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The European Central Bank (ECB) has been in existence for almost 20 years and more if one considers its immediate predecessor the European Monetary Institute (1994–1997). During these two decades the ECB has become an established institution. It secures price stability and further increased its reputation as a lender of last resort during the financial crisis and its aftermath. In the 2010s, in response to the global financial crisis and the sovereign debt crisis, the ECB has also taken on the role of supervisor of the financial system and monitors developments in the Euro Area financial sector. Political science literature on the ECB can be subdivided into different strands. One strand looks at the ECB as just another central bank and hence examines its role as a central bank with the usual instruments. Another strand of literature examines the role of the ECB as an institution that is insufficiently embedded into democratic checks and balances. This perennial criticism of the ECB was born when the European System of Central Banks (ESCB) was created to be independent from political influence. A third strand of the literature is newer and examines the unorthodox steps that the ECB (and other central banks) took, and have taken, to offset the financial crisis and the ensuing economic crisis. An analysis of European integration and the political economy of the Euro Area can contribute to a better understanding of why the ECB has taken a proactive role. The political science research of the ECB is discussed here as well as the various dimensions of research conducted on the ECB.

Conventional accounts argue that Spain escaped the Great Depression because its currency was not convertible to gold. Accordingly, when a bank run ensued in 1931, the Banco de España would have been able to lend freely as lender of last resort. Drawing on new archival data on bank balance sheets and discount window borrowing, I show that rapid currency depreciation caused by the reversal in international capital flows that started in 1928 bounded monetary authorities to a dilemma between liquidity assistance and capital mobility during the 1931 crisis. These limits to policy reaction help explain the sharp contraction in bank lending and economic activity during and after 1931.

Deposit withdrawal pressures on banks, which sometimes take the form of sudden runs, have figured prominently in the discussion of public policy toward banks and the construction of safety nets such as deposit insurance and the lender of last resort. This chapter examines historical evidence from the Great Depression, and other episodes, on the factors that prompted withdrawals, the discussion of contagious runs, and the public policy implications. The historical evidence is presented in detail and is connected to the debate over the proper roles of deposit market discipline via the threat of withdrawals, the insurance of deposits, and lender-of-last-resort support for banks facing withdrawal pressures.

The global financial crisis and the sovereign debt crisis in Europe have redefined the functions of the lender of last resort (LOLR). First, they have placed the LOLR at the intersection of monetary policy, fiscal policy, supervision, and regulation of the banking industry. Second, they have given regulatory authorities the additional responsibility of monitoring the interbank market. Third, they have extended the LOLR role to cover the possible bailout of non-bank institutions, including sovereign countries. This chapter explores the link between the theoretical models of the banking industry and the unprecedented policies displayed in the aftermath of the crisis. We begin by examining the justification of LOLR in a simplified framework where only liquidity shocks arise, to move to a setting where liquidity shocks cannot be disentangled from solvency ones. We then study contagion in the interbank market and systemic risk, two pathologies due to the imperfections of the financial markets, and we discuss the issues raised by the implementation of the LOLR policy within the safety net.

This chapter examines the architecture and functions of bank supervision. Bank supervision is the process through which compliance with discussed prudential, conduct, and systemic regulations is safeguarded and enforced. It is normally exercised by public agencies that have the competence to approve the establishment and operation of credit institutions and monitor continuous compliance with the requisite regulatory framework. The same public bodies are also vested with remedial (early intervention) and enforcement powers in the event of a breach of any of the above. The chapter covers the fundamental principles of financial supervision; bank supervisors' accountability and judicial review; bankers' conduct, money laundering, and terrorist financing; and the central bank as the lender of last resort to the banking system.

The concept of “bailing in” a distressed bank’s creditors to avoid a taxpayer-financed public rescue is commonly accepted as one of the most significant regulatory achievements in the post-crisis efforts to end the problem of “Too Big To Fail”. Yet behind the political slogan, surprising uncertainties remain as to the viability of the concept and its optimal legal design. This paper traces the development of the bail-in concept since it was first conceived in 2010 and demonstrates that it has undergone an important conceptual metamorphosis. Bail-in, first understood as fulfilling the “redistributory” purpose of sparing taxpayers from rescuing banks, has more recently been promoted as additionally serving a “market stabilizing” function: to stem a panic and to avoid run risks.Whilst this trend is to be welcomed, it requires a number of changes to the present legal frameworks that are in place in many jurisdictions around the world. Issues to be addressed include, inter alia, to formulate appropriate criteria to trigger bail-in measures and to overcome a natural reluctance by resolution authorities to intervene and apply bail-in powers. This paper makes the case for early intervention triggers and demonstrates that liquidity provision by a lender of last resort during resolution is crucial to make bail-in credible. The paper places bail-in as a conceptual tool into the broader debate of how to deal with distressed banks and derives a number of concrete regulatory proposals.

This chapter of the forthcoming Oxford Handbook of Financial Regulation considers, in broad historical perspective and also with respect to the global financial crisis, why financial systems are crisis-prone and the relationship between financial crises and regulation. It begins with an overview of financial crises generally, and then considers both the historical and potential future role of regulation in financial crises. It discusses various theories of the roots of financial crises (cognitive error, moral hazard, information asymmetry, agency costs, trust, and complications of measurement and specification), as well as relevant policy measures (governance reforms, bank capital requirements, capital controls, and the role of the lender of last resort).

We study a dynamic economy where credit is limited by insufficient collateral and, as a result, investment and output are too low. In this environment, changes in investor sentiment or market expectations can give rise to credit bubbles, that is, expansions in credit that are backed not by expectations of future profits (i.e., fundamental collateral), but instead by expectations of future credit (i.e., bubbly collateral). Credit bubbles raise the availability of credit for entrepreneurs: this is the crowding-in effect. However, entrepreneurs must also use some of this credit to cancel past credit: this is the crowding-out effect. There is an “optimal” bubble size that trades off these two effects and maximizes long-run output and consumption. The equilibrium bubble size depends on investor sentiment, however, and it typically does not coincide with the “optimal” bubble size. This provides a new rationale for macroprudential policy. A credit management agency (CMA) can replicate the “optimal” bubble by taxing credit when the equilibrium bubble is too high and subsidizing credit when the equilibrium bubble is too low. This leaning-against-the-wind policy maximizes output and consumption. Moreover, the same conditions that make this policy desirable guarantee that a CMA has the resources to implement it. We acknowledge support from the Spanish Ministry of Science and Innovation (ECO2011-23197), the Generalitat de Catalunya (grants 2009SGR1157, DIUE and 2014SGR830 AGAUR), and the Barcelona GSE Research Network. In addition, both Martin and Ventura acknowledge support from the ERC (Consolidator Grant FP7-615651 and Advanced Grant FP7-249588-ABEP, respectively), and Martin thanks the IMF Research Fellowship.