Banking and Supervision

Banking, Financial Regulation, and Supervision
In the wake of the financial crisis that began in the summer of 2007 in the U.S. subprime mortgage market, governments of major financial markets throughout the world are taking various steps to strengthen market regulation.

The credit crisis has exposed serious flaws in the financial system. Whereas most media attention focuses on greed and incompetence, some structural flaws deserve more academic interest. They relate to banks’ choice of business model and internationalization strategy, the way bank supervision is organized and the pro-cyclical effects of financial integration in the Eurozone.
 
The current problems partly have to do with a shift from relationship-oriented banking to transaction-oriented banking. In addition, banks’ risk profiles are raised by expansive international strategies. One question is therefore: which business model is right for banks? Do we have to move to smaller and less risky banks?
 
Second, how can we organize supervision of international banks? This question addresses the problem of having a domestic safety net (and thus domestic supervision) while simultaneously allowing banks to be active across borders. What are the advantages of international banking, compared to the risks of having banks whose size has outgrown the domestic economy? What can be done to control these risks? In the European context the presence of many national supervisors and regulators leads to distortions in the European financial services industry and may inhibit the creation of a single market in financial services. The EU seems to stand at a cross-road and will need to decide on whether to move forward in financial integration, or take a step back and ring-fence banking activities along national lines.
 
Further, within a monetary union, regional inflation differentials, working their way through real interest and real exchange rates, can cause pro-cyclical macroeconomic effects. In the Eurozone, these effects are augmented via the financial sector, as increasing financial integration and internationalization of the banking industry makes it easy for funds to flow across borders to booming member countries. Questions about whether monetary authorities should monitor the systematic macroeconomic risk associated with European financial and monetary integration and whether policymakers have the tools to mitigate the pro-cyclical effect of financial integration arise.
 
Blog Prof. Dr. Ivo Arnold

Ivo Arnold is Professor of Economics at Nyenrode Business Universiteit and Vice Dean at Erasmus School of Economics. His main research interests are European monetary and financial integration and exchange rate behavior. Read more about Ivo Arnold by visting his blog.

​Structured finance outlet
Dennis Vink is Professor of Finance and Investment, and Director of the Center for Finance at Nyenrode Business Universiteit. His research interests focus on structured finance and investment in the European market. Read more about the professional structured finance outlet of Dennis Vink.

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