Against the background of the emergence of macroeconomic imbalances within the European Monetary Union (EMU), we investigate in this paper the macroeconomic consequences of cross-border banking in monetary unions such as the Euro area. For this purpose, we incorporate a union-wide banking sector along the lines in an otherwise standard two-region monetary union DSGE model, accounting for borrowing constraints of entrepreneurs and impatient households and an internal constraint on the bank's leverage ratio. We illustrate in particular how rule-of-thumb lending standards based on the macroeconomic performance of the core region within the monetary union can translate into destabilizing spill-over effects into the other region, resulting in an overall higher macroeconomic volatility. Thereby, we demonstrate a channel through which the financial sector may have exacerbated the emergence of macroeconomic imbalances within the EMU. This effect may be mitigated by macroprudential policies, where especially policies that force the bank's lending standards to be less procyclical prove to be effective in stabilizing output in both regions of the monetary union.

This paper surveys the recent academic literature on the economics of cross-border regulatory cooperation as well as recent policy developments in this area. While institutional arrangements of cross-border regulatory cooperation used to focus on day-to-day supervisory tasks, the crisis has given an impetus to a focus on cooperation at the bank resolution stage, with an array of different cooperation forms. A growing theoretical literature has documented different externalities arising from national supervision of cross-border banks, while empirical evidence has been relatively scarce. The paper concludes with a forward looking agenda both for policy reform and academic research in this area.

Iceland was hit hard by the financial crisis in 2008, especially by the spill-over effects of its banking failure when all of its three major banks collapsed. This article examines the Icelandic regulatory response to the crisis. The Icelandic case is special as the banks were not only too big to fail but also too big to rescue. Thus, legislation dealt with the failure of the banks and the aftermath of the crisis. First, the most important legislation was the Emergency Act that provided the Financial Supervisory Authority (FME) with emergency authority over banks in danger of becoming insolvent. The role of banks is integral to any economy. In order to ensure normal banking services and the safety of deposits in Iceland, three new banks fully owned by the Icelandic government were established on the basis of the Emergency Act. The most controversial provision of the Emergency Act granted depositors' claims priority over other unsecured claims in the winding up of the collapsed banks. Now the EFTA Surveillance Authority has concluded that this did not constitute a breach of the EEA Agreement. The Emergency Act made necessary amendments to the Act on Financial Undertakings concerning the reorganisation and winding up of financial undertakings. Second, a Special Investigation Commission was established by law. To enable a search for the truth, the legislation was far-reaching. The primary role of the Commission was to seek the truth. The report of the Commission discloses information that otherwise would not have been disclosed because of bank secrecy laws and sheds a unique light on the practices of the banks. Third, it was considered important that the law would be enforced by all necessary means. Thus, the temporary position of Special Prosecutor was established by law. Fourth, cross-border banking in the EU/EEA is examined in the light of the so-called Icesave dispute between Iceland on the one hand and the UK and the Netherlands on the other. It sheds a light on some of the major flaws of cross-border banking in the EU/EEA already known and criticised long before the crisis. When the Icelandic banks collapsed, the government of Iceland declared that all deposits in domestic banks and branches were guaranteed but not those in foreign branches. This gave rise to the question of whether Iceland could be held liable on the basis of the EU Deposit Guarantee Directive or because of discrimination of depositors based on nationality. In any case, the financial crisis has shown that there is a gap between law and reality. The conclusion of this article is that it is questionable whether the potential economic benefits of full integration in the field of cross-border banking outweigh the dangers and risks that come with it. If not, the price of full integration may be too high.

Financial markets have increasingly grown cross-border, this having important implications for the design and conduct of prudential regulation and the provision of safety nets, such as deposit insurance or crisis management structures (lender of last resort operations).

The financial crisis has evidenced a number of weaknesses specific to cross-border banking. The study of regulation on the basis of recent cases of banking failure during the crisis allows developing conclusions about the evolution of cross-border banking and the challenges present in the current EU regulatory and supervisory framework. In particular, attention is paid to the impact that legal structures used in cross-border banking may have on financial stability.

This paper analyses the way in which cross-border banking has evolved during the last years, focusing on the legal structures and their impact on competition and financial stability. Thought is given to the specific changes in regulation and supervision that may lead to sustainable cross-border banking within the EU. Finally, the current EU regulatory proposals as well as the changes in the EU supervisory architecture are critically analysed, and final conclusions are drawn on the way forward.