Prudential policy in Europe has strong national traditions jealous of their peculiarities. The Maastricht Treaty has enshrined them, making a comprehensive prudential system for the EMU-wide area all the more problematic. The multiple and very costly banking crises of the 90's have shattered the wisdom of an arrangement whereby the word "subsidiarity" is a recipe for staying put. Therefore we are left with disparate supervisory agencies, piecemeal and ad hoc bilateral cooperation between these supervisory agencies, uncertainty at the identity of the lender of last resort against Euroland-wide systemic risk. It amounts more to destructive than to constructive ambiguity. The development of capital markets and the subsequent hazardous restructuring of banks are likely to emphasize the shortcomings in prudential policy and to bring forth macro-prudential issues at the European level. Euro markets will become more alike Dollar markets. They will become vulnerable to types of instability stemming from market finance whereas Continental European countries have shaped their prudential policies to deal with risks proceeding from bank finance. Market finance is prone to multiple equilibria, sudden discontinuities in value, high leverage and extreme dependence of credit risk on market risk, high speed contagious processes spurred by brutal changes in the correlation of market risks. Systemic risk is inherent to market dynamics and can trigger liquidity crises which know no borders and no national sanctuaries. What that means is the following : the development of financial markets in Europe requires a European lender of last resort.
Bank supervision; Liquidity crisis; Lender-of-last-resort; Safety net; System risk
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