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To understand and analyse the current situation and appropriate remedies, we must look for the origins of the crisis not only within the banking secotor and its excesses, but also in the real economy, and in economic and fiscal policy.
The concept I’m referring to is the no bail-out principle. In the euro area, there hasn’t always been a healthy balance between liability and control. The no bail-out principle was dangerously eroded for two major groups: governments and banks. This is because banks and governments were considered to be systemically important – it was feared that their financial difficulties could threaten the stability of the financial system. So it wasn’t the decisionmakers – those in control – who were ultimately liable. And this undermined the incentives for responsible behaviour.
To safeguard financial stability in the euro area and prevent future crises, we have to loosen the ties between governments and banks as much as possible. We have to make banks more resilient, make government finances more sustainable, and ensure that governments are shielded as far as possible from the effects of banks' problems – and vice versa.
Basel III, with its new capital and liquidity rules, will make banks less likely to experience financial difficulties and need government bail-outs. The first pillar of the planned Banking Union will be the single supervisory mechanism (SSM), which is also tasked with preventing bank difficulties at an early stage. Yet neither of those will allow us to prevent all financial distress among banks. It is therefore important to be able to allow banks to fail without governments – and thus also taxpayers – having to foot the bill.
There are plans to introduce a single resolution mechanism (SRM) – the second pillar of the Banking Union – to ensure that the owners and creditors of a bank needing restructuring or resolution take a sufficient share of its losses with a clear sequence of liability. When a bank runs into difficulties, taxpayers should be the last port of call rather than the first. This sequence of liability is compatible with the no bail-out principle and strengthens market discipline for banks.
I believe that there are still some weaknesses in the framework agreed by EU finance ministers two weeks ago as it allows substantial scope for discretionary exemptions from such bail-ins and I believe it should be implemented ahead of the current schedule, by 2015.
We can apply the same logic to public finances. There too, the first step is to ensure that governments no longer run into serious financial problems so easily. The new fiscal rules, for instance, will help to achieve this – provided that they are applied strictly in practice.
The no bail-out principle also needs to be reinforced: The potential for contagion among euro area countries was underestimated in the run-up to European monetary union. However, if one country’s public finance problems threaten financial stability throughout the euro area, limited assistance is justifiable – subject to strict conditionality. We have set up the ESM to perform this task. Yet our goal must be for each country to rapidly regain responsibility for its own public finances.
The ECB Governing Council agrees unanimously that monetary policy cannot solve the crisis. At best, it can buy time – but that is not its job. Monetary policy has already helped substantially in preventing an escalation of the crisis. I am critical of the ECB’s government bond purchase programmes in particular. If Eurosystem central banks buy government bonds issued by countries with poor credit ratings, this will distribute the risks of unsound fiscal policy among all the euro-area states. This weakens the no bail-out principle and entails redistribution, which is really the prerogative of fiscal policymakers.
Also the low interest rates are not without their side-effects. While they are currently justified from a monetary policy perspective, they tempt decisionmakers to delay reforms and necessary structural changes.