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An infamous feature of the sovereign-debt crisis in 2009-15 was the “doom loop”, through which weak banks and sovereigns dragged each other down. In 2012 members agreed that the doom loop needed to be broken, and the monetary union backed by a banking union. A common supervision and resolution framework for large banks has since been set up. But barely any progress has been made on common deposit insurance, because northerners are terrified that their taxpayers would be liable for risky loans made by southern banks, to their home governments among others. Now Mr Scholz seems amenable—provided other reforms happen. The most contentious would penalise banks for holding heaps of their home countries’ sovereign debt—long a non-starter for Italy and other heavily indebted states.
Supporters of such regulatory penalties say they would lead banks to scale back home exposures, and perhaps to diversify into other members’ sovereign debt. Critics worry about the effect on bond markets of losing banks’ captive demand.
New rules could take two forms. Banks could be forced to increase their capital buffers if their holdings of any particular security exceed a certain threshold—a “concentration charge”. Or they could be forced to back their holdings of risky sovereign debt with extra capital by increasing the risk score—known as the risk weight—attached to some sovereign bonds, which all regulators now treat as risk-free.
Risk weighting is more contentious because it is more potentially destabilising. In the worst case, it could mean that a downgrade by a credit-rating agency leads banks to dump some holdings, bringing about the very turmoil the reform was supposed to prevent. Germany’s finance ministry seems to prefer a hybrid approach, setting a concentration threshold above which holdings would be subject to a charge based on both concentration and credit risk.
Officials in Brussels want to prepare a “roadmap” for reform that leaders can rubber-stamp when they meet in mid-December. But the bar is low. Even concluding negotiations on whether or not to begin negotiating on reforms could be considered a victory. If fixing the house up were easy, it would have been done by now.