During the financial market crisis of 2007/08, it became abundantly clear that the regulation of the financial system was in need of fundamental reform. Basel II, which formed the basis of financial market regulation before the subprime crisis, was at least partly to blame for the financial meltdown (Goodhart 2008). In the EMU there was the additional problem of the lack of common financial market supervision – an absurdity for a monetary union. The EMU thus faced a double task: to adopt better regulations for the financial system and at the same time to develop a new architecture for European financial market supervision. In the following, the new institutional structure of financial market regulation will be discussed first, and then the creation of the Banking Union in the EMU and finally the reform of the financial market regulations will be presented. We refrain from making comparisons with the United States, as this would go beyond the scope of this chapter.

The new structure of financial market supervision in EMU

In 2011 and 2012, after lengthy consultations, the European System of Financial Supervision (ESFS) was created, which applies to all EU member states (see also Herr et al. 2019). The subprime crisis had revealed that the pre-crisis philosophy of financial market supervision under Basel II was inadequate. Basel II was developed in the 1990s following the triumph of neoclassical models. It is theoretically based on the ideas of efficient financial markets and of the rational behaviour of economic entities (i.e. that microeconomically derived rational behaviour always leads to macroeconomically desirable results). This approach ignores numerous theoretical objections as well as the recurring crises in financial markets. Individually rational behaviour can lead to irrational results for the whole economy (Herr 2011). For example, at a concert, it can be quite rational for an individual to stand up to have a better view. But if all visitors of the concert follow this individual rational behaviour, the irrational result is that all people are standing and none can see well. If in a financial market panic, all wealth owners want to sell their securities in order to obtain liquidity, there are no buyers and prices crash through the floor and liquidity vanishes.