Increasing integration within the European Union (EU) gives rise to cross-border spill-over effects or externalities. The present national based system of financial supervision does not incorporate these externalities. Assessing the degree of integration, we find that the EU has not yet a fully integrated financial market. But if and when the process of integration is nearing completion, policy-makers will need to consider moving to European solutions.
How to choose an appropriate supervisory model for Europe? Responding to the trend of cross-sector integration, two main models have emerged: a functional model (separate supervisors for prudential supervision and conduct of business) and an integrated model (a single supervisor). The jury is still out on which model performs better (e.g. in weathering a financial crisis). We propose to apply some degree of model competition to facilitate the discovery of the best model.
Finally, we explore the question of the appropriate policy stance for financial supervision in Europe. Key elements of such a policy stance are supervisory skills, market discipline and private-sector control. Policy standards could be further developed via benchmarking of best practices within the new Lamfalussy framework.
