Blog Post

Stress tests fail to rescue Europe’s banks

The situation in Europe has developed from a financial and banking crisis to a sovereign debt crisis, and from there to an institutional crisis, as the European Union’s collective inability to make effective decisions becomes an ever larger part of the problem. These three components of the predicament feed each other: they also threaten international […]

By: Date: July 13, 2011 Topic: Banking and capital markets

The situation in Europe has developed from a financial and banking crisis to a sovereign debt crisis, and from there to an institutional crisis, as the European Union’s collective inability to make effective decisions becomes an ever larger part of the problem. These three components of the predicament feed each other: they also threaten international financial stability.

The banking component can no longer be separated from sovereign and institutional developments. This is why Friday’s publication of stress tests results, while useful, is unlikely to be the game-changer it could have been two years ago. The London-based European Banking Authority has led the tests with a firmer hand than many anticipated. But even with these disclosures, individual member states remain in charge of ensuring that the weaker banks raise the capital they need, or are properly sold or restructured if they cannot. On past experience, many will be reluctant to do so, allowing Europe’s banking system to remain fragile.

In this, the stress tests exemplify the frustrating and unstable hybrid that is European financial integration. Financial services in the EU are more integrated than in any comparable set of countries, with related economic benefits. But in most of the eurozone, cross-border bank ownership remains limited, so market power and systemic risk are concentrated.

The pre-crisis momentum was towards more integration, with a slow dismantling of regulatory barriers, and pan-European banking groups gradually emerging from cross-border acquisitions. But the resurgence of sovereign risks has partly reversed this trend. In many member states, EU financial integration was not advanced enough to prevent renationalisation of credit conditions, even though the effect has been muted by the European Central Bank’s exceptional liquidity provision. Crisis-induced bank mergers have tended to be intra-country rather than cross-border. In the UK, the Vickers Commission has made regulatory proposals that are compelling but sit awkwardly with the EU’s single market framework.

The crisis has revealed that the EU banking market cannot be truly integrated as long as banks are implicitly guaranteed by fiscally sovereign national governments. Even in the US, market integration has been slow and protracted. In the less-than-federal EU, the crisis creates a real risk of harmful financial disintegration along national lines. To prevent it, the EU must go beyond the publication of stress test results. It must partly sever the link between governments and banking systems, deeply embedded as it is in political economy and history, and establish the institutional basis for a credible EU-level banking policy. Fast-moving developments on sovereign debt may force quicker decisions than had been envisaged even recently.

European leaders should ask the European financial stabilisation facility (EFSF) to guarantee explicitly all the eurozone’s national deposit guarantee schemes, thus countering the risk of bank runs in countries facing sovereign debt restructuring. The EBA, after its competent handling of the stress tests, should be granted direct supervisory and resolution authority over pan-European banking groups, either by EU decision or unilaterally by countries that are home to the largest such groups, including Austria, France, Germany, Italy, Spain and Sweden. This should also allow it to facilitate cross-border acquisitions of undercapitalised banks and negotiate the multilateral provision of taxpayer support in extreme cases (as happened for Dexia in 2008). The governance of the EBA should also be amended, with a new executive board as exists at the ECB to properly represent and defend the common European interest.

Decisions taken in the coming months will determine whether the legacy of this crisis is an integrated European banking system or a move back to fragmentation. The steps proposed here on banking would not replace urgent necessary actions on the sovereign and institutional fronts but they are a necessary building block for a comprehensive solution. In Europe too, united we stand or divided we fall.

A version of this column was also published in the Financial Times


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event
 

Past Event

Past Event

Nonperforming Loans in Asia and Europe—Causes, Impacts, and Resolution Strategies

What can we learn from the experiences of Asia and Europe with regard to NPLs during the financial crisis to help us weather the current and future ones?

Speakers: Rebecca Christie, Luis de Guindos, Alexander Lehmann, Cyn-Young Park, John Fell and Santiago Fernández de Lis Topic: Banking and capital markets, Global economy and trade Date: January 18, 2022
Read article
 

Blog Post

European governanceInclusive growth

12 Charts for 21

A selection of charts from Bruegel’s weekly newsletter, analysis of the year and what it meant for the economy in Europe and the world.

By: Hèctor Badenes, Henry Naylor, Giuseppe Porcaro and Yuyun Zhan Topic: Banking and capital markets, Digital economy and innovation, European governance, Global economy and trade, Green economy, Inclusive growth, Macroeconomic policy Date: December 21, 2021
Read about event More on this topic
 

Past Event

Past Event

The EU’s new foreign investment screening mechanism

At this members-only event we will discuss the European Commission's new foreign investment screening mechanism

Speakers: Damien Levie and Nicolas Véron Topic: Banking and capital markets Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: December 17, 2021
Read about event More on this topic
 

Past Event

Past Event

How to deal with small banks: consolidation, tailoring and the fintech challenge

Small banks face multiple challenges. What structural changes are needed to tackle these pressures?

Speakers: Alexander Lehmann, Nicolas Véron, Xavier Vives, Anne Fröhling and Philip Evans Topic: Banking and capital markets Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: December 9, 2021
Read article More on this topic More by this author
 

External Publication

Country case studies on resolving problem loans in Europe: Crises, policies and institutions

Contribution to 'Nonperforming Loans in Asia and Europe—Causes, Impacts, and Resolution Strategies' published by the Asia Development Bank.

By: Alexander Lehmann Topic: Banking and capital markets Date: December 3, 2021
Read about event More on this topic
 

Past Event

Past Event

The UK strategy for Green Finance

This members-only event discusses the UK's strategy for greening the financial system.

Speakers: Adam Lyons, Fayyaz Muneer and Nicolas Véron Topic: Banking and capital markets Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 22, 2021
Read article Download PDF
 

Policy Contribution

European governance

Next Generation EU borrowing: a first assessment

The Next Generation EU programme is radically changing the way the EU finances itself and interacts with financial markets. This paper assesses the first design decisions made by the European Commission and the issuances that have taken place so far. It also outlines the potential risks and opportunities linked to this upgrading of the EU borrowing.

By: Rebecca Christie, Grégory Claeys and Pauline Weil Topic: Banking and capital markets, European governance, Macroeconomic policy Date: November 10, 2021
Read article
 

External Publication

European Parliament

Don't let up - The EU needs to maintain high standards for its banking sector as the European economy emerges from the COVID-19 pandemic

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Rebecca Christie and Monika Grzegorczyk Topic: Banking and capital markets, European Parliament Date: October 21, 2021
Read article More on this topic More by this author
 

Blog Post

Better sustainability data is still needed to accelerate the low-carbon transition in capital markets

Investors need more trustworthy sustainability data. Regulators should leave space for better products to emerge, while remaining alert to well-known patterns of misconduct in capital markets.

By: Alexander Lehmann Topic: Banking and capital markets Date: October 18, 2021
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read about event More on this topic
 

Past Event

Past Event

What is the link between biodiversity loss and financial instability?

Biodiversity loss impacts financial stability. How big is the risk of biodiversity loss for financial institutions?

Speakers: Sylvie Goulard, Romain Svartzman, Guntram B. Wolff and Michael Wilkins Topic: Banking and capital markets Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: October 5, 2021
Read article More on this topic More by this author
 

External Publication

Brexit and European finance: Prolonged limbo

It will take longer than many had anticipated for the dust to settle on the post-Brexit financial landscape and its respective implications for the EU and the UK.

By: Nicolas Véron Topic: Banking and capital markets Date: September 24, 2021
Load more posts