Banking Supervision in Integrated Financial Markets: Implications for the EU



ing for all member states. The new Capital Accord (Basel II) will also be
implemented via EU legislation. Like its predecessor, Basel II focuses on the
calculation of risk-based capital requirements. Besides, Basel II assigns an
important role to supervisors who control the banks’ compliance with these
rules and take countermeasure in case of deviation. In order to strengthen
their powers, the new accord intends to give supervisors more leeway to use
instruments they consider appropriate.3

In contrast to the supranational approach to regulation, supervision stays
with national authorities.4 In the EU, this national approach of supervision
is implemented by the home country principle which assigns responsibility
for overseeing banks to the national authority in the banks’ home country.
Furthermore, the principle of consolidated supervision requires that the home
supervisor is not only liable for a national bank’s activities inside the coun-
try’s borders, but for the control of the whole financial group. However, in
practice, banking supervisors in the EU cooperate bilaterally on the basis of
so called Memoranda of Understanding (MoUs). These serve to specify the
cooperation between supervisors as envisaged in the Second Banking Coor-
dination Directive. MoUs typically include practical provisions with regard
to the exchange of information.

As I will argue, this national approach to supervision will not imple-
ment an overall EU optimum when an individual bank failure in one country
could trigger negative spillover effects in another country. Cross-border es-
tablishments and the interbank market are the most probable channels for
inter-country contagion. With respect to cross-border establishments, one
finds that market shares of foreign banks are extremely high for Ireland and
the UK, but remain moderate for most EU countries (see Figure 1). Hence,
this channel may gain relevance in the future, but is currently not the most
probable one.

In contrast, integration of the interbank market seems rather complete.
The largest part of total interbank activity in euro, namely 70%, takes place
in the interbank market for unsecured deposits.5 The TARGET system is
the primary channel for conducting and settling these unsecured interbank
transactions in the EU. The TARGET statistics of May 2002 show that the
share of cross-border payments in all payments is 21.9 % in volume and 31.1
% in value. Onother observation is the emergance of a ”tiered” interbank

3 The proposal for Basel II states that ”supervisors should have the discretion to use
the tools best suited to the circumstances of the bank and its operating environment.”
See Basel Committee on Banking Supervision (2001), p.31.

4See the Economic and Financial Committee (2000) for further details on the current
EU framework of supervision.

5 See Santillan, Bayle, and Thygesen (2000).



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