The European Central Bank has made it clear that it will not allow banks in the euro area countries to engage in too much easing of financial conditions. In fact, this has been communicated very clearly to all banks in the region. However, many banks have disregarded this instruction and are continuing with their efforts to loosen their stance. This is causing a great deal of concern, as the possibility of a huge recession in the euro area is increasing by the day.
As per the recent report of the European Central Bank, some companies in the region have been helping money managers to reduce their risk by altering their strategy and structure. Most noteworthy among these firms are German banks, whose specialised supervisory architecture was blamed for the credit crisis. It is clear from this report that the supervisory architecture of these banks needs to be corrected fast, or else other major financial institutions may be in deep trouble that they are not able to handle.
As such, the European Central Bank is in the process of preparing guidelines that will help it regulate the functioning of banks in the euro area countries. Among the things that will come out of these recommendations is a plan to introduce a supervisory principle known as the Basel III. The Basel III principles were introduced in response to the previous banking union, the European Union. The EU had set in place several guidelines that were aimed at preventing excessive credit risk at the height of the global credit crisis, but the banking union’s supervisory principles were found to be inadequate to ensure that these risks were reduced.
Supervision by a number of banks in one country has always been considered inefficient. This is because these banks do not operate in any single country. Instead, they operate across various countries, with each having its own regulations that need to be followed. While effective supervisory principles can bring about significant improvements in the firm investment risk management, the situation is definitely going to be compromised if some of these institutions engage in financial market activities that go beyond their assigned countries’ securities markets. The excessive international activity of global banking bodies can lead to serious problems for the overall supervision of financial market activities.
Some countries have tried to counter this problem by introducing a single supervisory mechanism, known as the European Supervisory System. This is a mechanism that has been designed to ensure that all banks in the euro area are brought under the same rules and regulation. This brings all institutions under the same constraints, which significantly reduces the risk of investment default. The introduction of the Single European Supervisory Mechanism was accompanied by the European Central Bank, who made it possible for banks in the euro area to use only funds from the European Central Bank as well as from other major international organisations that are part of the EU. The single supervisory mechanism is thus seen to be an important element in the fight against firm investment risk.
However, there are several criticisms that are being put forth against this hypothesis. The first criticism, as pointed out by several researchers, is that since the presence of several regional banks causes a variety of costs and other factors that can potentially lead to misvaluation, the regulation does not cover all potential sources of misvaluation-induced loss. Another point of criticism is that since the presence of a number of regional banks creates a certain level of competition, there might be some shifts towards concentration of investment in certain parts of the globe, leading to increased concentration of costs and prices, and consequently to misvaluation-induced loss. Finally, some argue that the introduction of the Single European Supervisory Mechanism has reduced incentives for banks to behave appropriately, since they are rewarded only if they behave appropriately (by holding their existing assets), and not if they choose to be less concerned with their clients’ loss.