This column argues that solving the eurozone crisis requires policies that separate the banking and sovereign facets of the crisis. The losses incurred by Europe's banks must be swiftly recognised by establishing a European Resolution Authority to identify weak banks and fix or liquidate them.
Such an institution needs a fiscal backstop and the ESM should provide one. But this would not create eurobonds – the very need for eurobonds might to some extent disappear with a strong banking union.
A long-term reform agenda…
The lesson of this crisis is that a stable Single European Market in banking is not possible with national supervision, something also referred to as the financial trilemma. One could of course argue that the problems of Spain (and Ireland) are due to local banks engaging in a classic real estate lending binge. This is true, but the problem would only remain local if the failure of mid-sized local banks did not endanger the stability of the entire eurozone banking system. Large, cross-border Spanish banks and indeed banks elsewhere have considerable exposure to these banks (and the Spanish economy in general). Failures of the Spanish local banks could thus set in motion a domino chain affecting the entire eurozone banking system. In addition, national supervision of cross-border banks gives rise to distortions... since home-country supervisors might intervene in a weak bank too early or too late. Finally, the recent experience across Europe has shown political and regulatory capture of national supervisors resulting in underestimates of losses and delayed intervention.
The authors [Thorsten Beck, Daniel Gros, Dirk Schoenmaker] have therefore – in different combinations and with different co-authors – repeatedly called for a supranational framework for the supervision of large pan-European banks. While different institutional solutions are possible, a European-level framework for deposit insurance and bank resolution is critical in order to enable swift and effective intervention into failing (cross-border) banks, reduce uncertainty, and strengthen market discipline. Critically, a central resolution authority needs the necessary resources to resolve large cross-border banks in an efficient manner. That is why a combination of the resolution authority with a deposit insurance scheme for cross-border banks might be necessary. Industry-based funding for such a scheme is also called for to reduce concerns of moral hazard, where the downside risk of banks’ risk-taking is borne by taxpayers. Since deposit insurance, even if financed by banks themselves, always faces limitations in case of systemic bank failure, however, a back-stop by national governments, possibly through a European institution, such as the EFSF and the new ESM, is necessary. This is especially important in the early phases as the fund is being built up.
A European Resolution Authority
To turn the European banking system from a source of fragility into a source of strength, the authors argue for bold steps and a stop to forbearance.
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They call for the establishment of a temporary European Resolution Authority, for which the ECB can make staff and offices available. This Resolution Authority will sort out fragile bank across Europe, both small and large; strongly capitalised banks go ahead, and weak banks are either recapitalised or (partly) liquidated.
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Where possible banks should be recapitalised through the market; if not feasible, the Resolution Authority recapitalises by taking an equity stake in the bank (by straight equity or hybrid securities). It is important that the Resolution Authority also receives the upside if the banks are getting on the right track, with even a possibility to make gains as happened in previous crises. In addition, the use of debt-equity swaps should be considered, as well as restrictions on divided and possibly salary payments imposed.
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The Resolution Authority would need a fiscal backstop from the EFSF/ESM to gain the necessary credibility not only with the banks it is tasked to restructure but also with the markets.
Addressing the restructuring needs of Europe’s banks on the European level has the additional advantage that it will also reduce political pressure and interference on the national level and will enable a more transparent and cost-effective process.
Conclusion
Restructuring and recapitalising banks across Europe will not only help disentangle sovereign and bank fragility, but it can also help Europe grow out of the crisis by turning the financial sector from a drag on sovereigns’ balance sheets to a motor for private-sector growth. Such a European Resolution Authority is thus not only a crisis resolution tool but also a critical part of the growth compact that is currently so high on the political agenda.
© VoxEU.org
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