30 May 2013

Stewart Fleming: Resolving to end European stagnation

In much of the European Union, ‘zombie' banks are desperately shrinking their balance sheets, while lending to failing ‘zombie' companies, in part because they cannot afford to take the losses that would come from cleaning up their loan books. This is yet another European vicious circle, comparable to the ‘doom loop' between banks and governments. In this case, as economists at Deutsche Bank point out (Focus Europe, 17 May), there is an added twist: lending by zombie banks to zombie companies is probably squeezing out lending to healthy companies that are vital to growth.

Almost four years ago, in a seminal paper for Bruegel, an economics think-tank in Brussels, Nicolas Véron and Adam Posen urged a swift, drastic clean-up of Europe's banking system. Véron told me last week that he believed it was needed more than ever. The opportunity is still there. The European Commission's (almost enacted) Single Supervisory Mechanism (SSM), coupled with a proposal expected in June for a single resolution mechanism (SRM) for banks in the eurozone, could lay the foundations for a banking clean-up – provided that European leaders can cut a deal on resolution which is more than a tacit bail-out for reform-shy governments. The SRM should not just be seen as yet another step towards stabilising the single currency, adding a vital component to the ECB-based supervisory mechanism, and addressing the threat from banks that are ‘too big to fail'.

It is all of these things, but most importantly it can also become the foundation for Europe's much needed growth strategy. Evidence of the importance of this next step towards banking union is provided by Japan. The failure there, early in the 1990s, to act swiftly to recapitalise and restructure banks contributed to Japan's economic stagnation, now nearly two decades-old. Today, a similar failure in Europe could herald a further protracted but worse stagnation. Japan, note well, managed to avoid the mass unemployment which is already wracking Europe.

Steps Forward

In their paper on banking union, Deutsche Bank economists argue that the eurozone must embrace what Nicolas Véron and Guntram Wolff of Bruegel have termed (February 2013) a “big bang” leap forward. “It is actually very difficult to ‘stop on route' and deliver credible single supervision, a single rulebook for bank resolution and no federal backstop", they write.

Graham Bishop, a London-based authority on EU financial markets, argues that if they are correct, then another big step towards deeper political as well as economic integration of the eurozone looms.

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