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A Solution for Europe's Banking Problem

  • Adam S. Posen

    ()

    (Peterson Institute for International Economics)

  • Nicolas Veron

    ()

    (Peterson Institute for International Economics)

The European Union's aggressive response to the global financial crisis has prevented financial meltdown, but the continent's banking industry remains very fragile. Experts estimate coming losses in excess of $500 billion, with very little written down so far. These losses plus the problems in Eastern Europe portend widespread cross-border bank insolvencies. Traditional banking (in corporate finance and household savings) remains predominant in the European economies, so healing the banking system is crucial for sustained recovery in Europe. Lingering banking fragility would result in constant disruption or misallocation of bank credit and hinder returns to savers, thus depressing investment and consumption. Ongoing fragility will also harm European trend productivity growth by skipping some investment and R&D cycles, misallocating capital to lower-return projects, and wasting human capital by consigning some workers to long-term unemployment. It will take time and political will to create an EU banking supervisory architecture, but Europe cannot afford to wait. Posen and Véron recommend that Europe engage in system-wide "triage" of major banks on the continent by capital position, leading to public restructuring of the weakest ones. They propose that relevant countries jointly create a temporary supranational agency or Treuhand to implement the triage process, catalyze recapitalizations, and manage any distressed assets that would fall into public ownership. Such a trustee would avoid both harmful races to the bottom within Europe by national supervisors and fiscal transfers between European states for bailouts.

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File URL: http://www.piie.com/publications/pb/pb09-13.pdf
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Paper provided by Peterson Institute for International Economics in its series Policy Briefs with number PB09-13.

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Date of creation: Jun 2009
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Handle: RePEc:iie:pbrief:pb09-13
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  1. Hoshi, Takeo & Kashyap, Anil K, 2010. "Will the U.S. bank recapitalization succeed? Eight lessons from Japan," Journal of Financial Economics, Elsevier, vol. 97(3), pages 398-417, September.
  2. Reint Gropp & Anil Kashyap, 2009. "A New Metric for Banking Integration in Europe," NBER Working Papers 14735, National Bureau of Economic Research, Inc.
  3. Eisenschmidt, Jens & Tapking, Jens, 2009. "Liquidity risk premia in unsecured interbank money markets," Working Paper Series 1025, European Central Bank.
  4. Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises; A New Database," IMF Working Papers 08/224, International Monetary Fund.
  5. Jean Pisani-Ferry & Bruno van Pottelsberghe, 2009. "Handle with care! Post-crisis growth in the EU," Policy Briefs 301, Bruegel.
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