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EU banks have so far weathered the storm caused by the pandemic, the war in Ukraine and sharp interest rate hikes. However, the failure of Credit Suisse and three US tech banks underlines how quickly investor and creditor trust can erode, prompting regulators to intervene and governments to provide public support. While swift and decisive action in the US and Switzerland prevented a systemic bank crisis, the EU will struggle to preserve financial stability if things go badly wrong. To boost confidence in its banking system, it is therefore high time for the EU to push ahead with banking union. To get its act together, the EU should 1) improve banks’ resilience by adopting strict prudential regulation instead of creating new vulnerabilities, 2) make the crisis management framework more credible to ensure that banks can fail without using taxpayers’ money, and 3) put in place European backstops to bank resolution and deposit insurance to withstand a systemic crisis.
The latest series of bank failures in Switzerland and the US reminds us of the inherent fragility of the financial system. Fifteen years after the collapse of Lehman Brothers, fears of a new systemic banking crisis are back in the headlines. Within two weeks, three regional banks in the US, Silvergate, Silicon Valley Bank, Signature Bank, and the second largest Swiss bank, Credit Suisse, collapsed. The problems leading to the failure of the four banks are quite different, but they all started to wobble when investors lost confidence and depositors suddenly withdrew their money. On financial markets, trust is obviously ephemeral in nature. Bank failures can always occur, but the crucial question is how to handle the aftermath.
Authorities contained contagion effects but at the price of violating the liability principle. After the global financial crisis, governments worldwide promised that never again would taxpayers be forced to bailout a private bank. Instead, private sector players should shoulder the cost of a bank failure by either letting it go into insolvency or putting it into resolution, triggering the bail-in of the bank’s shareholders and debt investors. This promise has not been kept: to prevent the bank failures in the US and Switzerland from spreading to other banks, central banks and governments provided large guarantees and liquidity support. While this has so far prevented a systemic bank crisis, it's a fact that the agreed rules were not respected. For fear of putting financial stability at risk, authorities decided to rescue the banks with public money instead of letting shareholders, bondholders and uninsured depositors fully bear the entire costs.
The EU should learn from these overseas failures and put its own house in order. EU banks so far seem to be weathering the turmoil in financial markets. Still, these latest bank failures raise the question where the vulnerabilities in the EU banking system lie and whether EU authorities could better handle the collapse of a systemically important bank. To boost confidence in the EU banking system, policymakers should seize the occasion to push ahead with banking union. In concrete terms, this requires three things. First, within the ongoing negotiations on transposing the final set of Basel III reforms into EU law, European co-legislators should consider the negative consequences lighter regulation and laxer supervision may have on banks’ resilience. Second, governments should put to one side national interests preventing the collective bank crisis management framework from making progress. And third, the EU should put in place European backstops to bank resolution and deposit insurance to ensure that the banking system can indeed withstand a systemic crisis...
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