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Allocating Lending of Last Resort and Supervision in the Euro Area

25 Pages Posted: 24 May 2002  

Charles M. Kahn

University of Illinois, Urbana-Champaign; Feseral Reserve Bank of Saint Louis; Bank of Canada

João A. C. Santos

Federal Reserve Bank of New York

Date Written: 2002


The Maastricht Treaty created the European System of Central Banks and the European Central Bank to head this system. The Treaty entrusted the European Central Bank with the responsibility for monetary policy, but it did not give this institution supervisory powers or an explicit mandate for providing emergency liquidity support to individual banks. National authorities remained responsible for financial stability. As a result, in the euro area some bank regulatory functions are centralized, while others are allocated to not one, but multiple, competing national regulators. Previous researchers have discussed the potential implications of this institutional allocation of regulation on the financial stability of the region. In this chapter, we investigate instead the potential efficiency implications. We focus on the consequences of the allocation of the lender of last resort and supervisory functions for the degree of forbearance in closing distressed banks and for the level of diligence in bank supervision. We conclude that the integration of banking markets without the integration of regulatory functions increases forbearance and decreases supervision. Centralizing regulatory functions will tend to reverse this decline. If only one of the two functions is centralized, then it will be more effective to centralize the supervisory function.

Suggested Citation

Kahn, Charles M. and Santos, João A. C., Allocating Lending of Last Resort and Supervision in the Euro Area (2002). Available at SSRN: or

Charles Kahn

University of Illinois, Urbana-Champaign ( email )

Department of Finance
340 Wohlers Hall
Champaign, IL 61820
United States


Feseral Reserve Bank of Saint Louis

411 Locust St
Saint Louis, MO 63011
United States

Bank of Canada

234 Wellington Street
Ontario, Ottawa K1A 0G9

João Santos (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States
212-720-5583 (Phone)
212-720-8363 (Fax)


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