publications.
6
For a recent study of such private international law issues and the private law of
monetary obligations, see Proctor, above note 2, in particular chs 4, 13, 15, and 16: ch 4
considers monetary obligations and the conflict of laws; ch 13 further elaborates upon a
number of private international law questions and the role of the law of the currency (lex
monetae); ch 15 explores in detail the consequences of Art VIII(2)(b) of the IMF Articles of
Agreement in proceedings before domestic courts; and ch 16 studies the private
international law of exchange control.
7
With regard to the distinction between microeconomics and macroeconomics, Dornbusch
and Fischer state: ‘The economy in the aggregate is nothing but the sum of its submarkets.
The difference between microeconomics and macroeconomics is, therefore, primarily one of
emphasis and exposition.’ See Rudiger Dornbusch and Stanley Fischer, Macroeconomics,
5th edn (New York: McGraw-Hill, 1990) 4.
8
The Fund released in April 2013 a comprehensive paper reviewing the recent application
of the Fund’s policies and practices on sovereign debt restructuring. See International
Monetary Fund, ‘Sovereign Debt Restructuring: Recent Developments and Implications for
the Fund’s Legal and Policy Frameworks’ (26 April 2013), at <https://www.imf.org/external/
np/pp/eng/2013/042613.pdf> (last visited 12 August 2014). See also International Monetary
Fund, ‘The Fund’s Lending Framework and Sovereign Debt—Preliminary Considerations’,
Policy Paper (June 2014), at <http://www.imf.org/external/np/pp/eng/2014/052214.pdf>
(last visited 12 August 2014). For an academic viewpoint, see Rosa M Lastra and Lee
Buchheit (eds), Sovereign Debt Management (Oxford: Oxford University Press, 2014) ch 5,
which extensively deals with sovereign debt crises and the role of the IMF.
9
See International Monetary Fund, ‘The Fund’s Mandate—The Legal Framework’ (22
February 2010), at <http://www.imf.org/external/np/pp/eng/2010/022210.pdf> (last visited
12 August 2014) (hereinafter IMF, ‘The Legal Framework’); International Monetary Fund,
‘The Fund’s Role and Mandate—An Overview’ (22 January 2010), at <http://www.imf.org/
external/np/pp/eng/2010/012210a.pdf> (last visited 12 August 2014) (hereinafter IMF, ‘An
Overview’).
10
IMF, ‘An Overview’, above note 9. IMF, ‘The Legal Framework’, above note 9, was a
background paper for the January paper (IMF, ‘An Overview’, above note 9). The latter
considered, at the request of the IMFC, a broader issue of what/how the Fund should be
doing to promote global stability. Thus, the Legal Paper discussed the Fund’s mandate not
only on surveillance (including members’ reserve policies and the authorities over and
capital flows) but also on the provisions by the Fund of financial assistance (‘lending’) and
advisory function (technical assistance).
11
The IMF is both at the centre of the international monetary system and at the centre of
the international financial system. The phrase ‘international monetary system’ covers the
official arrangements relating to the balance of payments—exchange rates, reserves, and
regulation of current payments and capital flows, while the ‘international financial system’
encompasses the international financial institutions—formal and informal—and the various
public and private actors in the so-called ‘global financial market’.
12
‘And while these powers [conferred upon the Fund] are often expressed in general
terms, the degree to which their interpretation can evolve is limited by the plain meaning of
the text, as supplemented by the travaux préparatoires (legislative history)’. See IMF, ‘The
Legal Framework’, above note 9, 3.
13
IMF, ‘The Legal Framework’, above note 9, 3.
14
Though the notion of State/country has no absolute fixed meaning, the IMF has
generally considered that a country in formal control of its external relations can be eligible
for IMF membership. In this respect, the Republica di San Marino became a member in
September 1992. I was working at the IMF Legal Department at the time and wrote a note
(earlier that year) on the issue of whether San Marino could be considered a country for the
purposes of IMF membership. Based on the documents I examined, such as the agreement
of cooperation with the European Economic Community (EEC), the statute of the
International Court of Justice (whose Art 34(1) says that only States may be parties in cases
before the Court) and the Charter of the United Nations, my conclusion was that San
Marino was a country, eligible for IMF membership.
15
I thank Sean Hagan for observations on this point.
16
IMF Articles of Agreement, Art XII, s 2, is about the Board of Governors, s 3 is about the
Executive Board, and s 4 is about the IMF Managing Director and staff. Article XII, s 1,
foresees the possibility of establishing a Council by a decision of the Board of Governors.
However, this Council has never been established. For an excellent legal analysis of the
decision-making organs and the decision-making process in the Fund, see Gianviti, ‘The
International Monetary Fund and the International Monetary System’, above note 2.
17
See Gianviti, ‘The International Monetary Fund and the International Monetary System’,
above note 2, 39. This is a comprehensive study of the legal framework within which the
organs of the Fund must operate. The decision-making process is analysed in depth at 50–
63.
18
See International Monetary Fund, ‘IMF Members’ Quotas and Voting Power, and IMF
Board of Governors’ (updated 13 August 2014), at <http://www.imf.org/external/np/sec/
memdir/members.htm> (last visited 13 August 2014).
19
Gianviti, ‘The International Monetary Fund and the International Monetary System’,
above note 2, 39.
20
Gianviti, ‘The International Monetary Fund and the International Monetary System’,
above note 2, 40.
21
This is in accordance with IMF Articles of Agreement, Art XII, s 3(a) and s 3(g). Section
3(g) states that ‘[t]he Executive Board shall function in continuous session as the principle
office of the Fund and shall meet as often as the business of the Fund may require.’
22
Under the current rules, the five largest appoint, and all others take part in the election,
even if one country can elect an Executive Director on their own.
23
See IMF Articles of Agreement, Art XII, s 3(b). See also International Monetary Fund,
‘The IMF at a Glance’ (27 March 2014), at <http://www.imf.org/external/pubs/ft/exrp/
what.htm> (last visited 13 August 2014). With regard to the voting procedures, see IMF
Articles of Agreement, Art XII, s 5.
24
These points are made by Gianviti, ‘The International Monetary Fund and the
International Monetary System’, above note 2, 47.
25
See IMF Articles of Agreement, Art XII, s 4(a). The Managing Director cannot be a
Governor or an Executive Director.
26
The employees of the IMF are international civil servants. About two thirds of its
professional staff are economists. See IMF, ‘IMF at a Glance’, above note 23.
27
The Fund’s departments and offices are headed by directors, who report to the
Managing Director. Most staff work in Washington, DC, although some resident
representatives are posted in member countries to help advise on economic policy. The IMF
maintains offices in Paris and Tokyo for liaison with other international and regional
institutions, and with organizations of civil society, and in New York and Geneva for liaison
with other institutions in the UN system. See IMF, ‘IMF at a Glance’, above note 23.
28
See International Monetary Fund, ‘International Monetary Fund Organization
Chart’ (updated 28 March 2014), at <http://www.imf.org/external/np/obp/orgcht.htm> (last
29
In addition to the work of Sir Joseph Gold (see above note 1), I should also like to
mention the contribution made to the development of the law of the IMF by François
Gianviti, who was Director of the Legal Department from January 1986 and General
Counsel from 1987, until his retirement from the IMF in December 2004. Gianviti steered
the legal work of the institution during the testing times of the late 1980s, through the
1990s, and into the new century. See ‘List of Selected Publications by François Gianviti’, at
<http://www.imf.org/external/np/bio/eng/fgl.htm> (last visited 13 August 2014). He has
been succeeded as General Counsel by Sean Hagan.
30
See William E Holder, ‘On Being a Lawyer in the International Monetary Fund’ in Robert
Effros (ed), Current Legal Issues Affecting Central Banks (Washington, DC: IMF, 1998) 14–
27. See IMF Articles of Agreement, Art XXIX, s (a):
Any question of interpretation of the provisions of the Agreement arising between

any member and the Fund or between any members of the Fund shall be submitted
to the Executive Board for its decision.
31
See IMF, ‘International Monetary Fund Organization Chart’, above note 28.
32
See Independent Evaluation Office, <http://www.ieo-imf.org/ieo/pages/ieohome.aspx>
(last visited 5 September 2014). At its Spring 2000 Meeting, the International Monetary and
Financial Committee (IMFC) endorsed the Executive Board’s decision to establish an
independent evaluation office (IEO) at the Fund as a means to enhance the learning culture
within the Fund, help build the Fund’s external credibility, promote a greater understanding
of the work of the Fund, and support the Executive Board’s institutional governance and
oversight responsibilities.
33
above note 2, 38. See also Norman Humphreys, Historical Dictionary of the International
Monetary Fund, 2nd edn (Lanham, MD: The Scarecrow Press, 1999), entry ‘Subscriptions to
the Fund’.
34
Prior to the Second Amendment, the reserve asset portion of the quota was paid in gold.
Where the currency of another member is involved, this requires the other member’s
concurrence.
35
See IMF Articles of Agreement, Art III, s 3(a). See also Decision of the Executive Board
No 6266-(79/156), ‘Guidelines on Payment of Reserve Assets in Connection with
Subscriptions’ (10 September 1979), published in Selected Decisions of the International
Monetary Fund, 17th issue (Washington, DC: IMF, 1992), at <https://www.imf.org/external/
pubs/ft/sd/index.asp?decision=6266-%2879/156%29> (last visited 13 August 2014). See
also François Gianviti, ‘Developments at the International Monetary Fund’ in Robert Effros
(ed), Current Legal Issues Affecting Central Banks (Washington, DC: IMF, 1997) vol 4, 6.
36
See International Monetary Fund, Financial Organization and Operations of the IMF,
IMF Pamphlet Series No 45, 6th edn (Washington, DC: IMF, 2001) 19–20, at <http://
www.imf.org/external/pubs/ft/pam/pam45/contents.htm> (last visited 13 August 2014)
(hereinafter IMF Pamphlet No 45, 6th edn).
37
IMF Pamphlet No 45, 6th edn, above note 36, 21. A member’s reserve tranche position
is also affected by other factors besides just subscription (eg, the reserve tranche position
(RTP) is affected by purchases by the member).
38
International Monetary Fund, Finance Department, ‘Financial Risk in the Fund and the
Level of Precautionary Balances’, approved by Eduard Brau (3 February 2004) 7, at <http://
www.imf.org/external/np/tre/risk/2004/020304.pdf> (last visited 13 August 2014).
39
See IMF, ‘Glossary of Selected Financial Terms’, at <http://www.imf.org/external/np/fin/
tad/docs/Glossary.pdf> (last visited 13 August 2014).
40
IMF Pamphlet No 45, 6th edn, above note 36, 66 (Box II.8 of the pamphlet). IMF Articles
of Agreement, Art XXX(c) defines ‘reserve tranche purchase’ as a ‘purchase by a member of
special drawing rights or the currency of another member in exchange for its own currency,
which does not cause the Fund’s holdings of the member’s currency in the General
Resources Account to exceed its quota’.
41
IMF Articles of Agreement, Art XXX (f):
A freely usable currency means a member’s currency that the Fund determines (i)
is, in fact, widely used to make payments for international transactions, and (ii) is
widely traded in the principal exchange markets.
The concept of ‘freely usable currency’ is relevant for some purposes such as the
convertibility of amounts purchased by the Fund; the concept of ‘usable currency’ is
relevant for the selection of currencies disbursed or received by the Fund under the
Financial Transactions Plan.
42
See eg Ariel Buira, Reflections on the International Monetary System, Princeton Essays
in International Finance No 195 (Princeton, NJ: Princeton University Press, 1995) 31–3.
Buira quotes Mikesell, who had been asked by the US Treasury to estimate the first quotas:
In mid-April 1943, White called me [ie, Mikesell] to his office and asked that I
prepare a formula for the quotas that would be based on the members’ gold and
dollar holdings, national incomes, and foreign trade. He gave no instructions on the
weights to be used but I was to give the United States a quota of approximately $2.9
billion, the United Kingdom (including its colonies) about half the US quota; the
Soviet Union, an amount just under the United Kingdom; and China somewhat less.
He [White] also wanted the total of the quotas to be about $10 billion. White’s major
concern was that our military allies (President Roosevelt’s Big Four) should have
the largest quotas. …Had there been reasonably good official national-income
estimates for the major countries in 1943, it might not have been possible for me to
approximate White’s conditions. …I confess to having exercised a certain amount of
freedom in making these estimates in order to achieve the predetermined quotas. …
The final formula for determining the quotas was 2 percent of national income, 5
percent of gold and dollar holdings, 10 percent of average imports, 10 percent of
the maximum variation in exports, and these three percentages increased by the
percentage ratio of average exports to national income.
43
IMF Pamphlet No 45, 6th edn, above note 36, 63–4.
44
See International Monetary Fund, ‘Report to the IMF Executive Board of the Quota
Formula Review Group’ (28 April 2000), at <http://www.imf.org/external/np/tre/quota/2000/
eng/qfrg/report/dload/EBAP52.pdf> (last visited 14 August 2014).
45
See International Monetary Fund, ‘Reform of Quota and Voice in the International
Monetary Fund—Report of the Executive Board to the Board of Governors’ (28 March
2008), at <http://www.imf.org/ external/np/pp/eng/2008/032108.pdf> (last visited 13 August
2014), and Sean Hagan, ‘Reforming the IMF’ in Mario Giovanoli and Diego Devos (eds),
International Monetary and Financial Law (Oxford: Oxford University Press, 2010).
46
See International Monetary Fund, ‘IMF Quotas’ (25 March 2014), at <http://
www.imf.org/external/np/exr/facts/quotas.htm> (last visited 13 August 2014).
47
See IMF, Board of Governors Resolution No 66-2 (effective 15 December 2012), at
<http://www.imf.org/external/pubs/ft/sd/index.asp?decision=66-2> (last visited 13 August
2014), and the IMF, ‘2010 Reforms and Fifteenth General Review of Quotas—Report of the
Executive Board to the Board of Governors’ (adopted January 2014), at <http://
www.imf.org/external/np/pp/eng/2014/011614.pdf> (last visited 13 August 2014)
(hereinafter IMF, ‘2010 Reforms’). The implementation effectiveness of the Fourteenth
Review quota increases and the Board Reform Amendment was delayed and, consequently,
the completion of the work related to the Fifteenth General Review. The main reason for
this is that the US Congress failed to ratify the reforms in January 2014. See Robin Harding,
‘US Fails to Approve IMF Reforms’ Financial Times (24 January 2014). Under the
Fourteenth Review, no increase in quotas can become effective until three conditions have
been met: (i) consent to quota increases by members having at least 70 per cent of quotas
as of 5 November 2010; (ii) entry into force of the proposed Amendment on the Reform of
the Executive Board; and (iii) entry into force of the Amendment on Voice and Participation.
Conditions (ii) and (iii) require acceptance of the proposed amendments by three-fifths of
the members representing 85 per cent of the total voting power.
48
A member’s quota cannot be changed without the member’s consent.
49
See IMF, ‘IMF Quotas’, above note 46.
50
See IMF Articles of Agreement, Art III, s 2(ba).
51
52
See International Monetary Fund, ‘The IMF at Glance—Factsheet’ (27 March 2014), at
<http://www.imf.org/external/np/exr/facts/pdf/glance.pdf> (last visited 13 August 2014).
53
IMF Pamphlet No 45, 6th edn, above note 36, 19 and 24. See International Monetary
Fund, ‘IMF Executive Board Reviews Fund’s Income Position, Sets Rate of Charge for FY
2007 and Approves Establishment of an Investment Account’, IMF Press Release 06/90 (4
May 2006), at <https://www.imf.org/external/np/sec/pr/2006/pr0690.htm> (last visited 13
August 2014). The IMF Articles of Agreement were amended recently to broaden the
investment authority of the IMF, which is the key component of the Fund’s new income
model. See International Monetary Fund, ‘Acceptances of the Proposed Amendments of the
Articles of Agreement’ (updated 12 August 2014), at <https://www.imf.org/external/np/sec/
misc/2008consents.htm> (last visited 13 August 2014). The Special Disbursement Account
is the vehicle for receiving and investing profits from the sale of the IMF’s gold and for
making transfers to other accounts for special purposes authorized in the Articles, in
particular for financial assistance to low-income members of the IMF. Though the IMF is
authorized to establish an Investment Account in the General Department to date no
decision has been made.
54
See IMF Pamphlet No 45, 6th edn, above note 36, 30 and 25–7. The Fund’s policy on
arrears is discussed in Chapter 14 in this volume.
55
The level and rate of accumulation of precautionary balances reflect the IMF’s
assessment of the risk of future operational deficits and general credit risk, including that
arising from overdue obligations and the risk that debtor members in good standing might
at some point fall into arrears. See generally IMF Pamphlet No 45, 6th edn, above note 36,
65–6.
56
above note 2, 5.
57
Financing in the credit tranches is today provided under a wider range of instruments
beyond the stand by arrangement. For example, credit for emergency financing (under the
Rapid Financing Instrument) is in the credit tranches, credit under a Flexible Credit Line
(FCL) or a Precautionary and Liquidity Line (PLL) arrangement is also in the credit
tranches. Credit tranche financing is available for any type of balance of payment need. On
the ‘credit tranche’ terminology, while historically it is true that the credit tranches referred
to the way in which access to GRA financing was made available in tranches of 25 per cent
of quota, today it is basically used to refer to the distinction between credit in the ‘first
credit tranche’ (raising Fund credit to no more than 25 per cent of quota) where the Fund
has a more liberal attitude to conditionality, and credit beyond the first credit tranche,
namely, ‘credit in the upper credit tranches’, where stronger justification and conditionality
are required. This distinction, however, has been further blurred with the establishment of
the FCL with ex-ante conditionality and no distinction between first and upper credit
tranches. See generally IMF Pamphlet No 45, 6th edn, above note 36, 40–1.
58
As regard the maintenance of value provisions under IMF Articles of Agreement, Art V, s
11, see IMF Pamphlet No 45, 6th edn, above note 36:
The purchase-repurchase mechanism explains why, from an accounting perspective,

the IMF’s total resources do not vary as a result of the IMF’s financial assistance—
only the composition of its assets change. Moreover, the value of members’
currencies held in the GRA’s pool of resources is maintained in SDR terms over time
through periodic additions to the amounts of currencies that are depreciating
against the SDR and reductions from those that are appreciating against the SDR.
This maintenance of value provision is an obligation of members under the Articles
(Article V, Section 11(a)).
59
IMF Pamphlet No 45, 6th edn, above note 36.
60
With regard to the law of trust funds in international law, see Joseph Gold, ‘Trust Funds
in International Law: The Contribution of the International Monetary Fund to a Code of
Principles’ (1978) 72 American Journal of International Law 856. Gold explains why the
technique of a ‘trust fund’ was employed. See also International Monetary Fund, ‘Where the
IMF Gets its Money—Factsheet’ (25 March 2014), at <http://www.imf.org/external/np/exr/
facts/finfac.htm> (last visited 13 August 2014).
61
62
See Jacques J Polak, Streamlining the Financial Architecture of the International
Monetary Fund, Princeton Essays in International Finance No 216 (Princeton, NJ: Princeton
63
Polak, above note 62, 2.
64
65
SDR allocations involve two elements: SDR holdings, which are assets, and SDR
allocations, which are liabilities. On the reason for the treatment of the SDR allocation as a
liability, see International Monetary Fund, ‘Guidance Note for Fund Staff on the Treatment
and Use of SDR Allocations’ (28 August 2009) 3 n 6, at <http://www.imf.org/external/np/pp/
eng/2009/082809.pdf> (last visited 13 August 2014). The rationale is that members pay
charges on the SDR allocation, and that they would have to repay the allocation in certain
circumstances, such as upon termination of their participation in the SDR department, or
upon liquidation of the SDR Department. Separately, on the payment of charges on the SDR
allocation, these are payable at the same rate as the interest that members receive on SDR
holdings, and hence, members only effectively pay interest on the net use of SDRs.
If there were a shortfall, the loss would be on the participants, not on the Fund. Merging
the two departments (General Department and SDR Department) would relieve the
participants of their liabilities and shift them to the Fund without any corresponding assets
to cover them.
66
See International Monetary Fund, ‘IMF Finances’, at <http://www.imf.org/external/
fin.htm> (last visited 13 August 2014). The IMF’s website is excellent, in my opinion, both
in terms of the information it provides and its accessibility. These attributes cannot be
predicated of the websites of other organizations, such as the ECB’s.
67
This power is limited to ‘any member’s currency’, thus excluding gold, SDRs, and non-
member’s currency. See Joseph Gold, ‘Borrowing by the IMF’ in Jacob A Frenkel and Morris
Goldstein (eds), International Financial Policy: Essays in Honour of Jacques J Polak
(Washington, DC: IMF, 1991) 185–6.
68
See Decision of the Executive Board No 1289-(62/1) of 5 January 1962 with effect from
24 October 1962.
69
Gold explains the background to the introduction of the GAB:
On February 6, 1961, President Kennedy sent to Congress a special message on the

balance of payments of the United States in the course of which he stated that the
United States might use the resources of the Fund. This statement encouraged the
Fund to place itself in a position to meet a request by the United States under its
large quota without reducing the Fund’s ability to meet the requests of other
members for balance of payments financing.
See Joseph Gold, ‘Symmetry as a Legal Objective of the International Monetary

System’ (1980) 12 New York University Journal of International Law and Politics 424.
70
See Decision of the Executive Board No 7403-(83/73) of 20 May 1983. The association
agreement with Saudi Arabia (like the GAB itself) was of a stand-by character.
71
See Decision of the Executive Board No 7337-(83/37) of 24 February 1983, para 21(b),
as amended:
The Managing Director may initiate the procedure…if…he considers that the Fund
faces an inadequacy of resources to meet actual and expected requests for
financing that reflect the existence of an exceptional situation associated with
balance of payments problems of members of a character or aggregate size that
could threaten the stability of the monetary system.
72
The activation of the GAB for Russia was cancelled in March 1999, when the Fund
repaid the outstanding amount, following the effectiveness of the Eleventh General Review
of Quotas and payment of the bulk of the quota increases. See Lowenfeld, above note 2,
661–2 and 661 n 97.
73
See Decision of the Executive Board No 11428-(97/60) of 27 January 1997.
74
See Lowenfeld, above note 2, 559.
75
See International Monetary Fund, IMF Executive Board Approves Major Expansion of
Fund’s Borrowing Arrangements to Boost Resources for Crisis Resolution’, Press Release
No 10/145 (12 April 2010), at <http://www.imf.org/external/np/sec/pr/2010/pr10145.htm>
76
The participants in the NAB as of September 2013 are: (i) Australia, SRD 4,370.41
million; (ii) Austria, SDR 3,579.24 million; (iii) Banco Central de Chile (which became a new
participant in February 2003), SDR 1,360.00 million; (iv) Banco de Portugal, SDR 1,542.13
million; (v) Bank of Israel, SDR 500.00 million; (vi) Belgium, SDR 7,861.85 million, (vii)
Brazil, SDR 8,740.82 million; (viii) Canada, SDR 7,624.43 million; (ix) China, SDR 31,217.22
million; (x) Cyprus, SDR 340.00 million; (xi) Danmarks Nationalbank, SDR 3,207.78 million;
(xii) Deutsche Bundesbank, SDR 25,370.81 million; (xiii) Finland, SDR 2,231.76; (xiv)
France, SDR 18,657.38 million; (xv) Greece (have yet to adhere to expanded NAB), SDR
1,654.51 million; (xvi) Hong Kong Monetary Authority, SDR 340 million; (xvii) India, SDR
8,740.82 million; (xviii) Ireland (have yet to adhere to expanded NAB), SDR 1,885.52
million; (xix) Italy, SDR 13,578.03 million; (xx) Japan, SDR 65,953.20 million; (xxi) Korea,
SDR 6,583.44 million; (xxii) Kuwait, SDR 341.29 million; (xxiii) Luxembourg, SDR 970.59
million; (xxiv) Malaysia, SDR 340.00 million; (xxv) Mexico, SDR 4,994.76 million; (xxvi) The
Netherlands, SDR 9,043.72 million; (xxvii) New Zealand, SDR 624.34 million; (xxviii)
Norway, SDR 3,870.94 million; (xxix) Bangko Sentral ng Pilipinas, SDR 340.00 million; (xxx)
National Bank of Poland (which became a new participant in November 2011), SDR
2,530.00 million; (xxxi) Russian Federation, SDR 8,740.82 million; (xxxii) Saudi Arabia, SDR
11,126.03 million; (xxxiii) Singapore, SDR 1,276.52 million; (xxxiv) South Africa, SDR
340.00 million; (xxxv) Spain, SDR 6,702.18 million; (xxxvi) Sveriges Riksbank, SDR 4,439.74
million; (xxxvii) Swiss National Bank, SDR 10,905.42 million; (xxxviii) Thailand, SDR 340.00
million; (xxxix) United Kingdom, SDR 18,657.38 million; (xl) United States; SDR 69,074.27
million. See IMF, ‘IMF Standing Borrowing Arrangements—Factsheet’ (30 April 2014), at
<http://www.imf.org/external/np/exr/facts/gabnab.htm> (last visited 13 August 2014).
77
See IMF, ‘IMF Standing Borrowing Arrangements—Factsheet’, above note 76.
78
See Gold, above note 69, 221–4. IMF Articles of Agreement, Art V, s 2(b) reads as
follows:
If requested, the Fund may decide to perform financial and technical services,
including the administration of resources contributed by members, that are
consistent with the purposes of the Fund. Operations involved in the performance of
such services shall not be on the account of the Fund. Services under this
subsection shall not impose any obligation on a member without its consent.
79
See Gold, above note 60.
80
See Decision of the Executive Board No 8757-(87/176) SAF/ESAF of 18 December 1987
and Decision of the Executive Board No 8759-(87/176) of 18 December 1987, ‘The
Establishment of the Enhanced Structural Adjustment Facility (ESAF) Trust’.
81
The IMF Interim Committee endorsed, on 26 September 1999, the replacement of the
ESAF by the new PRGF. The changes to the ESAF Trust Instrument to rename the facility
and redefine its purpose were agreed by the Board on 21 October 1999, and became
effective on 22 November 1999. See IMF Interim Committee Decision No EBS/99/193 of 14
October 1999 and Supplement 1 of 22 November 1999.
82
These reforms became effective in January 2010, when all lenders and bilateral subsidy
contributors to the PRGF–Exogenous Shocks Facility Trust consented to the reforms. It is
expected that these reforms will increase the resources available to low-income countries to
USD 17 billion during 2009–14. See IMF, ‘Where the IMF Gets its Money—Factsheet’, above
note 60.
83
See International Monetary Fund, Financial Organization and Operations of the IMF,
IMF Pamphlet Series No 45, 2nd edn (Washington, DC: IMF, 1991) 2. However, Art I of the
IMF Articles of Agreement does not refer specifically to international liquidity.
84
See Reinhard Munzberg, ‘Issues Regarding the Special Drawing Right of the
International Monetary Fund’ in Robert Effros (ed), Current Legal Issues Affecting Central
Banks (Washington, DC: IMF, 1997) vol 4, 26:
The SDR was created against a background of perceived potential shortage of

reserves. …The idea was that a mandatory credit line mechanism backed by a large
number of participants, in particular the major reserve countries, and based on
objective distribution criteria, such as Fund quotas, might assist in supplying the
reserves that a growing world economy would require. It was also thought that such
a supply of reserves should provide unconditional liquidity rather than conditional
credit.
85
See François Gianviti, ‘Special Drawing Rights’ in Robert Effros (ed), Current Legal
Issues Affecting Central Banks (Washington, DC: IMF, 1998) vol 5, 1.
86
IMF Articles of Agreement, Art XV, s 1.
87
See Joseph Gold, ‘Law and Reform of the International Monetary System’ (1975) 10
Journal of International Law and Economics 371, 385–6.
88
Gold, above note 87, 386–7.
89
See Decision of the Executive Board No 4233-(74/67)S of 13 June 1974. See Lowenfeld,
above note 2, 522.
90
See Decision of the Executive Board No 6631-(80/145)G/S of 17 September 1980, which
became effective 1 January 1981.
91
In November 2010, the IMF ended a review of the valuation of the SDR and concluded
that the value of the SDR would continue to be based on a weighted average of the values of
the four basis currencies (US dollar, euro, pound, and yen) and approved revised weights
for the represented currencies. See the Sean Hagan and Li Bo, ‘Special Drawing Rights—
Recent Developments’, IMF Committee Report presented at the ILA 75th Biennial
Conference, Sofia, Bulgaria (August 2012), at <http://www.ila-hq.org/download.cfm/docid/
35FA457F-F3FF-4AA8-8F70B811FA80313C> (last visited 5 September 2014).
92
See IMF Articles of Agreement, Art XVII concerning ‘prescribed holders’, which must be
accepted by the Fund (by decisions of the Executive Board). The following institutions are
the prescribed holders of SDRs: African Development Bank, African Development Fund,
Arab Monetary Fund, Asian Development Bank, Bank for International Settlements, Bank of
Central African States, Central Bank of West African States, East African Development
Bank, Eastern Caribbean Central Bank, European Central Bank, International Bank for
Reconstruction and Development, International Development Association, International
Fund for Agricultural Development, Islamic Development Bank, Latin American Reserve
Fund, and Nordic Investment Bank. See also IMF Articles of Agreement, Art XVIII
concerning allocation and cancellation of SDRs.
93
See International Monetary Fund, ‘Special Drawing Rights (SDRs)—Factsheet’ (25
March 2014), at <http://www.imf.org/external/np/exr/facts/sdr.HTM> (last visited 13 August
2014).
94
See Gianviti, above note 85, 3.
95
See Harold James, International Monetary Cooperation since Bretton Woods
(Washington, DC: IMF/Oxford University Press, 1996) 54. Keynes also complained about the
predominance of lawyers on the American side of the negotiating table. He observed that
‘lawyers seem to be paid to discover ways of making it impossible to do what may prove
sensible in future circumstances’ (54).
96
See Gianviti, above note 85, 9. Gianviti also complains about the complexity of the SDR:
‘The rules governing the creation, valuation and use of SDRs are extremely complex’ (4).
97
IMF Pamphlet No 45, 6th edn, above note 36, 11.
98
See James, above note 95, 46 and 50.
99
See Polak, above note 62, 25.
100
There are special provisions for the special allocation to members (and SDR
Department participants) that jointed the Fund after this date, which are not reflected here.
See in this regard the text of the IMF Articles of Agreement, in particular Schedule M.
101
IMF Articles of Agreement, Schedule M. Munzberg, above note 84, vol 4, 27, recalls
that in the 1990s ‘a proposal was made to cancel all or part of the existing SDRs and to
allocate at least the equivalent amount of SDRs on the basis of current quotas. This
proposal, however, faced…difficulties. …While the Fund is entitled to cancel SDRs, it can
only do so when there is no longer a need for the SDRs created previously to meet the need
for additional liquidity. Therefore, the bases for allocation and cancellation are findings in
opposite directions, one for more liquidity and one for less liquidity, and it is not possible to
make these findings in good faith at the same time.’
102
See eg Manuel Guitián, The Unique Nature of the Responsibilities of the International
Monetary Fund, IMF Pamphlet Series No 46 (Washington, DC: IMF, 1992) 31, at <https://
www.imf.org/external/pubs/ft/pam/pam46/pam46.pdf> (last visited 13 August 2014).
103
Recognizing that capital flows have grown significantly in recent years and that they
play a key role in the international monetary system, offering benefits but also some risks
for countries, the Fund proposes an institutional view. This view offers a clear and
consistent position of the Fund in relation to capital flows and policies associated to them,
provides a framework for managing inflows and outflows and promotes cooperation
between countries that generate and receive capital flows. See International Monetary
Fund, ‘The Liberalization and Management of Capital Flows—An Institutional View’ (14
November 2012), at <https://www.imf.org/external/np/pp/eng/2012/111412.pdf> (last
visited 13 August 2014). See also earlier IMF policy papers on the topic: International
Monetary Fund, ‘The Fund’s Role Regarding Cross-Border Capital Flows’ (15 November
2010), at <http://www.imf.org/external/np/pp/eng/2010/111510.pdf> (last visited 13 August
2014); International Monetary Fund, ‘The Multilateral Aspects of Policies Affecting Capital
Flows’ (31 October 2011), at <http://www.imf.org/external/np/pp/eng/2011/101311.pdf>
(last visited 13 August 2014); International Monetary Fund, ‘Recent Experiences in
Managing Capital Inflows—Cross-Cutting Themes and Possible Guidelines’, (14 February
2011), at <http://www.imf.org/external/np/pp/eng/2011/021411a.pdf> (last visited 13
August 2014); and International Monetary Fund, ‘Liberalizing Capital Flows and Managing
Outflows’ (13 March 2012), at <http://www.imf.org/external/np/pp/eng/2012/031312.pdf>
104
See IMF Decision No 144-(52/51) of 14 August 1952, ‘Payments Restrictions for
Security Reasons: Fund Jurisdiction’: ‘The Fund does not…provide a suitable forum for
discussion of the political and military considerations leading to actions of this kind.’
105
See eg Joseph Gold, ‘The Fund Agreement in the Courts—XV’ (1980) 27(3) Staff Papers
—International Monetary Fund. This fifteenth instalment was preceded by fourteen other
articles, all of them dealing with the effect of the IMF Articles of Agreement on litigation.
With regard to the interpretation of IMF Articles of Agreement, Art VIII, s 2(b), see also
Proctor, above note 2, ch 15, and François Gianviti, ‘The Fund Agreement in the Courts’ in
Robert Effros (ed), Current Legal Issues Affecting Central Banks, vol 1 (Washington, DC:
IMF, 1992) and Pierre Francotte, ‘Comment on The Fund Agreement in the Courts’ in
Effros, Current Legal Issues Affecting Central Banks, vol 1. Gianviti (8) notes that Art VIII, s
2(b) is a substantive rule of private international law.
106
The IMF provided an interpretation of Art VIII, s 2(b) in Decision No 446-4 of 10 June
1949.
107
IMF Articles of Agreement, Art XXX(d) explains the meaning of the term ‘payments for
current transactions’:
Payments for current transactions means payments which are not for the purpose of
transferring capital and includes, without limitation:
(1) all payments in connection with foreign trade, other current business, including
services and normal short-term banking and other credit facilities;
(2) payments due as interest on loans and as net income from other investments;
(3) payments of moderate amount for amortization of loans or for depreciation of
direct investments; and
(4) moderate remittances for family living expenses.
108
Countries under the transitional provisions of IMF Articles of Agreement, Art XIV
eventually move towards full current account convertibility, even though the transitional
period can be a very long one. For example, India only accepted the obligations of Art VIII
in 1994.
109
‘Jurisdiction’ in the context of the Fund’s activities is to be understood as the legal
authority of the Fund to assess and enforce members’ countries compliance with obligations
specified in the IMF Articles of Agreement.
110
See Cynthia Lichtenstein, ‘International Jurisdiction over International Capital Flows
and the Role of the IMF: Plus ça change?’ in Mario Giovanoli (ed), International Monetary
Law (Oxford: Oxford University Press, 2000).
111
IMF, ‘The Liberalization and Management of Capital Flows’, above note 103, 29–30.
IMF Articles of Agreement, Art VI, s 3, provides for some specific imitations on the right of
IMF members to impose capital controls.
112
See Keynes’s 1942 proposal, reproduced in J Keith Horsefield (ed), The International
Monetary Fund 1945–1965, Vol 3: Documents (Washington, DC: IMF, 1969) 13 para 45.
113
See White’s 1942 proposal, reproduced in J Keith Horsefield (ed), The International
Monetary Fund 1945–1965, Vol 3: Documents (Washington, DC: IMF, 1969) 47 and 63.
114
See Stanley Fischer, ‘Capital Account Liberalization and the Role of the IMF’ in Stanley
Fischer et al (eds), Should the IMF Pursue Capital Account Convertibility?, Princeton
Essays in International Finance No 207 (Princeton, NJ: Princeton University Press, 1998).
115
This point is made by the late Manuel Guitián, above note 102, 44.
116
See IMF, ‘Liberalizing Capital Flows and Managing Outflows’, above note 103.
117
IMF, ‘The Liberalization and Management of Capital Flows’, above note 103, 10.
118
See Jacques J Polak, ‘The Articles of Agreement of the IMF and the Liberalization of
Capital Movements’ in Fischer et al (eds), above note 114, 47.
119
See eg Joseph Stiglitz, ‘Capital Market Liberalization, Globalization and the
IMF’ (2005) 20 Oxford Review of Economic Policy 57.
120
Stanley Fischer et al (eds), above note 114, 5, 22, and 29. The ‘institutional view’ states
that ‘[c]apital flow liberalization needs to be well planned, timed, and sequenced, especially
in order to ensure that its benefits outweigh the costs, as it could have significant domestic
and multilateral effects. The integrated approach proposes a systematic approach to
liberalization that is consistent with each country’s institutional and financial development.’
See IMF, ‘The Liberalization and Management of Capital Flows’, above note 103, 35.
121
See International Monetary Fund Independent Evaluation Office, ‘The IMF’s Approach
to Capital Account Liberalization’, Evaluation Report (25 May 2005), at <http://www.ieo-
imf.org/ieo/files/completedevaluations/04202005report.pdf> (last visited 13 August 2014).
122
See International Monetary Fund, ‘IMF Concludes 2003 Article IV Consultation with
the People’s Republic of China’, Public Information Notice (PIN) No 03/136 (18 November
2003), at <http://www.imf.org/external/np/sec/pn/2003/pn03136.htm> (last visited 13
August 2014).
123
The ‘institutional view’ makes clear that, ‘when requested by a member, the Fund
would rely upon the proposed institutional view as a basis for its policy advice to that
member. While this advice is often sought and provided during the Article IV consultation
process, it is legally distinct from the Fund’s surveillance function, and does not impose an
obligation on members to accept it.’ See Guitián above note 102, 31.
124
See Guitián, above note 102, 9. During my stint at the Fund, I had the opportunity of
getting to know Manuel Guitián, a distinguished member of the staff of the IMF for many
years, who held, inter alia, the position of Director of the Monetary and Exchange Affairs
Department. Guitián made an outstanding contribution to the development of Fund policies
through his work and through his writings. He had a fine intellect and an independent
mind. He was also a true gentleman.
125
Guitián, above note 102, 11: ‘The focus of obligation on the part of members centers on
the point and the terms of intersection of their national economies with each other—that is
the balance of payments, the exchange rate and the exchange regime.’
126
See International Monetary Fund, ‘IMF Surveillance—Factsheet’ (31 March 2014), at
<http://www.imf.org/external/np/exr/facts/surv.htm> (last visited 13 August 2014).
127
See Decision of the Executive Board No 5392-(77/63) of 29 April 1977 as amended. This
decision implemented the new Art IV of the IMF Articles of Agreement, which at the time
was still in the process of being ratified. (The Second Amendment was approved in April
1976 and became effective in April 1978.)
128
See Decision of the Executive Board of 15 June 2007, ‘Bilateral Surveillance of Member
Policies’, at <http://www.imf.org/external/np/sec/pn/2007/pn0769.htm#decision> (last
129
See Rosa M Lastra, ‘The Role of the IMF as a Global Financial Authority’ (2011) 2
European Yearbook of International Economic Law.
130
See International Monetary Fund, ‘IMF Executive Board Adopts New Decision on
Bilateral and Multilateral Surveillance’, Public Information Notice (PIN) No 12/89 (30 July
2012), at <http://www.imf.org/external/np/sec/pn/2012/pn1289.htm> (last visited 13 August
2014). In the words of Ms Christine Lagarde, Managing Director of the International
Monetary Fund (IMF), the new Decision will:
• Help ensure consistency in the Fund’s assessment and views on individual

economies and global stability;
• Make Article IV consultations a vehicle for both bilateral and multilateral
surveillance;
• Emphasize that the Fund attaches importance to both a member’s
exchange rate and domestic policies;
• Ensure appropriate coverage of spillovers from members’ policies that may
have an impact on global stability; and,
• Clarify the modalities of multilateral surveillance and lay out a framework
for possible multilateral consultations.
See International Monetary Fund, ‘Statement by IMF Managing Director Christine Lagarde
on Strengthening IMF Surveillance’, Press Release No 12/262 (18 July 2012), at <http://
www.imf.org/external/np/sec/pr/2012/pr12262.htm> (last visited 13 August 2014).
131
Guitián, above note 102, 6. See also Manuel Guitián, ‘The IMF as a Monetary
Institution: The Challenge Ahead’ (1991) 31(3) Finance and Development 38.
132
As pointed out by Nadia Rendak, in addition to the Financial Sector Assessment
Program (FSAP) and the Reports on Observance of Standards and Codes (ROSCs) described
in this section, the exercise of surveillance is supported by other complementary activities
(some of which are voluntary and some mandatory) such as World Economic and Market
Developments sessions, spillover reports, Early Warning Exercise conducted jointly with the
Financial Stability Board, the new pilot External Sector Report and the G-20 Mutual
Assessment Program (G-20 MAP) process, among others. For a brief description of these
activities, see Nadia Rendak, ‘Monitoring and Surveillance at the International Monetary
System—What Can Be Learnt from the Trade Field?’ in Cottier et al (eds), The Rule of Law
in Monetary Affairs, above note 2.
133
For the first time, a general assessment of the soundness and stability of the EU’s
financial sector (EU FSAP) was conducted during November and December 2012. The
mission’s recommendations were mainly focused on strengthening the EU’s financial sector.
See International Monetary Fund, ‘European Union: Financial Sector Assessment,
Preliminary Conclusions by the IMF Staff’, Press Release No 12/500 (20 December 2012),
at <http://www.imf.org/external/np/sec/pr/2012/pr12500.htm> (last visited 13 August
2014). As noted in paragraph 9.63, in addition to its bilateral Article IV consultations with
the 18 eurozone Member States, IMF staff also hold consultations annually for the euro
area as a whole. See IMF Executive Board Concludes 2014 Article IV Consultation on Euro
Area Policies, Press Release No. 14/341, 14 July 2014, at <http://www.imf.org/external/np/
sec/pr/2014/pr14341.htm>. See also ‘The IMF and Europe’ (factsheet), International
Monetary Fund, 18 September 2014, at <https://www.imf.org/external/np/exr/facts/>.
It should be pointed out that there is no such separate function as ‘regional surveillance’. In
fact, ‘regional surveillance’ is considered, from the legal viewpoint, as outreach, or a form
of technical assistance. On this, as on so many other observations in this chapter, I am
grateful to the staff of the Legal Department of the IMF under the direction of Sean Hagan.
134
Proctor, above note 2, 562.
135
See Gianviti, ‘Evolving Role and Challenges for the International Monetary Fund’,
above note 2, 46. He defines a ‘soft obligation as an obligation that does not require the
achievement of a particular objective or even the exercise of best efforts or due diligence,
but only a reasonable effort in light of all relevant circumstances. In contrast, soft law
means that there is no obligation at all.’
136
Gianviti, ‘Evolving Role and Challenges for the International Monetary Fund’, above
note 2, 40–2.
137
note 2, 47–8.
138
note 2, 47. See also, the following documents: Palais-Royal Initiative, ‘Reform of the
International Monetary System: A Cooperative Approach for the Twenty First Century’ (8
February 2011), at <http://global-currencies.org/smi/gb/telechar/news/Rapport_Camdessus-
integral.pdf> (last visited 13 August 2014) and Edwin M Truman, ‘Strengthening IMF
Surveillance: A Comprehensive Proposal’, Peterson Institute for International Economics PB
10-29 (December 2010), at <http://www.iie.com/publications/pb/pb10-29.pdf> (last visited
13 August 2014).
139
note 2, 42–3.
140
note 2, 47: ‘In some cases, Article IV consultations offer an opportunity to exercise peer
pressure without asserting the existence of an obligation under Article IV.’
141
note 2, 48–9.
142
note 2, 38: ‘The new provision was a political compromise with the necessary calculated
ambiguities to allow both sides to claim victory. …[I]nstead of the former obligation to
achieve a certain result, there is now an obligation to cooperate toward common goals.’
143
Holder, above note 30, 19–20. The Fund’s regulatory jurisdiction focuses especially on
each member’s exchange rate policies and exchange restrictions, usually in the context of
the annual Article IV consultation report to the Executive Board. For each of the Fund’s
members, therefore, the exchange system of each member must be identified, understood
and explained; specifically it is for the ‘country lawyer’ to identify any restrictions, in order
that they may be included in the relevant Article IV consultation report to be considered by
the Board, as appropriate, for approval. When a member is considering relinquishing its
reliance on the transitional processes of Article XIV, thereby accepting the obligations of
Article VIII, the Legal Department undertakes a full and intensive review of the exchange
system.
144
See Decision of the Executive Board No 5392-(77/63) of 29 April 1977, as amended. In
October 2011, the ‘Triennial Surveillance Review’ was concluded. The review, which
covered both bilateral and multilateral surveillance, pointed out development since the
beginning of the global financial crisis. However, it also found remaining gaps in the IMF’s
surveillance. Consequently, the review suggested actions centred on improvements in six
key areas: interconnectedness, risk assessments, external stability, financial stability,
traction, and the legal framework. See International Monetary Fund, ‘2011 Triennial
Surveillance Review—Overview Paper’ (29 August 2011), at <http://www.imf.org/external/
pp/longres.aspx?id=4596> (last visited 13 August 2014).
145
See International Monetary Fund, ‘Financial Sector Assessment Program (FSAP)—
Factsheet’ (18 March 2014), at <http://www.imf.org/external/np/exr/facts/fsap.htm> (last
visited 13 August 2014) (hereinafter IMF, ‘FSAP—Factsheet’). See also International
Monetary Fund, ‘IMF Executive Board Reviews Experience with the Financial Sector
Assessment Program, Options for the Future, and Complementary Reforms in Surveillance
and the Assessment of Standards and Codes’, PIN No 09/123 (29 September 2009), at <htt
p://www.imf.org/external/np/sec/pn/2009/pn09123.htm> (last visited 13 August 2014)
(hereinafter IMF, ‘Executive Board Review’). The reports prepared by the World Bank under
the FSAP are called Financial Sector Assessments (FSAs).
146
IMF, ‘FSAP—Factsheet’, above note 145; IMF, ‘Executive Board Review’, above note
145.
147
The jurisdictions performing subject to the mandatory assessment every five years
under the FSAP are selected depending on the size and interconnectedness of their
financial sectors. The list will be reviewed regularly and is published on the IMF website.
See IMF, ‘FSAP—Factsheet’, above note 145.
148
See International Monetary Fund, ‘Reports on the Observance of Standards and Codes
(ROSCs)’ (updated 19 February 2014), at <http://www.imf.org/external/NP/rosc/rosc.aspx>
149
See IMF, ‘ROSCs’, above note 148.
150
note 2, 49, points out that ROSCs ‘bridge the gap between technical assistance and
surveillance’.
151
152
See François Gianviti, ‘Legal Aspects of the Financial Sector Assessment Program’,
Paper presented at the IMF Seminar on Current Developments in Monetary and Financial
Law (9 May 2002), at <https://www.imf.org/external/np/leg/sem/2002/cdmfl/eng/
gianv2.pdf> (last visited 13 August 2014).
153
Gianviti, above note 152.
154
155
I refer in para 13.234 to the Trade Integration Mechanism approved in April 2004: see
International Monetary Fund, ‘The IMF’s Trade Integration Mechanism (TIM)—
Factsheet’ (19 March 2014), at <http://www.imf.org/external/np/exr/facts/tim.htm> (last
visited 12 September 2014) (hereinafter IMF, ‘TIM—Factsheet’).
156
I refer in paras 13.200–13.204 below to the initiatives the Fund has undertaken with
regard to low-income developing countries.
157
IMF Pamphlet No 45, 6th edn, above note 36, 5:
The provision of financial assistance by the IMF is not technically or legally

‘lending’ as such. Rather, financial assistance is provided via an exchange of
monetary assets, similar to a swap. Nevertheless, the purchase and repurchase of
currencies from the IMF, with interest charged on outstanding purchases, is
functionally equivalent to loan. …Accordingly, for ease of reference, the terms
‘lending’, ‘loans’ and ‘borrowing’ are used in this pamphlet to refer to the provision
of financial resources by the IMF to its members.
158
With regard to these introductory notions, I draw heavily on François Gianviti, ‘The
Role of the Fund in the Financing of External Debt’ (1989) 215 Recueil des Cours 246 and
Gianviti, ‘Evolving Role and Challenges for the International Monetary Fund’, above note 2.
159
See IMF Articles of Agreement, Art V, s 4.
160
See IMF, ‘Glossary of Selected Financial Terms’, above note 39. See above note 40
regarding description of credit tranches policy.
161
See Gianviti, above note 158, 251. As I explained above, the drawing by a member of
the ‘reserve tranche’ (previously ‘gold tranche’) is automatic (unconditional); it can be
drawn at any time by the member, with no charge and no expectation of repayment.
162
See IMF Pamphlet No 45, 6th edn, above note 36, 41: ‘The segmentation in terms of
first and upper credit tranches underscores the basic principle that the IMF requires
stronger justification in terms of policy understandings from the member at higher levels of
IMF credit outstanding.’
163
See Gianviti, above note 33, 7–8.
164
The concept of ‘outright purchases’ is still used today (a purchase outside an
arrangement), albeit not frequently. Support in the form of outright purchases is provided in
the first credit tranche policy, the ‘compensatory financing facility’, and in the cases of
emergency assistance for natural disasters and for post-conflict situations. See IMF, Policy
Development and Review Department, ‘Review of Fund Facilities—Preliminary
Considerations’ (2 March 2000) 30, at <http://www.imf.org/external/np/pdr/fac/2000/
faciliti.pdf> (last visited 14 August 2014).
165

[A]t other times discussions between the member and the Fund may cover its
general position, not with a view to an immediate drawing, but in order to assure
that it would be able to draw if, within a period of 6 to 12 months, the need
presented itself. …In cases where it would appear appropriate and useful, the Fund
might arrange drawings to deal with special short-run situations accompanied by
arrangements for repurchase in a period not exceeding 18 months.
The statement of the Managing Director was then accepted by the Executive Board in
Decision No 102-(52/11) of 13 February 1952, published in Selected Decisions and Selected
Documents of the International Monetary Fund, above note 35.
166
Decision of the Executive Board No 102-(52/11) of 13 February 1952.
167
James, above note 95, 81, recalls: ‘In the course of providing aid to Finland in 1952 it
was established that in order to secure the principle of revolving access to Fund resources,
drawings should not be for more than three years.’
168
See Decision of the Executive Board No 270-(53/ 95) of 23 December 1953, ‘Stand-By
Arrangements’, as amended.
169
See IMF, ‘Review of Fund Facilities’, above note 164.
170
See IMF, ‘Glossary of Selected Financial Terms’, above note 39, entry ‘Stand-By
Arrangement (SBA)’.
171
See generally Joseph Gold, The Legal Character of the Fund’s Stand-by Arrangements
and Why it Matters, IMF Pamphlet Series No 35 (Washington, DC: International Monetary
Fund, 1980).
172
Decision of the Executive Board No 12864-(02/102) of 25 September 2002, as amended
by Decision No 13814-(06/98) of 15 November 2006, ‘Guidelines on
Conditionality’ (Decision I), para 9, at <http://www.imf.org/external/np/pdr/cond/2002/eng/
guid/092302.pdf> (hereinafter Guidelines on Conditionality (Decision I)).
173
Decision of the Executive Board No 12865-(02/102) of 25 September 2002, as amended
by Decision No 14283-(09/29) of 24 March 2009, ‘Stand-by Arrangements’ (Decision II), at
<http://www.imf.org/exter nal/pubs/ft/sd/index.asp?decision=12865-(02/102)> (hereinafter
Stand-by Arrangements (Decision II)).
174
See Guidelines on Conditionality (Decision I) and Stand-by Arrangements (Decision II).
175
International Monetary Fund, ‘Operational Guidance to IMF Staff on the 2002
Conditionality Guidelines Revised’ (25 January 2010), at <http://www.imf.org/external/np/
pp/eng/2010/012510a.pdf> (last visited 19 June 2014) (hereinafter IMF, ‘Operational
Guidance’). In August 2014, revised operational guidance to IMF staff on the 2002
Guidelines was published. See also International Monetary Fund, ‘IMF Conditionality—
Factsheet’ (31 March 2014), at <http://www.imf.org/external/np/exr/facts/conditio.htm>
176
The EFF was amended in March 2012 to allow for the approval of extended
arrangements of up to four years when certain conditions are met. See International
Monetary Fund, ‘IMF Executive Board Discusses Amendment to the Extended Fund Facility
to Extend the Arrangement Duration at Approval’, Public Information Notice (PIN) 12/24
(14 March 2012), at <https://www.imf.org/external/np/sec/pn/2012/pn1225.htm> (last
visited 12 September 2014) and International Monetary Fund, ‘Proposed Amendment of the
Extended Fund Facility Considerations to Extend the Duration of Extended Arrangements
on Approval from Three to Four Years’ (9 March 2012), at <http://www.imf.org/external/np/
pp/eng/2012/030912.pdf> (last visited 12 September 2014).
177
above note 2, 57.
178
‘Conditionality is the framework that assures Fund financing is being used in support of
an agreed program.’ See IMF, ‘Financial Risk in the Fund and the Level of Precautionary
Balances’, above note 38, 13.
179
See Ross Leckow, ‘Conditionality in the International Monetary Fund’ in Current
Developments in Monetary and Financial Law, Vol 3 (Washington, DC: IMF, 2005) 53.
180
Guidelines on Conditionality (Decision I), principle 1.
181
Guidelines on Conditionality (Decision I), principle 2.
182
Guidelines on Conditionality (Decision I), principle 7(c).
183
See Lowenfeld, above note 2, 513.
184
See Joseph Gold, ‘Conditionality’, IMF Pamphlet Series No 31 (Washington, DC: IMF,
1979) 3.
185
Gold, above note 184, 2. Gold cites the following extract from the 1964 IMF Annual
Report: ‘Drawings beyond the gold tranche…are conditional, in greater or lesser degree, on
the adoption by the drawing countries of policies designed to ensure the temporary
character of their payments problem.’
186
Decision of the Executive Board No 284-4 of 10 March 1948, ‘Use of the Fund
Resources—Meaning of Article V, Section 3(a)(i)’: ‘[T]he Fund may postpone or reject the
request [use of Fund’s resources], or accept it subject to conditions.’
187
Decision of the Executive Board No 102-(52/11) of 13 February 1952: ‘The Fund’s
attitude toward the position of each member should turn on whether the problem to be met
is of a temporary nature and whether the policies the member will pursue will be adequate
to overcome the problems within such a period.’
188
His article on ‘Conditionality’, published as IMF Pamphlet No 31 in 1979, remains an
authoritative reference for the understanding of the subject.
189
See Gold, above note 184, 2.
190
Decision of the Executive Board No 2603-(68/132) of 20 September 1968.
191
Decision of the Executive Board No 6056-(79/38) of 2 March 1979.
192
See International Monetary Fund, ‘Conditionality in Fund-Supported Programs—
Overview’ (20 February 2001), at <http://www.imf.org/external/np/pdr/cond/2001/eng/
overview/> (last visited 12 September 2014); International Monetary Fund, ‘Conditionality
in Fund-Supported Programs—Policy Issues’ (16 February 2001), at <http://www.imf.org/
external/np/pdr/cond/2001/eng/policy/021601.pdf> (last visited 12 September 2014);
International Monetary Fund, ‘Structural Conditionality in Fund-Supported Programs’ (16
February 2001), at <http://www.imf.org/external/np/pdr/cond/2001/eng/struct/cond.pdf>
(last visited 16 September 2014); International Monetary Fund, ‘Trade Policy Conditionality
in Fund-Supported Programs’ (16 February 2001), at <http://www.imf.org/external/np/pdr/
cond/2001/eng/trade/> (last visited 16 September 2014); International Monetary Fund,
‘Strengthening Country Ownership of Fund-Supported Programs’ (5 December 2001), at <h
ttps://www.imf.org/external/np/pdr/cond/2001/eng/strength/120501.pdf> (last visited 16
September 2014); International Monetary Fund, ‘Managing Director’s Report to the
International Monetary and Financial Committee—Streamlining Conditionality and
Enhancing Ownership’ (6 November 2001), at <https://www.imf.org/external/np/omd/
2001/110601.htm> (last visited 16 September 2014); International Monetary Fund,
‘Strengthening IMF—World Bank Collaboration on Country Programs and Conditionality—
Progress Report’ (24 February 2004), at <https://www.imf.org/external/np/pdr/cond/2004/
eng/022404.pdf> (last visited 16 September 2014); International Monetary Fund, ‘The
Modalities of Conditionality—Further Considerations’ (8 January 2002), at <https://
www.imf.org/external/np/pdr/cond/2002/eng/modal/010802.pdf> (last visited 16 September
2014).
193
The results of these discussions by the Board are typically published as Public
Information Notices. The following PINs relating to conditionality have been issued at the
request of the Board: International Monetary Fund, ‘IMF Executive Board Discusses
Conditionality’, Public Information Notice (PIN) No 01/28 (21 March 2001), at <https://
www.imf.org/external/np/sec/pn/2001/pn0128.htm> (last visited 12 September 2014);
International Monetary Fund, ‘IMF Concludes Discussions on Strengthening IMF-World
Bank Collaboration on Country Programs and Conditionality’, Public Information Notice
(PIN) No 01/92 (4 September 2001), at <https://www.imf.org/external/np/sec/pn/2001/
pn0192.htm> (last visited 16 September 2014); International Monetary Fund, ‘IMF Reviews
Strengthening Country Ownership of Fund-Supported Programs’, Public Information Notice
(PIN) No 01/125 (14 December 2001), at <https://www.imf.org/external/np/sec/pn/2001/
pn01125.htm> (last visited 16 September 2014); and International Monetary Fund, ‘IMF
Board Discusses Modalities of Conditionality’, Public Information Notice (PIN) No 02/26 (8
March 2002), at <https://www.imf.org/external/np/sec/pn/2002/pn0226.htm> (last visited
16 September 2014).
194
See Guidelines on Conditionality (Decision I) and Stand-by Arrangements (Decision II).
195
See International Monetary Fund, ‘Operational Guidance on the New Conditionality
Guidelines’ (8 March 2003), at <http://www.imf.org/External/np/pdr/cond/2003/eng/
050803.htm> (last visited 16 September 2014). This was updated in 2010: see IMF,
‘Operational Guidance’, above note 175.
196
See IMF, ‘Operational Guidance’, above note 175.
197
This changing nature of conditionality was stressed by the former Director of the
Monetary and Exchange Affairs Department, Manuel Guitián, in three papers: Manuel
Guitián, Fund Conditionality: Evolution of Principles and Practices, IMF Pamphlet No 38
(Washington, DC: IMF, 1981); Manuel Guitián, The Unique Nature of the Fund’s
Responsibilities, IMF Pamphlet No 46 (Washington, DC: IMF, 1992); and Manuel Guitián,
‘Conditionality: Past, Present and Future’ (1995) 42(4) Staff Papers—International
Monetary Fund 792.
198
See Guitián, Fund Conditionality, above note 197 and Guitián, ‘Conditionality: Past,
Present and Future’, above note 197.
199
See Gold, above note 184, 2. Sir Joseph also noted, above note 184, 1, that
‘conditionality cannot be defined by reference to the “conditions” of Article V, Section 3(b)’.
200
According Guidelines on Conditionality (Decision I), principle 1: ‘Conditions on the use
of Fund resources are governed by the Fund’s Articles of Agreement and implementing
decisions of the Executive Board.’
201
See Gianviti, ‘The International Monetary Fund and the International Monetary
System’, above note 2, 56. For a discussion of the procedural requirements that govern the
adoption of decisions by the Executive Board, see Gianviti, ‘The International Monetary
Fund and the International Monetary System’, above note 2, 50–6. He points out, inter alia,
that despite the different semantics, there is no clear distinction between guidelines and
decisions (53). The decisions of the organs of the IMF must be (i) consistent with the
Articles; (ii) consistent with higher norms; (iii) consistent with the regulations made by that
organ (54). The IMF may not make retroactive decisions to the detriment of its member
countries (59).
202
above note 2, 57–9.
203
note 2, 57–9.
204
See Rosa M Lastra, ‘IMF Conditionality’ (2002) 4(2) Journal of International Banking
Regulation 167, 171.
205
See Manuel Guitián, ‘Conditionality: Past, Present, Future’, above note 197, 796.
206
207
IMF Pamphlet No 45, 6th edn, above note 36, 13. See also IMF Pamphlet No 45, 6th
edn, above note 36, 17.
208
See International Monetary Fund, ‘Protecting IMF Resources: Safeguards Assessments
of Central Banks—Factsheet’ (4 April 2014), at <http://www.imf.org/external/np/exr/facts/
safe.htm> (last visited 16 September 2014). See IMF, ‘Financial Risk in the Fund and the
Level of Precautionary Balances’, above note 38, 14.
209
Guidelines on Conditionality (Decision I).
210
See Chapter 14 in this volume. The Fund can require collateral under IMF Articles of
Agreement, Article V, section 4, although it does not require collateral in practice.
211
Guidelines on Conditionality (Decision I).
212
See Guitián, ‘Conditionality: Past, Present, Future’, above note 197, 796.
213
International Financial Advisory Commission (Meltzer Commission), Report of the
International Financial Institutions Advisory Commission (Washington, DC: Government
Printing Office, 2000).
214
Council on Foreign Relations, ‘Safeguarding Prosperity in a Global Financial System:
The Future International Financial Architecture’, Task Force Report No 25 (17 October
1999) 116, at <http://www.cfr.org/international-law/safeguarding-prosperity-global-
financial-system/p3233> (last visited 16 September 2014).
215
A definition of each of these four forms of programme monitoring is provided in IMF,
‘Structural Conditionality in Fund-Supported Programs’, above note 192.
Performance criteria are not always subject to reviews. In the GRA, it is possible to make
purchases conditional only to performance criteria without a review.
216
Examples of structural benchmarks are provided, for instance, with regard to a stand-
by arrangement approved in July 1996 for Estonia, cited in IMF, ‘Structural Conditionality
in Fund-Supported Programs’, above note 192, 44. Twenty-two structural benchmarks are
mentioned, of which twelve are legal measures.
217
Only the FCL since 2009 and PCL since 2010 (now the PLL) rely on ex-ante
conditionality.
218
This is not in the GRA, but in the PRGT.
219
In the FCL there is no Fund-supported ‘programme’. However, the member qualifying
for the FCL is indeed expected to undertake and implement necessary policies if needed.
220
See International Monetary Fund, ‘The IMF’s Flexible Credit Line (FCL)—Factsheet’ (4
April 2014), at <http://www.imf.org/external/np/exr/facts/fcl.htm> (last visited 12
September 2014).
221
See International Monetary Fund, ‘The IMF’s Precautionary and Liquidity Line (PLL)—
Factsheet’ (5 September 2014), at <http://www.imf.org/external/np/exr/facts/pll.htm> (last
222
The 2002 guidelines on conditionality replaced the 1979 guidelines and elaborate upon
principles applied to the ‘use of Fund’s resources’ under Article V, section 3(a), (b), and (c)
of the Articles of Agreement. The Guidelines on Conditionality (Decision I) are divided into
three sections: section (A) on ‘principles’ (paras 1–8); section (B) on ‘modalities’ (paras 9–
13); and section (C) on ‘evaluation and review’. This division is somewhat unclear in my
opinion, since the section on principles comprises both some of the principles underlying
conditionality (which are then spelt out in a staff statement attached to the guidelines) and
some other definitional issues. Furthermore, the section on ‘modalities’ refers to the nature
of the IMF arrangement and the member’s programme on the one hand, and to the
monitoring techniques the IMF uses to assess the performance of a member on the other
hand. See also above note 194.
223
See IMF, ‘Conditionality—Factsheet’, above note 175, and International Monetary
Fund, ‘IMF Executive Board Concludes Discussion of 2011 Review of Conditionality’, Public
Information Notice (PIN) No 12/109 (17 September 2012), at <http://www.imf.org/external/
np/sec/pn/2012/pn12109.htm> (last visited 12 September 2014).
224
Guidelines on Conditionality (Decision I), para 10.
225
226
Guidelines on Conditionality (Decision I), para 9 (emphasis added).
227
Guidelines on Conditionality (Decision I), para 11.
228
229
IMF, ‘Operational Guidance’, above note 175, para 11(c)(ii).
230
IMF, ‘Operational Guidance’, above note 175, para 11(d)(i).
231
IMF, ‘Operational Guidance’, above note 175, para 11(d)(ii).
232
All programme conditions (not only structural benchmarks) need to be ‘critical’, either for
meeting the programme goals or for monitoring programme implementation.
233
IMF, ‘Operational Guidance’, above note 175, para 13.
234
Programme reviews are different from surveillance (Art IV consultation). As pointed out
in the description of the ‘programme reviews’ at the end of the prior page, programme
reviews are typically at least every six-months. These reviews are typically stand-alone
reviews, not in connection with Art IV consultation or further fund financing requests.
However, there are cases in which a request for a new arrangement or a programme review
could be combined with an Art IV consultation.
235
Guidelines on Conditionality (Decision I). With regard to the legal value of this staff
statement, para 14 states: ‘In case of conflicts between this explanatory staff statement and
the guidelines or other related Board decisions, the language in the relevant decision takes
precedence.’
236
IMF, ‘Operational Guidance on the New Conditionality Guidelines’, above note 195.
237
See IMF PIN No 12/109, above note 222.
238
IMF PIN No 12/109, above note 222.
239
See François Gianviti, ‘Provision of Information to the IMF’ in Current Developments in
Monetary and Financial Law, Vol 2 (Washington, DC: IMF, 2003) 13–14.
240
See Ross Leckow, ‘The Obligation of Members to Provide Information to the
International Monetary Fund under Article VIII, Section 5: Recent Developments’ in
Current Developments in Monetary and Financial Law, Vol 4 (Washington, DC: IMF, 2005)
42. Leckow cites the case of Ukraine, where the IMF found that the Ukrainian National
Bank misreported international reserves: see International Monetary Fund, ‘IMF Finds
Ukraine National Bank Misreported International Reserves, Considers Circumstances, and
Proposes Measures to Prevent Recurrences’, News Brief No 00/77 (6 September 2000), at
<https://www.imf.org/external/np/sec/nb/2000/nb0077.htm> (last visited 12 September
2014).
241
Leckow, above note 240, 48–9.
242
See Decision of the Executive Board No 13183-(04/0) of 30 January 2004, as amended
by Decisions Nos 13814-(06/98) of 15 November 2006, 13849-(06/108) of 20 December
2006, 14107-(08/38) of 2 May 2008, and 14354-(09/79) of 23 July 2009, effective 7 January
2010, ‘Strengthening the Effectiveness of Article VIII, Section 5’, available at <http://
www.imf.org/external/pubs/ft/sd/index.asp?decision=13183-(04/10)> (last visited 12
September 2014).
243
See Decision No 7842-(84/165) of 16 November 1984, as amended by Decisions Nos
12249-(00/77) of 27 July 2000 and 13849-(06/108) of 20 December 2006, ‘Misreporting and
Noncomplying Purchase in the General Resources Account—Guidelines on Corrective
Action’; and International Monetary Fund, ‘Summing Up by the Acting Chair Review of Side
Letters and the Use of Fund Resources’, Executive Board Meeting 02/59 (12 June 2002),
published in Selected Decisions and Selected Documents of the International Monetary
Fund, 29th issue (Washington, DC: IMF, 2011) 234–7.
244
245
See Decision of the Executive Board No 12250-(00/77) of 27 July 2000.
246
Guitián, ‘Conditionality: Past, Present and Future’, above note 197.
247
As Sir Joseph Gold points out, above note 184: ‘The legal justification for a special
policy is that it deals with a difficulty that is distinguishable from other difficulties
according to bona fide economic criteria and that there are good reasons why a special
policy should be created to take care of that difficulty.’
248
See Gold, above note 184, 14–15.
249
See Sir Joseph Gold, ‘Uniformity as a Legal Principle of the International Monetary
Fund’ (1975) 7 Law and Policy in International Business 765, 767.
250
251
See Gold, above note 67, 475.
252
Gold, above note 67.
253
The IMF’s technical assistance work, with emphasis on ‘legal technical assistance’ is
discussed in William E Holder, ‘The IMF’s Technical Assistance Activities’ in Robert Effros
(ed), Current Legal Issues Affecting Central Banks, vol 5 (Washington, DC: IMF, 1995).
254
IMF, ‘IMF at a Glance’, above note 23.
255
See International Monetary Fund, ‘Technical Assistance—Factsheet’ (17 September
2013), at <http://www.imf.org/external/np/exr/facts/tech.htm> (last visited 12 September
2014).
256
257
See International Monetary Fund, ‘IMF Executive Board Approves the Establishment of
Policy Support Instruments for Aiding Low-Income Countries’, Public Information Notice
(PIN) No 05/145 (14 October 2005), at <http://www.imf.org/external/np/sec/pn/2005/
pn05145.htm> (last visited 12 September 2014). See also International Monetary Fund,
‘Policy Support Instrument—Factsheet’ (3 April 2014), at <https://www.imf.org/external/np/
exr/facts/psi.htm> (last visited 12 September 2014).
258
The borrowing member purchases from the Fund currencies of members in strong
financial positions (which are reserve assets or currencies to be converted into reserve
assets) in exchange for its own currency. The Fund has a claim on the borrowing member to
repurchase its currency (represented by the use of Fund credit on the asset side of the
balance) in exchange for reserve assets. The other member that provided the reserve assets
has a claim on the Fund, called a reserve tranche position shown on the liability side of the
balance sheet. The currency that is provided in the financing is either a freely usable
currency (US dollar, euro, Japanese yen, and pound sterling) or the creditor member (if so
requested by the borrowing member) exchanges its currency for a freely usable currency.
See IMF, ‘Financial Risk in the Fund and the Level of Precautionary Balances’, above note
38.
259
Gold, above note 60.
260
I thank Sean Hagan for observations on this point. According to Gianviti, above note
158, 251, ‘[a]ll policies other than credit tranche policies are “special policies”.’
261
See IMF, ‘Review of Fund Facilities’, above note 164.
262
263
See International Monetary Fund, ‘IMF Support for Low-Income Countries—
Factsheet’ (14 March 2014), at <https://www.imf.org/external/np/exr/facts/poor.htm> (last
visited 12 September 2014), and International Monetary Fund, Strategy, Policy, Review
Department and Finance Department, ‘Review of Facilities for Low-Income Countries’ (26
July 2012), at <http://www.imf.org/external/np/pp/eng/2012/072612a.pdf> (last visited 12
September 2014).
264
Decision No 8759-(87/176) of 18 December 1987.
265
Decision No 12087-(99/118) of 21 October 1999, ‘The Transformation of the Enhanced
Structural Adjusted Facility’.
266
International Development Association (IDA), <http://www.worldbank.org/ida/> (last
267
See International Monetary Fund, ‘The Poverty Reduction Growth Facility (PRGF)—
Factsheet’ (31 July 2009), at <http://www.imf.org/external/np/exr/facts/prgf.htm> (last
268
269
270
IMF Pamphlet No 45, 6th edn, above note 36, 122. See also International Monetary
Fund, ‘Poverty Reduction Strategy Papers (PRSPs)—Factsheet’ (21 March 2014), at <http://
www.imf.org/external/np/exr/facts/prsp.htm> (last visited 12 September 2014) (hereinafter
IMF, ‘PRSP—Factsheet’).
271
See International Monetary Fund, ‘Financing the Fund’s Concessional Lending to Low-
Income Countries—Factsheet’ (3 June 2014), at <http://www.imf.org/external/np/exr/facts/
concesslending.htm> (last visited 12 September 2014).
272
The SCF is not just for precautionary needs as acknowledged in para 13.215 below.
273
See IMF, ‘Review of Facilities for Low-Income Countries’, above note 263, and IMF,
‘IMF Support for Low-Income Countries’, above note 263.
274
See International Monetary Fund, ‘IMF Lending—Factsheet’ (5 September 2014), at
<http://www.imf.org/external/np/exr/facts/howlend.htm> (last visited 12 September 2014).
275
International Monetary Fund, ‘Update on the Financing of the Fund’s Concessional
Assistance and Proposed Amendment to the PRGT Instrument’, Policy Paper (7 April 2014),
at <http://www.imf.org/exter nal/np/pp/eng/2014/040714a.pdf> (last visited 12 September
2014). See also IMF, ‘Concessional Lending to Low-Income Countries— Factsheet’, above
note 271.
276
See International Monetary Fund, ‘Debt Relief under the Heavily Indebted Poor
Countries (HIPC) Initiative—Factsheet’ (24 March 2014), at <http://www.imf.org/external/
np/exr/facts/hipc.htm> (last visited 12 September 2014).
277
Instrument to establish—under Article V, s 2(b)—the Poverty Reduction and Growth
Facility Trust, Decision No 8759-(87/176) of 18 December 1987, as amended.
278
IMF Pamphlet No 45, 6th edn, above note 36, 131. For more detail on the functioning of
the HIPC Initiative, see Thomas A Duvall, III, ‘Debt Relief for Low-Income Countries’ in
Lastra and Buchheit (eds), above note 8.
279
See IMF ‘Debt Relief under the HIPC Initiative’, above note 276.
280
International Monetary Fund Independent Evaluation Office, ‘Report on the Evaluation
of Poverty Reduction Strategy Papers (PRSPs) and The Poverty Reduction and Growth
Facility (PRGF)’ (6 July 2004), at <http://www.imf.org/External/NP/ieo/2004/prspprgf/eng/
index.htm> (last visited 12 September 2014).
281
IMF, ‘PRSP—Factsheet’, above note 270.
282
On 8 September 2000, the eighth plenary meeting of the United Nations General
Assembly adopted the Resolution No 55/2 also know as the ‘Millennium Declaration’, by
which all its 191 members have pledged that by the year 2015 they would meet the
following goals: (i) to eradicate extreme poverty and hunger by reducing by half the
proportion of people living on less than a dollar a day and suffering from hunger; (ii) to
achieve universal primary education by guaranteeing that everybody would be able to
complete a full course of primary schooling; (iii) to promote gender equality by eliminating
gender disparity in primary and secondary education; (iv) to reduce child mortality by two-
thirds in children under five years; (v) to improve maternal health by a three quarters
reduction of the maternal mortality ratio; (vi) to halt and begin to reverse the spread of
HIV/AIDS and the incidence of malaria and other major diseases; (vii) to ensure
environmental sustainability by reversing the loss of environmental resources; and, (viii) to
develop a global partnership for development. For an outline of the MDG, see Millennium
Development Goals and Beyond 2015, at <http://www.un.org/millenniumgoals/> (last
visited 12 September 2014). See also UNGA Res No 55/2 ‘Millennium Declaration’, 8
September 2000, at <http://www.un.org/millennium/declaration/ares552e.htm> (last visited
12 September 2014).
283
In the specific case of the Fund, the MDRI debt relief is not limited to countries that
complete HIPC. As described in a Fund factsheet on the MDRI, in deciding to implement the
MDRI, ‘the IMF Executive Board modified the original G-8 proposal to fit the requirement,
specific to the IMF, that the use of the IMF’s resources be consistent with the principle of
uniformity of treatment. Thus, it was agreed that all countries with per-capita income of
$380 a year or less (whether HIPCs or not) will receive MDRI debt relief financed by the
IMF’s own resources through the MDRI-I Trust. HIPCs with per capita income above that
threshold will receive MDRI relief from bilateral contributions administered by the IMF
through the MDRI-II Trust.’
284
See IMF, ‘Debt Relief under the HIPC Initiative’, above note 276.
285
See International Monetary Fund, ‘The IMF’s Post-Catastrophe Debt Relief Trust—
Factsheet’ (3 April 2014), at <http://www.imf.org/external/np/exr/facts/pcdr.htm> (last
visited 12 September 2014) (hereinafter IMF, ‘PCDR—Factsheet’).
286
IMF, ‘PCDR—Factsheet’, above note 285, 14.
287
International Monetary Fund, ‘The IMF’s Rapid Financing Instrument (RFI)—
Factsheet’ (5 September 2014), at <http://www.imf.org/external/np/exr/facts/rfi.htm> (last
visited 12 September 2014) (hereinafter IMF, ‘RFI—Factsheet’).
288
IMF, ‘RFI—Factsheet’, above note 287.
289
See Decision of the Executive Board No 12341-(00/17) of 28 November 2000,
‘Conversion of Emergency Assistance into a Special Policy’, at <http://www.imf.org/
external/pubs/ft/sd/index.asp?decision=12341-(00/ 117)> (last visited 12 September 2014).
290
The IMF introduced the Emergency Financing Mechanism—which is still in effect—in
September 1995 following the Mexican crisis as a set of accelerated procedures to facilitate
rapid Executive Board approval of IMF financial support in response to crises in a
member’s external account that require an immediate IMF response. This Emergency
Financing Mechanism is not a new facility, but rather the adaptation of existing facilities
(stand-by arrangements)—a framework that provides for accelerated procedures so as to
facilitate rapid Executive Board approval of IMF financial support in response to crises in a
member’s external account that require an immediate response. The Emergency Financing
Mechanism was used in 1997 during the Asian crisis; in 2001 for Turkey; in 2008–9 for
Armenia, Georgia, Hungary, Iceland, Latvia, Pakistan, and Ukraine; and in 2010 for Greece
and Ireland. The Emergency Financing Mechanism as a procedure is reminiscent of the
workings of the lender of last resort role of the central bank (lender of last resort, LOLR) at
the national level: it is the speed, the immediacy, of the availability of liquidity assistance
that makes the LOLR particularly suited to confront emergency situations. Guitián,
‘Conditionality: Past, Present and Future’, above note 197, argues that the interpretation of
conditionality is not independent of the international economic regime in place. See also
International Monetary Fund, ‘IMF Crisis Lending—Factsheet’ (24 March 2014), at <http://
www.imf.org/external/np/exr/facts/crislend.htm> (last visited 12 September 2014).
291
See IMF, ‘IMF Lending—Factsheet’, above note 274; IMF, ‘RFI—Factsheet’, above note
287, and International Monetary Fund, ‘IMF Rapid Credit Facility—Factsheet’ (19 March
2014), at <http://www.imf.org/external/np/exr/facts/rcf.htm> (last visited 12 September
2014) (hereinafter IMF, ‘RCF—Factsheet’).
292
While the FCL and the PLL are available in the credit tranches for any type of balance
of payments need, they are not associated in practice with ‘emergency assistance’. The
same happens with the Extended Arrangement in the EFF. Of course, once a member has an
FCL, PLL or extended arrangement and an emergency arises that gives rise to an urgent
balance of payments need, access can be granted for such purpose under these
arrangements.
The RFI and RCF are the tools under which assistance would be provided to members
facing urgent balance of payment need due to emergencies (eg, natural disasters).
293
IMF, ‘RFI—Factsheet’, above note 287; IMF, ‘RCF—Factsheet’, above note 291.
294
Decision of the Executive Board No 4377-(74/114) of 13 September 1974, as amended.
295
IMF, ‘Glossary of Selected Financial Terms’, above note 39.
296
IMF, ‘Review of Fund Facilities’, above note 164.
297
IMF, ‘Review of Fund Facilities’, above note 164, 14–15.
298
See International Monetary Fund, ‘IMF Executive Board Approves Trade Integration
Mechanism’, Press Release No 04/73 (13 April 2004), at <http://www.imf.org/external/np/
sec/pr/2004/pr0473.htm> (last visited 12 September 2014) and IMF, ‘TIM—Factsheet’,
above note 155.
299
IMF, Press Release No 04/73, above note 298.
300
See IMF, ‘Policy Support Instrument—Factsheet’, above note 257.
301
Guidelines on Conditionality (Decision I) 9.
302
Decision of the Executive Board No 10348-(93/61) of 23 April 1993.
303
Sir Joseph Gold already advanced in 1979 some of the issues at stake in the
transformation of formerly communist countries from a command economy into a market
economy: ‘It is argued that the pace of adjustment may be a political as well as an economic
problem. It is not necessarily easier, however, to pursue a slower pace. In some countries,
adjustment may be more acceptable politically if pursued rapidly. In others, political
determination may weaken if adjustment is a prolonged process.’ Gold, above note 184, 15.
304
International Monetary Fund, ‘The IMF’s Contingent Credit Lines (CCL)—
Factsheet’ (March 2004), at <http://www.imf.org/external/np/exr/facts/ccl.htm> (last visited
12 September 2014).
305
Decision of the Executive Board No 11627-(97/123) of 17 December 1997, ‘SRF’, as
amended by Decisions Nos 11492-(99/48) of 23 April 1999, ‘SRF/CCL’, 12340-(00/117) of 28
November 2000, ‘SRF/CCL’.
306
Decision No 14282-(09/29) of 24 March 2009.
307
308
309
310
See Decision No 14064-(08/18) of 22 February 2008, ‘Access Policy and Limits in The
Credit Tranches and Under the Extended Fund Facility and on Overall Access to the Fund’s
General Resources, and Exceptional Access Policy—Review And Modification’, as amended,
at <http://www.imf.org/external/pubs/ft/sd/index.asp?decision=14064-(08/18)> (last visited
12 September 2012).
311
The FCL, the PLL, and the RFI are not subject to the normal access limits. In the case
of the FCL, the access is determined on a case-by-case basis and is available in a single up-
front disbursement. Access under the six-month PLL is limited to 250 per cent of quota, but
can be raised to 500 per cent of quota in exceptional circumstances where the balance of
payments need is due to exogenous shocks. One- to two-year PLL arrangements are subject
to an annual access limit of 500 per cent of quota and a cumulative limit of 1,000 per cent
of quota. Under the RFI, access is subject to an annual limit of 50 per cent of quota and a
cumulative limit of 100 per cent of quota. See Nicole Laframboise and Boileau Loko
‘Natural Disasters: Mitigating Impact, Managing Risks’, IMF Working Paper WP/12/245
(October 2012) 21, at <http://www.imf.org/external/Pubs/ft/wp/2012/wp12245.pdf> (last
312
See International Monetary Fund, ‘IMF Extended Credit Facility (ECF)—Factsheet’ (19
March 2014), at <http://www.imf.org/external/np/exr/facts/ecf.htm> (last visited 12
September 2014).
313
See Decision No 14064-(08/18) of 22 February 2008, and see Table 13.1.
314
See Decision No 14064-(08/18) of 22 February 2008, and see Table 13.1.
315
See IMF, ‘IMF Lending—Factsheet’, above note 274.
316
IMF, ‘Financial Risk in the Fund and the Level of Precautionary Balances’, above note
38, 9.
317
See James M Boughton, Silent Revolution: The IMF 1979–1989 (Washington, DC: IMF,
2001), for the latest title (the fourth one) in this series of ‘official’ histories of the Fund.
318
International Financial Architecture
Rosa María Lastra

Rosa Lastra

ISBN: 9780199671090
Subject(s):
Basel committee on Banking Supervision — Financial Stability Board (FSB) — International Monetary
Fund (IMF)
(p. 499) 14 International Financial Architecture
B. ‘Soft Law’ and International Financial Standard Setting 14.07
Definition of soft law 14.10
Who is involved in the process of setting international standards for
financial markets? 14.18
The Basel Committee on Banking Supervision 14.24
The Financial Stability Board 14.32
The Compendium of Standards 14.37

Taxonomy 14.41
Advantages and disadvantages of soft law 14.50
The problems of country ‘ownership’ 14.57
Implementation and monitoring observance of standards 14.64
Incentives to promote observance of soft law rules 14.70
Monitoring progress in standards implementation 14.76
FSAP and ROSCs 14.78
From informal law to formal law 14.88

Soft law, informal law, lex mercatoria, and the emerging lex
financier 14.89
Relationship between soft law and hard law 14.95
C. The Role of the IMF in Crisis Management 14.100

Resolution of sovereign debt crises 14.114
Statutory solution 14.116
Collective Action Clauses and other contractual techniques 14.124
Code of conduct 14.132
Private creditors and the IMF 14.137

The IMF’s preferred creditor status 14.142
‘Burden sharing’ 14.148
‘Lending into arrears policy’ 14.153
International lender of last resort 14.162

Drawbacks of official sector ‘bail-out’ packages 14.174
D. The Actors in the International Financial Architecture 14.183

‘Formal’ international financial institutions 14.186
The Bank for International Settlements 14.188
E. A New Architecture: Do We Need a World Financial Organization? 14.195
F. Concluding Observations 14.216
A clear lesson of history is that a ‘sine qua non’ for sustained economic recovery
following a financial crisis is a thoroughgoing repair of the financial system.
Janet L Yellen, Presentation to the Annual AEA/ASSA Conference, San Francisco, 4
January 2009
A. Introduction
14.01 This chapter examines the international financial architecture and considers the
need to strengthen it in response to the global financial crisis and the limitations of the
current system.
14.02 National financial systems have at their disposal a set of institutional and legal
arrangements—a national financial architecture—for the safeguard of financial stability and
the prevention of systemic risk (as explained in Chapters 3 and 4). In contrast, the
international (p. 500) financial system lacks a strong legal and institutional framework for
the containment and orderly resolution of regional and international financial crises.
14.03 The definition of international financial architecture lacks precise contours and
refers to a variety of issues.1 A first definition provided by Giovanoli (drawing on Andrew
Crockett) establishes that: ‘This concept is generally understood as encompassing the rules,
guidelines and other arrangements governing international financial relations as well as the
various institutions, entities and bodies through which such rules, guidelines and other
arrangements are developed, monitored and enforced.’2 Andrew Crockett in a speech given
in 2010 provided a definition of the term covering three interconnected elements: ‘first, the
basic economic model that governs cross-border monetary and financial relations; second,
the institutional structure that exists to manage and, where necessary, adapt these
relations; and third, the distribution of decision making authority in international
institutions.’3
14.04 Whereas these definitions focus on the rule-making aspects of the international
financial architecture, other definitions emphasize instead the framework for the prevention
and resolution of international financial crises.4
(p. 501) 14.05 This chapter considers both aspects of the definition: the normative aspect
(‘international financial standard setting’), on the one hand, and the institutional framework
for the prevention and resolution of international financial and sovereign debt crises, on the
other. The common element of these two aspects is that they are aimed at ensuring
international financial stability (an international public good).5 Finally, the chapter
questions the need for a World Financial Organization (WFO).
14.06 A distinction is often made between the ‘international monetary system’ (the official
arrangements relating to the balance of payments—exchange rates, reserves, and
regulation of current payments and capital flows) and the ‘international financial
system’ (comprising the international financial institutions—formal and informal—and the
various public and private actors in the so-called ‘global financial market’). However, this
division is fluid; any discussion about the institution at the centre of the international
monetary system—namely, the International Monetary Fund (IMF)—is linked with the
international financial system, in the same way as the monetary authority at the national
level (the central bank) is linked with the financial system.
B. ‘Soft Law’ and International Financial Standard Setting
14.07 International financial law is mostly ‘soft law’. As Giovanoli points out,6 with a few
exceptions (notably, the Articles of Agreement of the IMF), most of the international
standards, rules, principles, guidelines, codes of conduct, best practices, and other
arrangements that govern cross-border financial relations are ‘soft law’.
14.08 The international legal system has long been described as a system comprised of
equal and sovereign States whose actions are limited only by rules freely accepted as
legally binding. In the well-known Lotus Case, the Permanent Court of International Justice
described this system:
International law governs relations between independent states. The rules of law
binding upon states therefore emanate from their own free will as expressed in
conventions or by usages generally accepted as expressing principles of law and
established in order to regulate the relations between these coexisting independent
communities or with a view to the achievement of common aims.7
14.09 However, globalization and regionalization (the latter in particular in the EU) have
challenged the traditional law-making process. The international financial standard-setting
process is only one aspect of a wider trend towards the development of a variety of
international commitments, which are often described as ‘soft law’.8
(p. 502) Definition of soft law
14.10 According to Goode, soft law can be defined as rules that are not legally binding, but
which in practice are adhered to by those to whom they are addressed or by those who
subscribe to them, for a variety of reasons (moral suasion, fear of adverse action, and other
‘incentives’ to observe the rules).9
14.11 While ‘hard’ law is characterized by formality, ‘soft’ law is characterized by
informality. Soft law is observed in a voluntary, self-imposed way. Hard law is binding in a
coercive, externally imposed way. Enforcement is the key element for distinguishing
between hard and soft law.10
14.12 The concept of ‘soft law’ remains unsettled. Abbott and Snidal11 argue that one
approach to defining soft law is to identify what soft law is not. It is not ‘hard law’, nor is it
a purely political understanding without a legal component. Rather, soft law is what lies
between these two alternatives.12 Some commentators use the term to define rules of
international law that are imprecise or weak. ‘It would seem better to reserve the term “soft
law” for rules that are imprecise and not really compelling, since sub-legal obligations are
neither “soft law” nor “hard law”: They are simply not law at all.’13 According to Goldsmith
and Posner:
The legal literature usually labels non-legal international agreements as ‘soft law’.
We avoid this label here for two reasons. First, non-legal agreements are not
binding under international (or any other) law, so it seems inappropriate to call
them ‘law’, soft or otherwise. Second, ‘soft law’ typically includes not only non-legal
agreements, but also legally binding agreements that are vague or indeterminate.14
14.13 Under another view, soft law ‘tends to blur the line between the law and the non-law,
be that because merely aspirational norms are accorded legal status, albeit of a secondary
nature; be that because the intended effect of its usage may be to undermine the status of
established legal norms’.15
14.14 Perhaps the most traditional position views agreements other than treaties as
nothing more than evidence of custom.16 ‘[M]ost public international lawyers, realists, and
positivists consider soft law to be inconsequential.’17 Hence, ‘it seems inappropriate and
unhelpful to use the term soft law to describe norms and normative instruments which are
clearly not (p. 503) in legal form, not intended to be legally binding, and thus not, in any of
the usual senses in which we use the word, law at all.’18
14.15 According to Sir Joseph Gold, ‘soft law expresses a preference and not an obligation
that states should act, or should refrain from acting, in a specified manner.’19
14.16 The contribution of non-sovereign entities to the formulation of non-binding rules
which are nevertheless expected or designed to be implemented and observed in national
legal systems marks a sharp departure from the standard law-making process in the
international legal system.20
14.17 In our view, soft law is law. In the field of international finance, soft law has been the
prevalent form of law. Indeed, in the absence of formal law and structures, soft law has
filled the vacuum.
Who is involved in the process of setting international standards for financial
markets?
14.18 The entities and bodies that are directly or indirectly involved in this process21
encompass formal international financial organizations (most prominently the International
Monetary Fund); regional organizations (such as the European Bank for Reconstruction and
Development, EBRD); de facto groupings created at the initiative of governments (such as
the G7, G10, G20, and other Gs);22 financial sector-specific international groupings of
supervisors and regulators (Basel Committee on Banking Supervision (BCBS), International
Organization of Securities Committees, International Association of Insurance Supervisors
(IAIS), International Association of Deposit Insurers (IADI), and others)23 and the Financial
Stability Board; central bank experts’ committees; market entities and professional
associations (the International Accounting Standards Board, the Emerging Markets Trade
Association, International Swaps and Derivatives Association (ISDA), the International
Chamber of Commerce (ICC) and its various commissions and working groups,24 and
others); think tanks with a contribution to international financial stability such as the Group
of Thirty, and so on.
(p. 504) 14.19 From a ‘private law’ perspective, the work of the organizations concerned
with the harmonization of transnational commercial law, such as United Nations
Commission on International Trade Law (UNCITRAL),25 the International Institute for the
Unification of Private Law (UNIDROIT),26 and the Hague Conference on International
Private Law,27 must also be mentioned.
14.20 While most of the entities involved in the process of international financial standard
setting are intergovernmental or official entities, and their principles or recommendations
can be characterized as ‘top down’ rules (typically ‘public law’), the work done by
professional associations and market entities (uniform rules and standards, voluntary ‘codes
of conduct’, ‘codes of practice’, etc) can be characterized as ‘bottom up’ rules, an exercise
in self-regulation.28 With regard to the harmonization of international commercial law
(‘private law’ governing cross-border transactions), the work of UNIDROIT and similar
efforts offer a ‘set of rules produced and agreed by scholars representative of the main
legal families of the world which, though deriving their inspiration from many legal
systems, are not the rules of any one system and in various instances offer new solutions’.29
14.21 Despite the plethora of ‘international financial standard setters’, there is no formal
legal framework for the allocation of responsibilities and the division of labour among them.
Though the creation of the Financial Stability Forum (FSF) in 1999 aimed to improve the
way in which existing institutions function, the problems of coordination remained.
14.22 The streamlining of the ‘international standard setters’ and of the standards
themselves is not only desirable, but necessary, given the ‘mushrooming’ of bodies with
standard-setting responsibilities over the last few years, the potential for overlap and
duplication, and the multiplicity of principles financial institutions must take into account.30
14.23 At the Declaration of the London Summit in 2009, the G20 Leaders made the
commitment to ‘establish much greater consistency and systematic cooperation between
countries, and the framework of internationally agreed high standards, that a global
financial system requires’31. Since 2009, the G20 has taken on the leadership in the
coordination of the (p. 505) efforts to reform of the international financial architecture
while considering itself as a forum for international economic cooperation.32 An expanded
membership and the issue of a revised chapter for the Financial Stability Board (FSB) are
elements intended to reinforce the legitimacy and institutionalism in the international
financial standard setting process.33 In Giovanoli’s own words:
…as a result of these efforts, a fairly structured—although by far not perfect—

international financial architecture emerged…It comprises three levels: at the top,
the G-20 as an informal steering group; one level below the FSB with the primary
mission of coordinating the activity of the sectoral [standard-setting bodies] SSBs in
the field of financial regulation and supervision, and finally the sectoral SSBs
themselves.34
The Basel Committee on Banking Supervision

14.24 The Basel Committee on Banking Supervision comprises representatives of the
central banks and supervisory authorities from Argentina, Australia, Belgium, Brazil,
Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea,
Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa,
Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States, and meets
in Basel under the auspices of the Bank for International Settlements (BIS). The Committee,
whose original name was Committee on Banking Regulations and Supervisory Practices,
was established by the central-bank governors of the Group of Ten (G10) countries at the
end of 1974 to encourage cooperation in the prudential supervision of international
banks.35
14.25 Though the Committee acts as an informal forum (a club of central banks and other
supervisory agencies), and its decisions do not have direct legal binding force upon the
member countries,36 it has become a de facto international regulatory body.37 A wide array
of countries have adopted many of the Committee’s resolutions and recommendations,
incorporating them into national legislation and regulations. In this respect, the powers and
influence of the Committee extend well beyond its founding mandate.
The Committee’s decisions have no legal force. Rather, the Committee formulates
supervisory standards and guidelines and recommends statements of best practice
in the expectation that (p. 506) individual national authorities will implement them.
In this way, the Committee encourages convergence towards common standards
and monitors their implementation, but without attempting detailed harmonisation
of member countries’ supervisory approaches.38
14.26 The informality and independence of the Committee have served well in the design
of international banking rules, as it has acted with a fair degree of depoliticization and a
considerable amount of technical expertise and competence in banking and monetary
affairs. However, such an informal character is likely to change in years to come. Indeed,
the 2013 Charter goes some way in the direction of ‘institutionalizing’ the work of the
Committee:
The BCBS is the primary global standard-setter for the prudential regulation of
banks and provides a forum for cooperation on banking supervisory matters. Its
mandate is to strengthen the regulation, supervision and practices of banks
worldwide with the purpose of enhancing financial stability.39
14.27 While cooperation and coordination can be reached within a framework of informal
rapprochement between bank supervisors and regulators, formal convergence and
harmonization of rules require a formal mandate.
14.28 For the first two decades of its existence, the Committee focused on the effective
supervision of cross-border establishments and on the establishment of a framework for the
measurement and adequacy of bank capital. Capital regulation has been at the core of the
Committee’s work. The Basel Capital Accords of 1988 (Basel I), 2004 (Basel II),40 and 2010
(Basel III),41(p. 507) as well as the more recently developed liquidity coverage ratio
(LCR),42 have become both regulatory standards and industry standards.43
14.29 Over the past few years, the Committee has moved more aggressively to promote
sound supervisory standards worldwide. In close collaboration with many non-members
supervisory authorities, the Committee in 1997 developed a set of Core Principles for
Effective Banking Supervision. To facilitate implementation and assessment, the Committee
in October 1999 developed the so-called Core Principles Methodology. Both the Core
Principles and the Methodology were reviewed in October 2006, and a new version of the
Core Principles was issued in September 2012.44 In the aftermath of the global financial
crisis, the BCBS and its oversight body have undertaken a reform programme to address
the lessons of the 2007–9 global financial crisis, as part of the banking sector reforms
agreed by the G20 at the Pittsburgh Summit in 2009.45
14.30 In order to enable a wider group of countries to be associated with the work
pursued in Basel, the Committee has always encouraged contacts and cooperation between
its members and other banking supervisory authorities. It circulates to supervisors
throughout the world published and unpublished papers. In many cases, supervisory
authorities in non-member countries have seen fit publicly to associate themselves with the
Committee’s initiatives. Contacts have been further strengthened by an International
Conference of Banking Supervisors which takes place every two years.46
14.31 As stated in its January 2013 Charter, the internal organizational structure of the
BCBS comprises: (a) the Committee; (b) Groups, working groups, and task forces; (c) the
Chairman; (d) the Secretariat. The Committee’s Secretariat is provided by the Bank for
International Settlements in Basel.47
(p. 508) The Financial Stability Board
14.32 The FSB was set up in 2009 as the successor to the Financial Stability Forum, to
continue its work with an enlarged membership and a broadened mandate to promote
international financial stability. To strengthen its institutional and operational basis, an FSB
Charter was published in 2009 (G20 London Summit, April 2009) and later revisited in 2012
(G20 Los Cabos Summit, June 2012).48
14.33 The FSF had been established in 1999 by the Group of Seven (G7) Ministers and
Governors to promote international financial stability through information exchange and
international cooperation in banking supervision and surveillance.49 In November 2008, at
the G20 Washington Summit, the Leaders called for an expanded membership of the FSF to
strengthen its effectiveness as a mechanism for national authorities, standard setting
bodies and international financial institutions to tackle vulnerabilities and to create and
implement strong regulatory, supervisory and other related policies in the interest of
international financial stability. Andrew Crockett pointed out that:
With its enhanced legitimacy, the FSB thus has the capacity to develop into a
genuine overseer of global financial stability and an effective coordinator of the
activities of other bodies. Indeed, US Treasury Secretary Geithner has labelled the
FSB the ‘fourth pillar’ of the international system, alongside the IMF, World Bank
and World Trade Organization.50
14.34 The FSB brings together twenty-four representatives of national authorities (central
banks, ministries of finance, supervisory authorities) from Argentina, Australia, Brazil,
Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Mexico,
the Netherlands, Republic of Korea, Russia, Saudi Arabia, Singapore, South Africa, Spain,
Switzerland, Turkey, United Kingdom, and the United States. The European Union is also
represented with the European Central Bank and the European Commission Members also
include representatives from four international financial institutions (International
Monetary Fund, World Bank, Bank for International Settlements, and the Organisation for
Economic Co-operation and Development (OECD)).51 Finally, representatives from six
international standard-setting, regulatory, and supervisory groupings (Basel Committee on
Banking Supervision, International Accounting Standards Board, International Association
(p. 509) of Insurance Supervisors, International Organization of Securities Commissions
(IOSCO), Committee on the Global Financial System and Committee on Payment and
Settlement Systems).52
14.35 The FSB is serviced by a secretariat located at the Bank for International
Settlements in Basel, Switzerland. The current Chairman is Mark Carney, Governor of the
Bank of England, who supervises the Standing Committee, the Plenary and the Secretariat.
According to the FSB Charter of 2012, the Plenary is the sole decision-making body and the
decisions are taken by consensus (Art 9); the Steering Committee provides operational
guidance between the Plenary meetings to carry forward the directions of the FSB (Art 12)
and the Secretariat supports the FSB and is directed by the Secretary General who should
be appointed by the Plenary (Art 22).53
14.36 The FSB seeks to coordinate at the international level the work of national financial
authorities and international standard setting bodies and to develop and promote the
implementation of effective regulatory, supervisory and other financial sector policies.54 The
mandate and tasks of the FSB are detailed in the Article 2 of its Charter of 2012.55 The FSB,
as before the Basel Committee on Banking Supervision, fills a legal need, a legal vacuum.56
In the absence of legal mechanisms for setting rules at the international level, informal
mechanisms have emerged. The informal legal nature of the FSB suggests a degree of
flexibility in its operations that may be appropriate for responding to some of the needs of
the international financial community, but that falls short of the legal certainty that
characterizes ‘formal law’. The lack of effective enforcement is the ‘eternal’ problem of
international financial soft law.57
The Compendium of Standards
14.37 As part of its efforts to coordinate the work of the various international standard-
setters, the FSF developed in 1999 a Compendium of Standards, which is regularly
reviewed and updated by the FSB, as the FSF’s successor.58 The Compendium of Standards
lists a series of economic and financial standards which are generally accepted by the
international community because of their relevance for sound, stable, and well-functioning
financial systems (p. 510) both at the national level and globally. It comprises twelve
standard areas which have been designated by the Financial Stability Board as Key
Standards for Sound Financial Systems. Of those twelve standards, three refer to
‘macroeconomic policy and data transparency’, six refer to ‘institutional and market
infrastructure’, and three to ‘financial regulation and supervision’.
14.38 The first three, all issued by the IMF, are the Code of Good Practices on
Transparency in Monetary and Fiscal Policies, the Code of Good Practices on Fiscal
Transparency, and the Special Data Dissemination Standard/General Data Dissemination
System. The ‘institutional and market infrastructure standards’ cover crisis resolution and
deposit insurance (issued by the BCBS jointly with the IADI); insolvency (with the World
Bank coordinating a broad-based effort to develop a set of principles and guidelines on
insolvency regimes59); corporate governance (issued by the OECD); accounting (issued by
the International Accounting Standards Board); auditing (issued by the International
Auditing and Assurance Standards Board); payment, clearing, and settlement (issued by a
Task Force comprising the Committee on Payment and Settlement Systems jointly with
IOSCO); and market integrity (recommendations by the Financial Action Task Force on
Combating Money Laundering (FATF) and the Financing of Terrorism and Proliferation).
14.39 The latter three standards concerning ‘financial regulation and supervision’ are the
Core Principles for Effective Banking Supervision issued by the Basel Committee on
Banking Supervision in September 1997 and reviewed in October 2006 and September
2012;60 the Objectives and Principles of Securities Regulation issued by IOSCO and fully
updated in June 2010;61 and the Insurance Core Principles, Standards, Guidance and
Assessment Methodology issued by IAIS, updated in October 2011 and revised in October
2013.62
14.40 The standards regarding financial regulation and supervision (in particular the Basel
Core Principles for Effective Banking Supervision) have become widely accepted in both
developed and developing countries.
Taxonomy
14.41 ‘Soft law’ rules are not a homogeneous group of rules. They can be classified
according to various criteria: their effect (their degree of ‘softness’), their scope, their
degree of specificity, their source and nature, and the contents of the rules.
(p. 511) 14.42 From the point of view of their effect, they range from professional
practices at the lowest end of the legal scale (best practices, gentlemen’s agreements) to
uniform rules, codes and guidelines, and progressively more ‘forceful’ arrangements with
various degrees of actions (sanctions) in the event of ‘non-observance’.63 The BCBS charter
distinguishes between ‘Standards’ and ‘Guidelines’. The BCBS sets standards for the
prudential regulation and supervision of banks and expects full implementation of such
standards by BCBS members and their internationally active banks. BCBS standards
constitute minimum requirements, and BCBS members may decide to go beyond them. The
Committee expects standards to be incorporated into local legal frameworks through each
jurisdiction’s rule-making process within the pre-defined timeframe established by the
Committee. If deviation from literal transposition into local legal frameworks is
unavoidable, members should seek the greatest possible equivalence of standards and their
outcome. The BCBS guidelines elaborate the standards in areas where they are considered
desirable for the prudential regulation and supervision of banks, in particular international
active banks. They generally supplement BCBS standards by providing additional guidance
for the purpose of their implementation.64
14.43 From the point of view of their scope they can be classified, according to the
Compendium of Standards published by the FSB, into sectoral standards (eg, banking,
securities, insurance) and functional standards (eg, disclosure and transparency,
governance, accounting, etc).65
14.44 From the point of view of their ‘degree of specificity’, the FSB Compendium
classifies standards into ‘principles’, ‘practices’, and ‘methodologies/guidelines’.66 This
degree of specificity with regard to their implementation influences, in turn, the discretion
afforded to the national authorities.67 Principles are defined in the Compendium as
fundamental tenets pertaining to a broad policy area, which offer a degree of flexibility in
implementation to suit the country’s circumstances. Practices spell out the practical
applications of the principles within a more narrowly defined context. Methodologies/
guidelines provide detailed guidance on steps to be taken or requirements to be met.
14.45 With regard to the contents of the rules, a distinction can be made between
‘substantive rules’ and rules that allocate regulatory jurisdiction. Most international
financial ‘soft law’ instruments intend to regulate the substantive aspect of a given matter,
for example, the Basel Capital Accord. Other international standards however are
concerned with the allocation of regulatory responsibility—division of labour—among
national authorities in cross-border financial transactions or activities, for example, the
Basel Concordat of 1975.68
(p. 512) 14.46 With regard to the sources of international soft law, a distinction can be
made between ‘top down’ rules and ‘bottom up’ rules, as pointed out above.69 ‘Top down’
rules emanate from official entities (formal intergovernmental institutions and groupings
created at the initiative of governments). ‘Bottom up’ rules typically constitute an exercise
in self-regulation.70 The former rules are generally agreed among regulators, supervisors,
or other national authorities and groups of experts.
14.47 They are not addressed to the persons to whom the standards are ultimately
intended to apply, but to national authorities which in turn undertake the obligation to
implement them in the national jurisdiction. In that respect, they resemble European
Directives that are addressed to Member States who must transpose them into national law
and are not the final addressees of the relevant standards.71
14.48 ‘Top down’ rules are typically ‘public law’ rules, while the rules that emanate from
professional associations (such as the ICC) are typically ‘private law’ rules (an exercise in
self-regulation).
14.49 The rules of UNIDROIT, UNCITRAL, and other organizations involved in the
harmonization of commercial law are also ‘private law’ rules governing cross-border
transactions (albeit of a different character from those that emanate from professional
associations).
Advantages and disadvantages of soft law
14.50 It is often argued that the advantages of soft law are its flexibility, informality, and
pragmatism.72 While international treaty making is a formal and time-consuming process,
which lacks flexibility for the purposes of revision or amendment,73 international standards
provide flexibility and informality to the rule-making process.74 ‘The extreme length of
international treaties’ negotiations and approval compared with the speed of financial
innovations in the marketplace has made these traditional tools of international diplomacy
ineffective in the financial domain.’75
14.51 It is also argued that the modus operandi of many ‘international standard
setters’ (ie, the technical expertise of those involved, the commonality of knowledge and
interests, and the relatively small size of the working groups) fosters pragmatism and
mutual trust.76
14.52 Another advantage is that their conceptual definition as minimum standards, which
are largely binding as to their effect but leave scope to national discretion (akin to EU
Directives), enhance (p. 513) their prospects for national implementation without the
anxiety of eroding (or appearing to erode) national sovereignty.
14.53 There are several drawbacks to relying upon soft law. First and foremost, there are
concerns about legitimacy. Treaty-making is slow, but formal and legitimate. In a
democratic system, this is a very important consideration.77 Giovanoli notes that, to
respond to this concern in the past years, the consultation procedure has acquired more
relevance among the standard setting bodies.78
14.54 Secondly, since implementation remains at the discretion of national authorities,
problems of legal certainty, predictability, and consistency may arise. As Giovanoli points
out, the lack of precise legal force until they are converted into national law may create
problems of protection for the parties concerned in the absence of formal legal remedies if
the rules are not followed.79 Notwithstanding that, with the inclusion—at the G20 London
Summit (2009)—of the possibility to impose countermeasures to non-cooperative
jurisdictions, a new challenge to the concept of soft law was introduced.80
14.55 Thirdly, the proliferation of standards may lead to complexity, inconsistency,
overlaps, or gaps (though the work of the Financial Stability Board could contribute to
simplifying and providing consistency to the process of international standard setting).81
14.56 Finally, there are concerns about ‘country ownership’, in particular with regard to
developing countries, as I further explore in the following paragraphs.
(p. 514) The problems of country ‘ownership’
14.57 The question of fair representation in international standard-setting bodies,82
particularly with regard to emerging market countries, is a fundamental issue in the
process of soft-law making, one that is directly related to the ‘ownership of financial law
reform’ projects, an issue which is related to the legitimacy of the process of international
financial standard setting.83
14.58 The implementation of international standards may not travel well to emerging or
transition economies owing to incompatibility with the domestic legal culture (eg, the
implementation of fiduciary duties towards investors and shareholders in civil law
systems)84 or the complexity or level of sophistication of some standards.
14.59 The Basel Committee on Banking Supervision, recognizing the need to include in its
proposals the interests of emerging market economies, developed its 1997 Core Principles
of Banking Supervision working in cooperation with other supervisory authorities which
were not at the time BCBS members (Chile, China, the Czech Republic, Hong Kong, Mexico,
Russia, Thailand, Argentina, Brazil, Hungary, India, Indonesia, Korea, Malaysia, Poland, and
Singapore).
14.60 However, the work of the Basel Committee (regarding the revised capital
framework) has often been perceived as inadequate for developing countries because of its
complexity.85
14.61 As mentioned earlier, as part of the reforms that were implemented in the aftermath
of the global financial crisis, the Basel Committee and other international standard setting
bodies have enlarged their membership in order to include more emerging market
economies. This is an important step forward to solve the issue of legitimacy. However, as
pointed out by Giovanoli, ‘the issue of restricted and selective membership (and hence of an
impaired representativity) remains…’.86
(p. 515) 14.62 The perceived under-inclusiveness of the process may create the impression
that peculiarities and special conditions of countries not directly involved in the standard-
setting process are not taken into account.87 The non-binding character of most
international standards indicates that the implementation of those standards relies on the
cooperation between the countries that are supposed to implement them and the standard-
setting organizations. It is therefore important that implementing countries assume
‘ownership’ of those rules (an important issue also with regard to IMF ‘conditionality’).88
14.63 Ownership of financial law reform matters because it provides safeguards of
genuine compliance with the spirit of the international standards, because it generates
political acceptance and streamlines the implementation process.89
Implementation and monitoring observance of standards
14.64 Implementation of international financial standards is typically done at the national
level, through appropriate legislation or regulation.90 Once they are incorporated into
national law, standards become ‘hard law’ and thus enforceable.
14.65 Giovanoli emphasizes the difference between implementation and enforcement.91
While enforcement is a legal concept, implementation is a ‘factual’ concept. The competent
State authorities—such as administrative authorities or courts of justice—enforce the rules,
that is, take the necessary measures to apply legally binding rules. It is the binding force of
the rules that triggers the ‘availability of measures of compulsory execution.
Implementation, on the other hand, is a factual concept, meaning that a certain result has
been achieved, through appropriate legislation or otherwise’.92
14.66 Soft law rules are not ‘legally enforceable’ and yet they have often proven to be
effective in finding their way into national law or into EU law, as the success of the Basel
process (ie, the work of the Basel Committee on Banking Supervision) clearly indicates.
14.67 Voluntary observance is often driven by regulatory competition which induces
national jurisdictions to adopt and implement the latest ‘must have’ set of rules, lest they be
frowned upon by the international community and international business.
(p. 516) 14.68 The international bodies which issue international financial standards tend
to provide assistance for implementation. For instance, with regard to the Basel Core
Principles for Effective Banking Supervision (2012) the associated Core Principles
Methodology sets out detailed guidelines for the assessment of compliance with the core
principles. For each principle, there is a set of criteria (essential and additional) against
which compliance can be assessed.93
14.69 The Financial Stability Board established, in 2011, a framework for monitoring and
reporting on the implementation of the G20 financial reforms. The Coordination Framework
for Implementation Monitoring (CFIM) was subsequently endorsed by the G20 Leaders at
the Cannes Summit as a way to ‘intensify our monitoring of financial regulatory reforms,
report on our progress and track our deficiencies’.94
Incentives to promote observance of soft law rules
14.70 In the absence of formal enforcement mechanisms, ‘incentives’ compel those to
whom they are addressed to observe the rules.95 These incentives function as a substitute
for formal enforcement mechanisms.
14.71 The official sector has developed a number of policies and measures to promote
observance of soft law rules.96 For example, the ‘name and shame’ practice associated with
the list prepared by the Financial Action Task Force on Money Laundering regarding non-
cooperating jurisdictions97 or the OECD list of offshore financial centres responsible for
harmful tax competition98 act as deterrents against ‘non-observance’. Institutionalized peer
review is another official incentive to promote observance, often as a complement to
financial sector surveillance. In 2010, the FSB launched a regular programme of peer
reviews comprising: thematic reviews and country reviews. These reviews are focused on
the implementation and effectiveness of international financial standards developed by
standard-setting bodies (SSBs) and of policies agreed within the FSB. The FSB’s Standing
Committee on Standards Implementation (SCSI) oversees the functioning of the peer review
programme that is mandatory for its members (Art 6.1 of the FSB Charter).99
(p. 517) 14.72 The use of IMF conditionality acts as a very powerful official incentive,
when the country’s adherence to a particular set of standards is made a ‘condition’ for the
disbursement of IMF funds under a stand-by or extended arrangement.100
14.73 The G20 supports and encourages the ‘official incentives’. Consequently, at the G20
Pittsburgh Summit in 2009, the Leaders confirmed they commit to take action with a
consistent implementation of the global standards both nationally and internationally.101 In
addition to official incentives, there are various instruments of market discipline, such as
credit risk weightings, private ratings, borrowing spreads, differentiated interest rates,
inter-bank exposure, and others that act as incentives to adhere to soft law rules.102 These
forms of market discipline are typically voluntary and require a developed framework of
transparency or disclosure.
14.74 International investors often require that developing countries adopt the best
available standards of best practice. This adoption enhances their credit standing and
improves the attractiveness and reputation of their financial systems in the international
marketplace.
14.75 The success of standardized clauses and model rules in private contracts developed
by trade and financial industry associations (such as the rules developed by the
International Swaps and Derivatives Association,103 governing derivative contracts) has
demonstrated that markets are capable of spreading existing standards across jurisdictions
and developing common rules (self-regulation). However, as noted by Giovanoli, the global
financial crisis evidenced the failure of the market driven incentives to maintain financial
stability.104
Monitoring progress in standards implementation
14.76 The IMF and the World Bank have developed a framework for assessing member
countries’ observance of standards and codes (the ‘Standards and Codes Initiative’),
working in cooperation with national authorities, standard-setting agencies, and other
international bodies.105 The standards relate to data and policy transparency, financial
sector regulation and supervision, and market integrity.106 Assessments of the degree of
implementation of these standards by countries result in the Reports on the Observance of
Standards and Codes (ROSCs).
(p. 518) 14.77 The Basel Committee is also committed to monitor its members’ compliance
with the globally agreed minimum standards. Hence, a regulatory consistency assessment
programme (RCAP) was launched in April 2012 with the aim to promote full and consistent
implementation of Basel III. The assessment programme will be conducted on three levels:
level 1, ensuring the timely adoption of Basel III; level 2, ensuring regulatory consistency
with Basel III; and level 3, ensuring consistency of outcomes.107
FSAP and ROSCs
14.78 As discussed in Chapter 13, the Financial Sector Assessment Program (FSAP) was
introduced in May 1999 in the wake of the financial crises of the late 1990s and revised in
September 2009.
The FSAP provides in-depth examinations of countries’ financial sectors. FSAPs are
done jointly by World Bank and IMF staff in developing and emerging market
countries (IBRD countries) and by the IMF alone in advanced economies. FSAPs
have two main components: the financial stability assessment and—in developing
and emerging market countries—the financial development assessment. These
components may be assessed at the same time during a joint IMF–World Bank
mission or at different times in separate stability and development ‘modules’
conducted by the Fund and the Bank, respectively.108
14.79 The World Bank describes the FSAP in the following terms:
The FSAP provides a comprehensive framework through which assessors and

authorities in participating countries can identify financial system vulnerabilities
and develop appropriate policy responses. The program also helps bring financial
sector analysis closer to the center of economic policy discussions within a country
and with the Fund and the Bank. Participating in the program helps inform
domestic policy-makers of the need for sequenced actions in areas requiring urgent
attention and offers countries a comprehensive framework in which to take on
financial sector reforms. It also provides countries with an opportunity to measure
their compliance with financial sector standards and codes and, therefore, to
benchmark their regulatory and supervisory systems against internationally-
accepted practices.109
14.80 The Standards and Codes Initiative is administered by different departments both at
the Fund and the Bank and the financing is drawn from the different departmental budgets.
(p. 519) The Bank–Fund Financial Sector Liaison Committee coordinates the programme in
consultation with the Bank’s regions and the Fund’s area departments.110
14.81 An FSAP report is prepared at the request of a member country by the staff of the
Bank and the Fund. An FSAP report consists of three volumes.111 The first volume (Main
Report) is an overall assessment of the member’s financial sector. It is confidential and
made available only to the country’s competent authorities. The second volume (Selected
Financial Sector Issues) is a detailed technical analysis, which is also confidential. These
first two volumes are not published by the member, the Fund, or the Bank. The third volume
of the FSAP report (Assessment of Observance of International Standards and Codes)
contains a detailed assessment of the observance of selected financial sector standards,
codes, and good practices. The authorities may publish these detailed assessments but only
with the consent of the Bank and the Fund.112
14.82 On the basis of the FSAP findings, the staffs of the Fund and the Bank prepare two
separate reports to their respective Executive Boards. The report to the Fund’s Board is a
Financial System Stability Assessment (FSSA). The report to the Bank’s Board is Financial
Sector Assessment. FSSAs focus on stability issues of relevance to Fund surveillance. The
FSSA, however, will not disclose information concerning the health or prospects of any
particular financial institution.113 The FSSA report can be published by the Fund with the
consent of the member. While the FSAP report is for the member’s own use, the FSSA
report is for the exercise of Fund surveillance.114
14.83 The countries can ask for an update of its FSAP reports and, since the 2009 revision,
instead of a ‘full update’ they can opt for more flexible update, assessing either financial
stability (Fund) or financial development (Bank).115
14.84 The Reports on Observance of Standards and Codes, which are a key component of
the FSAP, summarize the extent to which countries observe relevant internationally
recognized standards and codes and are prepared and published at the request of the
member country.116 Participation by countries in standard assessment and ROSC
publication are voluntary. The IMF has recognized twelve areas and associated standards as
useful for the operational work of the Fund and the World Bank, as explained in Chapter 13.
These comprise accounting; auditing; anti-money laundering and countering the financing
of terrorism (AML/CFT); banking supervision; corporate governance; data dissemination;
(p. 520) fiscal transparency; insolvency and creditor rights; insurance supervision;
monetary and financial policy transparency; payments systems; and securities regulation;
AML/CFT was added in November 2002.117 They are used to help sharpen the institutions’
policy discussions with national authorities, and in the private sector for risk assessment
(by rating agencies and others).
14.85 FSAPs and ROSCs are related but separate concepts. The FSAP reports are joint or
separately reports of Bank and Fund staff on financial sector issues, while ROSCs can be
prepared separately by Bank and Fund staff and are not limited to financial sector issues.118
Countries voluntarily sign up for intensive reviews of their financial system under the
FSAP119 and, although the results remain confidential, they serve as the basis for the
country’s compliance with the relevant standards—the ROSCs—which appear (if the
country agrees to have them published) on the IMF’s website and, thus, are available to
private sector investors for use in their lending and investment decisions. The idea behind
the ROSCs (ie, assessing the compliance with standards, which become a benchmark
against which countries are measured) is gaining support among official and market
participants. Gianviti cites the example of a US pension fund which has commissioned a
consultancy firm to prepare a report on observance by certain countries of the Fund’s codes
on monetary and fiscal transparency.120
14.86 Both the ROSCs and the FSAP are an indication of a truly worldwide interest in
aligning national legal and regulatory frameworks with international best practices,
ensuring consistency and comparability in the implementation of standards. In 2011, a
review on the work done by the Bank and the Fund on the Standards and Codes Initiative
concluded that the work was useful for the countries to identify gaps, to set the reform
agenda, to strengthen institutions and to enhance transparency.121
14.87 Though ideally the observance of standards should be assessed by the institution
that has developed them, the Fund and the Bank have been urged to offer their services in
cooperation with standards setters, to assess compliance with standards.122 (The only other
organization producing ROSCs, and solely in the area of anti-money laundering and
combating the financing of terrorism, is the Financial Action Task Force on Money
Laundering, including its FATF-style Regional Bodies.123)
(p. 521) The ‘good practices’ identified through ROSCs can, in turn, generate more
standards and codes.
From informal law to formal law
14.88 The evolution of law provides evidence of the formalization of rules over time. Many
legal rules that are today binding were at some point customs, usages, or practices. Since
financial law and, in particular, international financial law is a rather novel field of law, its
dynamic and evolving character is unsurprising. The process of law creation still
continues.124
Soft law, informal law, lex mercatoria and the emerging lex financiera
14.89 Formal law has often been born out of the development of informal law. This is not a
new phenomenon. It is a recurrent feature in the history of law. The evolution of
international law and of commercial law, to cite two relevant examples, provides clear
evidence in this regard.
14.90 The primary sources of international law are conventional law (treaty law),
customary law, and the general principles of the law, as recognized by Article 38 of the
Statute of the International Court of Justice.125 Customary international law results when
States follow certain practices generally and consistently. Customary law, however, can
evolve into conventional law. Indeed, important principles of customary international law
have become codified in the Vienna Convention of the Law of the Treaties,126 thus acquiring
the characteristic of ‘conventional law’.
14.91 The birth and development of formal commercial law was influenced by the
medieval lex mercatoria, that is, by the mercantile codes and customs which reflected the
usages of trade, the international maritime and commercial practice at the time. Goode
recalls that the lex mercatoria or law merchant (which was international rather than
English and which was administered by its own mercantile courts) was given full
recognition by the common law courts (absorbed in the common law itself) not ‘by way of
judicial notice of a proposition of law but by receiving evidence of mercantile custom as a
question of fact’.127 Many of the uncodified usages of trade that constituted the lex
mercatoria eventually became formal law. ‘The fertility of the business mind and the fact
that a practice which begins life by having no legal force acquires over time the sanctity of
law are key factors to which the commercial lawyer must continually be responsive.’128
(p. 522) 14.92 Interestingly, the increasing volume and the complexity of international
trade nowadays have led to a resurgence of interest in a new lex mercatoria.129 The work of
UNCITRAL, UNIDROIT, the ICC, and other harmonizing measures indicate a revival of the
spirit of internationalism that characterized the old lex mercatoria.130 Roy Goode, in the
28th F A Mann Annual Lecture in November 2004, discusses the changing face of
transnational commercial law, whose sources encompass ‘the so-called lex mercatoria and a
variety of forms of soft law, including model laws, legislative guides, contractually
incorporated uniform rules, trade terms promulgated by international business
organizations and international restatements prepared by scholars from different legal
families and jurisdictions’.131
14.93 The emerging lex financiera is similar to the lex mercatoria in its international
character.132 The development of international financial law has been a slow and patchy
phenomenon because of three reasons: (1) the lack of a clear legal mandate; (2) a reactive
rather than a proactive character; and (3) the vested interests national governments have in
the supervision and regulation of their financial sectors. The lack of a clear legal mandate
raises important issues of legitimacy and accountability. The reactive nature, the fact that
we appear to always be fighting the last war haunts regulation. And the national vested
interests are again behind the reluctance to further liberalise and integrate financial
markets.
14.94 Some may argue that certain national laws can be exported or transplanted into
other jurisdictions on the basis of their intrinsic superiority (the case for common law is
often made in finance). That is surely one way in which the lex financiera can progress. But
there are other ways of achieving legislative convergence, such as rule harmonization via
conventions, model laws, soft-law rules or standards, or the centralization of regulatory
functions in a common authority to which responsibility in this area is transferred.
International financial regulation so far has proceeded through the harmonization route,
and has done so via soft law. Over time though we should expect a degree of formalization
of the emerging lex financiera in line with the evolution of law generally.133
Relationship between soft law and hard law
14.95 Soft law sometimes complements or supplements hard law. For instance, in the
context of the law of the IMF, a number of international guidelines, recommendations,
codes of (p. 523) conduct, standards, and policies have been developed to interpret,
supplement, or implement the Articles of Agreement.134
14.96 It is often argued that while lawyers express a preference for hard law (legally
binding, legitimate, and enforceable treaties), economists support the opposite view,
acknowledging the advantages of soft law rules (speed, flexibility, and pragmatism).135
Giovanoli explores a third way, espousing the view that soft law and hard law can be
combined in an optimal manner: ‘Standards on which an international consensus has been
established on an informal basis could be made the object of an international treaty, under
which countries could sign up to specific standards, thus committing themselves to
implement and enforce them within their national jurisdictions.’136
14.97 Lichtenstein137 contends that an effort to embody international financial law
standards into a treaty structure might focus on the enforcement model applicable to the
violation of treaty obligations (based on a coercive approach and the imposition of sanctions
for failure to comply) rather than a better ‘compliance-based’ or ‘managerial model’ which
relies more upon a cooperative, problem-solving approach.138
14.98 Brummer points out that ‘…international financial regulation suggests that attempts
to classify law as soft or hard on the basis of formal legal obligation is fraught with hazard,
and may indeed be impossible. In some ways, employing the soft law label disguises the
potential effects on regulatory activities and expectations.’139 Bin Gu and Tong Liu propose
four dimensions to harden soft international finance law:
Those dimensions are obligation, stringency, delegation, and enforcement.

Obligation points to a set of requirements that has legally binding effect. Stringency
focuses on a higher degree of quantitative restraint. Delegation refers to a third
party authorized to administrate the execution of law. And enforcement calls for
disciplinary measures ensuring compliance. Those dimensions are mutually
dependent, as opposed to mutually exclusive. Soft international finance law can be
hardened along one or more of those dimensions.140
14.99 My own view on the relationship between ‘soft law’ and ‘hard law’ can be
summarized as follows. Law has progressed over time, both with regard to its substance
and with regard to the way it is created (the process or procedures). It is in this context that
soft law—as an instrument of change and reform—ought to be understood. Soft law is
indeed law (rules of an informal nature, but yet rules). International financial soft law is
often well suited (p. 524) to the changing needs and rapidly evolving structures that
characterize the workings of financial markets. It would be wrong to dismiss it because of
its ‘softness’. It is ‘soft’ from the perspective of traditional mechanisms of enforcement
(international standards are not international obligations), but in many instances it is, or it
can become, as compelling as ‘hard law’.141 Indeed, one can argue that there is hard ‘soft
law’ (eg, the international standards on money laundering, ie, the Forty Recommendations
on Money Laundering and the Nine Special Recommendations on Terrorist Financing by the
Financial Action Task Force, with specific measures that countries should have in place
covering their criminal justice, law enforcement, and financial regulatory systems) and soft
‘hard law’ (eg, treaties dealing with economic integration in West Africa, such as the 1975
and 1993 Economic Community of West African States (ECOWAS) Treaties, notorious for
their lack of enforcement). Furthermore, soft law can turn into hard law and/or complement
hard law, as exemplified by the case of the IMF mentioned above.
C. The Role of the IMF in Crisis Management

14.100 In Chapter 4 we discussed the recurrent feature of financial crises at the domestic
level. By analogy, it can be said that the history of sovereign debt is also the history of
sovereign debt crises.
14.101 The IMF has played a key role in the resolution of sovereign debt crises over the
last four decades.
14.102 Although the approach favoured by the IMF has changed over time, two principles
remain constant. First, the IMF can only provide financial assistance to remedy temporary
balance of payments problems (whether they are general or special balance of payments
problems) and is not designed to provide long-term financial assistance to countries with
unsustainable debts burdens142 (nor to finance long-term development projects, the domain
of the World Bank). This means that the IMF will in principle only lend itself when the
problems are of ‘liquidity’, not when the problems are of ‘prolonged and unsustainable
debts’ (insolvency).143
(p. 525) 14.103 The primary criterion to determine whether or not to provide such support
is the debt sustainability analysis (DSA)144—in itself a judgement call—on whether a
country has the capacity to grow out of its debt.145 Secondly, any financial assistance
provided by the Fund must be consistent with the Articles of Agreement. This second
principle, which is at the root of conditionality (as explained in Chapter 13), is also at the
root of the other policies and procedures adopted by the Fund over the years to safeguard
the quality of the IMF asset portfolio (the ‘adequate safeguards’ of IMF Articles of
Agreement, Art 1(v)) and, therefore, to safeguard repayment.
14.104 The IMF often acts as an honest broker, as a ‘master-of-ceremonies’, as an arbiter
in sovereign debt negotiations (and debt restructuring) between debtor countries and
creditors and creditor countries.146 The IMF can give or withhold its blessing on the
member country’s plan of reform. Creditors expect that the debtor country will address the
structural economic problems that contributed to the crisis and they know that the IMF is
the only player that can ‘prescribe economic medicine’ to the sovereign debtor with a
certain degree of independence from their own interests and the interests of debtor
countries.147 (Even though the IMF also has an interest at stake since it itself lends, it has a
de facto preferred creditor status and treats arrears in repayments to the Fund with
severity.)
14.105 The IMF also has unique expertise in understanding the vicious link or doomed
loop between bank debt and sovereign debt, that we already discussed in Chapter 10, in the
context of banking union (the fatal embrace between banks and sovereigns was a catalyst
for the advent of single supervision in Europe).
14.106 The Eurozone crisis evidenced once again the unique position of the Fund as crisis
manager and, discussed below, international lender of last resort for all Member countries
(developed and developing). The fact that the Fund ‘comes in when everyone goes
out’ (using colloquial language) explains its fundamental role in the financing needs of
emerging economies or developing countries.
(p. 526) 14.107 The composition and volume of private capital flows to emerging
economies has changed considerably following the Mexican default in August 1982. While
in the 1970s, commercial bank loans (typically in the form of a syndicated loan agreement)
were the primary financing instrument, following the debt crisis in the 1980s and the
subsequent debt restructuring, the relative importance of bank lending has declined.
Countries turned increasingly from loans to bonds. This was in part a result of the Brady
initiative (securitization) and in part a result of the damaged reputation of bank lending
following the debt crisis and the perceived creditworthiness of bonds. Since countries
defaulted on their bank loans but continued to service their bonds (though the outstanding
amount of bonds was very small in the 1970s–80s), the bonds acquired an aura of de facto
seniority that was a contributing factor to the growth of bond issues in the 1990s.148
14.108 Sovereign debt restructuring has evolved substantially in response to this change
in financing patterns (from bank loans to bonds). In the 1980s the restructuring of
sovereign debt brought bank creditors to the negotiating table. While bank creditors are
easily identifiable, bond creditors are numerous, anonymous (in the case of bearer bonds),
and more difficult to coordinate. In addition, many investors who hold these bonds have no
close links with the debtor countries and no commitment to repeat or further investments.
The variety of bond instruments and the range of jurisdictions in which debt is issued
further complicate the restructuring. Finally, the problems are exacerbated by the
incentives that some private creditors have to ‘hold out’ from the restructuring in the hope
of obtaining more favourable terms, or to sue in order to get better terms.149,150,151
149 150 151
(p. 527) 14.109 In the aftermath of the Greek debt restructuring and the Argentine
litigation, the IMF published a paper on sovereign debt restructuring152 setting out a new
path for the Fund’s involvement in sovereign debt workouts considering four issues. First,
acknowledging that debt restructurings have been often ‘too little and too late’, the Fund
requires increased rigor and transparency of debt sustainability and market access
assessments and will explore ways to prevent the use of Fund resources to bail out private
creditors. Secondly, the Fund has encouraged since the early 2000s the voluntary inclusion
of Collective Action Clauses (CACs) in sovereign bonds.153 Thirdly, the growing role of
official lending calls for a clearer framework for OSI (official sector involvement), especially
with regard to non-Paris Club creditors. Finally, as discussed below, a review of the Fund’s
lending into arrears policy (‘LIA policy’) is needed in light of the increased complexity of the
creditor base. Consideration could also be given to extending the LIA policy to official
arrears.
14.110 In a country report on Greece,154 the Fund acknowledged mistakes in its debt
sustainability analysis (mea culpa), calling for a reassessment of the Fund’s lending policies
in the case of a monetary union and for ‘spreading the burden of adjustment across
different strata of society’. In addition, the report emphasized the need to streamline the
Troika process and ‘for Fund staff to be more sceptical about official data during regular
surveillance’. Clearly, the way forward is going to show a stricter assessment of a country’s
debt sustainability before the Fund provides financial support.
14.111 In June 2014, the IMF Executive Board discussed a staff report of 22 May 2014,155
setting out a possible approach for reform of the Fund’s lending framework in the context
of sovereign debt vulnerabilities.156 The approach outlined in the 2014 report relates to the
Fund’s exceptional access framework and places emphasis on market-based options for
reducing the costs of crisis resolution for both creditors and debtors. The report points out
(at 1) that ‘in circumstances where a member has lost market access and debt is considered
sustainable, but not with high probability, the Fund would be able to provide exceptional
access on the basis of a debt operation that involves an extension of maturities normally
without (p. 528) any reduction of principal or interest’. Such operation called ‘reprofiling’
would improve ‘the prospect of securing sustainability and regaining market access,
without having to meet the criterion of restoring debt sustainability with high probability’.
As market-based mechanism, ‘reprofiling’ requires the sovereign’s creditors to agree to
amend the terms of the instruments to extend maturities. The Fund observes that from the
perspective of the international monetary system, by helping to mitigate moral hazard
problems associated with bailouts, ‘reprofiling’ may reduce the incidence of future crises
(at 14). A reprofiling may not reduce the need for a more severe form of debt restructuring
down the road, but it will give the Fund time to assess with greater accuracy whether such
a debt restructuring is in fact necessary in light of the adjustment measures being
undertaken in conjunction with a Fund programme and, if so, what its terms should be.
14.112 The staff’s recommendation on reprofiling is intended to buy the time needed for
that diagnostic work to take place without having to lend the money to repay all maturing
debts in full (the approach taken by the official sector in the Eurozone debt crisis).157
Reprofiling should enable a smoother economic adjustment path with a greater chance of
securing debt sustainability for the benefit of the debtor and its creditors. At least a portion
of unlocked resources could be used to finance a more even pace of adjustment.158
14.113 Using an analogy with the bail-in tool in bank resolution, the Fund reforms would
mean that before proceeding to grant financial assistance, a country would need to ‘bail-
in’ (at least lightly) its private creditors. IMF financial assistance would be expected to give
the troubled country the ‘breathing space’ it needs to undertake necessary reforms, without
eliminating the need for the country to embark upon such reforms.159
Resolution of sovereign debt crises
14.114 The restrictive theory of sovereign immunity160 now prevails in most jurisdictions,
so that a sovereign State can be subject to civil proceedings in a foreign court with respect
to its commercial activities. Sovereign immunity is now largely confined to acta jure imperii
as opposed to acta jure gestionis.161 Sovereign debt documentation typically provides—
through a waiver (p. 529) of sovereign immunity—for the sovereign’s consent to a foreign
jurisdiction and judgment enforcement proceedings.162
14.115 There is no institutional framework (no international bankruptcy court nor a
transnational sovereign bankruptcy regime or code) that will permit sovereign borrowers to
obtain debt relief when their financial obligations outstrip their ability to pay without
worrying about hostile creditor actions. In order to make the sovereign debt restructuring
process more orderly, there are at least three policy options that have been proposed in
recent years:163 (1) a statutory regime, either of a limited nature, based on a model law/
statute, a treaty, or an amendment to the IMF Articles of Agreement; or a wider statutory
regime, akin to the Sovereign Debt Restructuring Mechanism (SDRM) proposals,164
possibly giving a role to the IMF; (2) a voluntary/contractual regime based on collective
action clauses and other contractual techniques; (3) a code of conduct (soft law).
Statutory solution
14.116 Domestic bankruptcy laws and bankruptcy courts provide a statutory solution at
the national level to the problems of corporate insolvency (including bank insolvency).165 At
the international level, there is no international bankruptcy court or international
bankruptcy code.
14.117 The ad hoc resolution of international debt crises and the involvement of a variety
of actors, including international organizations (notably the IMF), informal clubs (the Paris
Club for official debt, the London Club for commercial bank debt), national authorities, and
private financial institutions have sometimes been criticized as inefficient.166 A centralized
statutory solution has been hailed in some official and academic circles as an improvement
over the current piecemeal approach. Others have suggested the resort to arbitration or to
a dispute resolution mechanism akin to the World Trade Organization (WTO) dispute
settlement system.
14.118 The ‘statutory solution’ to the problem of orderly resolution of sovereign debt
crises refers to the possible adoption of what has been referred to as the Sovereign Debt
Restructuring (p. 530) Mechanism or SDRM, with the IMF playing a central role.167 This
‘mandatory approach’ would entail the creation at an international level of a bankruptcy
procedure for countries, akin to Chapter 11 of the US bankruptcy code, and of an
independent dispute resolution forum to verify claims.
14.119 Advocates of the SDRM claim that it would fill a gap in the international financial
system by providing a framework to help resolve the problems of collective action and
creditor coordination and to encourage a country with unsustainable debt and its creditors
to restructure before it gets to the point where default is the only option.
14.120 The IMF started considering the SDRM in 2001,168 though Jeffrey Sachs169
anticipated the concept in 1995 and the idea of an international bankruptcy procedure was
also discussed in the 1980s.170
14.121 The SDRM was first proposed by Anne Krueger (under the auspices of the IMF)
and went through several modifications.171
14.122 However, enthusiasm for the SDRM waned for over a decade after 2003, and
reliance on market solutions (contractual mechanisms) became the preferred approach.
Political opposition in the USA and resistance on the side of many market participants
contributed to the loss of momentum.
14.123 The adoption of the SDRM would in principle imply an amendment to the IMF’s
Articles of Agreement. Enthusiasm for some form of SDRM has been reignited in the light of
the (p. 531) Argentine litigation and the Eurozone woes.172 An alternative and much more
modest proposal could be a creative interpretation of Article VIII, section 2(a), of the IMF
Articles of Agreement. The sections reads as follows: ‘Subject to [conditions not relevant
here], no member shall, without the approval of the Fund, impose restrictions on the
payment of payments and transfers for current international transactions.’ It could be
amended to either affect creditor rights (rendering unenforceable in the territories of any
IMF member country a debt instrument that was invited to participate in a Sovereign Debt
Adjustment Programme but declined to do so)173 or creditor remedies (immunizing in all
IMF member countries the assets and revenue streams of the debtor country against which
attachment by the holder of a debt instrument that was invited to participate in a Fund
approved Sovereign Debt Adjustment Programme but declined to do so).174
Collective Action Clauses and other contractual techniques
14.124 Reliance on contractual techniques is the approach that has been favoured in
recent years to confront the problems of sovereign debt workouts and in particular the
hold-out problem. In 1996, a G10 Working Group issued a report (known as the Rey Report,
after its Chairman, Jean-Jacques Rey of Belgium) recommending, inter alia, the inclusion of
Collective Action Clauses in sovereign bonds and greater reliance on market discipline,
following the Mexican ‘bail-out’.175 This approach is consistent with the enforceability of
contracts, which is at the heart of our trade and financial system. The US Government, the
G7, the International Monetary Fund and the Financial Committee of the IMF, and others
supported this solution, which also enjoyed considerable academic support.
14.125 Collective Action Clauses are provisions contained in bonds that allow the holders
of a specified majority (75 per cent) to amend the terms (payment and non-payment terms)
of the bonds and make them binding on the minority.176 CACs thus allow the debtor to
restructure its debt by a resolution of a binding majority of bondholders. CACs can deal
effectively with the ‘hold-out’ problem, that is, of creditors who use litigation and other
means to extract preferential terms at the expense of the debtor and the other creditors,
but such clauses can only bind the creditors in the specific instruments in which they
appear.177
(p. 532) 14.126 Under English law, the amendment clauses in bonds (sometimes called
‘majority action’ clauses) have typically permitted a change to the payment terms of the
bond with the consent of seventy-five per cent of the bondholders who attend a
bondholders’ meeting (assuming the quorum requirement for the meeting has been met).
CACs thus permit a form of contractual ‘cram-down’ of changes to payment terms on
dissenting minorities, something that could not happen until recently in bonds governed by
New York law (where unanimity was required to change the terms of payment of a bond
issue). However, since 2003 (with the bond issuances of Mexico and Brazil), the prevailing
practice with regard to bonds governed by New York law is to include CACs. This practice
has become the norm worldwide.
14.127 A special mention ought to be made of Uruguay’s 2003 debt reprofiling, since it
changed the international sovereign debt-restructuring scenario.178 Uruguay had nineteen
series of bonds issued in the international markets (some of them rather small issues),
which made the Uruguayan debt stock rather fragmented and dispersed.179 Uruguay made
an offer (pre-emptive action, since Uruguay had not defaulted at the time) to all holders of
its foreign currency denominated bonds (other than a Japanese yen samurai issue) to
exchange those instruments for new bonds. Uruguay sought the consent of bondholders to
amendments of their sovereign bonds prior to the completion of the exchange offer (‘exit
consents’).180 Uruguay elected to issue its new bonds through a trust indenture rather than
a fiscal agency agreement. Uruguay’s debt reprofiling resulted in the inclusion of CACs in
each series of new bonds issued as part of the exchange.
14.128 A major innovation of Uruguay’s version of the CAC was the ‘aggregation
mechanism’, by which a proposed amendment to the payment terms of two or more series
of bonds could be incorporated through aggregated voting to other series of bonds
simultaneously by the approval of a double majority (of 85 per cent of the aggregate
principal amount of all affected series and by 66⅔ per cent of each specific series). This
aggregation feature was designed to address one of the perceived infirmities of
conventional CACs (that they operate only to bind holders within the specific instrument
containing the clause).
14.129 The Uruguay transaction challenged the widely held view that investors would
refuse to take seriously a proposal to restructure sovereign bonds unless forced to confront
an open payment default. The way the transaction was structured increased the
participation of bondholders. It also challenged the view that CACs were of marginal
importance for small issues of bonds.
14.130 The aggregation voting mechanism à la Uruguay also facilitates a more
comprehensive approach to sovereign debt workouts than a single series Collective Action
Clause, since it (p. 533) affects multiple series of bonds, rather than an individual bond
issue. In this respect, the aggregation mechanism bridges the gap between the SDRM
proposals (dealing with the whole existing stock of debt, thus including different classes of
creditors) and the single series CAC.
14.131 What is interesting about CACs and other contractual techniques used in sovereign
bond documentation is that they are increasingly becoming ‘standard’, a kind of new lex
mercatoria in this field (creation of law ex novo).
Code of conduct
14.132 The adoption of a voluntary ‘code of conduct’ with principles that could guide the
negotiations of sovereign debtors and their creditors has been discussed in several fora,
such as International Association of Restructuring, Insolvency & Bankruptcy Professionals
(INSOL International),181 the Council of Foreign Relations and the Institute of International
Finance.
14.133 In this context, UNCTAD released its Draft Principles on Promoting Responsible
Sovereign Lending and Borrowing in April 2011.182
14.134 A code of conduct accepted by market participants can be a helpful guide for
judges dealing with the problems of litigious dissenting minorities. ‘The world of commerce
functions largely on the principle that what are generally accepted by business people as
the legal consequences of their actions will be recognised by the courts.’183
14.135 The second and third solutions (the market approach and the adoption of a ‘code of
conduct’) are clearly complementary and can be pursued in parallel, as evidenced by the
‘standardization’ of collective action clauses in sovereign bonds in recent years or by the
inclusion of CACs in the European Stability Mechanism (ESM) Treaty.184
14.136 In November 2013, a discussion paper issued jointly by the Bank of Canada and
the Bank of England proposed modifications to the contractual terms of sovereign debt with
the introduction of two new and complementary types of ‘State-contingent bonds’.185
The aim of these bonds would be to enhance private creditors’ involvement in risk-sharing
and in the resolution of sovereign debt crisis through well-designed contractual technics.
(p. 534) The proposal includes ‘sovereign cocos’ to help prevent liquidity crises and ‘GDP-
linked bonds’ to help reduce solvency crises.186 International cooperation and coordination
would be essential to develop these new tools.
Private creditors and the IMF
14.137 In the resolution of international debt crises, the IMF typically has a vested
interest, since it is a creditor in its own right (it provides financial support to troubled
countries). As explained in Chapter 13, the IMF has developed a number of special facilities
to deal with acute and sudden financial crises stemming from problems in the capital
account. The problem is that ‘these acute and sudden’ financial crises (a terminology
reminiscent of liquidity problems) can turn into something more prolonged, leading to a
sovereign debt crisis, where the problems are no longer of illiquidity but of insolvency.187
14.138 The Fund has a unique position vis-à-vis private creditors in that it has on-going
relationships with both creditor and debtor countries. Private creditors in the 1970s and
1980s were mostly commercial banks. The situation has changed in the last two decades,
with the change in financing patterns and the shift from loans to bonds.
14.139 In the relations between the IMF and commercial bank creditors in the 1970s, the
commercial banks were often ‘third party beneficiaries of the Fund’s stabilization
programmes’.188 Commercial bankers typically applauded a country’s acceptance of a
stabilization programme, since they received the ‘implicit protection of IMF
conditionality’.189 The de facto (unofficial) coordination of bank’s private loans with IMF
financing explains the influential role of the IMF in the debt restructuring proceedings and
negotiations in the 1980s. The banks typically required that countries reach an
arrangement with the Fund as a precondition for rescheduling, as an assurance that the
policies pursued by the debtor in question would help restore external viability and would
be subject to enhanced Fund surveillance.
(p. 535) 14.140 The Fund’s influential role in sovereign debt work-outs has been a
characteristic feature of the international financial system since 1982 and one that has had
a profound influence on private creditors’ incentives on the one hand and on the design of
certain IMF policies on the other hand.
14.141 The IMF’s desire to safeguard its own assets provides an important rationale for
the Fund’s involvement in the debtor countries’ dealings with private creditors.190 It is in
this context that the Fund’s ‘lending into arrears policy’, the concept of ‘burden sharing’,
and the defence of its de facto ‘preferred creditor’ status must be understood.
The IMF’s preferred creditor status
14.142 The Fund enjoys a de facto preferred creditor status and its claims are not subject
to rescheduling. This practice has been recognized in the Paris Club and in other fora for
sovereign debt restructuring. However, creditors have not legally subordinated their claims
to those of the Fund.
14.143 Interestingly, the IMF preferred creditor status has found its way into a legislative
text via the adoption of the ESM Treaty191 (signed in February 2012 and ratified in
September 2012). Recital 13 of the ESM Treaty reads as follows:
Like the IMF, the ESM will provide stability support to an ESM Member when its
regular access to market financing is impaired or is at risk of being impaired.
Reflecting this, Heads of State or Government have stated that the ESM loans will
enjoy preferred creditor status in a similar fashion to those of the IMF, while
accepting preferred creditor status of the IMF over the ESM. This status will be
effective as of the date of entry into force of this Treaty. In the event of ESM
financial assistance in the form of ESM loans following a European financial
assistance programme existing at the time of the signature of this Treaty, the ESM
will enjoy the same seniority as all other loans and obligations of the beneficiary
ESM Member, with the exception of the IMF loans.192
14.144 The Fund justifies this priority ranking on the grounds that the IMF is not a
commercial organization seeking profitable lending opportunities. In fact, the Fund likes to
remind its members that it often lends precisely at the point where other creditors are
reluctant to do so, and at interest rates that are below those that would be charged at that
juncture by the private sector.193 In so doing, the IMF helps countries to catalyse private
financing and to avoid disorderly adjustment and policies that would harm themselves,
private creditors, and other countries. Putting IMF claims together with commercial claims
in a workout would fundamentally undermine the Fund’s capacity to play that vital role in
future.
14.145 Therefore, from the IMF perspective, its preferred creditor status is fundamental
to the Fund’s financial responsibilities. ‘If the Fund were no longer a preferred creditor, the
risk (p. 536) on its lending would increase and the funds made available by creditor
members could no longer be regarded as risk free. If reserve positions in the Fund are not
regarded as fully liquid and of the highest quality, members cannot treat them as part of
their international reserves, which is crucial for the Fund’s financing mechanism to
operate.’194
14.146 From the members’ perspective, remaining current (ie, not being in arrears) with
the Fund is considered essential to getting access to additional financing from the IMF or
debt relief from other official creditors. Members thus give priority to repayment of their
obligations to the Fund over their obligations to other creditors.
14.147 It is also argued that the Fund’s preferred creditor status benefits not just Fund
members but official and private creditors alike by allowing the Fund to assist member
countries in regaining a sustainable financial path and helping to promote orderly
resolutions to debt problems, when needed.195
‘Burden sharing’
14.148 The concept of ‘burden sharing’ (ie, dividing the burden of financing or
restructuring between the IMF and other official and private creditors) has been an
important component of the IMF strategy towards the resolution of debt crises. The concept
of sharing is a very difficult one to enforce and implement.196 In the first edition, I wrote:
‘My three-year-old daughter often tells her brothers: “Share, you have to share.” Her
concept of sharing, though, is “unilateral”. If she has something, she does not expect to
share it. If the others have something, they should share it with her. In international
finance, this “selfish” behaviour of small children often gets replicated.’ Though my
daughter is now twelve, and she has learnt to share, the lesson remains.
14.149 As Lee Buchheit reminds us: ‘Creditors to the same borrower exist in a Hobbesian
state of nature.’197 He further points out that, while in corporate lending these Hobbesian
tensions have a logical stopping point, which is bankruptcy, in the sovereign context, there
is no neutral referee like a bankruptcy judge, which means that every class of creditor, and
every creditor within every class, must look out for itself.198
14.150 In the absence of a formal bankruptcy procedure, sovereign creditors have
developed some principles to manage their relationships. The first and foremost principle is
parity of treatment among private creditors.199 The principle of parity of treatment among
private creditors has influenced a number of clauses that were inserted in international
loan agreements, such as the negative pledge cause, the pari passu clause, and the sharing
clause.200 With regard to (p. 537) bond agreements, the adoption of majority action clauses
or collective action clauses, CACs, is also influenced by this principle of parity of treatment.
The insertion of CACs allows the holder or holders of a specified majority to amend all the
terms (payment and non-payment terms) of the bonds and make them binding on the
minority, as I explained above.
14.151 Coordination amongst creditors is always problematic. By definition, the problems
of inter-creditor coordination (‘the tyranny of the minority’) are greater in the case of bonds
than in the case of loans.201 The dissenting minority can be very forceful, as several cases
involving the so-called ‘vulture funds’ (distressed securities funds) evidence.
14.152 The IMF has inside information about the debtor countries through its surveillance
function (Art IV consultation) and can help debtors sort out their problems through balance
of payments assistance, and technical assistance. This IMF’s unique set of responsibilities
helps countries restore their creditworthiness through economic reform (we must
remember here the ‘logic’ of conditionality: a country that overspends—ie, spends more
than it takes in—will continue to overspend unless economic reform takes place).202
‘Lending into arrears policy’
14.153 The Fund’s policy regarding ‘lending into arrears’,203 that is, lending to members
who have incurred payment arrears to private creditors (including both commercial banks
and bondholders), has undergone significant developments in the last few decades.204
14.154 In the early 1980s, the policy of the Fund was ‘not to lend into arrears’, that is,
arrears to private creditors (mostly commercial banks at the time) were not tolerated.
However, in 1989, the Fund changed its ‘arrears policy’, acknowledging the difficulties
faced by some (p. 538) members with regard to the approval of their adjustments
programmes. These difficulties arose from the fact that commercial bank creditors had a
‘de facto veto’ over the extension of IMF financial assistance via a standby arrangement,
since the provision of financial assistance by the Fund had become effectively linked to the
existence of an agreement between the debtor country and its commercial bank
creditors.205 The Fund also established a policy to help members finance their debt-service
reduction (DDSR) operations.206
14.155 According to the decision adopted in 1989, the Fund could provide financial
support to a member before an agreement had been reached with its commercial bank
creditors (‘lending into arrears’) if the following three criteria were met: (i) such support
was considered essential for the success of the adjustment programme; (ii) negotiations
between the debtor and its commercial bank creditors had begun; and (iii) agreement on a
financial package was expected within a reasonable period.207
14.156 In 1998, as a result of the changes in the composition of capital flows to emerging
market economies (shift from bank loans to bonds), the Fund’s policy was generalized to
also encompass sovereign bonds.208 The revised policy replicated the first two criteria
established in 1989 and introduced a third criterion specific to bondholders. According to
this third criterion, ‘lending into arrears’ could take place if ‘there were firm indications
that the sovereign borrower and its private creditors would negotiate in good faith on a
debt restructuring plan’ (emphasis added).209
14.157 In 1999, in recognition of the fact that some creditors were inclined to delay
negotiations, because of the perceived rewards of litigation or problems of inter-creditor
coordination, the Fund revised its policy again and replaced the ‘negotiation in good faith’
criterion with a ‘good faith efforts’ test.210 Accordingly, if the member was considered to be
making ‘good faith efforts’ to reach an agreement with its private creditors, then the Fund
could lend (‘lend into arrears’) to the member.211
14.158 The reaction of many private creditors to the changes in the Fund’s policy of
‘lending into arrears’ was rather critical.212 Some argue that ‘there should be a
presumption of close and timely consultations with creditors on steps to remedy the
underlying problem and the development of restructuring proposals.’213 Some others have
advocated that ‘recognition should be accorded to bondholders committees similar to that
given to bank steering committees’ in the 1980s.214 Investors, in short, want clarity and
predictability in the (p. 539) interpretation of this ‘good faith efforts’ criterion. The debtor
countries, on the other hand, want flexibility and continuing access to IMF financing.215
14.159 In an effort to align the contrasting interests of sovereign debtors and private
creditors, a number of principles and procedures with regard to the Fund’s ‘lending into
arrears’ policy, as well as issues for discussion, have been suggested.216 It is clear, however,
that ‘lending into arrears’ does not resolve the member’s problems. The country must
endeavour to get to an agreement with its private creditors with regard to the rescheduling
or restructuring of the debt, in order to enjoy access to international capital markets.217
14.160 On 4 September 2002, the Executive Board considered once again the good faith
criterion in the Fund’s lending into arrears policy,218 based upon a paper prepared by IMF
staff219 in light of the bond restructurings concluded by Ecuador, Pakistan, and Ukraine.220
This time around, the good faith criterion was elaborated into a full-blown set of general
principles and procedural rules for conducting negotiations with creditors.
14.161 In the recent IMF paper on sovereign debt restructuring,221 the Fund
acknowledges that ‘the application of the LIA policy appears to have been uneven’ and that
therefore a review of the LIA policy is again needed. While in Dominican Republic,
Seychelles, and St Kitts & Nevis, IMF staff judged that the ‘authorities were engaged in
good faith efforts to reach a collaborative agreement with creditors’; the assessment of this
‘good faith efforts’ criterion was inconsistent. In the case of Argentina, ‘no constructive
dialogue was observed’. The paper points out that ‘it may be difficult for any creditor
committees to be deemed representative of such a wide diversity of interests’.222
International lender of last resort
14.162 The fear that a domestic crisis can expand—by contagion—to other countries has
led to the emergence of the International Monetary Fund as a de facto international lender
of last resort. The Emergency Financing Mechanism following the Mexican Crisis was a
response (p. 540) by the Fund to the need for prompt support assistance, a typical feature
of the operation of the lender of last resort at the domestic level.
14.163 The IMF provided—through stand-by arrangements—rescue packages to Thailand,
Indonesia, and South Korea during the regional East-Asian crisis that commenced in 1997.
What became known in the jargon as a ‘bail-out’ was deemed necessary at the time to
restore confidence and to renew access to funding in the international capital markets. The
creation of the Supplemental Reserve Facility (SRF) in 1997 was another step forward in
the ‘formalization’ of the role of the Fund as international lender of last resort (ILOLR).223
14.164 A distinctive feature of the crises at the end of the twentieth century and beginning
of the twenty-first century is that the acute balance of payments problems these countries
have stemmed from the capital account instead of the current account.
14.165 As explained in Chapter 13, the Fund also created another facility in 1999 to deal
with the contagion effects of a crisis, the Contingent Credit Line (CCL). However, the CCL
was never used and was allowed to expire in 2003.
14.166 In the aftermath of the 2007–9 global financial crisis—as discussed in Chapter 13—
the IMF has adopted the so-called Flexible Credit Line (FCL) in 2009 to reduce the stigma
effect of applying for assistance, a key challenge in the design of lender of last resort
(LOLR).224 Access to the FCL is restricted to countries that meet strict qualification criteria
and provides countries with large and up-front access to IMF resources.
14.167 But once a FCL arrangement has been approved, a country can draw on it with no
on-going conditions.225 The FCL works as a renewable credit line at low cost to get through
tough times. In situations where a full-fledged economic programme is either not necessary
or not feasible, the Fund can provide financial support to meet urgent balance of payments
needs under the Rapid Financing Instrument (RFI) and Rapid Credit Facility (RCF).
14.168 In 2010, the IMF introduced the Precautionary Credit Line, which was replaced by
the Precautionary and Liquidity Line (PLL) in 2011.226 The PLL combines a qualification
process (similar to that for the FCL, ex-ante conditionality) with focused ex-post
conditionality aimed at addressing the remaining vulnerabilities identified during
qualification. PLL-eligible countries may face moderate vulnerabilities and may not meet
the FCL (p. 541) qualification standards, but they do not require the same large-scale policy
adjustments normally associated with regular stand-by arrangements.
14.169 A few considerations ought to be made when comparing the lender of last resort
role of the central bank at the national level and the role of the IMF as an ILOLR.227
14.170 First, the IMF cannot create money, which limits its lending capacity.228 Goodhart
contends that the key factor determining the scope and scale of a domestic LOLR is its
ability to absorb losses, an ability which rests ultimately with the government. Since
governments are constrained by the domain of their domestic jurisdiction, they cannot
create foreign currency. So, just as commercial banks will turn to their central bank when
they cannot borrow at acceptable terms in the money markets, these national governments
and central banks will turn to an ILOLR when then cannot borrow foreign currency on
acceptable terms in the international money market.229
14.171 Secondly, the lender of last resort should generally address problems of illiquidity,
not of insolvency. Problems of insolvency are best dealt with—nationally and internationally
—by other legal and policy mechanisms of crisis management.
14.172 Thirdly, the risk of contagion is the key factor affecting the discretionary decision
to provide (or not) lender of last resort assistance.230
14.173 Fourthly, any degree of protection justifies regulation and supervision, nationally
and internationally. The greater the expected protection, the more justifiable regulation and
supervision becomes. It then follows that any degree of international protection justifies
strengthening international banking rules231 and enhancing surveillance of domestic bank
supervisory and regulatory policies. In fact, this increased surveillance and enhanced
transparency in banking and financial matters is needed to preserve international financial
stability. As explained in Chapter 13, greater and closer surveillance over financial systems
and their supervision and regulation has become an important component of an Article IV
consultation. The FSAP programme is another step forward in the Fund’s efforts to gather
appropriate information to assess the stability and soundness of the financial systems of
member countries.
Drawbacks of official sector ‘bail-out’ packages
14.174 The first drawback is of course the finite nature of IMF resources and the
magnitude of private capital flows nowadays.232 As in a fair, the merry-go-round keeps on
going until it stops. (p. 542) And after the relative success stories of Mexico, Thailand,
Indonesia, and South Korea, came Russia (a ‘managed’ default) and Argentina (a ‘chaotic’
default, a failure). However, the idea of an official sector bail-out has not been abandoned,
and, indeed, it was used again in Turkey in 2001 (where geopolitical considerations played
an important role) and in Greece more recently (as discussed in Chapter 8).
14.175 The key to determining the success (or failure) of ‘bail-out’ packages (indeed of any
crisis resolution mechanism) is the ability to renew access to funding in the international
capital markets and, thereby, help restore confidence in the country.
There are several problems and disadvantages with international bailouts. First, they give
rise to moral hazard incentives: investors’ folly, reckless bank lending, irresponsible
policies, delays in policy change, and so on. Though the moral hazard is not created by the
bailout per se, but by the precedent it constitutes and by the expectations it generates,
particularly on creditors.
14.176 Secondly, other techniques to deal with crises may prove more efficient and less
costly than bailouts; for instance, what appeared to settle the issue in South Korea in
December 1997 was the agreement between Western banks and Korean banks as to the
restructuring of the Korean debt (rolling it over).233
14.177 Thirdly, any commitment of funds in advance might not only give rise to moral
hazard incentives but also be insufficient to contain a crisis when massive financial
assistance is needed. Unlike domestic central banks, the IMF cannot print money and, thus,
cannot lend freely. Neither in the Mexican and Asian bailout packages, nor in the packages
for Greece and Portugal did the IMF provide the funds alone. The IMF acted as a leader or
coordinator in the design of the packages (akin to the role of the lead bank in a syndicated
loan), but the support of national governments—in particular of the US government—was
essential. Indeed, if what people want in a crisis is US dollars, one could argue that the Fed
is also assuming a quasi-international LOLR role.
14.178 Fourthly, bail-outs may be inequitable if they allow investors to ‘escape’ when they
should take a hit for their bad decisions.
14.179 Fifthly, financial crises are often a good stimulus for reform; the moral hazard of an
international LOLR may allow bad policies to remain in effect much longer. Ultimately, the
response must be at the domestic level: reforming the domestic financial sector and
strengthening its institutional framework.
14.180 Sixthly, stand-by arrangements of the magnitude of those for Mexico and Korea
stretch IMF resources which exist for the benefit of the entire membership, impeding the
use of those resources for other purposes. (Indeed, following the Russian and Brazilian
crises in 1998, access to borrowed funds was needed.)234 The IMF—and for that token the
(p. 543) ESM—can only engage at any given time in a limited number (very few) of ‘bail-out’
packages, thus raising questions of possible asymmetrical treatment of members.
14.181 Finally, given the recurrent nature of crises,235 and the difficulties in predicting
and preventing the next crisis, one might wonder if today’s solution (ie, a bail-out package)
might be a good response for tomorrow’s crisis.
14.182 The IMF is now firmly inserted in the EU process. Given the no bail-out clauses of
the Treaty (as discussed in Chapter 8, Article 125 TFEU prohibits the bail out of
governments, while Article 123 TFEU prohibits the monetization of government debt) and
the concerns of creditors countries (in particular Germany) to effectively bail out debtor
countries (notably Greece, but others followed…), the EU/Eurozone turned to the IMF, since
the Fund can act as international lender of last resort. The wavering and changing policies
of the EU have left the Fund befuddled at times. The IMF of course possesses the know-how
and the credibility when it comes to assisting countries in financial need. And the EU/
Eurozone have been in a learning process when it comes to resolution of sovereign debt
problems. The troika—IMF, ECB, and European Commission—has become the foundation
that supports the programmes under the architecture established to deal with sovereign
debt problems that has culminated with the adoption of the ESM Treaty.236 And the ESM,
lest we forget, is modelled upon the IMF, while the ECB does have the limitless capacity to
act as supranational lender of last resort (both the ESM and IMF have finite resources). The
new role that the IMF has adopted since 2010 as a one third participant in full ‘bail-out’
programmes, most of which go to pay private creditors at par, may damage the credibility of
its debt sustainability analyses and can potentially jeopardize its preferred creditor status.
The ex-post evaluation of Greece—mentioned in paragraph 14.110—is an acknowledgement
that things need to change.
D. The Actors in the International Financial Architecture

14.183 Having discussed the rule-making process that prevails in the field of international
financial law (soft law/international standards) and the role of the IMF in the resolution of
sovereign debt crisis we now turn our attention to the institutional framework in our
existing international financial architecture.
14.184 The actors in the international financial architecture are ‘formal’ international
organizations and regional financial institutions, a kaleidoscope of international fora
meeting either under the auspices of a formal international organization (such as the
Financial Stability Board, and the Basel Committee on Banking Supervision, both located in
Basel under the auspices of the BIS)237 or in other settings (such as the International
Organization of Securities Commissions, which is located in Madrid), ‘informal’
international groupings (p. 544) where international financial issues are discussed (such as
the Group of Seven (G7), the Group of Ten (G10), and the Group of Twenty (G20) countries),
national central banks and ministries of finance or treasuries (which can play a role
individually or collectively meeting in an international forum of a formal or informal
character), and private financial institutions acting on a global scale.238
14.185 This multiplicity of actors and the mushrooming of international fora create a very
complex structure. As Cooke explains, ‘[o]utside the supervisors’ window there is a
kaleidoscope of financial markets and institutions and range of services—all interlinked to a
greater or lesser degree. Each regulator, national or sectoral, only sees a part of this
kaleidoscope and cannot be sure he controls all that he can see.’239 Luis Garicano and I
expressed that, ‘…given the rise in systemic risks noted by all the reports on the current
system and the interconnectedness of the global financial system the way forward must
involve the substitution of this loose network with a hierarchical structure more akin to the
one used in the WTO.’240
‘Formal’ international financial institutions
14.186 Under the genus of ‘formal’ international financial institutions, whose existence is
formally recognized by a treaty, there are multilateral organizations and regional
institutions. The main multilateral organizations (international financial institutions) are the
International Monetary Fund, the World Bank Group (comprising the IBRD; the
International Development Association (IDA); the Multilateral Investment Guarantee
Agency (MIGA); and the International Centre for the Resolution of Investment Disputes),
the Bank for International Settlements, the Organisation for Economic Co-operation and
Development, and the World Trade Organization (with regard to trade-in financial services).
The regional institutions are a broad category that includes the European Bank for
Reconstruction and Development and other regional development banks (Inter-American
Development Bank, African Development Bank, Asian Development Bank), other
supranational organizations at the European level, such as the European System of Central
Banks and the European Investment Bank, and supranational institutions in other ‘regions’
of the World.
14.187 This chapter discusses briefly the role of the BIS (the oldest international financial
institution in the world) and expands further upon the ‘crisis management role’ of the IMF.
However, it does not enter into the detail of the working of other ‘formal’ international
organizations such as the World Bank (the sister institution of the IMF, whose origins also
(p. 545) stem from the Bretton Woods conference in 1944), the OECD (whose predecessor
was the Organisation for Economic Cooperation and Development (OEEC)), or the WTO,
whose formal existence was finally sanctioned in 1994, and whose agenda for trade
liberalization is a very broad one, covering all goods and services. (It is with regard to trade
in financial services, where the work of the WTO must be considered by financial
lawyers.241 In particular, the competing or conflicting character of the goals of prudential
supervision and financial liberalization is a fascinating subject,242 whose analysis exceeds
the scope of this book.)
The Bank for International Settlements
14.188 The BIS is an international organization which fosters cooperation among central
banks and other agencies in pursuit of monetary and financial stability and which provides
banking services to central banks (a bank for central banks) and international
organizations.243
14.189 As mentioned in Chapter 12, the BIS was set up in 1930 in Basel, Switzerland (in
the context of the Young Plan) by a decision of the Hague Conference that dealt with the
German reparations payments imposed by the Treaty of Versailles after the First World War.
From a legal point of view, the BIS has a defined, albeit complex, legal personality. On the
one hand, it is a company limited by shares;244 on the other, it is an international
organization which was (p. 546) established pursuant to the Hague Agreements of 20
January 1930 and, as such, is governed by international law.245 The BIS was also created as
a forum for the cooperation of central banks and this feature has remained a constant in the
history of the BIS.
14.190 The BIS fulfils its mandate by promoting discussion and facilitating decision-
making processes among central banks and within the international financial community, by
providing a centre for economic and monetary research, by acting as a prime counterparty
for central banks in their financial transactions, and by performing agent or trustee
functions with regard to various international financial arrangements.246
14.191 Throughout its history the BIS has carried out important monetary and banking
functions. The BIS was the agent for the European Payments Union (EPU, 1950–8), helping
the European currencies restore convertibility after the Second World War. Similarly, the
BIS has acted as the agent for the Exchange Rate Mechanisms of the European Monetary
System before the adoption of the euro.
14.192 The BIS has also provided financial assistance to support the international
monetary system in various instances. During the 1931–3 financial crisis, the BIS organized
support credits for both the Austrian and German central banks. In the 1960s, the BIS
arranged special support credits for the Italian lira (1964) and the French franc (1968), and
two so-called Group Arrangements (1966 and 1968) to support sterling. More recently, the
BIS has provided finance in the context of IMF-led programmes of financial assistance (eg,
Brazil in 1998).
14.193 Since the BIS provides an institutional framework for cooperation in the monetary
and financial area and serves as a meeting place mainly for central banks and other
financial and regulatory authorities (centre for economic research), the BIS has played an
important role in the development of international financial standards through the various
experts’ committees that meet under its auspices and to which the BIS provides
secretariats. Special mention ought to be made of the BCBS and of the Committee on
Payment and Settlement Systems (CPSS) and the Committee on the Global Financial
System. By providing the secretariat to these committees, and a physical location, the BIS
contributes to their work.
(p. 547) 14.194 In addition to the FSB, the work of the Joint Forum on Financial
Conglomerates (created in 1996 under the aegis of the Basel Committee on Banking
Supervision, the International Organization of Securities Commission (IOSCO), and the
International Association of Insurance Supervisors (IAIS)) is also noteworthy.
The Financial Stability Institute, created by the Bank for International Settlements and the
Basel Committee on Banking Supervision in 1999 to assist supervisors around the world in
improving and strengthening their financial systems,247 is an internal department of the
BIS, which draws upon the resources of the BIS and of the Basel Committee to organize its
training for supervisors.
E. A New Architecture: Do We Need a World Financial

Organization?248
14.195 Globalization has changed the traditional understanding of financial markets and
has led to the emergence of multinational banks, financial groups and new instruments and
markets that operate across jurisdictions.249 But the global financial market is not a huge
global homogenous market. It is more like a spider’s web or a radial web with multiple
interconnections and linkages,250 in which local markets permeate each other and in which
a few players dominate the scene. The size or importance of some of these players (the term
SIFIs or systemically significant financial institutions is now in vogue) is a source of concern
globally and nationally.251
14.196 A global banking and financial system requires some binding international rules
(regulation), efficient supervision or surveillance, and an international system for the
resolution of conflicts and crises (both with regard to the cross-border resolution and
insolvency of financial institutions252 and with regard to the resolution of sovereign debt
crises). We (p. 548) also need better coordination of macro-prudential supervision to
prevent and contain systemic risk.253
14.197 This is the ‘functional background’—regulation, supervision and crisis management
—in which we ought to frame the debate about the need for a World Financial Organization
(WFO).
14.198 We live in a family of nations and we have public international law to regulate the
relations between nation States as well as a set of international organizations to govern
such relations.254 Some areas of international law are quite developed, for example the law
of the sea. In the field of international economic law, the three main pillars of economic
relations between States—money, trade and foreign investment—are supported by a
different legal regime. The regime in trade is multilateral with the WTO providing an
adequate system of international rules and dispute settlement. The regime in foreign
investment is mostly bilateral (and what glues it together is arbitration). The regime in
finance still relies mostly on national law and soft law.255
14.199 In finance we have a ‘black hole’ with few formal international rules and no
adequate system to deal with cross-border crisis or conflicts. We may think there has been a
proliferation of rules, but in fact we have very few formal international rules. Why this
‘black hole’?256 This is due, in part, to the belief—widespread before the crisis—that
financial markets are best left to their own devices and that therefore soft law was
sufficient. Indeed, the fact that the legal framework appeared to be lagging behind or even
not to play a major role in the development of international finance was considered by many
as a rather good state of affairs pre-2007 (even though at the national level, financial
markets are heavily regulated). And this ‘black hole’ is also due to the reticence that Nation
States have to make the sacrifices that are needed in terms of national sovereignty to agree
upon international solutions.
14.200 It may actually be in the best interests of countries to pool sovereignty in this area.
Drawing on the lessons of history, it was in the context of the Second World War that
countries were (p. 549) ready to make the sacrifices needed in terms of sovereignty by
signing a number of international treaties that gave rise to international organizations such
as the United Nations, the International Monetary Fund and the World Bank. John Maynard
Keynes had wisely stated that in order to win the war we needed to ‘win the peace’. It was
this understanding that also inspired Henry Morgenthau (then US Treasury Secretary) to
proclaim in the opening remarks of the Bretton Woods conference in New Hampshire in July
1944 that ‘prosperity like peace is indivisible’.257 Neither Keynes nor Morgenthau were
thinking only in territorial/national terms: they were thinking in international terms.258
14.201 Financial markets need to rely on different levels of governance.259 We need to
identify the functions (or sub-functions) that require a supranational or international
structure and the functions that are best left at the national level.
14.202 The doctrine of multi-layered governance,260 which discusses the allocation of
powers or functions at the national, regional, and international levels, provides a template
to address some of these issues. The challenge is to identify the criteria under which
financial regulatory powers or functions should be allocated (who decides what) and the
different layers that are needed as well as the links between the different international and
supranational structures and spill-over effects.261 For example, in the context of the
extraordinary measures undertaken by central (p. 550) banks to combat the crisis (national
measures with cross-border effects) the debate about ‘currency wars’ has been recently
rekindled.262
14.203 The functional debate is particularly important because a WFO (or several WFOs)
should not become some sort of global regulatory Leviathan. For example, if we agree that
we need rules on cross-border resolution, or rules with regard to capital movements, or
guidance on remuneration, who is going to enforce such rules? We lack an effective
mechanism to ensure the consistent application of global financial rules.
14.204 We need to foster better observance of the standards to preserve competitive
equality amongst nations; we need a mechanism for ensuring the consistent application of
global financial rules;263 and we need a forum to bring disputes when standards are not
observed, which brings us back to the institutional debate.
14.205 Having identified the key functions (regulation, supervision/surveillance and crisis
management), let us look at the candidates for the WFO job (or jobs) given that there are
different functions which require a different ‘skill set’ each. In addition to this functional
analysis we also need to address the issues of accountability, legitimacy, expertise
(adequate personnel) and resources. The top candidates for the WFO job (or jobs) are the
IMF, the BIS, the WTO, the FSB and other standard-setters, such as the BCBS, IOSCO, and
IAIS.
14.206 Standard-setters264 are adept at the regulatory function, though the rules that
emanate from them are of a soft-law nature. However, when it comes to the supervisory and
crisis management function the IMF is uniquely qualified in my opinion.
(p. 551) 14.207 As discussed in Chapters 12 and 13, the IMF was conceived in the 1940s
as an international monetary authority with a very particular and rather narrow remit; once
the fixed exchange regime (the so-called ‘par value system’) was abandoned in the 1970s,
the IMF lost a large part of its original role. Nonetheless, the IMF has become the ‘master
of reinvention’. Like a Phoenix bird resurrecting out of its own ashes, following the
abandonment of what had been its raison d’être—the par value regime—the IMF has been
singularly adept at finding new roles (as arbiter in negotiations between debtor and
creditor countries, as gatekeeper of stability and creditworthiness—via conditionality and
surveillance—and as a de facto international lender of last resort). Why? Colloquially we
would answer: ‘because there is no other institution in town’. The IMF has survived because
its role is indispensable when it comes to solving countries’ external payments and debt
problems, as the experience in the 1980s, the 1990s, and the first thirteen years of the
twenty-first century have confirmed.265
14.208 As stated in Chapter 13, the challenges faced by the IMF have changed since the
collapse of the Bretton Woods regime. With minimum amendments to the IMF Articles of
Agreement, the IMF has been called to respond to all these challenges: financial reform,
financial crises, financial stability, and sovereign debt crises with its array of tools, namely
surveillance, conditional financial assistance and technical assistance. The IMF has become
the de facto international financial authority par excellence.
14.209 The IMF is the only institution (other than the BIS and the WTO) that has
international legitimacy, an array of tools (surveillance, conditional financial assistance and
technical assistance), appropriate financial resources and staffing to assume a formal role
as global financial authority. Other informal international standard setters, such as the FSB,
the BCBS, or IOSCO, can continue with their rule-making role, but only the Fund can
effectively contribute to the enforcement of those standards through its surveillance
function.
14.210 The IMF can play a role similar to that played by the FATF with regard to AML/CFT
standards. In the same way as the FATF seeks partnership with the IMF, World Bank, FATF
regional bodies, national financial intelligence units (FIUs) and even the financial industry
itself266 to verify the observance of AMF/CFT standards and to ensure that every (p. 552)
country in the world is assessed using the same methodology, the IMF can also seek to
further develop partnerships with other national, regional, and international bodies to
ensure adequate implementation of adequate standards for supervision, regulation and
resolution of financial institutions.
14.211 The IMF is thus uniquely placed to monitor the compliance with standards and
rules through its function of surveillance and through its assessment of the health of the
financial sector (as part of Article IV consultations and via the Financial Sector Assessment
Program, FASP, and the Reports on the Observance of Standards and Codes, ROSCs) and to
provide countries with the incentive to observe those standards through the design of
conditionality (carrots and sticks). The IMF also has the know-how when it comes to
sovereign debt workouts [as stated earlier, it is now firmly inserted in the EU process], as
well as the financial capacity to act as international lender of last resort, and also has the
experience in understanding the relationship between banking crises and sovereign debt
crises, as well as adequate resources and personnel.
14.212 Therefore, the IMF should have an enhanced role in the prevention of future crises
and in the development of appropriate tools and frameworks for the resolution of both
cross-border financial crises and sovereign debt crises (often intertwined). However, from a
legal perspective, the IMF is not expected to supervise financial institutions. The
supervisory function it exercises is the ‘surveillance of financial sector policies’, ie, the
supervision of how countries comply with standards, and what type of procedures and tools
they have in place for resolution, supervision, regulation and others. Surveillance is key to
the understanding of the role of the IMF in the twenty-first century.
14.213 In my opinion, a creative interpretation of Article I and Article IV of the IMF
Articles of Agreement provides sufficient legal basis for the Fund to exercise the role of
‘global sheriff’.267 (A sheriff does not make rules, but enforces and makes sure individuals
comply with the rules. By analogy, a global sheriff is not expected necessarily to make the
rules, but to monitor countries’ observance with such rules.268)
14.214 The BIS could also assume an enhanced role in crisis management, since it has
historically acted as a bank for central banks, and it could also play a role in the
formalization of the (p. 553) standard setting process, since it already acts as an umbrella
organization for several international financial standard setters (though IOSCO is oddly
placed in Madrid).269
14.215 The WTO has ‘know-how’ with regard to financial services liberalization and
dispute settlement. As such, its powers in this area could be enhanced. However, WTO lacks
expertise when it comes to issues of financial regulation, monetary and financial stability
(which have been traditionally the domain of the IMF and the BIS and, of course, of national
central banks). As for the FSB, though it is singled out as the pillar of the emerging
international financial architecture by many experts, the FSB remains an international
standard setter and not a formal international organization. Its role in international
financial stability and in the process of setting international standards has been endorsed
by the G20. However, it still lacks ‘real’ powers. In terms of resources, personnel, formal
legitimacy and accountability, it has some way to go before it could act as a formal WFO.
F. Concluding Observations

14.216 Under the rubric of international financial architecture, this chapter examined the
evolving legal framework for the prevention and resolution of international financial crises
(in the pursuit of international financial stability) and the process of law-making with regard
to cross-border financial relations, and has discussed the need for a World Financial
Organization using a multi-layered governance approach.
14.217 The IMF’s unique set of responsibilities (in particular, surveillance, conditional
financial assistance and technical assistance) and its singular role in sovereign debt
resolution explain its central position in the ‘international financial architecture’. The IMF
is the institution both at the centre of the international monetary system and at the centre
of the international financial system.
14.218 The IMF plays different roles and wearing different ‘hats’: that of an ‘honest
broker’ or arbiter between creditors and debtors, a primary lender (financial assistance to
countries experiencing balance of payments needs), a de facto preferred creditor (hence
with an interest at stake), an international lender of last resort, a crisis manager, a standard
setter, and others.
14.219 While ‘hard law’ governs the IMF functions and activities, the IMF has developed—
within the framework of its Articles of Agreement—a number of policies, practices,
standards, and (p. 554) codes of good practice that can be characterized as soft law. The
IMF, however, is not the only international financial standard setter, nor is it the most
relevant one. That regulatory function is shared by a number of formal and informal
groupings and fora of an international character, with the FSB, the BCBS, and other
Committees that have grown under the auspices of the BIS playing a significant role.
However, the IMF is uniquely placed to monitor the compliance with standards through its
function of surveillance, through its assessment of the health of the financial sector (via the
FSAP, ROSCs, and FSSAs), and to provide countries with the incentive to comply through
the design of conditionality policies.270 The IMF is thus well placed to exercise the role of
‘global financial sheriff’.
14.220 The process of international financial standard setting that has been critically
examined in this chapter is a key feature of the evolving international financial architecture.
Soft law is informal law. Its main problem is enforcement. Its main drawback is legitimacy.
Its greatest advantage is flexibility. Hard law is formal law, enforceable and legitimate. It is
also rigid and this rigidity can be problematic with regard to the regulation of money and
financial markets. Soft law fills a need, a legal vacuum in the regulation of cross-border
banking activities. It cannot therefore be dismissed.
14.221 International financial soft law is often a ‘top down’ phenomenon with a two-layer
implementation scheme. The rules are agreed by international financial standard setters
and national authorities must implement them in their regulation of the financial industry.
The financial intermediaries are the ‘final’ addressees of those rules. Standards and uniform
rules, however, can also be designed by the financial industry itself. Self-regulation, by
definition, has a ‘bottom-up’ character.
14.222 International law-making relies upon a variety of sources. It is in the confluence of
‘hard law’ (legally enforceable rules), soft law of a ‘public law’ nature (which can
complement, coexist or turn into hard law), and soft law of a ‘private law’ nature
(comprising rules of practice, standards, usages, and other forms of self-regulation as well
as rules and principles agreed or proposed by scholars and experts) where the future of
international financial and monetary law lies.
Footnotes:
1
See Rosa M Lastra (ed), The Reform of the International Financial Architecture (The
Hague: Kluwer Law International, 2001). While some contributions (those by Loukas
Mistelis, Joseph Norton, and Jeswald Salacuse) focused on law reform and soft law, some
other contributions (those by Thomas Baxter and Lee Buchheit), focused on financial crises
and their resolution, while a few others (those by Huw Evans, Francois Gianviti, Antonio
Sainz de Vicuña, George Walker, the preface by Peter Cooke, and Rosa Lastra) focused on
the institutional framework. In the context of the global financial crisis and its aftermath an
abundant literature has emerged. See eg Howard Davies and David Green, Global Financial
Regulation; the essential guide (Cambridge: Polity Press, 2008); Daniel Tarullo, Banking on
Basel: the Future of International Financial Regulation (Washington, DC: Peterson Institute,
2008); Mario Giovanoli and Diego Devos (eds), International Monetary and Financial Law.
The Global Crisis (Oxford: Oxford University Press, 2010); Viral V Acharya et al (eds),
Regulating Wall Street: The Dodd–Frank Act and the New Architecture of Global Finance
(Hoboken, NJ: Wiley, 2011); Thomas Cottier, John H Jackson, and Rosa M Lastra (eds),
International Law in Financial Regulation and Monetary Affairs (Oxford: Oxford University
Press, 2012); Benn Steil, The Battle of Bretton Woods. John Maynard Keynes, Harry Dexter
White, and the Making of a New World Order (Princeton, NJ: Princeton University Press,
2013); Emilios Avgouleas, ‘Rationales and Designs to Implement an Institutional Big Bang
in the Governance of Global Finance’ (2013) 36 Seattle University Law Review 321; Emilios
Avgouleas, Governance of Global Financial Markets: The Law, the Economics, the Politics
(Cambridge: Cambridge University Press, 2012); Julia Black, ‘Restructuring Global and EU
Financial Regulation: Character, Capacities, and Learning’ in Eddy Wymeersch, Klaus Hopt,
and Guido Ferrarini (eds), Financial Regulation and Supervision: A Post-Crisis Analysis
(Oxford: Oxford University Press, 2012) 3; Kern Alexander, ‘Global Financial Standard-
Setting, the G-10 Committees, and International Economic Law’ (2009) Brooklyn
International Law Journal 861.
2
See Mario Giovanoli, ‘A New Architecture for the Global Financial Markets: Legal Aspects
of International Financial Standard Setting’ in Mario Giovanoli (ed), International Monetary
Law. Issues for the New Millennium (Oxford: Oxford University Press, 2000) 9.
3
See Andrew Crockett, ‘What Have We Learned in the Past 50 Years About the
International Financial Architecture?’, Reserve Bank of Australia 50th Anniversary
Symposium (2010), at <http://www.rba.gov.au/publications/confs/2010/pdf/crockett.pdf>
4
See World Bank, ‘International Financial Architecture’, at <http://www.worldbank.org/ifa/
ifa_more.html> (last visited 17 September 2014):
While there is no agreed definition of what constitutes international financial

architecture, it refers broadly to the framework and set of measures that can help
prevent crises and manage them better in the more integrated international
financial environment. Several aspects of the agenda for crisis prevention and crisis
resolution deal with weaknesses in the international financial system that
potentially contribute to the propensity and magnitude of global instability, hence
requiring collective action at the international level. But there is widespread
recognition that global financial stability also rests on robust national systems and
hence requires enhanced measures at the country level as well.
See also Pierre-Hugues Verdier, ‘The Political Economy of International Financial

Regulation’ (2013) 88(4) Indiana Law Journal 1467–8.
5
For a definition of financial stability, see Chapter 3, paras 3.60–3.63 in this volume.
6
See Giovanoli, ‘A New Architecture for the Global Financial Markets’, above note 2, 33.
7
See SS ‘Lotus’ (France v Turkey), Judgment, 7 September 1927, PCIJ, Ser A, No 10, para
18, at <http://www.worldcourts.com/pcij/eng/decisions/1927.09.07_lotus> (last visited 17
September 2014).
8
See generally Hiram Chodosh, ‘Neither Treaty nor Custom: The Emergence of
Declarative International Law’ (1991) 26 Texas International Law Journal 88; Prosper Weil,
‘Toward Relative Normativity in International Law’ (1983) 77 American Journal of
International Law 413; and Chris Brummer, Soft Law and the Global Financial System, Rule
Making in the 21st Century (Cambridge: Cambridge University Press, 2012).
9
See Roy Goode, Commercial Law, 2nd edn (London: Penguin Books, 1995) 20–1.
10
Giovanoli, ‘A New Architecture for the Global Financial Markets’, above note 2, 35.
Giovanoli points out (35 n 118) that ‘from the legal point of view, no remedies are available
if the rules are not followed. This does not, of course, preclude the existence of factual
“sanctions”, either from the market or from other bodies, which can be very effective.’
11
See Kenneth W Abbott and Duncan Snidal, ‘Hard and Soft Law in International
Governance’ (2000) 54 International Organization 421, 422.
12
For more about ‘soft law’, see generally Gunther F Handl et al, ‘A Hard Look at Soft
Law’ (1998) 82 American Society of International Law Proceedings 371.
13
See generally Weil, above note 8, 415 n 11.
14
See Jack L Goldsmith and Eric A Posner, ‘International Agreements: A Rational Choice
Approach’ (2003) 44 Virginia Journal of International Law 113, 114 n 3.
15
See Handl et al, above note 12, 26.
16
See Pierre-Marie Dupuy, ‘Soft Law and the International Law of the Environment’ (1991)
12 Michigan Journal of International Law 420, 432.
17
See Richard H Steinberg, ‘In the Shadow of Law or Power? Consensus-based Bargaining
and Outcomes in the GATT/WTO’ (2002) 56 International Organization 339, 340.
18
See Richard Bilder, ‘Beyond Compliance: Helping Nations Cooperate’ in Dinah Shelton
(ed), Commitment and Compliance: The Role of Non-Binding Norms in the International
Legal System (Oxford: Oxford University Press, 2000) 72.
19
See Joseph Gold, Interpretation: The IMF and International Law (The Hague: Kluwer
20
See generally Dinah Shelton, ‘The Impact of Globalization on the International Legal
System’, Paper presented in the conference of the University of Sydney on Globalisation and
its Challenges, Sydney (12–14 December 2001).
21
See Financial Stability Board, ‘Who Are the Standard-Setting Bodies?’ <http://
www.financialstabilityboard.org/cos/wssb.htm> (last visited 17 September 2014) and
International Monetary Fund, ‘Standard Setting Agencies’ (updated 2 May 2002), at <http:/
/www.imf.org/external/standards/agency.htm> (last visited 17 September 2014).
22
See Giovanoli, ‘A New Architecture for the Global Financial Markets’, above note 2, 17–
20.
23
Chris Brummer, above note 8, 74–80 (ch 2) refers to them as ‘sectoral standard setters’.
24
The ICC has sixteen commissions of experts which cover every specialized field of
concern to international business. Subjects range from banking techniques and financial
services to taxation, trade policy, competition policy, telecommunications, intellectual
property, information technology, and others. Self-regulation is a common thread running
through the work of the commissions. The ICC has direct access to national governments all
over the world through its national committees. The ICC’s Paris-based international
secretariat feeds business views into intergovernmental organizations on issues that
directly affect business operations. See International Chamber of Commerce, ‘About ICC’, at
<http://www.iccwbo.org/id93/index.html> (last visited 17 September 2014).
25
United Nations Commission on International Trade Law website, at <http://
www.uncitral.org/ uncitral/ en/index.html> (last visited 17 September 2014).
26
International Institute for the Unification of Private Law website, at <http://
www.unidroit.org> (last visited 17 September 2014).
27
The Hague Conference on Private International Law website, at <http://www.hcch.net/
index_en.php> (last visited 17 September 2014).
28
See also Giovanoli, ‘A New Architecture for the Global Financial Markets’, above note 2,
10 and 10 n 25. See also Loukas A Mistelis, ‘Regulatory Aspects: Globalization,
Harmonisation, Legal Transplants and Law Reform—Preliminary Remarks’ in Lastra (ed),
29
See Roy Goode, ‘Rule, Practice and Pragmatism in Commercial Law’ (2005) 54
International Comparative Law Quarterly 539, 553. Goode refers to the UNIDROIT
Principles of International Commercial Contracts. Goode points out (539) that transnational
commercial law is the product of various means: ‘international conventions, model laws,
contractually incorporated uniform rules, international restatements and conscious or
unconscious legislative or judicial parallelism, which lead to the harmonization of
commercial law at the international level’. He further notes (539) that his concern ‘is
primarily with the private law governing cross-border transactions, not with international
economic law or regulatory law’. My approach, on the other hand, is with international
economic law and with regulatory law.
30
Giovanoli, ‘A New Architecture for the Global Financial Markets’, above note 2, 32–3.
31
G20, ‘London Summit—Leaders’ Statement’ (2 April 2009), at <http://www.imf.org/
external/np/sec/pr/2009/pdf/g20_040209.pdf> (last visited 17 September 2014).
32
See Mario Giovanoli, ‘The International Monetary and Financial Architecture—Some
Institutional Aspects’ in Thomas Cottier, Rosa M Lastra, and Christian Tietje (eds), The Rule
of Law in Monetary Affairs (Cambridge: Cambridge University Press, 2014). For a critical
analysis of the G20, see Kern Alexander et al, ‘The Legitimacy of the G20—A Critique Under
International Law’ (14 April 2014), at <http://ssrn.com/abstract=2431164> (last visited 17
September 2014).
33
Giovanoli, above note 32.
34
Giovanoli, above note 32.
35
See Joseph Norton, Bank Regulation and Supervision in the 1990s (London: Lloyd’s of
London Press, 1991) 83–5 and generally Bank for International Settlements, ‘History of the
Basel Committee’, at <http://www.bis.org/bcbs/history.htm> (last visited 17 September
2014). For an excellent recent study on the history of the Basel Committee, see Charles A E
Goodhart, The Basel Committee on Banking Supervision. A History of the Early Years 1974–
1997 (Cambridge: Cambridge University Press, 2011).
36
The membership of the BCBS was enlarged in 2009. See Bank for International
Settlements, ‘Expansion of Membership Announced by the Basel Committee’, Press Release
(13 March 2009), at <http://www.bis.org/press/p090313.htm> (last visited 17 September
2014); Bank for International Settlements, ‘Basel Committee Broadens Its Membership’,
Press Release (10 June 2009), at <http://www.bis.org/press/p090610.htm> (last visited 17
September 2014).
37
It now has its own ‘charter’: Bank for International Settlements, ‘Basel Committee on
Banking Supervision (BCBS) Charter’ (January 2013), at <http://www.bis.org/bcbs/
charter.htm> (last visited 17 September 2014) (hereinafter BCBS Charter).
38
See BIS, ‘History of the Basel Committee’, above note 35.
39
BCBS Charter, above note 37.
40
The texts of Basel I and Basel II and their respective modifications can be found at,
Basel Committee on Banking Supervision, ‘Basel Committee—Basel I’ (1988), at <http://
www.bis.org/list/bcbs/tid_21/index.htm> (last visited 17 September 2014) and Basel
Committee on Banking Supervision, ‘International Convergence of Capital Measurement
and Capital Standards: A Revised Framework’ (June 2006), at <http://www.bis.org/publ/
bcbs128.pdf> (last visited 17 September 2014). For details on the elements of Basel I and
Basel II, see eg Rosa M Lastra, ‘Risk-based Capital Requirements and their Impact upon the
Banking Industry: Basel II and CAD III’ (2004) 12(3) Journal of Financial Regulation and
Compliance 225; Joseph J Norton, ‘The Work of the Basle Supervisors Committee on Bank
Capital Adequacy and the July 1988 Report on “International Convergence of Capital
Measurement and Capital Standards”’ (1989) 23 International Law 245.
41
Basel Committee on Banking Supervision, ‘Basel III: A global Regulatory Framework for
More Resilient Banks and Banking Systems’ (December 2010, revised June 2011), at <http:/
/www.bis.org/bcbs/basel3.htm> (last visited 17 September 2014) . Basel III adopts changes
to the existing capital requirements and introduces a leverage ratio and liquidity
requirements for banks: (a) the capital requirements are stricter than in the previous
accords and a new common equity standard is adopted (by 2019, banks should have 8.5 per
cent tier 1 capital, 10.5 per cent total capital, and 7 per cent of common equity). Also,
additional capital buffers were introduced, a 2.5 per cent mandatory capital conservation
buffer and a discretionary counter-cyclical buffer, which gives the domestic regulators the
possibility to require an extra 2.5 per cent of capital during periods of high credit growth;
(b) the new leverage ratio, as an additional test for capital adequacy, requires that the
banks maintain 3 per cent in excess of their tier 1 assets; and (c) the two completely new
liquidity requirements are the liquidity coverage ratio (LCR) and the net stable funding
ratio (NSFR). The LCR demands banks to have sufficient high-quality liquid assets to
tolerate a 30-day stressed funding scenario, while the NSFR is a longer-term structural
ratio designed to address liquidity mismatches for a longer period. See, Bank for
International Settlements, ‘Basel Committee on Banking Supervision Reform—Basel III’, at
<http://www.bis.org/bcbs/basel3/b3summarytable.pdf> (last visited 17 September 2014).
Avgouleas summarizes the critics and deficiencies of the Basel I and Basel II capital
framework and provides a detailed analysis of Basel III. See Avgouleas, ‘Rationales and
Designs to Implement an Institutional Big Bang in the Governance of Global Finance’, above
note 1, 363–65, 373–77. On procyclicality, see Patricia McCoy, ‘Countercyclical Regulation
and its Challenges’, Paper presented at the Centre for Commercial Law Studies (CCLS)
Roundtable: Financial Markets: Impossible to Govern?, London (26 June 2014).
42
Basel Committee on Banking Supervision, ‘Basel III: The Liquidity Coverage Ratio and
Liquidity Risk Monitoring Tools’ (January 2013), at <http://www.bis.org/publ/bcbs238.htm>
(last visited 17 September 2014). These new international standards created to tackle both
firm-specific and broader systemic risks have been called ‘Basel III’.
43
Lastra, above note 40, 225.
44
Supervision’ (September 2012), at <http://www.bis.org/publ/bcbs230.pdf> (last visited 17
September 2014).
45
For example, in March 2013, the Basel Committee published a proposed final standard
that sets out a supervisory framework for measuring and controlling large exposures (which
will take effect from 1 January 2019) with the intention to ensure greater consistency in the
way banks and supervisors measure, aggregate and control exposures to single
counterparties. The BCBS considers that the large exposures framework is a tool that could
be used to diminish the risk of contagion between global systemically important banks
(GSIBs), thus strengthening financial stability. See Basel Committee on Banking
Supervision, ‘Supervisory Framework for Measuring and Controlling Large Exposures’,
Consultative Document (March 2013) at <http://www.bis.org/publ/bcbs246.htm> (last
46
As stated in the BCBS Charter, above note 37:
The BCG provides a forum for deepening the Committee’s engagement with
supervisors around the world on banking supervisory issues. It facilitates broad
supervisory dialogue with non-member authorities on new Committee initiatives
early in the process by gathering senior representatives from various countries,
international institutions and regional groups of banking supervisors that are not
members of the Committee. …The biennial International Conferences of Banking
Supervisors ICBS provides a venue for supervisors around the world to discuss
issues of common interest. …By participating as observers in BCBS bodies, non-
member authorities contribute to the Committee’s policy development work.
47
48
Since January 2013, the FSB is an association under the Swiss Civil Code, Art 60. See
Financial Stability Board, ‘Meeting of the Financial Stability Board in Zürich’, Press Release
(28 January 2013), at <https://www.financialstabilityboard.org/press/pr_130128.htm> (last
visited 17 September 2014), and Financial Stability Board, ‘Articles of Association of the
Financial Stability Board (FSB)’ (28 January 2013), at <http://
www.financialstabilityboard.org/publications/r_130128aoa.pdf> (last visited 17 September
2014) (hereinafter FSB Articles of Association). The FSB Articles of Association complement
the BCBS Charter and are binding under Swiss law and not internationally where the
Charter continues as a non-binding agreement between members.
49
See generally the FSB’s website, at <http://www.financiastabilityboard.org> (last visited
17 September 2014), and a recent study on the role of the FSB by Eva Hüpkes, ‘The
International Financial Cooperation—Recent Reforms’ (2012) 9(2) European Company and
Financial Law Review 179. See also George A Walker, ‘International Financial Instability
and the Financial Stability Board’ (2013) 47(1) International Lawyer 1.
50
Crockett, above note 3.
51
Wouters and Obermatt remarked that one of the pillars of global economic governance,
the World Trade Organization (WTO), is not a member of the FSB. Despite recognizing that
the WTO is not devoted to work on financial regulation, they pointed out that it has a key
role in the liberalization of financial services through its General Agreement on Trade in
Services (GATS) and that is why it could have been under the FSB coordination. See Jan
Wouters and Jed Odermatt, ‘Comparing the “Four Pillars” of Global Economic Governance:
A Critical Analysis of the Institutional Design of the FSB, IMF, World Bank and WTO’ (2014)
17 Journal of International Economic Law 49.
52
See Financial Stability Board, ‘Links to FSB Members’, at <http://
www.financialstabilityboard.org/members/links.htm> (last visited 17 September 2014).
According to the Financial Stability Board, ‘Charter of the Financial Stability Board’ (June
2012) Art 10(1), at <http://www.financialstabilityboard.org/publications/r_120809.pdf> (last
visited 17 September 2014) (hereinafter FSB Charter), the number of seats assigned to the
jurisdictions varies from one to three and reflects the size of the national economy, financial
market activity, and national financial stability arrangements.
53
FSB Charter, above note 52,
54
See Financial Stability Board, ‘Overview’, at <http://www.financialstabilityboard.org/
about/overview. htm> (last visited 17 September 2014).
55
FSB Charter, above note 52.
56
Brummer pointed out that in the aftermath of the global financial crisis the FSB moved
its regulatory focus from micro-prudential regulation to macro-prudential regulation. See
Brummer, above note 8, 73.
57
See Giovanoli, above note 32. Giovanoli points that, ‘[t]he publication of the FSB Charter
(approved in its revised form at the June 2012 Los Cabos G-20 Summit) is a significant step
towards increased transparency and accountability of the institution.’ Bin Gu and Tong Liu
go further by proposing the enhancement of the FSB’s institutional capacity mainly on three
aspects ‘increasing the number of secretariat staff: formalizing the decision-making system;
and diversifying funding sources’, see Bin Gu and Tong Liu, ‘Enforcing International
Financial Regulatory Reforms’ (2014) 17(1) Journal of International Economic Law 139,
150–1.
58
See Financial Stability Board, ‘Key Standards for Sound Financial Systems’, at <http://
www. financialstabilityboard.org/cos/key_standards.htm> (last visited 17 September 2014).
59
The World Bank, working with UNCITRAL and internationally recognized experts,
completed and implemented the insolvency and creditor rights (ICR) Report on Observance
of Standards and Codes (ROSC) Assessment Methodology. The ICR ROSC Assessment
Methodology is based on the current Creditor Rights and Insolvency Standard (ICR
Standard), derived from the World Bank’s Principles and Guidelines for Effective Insolvency
and Creditor Rights Systems, and the recommendations included in the UNCITRAL’s
Legislative Guide on Insolvency Law. (UNCITRAL adopted a Model Law on Cross-Border
Insolvency in 1997.)
60
See BCBS, ‘Core Principles for Effective Banking Supervision’, above note 44.
61
See International Organization of Securities Commission, ‘Objectives and Principles of
Securities Regulation’ (June 2010), at <http://www.iosco.org/library/pubdocs/pdf/
IOSCOPD323.pdf> (last visited 17 September 2014).
62
These principles were amended in 2012 and 2013. See International Association of
Insurance Supervisors, Insurance Core Principles, Standards, Guidance and Assessment
Methodology (Basel: IAIS, 2011), at <http://www.iaisweb.org/Supervisory-Material/
Insurance-Core-Principles-795> (last visited 17 September 2014).
63
6. Giovanoli also uses other criteria to classify soft-law rules. With regard to the ‘gradation’
of rules, see also Weil, above note 8. I use the term ‘forceful’, instead of ‘binding’ (which
denotes hard law), and the term ‘non-observance’, instead of ‘non-compliance’.
64
65
FSB, ‘Key Standards for Sound Financial Systems’, above note 58.
66
See Financial Stability Board, ‘What Are Standards?’, at <http://
www.financialstabilityboard.org/cos/standards.htm> (last visited 17 September 2014).
67
See generally Joseph Norton, ‘Pondering the Parameters of the New International
Financial Architecture: A Legal Perspective’ in Lastra (ed), above note 1, 16–19.
68
40.
69
See also Mistelis, above note 28, 163.
70
For example, the ISDA Master Agreement, which is the standard agreement used in
over-the-counter derivatives transactions.
71
See Giovanoli, ‘A New Architecture for the Global Financial Markets’, above note 2, 39
and 55–6.
72
73
See eg Anthony Aust, ‘The Theory and Practice of Informal International
Instruments’ (1986) 35 International and Comparative Law Quarterly 787, 791–2.
74
See Hartmut Hillgenberg, ‘A Fresh Look at Soft Law’ (1999) 10 European Journal of
International Law 499; Charles Lipson, ‘Why are Some International Agreements
Informal?’ (1991) 45 International Organization 495, 500; Christine Chinkin, ‘The Challenge
of Soft Law: Development and Change in International Law’ (1989) 38(4) International and
Comparative Law Quarterly 850.
75
See Cally Jordan and Giovanni Majnoni, Financial Regulatory Harmonization and the
Globalization of Finance (Washington, DC: World Bank, 2002) 6–7.
76
Also, Brummer argues in this point that soft law fosters international governmental
cooperation, ‘…soft law serves as a building block and focal point for coordination, and
creates patterns of relationships that link agencies, financial authorities, and heads of
state.’ See Brummer, above note 8, 112.
77
Schoenmaker argues that ‘the soft law approach with voluntary cooperation does not
provide sufficient incentives for authorities to cooperate effectively during a crisis. Properly
reforming global governance means that we have to explore a hard law approach based on
convention or treaty. …[E]xisting international institutions, in particular de FSB, the BIS
and the IMF, can play a major role in such a strengthened global governance framework.
But major reforms would be needed.’ See Dirk Schoenmaker, Governance of International
Banking: The Financial Trilemma (Oxford: Oxford University Press, 2013) 131. In the same
line, Avgouleas suggested a new model of governance for global financial markets that
assumes the previous signing of an international treaty. See Avgouleas, ‘Rationales and
note 1, 325. Also, on the issue of democratic legitimacy, see Julia Black, ‘Legitimacy,
Accountability and Polycentric Regulation: Dilemmas, Trilemmas and Organisational
Response’ in Anne Peters et al (eds), Non-State Actors as Standard Setters (Cambridge:
Cambridge University Press, 2009) 241.
78
See Giovanoli, above note 32. See also Michael S Barr and Geoffrey P Miller, ‘Global
Administrative Law: The View from Basel’ (2006) 17 European Journal of International Law
15–16 and Daniel C Esty, ‘Good Governance at the Supranational Scale: Globalizing
Administrative Law’ (2006) 115 Yale Law Journal 1490.
79
80
See G20, ‘Meeting of Finance Ministers and Central Bank Governors, United Kingdom’,
Communiqué (14 March 2009) point 7, at <http://www.treasury.gov/resource-center/
international/g7-g20/Documents/2009_communique_horsham_uk%20March.pdf> (last
visited 17 September 2014): ‘…the relevant international bodies identify non-cooperative
jurisdictions and to develop a tool box of effective counter’.
81
On this point, Gu and Liu, above note 57, 16–17, pointed that, ‘[t]he experience relating
to the 2008 financial crisis proves that the soft-law approach is not able to ensure a
sufficient degree of consistency and internationally harmonized implementation, and thus,
it is not able to provide for the level playing-field that is essential for competition in a global
market.’ Also Schoenmaker, above note 77, 131, states that, ‘[h]armonization of rules,
without enforcement mechanisms, is not sufficient. Binding forms of cooperation are
necessary to make real progress.’ Avgouleas provided a detailed analysis of the
shortcomings in regulatory coordination after the global financial crisis. See Avgouleas,
‘Rationales and Designs to Implement an Institutional Big Bang in the Governance of Global
Finance’, above note 1, 354–7.
82
83
See Chapter 5 in this volume. See generally John J Kirton, ‘The G20: Representativeness,
Effectiveness and Leadership in Global Governance’ in John J Kirton, Joseph P Daniels, and
Andreas Freytag (eds), Guiding Global Order: G8 Governance in the Twenty-First Century
(Aldershot: Ashgate, 2001) 143; Tony Porter, ‘The G-7, the Financial Stability Forum, the
G20 and the Politics of International Financial Regulation’, Paper prepared for the
International Studies Association Annual Meeting, Los Angeles, CA (15 March 2000) and
Brummer, above note 8, 97–104, 110–11, 177–209.
84
See Daniel Berkowitz, Katharina Pistor, and Jean-François Richard, ‘Economic
Development, Legality and the Transplant Effect’ (2003) 47(1) European Economic Review,
at <http://ssrn.com/abstract=290000> (last visited 17 September 2014).
85
For instance, the People’s Republic of China (PRC) once made it clear that it would not
adopt the Basel II proposals (in their proposed form):
It is also questionable whether standards developed in and designed to fit large and
developed economies fit equally well small, emerging countries which account for
the majority of jurisdictions around the world. Even independent from the level of
development, the size of an economy is by itself an important determinant of the
desirable structure and size of its financial and regulatory system. The fixed costs in
setting up a regulatory structure, a market, a bank, are such that not many
countries around the world can be expected to have all financial intermediation
services produced domestically and conversely to have all the regulatory structures
currently considered by the standards and codes currently in circulation.
See Jordan and Majnoni, above note 75, 19.

86
Giovanoli, above note 32. Also, Brummer, above note 8, 209, states that:
[I]nternational standard-setting bodies are evolving rapidly, incorporating novel

processes to include both non members’ advice in the process of rule making and
standard setting, and developing outreach mechanisms to generate increased buy-
in of the standards adopted after consultations. However, additional innovations in
membership are still needed—ones that acknowledge the pragmatic coordination
difficulties of universal participation but that allow for broader and more diverse
involvement in the global standard-setting processes.
87
Jordan and Majnoni, above note 75, 19:
Fair representation of all parties is crucial for the acceptance of standards with no
legally binding character. On the other hand, it must be recognized that rules are
much easier to draft in relatively small and manageable groups, as broad groups,
especially if they are not homogeneous, move slowly and may fail to achieve the
necessary degree of consensus. Reconciling at the international level the conflicting
requirements of legitimacy and effectiveness is akin to squaring the circle.
88
See Chapter 13 for a discussion on this issue.
89
See Mohsin S Khan and Sunil Sharma, Conditionality and Country Ownership of
Programs (Washington, DC: IMF, 2001) 14.
90
91
92
93
See <http://www.bis.org/publ/bcbs130.pdf> and BCBS, ‘Core Principles for Effective
Banking Supervision’, above note 44.
94
See Financial Stability Board, ‘Implementation Monitoring’, at <http://
www.financialstabilityboard.org/activities/implementation_monitoring/index.htm> (last
visited 17 September 2014). On this point Gu and Liu, above note 57, 2, stated that, ‘[b]y
carrying out its mandate through the peer review program, the FSB has detected two major
problems in national implementation. First, nations have trimmed G20 reform
requirements. Second, inconsistent implementation across borders has induced nations to
race to the bottom. In sum, implementation is the Achilles’ heel of international financial
regulatory reforms.’
95
Though the word ‘compliance’ is a term typically used in the case of hard law and
‘observance’ (or adherence to) in the case of soft law, sometimes the word compliance is
also used in references to soft law.
96
97
See Organisation for Economic Co-operation and Development Financial Action Task
Force on Money Laundering, ‘Non-Cooperative Countries and Territories’ (2004).
98
See Organisation for Economic Co-operation and Development, ‘List of Unco-operative
Tax Havens’ at <http://www.oecd.org/countries/monaco/listofunco-operativetaxhavens.htm>
99
The objectives and guidelines for the conduct of FSB peer reviews are included in
Financial Stability Board, ‘Handbook for FSB Peer Reviews’ (7 January 2014), at <http://
www.financialstabilityboard.org/publications/r_140106.pdf> (last visited 17 September
2014) and for more information see Financial Stability Board, ‘Peer Reviews’, at <http://
www.financialstabilityboard.org/activities/peer_reviews.htm> (last visited 17 September
2014).
100
101
G20, ‘Leaders’ Statement: The Pittsburgh Summit’ (24–25 September 2009), at <http://
ec.europa.eu/commission_2010-2014/president/pdf/statement_20090826_en_2.pdf> (last
102
103
Giovanoli, ‘A New Architecture for the Global Financial Markets’, above note 2, 28. See
generally International Swaps and Derivatives Association website, at <http://
www.isda.org> (last visited 17 September 2014).
104
See Giovanoli, above note 32.
105
See generally International Monetary Fund, ‘Standards and Codes: The Role of the IMF
—Factsheet’ (19 March 2014), at <http://www.imf.org/external/np/exr/facts/sc.htm> (last
visited 17 September 2014). The standards and codes initiative was launched in 1999 as a
prominent component of efforts to strengthen the international financial architecture. The
initiative was designed to promote greater financial stability through the development,
dissemination, adoption, and implementation of international standards and codes. The
initiative covers twelve standards which the Bank and Fund Boards recognized as relevant
for their work with regard to policy transparency, financial sector regulation and
supervision, and market integrity. Assessments of the degree of implementation of these
standards by countries result in the ROSCs.
106
See International Monetary Fund, ‘IMF Executive Board Concludes Review of
Standards and Codes Initiative’, Public Information Notice (PIN) No 11/38 (22 March 2011),
at <http://www.imf.org/external/np/sec/pn/2011/pn1138.htm> (last visited 17 September
2014).
107
See Basel Committee on Banking Supervision, ‘Basel III Regulatory Consistency
Assessment Programme’ (April 2012), at <http://www.bis.org/publ/bcbs216.htm> (last
visited 17 September 2014). The following jurisdiction level assessments have been
successfully completed as of March 2014: Australia (March 2014), Brazil (December 2013),
China (September 2013), Switzerland (June 2013), Singapore (March 2013), European
Union, Japan, and the United States (October 2012). For details on the assessments, see
Basel Committee on Banking Supervision, ‘Assessing Consistency of Implementation of
Basel III Standards’, at <http://www.bis.org/bcbs/implementation/l2.htm> (last visited 17
September 2014).
108
See International Monetary Fund, ‘Financial Sector Assessment Program: Frequently
Asked Questions’ (7 August 2014), at <http://www.imf.org/external/np/fsap/faq/index.htm>
(last visited 17 September 2014) and International Monetary Fund, ‘Financial Sector
Assessment Program (FSAP)—Factsheet’ (29 August 2014), at <http:// www.imf.org/
external/np/fsap/fsap.asp> (last visited 17 September 2014).
109
See World Bank, ‘Financial Sector Assessment Program (FSAP)’, at <http://
web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTFINANCIALSECTOR/0,,contentMDK:
22142161~menuPK:6459396~pagePK:210058~piPK:210062~theSitePK:282885,00.html>
(last visited 17 September 2014) (hereinafter World Bank, ‘FSAP’).
110
International Monetary Fund and World Bank, ‘2011 Review of the Standards and
Codes Initiative’ (16 February 2011), at <http://www.imf.org/external/np/pp/eng/
2011/021611.pdf> (last visited 17 September 2014).
111
See François Gianviti, ‘Legal Aspects of the Financial Sector Assessment Program’,
(2005) 3 Current Developments in Monetary and Financial Law, Paper 13, at <http://
www.imf.org/external/pubs/nft/2005/cdmf/> (last visited 17 September 2017).
112
113
Gianviti, above note 111. According to Articles of Agreement of the International
Monetary Fund (Bretton Woods, NH, adopted 22 July 1944, entered into force 27 December
1945) Art VIII, s 5(b) (hereinafter IMF Articles of Agreement), ‘Members shall be under no
obligation to furnish information in such detail that the affairs of individuals or corporations
are disclosed.’
114
115
See World Bank, ‘FSAP’, above note 109.
116
International Monetary Fund, ‘Reports on the Observance of Standards and Codes
(ROSCs)’ (21 August 2014), at <http://www.imf.org/external/NP/rosc/rosc.aspx> (last
visited 17 September 2014) (hereinafter IMF, ‘ROSCs’).
117
IMF, ‘ROSCs’, above note 116.
118
See Gianviti, above note 111.
119
In September 2010, the IMF made the stability assessments under the FSAP a
mandatory part of bilateral surveillance for twenty-five jurisdictions with systemically
important financial sectors. See International Monetary Fund, ‘Financial Sector Assessment
Program (FSAP)—Factsheet’ (18 March 2014), at <http://www.imf.org/external/np/exr/facts/
fsap.htm> (last visited 18 September 2014). The number of such jurisdictions was
increased to 29 in December 2013.
120
121
IMF, ‘Standards and Codes—Factsheet’, above note 105. Avgouleas remarked that the
monitoring of the implementation of standards through the FSAP surveys is one of the
biggest achievements of the new financial architecture. However, he also recalled that
these surveys were subject to strong criticism because they failed to give clear warnings to
prevent the global financial crisis. See Avgouleas, ‘Rationales and Designs to Implement an
Institutional Big Bang in the Governance of Global Finance’, above note 1, 333 and 342–44.
122
123
124
See Giovanoli, ‘A New Architecture for the Global Financial Markets’, above note 2, 52:
Historical experience with soft law in other fields suggest that sooner or later a
process of consolidation and ‘crystallisation’ into legally binding rules occurs. …Soft
law has proved to be a precursor of emerging hard law. …The relation between soft
law and legally binding rules (statutory law in domestic jurisdictions, formal treaties
at the international level) often appears to be an evolutionary process.
125
See Statute of the International Court of Justice, Art 38, at <http://www.icj-cij.org/
documents/?p1= 4&p2=2> (last visited 17 September 2014) (hereinafter ICJ Statute). As
acknowledged, the ICJ Statute is a an integral part of the Charter of the United Nations
(signed in San Francisco, 26 June 1945; came into force 24 October 1945) 1 UNTS 16.
126
Vienna Convention of the Law of the Treaties (adopted 22 May 1969; entered into force
on 27 January 1980, in accordance with its Art 84(1)) 596 UNTS 261 (hereinafter VCLT).
127
See Goode, above note 9, 3.
128
Goode, above note 9, 14.
129
Goode, above note 9, 1210–11.
130
Goode, above note 9, 21. However, while uncodified international trade usages exist,
they do not have legal force merely by virtue of their existence. Those principles are only
given formal legal effect by the express or implied adoption of the parties entering a
transaction (incorporation by contract) or by reception into the law of a national or
supranational legal system (adoption by legislation or judicial reception).
131
See Goode, above note 9, 541. Goode makes a case (above note 9, 547–8) for ‘confining
the lex mercatoria to international trade usage, which is surely the epitome of spontaneous
law creation’. He clarifies (above note 9, 550) that ‘[u]sages (in the sense of practices that
have acquired normative force) are to be distinguished from rules set out in codes of
practice promulgated by trade and professional organizations…, which take effect in the
first instance by their express or implied incorporation into contracts’.
132
In this section I draw on Rosa M Lastra, ‘Do We Need a World Financial
Organization?’ (forthcoming December 2014) 17(4) Journal of International Economic Law.
133
The greatest limitation of international financial soft law is, as mentioned above, its
lack of effective enforcement. It is only by their adoption into national law that such laws
typically become enforceable. Observance is to soft law what enforcement is to hard law.
Yet, the imposition of sanctions in the case of non-observance remains a formidable
challenge. One way of tackling this problem could be the conditioning of market access on
the basis of compliance with some international rules.
134
See Joseph Gold, Interpretation: The IMF and International Law (The Hague: Kluwer
Law International, 1996) 299–401. See also Joseph Gold, ‘Strengthening the Soft
International Law of Exchange Arrangements’ (1983) 77 American Journal of International
Law 443.
135
2. See Tommaso Padoa-Schioppa and Fabrisio Saccomanni, ‘Managing a Market-Led Global
Financial System’ in Petter K Kenen (ed), Managing the World Economy Fifty Years After
Bretton Woods (Washington, DC: Institute of International Economics, 1994) 266.
136
See also Barr and Miller, above note 78, and Esty, above note 78.
137
See Cynthia C Lichtenstein, ‘Hard Law v. Soft Law: Unnecessary Dichotomy?’ (2001) 35
International Lawyer 1433.
138
Lichtenstein, above note 137, 1441.
139
Chris Brummer, ‘How International Financial Law Works And How It Doesn’t’ (2011) 99
Georgetown Law Journal.
140
See Gu and Liu, above note 57, 141.
141
See Tommaso Padoa-Schioppa, Regulating Finance (Oxford: Oxford University Press,
2004) 41.
142
Though the assistance provided to Greece in 2010 is a departure from this principle.
See Rosa M Lastra ‘The Role of the International Monetary Fund’ in Rosa M Lastra and Lee
Buchheit (eds), Sovereign Debt Management (Oxford: Oxford University Press, 2014) 49. In
the case of Greece, the Fund determined that its debt was sustainable, but not with high
probability required under the exceptional access policy. Hence the establishment of a
systemic exemption under which the high probability requirement need not be met in cases
of international spillovers.
143
The literature on financial crises draws heavily on the distinction between illiquidity
and insolvency. However, an insolvent country is more difficult to identify conceptually than
an insolvent company (or bank).
An insolvent country is one that cannot pay its debts, not because it has insufficient
assets but because it cannot mobilize the revenues required to service its debt
without imposing great pain on its citizens, jeopardizing the survival of its
government and impairing the social and political stability of the country itself.
See Peter Kenen, ‘The International Financial Architecture: Old Issues and New
Initiatives’ (2002) 5 International Finance 23, 31.
144
In a DSA, a judgement is made about a member’s debt-to-GDP ratio. It is deemed
unsustainable if such ratio is likely to continue to rise in the medium term, no matter what
adjustment measures are introduced and no matter how much financing is provided by the
Fund. The Fund’s approach to debt sustainability analysis differentiates between market-
access countries, that typically have significant access to international capital markets, and
low-income countries, which meet their external financings needs mostly through
concessional resources. The assessments of public and external debt sustainability are
conducted in the context of both IMF programme design and reviews, and Art IV
surveillance. The framework for public debt sustainability analysis was reformed in 2011
and guidance to staff on the implementation of the new framework was introduced in May
2013. See International Monetary Fund, ‘Staff Guidance Note for Public Debt Sustainability
Analysis in Market-Access Countries’ (9 May 2013), at <http://www.imf.org/external/np/pp/
eng/2013/050913.pdf> (last visited 17 September 2014). The paper underlined the need for
further improvements of the Fund’s DSA Framework in order to make sharper judgements
with respect to debt sustainability and ensure that debt restructuring is timely and
sufficient in those cases where it is clearly warranted.
145
Sean Hagan, ‘Debt Restructuring and Economic Recovery’ in Lastra and Buchheit
(eds), above note 142, 359.
146
The Fund may be perceived by some to act as an honest broker, but as noted below, the
Fund is also a creditor. As such, from its own perspective: (1) the Fund does not act as a
broker; (2) the Fund does not arbiter between creditors and debtors as it does not
micromanage the restructuring process. It determines the financing envelope that anchors
the deliberation between the debtor and its creditors.
147
See Lee Buchheit, ‘The Search for Inter-creditor Parity’ (2002) 8 Law and Business
Review of the Americas 73, 78: ‘The IMF has more information than any other creditor,
greater access to government decision-makers and a broader peripheral vision of the
effects of measures on neighbouring countries. It also occupies a building that is infested
with economists who profess sublime diagnostic and prognostic powers.’
148
See Lee Buchheit, ‘A Quarter Century of Sovereign Debt Management: An
Overview’ (2004) 35 Georgetown Journal of International Law 637–8.
149
See CIBC Bank & Trust Co (Cayman) Ltd v Banco Central do Brasil, 886 F Supp 1105,
1115–16 (SDNY 1995). The Dart family had been accumulating Brazilian debt from creditor
banks in the secondary market at discounts of 60 per cent or more since 1991. The Darts
tendered the entirety of their claims in response to Brazil’s restructuring proposal, but
balked at Brazil’s unilateral changes to the terms of the restructuring after tenders from
creditors had been submitted. They were not the only ones that held out debt, though; the
Banco Central do Brasil and Banco do Brasil also kept holdings of unrestructured debt in a
coordinated response aimed at combating the Darts. The Darts sued (with the Canadian
Imperial Bank of Commerce (CIBC), acting as the holder of record of the debt) the Central
Bank of Brazil arguing that the defendants were subject to an implied covenant of good
faith and fair dealing. (The defendant banks intentionally retained their debt to ensure that
they were the majority holders, thus precluding the Dart family from accelerating the debt.)
US government officials filed an amicus curiae brief urging the court to dismiss the Darts’
suit because of the undermining effects that such litigation had on the sovereign debt
restructuring process. The case was eventually settled in March 1994, with the Darts
emerging as the victorious party.
150
Pravin Bankers Assocs Ltd v Banco Popular del Peru, 109 F3d 850, 853 (2d Cir 1997).
Pravin had bought a portion of Peruvian debt on the secondary market at a steeply
discounted price (27 cents on the dollar) from Mellon Bank. Banco Popular del Peru (a
State-owned bank) made interest payments to Pravin until February 1992. In December
1992, Banco Popular was liquidated. Pravin did not participate in the liquidation process
nor in the Brady debt restructuring. Pravin sued Banco Popular requesting full payment on
principal of its debt and brought its claim to the Southern District of New York. In October
1996, the Court ruled in favour of Pravin, thus confirming the ability of debt-holders to
enforce their demands individually upon default by the issuer.
151
See Elliott Associates, LP v Banco de la Nacion, 194 F3d 363 (2d Cir 1999). For a
doctrinal elaboration on the problems of the litigation by dissenting minorities, see G Mitu
Gulati and Kenneth N Klee, ‘Sovereign Piracy’ (2001) 56 Business Lawyer 635. See also
Samuel Goldman, ‘Mavericks in the Market: The Emerging Problem of Hold-Outs in
Sovereign Debt Restructurings’ (2000) 5 UCLA Journal of International Law and Foreign
Affairs 159.
152
See International Monetary Fund, ‘Sovereign Debt Restructuring: Recent
Developments and Implications for the Fund’s Legal and Policy Frameworks’ (26 April
2013), at <http://www.imf.org/external/np/pp/eng/2013/042613.pdf> (last visited 17
September 2014).
153
The International Monetary Fund has been considering potential remedies to deal with
problems of contractual framework in the context of sovereign debt distress. See
International Monetary Fund, ‘The Fund’s Lending Framework and Sovereign Debt—
Preliminary Considerations’, Policy Paper (22 May 2014, published in June 2014) 6 para 1,
at <http://www.imf.org/external/np/pp/eng/2014/052214.pdf> (last visited 17 September
2014). See also International Monetary Fund, ‘Strengthening the Contractual Framework to
Address Collective Action Problems in Sovereign Debt Restructuring’, Staff Report (2
September 2014, published in October 2014) at <http://www.imf.org/external/np/pp/eng/
2014/090214.pdf>.
154
See International Monetary Fund, ‘Greece: Ex post Evaluation of Exceptional Access
under the 2010 Stand-by Arrangement’ (20 May 2013, published in IMF Country Report No
13/156, June 2013), at <http://www.imf.org/external/pubs/ft/scr/2013/cr13156.pdf> (last
visited 17 September 2014). The report points out (at 28 point 57) that ‘the SBA-supported
programme served as a holding operation’, and that ‘[a]n upfront debt restructuring would
have been better for Greece. …The delay provided a window for private creditors to reduce
exposures and shift debt into official hands. This shift occurred on a significant scale and
left the official sector on the hook’ (at 33 point 68).
155
See IMF, ‘The Fund’s Lending Framework and Sovereign Debt’, above note 153.
156
This 2014 report follows up on the Executive Board guidance to staff in May 2013
following the publication of the earlier staff paper on sovereign debt restructuring in 2013.
See IMF, ‘Sovereign Debt Restructuring’, above note 153.
157
See IMF, ‘The Fund’s Lending Framework and Sovereign Debt’, above note 153.
158
For a detailed discussion of this issue, see IMF, ‘The Fund’s Lending Framework and
Sovereign Debt’, above note 153, paras 41 and 42 as well International Monetary Fund,
‘IMF Executive Board Discusses the Fund’s Lending Framework and Sovereign Debt’, Press
Release No 14/294 (20 June 2014), section ‘Executive Board Assessment’, third para, at <ht
tp://www.imf.org/external/np/sec/pr/2014/pr14294.htm> (last visited 17 September 2014).
159
The financing the country receives should not be used to pay private creditors in full
and in time; hence the need for ‘reprofiling’. For a commentary, see Brett House, ‘A Great
New Way for the IMF to Help Debt-laden Countries without Forcing them to Default’ (23
June 2014), at <http://qz.com/224564/a-great- new-way-for-the-imf-to-help-debt-laden-
countries-without-forcing-them-to-default> (last visited 18 September 2014): ‘Without a
debt restructuring in such cases, IMF financing would just throw good money after bad by
bailing out private creditors and absolving them of poor lending decisions—while at the
same time saddling a country’s taxpayers with more debt that can’t be written down.’
160
As acknowledged, the doctrine of sovereign immunity (precluding bringing suits
against the government without its consent) is founded in the ancient principle that ‘the
King can do no wrong’. See Hal Scott, ‘A Bankruptcy Procedure for Sovereign
Debtors?’ (2003) 37 International Lawyer 103.
161
See Goode, above note 9, 21:
When in 1981 the House of Lords decided to abandon the old rule and bring English
law into line with that of other jurisdictions by removing sovereign immunity in
relation to the trading activities of the state, it thereby received into English law a
restrictive doctrine of sovereign immunity which had by that time become adopted
by almost all influential trading nations.
162
See International Law Association, Report of the International Monetary Law
Committee, Berlin Conference (2004) 6, at <http://www.ila-hq.org/en/committees/index.cfm/
cid/9> (last visited 17 September 2014). Under US law, foreign State property enjoys
immunity from prejudgment attachment unless the State has expressly waived that
immunity, and from post-judgment attachment unless the sovereign has explicitly or
implicitly waived that immunity or the property seized is the very property upon which the
plaintiff’s claim is based.
163
See generally Lastra and Buchheit (eds), above note 142, which extensively deals with
all these issues. See also International Law Association, Report of the Sovereign Insolvency
Study Group, The Hague Conference on ‘State Insolvency: Options for the Way
Forward’ (August 2010), at <http://www.ila-hq.org/en/committees/study_groups.cfm/cid/
1026> (last visited 18 September 2014).
164
See Ann Krueger, ‘International Financial Architecture for 2002: A New Approach to
Sovereign Debt Restructuring’, Address at the National Economists’ Club Annual Members’
Dinner, American Enterprise Institute, Washington, DC (16 November 2001), at <http://
www.imf.org/external/np/speeches/2001/112601.htm> (last visited 18 September 2014).
See generally Sean Hagan, ‘Designing a Legal Framework to Restructure Sovereign
Debt’ (2005) 36 Georgetown Journal of International Law 299.
165
In some countries, municipal insolvency as well (eg, the USA).
166
See Enrique Cosìo-Pascal, ‘Paris Club’, in Barry Herman, Josè Antonio Ocampo, and
Shari Spiegel (eds), Overcoming Developing Country Debt Crises (Oxford: Oxford University
Press, 2010) 231, where it is underlined that debtor countries express genuine concern
about the effectiveness and lack of impartiality of the ‘Paris Club’, the heavy cost in terms
of the time consumed in individual negotiations with many creditors, and the fact that
creditors can also apply pressure in bilateral rescheduling.
167
In his comments on this chapter, Jeremy Pam noted that he and Lee [Buchheit]
‘distinguished the “contractual plus” approaches as potentially ranging from various kinds
of full-blown “treaty” approaches such as SDRM or a Chapter 9—based alternative [Chapter
9 of the US Bankruptcy Code] on the one hand, to a national “statutory” approach that
would rely only on national legal (legislative or executive) action by governments in key
jurisdictions. Consequently, we used the term “treaty/statutory approach” and thought of
SDRM as exemplifying the former rather than the latter.’
168
See Krueger, above note 164. See International Monetary Fund, ‘Proposals for a
Sovereign Debt Restructuring Mechanism (SDRM)—Factsheet’ (January 2003), at <http://
www.imf.org/external/np/exr/facts/sdrm.htm> (last visited 18 September 2014) (hereinafter
IMF, ‘SDRM—Factsheet’).
169
See Jeffrey Sachs, ‘Do We Need an International Lender of Last Resort?’, Frank D
Graham Lecture, Princeton University (1995), at <http://www.cid.harvard.edu/archive/hiid/
papers/intllr.pdf> (last visited 18 September 2014). Sachs argues that international
bankruptcy procedures modelled upon chs 9 and 11 of the US Bankruptcy Code would be
the best response to cope with crises of the Mexican type. Sachs’s proposals included the
reorganization of the IMF to act as a kind of international bankruptcy court rather than as a
lender of last resort to member governments. Sachs emphasized the need to prevent a ‘grab
race’ by creditors and the need to prevent a small number of dissident creditors from
blocking an agreement acceptable to the vast majority of creditors. See also Barry
Eichengreen and Richard Portes, Crisis? What Crisis? Orderly Workout for Sovereign
Debtors (London: Centre for Economic Policy Research, 1995), and Peter Kenen (ed), From
Halifax to Lyons: What has been done about crises management?, Essays in International
Finance No 200 (Princeton, NJ: Princeton University Press, 1996).
170
See eg Benjamin Cohen, ‘A Global Chapter 11’ (1989) 75 Foreign Policy 109.
171
Anne Krueger, ‘New Approaches to Sovereign Debt Restructuring: An Update on Our
Thinking’, Conference on Sovereign Debt Workouts: Hopes and Hazards, Institute for
International Economics, Washington, DC (1 April 2002), at <http://www.imf.org/external/
np/ speeches/2002/040102.htm> (last visited 18 September 2014). On 24 March 2003, the
IMF Executive Board continued its discussions on the possible features of a new Sovereign
Debt Restructuring Mechanism based on the staff paper ‘Proposed Features of a Sovereign
Debt Restructuring Mechanism’. See International Monetary Fund, ‘IMF Board discusses
possible features of a Sovereign Debt Restructuring Mechanism’, Public Information Notice
(PIN) No 03/45 (3 April 2003), at <http://www.imf.org/external/np/sec/pn/2003/
pn0345.htm> (last visited 18 September 2014).
172
On 9 September 2014, the UN General Assembly adopted a resolution (with 124 votes
in favour and 11— including US, UK, Germany, and Canada—against) considering a legal
framework for restructuring sovereign debt that would go beyond the market-based
solution. The resolution, ‘Towards the establishment of a multilateral legal framework for
sovereign debt restructuring processes’ (document A/68/L.57/Rev.1), is at <http://
www.un.org/press/en/2014/ga11542.doc.htm>. For a recent discussion on the statutory
solution see Rodrigo Olivares-Caminal, ‘Statutory Sovereign Debt Resolution Mechanisms’
in Lastra and Buchheit (eds), above note 142, 333.
173
As acknowledged, IMF Articles of Agreement, Art VIII, s 2(b) declares ‘unenforceable in
the territories of any member’ certain types of contracts that are inconsistent with Fund-
approved exchange control regulations.
174
In his comments on this chapter, Jeremy Pam noted: ‘An amendment to VIII 2(a) could
be one possible approach, but the even more modest approach that Lee [Buchheit] and I
proposed in Washington was for creditor remedies to be limited in the event of a super-
majority and IMF approved debt restructuring by national legal action in key jurisdictions,
with no requirement of a formal treaty or treaty amendment (just informal coordination).’
175
See Bank for International Settlements, ‘Group of Ten—The Resolution of Sovereign
Liquidity Crises’ (August 1997), at <http://www.bis.org/publ/gten03.htm> (last visited 18
September 2014). There was another G10 Report on CACs published in September 2002.
176
See Anna Gelpern and G Mitu Gulati, ‘The Wonder-Clause’ (2013) 41(2) Journal of
Comparative Economics 367; Stephen J Choi, Mitu Gulati, and Eric A Posner, ‘The Evolution
of Contractual Terms in Sovereign Bonds’ (2012) 4(1) Journal of Legal Analysis 141–2;
Philip R Wood, ‘Sovereign State Restructuring and Credit Default Swaps’ (2011) 26(11)
Journal of International Banking and Financial Law 661.
177
See Lee Buchheit and G Mitu Gulati, ‘Sovereign Bonds and the Collective Will’ (2002)
51 Emory Law Journal 1317, 1324. For an analysis of CACs in the European context (since
CACs are now mandatory for all new euro area government bonds issued since 2013, in
accordance with the ESM Treaty) see David Billington, ‘European Collective Action
Clauses’, Chapter 25 in Lee Buchheit and Rosa Lastra, Sovereign Debt Management
(Oxford: Oxford University Press,, 2014), pp. 399–416.
178
Lee Buchheit and Jeremiah Pam, ‘Uruguay’s Innovations’ (2004) 19 Journal of
International Banking Law and Regulation 28.
179
Buchheit and Pam, above note 178.
180
On the use of exit consents, see Lee Buchheit and G Mitu Gulati, ‘Exit Consents in
Sovereign Bond Exchanges’ (2000) 28 UCLA Law Review 59. Exit consents (exit
amendments) were used in Ecuador’s debt exchange in 2000. When holders tendered their
old bonds, they agreed to certain amendments of those bonds (ie, exit amendments), which
removed the cross-default, cross-acceleration, and negative pledge clauses. The idea was to
make the old bonds so unattractive that all of the creditors would tender them for the new
bonds. The difference between the use of exit consents in Ecuador and in Uruguay is that in
the latter case, the creditors could vote against the package of exit amendments (a
consensual approach).
181
International Association of Restructuring, Insolvency & Bankruptcy Professionals,
‘Statement of Principles for a Global Approach to Multi-Creditor Workouts’ (October 2000),
at <http://www.ifecom.cjf.gob.mx/PDF%5Carticulo%5C4.pdf> (last visited 18 September
2014).
182
See United Nations Conference on Trade and Development, ‘Draft Principles on
Promoting Responsible Sovereign Lending and Borrowing’ (26 April 2011), at <http://
unctad.org/en/docs/gdsddf2011misc1_en.pdf> (last visited 18 September 2014) and for a
study on the desirability and viability of these principles see, Juan Pablo Bohoslavsky and
Yuefen Li, ‘UNCTAD Principles on Responsible Sovereign Financing’ in Lastra and Buchheit
(eds), above note 142, 443.
183
Goode, above note 9, 22.
184
See Treaty Establishing the European Stability Mechanism (ESM) (2 February 2012),
OJ L 91/1 (6 April 2011) (hereinafter ESMT), at <http://www.european-council.europa.eu/
media/582311/05-tesm2.en12.pdf> (last visited 18 September 2014). From 1 January 2013,
all Eurozone Member States have been required to include the Model CAC in both
international and domestic government securities.
185
See Martin Brooke et al, ‘Sovereign Default and State-Contingent Debt’, Bank of
England Financial Stability Paper No 27 (November 2013), at <http://
www.bankofengland.co.uk/research/documents/fspapers/ fs_paper27.pdf>http://
www.bankofcanada.ca/2013/11/discussion-paper-2013-3/> (last visited 18 September 2014).
186
Basically, according to Brooke et al, above note 185, 3 and 16, these new instruments
are
…sovereign cocos…[that] would automatically extend the maturity of bonds when a

sovereign borrows from the official sector. This has the effect of: i) significantly
reducing the size of official sector support packages (better safeguarding taxpayer
resources and making voluntary debt restructurings easier to agree); ii) better
incentivising market discipline by reducing the risk of moral hazard; and, iii)
making private sector bail-in more predictable and credible. …GDP-linked bonds
provide a natural complement to sovereign cocos…By linking the return of a bond to
nominal GDP—and therefore indirectly to a government’s ability to pay—they
provide a form of recession insurance. They reduce the volatility of a sovereign’s
debt-to-GDP ratio, as well as increasing its fiscal space.
187
It is important to distinguish between debt crises that arise in low-income (and heavily
indebted) countries (countries that fall under the heavily indebted poor countries (HIPC)
initiative, with no access to international private capital markets) and those that arise in
middle income or in developed countries, with access to international private capital
markets.
188
This point is made by Lee Buchheit and Mark Walker, ‘Legal Issues in the Restructuring
of Commercial Bank Loans to Sovereign Borrowers’ in Michael Gruson and Ralph Eisner
(eds), Sovereign Lending: Managing Legal Risk (London: Euromoney Publications, 1984)
149.
189
See Victoria E Marmorstein, ‘Responding to the Call for Order in International Finance:
Co-operation between the International Monetary Fund and Commercial Banks’ (1978) 18
Virginia Journal of International Law 445, 453. Marmorstein (454) cites the example of
Peru, where a consortium of banks syndicated a loan to the government trying to impose an
economic stabilization programme ‘patterned after an IMF stand-by [sic] as a condition of
their commitment’. The banks failed and thus decided that ‘it would be more prudent to
leave the role of adjustor to the Fund’.
190
See Lee Buchheit, ‘The Role of the Official Sector in Sovereign Debt Workouts’ (2005) 6
Chicago Journal of International Law Symposium 333, 341.
191
See ESMT.
192
In Eurogroup Statement (28 November 2010), at <http://eurozone.europa.eu/media/
596738/statement_ by_the_eurogroup_28_nov.pdf> (last visited 18 September 2014), it was
clearly stated: ‘In all cases, in order to protect taxpayers’ money, and to send a clear signal
to private creditors that their claims are subordinated to those of the official sector, an ESM
loan will enjoy preferred creditor status, junior only to the IMF loan’. Unlike the IMF, the
EFSF has the same standing as any other sovereign claim on the country (pari passu): see
European Financial Stability Facility, ‘Frequently Asked Questions’, at <http://
www.efsf.europa.eu/attachments/faq_en.pdf> (last visited 18 September 2014).
193
IMF, ‘SDRM—Factsheet’, above note 168.
194
See International Monetary Fund, ‘Financial Risk in the Fund and the Level of
Precautionary Balances’ (3 February 2004) 6, at <http://www.imf.org/external/np/tre/risk/
2004/020304.pdf> (last visited 18 September 2014).
195
IMF, ‘Financial Risk in the Fund and the Level of Precautionary Balances’, above note
194.
196
For a general discussion, see Dirk Schoenmaker, ‘Burden Sharing: From Theory to
Practice’, Duisenberg School of Finance Policy Paper, No 6 (12 October 2010), at <http://
ssrn.com/abstract=1690856> (last visited 18 September 2014).
197
Buchheit, above note 147.
198
Buchheit, above note 147.
199
Official creditors such as the IMF and the World Bank, however, enjoy a de facto
‘preferred creditor’ status, as pointed out earlier.
200
The negative pledge clause is a restriction on the borrower’s ability to grant security
interests in its property to secure other lenders. The pari passu clause is a covenant on the
part of the borrower that the debt will always rank equally in priority of payment with the
borrower’s other unsubordinated indebtedness. The sharing clause is a requirement in
many syndicated loan agreements that any bank receiving a disproportionate payment
share that payment rateably with its fellow lenders. See Lee Buchheit, How to Negotiate
Eurocurrency Loan Agreements, 2nd edn (New York: Euromoney, 2000) 76, 82, and 86. On
the pari passu clause, see Rodrigo Olivares-Caminal, ‘Understanding the Pari Passu Clause
in Sovereign Debt Instruments: A Complex Quest’ (2009) 43(3) The International Lawyer
1217; Phillip R Wood, ‘Pari Passu Clauses—What Do they Mean?’ (2007) 18(10)
Butterworths Journal of International Banking and Financial Law 371; William W Bratton,
‘Pari Passu and a Distressed Sovereign’s Rational Choices’ (2004) 53 Emory Law Journal
833; Lee C Bucheit and Jeremiah S Pam, ‘The Pari Passu Clause in Sovereign Debt
Instruments’ (2004) 53 Emory Law Journal 917.
201
Buchheit and Mitu Gulati, above note 177, 1336.
202
Recent developments in the Eurozone may challenge the IMF’s cherished preferred
creditor status if Greece chose to restructure debt owed to the IMF and other official sector
lenders. See Christopher Spink and John Geddie, ‘IMF Set to be Dragged into Greek OSI’
International Financing Review (11 May 2013). ‘It is increasingly likely’—they claim—‘that
Greece will become the first sovereign ever to choose to restructure debt owed to the IMF—
putting in question for the first time the IMF’s status as an unchallengeable preferred
creditor when it comes to sovereign debt. …A restructuring…is all but inevitable as part of
the so-called Official Sector Involvement (OSI) that would also see Greece restructure debt
owed to fellow eurozone member and the ESFS. …The Fund has thus far remained resolute
that its loans to Greece’s bailout cannot be revised. …A return to genuine market access
will require these countries to make themselves presentable to the market’, said Buchheit.
‘With huge debt stocks, now owed mainly to official sector lenders, hanging over their
heads, it may be difficult to make that case. The options for the debtor countries? Reduce or
stretch the official sector debts—or remain wards of the official sector for an indefinite
period’. It is against this background that Greece’s financial minister Yannis Stournaras told
Greek television’…that the country plans to return to the capital markets by the end of next
year.’
203
See generally Lee Buchheit and Rosa M Lastra, ‘Lending into Arrears—A Policy
Adrift’ (2007) 41(3) International Lawyer 939.
204
International Monetary Fund, ‘Fund Policy on Lending into Arrears to Private Creditors
—Further Consideration of the Good Faith Criterion’ (30 July 2002) 3, at <http://
www.imf.org/external/pubs/ft/privcred/073002.pdf> (last visited 18 September 2014).
205
IMF, ‘Fund Policy on Lending into Arrears to Private Creditors’, above note 204, 3.
206
IMF, ‘Fund Policy on Lending into Arrears to Private Creditors’, above note 204, 4–5.
207
IMF, ‘Fund Policy on Lending into Arrears to Private Creditors’, above note 204, 5. See
International Monetary Fund, Minutes of the Executive Board Meeting 89/61, EBM/89/61
(24 May 1989).
208
IMF, ‘Fund Policy on Lending into Arrears to Private Creditors’, above note 204, 5–6.
See International Monetary Fund, ‘Fund Policy on Sovereign Arrears to Private Creditors’,
SM/98/8 (9 January 1998).
209
210
211
IMF, ‘Fund Policy on Lending into Arrears to Private Creditors’, above note 204, 6. See
International Monetary Fund, ‘Fund Policy on Arrears to Private Creditors—Further
Considerations’, EBS/99/67 (30 April 1999).
212
213
214
215
216
These are outlined in IMF, ‘Fund Policy on Lending into Arrears to Private Creditors’,
217
See François Gianviti, ‘The Reform of the International Monetary Fund’ in Lastra (ed),
The Reform of the International Financial Architecture, above note 1, 101–2.
218
See International Monetary Fund, ‘IMF Board Discusses the Good-Faith Criterion under
the Fund Policy on Lending into Arrears to Private Creditors’, Public Information Notice
(PIN) No 02/107 (24 September 2002), at <http://www.imf.org/external/np/sec/pn/2002/
pn02107.htm> (last visited 18 September 2014).
219
See IMF, ‘Fund Policy on Lending into Arrears to Private Creditors’, above note 204.
220
IMF, ‘Fund Policy on Lending into Arrears to Private Creditors’, above note 204.
221
IMF, ‘Sovereign Debt Restructuring’, above note 152, paras 50–2.
222
The recent involvement of creditor committees in sovereign debt restructurings (eg,
Belize, Grenada, Greece, and St Kitts) brought back the debate around the pros and cons of
the use of this type of committee in the restructuring process. Lee Buchheit in an article on
the topic listed a number of potential benefits and drawbacks and concluded by stating that,
‘…if a creditors’ committee is to be formed and recognized by the sovereign, the ground
rules for the operation of that committee should be carefully thought through and agreed in
advance to ensure that the work of the committee can proceed efficiently’. See Lee C
Buchheit, ‘The Use of Creditor Committees in Sovereign Debt Workouts’ (2009) 10 Business
Law International 205. A proposal to amend the LIA Policy of the Fund to include specific
bondholder committee guidelines in the restructuring process was suggested by Timothy B
DeSieno in a panel discussion, ‘What Role for Improvements to Contractual
Arrangements?’, at a Conference on Sovereign Debt Restructuring: The Road Ahead,
sponsored by the United Nations and the Bank of England, London (April 2014).
223
The workings of the SRF are reminiscent of the workings of the domestic lender of last
resort role of the central bank at the domestic level, in terms of access beyond the normal
access limits, relatively high rate of charge (surcharge) and disbursements. Indeed, the
‘special’ policy—according to Article V, s 3(a)—in the case of the SRF entails the application
of terms of conditionality more severe than the regular terms applied to general stand-by
arrangements. See also Adam Lerrik, ‘International Lender of Last Resort. A Floor of
Support for Troubled Sovereign Debt’ in Lastra and Buchheit (eds), above note 142, 219.
224
International Monetary Fund, ‘The IMF’s Flexible Credit Line (FCL)—Factsheet’ (4
April 2014), at <http://www.imf.org/external/np/exr/facts/fcl.htm> (last visited 18
September 2014).
225
If a two-year arrangement is approved, a review of qualification criteria would be
required after the first year.
226
International Monetary Fund, ‘The IMF’s Precautionary and Liquidity Line (PLL)—
Factsheet’ (5 September 2014), at <http://www.imf.org/external/np/exr/facts/pll.htm> (last
visited 18 September 2014). Duration of PLL arrangements can be either six months or one
to two years. Access under the six-month PLL is limited to 250 per cent of quota in normal
times, but this limit can be raised to 500 per cent of quota in exceptional circumstances due
to exogenous shocks, including heightened regional or global stress. One- to two-year PLL
arrangements are subject to an annual access limit of 500 per cent of quota and a
cumulative limit of 1,000 per cent of quota. The repayment term of the PLL is the same as
for the SBA.
227
See Chapter 4 in this volume for a review of the theoretical foundations of the lender of
last resort doctrine, in particular the contributions by Henry Thornton and Walter Bagehot.
(‘Lend freely at a higher interest rate and with good collateral.’)
228
According to Capie and Wood, ‘[u]nless the IMF…can issue any currency it wishes on
demand and without limit, there can be no ILOLR.’ See Forrest Capie and Geoffrey Wood,
‘The IMF in a Changing World’, Paper prepared for Essays in Honour of Sir Joseph Gold,
mimeo (7 November 2001).
229
See Charles A E Goodhart, ‘Myths about the Lender of Last Resort’ (1999) 2(3)
International Finance 339, 348–52.
230
See Charles A E Goodhart and Haizhou Huang, ‘A Model of the Lender of Last Resort’,
IMF Working Paper No 99/39 (March 1999). Goodhart and Huang’s model suggests that
contagion (and not moral hazard) is the main concern in providing LOLR.
231
BCBS, ‘Core Principles for Effective Banking Supervision’, above note 44, adopted in
September 1997, are a step in this direction.
232
I further discuss the role of the IMF as international lender of last resort in Rosa M
Lastra, ‘Lender of Last Resort, an International Perspective’ (1999) 48(2) International and
Comparative Law Quarterly 339.
233
However, Kenen, above note 143, 30, claims that the banks agreed to roll over their
claims on Korean banks because they were told to volunteer by their own countries’
governments. He also points out that the Korean government guaranteed the claims of the
Korean banks. Kenen cites other authors (above note 143, 34 n 14) who suggest that the
IMF might have ‘sought to engineer an earlier rollover of interbank claims not only in the
Korean case, but also in the Thai case’.
234
In July 1998 the General Arrangements to Borrow (GAB) were activated for an amount
of SDR 6.3 billion in connection with the financing of an Extended Arrangement for Russia.
Of that amount, SDR 1.4 billion was used. The New Arrangements to Borrow (NAB), which
came into effect in November 1998, were first activated in the extended arrangement
offered to Brazil in December 1998, when the IMF called on funding of SDR 9.1 billion, of
which SDR 2.9 billion was used. The activations for both Russia and Brazil were cancelled
in March 1999, when the Fund repaid the outstanding amounts following payments of quota
increases under the Eleventh General Review of Quotas.
235
236
See ESMT at <http://europa.eu/rapid/press-release_DOC-12-3_en.htm> and above
Chapter 8.
237
See Brummer, above note 8, 72–3: ‘[T]he FSB…in many ways operates as technocratic
extension of the more political G-20. …Key organizational features were transformed in the
creation of the FSB…; a full time secretary general was tasked with providing
administrative support with the help of the BIS…’. Plus ça change?
238
For a recent analysis of the institutional design of the FSB, IMF, World Bank, and WTO,
see Wouters and Odermatt, above note 51, and for a description of the evolution of the ‘G’
groups, see Lawrence G Baxter, ‘Internationalization of Law—The “Complex” Case of Bank
Regulation’ in Mary E Hiscock and William Van Caenegem (eds), The Internationalisation of
Law: Legislating, Decision-Making, Practice, and Education (Cheltenham: Edward Elgar,
2010). See also Brummer, above note 8, ch 2.
239
See Peter Cooke, ‘The Future of Global Financial Regulation and Supervision’ in Lastra
(ed), above note 1, xxiv.
240
Luis Garicano and Rosa M Lastra, ‘Towards a New Architecture for Financial Stability:
Seven Principles’ (2010) 13(3) Journal of International Economic Law 597. Lord Eatwell and
Lance Taylor have proposed the creation of a World Financial Authority in their book Global
Finance at Risk: The Case for International Regulation (New York: New Press, 2008). See
also Kern Alexander, Rahul Dhumale, and John Eatwell (eds), Global Governance of
Financial Systems. The International Regulation of Systemic Risk (Oxford: Oxford
University Press, 2005) and Christoph Ohler, ‘International Regulation and Supervision of
Financial Markets After the Crisis’ (2010) European Yearbook of International Law 3.
241
For studies on the subject, see eg Apostolos Gkoutzinis, ‘International Trade in Banking
Services and the Role of the WTO: Discussing the Legal Framework and Policy Objectives of
the General Agreement on Trade in Services (GATS) and the Current State of Play in the
Doha Round of Trade Negotiations’ (2005) 39 (4) International Lawyer 877; Panagiotis
Delimatsis and Pierre Sauvé, ‘Financial Services Trade After the Crisis: Policy and Legal
Conjectures’ (2010) 13(3) Journal of International Economic Law 837.
242
For a brief analysis of this issue, see Rosa M Lastra, ‘Cross-Border Trade in Financial
Services’ in Ian Fletcher, Loukas Mistelis, and Marise Cremona (eds), Foundations and
Perspectives of International Trade Law (London: Sweet & Maxwell, 2001) 428, and Rosa M
Lastra, ‘The Role of the IMF as a Global Financial Authority’ (2011) 2 European Yearbook of
243
See generally Bank for International Settlements website, at <http://www.bis.org> (last
visited 18 September 2014). See also Gianni Toniolo, Central Banking Co-operation at the
Bank for International Settlements, 1930–1973 (Cambridge: Cambridge University Press,
2005). Toniolo’s book—which constitutes an in-depth study of central bank cooperation
during the period covered—explores the foundation of the BIS, its role in the financial crisis
of 1931, the London financial conference of 1933, the much-criticized activity of the BIS
during the Second World War, the Bretton Woods system, the creation of the European
payments union in the 1950s, and the support of the Bretton Woods system in the 1960s.
The last chapter is devoted to the first steps towards monetary union in Europe and
financial stability. Toniolo surveys the legal basis of the BIS in ch 2 (48–52), and Brummer
states that, ‘The BIS is a unique organization. It is both a formal international organization
and a private market participant whose shares are publicly traded’. See Brummer, above
note 8, 89–90.
244
The BIS is owned by sixty central banks and monetary authorities and its Board of
Directors may have up to twenty-one members, including six ex officio directors, comprising
the Governors of the central banks of Belgium, France, Germany, Italy and the United
Kingdom and the Chairman of the Board of Governors of the US Federal Reserve System.
Each ex officio member may appoint another member of the same nationality. The Statutes
also provide for the election to the Board of not more than nine Governors of other
members’ central banks. On 8 January 2001, an Extraordinary General Meeting of the BIS
decided to restrict the right to hold shares in the BIS exclusively to central banks and
approved the mandatory repurchase of all 72,648 BIS shares held by private shareholders
as of that date against payment of compensation of CHF 16,000 per share. The former
private shareholders were informed by means of the Notes to Private Shareholders dated
15 September 2000 and 10 January 2001, which described the transaction in more detail; a
further Note was sent on 27/28 November 2002 following the Tribunal’s 22 November 2002
decision. Pursuant to Art 54 of the BIS Statutes, disputes concerning the interpretation or
application of the Statutes, in particular between the Bank and its shareholders, must be
referred for final decision to the Hague Arbitral Tribunal. In 2001, three former private
shareholders challenged the shares withdrawal by initiating proceedings before the
Tribunal. The Tribunal proceedings consisted of two phases of written submissions and oral
hearings in The Hague. The first phase involved hearings on 26–28 August 2002, and
resulted in the 22 November 2002 judgment by the Tribunal on the lawfulness of the shares
withdrawal and the valuation standard for the shares. A second phase to determine the
exact amount of additional compensation involved hearings on 28–29 May 2003 and
resulted in the Tribunal’s final award published on 22 September 2003. Decisions of the
Tribunal are final and not subject to appeal. See Bank for International Settlements,
‘Withdrawal of All Shares of the Bank for International Settlements Held by Private
Shareholders’, at <http://www.bis.org/about/shareswd.htm> (last visited 18 September
2014).
245
The Convention respecting the Bank for International Settlements (of 20 January 1930),
the Constituent Charter of the Bank for International Settlements (of 20 January 1930), and
the Statutes of the Bank for International Settlements (of 20 January 1930, as amended in
1937, 1950, 1961, 1969, 1974, 1975, 1993, 1994, 1999, 2001, and 2005) are available at
Bank for International Settlement, ‘Legal Information’, at <http://www.bis.org/about/
legal.htm> (last visited 18 September 2014). (Switzerland issued the Charter and the
annexed Statutes.)
246
Schoenmaker has suggested that the BIS could be in charge of supervision and lender
of last resort for global systemically important banks (G-SIBS): ‘A supervisory role for the
BIS would be consistent with a wider trend of central bank involvement in banking
supervision. …The BIS, as central bankers’ bank, is also the natural candidate for the
international lender of last resort role of the G-SIBs.’ In this reformed global governance
structure, the FSB keeps its central role in the design and implementation of international
finance standards and the IMF assumes the role of resolution agency for these G-SIBs. See
Schoenmaker, above note 77, 130–52.
247
Bank for International Settlements, ‘The Financial Stability Institute (FSI)’, at <http://
www.bis.org/fsi/aboutfsi.htm> (last visited 18 September 2014).
248
In this section, I draw substantially on Lastra, above note 132.
249
Financial globalization was fostered by financial innovation, the technological
revolution, the integration and liberalization of markets, the mobility of people and capital
and other factors. A fragmented global regulatory and accounting regime gives rise to
regulatory arbitrage (‘forum shopping’), loopholes, and shadow institutions and markets; it
also increases transaction costs and can lead to financial protectionism. Incompatible or
conflicting rules from country to country increase the regulatory costs and can create new
risks.
250
Andrew Haldane of the Bank of England has looked at the lessons that ecology,
epidemiology and genetics provide in order to understand financial networks and complex
financial systems. See eg Andrew G Haldane, ‘Rethinking The Financial Network’, Speech
at the Financial Student Association, Amsterdam (28 April 2009), at <http://
www.bankofengland.co.uk/archive/Documents/historicpubs/speeches/2009/speech386.pdf>
251
See generally Rosa Lastra, ‘Systemic Risk, SIFIs and Financial Stability’ (2011) 6(2)
Capital Markets Law Journal 197. See also Inaugural Lecture of 23 March 2011 at <http://
www.law.qmul.ac.uk/podcast/lastra2011.html>.
252
See Financial Stability Board, ‘Key Attributes of Effective Resolution Regimes for
Financial Institutions’ (October 2011), at <http://www.financialstabilityboard.org/
publications/r_111104cc.pdf> (last visited 18 September 2014) and Directive 2014/59/EU of
the European Parliament and of the Council of 15 May 2014 establishing a framework for
the recovery and resolution of credit institutions and investment firms and amending
Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC,
2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU)
No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council, OJ L
173 (12 June 2014) 190, at <http://eur-lex.europa.eu/legal-content/EN/TXT/?
uri=uriserv:OJ.L_.2014.173.01.0190.01.ENG> (last visited 18 September 2014) (hereinafter
Bank Recovery and Resolution Directive, BRRD). See also International Monetary Fund,
‘Cross-border Bank Resolution: Recent Developments’, IMF Board Paper (2 June 2014), at
<http://www.imf.org/external/np/pp/eng/2014/060214.pdf> (last visited 18 September
2014) and International Monetary Fund, ‘The Key Attributes of Effective Resolution
Regimes for Financial Institutions—Progress to Date and Next Steps’, IMF Policy Paper (27
August 2012), at <http://www.imf.org/external/np/pp/eng/2012/082712.pdf> (last visited 18
September 2014).
253
See Cooke above note 239.
254
The ‘School of Salamanca’ (Salamanca being my home town in Spain) is the name
applied to a group of Spanish jurists, theologians and philosophers who created a body of
doctrine on natural, international and economic law, rooted in the intellectual work of
Francisco de Vitoria, who started teaching in Salamanca in 1526 on the catedra de prima,
the most important chair of theology at the University. The role of the School of Salamanca
in the development of early monetary theory has been documented in the work of Marjorie
Grice-Hutchinson. While at the LSE, Marjorie came under the influence of Friedrich von
Hayek, who urged her to study the manuscripts of this group of Spanish scholars from the
sixteenth and early seventeenth centuries. See Marjorie Grice-Hutchinson, School of
Salamanca. Readings in Spanish Monetary Theory, 1544–1605 (Oxford: Clarendon Press,
1952).
255
Chris Brummer, Mini-Lateralism. How Trade Alliances, Soft Law and Financial
Engineering are Redefining Economic Statecraft (Cambridge: Cambridge University Press,
2014).
256
As explained in the special issue of the Journal of International Economic Law of 2010
(co-edited with John Jackson and Thomas Cottier) on ‘The Quest for International Law in
Financial Regulation and Monetary Affairs’ (2010) 13(3), also available as Cottier et al
(eds), above note 1.
257
See generally Lastra, Legal Foundations of International Monetary Stability (Oxford:
Oxford University Press, 2006), ch 12. For a recent study, see Benn Steil, The Battle of
Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World
Order (Princeton, NJ: Princeton University Press, 2013).
258
See Dani Rodrik, The Globalization Paradox. Democracy and the Future of the World
Economy (New York/London: WW Norton & Company, 2011) 200–1. See Rosa M Lastra,
‘Book Review of Dani Rodrik’s The Globalization Paradox: Democracy and the Future of the
World Economy’ (2013) 11(3) International Journal of Constitutional Law 809. A different
view is held by Dani Rodrik, who argues that we cannot have ‘deep economic
integration’ (he uses the terms ‘hyper-globalization’), national sovereignty (nation State)
and democratic politics all at once. We can have at most two out of three. Since democracy
cannot be compromised, and he rejects the ‘global governance’ option, he proposes a return
to national sovereignty. He considers that ‘global standards and regulations are not just
impractical; they are undesirable. The democratic legitimacy constraint ensures that global
governance will result in the lowest common denominator, a regime of weak and ineffectual
rules’. Interestingly Rodrik contends (in ch 11) that markets need other institutions to
support them, notably courts of justice, legal arrangements to enforce property rights, and
regulations to rein in abuse and fix market failures, since ‘markets do not create, regulate,
stabilize or sustain themselves’ and he points out that ‘what is true of domestic markets is
true also of global ones’. The logical extension of his argument (which would contradict a
basic tenet of the book, Rodrik’s choice to solve the ‘trilemma’) is that if national markets
need adequate national rules, international markets need adequate international rules. This
would mean that national sovereignty, rather than global governance, should be sacrificed
in order to solve the ‘trilemma’. And, in my opinion, this is the best solution to the trilemma.
259
An analogy with football (soccer) can be instructive in this regard. There are domestic
leagues, ruled by national football associations, there is in Europe a Champions League
governed by UEFA, and finally—though this is a competition among countries not clubs—
there is FIFA and the World Cup. Some institutions play locally, while others compete in the
European or global stage. Banking union in the EU—discussed in Chapter 10—is a
recognition of this need at a regional level
260
See Thomas Cottier, ‘Multilayered Governance, Pluralism, and Moral Conflict’ (2009)
16(2) Indiana Journal of Global Legal Studies 647.
261
Following John Jackson’s notion of ‘sovereignty-modern’, we should ‘disaggregate and…
break down the complex array of “sovereignty” concepts and examine particular aspects in
detail and with precision to understand what is actually at play. A major part of this
approach is to understand the pragmatic functionalism of the allocation of power as
between different levels of governance entities in the world. To the extent feasible, this
should be done in a manner not biased either in favor of or against international
approaches.’ See John Jackson, ‘Sovereignty—Modern: A New Approach to an Outdated
Concept’ (2003) 97 American Journal of International Law 782, 801.
262
The phrase ‘currency war’ was coined by Brazilian Minister of Finance Guido Mantega
in 2010. The issue, however, is not new. Competitive currency devaluations have pernicious
effects upon the economic relations between States, in particular upon their trading
relations. Through the abandonment of the par value regime (original IMF Articles of
Agreement, Art IV), the IMF lost the jurisdictional power over exchange rates: Since the
entry into force of the Second Amendment, the Fund has no substantive legal rights with
respect to the choice of exchange rate arrangements of its members. But exchange rates
were and are a key focus of Art IV consultations, and Art IV prohibits currency
manipulation. General Agreement on Tariffs and Trade General Agreement on Tariffs and
Trade (adopted 15 April 1994, entered into force 1 January 1995) 1867 UNTS 187, Art XV
provides the legal link between the IMF and WTO (and it was not amended following the
collapse of the par value regime). Article XV establishes that ‘the contracting parties shall
not, by exchange actions, frustrate the intent of the provisions of this agreement, nor by
trade action, the intent of the provisions of the Articles of Agreement of the IMF’. See
generally Vera Thorstensen, Daniel Ramos, and Carolina Muller, ‘The “Missing Link”
Between the WTO and the IMF’ (2013) 16(2) Journal of International Economic Law 353.
Gregory Shaffer and Michael Waibel, ‘The (Mis)Alignment of the Trade and Monetary Legal
Orders’ in Terence C Halliday and Gregory Shaffer (eds), Transnational Legal Orders
(Cambridge: Cambridge University Press, forthcoming 2014), claim that ‘[w]hile trade in
goods, and to a lesser extent trade in services, are highly regulated by legal rules backed by
an enforcement mechanism, currency valuation is now determined by the discretionary
activities of central banks and treasury departments run largely by economists with little to
no guidance from law’.
263
Effective enforcement though remains the greatest challenge at the international level,
since enforcement mechanisms have traditionally been nationally based, a logical extension
of the principle of sovereignty. But we need to seek new ways of enforcement. In the
current process of globalization, the State is finding it increasingly difficult to enforce its
laws against global actors such as multinational corporations and criminal organizations;
tax laws are a case in point. Resolving conflicts is also diverging from the State’s judicial
machinery to private bodies through the increasing popularity of arbitration as an
alternative dispute resolution mechanism. Even in the area of policing, the State is enlisting
the private sector in the fight against crime. Money laundering control systems and the
reporting duties they impose on financial institutions are examples of this shift towards
private policing.
264
As described earlier in this chapter, the ‘regulatory function’ at the international level
is currently shared by a variety of actors, including formal international organizations (such
as the IMF), informal groupings of an international character such as the FSB, the BCBS,
the IOSCO and the IAIS, professional associations—such as the ISDA—and other entities.
International financial soft-law is often a ‘top-down’ phenomenon with a two-layer
implementation scheme. The rules (eg the Basel capital rules) are agreed by international
financial standard setters and national authorities must implement them in their regulation
of the financial industry. The financial intermediaries are the ‘final’ addresses of those
rules. Standards and uniform rules, however, can also be designed by the financial industry
itself. Self-regulation, by definition, has a ‘bottom up’ character, comprising rules of
practice, standards, master agreements, usages as well as rules and principles agreed or
proposed by scholars and experts.
See Julia Black and David Rouch, ‘The Development of the Global Markets as Rule-makers:
Engagement and Legitimacy’ (2008) 2(3) Law and Financial Markets Review 223.
265
For more detail about the IMF, see Chapter 13 in this volume. See also Rosa Lastra,
‘The Role of the IMF as a Global Financial Authority’ in Christoph Herrman and Jörg Philipp
Terhechte (eds), European Yearbook of International Economic Law (EYIEL), Vol 2 (Berlin,
Heidelberg: Springer, 2011) 121–36.
266
See James Fries, ‘Global Markets and Global Vulnerabilities: Fighting Transnational
Crime Through Financial Intelligence’, Prepared remarks for the MOCOMILA meeting in
Salamanca (25 April 2008), at <http://www.mocomila.org/meetings/2008-freis.pdf> (last
267
In the words of George Soros: quoted in Andrew Ross Sorkin, ‘Still Needed: A Sheriff of
Finance’ New York Times (25 January 2010), at <http://www.nytimes.com/2010/01/26/
business/26sorkin.html?_r=0> (last visited 18 September 2014). Lord Eatwell and Lance
Taylor proposed the creation of a World Financial Authority in Eatwell and Taylor, above
note 240. See also Alexander et al (eds), above note 240 and Ohler, above note 240.
Avgouleas proposed a new model of governance for global financial markets based in four
pillars, a global macro-prudential supervisor (assigned by treaty to the IMF); a global micro-
prudential supervisor (assigned to the FSB); a global financial policy, regulation, and
knowledge supervisor and a global resolution authority. See Avgouleas, ‘Rationales and
note 1, 380–9.
268
In terms of the official interpretation of the IMF Articles of Agreement, the Board of
Governors at its first meeting in 1946 made a broad delegation of powers to the Executive
Board, in accordance with the possibility foreseen in Art XII, s 2(b), as stated in Chapter 13,
paragraph 13.17. According to the current text of s 15 of the IMF’s By-Laws: ‘The Executive
Board is authorised by the Board of Governors to exercise all the powers of the Board of
Governors, except for those conferred directly by the Articles of Agreement on the Board of
Governors.’ The Executive Board does indeed have the power of interpretation, though this
power has to be exercised consistent with general principles of interpretation, including
those set forth in the Vienna Convention on the Law of Treaties. See in particular VCLT,
Arts 31 and 32 (s 3, ‘Interpretation of Treaties’).
269
This is the view espoused among others by William Peter Cooke, former Chairman of
the Basel Committee. See Cooke, above note 239, xxiv:
My own view, not least because of an involvement with the organisation for over 40
years, is to believe that the BIS is likely to play a critical role in this whole area of
work. There are a number of reasons for this. First and foremost, it is there. It also
has a measure of independence (despite being subject to the ultimate authority of
its central bank shareholders). It has, for many years, been a forum where the
macro-economic, macro-prudential issues have been discussed. …The BIS has
widened its membership over the past few years to embrace a much more
representative group of countries around the world than its original shareholders. It
has also become a little more comfortable in allowing Ministries of Finance to
participate in bodies spawned by what has traditionally been a Central Bankers
club. It already houses the secretariats of the major international bodies working on
banking and insurance regulation. If the securities regulators could be persuaded to
establish themselves in Basel [they were not!]…, then the ongoing capacity in and
around the BIS to pursue a continuing regulatory and supervisory debate
internationally would be unparalleled.
270
Conditionality—of course—is only relevant for countries that ‘borrow’ from the Fund.
Therefore, using conditionality as an incentive for countries to comply with standards would
be limited to borrowing countries, while other ‘incentives’ are also needed for the ‘non-
borrowing’ IMF members.
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Index

Rosa Lastra

ISBN: 9780199671090
Index
(p. 607) accountability
accountee 2.173–2.175
assessment criteria 2.174, 2.178
Bank of England, of 2.181–2.182, 2.192, 3.104–3.105
banking union, and 11.76–11.78
central banks 1.68, 2.11, 2.97, 2.147, 2.163–2.172, 2.180, 2.188–2.194, 7.86–7.91
definitions 2.173–2.174, 2.176–2.177, 2.191
ex ante vs. ex post 2.175
explanatory vs. amendatory 2.174
IMF, of 13.242
independence, conflicts between 2.179
judiciary, of 2.174, 2.191–2.192
transparency, and 2.183, 2.185–2.186, 2.193
views of 2.176–2.177
Acheson, Keith 2.76
administrative law
challenges 3.41
independence of 2.121
Amtenbrink, Fabian 2.164, 2.178, 7.87
Bagehot, Walter 4.09–4.10
bail ins 4.82–4.85
bail outs 4.75–4.81, 14.163, 14.174–14.182
Bank for International Settlements
central bank immunity 2.209
disbandment proposals 12.23
establishment 12.01, 12.11, 14.189
financial crisis, actions during 14.192–14.193
financial stability, definitions 3.70
organizational structure 14.189
role 12.23, 14.188, 14.190–14.193, 14.214
bank insolvency
cross-border
Basel Committee on Banking Supervision work on 4.93, 4.103
BRRD 4.90–4.91, 4.112, 10.47–10.48
challenges 4.86–4.88, 4.101–4.102
consolidated supervision 4.94
ex ante binding commitments vs. ex post ad hoc solutions 4.109–4.110
harmonization, need for 4.88–4.91
institutional interconnectedness 4.158–4.164
international regime, lack of 4.88–4.89
Latin America, treaties in 4.100
parental responsibility principle 4.93
regulatory progress, post-2007 crisis 4.103–4.112
regulatory progress, pre-2007 crisis 4.93–4.102
single entity approach 4.95
UNCITRAL Model Law on 4.96–4.97
World Bank ICR Standard 4.98–4.99
definitions 4.64–4.66, 4.71
domino effect 4.113–4.115
laws, objectives of 4.68–4.73
lex specialis vs. lex generalis 4.59–4.67, 4.69
regime reforms 4.64
resolution/rescue packages
bail ins 4.82–4.85
bail outs 4.75–4.81
CoCo bonds 4.85
convoy rescues 4.173
doomed loops 4.76, 10.12–10.13
FSB Key Attributes 4.82–4.85, 4.104–4.109
lifeboat operations 4.173
rationale behind 4.74
resolution toolkits 4.81–4.85
State aid 4.77–4.78
structured early intervention and resolution (SEIR) 4.70
top-down strategies 4.111–4.112
UK procedures 4.63
US procedures 4.61–4.62, 4.80, 4.95
social costs 4.72–4.73
trigger points 4.71
vs. illiquidity, identification challenges 4.21–4.22, 4.71
Bank of England
accountability 2.181–2.182, 2.192, 3.104–3.105
BCCI damages actions 2.192, 3.105
establishment 2.07
financial stability, and 2.182, 3.78, 3.90
functions 2.49, 2.55, 2.73, 3.03
independence 2.181
Monetary Policy Committee 2.178, 2.181
monetary policy forward guidance 2.43–2.44
nationalization 2.105
Prudential Regulatory Authority 3.40
Special Liquidity Scheme (SLS) 4.30
Bank Recovery and Resolution Directive (BRRD) 4.90, 10.47–10.48
banking
convertibility 2.19–2.20
crisis management 3.39, 3.43
forbearance 3.31
free banking 2.18–2.24, 2.19–2.24, 2.29, 2.113, 2.122, 4.143
banking law
licensing 3.23–3.25, 3.47
purpose 3.12, 3.21
banking regulation
definition 2.64, 3.07–3.08
large credit exposures 3.33
loan classification 3.31–3.33
purpose 3.10–3.13, 3.22
banking supervision see also financial supervision; supervisory authorities
accountability and transparency 2.193
central bank role 2.56–2.57, 3.02–3.03
development 2.57
(p. 608)
financial crisis influences on 2.58
macro- vs. micro-prudential supervision 2.57–2.61, 2.63, 3.14–3.16
financial stability, and 3.60–3.71
need for 3.26
optimum responsibilities debate 3.02
regulation, links between 3.21
supervisory process 3.18–3.22, 3.27
licensing, authorization, and chartering 3.23–3.25, 3.47
regulation 3.28
sanctioning/imposing penalties
stricto sensu 3.20, 3.26–3.34, 3.48
banking union
accountability and legitimacy 11.76–11.78
basis for 10.02
challenges 10.11–10.13, 10.16, 10.33, 11.59–11.67
common supervisory rulebook concept 10.03
definition and interpretation 10.16–10.17
EBA coordination with ECB 11.59–11.73
EBA role in 11.70–11.73
enabling provisions 10.09
European Stability Mechanism, and 10.14–10.15
importance of 10.01, 10.91–10.92
institutional design flaws 10.10
lender of last resort 10.05, 10.69–10.90
monetary sovereignty, and 10.01
rationale 10.06–10.09, 10.18–10.19, 11.75
Single Deposit Guarantee Scheme (SDGS) 10.65–10.68
single market for financial services, and 10.03, 10.33, 11.01, 11.60–11.65, 11.68–
11.69
Single Resolution Fund (SRF) 10.38–10.39, 10.55–10.58
Single Resolution Mechanism (SRM) 10.02, 10.36–10.38, 10.41–10.64
Single Supervisory Mechanism (SSM) 1.61, 3.16, 10.02, 10.04, 10.09, 10.18–10.35, 11.44–
11.45, 11.60–11.65, 11.68–11.69
banks see also central banks
domestic systemically important banks (D-SIBs) 4.164
global systemically important banks (G-SIBs) 4.163
ring-fencing 3.120, 3.124
separation of monetary and supervisory functions 3.51–3.57
Baring, Francis 2.16
Barings, Francis 4.08
Barosso, José 11.25–11.26
Barth, James R. 3.94
Basel Committee on Banking Supervision
Basel III 3.32, 3.96, 4.23, 14.77
capital adequacy policies 14.28
cooperation challenges 14.59
Core Principles for Effective Banking Supervision 3.101, 4.38, 14.29, 14.39–14.40, 14.59
criticism of 14.60
Cross-Border Bank Resolution Group 4.93, 4.103
deposit insurance 4.38
G-SIBs and D-SIBs rules 4.163–4.164
informal character 14.26
liquidity standards 3.32, 4.23
membership 14.24, 14.61
monitoring programmes 14.77
policy cooperation and coordination function 2.11, 14.27
policy focus trends 14.28–14.29
powers and influence 14.25, 14.30, 14.40
private and public supervision elements 3.96
securitization 3.30
Baxter, Thomas 2.205, 2.214
Bernanke, Chris 2.146
Bickel, Alexander 2.167
Bitcoin 1.03, 1.30, 2.23–2.24
Bodin, Jean 1.12
Borio, Claudio 2.39, 4.123
Bretton Woods system see also International Monetary Fund
background 12.03, 12.15–12.21, 14.200
basis for 12.08
BIS disbandment proposals 12.23
challenges 12.04
changing attitudes to 2.222
collapse, implications of 1.64, 6.29–6.31, 12.35–12.38, 13.06, 13.57
Conference proceedings 12.22–12.25
EU monetary policy, influences on 6.11
gold standard, differences from 12.08
Keynes’ proposal 12.19–12.21
White’s proposal 12.15–12.19
Brittan, Samuel 8.01
Brummer, Chris 14.98
Brunnermeier, Markus K. 4.150–4.151
Buchheit, Lee 14.148
Bundesbank
accountability 2.180
ERM and EMU membership, and 2.152–2.156
establishment 2.07, 2.149
independence 2.148–2.158
purpose 2.100, 2.149–2.151
structure 2.149
Burdeau, Genevieve 1.38
Bureau of Consumer Financial Protection 3.93
Canada
currency devaluation 12.47
capital
Basel liquidity standards 3.32
forbearance 3.31
free movement principle 2.81, 6.11, 6.106–6.110, 12.66
loan loss reserves 3.31
optimum currency area 6.106–6.110
purpose 3.30
regulation 3.29–3.30
supervision intensity, and 3.32, 4.12
(p. 609) capital adequacy 3.30
capital transfers
central bank controls 2.79
cross-border, and monetary sovereignty limitations 1.66–1.68
IMF controls 13.69, 13.72, 13.245
capitalism 5.09, 5.17
Caprio, Gerard 3.94
central banks see also European Central Bank
accountability 1.68, 2.01, 2.97, 2.111, 2.147, 2.163, 2.188–2.194, 7.86–7.91
bankers’ bank, as 2.48–2.54
benefits of 2.99
competition, and 2.49
currency boards, and 2.229–2.230, 2.232–2.234
definition 2.14
developing and emerging economies, in 2.45, 2.83–2.84
establishment 2.01
evolution and development 2.07, 2.50
financial crisis influences on 2.03–2.05, 2.41
functions
bankers’ bank, as 2.48–2.54
banking supervision 3.02–3.03
debt management 2.75–2.78
economic development role 2.83–2.84
exchange controls 2.79
financial stability 2.12, 2.85–2.100, 3.02, 3.58–3.84, 3.60–3.84
financial supervision 2.01, 2.55–2.64, 3.02–3.03
first line of defence 4.170
generally 2.01, 2.08, 2.12–2.13, 2.55–2.64, 3.02–3.03
gold and foreign reserves, management of 2.69–2.74, 2.210–2.220, 9.65–9.66
government’s bank, as 2.65–2.68
lender of last resort, as 2.16, 2.51–2.54, 3.64, 4.08–4.36
macro-prudential supervision 2.57–2.60, 2.63, 3.60–3.71
micro-prudential supervision 2.57–2.60, 2.63, 3.72–3.79
monetary stability 2.12, 2.85–2.100
multiplicity 2.50, 2.134, 2.198
note-issuing 1.32, 2.16–2.24
price stability 2.07, 2.33, 2.88, 2.91
private note issuance, and 2.18–2.19
regulatory powers 2.132
reserve asset management 2.69–2.74, 2.210–2.220
government, relationship with 2.09, 2.104–2.114, 2.122
historical influences on 2.07
independence
absolute 2.134–2.140
accountability 2.111, 2.172, 2.180
benefits 2.101, 2.117–2.118
challenges 2.113, 2.119
constitutionalization 2.171
declaration of 2.125
democratic legitimacy 2.141, 2.163–2.171
democratic self-determination theory 2.167
depoliticization of money supply, and 2.29, 2.113, 2.122, 2.194
development, influences on 2.120
discretion, and 2.103
economic test of 2.130
financial autonomy 2.131
functional or operational guarantees 2.129
generally 2.03, 2.27, 7.75, 7.77
government, relationship with 2.104–2.114, 2.122, 2.135
importance 2.31, 2.66
incentive structure 2.123
juridical personality 2.106–2.110
justification for 2.117–2.118
legal articulation 2.123–2.128
limitations 2.111, 2.133–2.158, 2.232
monetary independence 2.115–2.123, 2.136, 2.187–2.188, 2.193
officers, appointment of 2.138
ordinary vs. extraordinary times 2.142–2.147, 2.169–2.170
organic guarantees of 2.126–2.128
political influences on 2.122, 2.135–2.136
price stability, and 2.114, 2.116–2.117, 2.136
professional independence 2.126–2.128
public vs. private ownership 2.105
scope of 2.114
supervisory independence 2.187–2.194
international cooperation, and 2.11
issue of money
alternative arrangements 2.18–2.24
free banking 2.18–2.24
monopoly power 1.32, 2.16–2.24
private issuance 2.18–2.24
legal controls 2.01, 2.130
legal personality 2.106–2.110, 9.45, 9.50–9.57
lender of last resort, as 2.16, 2.51–2.54, 3.64, 4.08–4.36
financial crisis, role during 4.29–4.35, 10.74–10.80
limitations 4.19–4.20
moral hazard and adverse selection, and 4.15–4.20
theory vs. practice 4.21–4.28
monetary policy, and 2.25–2.47
balance sheet expansion, and 2.39
developing and emerging economies, and 2.45, 2.83–2.84
disagreements over 2.36
financial crisis, standard/non-standard responses to 7.39–7.44
forward guidance 2.43–2.44
necessity for 2.28, 2.38
price stability role 2.07, 2.33, 2.88, 2.91, 9.04
privatization or liberalization 2.30
quantitative easing (QE), and 2.35, 2.38–2.39, 2.41–2.42, 7.43
responsibilities 2.27
(p. 610)
rules vs. discretion 2.37
unconventional policies 2.37–2.42
nationalization 2.105
purpose 2.07–2.12, 2.31, 2.41, 4.170
quantitative easing (QE) 2.35, 2.38–2.39, 2.41–2.42
reserve assets
commercial/non commercial purposes, relevance of 2.215–2.220
financial crisis, increases during 2.195–2.196
management functions 2.69–2.74, 2.210–2.220
targeting 2.197
seigniorage, and 2.17–2.19, 2.142–2.144
soft law advantages 2.11
sovereign immunity, and 2.13, 2.198, 2.201–2.204, 2.210–2.220
Chant, John F. 2.76
Chile
central bank independence 2.171
clearing systems
systemic risk, and 4.134–4.145
Coase, Ronald 5.07
Cohen, Benjamin 1.68, 6.113
Cohesion Fund 8.201
Colares, Juscelino F. 2.227
Collective Action Clauses (CAC) 14.109, 14.124–14.131
commercial banks
liabilities, definition of 2.19
seigniorage, shared with central bank 2.18–2.19
Committee of Wise Men see Lamfalussy procedure
Committee on Payment and Settlement Systems (CPSS) 14.193
Committee on the Global Financial System 14–193
communism
collapse of, implications 5.09, 5.15
Compendium of Standards 14.37–14.40
competition
central bank controls, and 2.23–2.24
central banks, and 2.49
regulation, interaction between 3.25
constitutionalism
central bank independence, and 2.171
Consumer Price Indices 2.89
Cooke, Peter 14.185
Coordination Framework for Implementation Monitoring (CFIM) 14.69
Core Principles for Effective Banking Supervision 3.101, 4.38, 14.39–14.40, 14.59
corporate governance
supervisory authorities, structural reforms 3.129
Counterparty Risk Management Policy Group 4.131
credit derivatives 4.129, 4.131–4.132
credit rating agencies 3.27
creditors
burden sharing 14.148–14.152
coordination challenges 14.151
parity of treatment principle 14.150
preferred creditor status, of IMF 14.142–14.147
crisis management see also International Monetary Fund
bank insolvency, and
cross-border insolvency resolution 4.86–4.92
FSB Key Attributes 4.82–4.85, 4.104–4.109
laws, objectives of 4.68–4.73
lex specialis vs.lex generalis 4.59–4.67
rescue packages and resolution procedures 4.74–4.85
resolution and insolvency laws 4.59–4.112
social costs of 4.72–4.73
vs. illiquidity, identification challenges 4.21–4.22, 4.71
corrective action 4.03
definition 4.02
deposit insurance schemes 4.03, 4.37–4.58
institutional interconnectedness 4.158–4.164
lender of last resort 4.03, 4.08–4.36
preventative mechanisms 4.02
regulation and supervision, and 3.39, 3.43
remedial instruments 4.02–4.03
Single Resolution Mechanism (SRM), and 10.36–10.37
systemic risk, and 4.04, 4.113–4.114
liquidation, and 4.171
liquidity injections 4.170
nationalization, and 4.171–4.172
prevention and resolution 4.165–4.174
transparency 2.193
Crockett, Andrew 14.03, 14.33
cross-border capital flows
monetary sovereignty, limitations on 1.66–1.68
Cross, Sam 12.63
crowdfunding 1.03
currency see also Euro
alternative currencies 1.03, 1.30, 2.23–2.24
convertibility of 2.19–2.20
deterritorialization 1.68
devaluations 12.46–12.48, 12.59
devolution, state rights regarding 1.47
elastic currencies 2.85–2.86
exchange rate stability, and 2.95
foreign reserves, central bank management role 2.69–2.74, 2.210–2.220, 9.65–9.66
free banking 2.18–2.24
free choice concept 2.22
global, legal authority for 12.70
power to issue 1.01, 1.76
reserve currency 12.52–12.54
symbol of national identity, as 1.58
currency boards
central banks, and 2.229–2.230, 2.232–2.234
context 2.222, 2.224
credibility 2.235–2.242
delegation mechanisms 2.225–2.226
history 2.229–2.231
legal frameworks 2.233
lender of last resort, unavailability as 2.228, 2.236
limitations and challenges 2.227, 2.235–2.242
monetary sovereignty, and 1.75, 2.227–2.228
monetary stability, and 2.101, 2.221, 2.225, 2.236
(p. 611)
pegged exchange rates, compared 2.223
purpose 2.221, 2.224–2.225, 2.231, 2.241
requirements 2.224, 2.235
success record 2.221, 2.237–2.239
theory 2.224–2.228
types 2.231–2.233
customary law 14.90
customs union
EU, in 6.82–6.86
Cyprus
financial aid package 8.176
Czechoslovakia
withdrawal from IMF 13.13
D-SIBs rules 4.164
de Gaulle, Charles 12.54
de Grauwe, Paul 12.06, 12.36–12.38
de Krivoy, Ruth 3.108
De Larosière Report 11.25–11.27
deflation
re-emergence 2.98, 7.43
democracy
banking union legitimacy, and 11.76–11.78
democratic legitimacy of central banks 2.163–2.171
sovereignty, and 1.16, 1.18–1.19, 1.27
theory of democratic self-determination, and 2.167
Denmark
European Monetary Union opt-out 6.59–6.60
deposit insurance
adoption trends 4.38–4.39
debate over 4.37–4.38
deposit guarantee schemes 4.43–4.47
explicit insurance 4.43–4.47, 4.49, 4.51–4.54
implicit insurance 4.48–4.50
insured depositors 4.51–4.54
mandatory vs. contingent guarantees 4.55–4.58
moral hazard, and 4.56
obectives 4.43–4.46
pre-funding 4.40
preferred creditors 4.51–4.54
structure of 4.42
too-big-to-fail doctrine, and 4.50
US, in 4.61
deposit protection 3.122
derivatives
choice of laws 2.208
systemic risk, and 4.129, 4.131–4.132
developing countries see emerging economies
discretion vs. rules
monetary policy, in 2.37, 2.102–2.103
regulation and supervision, in 3.44–3.50
Disyatat, Piti 2.39
Draft Principles on Promoting Responsible Sovereign Lending (UNCTAD) 14.133
Economic and Monetary Union see economic union; European Monetary Union
economic policy
balancing multiple goals 2.93
economic and social cohesion, role of 8.14
fiscal coordination, regional adjustment 8.198–8.206
Tinbergen Rule 2.93
economic union
definition 6.99–6.100
monetary union, sequencing with 6.101
social cohesion, and 6.102
Eisenbeis, Robert A. 4.70
emerging economies
best practice standards adoption requirement 14.73
central banks 2.83–2.84, 2.120, 3.55
definition 5.01
HIPC Initiative 13.218–13.220
IMF financial assistance 13.07, 13.200–13.223
law reform
challenges 5.01
directions for 5.04
domestic legal system development 5.44–5.45
financial crisis, trends after 5.03
foreign law, local adaptation of 5.46–5.47
foreign law, wholesale adoption of 5.48–5.51
IMF criteria, importance of 5.04
international financial standards/soft law, adoption of 5.61–5.67
legal framework, importance of 5.06–5.09, 5.13
legal theory of finance, and 5.26
model laws and clauses, adoption of 5.52–5.57
process, scope of 5.05
regulatory convergence technique harmonization 5.58–5.60
role in international regime 5.26
Salacuse’s developmental models 5.15–5.16
soft law, adoption by 5.61–5.67
Washington Consensus influences 5.10–5.12
monetary policy challenges 2.45
enforcement
personal liability trends 3.38
regulation, of 3.35–3.38
soft law 3.38, 14.65–14.67
Enhanced Structural Adjustment Facility (ESAF) 13.53
Estonia
financial crisis 8.100
EU common market
challenges 6.93–6.95
development 6.87–6.95
EU constitution
ratification failure implications 6.02
EU exchange rate policy
dual purpose 9.10
ECJ interpretation role 9.27–9.29
Euro, international role of 9.42
floating rates 9.35–9.37
formal exchange rate agreements 9.31–9.34
general orientations 9.35–9.36
IMF membership, implications of 9.49–9.66
jurisdiction 9.20
monetary matters, definition 9.40
monetary policy, and
lato sensu 9.22–9.25
stricto sensu 9.24–9.26
Mr Euro 9.12–9.17
(p. 612)
parallelism, doctrine of 9.27–9.29
policy principles 9.18
politicization implications 9.11
primary law on 9.18–9.26
responsibility for 9.70–9.74
ambiguities in 9.01–9.05, 9.08
Council role 9.31–9.32
international agreements on monetary matters 9.38–9.41
Member States, residual role 9.43–9.44
multiple agencies, conflicts between 9.67–9.69
national vs. EU political conflicts 9.10–9.11
policy development 9.07
stability of 9.09
Euro Plus Pact 8.118, 8.161–8.162
Euro, the
coins and notes
counterfeiting 7.117, 7.123–7.129
issue and distribution 6.79, 7.99–7.102, 7.117
legal tender status 7.118–7.119, 7.131–7.136
reproduction, exchange and withdrawal 7.130
technical specification 7.121
transitional periods 7.112, 7.118–7.119
currency changeover
consultation 7.93–7.94
legal provisions governing 7.105–7.119
economic and legal criteria 7.98
exchange controls, need for single external mechanism 9.12–9.17
exchange rates, international role 9.42
exit procedures 7.140–7.141
floating exchange rates 9.35–9.37
framework development 6.67–6.73, 7.92–7.98
introduction 7.92
legal and regulatory framework 7.103–7.129
anti-counterfeiting obligations 7.117, 7.123–7.129
coins, technical specification 7.121
conversion rates 7.122
exit procedures 7.140–7.141
introduction of Euro, for 7.105–7.119
legal tender status 7.118–7.119, 7.131–7.136
status in non-EU Member States 7.131–7.136
Mr Euro 9.12–9.17
name, choice of 7.96
recognition of 6.97
reserve currency, as 12.54
symbolic value 7.92
Treaty rules regarding 7.97, 9.13
EUROCLEAR 2.209
Eurogroup
political recognition 9.14–9.15
president, role of 9.14, 9.16
Europe 2020 Strategy 8.156–8.161
European Agricultural Guidance and Guarantee Fund (EAGGF) 8.201
European Banking Authority (EBA)
banking union, role in 11.70–11.73
coordination with ECB 11.59–11.73
reform proposals 11.70–11.72
supervision role 11.46–11.58
European Central Bank see also European System of Central Banks (ESCB)
accountability 7.86–7.91
coordination with EBA 11.59–11.73
establishment 6.75
Eurozone debt crisis, actions during 8.46–8.47
exchange rate policy role 7.51
financial autonomy 2.131
financial crisis, and
asset purchase programmes 7.43–7.44
lender of last resort, as 10.75–10.90
liquidity schemes during 4.30, 7.41, 10.74–10.80
long-term refinancing operations 7.46
negative interest rates 7.42
outright monetary transactions programme 7.47–7.59
quantitative easing 7.43
securities markets programmes 7.45
standard/non-standard responses to 7.40–7.43
functions 7.33–7.35, 7.62–7.67
advisory functions 7.64–7.65
banking supervision 2.59, 3.03, 3.16, 7.07, 7.64–7.65
currency, issue and control 7.63, 7.99–7.102
financial supervision 3.03, 3.16
foreign exchange operations 7.51–7.58
foreign reserves controls 2.74, 7.59
international cooperation 7.67
lender of last resort, as 10.74–10.90
monetary policy responsibilities 7.36–7.38
payment systems management 7.60–7.61
statistical information sharing 7.66
IMF observer status 9.61
independence of 2.109–2.110, 2.131, 7.53, 7.74–7.85, 7.90
law governing 2.109–2.110
legal personality 2.109–2.110, 7.18–7.19, 7.72–7.73, 9.45, 9.50–9.55
monetary policy
responsibilities for 7.51, 7.55
standard/non-standard responses to financial crisis 7.40–7.43
national central banks, and
division of responsibilities 7.10–7.23
relationships with 2.109–2.110
officers, appointment of 6.74
payment systems role 4.145
purpose 2.89, 7.17
separation of powers 3.57
sovereign immunity, and 2.202
status of 7.68–7.73
Treaty restrictions on 7.40
European Community
common market/internal market 6.87–6.95
customs union 6.82–6.86
economic union 6.99–6.102
monetary union 6.96–6.98
political union 6.103–6.105
(p. 613) European Court of Justice
EU competence to conclude international agreements, ruling on 9.28
excessive deficits, ruling on 8.86–8.94
European Currency Unit (ECU) 6.35, 6.76, 7.96
European Financial Services Authority 11.07
European Financial Stabilisation Facility 8.170–8.172
European Financial Stabilisation Mechanism 8.170–8.171
European Insurance and Occupational Pensions Authority (EIOPA) 11.46–11.58
European Investment Fund 8.199
European Monetary Cooperation Fund 6.27–6.31, 6.61
European Monetary Institute 6.61, 6.63, 6.67
European Monetary System (EMS)
Basel and Nyborg agreement influences 6.38
ECU, establishment of 6.35, 6.76
ERM, establishment of 6.36
ERM II 6.39–6.40
historical development 6.32–6.40
objectives 6.34
European Monetary Union see also Euro; Eurozone debt crisis
arguments for 10.11
asymmetry of 8.15–8.18
basis for 10.19
central banks 2.66, 2.120
development 6.06–6.49, 6.96
Barre Report 6.15
Bretton Woods par value system collapse, and 6.29–6.31
Delors Report 6.44–6.49
early post-War developments 6.06–6.16
ECU, establishment of 6.35, 6.76
European Monetary Cooperation Fund 6.27–6.31, 6.61
European Monetary Institute 6.61, 6.63, 6.67
European Monetary System 6.32–6.40
IMF and World Bank influences 6.08–6.09
Lisbon Treaty, and 8.15
Maastricht Treaty, and 6.50–6.55
Marshall Plan influences 6.09
Single European Act 6.41–6.43
‘snake in the tunnel’ 6.22–6.26
stage one 6.48, 6.56–6.60
stage two 6.48, 6.61–6.75
stage three 6.48, 6.76–6.79
Werner Report 6.17–6.21
exchange controls, Member State imposition of 1.47, 2.81
fiscal policy regional adjustment 8.198–8.206
Genuine Economic and Monetary Union (GEMU) 8.193–8.197
impact on other regional groupings 6.111–6.114
medium-term balance of payments facilities 8.41–8.42
monopoly power, influences on 1.02, 1.47, 1.56–1.63
non-members, provisions relating to 8.41–8.42
optimum currency areas, and 6.106–6.110
post-crisis reforms
background 8.115
corrective rules 8.132–8.136, 8.152–8.154
Euro Plus Pact 8.118, 8.161–8.162
European Semester 8.165–8.166
excessive imbalance procedure 8.152–8.154
fiscal policy coordination 8.119–8.146, 8.163–8.164
fiscal surveillance 8.124–8.131, 8.149–8.151
Intergovernmental Treaty 8.116
national framework development 8.137–8.138
sanctions and reverse voting 8.139–8.146
Six Pack legislation 8.09, 8.23, 8.147
soft policy coordination 8.155, 8.163
Stability, Coordination and Governance Treaty (TSCG) 8.10–8.11, 8.13, 8.116–
8.117, 8.163–8.164
Two Pack legislation 8.09, 8.23, 8.116
Van Rompuy Task Force 8.119, 8.165
price stability policy entry condition 2.91
primary law 8.19–8.62
categories of competence 8.22
early warning rights 8.29
economic component 6.96, 8.19–8.25
economic policy coordination 8.21, 8.26–8.30
excessive deficit rules 8.03, 8.23, 8.50, 8.58–8.62
extraordinary circumstances provisions 8.43–8.44
guidelines, provision for publication of 8.27
monetization of government debt prohibition 8.33–8.35
multilateral surveillance 8.28–8.29
mutual guarantee of debt prohibition 8.37–8.49
negative integration element 8.25, 8.31–8.62
positive integration element 8.24, 8.26–8.30
privileged access to financial institutions prohibition 8.36
reference values 8.51–8.57
regional financial transfers, need for 8.48–8.49
secondary law
budgetary surveillance programmes 8.77–8.80
economic policy coordination 8.63–8.64, 8.78–8.80
excessive deficit rules 8.65, 8.81–8.84
flexible vs. rigid policy approaches 8.75–8.84, 8.109
Stability and Growth Pact 8.63–8.94
strategic importance 6.03
UK opt-out clause 6.59
withdrawal or expulsion from 1.62–1.63
European Payments Union 6.09
European Regional Development Fund (ERDF) 8.201
European Securities and Markets Authority (ESMA) 11.46–11.58
European Securities Committee (ESC) 11.20
European Social Fund 8.201
European Stability Mechanism (ESM)
banking union, and 10.14–10.15
eligibility conditions 8.180, 10.14
(p. 614)
fund-raising methods 8.179
lending capacity 8.178
preferred creditor status 14.143
recapitalization instruments 8.181, 10.14
revision 8.178
European Stability Mechanism Treaty (ESMT) 8.178
compatibility with EU Treaties 8.188–8.192, 8.196
constitutional review 8.182
legality challenge 8.183–8.192
European Supervisory Authorities (ESAs)
binding technical standards 11.48
coordination with ECB 11.59–11.73
establishment 11.46
legal personality 11.46
purpose 11.46, 11.48–11.49
stakeholder groups 11.58
structure 11.48, 11.57
task and powers 11.47–11.56
European System of Central Banks (ESCB) see also European Central Bank
accountability 7.86–7.91
banking union, and 10.08
consultation requirement 7.08
domestic law compatibility requirement 6.64
ECB and National central banks, division of responsibilities 7.10–7.23
establishment 6.48
Executive Board 4.13–4.15
Federal Reserve System, compared with 7.21–7.22
functions 7.33–7.35, 7.62–7.67
advisory functions 7.64–7.65
currency, issue and control 7.63, 7.99–7.102
foreign exchange operations 7.51–7.58
foreign reserves controls 2.74, 7.59, 9.65–9.66
international cooperation 7.67
monetary policy responsibilities 7.36–7.38, 9.01
payment systems management 7.60–7.61
regulatory powers 2.132, 7.07, 9.01
statistical information sharing 7.66
supervision 3.16, 7.07, 7.64–7.65, 10.08
independence 2.171, 2.180, 7.51, 7.74–7.85
legal framework
primary EU law 7.05–7.06
secondary EU law 7.07–7.09
legal personality 2.109–2.110, 7.18–7.19, 7.72–7.73, 9.45, 9.50–9.55
objectives 7.24–7.32
financial stability 7.30–7.32
inflation control 7.25
price stability 2.07, 7.25–7.31
opted-out Member States, rules regarding 7.16
outright monetary transactions programme 7.47–7.59
purpose 7.17, 9.01
regulatory powers 2.132, 7.07, 9.01
structure 4.13–4.15, 7.03–7.04, 7.10, 7.13–7.15, 7.21
Tietmeyer rule 7.14
voting structures 7.14
European System of Financial Supervision (ESFS) 11.03–11.04, 11.28–11.29
European Systemic Risk Board (ESRB)
Advisory Committees (Scientific/ Technical) 11.36, 11.39
background 11.30
definitions 11.31
Economic and Financial Committee 11.36
functions and powers 2.59, 3.16, 11.30–11.45
governance and review mechanisms 11.36, 11.42
IMF, interaction with 11.41
information provision mechanisms 11.32–11.33
inter-institutional coordination 11.41–11.43
legal personality 11.35
organizational structure 11.36–11.39
recommendations procedures 11.34–11.35
Secretariat 11.36, 11.38
SSM, interaction with 11.44–11.45
Steering Committee 11.36–11.37
European Union see also European Monetary Union
accession policies 8.202
budgetary constraints 8.16
cohesion policies 8.201
constitution ratification failure implications 6.02
definition 6.01
free movement of capital 2.81, 6.11, 6.106–6.111
history of 6.02
IMF membership implications 9.59–9.66
institutions of, legal personality 9.46–9.49
integration mechanisms
challenges 6.04
common market/soft policy coordination internal market 6.87–6.95
customs union 6.82–6.86
economic union 6.99–6.102
political union 6.103–6.105
introduction 6.01
regulatory convergence and harmonization 5.58
sovereign immunity 2.200, 2.202
supervisory authorities 3.121, 3.123–3.124
Eurozone debt crisis
background and causes 8.06–8.07, 8.45–8.46, 8.97–8.114
competitiveness gains and losses 8.112–8.114
EMU framework influences 8.101–8.103
fiscal discipline failures 8.106–8.114
macroeconomic imbalances 8.112–8.114
market discipline failures 8.111
sanctions and enforcement inadequacies 8.110
ECB actions during 8.46–8.47
fiscal policy, and
imbalances, prevention and correction 8.147–8.154
implications for 8.03–8.05
influences on 8.95–8.96
legislation following 8.08–8.09
IMF actions during 13.07, 14.106
post-crisis reforms
background 8.115
corrective rules 8.132–8.136, 8.152–8.154
Euro Plus Pact 8.118, 8.161–8.162
excessive imbalance procedure 8.152–8.154
(p. 615)
fiscal policy coordination 8.119–8.146, 8.163–8.164
fiscal surveillance 8.124–8.131, 8.149–8.151
Intergovernmental Treaty 8.116
national framework development 8.137–8.138
sanctions and reverse voting 8.139–8.146
Six Pack legislation 8.09, 8.23, 8.147
soft policy coordination 8.155, 8.163
Stability, Coordination and Governance Treaty (TSCG/ Fiscal Compact) 8.10–8.11, 8.13
8.117, 8.163–8.164
Two Pack legislation 8.09, 8.23, 8.116
Van Rompuy Task Force 8.119, 8.165
excessive deficits
ECJ ruling on German breach 8.86–8.94
EMU reference values 8.51–8.57
EMU rules 8.03, 8.23, 8.50, 8.55–8.56, 8.58–8.62
secondary law developments 8.65, 8.81–8.84
exchange controls
central bank role 2.79
domestic credit controls, and 2.80
EMU Member State imposition of 1.47, 2.81–2.82
purpose 2.80
single external controls, need for 9.12–9.17
state rights to impose 1.47
Exchange Equalization Account 2.73
exchange rate and intervention mechanism (ERM) 3.53, 6.36, 6.54, 12.65
exchange rates see also EU exchange rate policy
choice of, under IMF Articles of Association 12.55–12.68, 13.03
Euro, international role of 9.42
floating rates 9.35–9.37, 12.56, 12.67–12.68
formal exchange rate agreements 9.31–9.34
general orientations 9.35–9.36
IMF membership, implications of 9.49–9.66
international obligations regarding 12.63
monetary policy, and
lato sensu 9.22–9.25
stricto sensu 9.24–9.26
monetary sovereignty, and 1.45, 1.73–1.75
pegged rates 12.65–12.68
politicization implications 9.11
principles 9.10, 9.18
SDR valuation criteria 9.64
single external controls, need for 9.12–9.17
stability of 2.95, 9.09
trade and employment policy, links with 2.71
Exchange Stabilization Fund 2.72
Federal Deposit Insurance Corporation (FDIC) 3.93, 4.61–4.63, 4.95, 4.111, 4.161
Federal Open Market Committee 2.72, 2.86, 2.94, 2.177
Federal Reserve System
changing policy emphasis 2.96–2.97
democratic legitimacy 2.159
emergency liquidity assistance 4.13–4.14, 4.31–4.33
ESCB, compared with 7.21–7.22
Exchange Stabilization Fund 2.72
functions 2.72, 2.119, 4.11–4.14, 4.31–4.34
gold and foreign reserve management 2.72
Great Depression, and 2.96, 2.146
historical influences on 2.96–2.97
independence 2.119
legal personality 2.108, 7.21
lender of last resort 4.11–4.14, 4.31–4.34
monetary policy discretion 2.27
oil prices shock, and 2.97
open market operations (OMOs) 4.31–4.32
regulation of 2.01
regulatory powers 2.119, 2.132
reserves held and invested 2.205–2.206
special drawing rights (SDRs) 2.72
statutory mandate 2.85–2.86
supervisory role 2.59, 2.62, 3.56, 3.92–3.93, 4.12
swap transactions 2.206
Financial Action Task Force on Combating Money Laundering (FATF) 14.38, 14.71
financial architecture see international financial architecture
financial assistance see International Monetary Fund; State aid
Financial Conduct Authority 3.40
financial crisis see also crisis management; Eurozone debt crisis
2007–2009 crisis
emerging economies, impact on 5.50
fiscal policy influences on 8.95
IMF role in 13.07
market influences 4.129, 4.131–4.133
payment system resilience 4.144
prediction difficulties 4.126
supervisory weaknesses 10.10
bank interconnectedness, and 4.128, 4.158–4.164
causes 2.90, 8.06–8.07, 8.45–8.46, 8.97–8.114
central banks, and
actions during 2.145–2.146
asset purchase programmes 7.43–7.44
financial stability considerations 3.77
immunity of 2.204
influence on role of 2.41, 2.58
lender of last resort, as 2.51–2.54, 4.08–4.36
long-term refinancing operations 7.46
policy focus 2.91
securities markets programmes 7.45
standard/non-standard responses of 7.39–7.44
cyclical nature of 4.01
derivatives markets 4.129, 4.131–4.132
development, psychological influences on 4.153–4.157
domino effect 4.113–4.115
doomed loops 2.78, 4.76, 10.12–10.13
ERM crisis (1992) 6.54
financial supervision responsibility trends following 3.03, 3.99–3.100
identification 2.90
liquidity spirals 4.150–4.152
market supervision, failure of 3.95, 3.99–3.100
sovereign debt, and 3.30
(p. 616)
speculation excesses role in 4.06–4.08
stages of
decline and distress stage 4.07
displacement stage 4.05–4.06
speculative bubbles 4.06–4.07
systemic risk, and 4.113–4.115, 4.129, 4.131–4.132
financial engineering instruments 8.203
Financial Instruments for Fisheries (FIFG) 8.201
financial markets
de-globalization of 1.04, 1.76
UK and US role in 2.206–2.207
Financial Policy Committee 2.59, 3.16, 3.83
financial regulation see also European System of Financial Supervision (ESFS)
enforcement 3.35–3.38
EU law development 11.13–11.17
De Larosière Report 11.25–11.27
Lamfalussy procedure 11.18–11.24
strategy focus changes 11.15–11.16
Treaty basis for 11.13
international regime 14.198–14.202
Financial Sector Assessment Programme (FSAP) 13.105, 14.85–14.86
Bank–Fund Financial Sector Liaison Committees 14.80
features 13.106
purpose 13.107–13.109, 14.78–14.79
reports process 14.81–14.83
financial services
single market
banking union, conflicts with 10.03, 10.33, 11.01, 11.60–11.65, 11.68–11.69
centralization proposals 11.09–11.12
challenges 10.03, 11.01, 11.60–11.67
European Financial Services Authority (proposed) 11.07
European System of Financial Supervision (ESFS) 11.03–11.04
Financial Services Action Plan 11.02–11.03
integration models 11.07–11.12
market federalization 11.03
purpose 11.02
Financial Services Action Plan 11.02
Financial Services Authority 11.07
financial stability
central bank role 2.12, 2.85–2.100, 3.02, 3.58–3.84
centralization vs. decentralization 3.91–3.92
concept development 3.60–3.64
Councils for 3.80–3.84
culture 2.86
ESCB objective, as 2.07, 7.30–7.32
EU institutional reform 3.81
global nature of 3.71
lender of last resort role 2.96
macro-prudential supervision, and 3.60–3.71
micro-prudential supervision, and 3.72–3.79
monetary stability, and 3.02
other policies, interaction with 3.63–3.66
public good, as 3.10, 3.70–3.71
stability vs. resilience 2.86
state role in 1.34, 3.92
systemic risk concept, and 3.68, 4.119
UK policy developments 3.78, 3.83, 3.90
US supervisory responsibilities 3.92–3.93
Financial Stability Board (FSB)
Coordination Framework for Implementation Monitoring (CFIM) 14.69
Key Attributes 4.82–4.85, 4.104–4.109
membership 14.34
peer review processes 14.71
purpose and role 3.82, 14.32, 14.34, 14.36
soft law rules 3.32, 14.71
Standing Committee on Standards Implementation (SCSI) 14.71
Financial Stability Forum (FSF)
purpose 14.21, 14.33
Financial Stability Institute 14–194
Financial Stability Oversight Council (FSOC) 2.16, 2.59, 2.62, 3.80, 11.30
financial supervision
central bank’s role 2.01, 2.56, 3.02–3.03
consolidation benefits 10.11
macro- vs. micro-prudential supervision 2.57–2.61, 2.63, 3.14–3.16
optimum responsibilities debate 3.02
transparency 2.193
Financial System Stability Assessments (FSSA) 13.105
Financing of Terrorism and Proliferation 14.38
Fiscal Compact see Stability, Coordination and Governance Treaty (TSCG)
fiscal policy see also Eurozone debt crisis
EMU prohibitions 8.31–8.62
excessive deficits 8.03, 8.23, 8.50, 8.58–8.62
extraordinary circumstances provisions 8.43–8.44
monetization of government debt 8.33–8.35
mutual guarantee of debt 8.37–8.49
non-members, provisions relating to 8.41–8.42
privileged access to financial institutions 8.36
financial crisis, influences on 8.95
fiscal imbalances 8.07, 8.13
excessive imbalance procedures 8.152–8.154
prevention and correction 8.147–8.154
jurisdiction 8.15
monetary policy, interaction with 2.35, 8.15, 8.17, 8.72
multiplicity 8.15
regional adjustment 8.198–8.206
fiscal stability 8.02
Fischer, S. 2.77
floating exchange rates 9.35–9.37
foreign exchange markets 2.69–2.74
(p. 617) foreign exchange policy see also currency boards
central bank role 2.70–2.74
responsibility for 2.70–2.71
foreign reserves
central bank management role 2.69–2.74, 2.210–2.220
commercial/non-commercial purposes, relevance of 2.215–2.220
IMF membership implications 9.65–9.66
France
Euro, depoliticization influences 9.11
excessive deficit rules, breach of 8.01, 8.91–8.92
Frankel, Jeffrey 12.53
free banking
advantages and disadvantages 2.19–2.24
depoliticization of money supply 2.29, 2.113, 2.122
proposals 2.18–2.24
systemic risk, and 4.143
Friedman, Milton 2.30, 2.146, 4.114, 12.68
G-SIBs rules 4.163
Galati, Gabrielle 4.123
Garicano, Luis 14.185
Gasset, José 6.112
gatekeepers 3.27
General Agreement of Tariffs and Trade (GATT) 12.02
General Arrangements to Borrow (GAB) 13.47–13.49
Genuine Economic and Monetary Union (GEMU) 8.193–8.197, 8.194, 8.210
Georgosouli, Andromachi 4.120
German Federal Authority for the Supervision of Financial Services (BaFin) 3.112
Germany
central banks 2.100, 2.148–2.158
EMU, and 8.01, 8.86–8.94
excessive deficit rules, breach of 8.86–8.94
financial crisis 8.01, 8.99
fiscal stability, importance of 8.01–8.02
inter-War hyperinflation 12.10
reunification influences 6.54, 8.01
Stability and Growth Pact 8.01–8.02, 8.86–8.94
supervisory authorities 3.112
Gianviti, F. 3.122, 13.59, 13.100, 13.152
Giovanoli, Mario 14.03, 14.07, 14.53–14.54, 14.65, 14.75, 14.96
Glasner, David 2.22
globalization
de-globalization of financial markets 1.04, 1.76
erosion of state power, and 1.56–1.57
gold–dollar standard see par value system
Gold, Joseph 12.56, 12.64, 13.01, 14.15
gold reserves
central bank management role 2.69–2.74, 2.210–2.220
gold standard 12.06–12.09, 12.12
Goode, Roy 14.91–14.92
Goodhart, Charles 2.24, 2.41, 2.43, 2.47, 2.90–2.91, 2.193, 3.53–3.54, 10.82, 14.170
Gorton, Gary 4.133
Great Depression 12.11–12.13
central bank actions during 2.96, 2.145–2.146
systemic risk, analysis of 4.114
Greece
ERM membership assessment 6.78
financial crisis 8.44, 8.98, 8.169, 8.173, 8.177
IMF resolution role 14.109–14.110
Greenspan, Alan 3.95, 3.111
Gu, Bin 14.98
Guitián, Manuel 13.84
Hagan, Sean 2.200
Hamilton, Alexander 1.22–1.23
Hanke, Steve 12.67
Hayek, Friedrich A. von 1.71, 2.22
Herrmann, C.W. 9.49
Hirsch, Gunter 6.114
Ho, Corrinne 2.233
Hobbes, Thomas 1.14–1.15
Holtham, Gerald 2.113
Honahan, Patrick 6.113
Hong Kong
currency board system 2.227, 2.233
Hungary
immunity see sovereign immunity
independence
central banks, of (see central banks)
judiciary, of 2.167–2.168, 3.35
regulatory independence 2.121
supervision, and
legal framework for 3.107–3.108
monetary vs. supervisory independence 2.187–2.188, 2.193, 3.102–3.103
vs. political direction 3.101–3.109
independent agencies
democratic legitimacy of 2.159–2.171
purpose 2.159
Independent Evaluation Office (IMF) 6.21
inflation
asset prices, relevance to 2.90–2.91
control, as ESCB objective 7.25
costs of 2.116
definition 2.89
Great Moderation 2.90
inter-War hyperinflation 12.10
measurement mechanisms 2.89–2.90
monetary union policies, influences on 6.31
oil prices influences on 2.97
targeting 2.89, 2.101–2.102
information
domino effect, and 4.146, 4.151
ex ante information, availability of 4.148–4.149
public perception, and 4.153
responses to, and financial crisis 4.146–4.152
transparency, and 4.147–4.148
Ingham, Barrie 3.106
insolvency see also bank insolvency
domestic resolution mechanisms 14.116
international resolution mechanisms, lack of 14.115
(p. 618) institutions
democratic legitimacy 2.159–2.171
influences on 2.95
interconnectedness 4.128, 4.158–4.164
legal personality 9.46–9.49
moral hazard challenges 4.15–4.20
outside EU treaty framework, constitutional implications 8.11
Instrument for Structural Policies for Pre-Accession (ISPA) 8.202
insurance see also deposit insurance
Core Principles, Standards, Guidance and Assessment Methodology (IAIS) 14.39
US state responsibility for 3.92
inter-War period
gold standard, abandonment 12.09, 12.12
Great Depression 2.96, 2.145–2.146, 4.114, 12.11–12.13
hyperinflation, influences of 12.10
international monetary cooperation 12.01, 12.09–12.12
reparations policies 12.09, 12.11
internal market see EU common market
International Accounting Standards Board 14.38
International Auditing and Assurance Standards Board 14.38
International Bank for Reconstruction and Development see World Bank
International Chamber of Commerce 14.18, 14.92
international financial architecture
BIS role 14.188–14.194, 14.214
definitions 14.03–14.04
formal institutions 14.184–14.194
globalization influences on 14.195–14.196
IMF role 14.207–14.213, 14.216–14.219
informal institutions 14.184–14.185
reform, need for 14.195–14.196
World Financial Organization, proposal 14.203–14.204
WTO role 14.215
international financial standards
Financial Sector Assessment Programme (FSAP) 9.66, 13.105–13.109, 14.78–14.83, 14.85–
14.86
implementation 14.64–14.65
importance 5.63
incentives 14.70–14.75
monitoring 14.76–14.77
purpose 5.64
Reports on Observance of Standards and Codes (ROSCs) 13.107–13.109, 14.84–14.87
soft law, adoption of 5.61–5.67, 14.09
International Gold Standard 12.06–12.09, 12.12
International Institute for the Unification of Private Law (UNIDROIT) 14.19, 14.49
international law
challenges 14.09
customary international law 14.90
definition 14.08
primary sources 14.90
purpose 14.08
soft law prevalence in 14.07
international legal system
financial regulation, limitations of 14.198–14.199
reform, need for 14.195–14.202
strengths 14.198
international monetary cooperation see also Bretton Woods System; International
Monetary Fund
gold standard 12.06–12.09, 12.12
inter-War developments 12.01, 12.09–12.12
Keynes’ and White’s proposals 12.15–12.21
International Monetary Fund
Annual Reports 13.33
Articles of Agreement
adoption 13.03
amendment of 6.37, 12.55–12.68, 13.03, 13.10, 13.43–13.44, 13.75–13.76
borrowing powers 13.46
capital account liberalization 13.75–13.78
commencement 12.27
conditionality 13.140–13.143, 13.186
current vs. capital transactions 13.64
debt restructuring 14.123
exchange rate choice rules 12.55–12.68, 13.03
flexibility of 13.10
importance of 12.26
investment authority powers 13.03
management 13.14–13.21
member state obligations 13.63–13.65, 13.69
objectives 13.05
quotas, reform of 13.03
Special Drawing Rights 13.03
stand-by arrangements 13.125, 13.127
voting right suspension rules 13.03
background 12.21, 14.207
balance sheet audits 13.33
Board of Governors 6.15–6.17
capital account liberalization 13.75–13.78, 13.245
capital movement controls 13.72–13.78
challenges 12.70, 13.10, 13.242, 13.245, 13.247, 14.208
Codes of Good Practice 14.38
conditionality
cooperation requirement 13.178
credit tranches 13.120
criticisms of 13.154–13.164
definition and interpretation 13.137–13.139, 13.149–13.150, 13.152
Flexible Credit Line 13.161–13.163
guidelines, development 13.133, 13.144–13.146, 13.158–13.161
guidelines, 2010 revision 13.164–13.175
hard vs. soft conditionality 13.184–13.188
information provision requirements 13.180–13.183
legal basis 13.147–13.152
letters of intent 13.159
misreporting 13.180–13.183
(p. 619)
national ownership 13.168–13.169, 13.177
parsimony principle 13.178–13.179
performance reviews 13.171–13.175
policy development 13.140–13.146
practical operation of 13.165–13.175
Precautionary and Liquidity Line 13.161, 13.163
principles 13.176–13.183
purpose 13.153
soft law incentive, as 14.72
stand-by arrangements 13.123, 13.127, 13.133–13.135
structural benchmarks 13.158, 13.174
symmetry principle 13.188
transparency 13.179
types 13.152, 13.187
uniformity principle 13.188
crisis management role
bail outs 14.163, 14.174–14.182
burden sharing concept 14.148–14.152
debt-service reduction (DDSR) operations 14.155
debt sustainability analysis (DSA) 14.103
honest broker, as 14.104
international lender of last resort 14.162–14.173
lending into arrears policy 14.153–14.161
preferred creditor status, and 14.142–14.147
private creditors, and 14.137–14.161
process reform proposals 14.111–14.113
Sovereign Debt Restructuring Mechanism (SDRM) 14.118–14.123
unique expertise, and 14.105–14.106
current account convertibility 13.65–13.71
Data Dissemination Standards 14.38
domestic policy, influences on 1.65, 5.04, 5.64
establishment 12.02, 12.24, 12.39
EU monetary union, influences on 6.08–6.09
European Systemic Risk Board (ESRB), interaction with 11.41
exchange rate choice rules 12.55–12.68
Executive Board 6.15–6.19
facilities
Buffer Stock Financing Facility 13.236
Compensatory and Contingency Financing Facility 13.236
Compensatory Financing Facility 13.236
concessional facilities 13.197–13.216
Contingent Credit Lines Facility 13.236
criticism of 13.196
Currency Stabilization Fund 13.237
Debt and Debt Service Reduction (DDSR) 13.232
definitions 13.195, 13.197–13.199
emergency assistance 13.225–13.229
Enhanced Structural Adjustment Facility 13.207–13.208
Extended Credit Facility 13.214, 13.229
Extended Fund Facility 13.230–13.231
financial assistance to low-income countries 13.197–13.223
interest rates 13.239
lapsed instruments 13.236–13.237
non-concessional facilities 13.197–13.199
Oil Facility 13.236
Policy Support Instruments 13.235
Poverty Reduction and Growth Facility (PRGF) 13.53, 13.209–13.212
Poverty Reduction and Growth Trust (PRGT) 13.213–13.216
Rapid Credit Facility 13.214, 13.228
Short-Term Liquidity Facility 13.237
special facilities 13.224–13.235
Stand-by Credit Facility 13.214, 13.229
Structural Adjustment Facility 13.202, 13.205–13.206
summary 13.232
Supplemental Reserve Facility 13.236
Systemic Transformation Facility 13.236
Trade Integration Mechanism (TIM) 13.234
Y2K Facility 13.236
financial assistance 13.79–13.81, 13.112–13.136
access limits 13.238
conditionality 3.120, 13.123, 13.127, 13.133–13.135, 13.137–13.188
credit tranche policies 13.118–13.121
debt relief 13.217–13.223
eligibility criteria 13.115
extended arrangements 13.136
HIPC Initiative 13.218–13.220
interest rates 13.239
low-income countries, to 13.200–13.223
purchases 13.116
stand-by arrangements 3.121–3.135, 13.112
financial structure 13.32–13.44
Financial System Stability Assessments (FSSA) 13.105
freely usable currency 13.26
funding
accounts 13.34
borrowing 13.45–13.53
complexity 13.42–13.43
concessional facilities 13.53
Financial Transactions Plans 13.38
formula review procedures 13.29–13.31
purchases and drawings 13.37
quotas and subscriptions 13.23–13.31, 13.35–13.36
sources 13.35–13.36
special facilities 13.52
General Arrangements to Borrow (GAB) 13.47–13.49
General Resources Account (GRA) 13.34–13.36, 13.39
gold and financial reserves management 2.74, 2.210–2.214
importance 13.243
Independent Evaluation Office 6.21
international legitimacy 14.209
jurisdiction 6.11, 13.64, 13.245
law and economics interplay 13.241
mandate 13.09, 13.243
Meltzer Report 13.154
(p. 620)
member state obligations 9.58–9.66, 12.62, 13.63–13.65, 13.69
flexibility in 13.69–13.70
interpretation challenges 13.67
sanctions for breach of 13.70
surveillance 13.94–13.101
membership 13.05, 13.11–13.13, 13.71
monetary sovereignty, limitations of 1.64–1.65
Multilateral Debt Relief Initiative (MDRI) 13.223
New Arrangements to Borrow (NAB) 13.50–13.52
organizational structure 6.15–6.19, 12.28, 13.14–13.21
par value system 1.63–1.65, 12.28–12.35
collapse, causes of 12.35–12.38
collapse, implications of 1.64, 6.29–6.31, 12.35–12.38, 12.55–12.56, 13.06, 13.57
devaluations, revaluations, and floating rates 12.45–12.51
duration, influences on 12.39–12.51
EMU, influences on 6.29–6.31
gold reserves and liquidity challenges 12.40–12.44
repair attempts 12.55
role in 12.32–12.34
US dollar influences on 12.49–12.51
Post-Catastrophe Debt Relief Trust 13.223
preferred creditor status 14.142–14.147
purpose 13.05–13.08, 13.246
reserve tranche positions 13.25, 13.59
Special Drawing Rights (SDR) 13.03, 13.40–13.41, 13.54–13.62
Standards and Codes Initiative 14.76–14.77, 14.86–14.87
surveillance function 12.60–12.62, 13.08, 13.79–13.85
consultation and review 13.102–13.103
discretion in 13.85
Financial Sector Assessment Programme (FSAP) 9.66, 13.105–13.109, 14.78–
14.79, 14.81–14.83, 14.85–14.86
importance of 13.90, 13.244
Integrated Surveillance Decision 13.89
macro vs. micro surveillance 13.104–13.111
member obligations 13.94–13.101
member sanctions 13.99
national policy surveillance 13.110
poverty monitoring 13.111
purpose 13.93
Reports on Observance of Standards and Codes (ROSCs) 13.107–13.109, 14.84–
14.87
types of 13.92–13.93
technical assistance 13.79–13.81
importance 13.189
policy development 13.190–13.193
Policy Support Instruments 13.193
Trade Integration Mechanism (TIM) 13.234
transparency 13.242
voting rights 5.66, 13.03
withdrawal from 13.13
International Monetary Fund Committee 13.16–13.17
International Organization of Securities Commission (IOSCO) 3.107, 14.39
International Swaps and Derivatives Association (ISDA) 2.207
International Trade Organization 12.02
Ireland
ESMT legality challenge 8.183–8.192
financial crisis 8.97, 8.177
Italy
Jackson, Howell, E. 5.44, 5.47, 5.51, 5.55
James, Harold 12.13
Japan
central bank easing 2.98
deflation 2.98
Yen as reserve currency 12.54
Jeanneau, Serge 3.66
Joint Forum on Financial Conglomerates 14.194
judiciary
accountability 2.174, 2.191–2.192
independence 2.167–2.168, 3.35
law-making function 8.13, 8.211
Kaufman, George G. 4.70, 4.123
Kenen, Peter 6.106
Keynes, John Maynard 2.103, 12.03, 12.10, 12.15, 12.19–12.21, 13.59–13.60, 13.73, 14.200
Kindleberger, Charles P. 4.05, 4.07, 4.169
Lamfalussy, Alexandre 8.15
Lamfalussy Procedure 10.07, 11.18–11.24
Lamy, Pascal 8.17
Lane, Philip 6.113
Latvia
law, generally see also law reform; soft law
cross-border transplantation of 14.94
definition 5.25
elasticity of 5.24, 5.27
evolution 14.88–14.94
law-finance paradox 5.23
legal origins theory 5.18–5.19
legal theory of finance 5.20–5.27
lex financiera 14.93–14.94
lex mercatoria 14.91–14.93
lex specialis 4.59–4.67, 4.69, 4.162
model law and model clauses 4.96–4.98, 5.52–5.57
rule-bound systems, and 5.22
law reform
features 5.30–5.35
methods 5.43–5.67
domestic legal system development 5.44–5.45
foreign law, local adaptation 5.46–5.47
(p. 621)
foreign law, wholesale adoption 5.48–5.51
international financial standards/soft law, adoption 5.61–5.67
model laws and clauses, adoption 5.52–5.57
regulatory convergence technique harmonization 5.58–5.60
stages 5.29
legal origins theory 5.18–5.19
legal theory of finance 5.20–5.24
Lehman Brothers 4.147
lender of last resort
adverse selection, and 4.15–4.20
banking union, and
financial assistance and state aid rules 10.81–10.90
general market liquidity crisis, and 10.74, 10.80
individual liquidity crisis, and 10.75–10.80
lack of policy on 10.05, 10.69–10.72
payments system crisis, and 10.73–10.90
Basel III 4.23
central banks as 2.16, 2.51–2.54, 3.64, 4.05–4.36
concept development 4.08
constructive ambiguity 4.36, 10.79
cost–benefit analysis 4.20
currency boards, and 2.228, 2.236
emergency liquidity assistance model 4.09–4.14, 4.26–4.28, 4.55
financial crisis 2007–8, role during 4.29–4.35
illiquidity vs. insolvency, interpretation challenges 4.21–4.22
IMF role 14.162–14.173
long-term refinancing operations (LTROs) 4.30
moral hazard, and 4.15–4.20, 14.179
State aid, legality of 4.26–4.28
theory vs. practice 4.21–4.28
Thornton–Bagehot model 4.09–4.10
Levine, Ross 3.94
lex financiera 14.93–14.94
lex mercatoria 14.91–14.93
lex specialis 4.59–4.67, 4.69, 4.162
licensing 3.23–3.24, 3.47
Lichstenstein, Cynthia 14.97
lifeboat operations 4.173
Liikanen Report 3.121, 3.123–3.125
liquidity
Basel liquidity standards 3.32
funding liquidity vs. market liquidity 4.150
lender of last resort 2.51–2.54, 4.09
spirals 4.150–4.152
Liu, Tong 14.98
loans 3.31, 3.33
Locke, John 1.17
long-term capital management (LTCM) 4.75, 4.173
long-term refinancing operations (LTROs) 7.46
Louis, Jean Victor 1.43, 8.34, 8.209
Lowe, Vaughan 1.08
Lowenfeld, Andreas 1.65
M-Pesa 1.03, 1.30
Machiavelli, Niccolo 1.13
McKinnon, Ronald 6.106–6.107, 12.53
McNamara, Kathleen 9.12
Madison, James 1.22–1.25
Mann, Frederick A. 1.38, 1.41, 1.44–1.45, 1.54–1.55
market economy
role of law in 5.29, 5.34, 5.36, 5.39
transition to, challenges 2.83
transparency, importance of 2.183
Marshall Plan 6.09, 12.25
Metrick, Andrew 4.133
Meunier, Sophie 9.12
model law
purpose and advantages 5.52–5.54, 14.74
UNCITRAL Model Law on Cross-Border Insolvency 4.96–4.97
Modigliani–Miller theorem 3.30
Moessner, Richhild 4.123
monetary and financial law reform see law reform
monetary law, generally see also Euro; European System of Central Banks; International
Monetary Fund
economic definitions 8.15
public international law, and 1.35–1.39, 1.54
monetary obligations
indestructible nature of 1.41
monetary policy
accountability requirements 2.190
central banks, and 2.25–2.47
balance sheet expansion, and 2.39
disagreements over 2.36
ESCB functions 7.36–7.38, 9.01
financial crisis, standard/non-standard responses to 7.39–7.44
monetary stability 2.87–2.88
necessity for 2.28, 2.33
price stability role 2.33, 2.88, 9.04
privatization or liberalization 2.30
quantitative easing (QE), and 2.35, 2.38–2.39, 2.41–2.42
responsibilities 2.27
rules vs. discretion 2.37
unconventional policies 2.37–2.42
challenges 3.41
developing and emerging economies, influences on 2.45, 2.83–2.84
exchange rate responsibilities, ambiguity in 9.01–9.05, 9.08
fiscal policy, interaction between 2.35, 8.15, 8.17, 8.72
focus, vs. fiscal policy 8.15
monetary matters, definition 9.40
objectives 2.26
public interest, and 2.46
monetary reform
depoliticization of money supply 2.29, 2.113, 2.122
monetary sovereignty
attributes of 1.51–1.54
banking union, and 10.01
boundaries of state, law outside 1.39, 1.47
currency boards, and 1.75, 2.227–2.228
(p. 622)
customary international law, and 1.54
definition 1.09–1.10, 1.37, 1.51–1.52
erosion of 1.02–1.03, 1.43–1.47, 1.56–1.58, 1.66–1.70
exchange rate, control of 1.45, 1.73–1.75
faux currencies, control of 1.72
foreign nationals, discrimination against 1.53
limitations
cross-border capital flows 1.66–1.68
currency deterritorialization 1.68
depreciation and devaluation 1.74
globalization 1.66–1.67
IMF Articles of Agreement 1.64–1.65
international obligations 1.64–1.65
monetary union membership 1.02–1.03, 1.56–1.63
transnational money markets 1.69–1.72
voluntary or consensual 1.56–1.65
money supply and interest rates, controls over 1.68–1.71
notes and coins, issue and regulation 1.20–1.21, 1.25, 1.33, 1.35–1.38, 1.45–1.47, 1.51–
1.52
private notes, control of 2.18–2.20
public international law, and 1.35–1.39, 1.54
territorial dimensions 1.46
monetary stability
central banks, and 2.12, 2.85–2.100, 2.1114
culture 2.86
currency boards, and 2.101, 2.221, 2.225, 2.236
currency value dimension 2.95
definition 2.87–2.88, 2.92–2.95
financial crisis, and 2.90
financial stability, and 3.02
fiscal stability, and 8.02
inflation control, and 2.89
institutional arrangement to promote 2.101–2.103
Maastricht treaty influences 6.53
multiple economic goal management 2.93
oil prices, policy influences 2.97
par value system, role in 6.32
price stability 2.33, 2.88, 2.91, 9.04
principles 2.89
rules vs. discretion debate 2.102–2.103
stability vs. resilience 2.86
state role in 1.34
sustainability, importance of 8.02
Tinbergen Rule 2.93
monetary union see also European Monetary Union
membership implications 1.02–1.03, 1.47, 1.56–1.63
sovereignty, erosion of 1.02–1.03, 1.56–1.63
money see also Euro
concept of 1.29–1.35
denationalization of 1.71
economic definition 1.30, 1.34
fiat money 1.30, 1.32
functions of 1.30–1.31, 1.34
issue and regulation of
commercial bank role 1.70–1.72
ECB, by 7.63, 7.99–7.102
monetary sovereignty, and 1.20–1.21, 1.25, 1.33, 1.35–1.38, 1.45–1.47
monopoly power over 1.33
law, and 1.32, 1.34
legal tender concept 1.44, 1.48–1.49
lex monetae 1.40–1.50
metals used as 1.21, 1.30
monetary aggregates 1.31
necessity of 1.20
private money 1.71
public international law, and 1.35–1.39
scriptural money 1.49–1.50
state, and
issue and regulation by 1.20–1.21, 1.25, 1.33, 1.35–1.38, 1.45–1.47
jurisdiction of 1.40
prerogative power of 1.20–1.21, 1.25
theories of 1.40–1.50, 1.49
value of merchandise as 1.21
virtual money 1.03, 1.30, 2.23
money laundering
Financial Action Task Force on 14.38, 14.71
virtual currencies, vulnerabilities of 2.23
money supply
definition 1.31, 1.70
depoliticization of 2.29, 2.113, 2.122, 2.194
Montesqieu, Charles de 1.18–1.21
moral hazard
deposit insurance, and 4.56
lender of last resort, and 4.15–4.20, 14.179
supervisory authorities, structural reforms 3.126
Morgenthau, Henry 12.71, 14.200
Multilateral Debt Relief Initiative (MDRI) 13.223
Mundell, Robert A. 1.75, 6.106–6.110, 71.54
nationalization 4.171–4.172
net settlement systems payments 4.139
Netherlands
supervisory authorities 3.113
New Arrangements to Borrow (NAB) 13.50–13.52
New Zealand
nominalism, principle of 1.41
North, Douglas 5.07
Northern Rock 10.86
oil prices 2.97
open market operations (OMOs) 4.31
optimum currency area 6.106–6.110
Orderly Liquidation Authority (ODA) 4.62, 4.161
Organization for European Economic Cooperation 14.71
Outright Monetary Transactions 2.35, 4.30, 7.47–7.59
Padoa-Schioppa, Tommaso 3.62–3.63, 6.44, 10.01
par value system
challenges
devaluations, revaluations and floating rates 12.45–12.51
gold reserves and liquidity 12.40–12.44
(p. 623)
collapse
causes 12.35–12.38
implications 1.64, 6.29–6.31, 12.35–12.38, 12.55–12.56, 13.06, 13.57
duration, influences on 12.39–12.51
EMU, influences on 6.29–6.31
IMF role in 12.32–12.34
US dollar influences on 12.49–12.51
Parliamentary Commission on Banking Standards (UK) 3.120
payment
definition 1.35
payment systems
crisis in 10.73–10.90
delivery vs. payment risk (DVP) 4.142
lender of last resort role 10.73–10.90
mobile payment systems 1.03, 1.30
systemic risk, and 4.134–4.145
payments
cross-border, liberalization of 6.11–6.12
digital transactions 1.03, 1.30
PayPal 1.30
peer-to-peer lending 1.03
Polak, Jacques 13.42–13.44
Portugal
financial aid package 8.177
Post-Catastrophe Debt Relief Trust 13.223
Poverty Reduction and Growth Facility (PRGF) 13.53, 13.209–13.212
Poverty Reduction Strategy 13.221
price stability
central banks
accountability 2.97
ESCB objective 2.07, 7.25–7.31
independence 2.136
role 2.07, 2.33, 2.88, 2.91, 2.100, 2.114, 2.116–2.117
definition 2.89, 2.92
ESCB objective, as 2.07, 7.25–7.31
oil shock, historical context 2.97
primary goal of monetary policy, as 2.33, 2.91, 9.04
Tinbergen Rules, and 2.93
privatization
national identity, and 1.58
Proctor, Charles 6.13, 7.95, 13.96
proportionality, principle of 2.42
Prudential Regulatory Authority 3.40
public international law
banking regulation 3.07
monetary sovereignty, and 1.35–1.39, 1.54
sovereignty in 1.07–1.08
quantitative easing (QE) 2.35, 2.38–2.39, 2.41–2.42, 7.43
real-time gross settlement systems payments 4.140
regional adjustment
accession assistance funds 8.202
cohesion funds 8.203–8.204
financial assistance funds 8.201
fiscal coordination 8.198–8.206
sustainability, and 8.200
regulation see also banking regulation; financial regulation
capital regulation 3.29–3.30
competition, and 3.25
design criteria 3.08–3.09, 3.34
judgement-based approach 3.40–3.50
limitations of 3.33
optimal regulation 3.08–3.09
purpose 3.10
supervision, and 3.21
trading, of 3.34
reserve assets
foreign wealth funds 2.213
Reserve Bank of New Zealand 2.180
Rey, Jean-Jacques 14.124
risk
definition and interpretation 3.08
profiles, investors vs. depositors 4.45
risk-taking
moral hazard and adverse selection, and 4.15–4.20
Rodrik, Dani 5.08
Romania
Rooth, Ivar 13.125
Rousseau, J.J. 1.16
rules vs. discretion
monetary policy, in 2.37, 2.102–2.103
regulation and supervision, in 3.44–3.50
Russia 4.171
Sainz de Vicuña, Antonio 1.49
Salacuse, Jeswald W. 5.15
Salzberger, Eli M. 2.225–2.226
Schinasi, Garry 4.129
Schoenmaker, Dirk 3.53–3.54, 10.11
Schwartz, Anna 2.146, 4.114
Scott, Hal 4.118
Scott, Ken 4.147
Securities Market Programme 8.99
securitization
Basel framework treatment 3.30
seigniorage
central bank controls 2.17–2.19, 2.142–2.144
shared 2.18–2.19
Selgin, George A. 2.22
Selmayr, M. 9.34
separation of powers
banks, monetary vs. supervisory functions 3.51–3.57
sovereignty, and 1.19, 1.23
Shin, Hyun Song 4.120–4.122
(p. 624) single market see also financial services
development 6.87–6.95
integration 6.87–6.95
Single Resolution Fund (SRF) 10.38–10.39, 10.55–10.58
Single Resolution Mechanism (SRM)
background 10.38
basis for 10.02, 10.41–10.43
BRRD, and 10.47–10.48
crisis management, and 10.36–10.37
institutional interactions and conflicts 10.58–10.64
jurisdiction of 10.44–10.48
management structure 10.49
Meroni ruling, and 10.42
resolution financing measures 10.55–10.58
resolution procedures 10.50–10.54
Single Supervisory Mechanism (SSM)
administrative review procedures 10.32
Asset Quality Reviews 10.34–10.35
basis for 10.02, 10.04
coordination challenges 11.60–11.65, 11.68–11.69
domestic powers 10.24
ECB role and powers 10.24–10.35
ESRB, interaction with 11.44–11.45, 11.60
Framework Regulation 1.61, 3.16, 10.04, 10.20–10.28
governance 10.29–10.33
preparatory work 10.34–10.35
rationale 10.09
scope of application 10.21
significance test 10.23
single market, conflicts with 10.33, 11.60–11.65, 11.68–11.69
stress tests 10.34–10.35
Supervisory Board role 10.29–10.30
Supervisory Risk Assessments 10.34–10.35
Smith, Adam 5.06
Smits, René 7.55, 8.39, 9.16, 9.28, 9.33–9.34, 9.36
Snidal, Duncan 14.12
social contract theory 1.16
soft law
advantages 5.63, 14.50–14.52
characteristics of 14.13–14.14, 14.43
classification 14.41–14.49
coordination, need for 14.21–14.23
country ownership challenges 14.56–14.63
definitions 14.10–14.17
degree of specificity 14.44
development agencies 14.18–14.23
disadvantages 14.53–14.56, 14.220
effect of 14.42
emerging economies, adoption by 5.61–5.67
enforcement 3.38, 14.65–14.67
G20 promotion role 14.22–14.23, 14.69
IMF/World Bank Standards and Codes Initiative 14.76–14.77, 14.86–14.87
IMF conditionality, and 14.72
implementation 14.64–14.65, 14.68
incentives 14.70–14.75
informal law vs. formal law 14.88–14.99, 14.220
international law prevalence of 14.07
lex mercatoria, and 14.91–14.93
model laws, purpose and advantages 5.52–5.54, 14.74
self-governance 14.67
substantive rules vs. regulatory jurisdictional rules 14.45
‘top down’ rules vs. ‘bottom up’ rules 14.46–14.48, 14.221
vs. hard law 5.62, 14.12, 14.95–14.99, 14.220–14.222
sovereign debt see also Eurozone debt crisis
central bank management role 2.75–2.78
doomed loops 2.78, 10.12–10.13
financial crisis, and 3.30, 14.117–14.118
management responsibility for 2.75–2.76
monetization, EMU prohibition 8.33–8.35
restrictions 14.114–14.115
restructuring
bail outs 14.163, 14.174–14.182
challenges 14.109
code of conduct proposals 14.132–14.136
IMF role in 13.07, 14.107–14.113, 14.118–14.119, 14.137–14182
lending into arrears policy 14.153–14.161
Sovereign Debt Restructuring Mechanism (SDRM) 14.118–14.123
State-contingent bond proposals 14.136
trends 14.107–14.108
Uruguay debt reprofiling 14.127–14.131
sovereign immunity
central banks, and 2.13, 2.198, 2.201–2.204, 2.210–2.220
concept 2.199–2.200
erosion of 2.200
sovereignty see also monetary sovereignty; sovereign immunity
currency, power to issue 1.01, 1.76
definitions 1.06–1.08, 1.10, 1.15, 1.27
democracy, exercise in 1.16, 1.18–1.19, 1.27
erosion of 1.01–1.02, 1.56–1.58
history of 1.09–1.15
law, and 1.37–1.38
monarch, of 1.01, 1.12–1.15, 1.48
people, of 1.16–1.28
public international law, in 1.07–1.08, 1.35–1.39, 1.54
purpose 1.07–1.08
separation of powers, and 1.19, 1.23
social contract theory 1.16
state power, types of 1.57
submission to 1.16–1.17
Spain
financial crisis 8.99, 8.173, 8.177
Special Accession Programme form Agriculture and Rural Development (SAPARD) 8.202
(p. 625) Special Drawing Rights (SDR)
allocation events 13.58
allocation principles 13.55–13.56, 13.61–13.62
authority for 13.40–13.41, 13.54
criticism of 13.56
definition 13.60
establishment 13.03, 13.54, 13.59
Federal Reserve System, under 2.72
importance of 13.57–13.58
interest calculation role 13.58
one-time allocations 13.03
Special Liquidity Scheme (SLS) 4.30
speculation 4.06–4.07
Sproul, Allan 2.47
Stability and Growth Pact 8.63–8.94
background 8.63–8.74
breach of rules, impact of 8.01
Code of Conduct on Content and Format of 8.74
ECJ ruling on 8.86–8.94
flexible vs. rigid policy approach 8.74–8.77, 8.109
Germany, and 8.02, 8.86–8.94
objectives 8.02, 8.75–8.84
practical influences of 8.85
revision 8.73–8.74
scope 8.69
Stability, Coordination and Governance Treaty (TSCG) 8.10–8.11, 8.13, 8.116–8.117, 8.163–
8.164
stagflation 2.97
Standing Committee on Standards Implementation (SCSI) 14.71
State aid
bank insolvency, and 4.27, 4.78–4.79
central banks, and 10.81–10.90
crisis rules extension 10.87–10.90
emergency liquidity assistance, legality of 4.26–4.28, 10.86
institutional cooperation, need for 10.83
Subramanian, Arvind 5.08
subsidiarity, principle of 10.76–10.77, 10.79
supervision
definition 3.06, 3.14–3.16, 3.27
failure, state liability for 3.104–3.105
independence, and 3.101–3.109
institution, by 3.110–3.115
intensity, and capitalization 3.32, 4.12
judgement-based approach 3.40–3.50
macro- vs. micro-prudential supervision 2.57–2.61, 2.63, 3.14–3.16, 3.40, 3.60–3.71
market supervision 3.94
process 3.18–3.22, 3.27
licensing, authorization, and chartering 3.23–3.25, 3.47
regulation 3.28
stricto sensu 3.20, 3.26–3.34, 3.48
public vs. private 3.94–3.100
purpose 3.45
regulation, links between 3.21
self-regulation 3.99
supervisory authorities see also European Banking Authority; European Supervisory
Authorities (ESAs)
centralization vs. decentralization 3.91–3.92
fragmentation 3.04, 3.90
institutional design 3.05
national models, historical and political influences on 3.86
optimal number 3.04, 3.85–3.93
optimum responsibilities debate 3.02, 3.04
regulation by business function 3.110–3.113
regulatory responsibilities 3.21
single authority, case for 3.88–3.89
structural reforms 3.116–3.129
jurisdiction shopping implications 3.123
Liikanen Report 3.121, 3.123–3.124
moral hazard challenges 3.126
objectives 3.117
public subsidies, and 3.125–3.127
ring-fencing 3.120, 3.124
separation of commercial and investment banking 3.119, 3.122
taxation, and 3.128–3.129
UK, in 3.118–3.120, 3.128–3.129
Vickers Report 3.119–3.122, 3.124–3.125
Volcker Rule 3.122
swaps 2.207–2.208
Sweden 4.170
central bank establishment 2.07
currency devaluation 12.59
systemic risk
analysis of 4.114
causes 4.120–4.121
derivatives markets 4.129, 4.131–4.132
domino effect 4.113–4.115, 4.130, 4.151
institutional interconnectedness 4.128, 4.158–4.164, 4.168
contagion mechanisms 4.125–4.127
information flow 4.146–4.152
inter-bank, inter-institution, and inter-instrument influences 4.128–4.133
payments systems 4.134–4.145
psychological influences 4.153–4.157
definitions 4.04, 4.113, 4.117–24, 4.161, 4.168
financial stability, and 3.68, 4.119
geographical reach of 4.166–4.167
Herstatt risk 4.142
macro vs. micro dimensions of 4.121–4.124
risk prevention and resolution 4.165–4.174
system crisis management theories 4.168–4.174
time, influences on 4.142, 4.168–4.169
TARGET 4.139, 4.145
Taylor, John 4.147
Term Auction Facility (TAF) 4.30
Thieffry, Gilles 11.12
Thornton, Henry 2.65, 4.09–4.10, 5.06
Thygessesn, Niels 10.11
(p. 626) Timberlake, Richard H. 2.49
too-big-to-fail doctrine 3.39, 3.121, 3.125, 4.50, 4.159
Toqueville, Alexis de 1.26–1.28
trading regulation 3.34
transparency
accountability, and 2.177, 2.183, 2.185–2.186, 2.193
balance sheet asset treatments, and 4.147–4.148
concept development 2.183
constructive ambiguity, and 10.79
crisis management 2.193
ECB, of 7.89
essential elements 2.184
financial supervision 2.193
IMF Codes of Good Practice 14.38
IMF, of 13.242
information disclosure, and 2.186
legal obligations, clarification challenges 2.193
reporting requirements 2.193
rules vs. discretion, in monetary policy 2.37
Treves, Tullio 1.37
Triffin, Robert 12.35–12.37
Troubled Asset relief Program (TARP) 4.172, 4.174
UN Convention on Jurisdictional Immunities of States and their Properties 2.200–
2.202
United Kingdom
bank insolvency regime 4.63, 4.95
European Monetary Union opt-out 6.59
financial supervision challenges 11.67
sovereign immunity 2.200–2.202, 2.215–2.218
sterling
devaluation 12.46
supervisory authorities
development trends 3.113–3.115
reform 3.118–3.120, 3.128–3.129
United Nations Commission on International Trade Law (UNCITRAL)
Legislative Guide on Insolvency Law 4.97–4.98
model laws
cross-border insolvency 4.96–4.97
purpose and advantages 5.52–5.54
United States see also Federal Reserve System
bank insolvency regime 4.61–4.62, 4.80
banking supervision model 11.10
central banks 2.201–2.202, 2.218–2.220
deposit insurance regime 4.12, 4.61
dollar
devaluation 12.49–12.51
Financial Stability Oversight Council 2.16, 2.59, 2.62, 3.80, 11.30
financial supervision
jurisdictional challenges 11.66
supervisory authority reforms 3.121
Humphrey–Hawkins hearings 2.180
independent agencies, democratic legitimacy 2.159–2.160
Orderly Liquidation Authority (ODA) 4.62
sovereign immunity 2.200–2.202, 2.218–2.220
Uruguay
debt reprofiling 14.127–14.131
utilities regulation 2.162
Valukas, Anton 4.147
Van Rompuy Task Force 8.119, 8.165, 10.18
Venezuela 4.170
Vickers Report (UK) 3.119–3.122, 3.124–3.125
virtual money 1.03, 1.30, 2.23–2.24
Voigt, Stefan 2.225–2.226
Volcker, Paul 2.33
Wahlig, Bertold 1.42
Washington Consensus
criticism 5.11–5.12
definition 13.168
emerging economies, influences on 5.10–5.12
legacy 5.14, 5.17–5.28
Salacuses’s developmental models 5.15–5.16
Werner Report 6.17–6.21
White, Harry Dexter 12.03, 12.15–12.19, 12.28, 13.60, 13.73
White, Lawrence H. 2.22, 2.28
White, William 2.37, 2.90
Williams, Mark 2.24
Williamson, John 2.230, 5.10–5.12
World Bank
EU monetary union, influences on 6.08–6.09
ICR Standard 4.98–4.99
purpose 12.21
World Financial Organization (proposal) 14.25, 14.189–14.204
World Trade Organization 12.02, 14.215
Zilioli, Chiara 7.87, 7.89–7.90, 9.34
Zimmerman, Claus D. 1.51

Foreword: International Monetary Stability (OUP, 2006), I Very Much Doubt Whether She Then Expected

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Foreword: International Monetary Stability (OUP, 2006), I Very Much Doubt Whether She Then Expected

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Foreword

From: International Financial and Monetary Law (2nd Edition)

Content type: Book content

From: International Financial and Monetary Law (2nd Edition)

Content type: Book content

From: International Financial and Monetary Law (2nd Edition)

Content type: Book content

From: International Financial and Monetary Law (2nd Edition)

Content type: Book content

Table of Cases xxiii

Table of Legislation xxv

List of Abbreviations xliii

I Developments at the National Level

1. Monetary Sovereignty

A. Introduction 1.01

2. Central Banking Law

A. Introduction 2.01

3. Supervision, Regulation, and Financial Stability

A. Introduction 3.01

4. Crisis Management

A. Introduction 4.01

5. Law Reform in Emerging Economies

A. Introduction 5.01

II Developments at the EU Level

6. History of Monetary Integration in Europe

A. Introduction 6.01

A. Introduction 7.01

8. Economic Governance

A. Introduction 8.01

9. External Aspects of EMU

A. Introduction 9.01

10. Banking Union

A. Introduction 10.01

11. European Financial Architecture

A. Introduction 11.01

III Developments at the International Level

12. History of International Monetary Cooperation

A. Introduction 12.01

13. The Law of the International Monetary Fund

A. Introduction 13.01 (p. xxii)

14. International Financial Architecture

A. Introduction 14.01

From: International Financial and Monetary Law (2nd Edition)

Content type: Book content

BVerfG, 2 BvR 1390/12 (12 September 2012) German Constitutional Ct 7.50

Casati, Re (203/80) [1981] ECR 2595 6.12

Case Concerning the Payment in Gold of Brazilian Federal Loans Contracted in

Commission of the European Communities v Council of the European Communities

Commission of the European Communities v European Central Bank (OLAF case)

Costa v Enel (6/64) [1964] ECR 585 1.59

Estager SA v Receveur principal de la recette des douanes de Brive (C-359/05)

Gaston Schul Douane Expediteur BV v Inspecteur der Invoerrechten en Accijnzen

Peter Gauweiler (C-62/14) pending 7.50

Peter Paul v Bundesrepublik Deutschland (C-222/02) [2004] ECR I–09425 2.193,

Schlüter v HZA Lörrach (9/73) [1973] ECR 1135 6.12

SS ‘Lotus’ (France v Turkey), Judgment, 7 September 1927, PCIJ, Ser A, No 10 14.08

Thesing and Bloomberg Finance v ECB (C-28/13 P) 7.87

Trinh v Citibank, 850 F 2d 1164 (6th Cir 1988) 4.95

Tyson v United States 285 F 2d 19 (1960) 1.48

Wade case [1601] 77 ER 232 1.48

Züchner v Bayerische Vereinsbank (172/80) [1981] ECR 2021 4.26, 10.85

From: International Financial and Monetary Law (2nd Edition)

Content type: Book content