Europe Financial Regulation

Overall, financial integration has greatly contributed to economic growth in Eastern Europe. Industries that depend heavily on external finance grew faster in countries with large capital inflows than in countries with more modest inflows. BUT the rapid expansion of credit brought about by foreign financial intermediaries using various channels (including direct lending, lending via banking subsidiaries, and lending via leasing subsidiaries) has fueled asset booms and heightened exposure to foreign-exchange risk. In the absence of effective regulation, financial integration has made the region vulnerable to a sudden and massive contraction of capital inflows.

Proposal
[W]hen the effects of a financial institution’s activities are sufficiently large, the country affected should be allowed to assume regulatory power, irrespective of the institution’s domicile.

The authors believe
[…] that an effect-based approach, based on an agreed threshold, would minimize the negative consequences of more host-country intervention in regulation and supervision.

Project-Syndicate, Berglof & Pistor