PARIS (MNI)- The following is the text of a letter by Mario Draghi
in his capacity as chairman of the European Systemic Risk Board to
European Union legislators. The letter seeks to help legislators
develop the legal basis for policies to address future threats to
financial stability in the European Union.

“Dear Sir/Madam,

The EU institutions are working to reform the prudential
supervision of banks through the Capital Requirements Regulation and
Directive (CRR/CRD). With this letter, the ESRB seeks to convey to you
and the broader public some principles regarding these reforms from a
macro-prudential angle. It hopes that these principles will
assist legislators in further developing the basis for macro
prudential actions within the CRR/CRD and in finalising the reforms.

The CRR/CRD reforms arise from the Basel Ill Agreement and the
report of the de Larosiere Group, which recommended a single rule
book for the supervision of banks and the establishment of a
macro-prudential framework. Also from a macro-prudential
perspective, the ESRB regards as essential a single rule book based
on common definitions for both prudential methodologies and requirements
across the Union, and on the full implementation of Basel Ill.

In pursuing these reforms, the diversity of our Union and
the risks its economic and financial systems may give rise to must
hold centre stage. Policies must be commensurate with the scale and
evolution of future threats at both EU and Member State level, and
biases toward inaction must be avoided. Under a single rule book,
this approach to risks requires a framework that permits
constrained discretion, with workable safeguards, for
macro-prudential authorities at both Member State and Union level
to tighten calibrations (while leaving definitions untouched) of
commonly defined prudential requirements. This was advocated also
by the de Larosiere Group (Recommendation 10) and is consistent with
advice to the G20 by the Financial Stability Board, International
Monetary Fund and the Bank for International Settlements.

Furthermore, the macro-prudential framework must be designed
to tackle systemic risk, which includes risks from a wide range of
sources: from within the financial system (given intra-system
interconnections and contagion between banks, and between banks
and others including nonregulated entities or ‘shadow banks’);
from the system to the real economy; and from strong feedback
mechanisms between the two.

The ESRB has identified three principles to underpin such a
framework: flexibility, scope to act early and effectively, and
efficient coordination consistent with a ‘constrained discretion’
approach to macro-prudential policy in the EU and its Member States.

First, authorities will require flexibility in the set of available
policy tools to both prevent and mitigate specific risks.
Macro-prudential authorities at both Member State and Union level need
discretion to require additional disclosures and to tighten
temporarily a diverse range of (Pillar I) calibrations: for broad
requirements, such as aggregate capital levels, liquidity
requirements and limits to large exposures and to leverage;
and for more targeted requirements, such as sectoral
capital requirements to address specific vulnerabilities (e.g.
household, corporate, real estate, intra-financial system) across the
different parts of banks’ balance sheets (banking and trading books)
in order to limit arbitrage. The ESRB is working to develop
macro-prudential tools further and, where they are used also for
micro-prudential purposes, on ways to ensure consistency.

Second, macro-prudential policy must have the scope to act early
and effectively before the build up of significant imbalances or
unstable interconnections, having regard for unintended
consequences. This requires a framework that supports the use of the
most effective policy tools, for a given risk, in a pre-emptive,
timely and efficient manner. Exposures to the same risk must be
treated consistently: where institutions exposed to a risk in one
Member State are regulated by other Member States, provision should
be made for, at least, the voluntary mutual recognition of policy
measures between the States concerned.

Finally, discretion to pursue macro-prudential policies in these
ways requires efficient coordination as a safeguard to limit possible
negative externalities or unintended effects for the sustainability
of the single market in financial services or for the economies
of other Member States. However, tightening calibrations imposes
short-term costs also on initiating Member States, with positive
stability externalities across the Union. That calls for
ex-ante exchange of information and coordination, rather than
for an authorisation procedure by a European body. Without any
prejudice to the role of the Commission under the acquis
communautaire, competence for this coordination lies with the ESRB as
the Union’ s macro-prudential overseer.

The ESRB is working out procedures which would support
efficient ex-ante coordination, on the basis of advance
notification to the ESRB of proposals for macro-prudential action to
tackle risks, and with discussions in parallel with the national
approval processes as appropriate. Where the ESRB determines that
the risks that led to stricter prudential requirements are not
justified or cease to exist, the ESRB would issue a recommendation
to the Member State in question to remove or adjust the measure. In
case of an inadequate follow-up to that recommendation, the ESRB would
recommend to the European Commission that it considers appropriate
action.

This letter will be published on the ESRB’s website on Monday 2
April 2012.”

Paris newsroom, +33142715540; jduffy@marketnews.com
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