ELLO l a i t n e n d o i u s r i p v o r r e c p Ma ing Su olicy Bank netary P & Mo raction ion LUC OR A AM te an Un n I l Lega e Europe in th Macroprudential Banking Supervision & Monetary Policy Luca Amorello Macroprudential Banking Supervision & Monetary Policy Legal Interaction in the European Union Luca Amorello Cleary Gottlieb Steen & Hamilton LLP London, UK ISBN 978-3-319-94155-4 ISBN 978-3-319-94156-1 (eBook) https://doi.org/10.1007/978-3-319-94156-1 Library of Congress Control Number: 2018948902 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer International Publishing AG, part of Springer Nature 2018 This work is subject to copyright All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations Cover illustration: Achim Thomae / Getty Images Cover design by Akihiro Nakay This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland Acknowledgments This book is dedicated to my mentor Prof Mauro Bussani (University of Trieste and University of Macau), whom I greatly admire Throughout the process of writing this book, many law and economics scholars and practitioners have taken time out to help me Special thanks go to my supervisor, Prof Helmut Siekmann (Goethe University of Frankfurt), for his patience and guidance In addition, I would like to give a special thanks to Dr Francesco Papadia (Bruegel), and Dr Francesco Mazzaferro (ESRB Secretariat), for providing precious feedback and contributions to this book For valuable comments and inputs, I also thank Avv Giuseppe Napoletano (Banca d’Italia), Prof Isabel Feichtner (Goethe University of Frankfurt), Prof Brigitte Haar (Goethe University of Frankfurt), Prof Rosa Lastra (Queen Mary Law School), Prof Katerina Pistor (Columbia Law School), Olaf Weeken (ESRB Secretariat), Dr Norbert Metiu (Deutsche Bundesbank), Frank Dierick (ESRB Secretariat), Mario Marangoni (Banca d’Italia), Kosmas Kaprinis (Oxford University), Jurgita Abisalaite (ESRB Secretariat), and Giovanni Di Balsamo (ESRB Secretariat) I would also like to thank all my colleagues in the PhD/ Doctoral Program in Law and Economics of Money and Finance for their help and encouragement I would like to thank Banca d’Italia for the financial support provided through the ‘Menichella Scholarship Award’, which helped me finance my doctoral program, and the ESRB Secretariat for the theoretical and practical teachings in in the field of macroprudential policy and regulation Finally, very special thanks to my parents, Paolo and Rosamaria, for their love, understanding, and financial support during these years abroad v Contents 1 Introduction 1 1.1 Reasons for a Research 1 1.2 The Problem at Issue 4 1.3 The ‘Legal Interaction’ in a Nutshell 6 References 8 2 Law and Economics of Macroprudential Banking Supervision 11 2.1 Defining Macroprudential Policy 11 2.2 Legal Components of the Macroprudential Policy Definition 28 2.3 The EU Regulatory Archipelago 47 2.4 A European Institutional Overview 65 References 90 3 A Legal Approach to Monetary Policy 109 3.1 Past Experiences and Main Developments in Monetary Policy109 3.2 The Monetary Policy Transmission Channels in a Nutshell124 3.3 Price Stability, Instruments, and Monetary Transmission Mechanisms Under a Legal Perspective139 3.4 Monetary Policy in the Institutional Framework of the EU165 References 182 vii viii Contents 4 Policy Interactions and Conflicts 205 4.1 Interactions Between Monetary Policy and Financial Stability205 4.2 Interactions Between Macroprudential Policy and Price Stability220 4.3 Policy Complementarities and Risk of Conflicts230 4.4 Addressing the Conflicts239 References 254 5 The Legal Interaction in the EU Institutional Framework 265 5.1 Defining the Legal Interaction265 5.2 The Legal Interaction in the EU Regulatory Architecture276 5.3 Possible Conflict of Policies as a Problem of Rules?301 5.4 The Legal Limits of the ESRB314 References 328 6 Some Concluding Remarks 337 6.1 Rethinking the Interaction Between Macroprudential Supervision and Monetary Policy338 6.2 Expanding the Array of Policy Instruments by Exploiting the Legal Interaction341 6.3 A Cornerstone for a ‘Law and Macroeconomic’ Analysis342 Reference 344 Glossary 345 References 349 Index 405 List of Tables Table 2.1 Table 2.2 Table 3.1 Table 5.1 Example of indicators for typology of systemic risk Lists of macroprudential tools classified by systemic risk typology and strategy Main legal features of ECB monetary policy instruments National authorities entrusted with macroprudential powers 41 44 153 295 ix CHAPTER Introduction 1.1 Reasons for a Research It is not a revelation that the 2008 global financial crash considerably distressed the European Union and its members leading to the worst recession in Europe since World War II. A fundamental lack of understanding of system-wide risk and the failure to appreciate the threat posed by aggressive risk-taking behaviors of financial institutions led to underestimate the consequence of excessive accumulation of growing debt and leverage which resulted from booming credit and asset prices.1 Defaulting loans secured by mortgages2 and securities mispricing3 in a deregulated environment played a key role in catalyzing the eruption of the banking system’s failure that ultimately resulted in an impairment of the real and financial transmission channels.4 Further, the soft touch supervision helped amplifying the externalities related to financial shocks.5 Attempts made by some European governments to bail out the banking system eventually triggered a dramatic increase of public debt Galati and Moessner (2013), p. 846 For a better understanding on the role of mortgages defaults in 2007 crisis, see Mayer, Pence, and Sherlund (2008) See Levitin and Wachter (2012), pp. 1177–1258 See also Ball (2009) For a better insight of the real and financial transmission channels, see BCBS (2011) Enoch, Everaert, Tressel, and Zhou (2013), p. 8 © The Author(s) 2018 L Amorello, Macroprudential Banking Supervision & Monetary Policy, https://doi.org/10.1007/978-3-319-94156-1_1 2 L AMORELLO across many EU countries, leading to the outbreak of the Eurozone Debt Crisis.6 Among different views upon the reasons behind the European financial turmoil, the law & economics literature acknowledges that a prominent fraction of responsibilities lies on the institutional features and competences of the European Monetary Union and, more broadly, of the European Union as a whole.7 As a result, the European debt crisis brought about not only a change in the EU statutory framework8 but also a shift in the institutional competences of the European institutions with the establishment of new supervisory authorities and institutional powers.9 One of the key attributes of the institutional response against the financial turmoil lies in the unconventional reaction of both monetary and prudential authorities seeking to restore the sustainability of the financial markets For decades mainstream central banking has been dominated by the target of price stability, and conventional operating instruments have been implemented rather straightforward.10 The struggle for price stability (and/or full employment) through the influence of the short-term interest rate represented the ultimate objective of monetary policy, while open market operations were the artillery used to meet the desired interest rate target Simultaneously, separate prudential agencies have relied mainly on microprudential regulatory instruments aimed at protecting the soundness and prudent management of private Inter alia, see on the issue: Reinhart and Rogoff (2011), pp. 1676–1706; Mody and Sandri (2011) More generally, about the transmission from banking sector stress to sovereigns, see Correa and Sapriza (2014) On this topic, see Dabrowski (2009); Avgouleas and Arner (2013); Vourloumis (2012) Besides, see also the Communication from the Commission—From financial crisis to recovery: A European framework for action, COM/2008/0706 final, Brussels, 29 October 2008 where the Commission stated the ‘need to redefine the regulatory and supervisory model of the EU financial sector, particularly for the large cross border financial institutions’ We refer, in particular, to the approval of the ‘EU Stability and Growth Pack’, designed to ensure that countries in the European Union pursue sound public finances and coordinate their fiscal policies, and the following ‘EU Six Pack’, containing five regulations and one directive intended to tighten economic coordination and macroeconomic surveillance among Eurozone countries For example, we refer to the establishment of the European Stability Mechanism (ESM), and of the European System of Financial Supervision (ESFS) comprising the European Supervisory Authorities (ESAs) and the European Systemic Risk Board (ESRB) See also the creation of the Single Supervisory Mechanism (SSM), the Single Resolution Mechanism (SRM), and the Single Resolution Fund (SRF) 10 For details, see Wachtel (2011) 394 References Rochet, Jean-Charles (2008a) Procyclicality of Financial Systems: Is There a Need to Modify Current Accounting and Regulatory Rules?, Banque de France Financial Stability Review, No 12 Rochet, Jean-Charles (2008b) Liquidity Regulation and the Lender of Last Resort, Banque de France Financial Stability Review, No 11 Rodríguez-Moreno, María, Pa, Juan Ignacio (2013) Systemic Risk Measures: The Simpler the Better?, Journal of Banking and Finance, Vol 37, Issue Roger, Scott (2010) Inflation Targeting Turns 20 IMF Finance & Development, Vol 47, No Roger, Scott, Vlček, Jan (2011) Macroeconomic Costs of Higher Bank Capital and Liquidity Requirements, IMF Working Paper, No 103 Rogoff, Kenneth (1985) The Optimal Degree of Commitment to an Intermediate Monetary Target, Quarterly Journal of Economics, Vol 100 Rogoff, Kenneth (1986) Social Institutions for Overcoming Monetary Policy Credibility Problems, Paper Presented at the American Economic Association Meetings, New Orleans, December 1986 Rosenfeld, Micheal (2001) The Rule of Law and the Legitimacy of Constitutional Democracy, Southern California Law Review, Vol 74 Rothbard, Murray N (1995) Classical Economics An Austrian Perspective on the History of Economic Thought, Vol II, Edward Elgar Publishing Company, Brookfield, Vt Rubio, Margarita, Carrasco-Gallego, José A (2014) Macroprudential and Monetary Policies: Implications for Financial Stability and Welfare, Journal of Banking & Finance, Vol 49 Ruser, Alexander (2015) By the Markets, of the Markets, for the Markets? 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The Impact on Systemic Risk by Imposing a Capital Requirement, DNB Working Paper No 256/July 2010 Index B Bank for International Settlements, 89, 168 Banking supervision Internal Capital Adequacy Assessment Process, 57 Internal Liquidity Adequacy Assessment Process, 57 Pillar I, 57 Pillar II, 57 Pillar III, 57 Supervisory Review and Evaluation Process, 57, 58, 286 Basel III, 48, 51, 52, 61, 322 countercyclical capital buffer, 51 Bundesbank, 170 E EU regulatory framework capital conservation buffer, 55 Capital Requirement Directive, 52, 53, 84, 87 Capital Requirement Regulation, 52, 60, 84, 87 Committee of European Banking Supervisors (CEBS), 67 Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS), 67 Committee of European Securities Regulators (CESR), 67 conditionality, 157 countercyclical capital buffer, 53, 54, 238 De Larosière Report, 49, 50, 65, 66, 69, 268 ECB monetary policy guideline, 151, 152 economic policy, 156–158 EU macroprudential layer, 280, 282 European System of Financial Supervision (ESFS), 51, 66–67, 69, 70 European Systemic Risk Council (ESRC), 50, 67 Eurosystem, 152, 169, 171, 172 G-SII buffer, 54 Harmonised Index of Consumer Prices (HICP), 146, 148 © The Author(s) 2018 L Amorello, Macroprudential Banking Supervision & Monetary Policy, https://doi.org/10.1007/978-3-319-94156-1 405 406 INDEX EU regulatory framework (cont.) harmonization, 149, 271, 280, 303, 305 liquidity coverage ratio, 60, 61 Mediation Panel, 289, 291 monetary financing, 155, 158, 159, 161 monetary policy instruments, 150–152, 156, 162 national designated authorities, 83, 85, 180, 292, 296 national flexibility measures, 59, 63, 84 national macroprudential layer, 281–283, 291 Net Stable Funding Ratio, 60, 62, 303 O-SII buffer, 54 Pillar Instruments, 57, 58, 62 price stability, 143, 145, 148, 150, 155, 160 proportionality test, 155, 159, 161 structure, 268, 270, 271 systemic risk buffer, 55 system of checks and balances, 302, 307, 311, 313, 315, 321 European Central Bank decision-making, 176 ECB staff, 177 ESRB support, 77, 78, 281 Executive Board, 172, 178 Governing Council, 146, 149, 152, 171, 172, 176–178, 268, 287, 288, 290, 291, 339 macroprudential tasks, 84, 86, 286, 303 Pillar strategy, 176, 309, 310 principle of decentralization, 175, 176 Single Supervisory Mechanism, 84, 88, 180, 283, 285, 286, 288–290, 303, 304 Supervisory Board, 286, 290, 291, 319, 326 European Supervisory Authorities macroprudential tasks, 81 European Systemic Risk Board competences, 73, 280, 314, 318 General Board, 79, 89, 283, 325–327 impartiality, 78–80, 316, 318, 326 instruments, 73, 75, 180, 317, 321 objectives, 71 Secretariat, 77 structure, 74, 75, 79, 315, 325 European System of Central Banks, 168–170, 172 Committees, 177 hierarchy, 181 independence, 172–175, 177, 285, 287, 317, 319, 322 macroprudential tasks, 279–281, 308 national central banks, 151, 168, 176, 178–181, 268, 290, 339 principle of decentralization, 179 supervisory competences, 76 F Federal Reserve System, 170 Federal Open Market Committee, 170 Federal Reserve Banks, 170 Financial cycles, 27, 33, 34, 45, 48, 210, 215, 224, 230, 236, 251, 270, 305 Financial instability definition, 21, 30 Financial Instability Hypothesis, 15, 17 Financial Stability Board, 89 Financial system structure, 25, 26, 28 I International Monetary Fund, 89 early warning exercises, 89 INDEX M Macroprudential policy definition, 11, 13, 14, 19, 24, 28, 37 discretion-based approach, 45, 46 indicators, 39, 40 instruments, 45, 52, 63 objectives, 29–32 rule-based approach, 45 strategies, 38, 42, 43, 305, 306 Microprudential policy, 19, 21–23 Monetary policy asset prices channel, 127 balance sheet channel, 130 bank lending channel, 129 Bretton Woods, 110, 111 business cycles, 269, 270, 272 consumer price index, 118 exchange rate channel, 126 inflation targeting, 114–117, 119 instruments, 120, 122, 125, 134, 150 interest rate channel, 126 intermediate objectives, 122, 159 juridification, 147 legal construction, 167 Outright Monetary Transactions, 147, 154, 161, 163 Period of Great Inflation, 111 portfolio balance sheet channel, 136 price stability, 117, 143 risk-taking channel, 131 signaling channel, 136, 165 Taylor curve, 113 transmission channels, 124, 125, 157, 162 transmission mechanism, 124, 162, 164 transparency, 133 unconventional instruments, 135, 137, 164, 212, 268, 324, 340 407 N National macroprudential authorities, 82, 83, 282, 292, 293, 296, 300 National measures debt-to-income, 64 loan-to-deposits, 64 loan-to-income, 63 loan-to-stable-funding, 64 loan-to-value, 63 O Ordo-liberalism, 139, 142 P Policy interactions, 206, 208 accountability, 244, 245, 248, 252, 253 asset encumbrance, 322, 323 asset price channels, 214 bank lending channel, 215 bank-sovereign nexus, 323, 324 constitutional constraints, 271, 272, 274–276, 320, 321, 324, 343 coordination, 211, 230, 238–243, 245, 248, 249, 251–253, 266–267, 283, 300, 327 exchange rate channel, 213, 223 information sharing, 243, 248, 252 interest rate channel, 213, 222 lending decisions, 222 liquidity coverage requirement, 225 Loan-to-Value Cap, 305 net stable funding requirement, 226 political pressure, 244, 272 principle of effective market classification, 231 real estate prices, 227, 228 risk of conflicts, 230, 231, 235, 237, 239, 291, 313 risk-taking channel, 217–219, 222, 236 408 INDEX S Systemic risk cross-sectional dimension, 34 definition, 22, 23, 32, 33 endogenous risk, 23 exogenous risk, 23 taxonomy, 35, 36 time dimension, 33 U Ultra vires act, 154 .. .Macroprudential Banking Supervision & Monetary Policy Luca Amorello Macroprudential Banking Supervision & Monetary Policy Legal Interaction in the European... and Economics of Macroprudential Banking Supervision 2.1 Defining Macroprudential Policy A legal analysis on the interactions between macroprudential supervision and monetary policy requires... References 8 2 Law and Economics of Macroprudential Banking Supervision 11 2.1 Defining Macroprudential Policy 11 2.2 Legal Components of the Macroprudential Policy Definition 28 2.3 The