How Europe plans to prevent a repeat of banking nightmare


EUROPEANS INVENTED banks. These days it feels as if banks will end up “uninventing” Europe.

The euro crisis is – first and foremost – a financial crisis. Preventing finance from threatening economic prosperity, and, ultimately, societal stability is probably the biggest and most urgent public policy challenge facing the rich world in the medium term.

Yesterday the European Commission chipped in with its tuppence ha’penny worth, publishing a 250-page menu of proposals on how the EU and euro zone banking systems can be made safer.

It includes proposals on how the risk of banks failing can be reduced, how regulators can get stuck early to banks that are showing signs of weakness and – perhaps most importantly – how taxpayers can be spared the cost of picking up bankers’ losses.

There is no shortage of context on just how big the challenge is in achieving all these aims.

When one thinks of overblown finance, Wall Street may be the first place on the planet that comes to mind.

But, lamentably, European bankers put their American counterparts in the ha’penny place when it comes to ballooning their balance sheets.

The commission noted yesterday that of the assets of the world’s 1,000 largest banks in 2008-2009, EU banks account for 56 per cent, versus US banks’ meagre 13 per cent. In terms of assets relative to size of national economies, the largest EU banks dwarf their US counterparts.

One reason for this is because European companies depend much more on banks for their financing needs than their American counterparts. The latter are far more likely to cut out the middle men in banks and tap stock and bond markets directly when they need to raise money. According to the Institute of International Finance, a club for the world’s biggest bankers, three-quarters of all credit intermediation in Europe is handled by banks. In the US it is only one-quarter.

To summarise: Europe’s banks have grown dangerously big but the real economy remains hugely dependent on them.

The size, interconnectedness and sheer complexity of the European banking system has become a nightmare. There are enough issues and complexities to make any head hurt.

The biggest conundrum in the long term is how to handle banks that blow up so that panic is not triggered and taxpayers’ money does not have to be used to reassure or bail out stampeding financiers.

It is often said that this should be straightforward – corporate and personal bankruptcies are inevitable in a market economy because companies and individuals make bad financial decisions and get unlucky all the time. As most countries have laws and structures to ensure that these forms of bankruptcy happen as smoothly as possible, why not treat banks in the same way?

In Europe, few countries had similar laws and structures to deal with bankrupt banks when the financial crisis erupted half a decade ago (since successive administrations here never bothered to modernise even personal bankruptcy laws, it will come as no surprise that Ireland was not among the small number of European countries with the foresight to enact bank resolution laws).

One reason for this failure was because so few banks have crashed in living memory. The less something happens, the less well prepared one tends to be when it does happen.

Another understandable lament one hears frequently is why normal corporate bankruptcy laws are not simply applied to banks. The reason is confidence. If, say, a telecoms company’s bondholders are burned, there is very little danger of a knock-on effect to other companies in the industry and no chance of anything as dramatic as a run on them. Banking is different.

That said, while designing resolution mechanisms poses challenges, these are not insurmountable, as the US’s system of aggressively shutting down teetering banks shows.

For what it is worth, yesterday’s report by the commission said that the resolution measures the Government is now putting in place are not incompatible with any of its proposals for a Europe-wide resolution mechanism.

If resolution mechanisms are to be successful, says the report, the authorities will need a range of powers. One is “the power to remove or replace the senior management of an institution under resolution”.

How many objections would that raise in this jurisdiction?

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