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Economics of Regulation: Comparing international economic regulation systems in the banking sector and assessing the Market Impact of the Single Supervisory Mechanism in Europe’s banking sector

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Countries in the European Union (EU) have provided a unique opportunity of supervisory integration and financial regulatory, a move that has immensely complemented numerous integration efforts that have been in place since the World War II. Before the 2008 financial crisis, international economic regulation and financial supervisory progressed slowly irrespective of the increased global integration, particularly in the financial markets. The existing financial policy at that time was obviously inappropriate in the face of the 2008 economic downturn. The 2008 crisis initiated critical changes in both financial systems and supervisory structure of the EU as evident by the introduction several banking supervisory bodies in the post-crisis era. The most notable one was the introduction of SSM upon which the European banking union was formed. The purpose of this paper was to compare international economic regulation systems in the banking sector and assess the market impact of SSM in Europe’s banking sector.  

The debt and financial crises have progressively become interrelated in the modern world.  The growth of contemporary economies requires a financial system that is both highly innovative and liquid (Benink, 2016). Due to its high volatility and liability, finance ought to be managed with utmost care.  The EU decided to separate the two components by establishing a similar supervisory mechanism in the financial sector known as the single supervisory mechanism (SSM). 
International financial markets are highly volatile as evident by the 2008 economic downturn that emanated from the US and quickly spread to the rest of the world (Ferrarini & Chiodini, Nationally fragmented supervision over multinational banks as a source of global systemic risk: a critical analysis of recent EU reforms, 2016). The underlying causes of the 2007-2008 financial crises could be attributed to the financial market development that began in the 1980s. Initially, banks used to hold deposits, lend money and attract savings. In such a financial market, it was a common practice to identify risks and restrain them via self and voluntary restraint (Viscusi, Harrington, & Sappington, 2018).  Interbank lending and borrowing were common practices in the banking industry, and thus banks were supposed to restrain from risks in their financial operations. Banks were expected not engage in activities that were perceived riskier by other banks as doing so would disqualify them from inter-bank borrowing and lending. Such a self-regulation mechanism would require minimal supervision by the state (Benink, 2016). However, financial markets have in the recent past changed significantly due to the emergence of new institutions in the banking industry, securities, and insurance sector. For example, new financial institutions like investment banks and hedge funds that engage in high leveraged and innovative financial products have emerged. Such financial institutions may not adequately exercise self-restraint practised by conventional banks and could easily erode the confidence in the banking sector (Ferrarini & Chiodini, Nationally fragmented supervision over multinational banks as a source of global systemic risk: a critical analysis of recent EU reforms, 2016).  Erosion of such confidence could adversely affect borrowing and lending within the financial markets. Such a scenario might be devastating on economies that depend on credit to thrive. 
Moreover, there has been increased competition among financial institutions which has made them more innovative and takes increased risks (Ferrarini & Recine, 2015). Banks are currently engaging in profitable and high-leveraged products to generate more income for their shareholders. The present condition of the financial industry can be attributed to the increased appetite for risky investments (Molinelli & Paccagnella, 2013). The collective failure of the supervisory mechanisms has worsened the state of affairs in the banking industry (Benink, 2016). National supervisory bodies such as financial authorities and central banks have not been effective in alerting banks early enough before the occurrence of market failures. Such inefficiencies could be attributed to the inability of supervisory bodies to remain at par with the market innovativeness and their little knowledge of financially engineered complex products (Benink, 2016). Moreover, the supervisory bodies in the banking have limited knowledge in financial products such as investment banks and hedge funds. Initially, hedge funds were hardly regulated by financial authorities and central banks and where regulation was available; it did not go beyond national borders (Matthews & Thompson, 2014). Therefore, the failure of supervisory authorities to tame the banking institutions is one of the main causes of the crises in the industry. 
The collapse of the banking sector in the recent times has necessitated the calls for reforms from various stakeholders. For example, the prime ministers of German and the UK recently emphasized the need to form robust and integrated global supervisory and regulatory mechanisms (Ferrarini & Chiodini, 2016). The need to replace the traditional supervisory system and formulate early warning mechanisms to detect risks is critical to the achievement of world-class economies. It is also important to strengthen and reform financial products and institutions so that banks are capacitated to invest on a global scale (Swinnen, 2011). Additionally, the framework of the G20 countries presents a platform where global leaders converge to discuss reform matters concerning the stability of financial markets. The current focus of the G20 summits is to streamline strategies for detecting early signs and improvement of financial management as well as mitigation of future risks (Benink, 2016). 
Both governmental and international institutions have a role to play in the supervision of the banking industry. Should the local regulatory mechanisms be embraced under the supervision of the banking sector or are the global mechanisms override the national frameworks?  How can national supervisory and regulatory authorities be organized to handle the seamless international monetary institutions?   The 2008 economic meltdown revealed some of the shortfalls of financial authorities mandated to regulate the financial sector and the need to establish dedicated institutions of both local and international stature to supervise and coordinate the financial markets (Ferrarini & Chiodini, 2016). 
Comparing International Regulation Systems in the Banking Sector
The creation of global financial regulatory authorities tends to eliminate some restrictions faced by national supervisory bodies. Some of the merits of establishing international regulatory bodies include the capacity to have jurisdiction covering the financial markets on a global scale. Due to its cross-border capacity, international regulatory systems can control international capital movement is possible (Benink, 2016). Moreover, international regulation systems have continuous data flow making it possible to understand complex and innovative financial products. Consequently, it is easy tracking the origins of the various financial products which help in understanding how such products move through the monetary system. Furthermore, international regulatory systems bring on innovative board skills as they have the financial muscle necessary to hire top financial experts. Moreover, international financial systems are not limited by national boundaries, and this makes staffs independent and aggressive in coming up with new warming mechanisms for the national performance of banks (Kanopy, 2014). 
However, it is important to note that a single international regulation system cannot achieve financial success. Moreover, it would be quite hard for the present financial regulators in Asia, Europe and the US to submit their jurisdiction to a global institution (Keiding, 2016). It is likely that financial market lobbyists may influence the decision-making process of international regulatory systems which would stir bureaucracies in the management of such institutions (Ferrarini & Recine, 2015). An effective financial regulatory model might thus be the one that comprises of global supervisors who work through regional or local regulators. A good example of an international financial system includes the European SSM. 

Assessing the Market Impact of SSM in Europe’s Banking Sector 
The major global financial institutions are currently facing market, regulatory and political pressure. European banks, in particular, are facing overwhelming changes and it has become essential that they change their business models. The management of banks in the modern day has to realize that the model they used a decade ago can no longer be viable in addressing the current challenges (Ferrarini & Recine, 2015). The creation of the European banking union in 2014 has significantly defined the financial landscape of Europe. 
SSM has evolved to be a strong financial regulator that seeks to stabilize the banking system of Europe. Europe has in the recent past pushed to have a common banking system within the EU. Europe underwent through tough economic times from 2008 when the global economic downturn broke which culminated in the sovereign debt depression in the Eurozone in 2010 (Benink, 2016). The crisis awakened the need to develop extensive economic stabilization strategies which included aggressive tax cuts, progressive fiscal policy strategies, and aid loans from international and local institutions as well as economic incentive programs (Ferrarini & Chiodini, 2016). All these measures were aimed at maintaining the economy from crashing down. The main aim of SSM was to sustain a prudent supervision and policy framework for all the banks of the member states by providing high quality supervision on financial matters. The role of the SSM is often manifested through the functions of the European central bank, but it is important that note that the SSM is a system not necessarily a function of a single entity (Somanathan & Nageswaran, 2015). For instance, the European central bank forms the core of the SSM and carries out its tasks as mandated by the SSM, whereas national regulatory agencies are tasked with the mandate to ensure there is a continuous operation of the SSM. 
There are several single supervisory mechanisms employed by Europe’s banking sector including world trade organization, European central bank, and European banking supervisors (Ferrarini & Chiodini, 2016).  Currently, banks are operating globally whereas local regulators operate locally. Since the euro was introduced in 1999, there has been a tremendous improvement in the integration of the European banking industry. When euro was introduced as the single currency, it was anticipated that financial integration in the region would get enhanced.  As expected, the financial integration improved in the EU in the years that ensued as evident by price convergence for a variety of asset classes in the region (Benink, 2016). Nevertheless, the onset of the economic depression of 2008 disrupted this progress which led to financial disintegration and consequently prompted the formation of the European banking union. 
SSM is a crucial pillar of the banking union of Europe which comprises of the national supervisory agencies and the European central bank. The central bank of Europe is tasked with regulating the credit institutions in the areas of authorizing or disqualifying them from operations, monitoring their compliance with the setout operational guidelines, and in providing policy guidelines in the banking sector in the region (Ferrarini & Recine, 2015). The European central bank enjoys equal powers like the ones conferred on supervisory agencies operating in the EU. Moreover, the central bank of Europe donates its powers to national supervisory agencies, particularly where there are no explicit powers under the SSM guidelines. SSM has both direct and indirect privileges and powers over all the banking institutions operating in the member states (Cheshire & Hilber, 2017). 
The SSM largely operates via the delegation of authority to domestic supervisory and regulatory agencies.  For instance, the central bank or Europe carries out its supervisory duty under SSM alongside other proficient financial regulatory agencies (Benink, 2016). The national supervisory agencies are required to cooperate and provide information to the SSM. Therefore, the SSM model largely thrives on cooperation among both local and international supervisory bodies. The structure of the SSM has become a necessity in the European given the large number of banks operating in the EU.  Currently, banks more than 6,000 have their operations in the EU out of which 150 institutions are accounting for aboutn80% of the industry’s asset value (Ferrarini & Chiodini, 2016). The top banking institutions are regulated by the central bank of Europe whereas the rest get regulated by national agencies. Though SSM is a centralized form of supervision, it does not take away the task of national agencies in their regulatory and supervisory mandate.  
It is difficult to assess the full impact of the SSM as it is still in the early stages of its inception. Since its inception in 2014, SSM remarkably represents a semi-strong centralized system due to its reliance on cooperation from the member states (Benink, 2016). Though this cooperation may weaken during the periods of crises forcing member states to pursue domestic interests, summits are often organized to explore the region interest. Nevertheless, the conceptual soundness of the SSM does not mean that it is acceptable by all countries in the EU. For instance, some countries in the UE are yet to join the SSM and others may leave as witnessed by the recent exit of Britain (Ferrarini & Chiodini, 2016). The greatest fear of non-members includes loss of supervisory privileges to SSM.    
The current EU regime is anchored on prudential supervision which is characterized by multilayered regulation and optimal harmonization. As such, the SSM may not be that much flexible, but it helps in eradicating the challenge of supervisory competition (Berger & Olson, 2013). Though there are no explicit incentives for participating in the SSM, it is undoubtedly important for all the EU countries to cooperate for the systemic stability and interest of the region. Going forward, the SSM will require a homogenous and continuous framework that is based on uniform supervision of the banking institutions in the EU.