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A key difference between the eurozone and the United States is that lending between two banks located in two different member countries is still perceived as carrying quite different risks than “domestic” lending (between two banks in the same country). This is not the case in the US, because it has an integrated financial system, and support for banks (deposit insurance or outright bailouts) is administered at the federal level.
When the cross-border interbank market stopped working this summer, a similar economic collapse was avoided only because the ECB, without much fanfare, became the eurozone’s central clearing house. German and other northern European banks that no longer trust their southern counterparts parked their funds at the ECB’s deposit facility, whereas southern European banks used the ECB’s lending facilities to make up for the loss of private interbank funding.
In the eurozone however, banking is still predominantly concentrated along national lines. A savings surplus in Germany is recycled to Spain mainly through interbank lending (German to Spanish banks). Moreover, although the EU is supposed to have an integrated banking market, the few existing cross-border banking groups are not even allowed to operate as integrated international banks, because national regulators and supervisors are “ring-fencing” the liquidity and assets of foreign banks’ local subsidiaries.
The imperfect integration of Europe’s financial markets and supervisory structure thus risks overburdening the ECB, which has had to become the central counterparty for cross-border lending. But in this function it has accumulated large risks, concentrated along national lines, thus leading to conflicts among Member States.
A common money and a common monetary policy cannot work properly with a banking system that is segmented along national lines. The most urgent step to stabilise the euro is not to follow the chimera of “euro economic government”, but to create the underpinnings of a truly integrated banking market with a common supervisor, a form of “federal” deposit insurance, and a “euro bank rescue fund” for the large cross-border institutions.