Blog post

The European Banking Gordian Knot

Publishing date
13 April 2009
Nicolas Véron

Nicolas Véron notes that European Policymakers have not started to tackle the necessary restructuring of the banking sector. On the continent, the industry is too integrated to be handled on a purely national basis. But there is no working cross-border policy framework yet. Urgent action is needed -- and the political challenges are breathtaking.

The 2 April London Summit of the G20 was a success, with banking secrecy curtailed and the ball set rolling on reforming and strengthening the International Monetary Fund.
But the meeting also confirmed the limits of multilateral decision-making.
In practice, two of the most critical questions of the moment – macroeconomic policy, and the banking sector – are not amenable to G20 action.
The banking issue is especially pressing. As Dominique Strauss-Kahn, the IMF’s managing director, and others have noted, our economies will not come back to life as long as financial intermediaries remain comatose, which is the case today both in Europe and in the US.
Banking crises are a big headache for public policymakers. In most cases, such as US savings banks in the 1980s and Japan in the 1990s, they turn a blind eye for many years, until they are finally obliged to take extremely costly action.
True, Sweden provided a counterexample when it managed a banking crisis with relative speed and efficiency in 1992.
But the Swedish template cannot easily be replicated, if only because it relied on a political consensus unthinkable in most other countries, particularly the US.
This explains the intricacies of the current Geithner plan, with its combination of stress tests and leveraged purchases of assets. At this point, its success remains far from sure. Europe’s banking problem is even more intractable.
The banking market here is too integrated to be fixed at a purely national level. But the EU level provides neither the legal framework nor the institutional machinery for a suitable response.
Member states are torn between, on the one hand, the need to restructure their sick banks, and, on the other hand, the desire to protect them from rivals in neighbouring countries.
The European Commission possesses neither the political leadership, nor the resources and skills, nor the policy tools to make much of a difference.
Meanwhile, the European Central Bank has enough to do on the monetary policy front. It cannot singlehandedly take over the burden of supporting ailing banks.
Europe cannot keep on dithering indefinitely. With the brutal economic downturn, many banks’ balance sheets are deteriorating at breakneck speed.

According to media reports, the IMF will this month increase its estimate of aggregate global bank losses to four trillion dollars from ‘only’ 2.2 trillion in January. Of this, less than 1.3 trillion have been disclosed so far by individual banks.
These numbers are staggering, even if viewed with the caution warranted by the volatility of the times. Furthermore, our continent faces the additional risk of national budgetary or currency crises, especially in Central and Eastern Europe. The scenario whereby a major cross-border European bank would be found insolvent in the short term is becoming ever less improbable. Yet we have no credible policy framework to tackle it.
Recent examples hardly give cause for optimism. The Fortis saga has already brought down one Belgian government. But this was a relatively straightforward case. It was essentially limited in scope to the Benelux countries, which are accustomed to cooperation. And when it had to be rescued, Fortis still had high-quality assets on its books. At present, Europe’s political leaders seem keen to steer clear of this problem, whose sheer magnitude apparently paralyses them.
They have fallen back on easier and more rewarding ground, such as rogue bonuses and tax havens; or longer-term challenges such as regulatory architecture, on which the Larosière report to the Commission in February has revived the debate.
In some cases they have embarked on outright counterproductive fights, such as the French crusade for ‘flexible’ accounting standards, read allowing banks to conceal the bad news while hoping for the best.
But one day the Gordian knot will have to be cut, and Europe’s banking sector will need intervention.
On this continent it will imply unprecedented institutional solutions in order to ensure consistent action across countries, at least if market distortion is to be contained and if the eventual cost to the taxpayer is to be kept under control. This problem has no pain-free solution. It is a political minefield. But it will not resolve itself. And the longer we wait, the higher the cost will be.

Nicolas Véron is a research fellow at Bruegel.
Andrew Fielding’s help in translating from the French is gratefully acknowledged

This comment was also published in Cinqo Dias in Spanish and in La Tribune in French.

About the authors

  • Nicolas Véron

    Nicolas Véron is a senior fellow at Bruegel and at the Peterson Institute for International Economics in Washington, DC. His research is mostly about financial systems and financial reform around the world, including global financial regulatory initiatives and current developments in the European Union. He was a cofounder of Bruegel starting in 2002, initially focusing on Bruegel’s design, operational start-up and development, then on policy research since 2006-07. He joined the Peterson Institute in 2009 and divides his time between the US and Europe.

    Véron has authored or co-authored numerous policy papers that include banking supervision and crisis management, financial reporting, the Eurozone policy framework, and economic nationalism. He has testified repeatedly in front of committees of the European Parliament, national parliaments in several EU member states, and US Congress. His publications also include Smoke & Mirrors, Inc.: Accounting for Capitalism, a book on accounting standards and practices (Cornell University Press, 2006), and several books in French.

    His prior experience includes working for Saint-Gobain in Berlin and Rothschilds in Paris in the early 1990s; economic aide to the Prefect in Lille (1995-97); corporate adviser to France’s Labour Minister (1997-2000); and chief financial officer of MultiMania / Lycos France, a publicly-listed online media company (2000-2002). From 2002 to 2009 he also operated an independent Paris-based financial consultancy.

    Véron is a board member of the derivatives arm (Global Trade Repository) of the Depositary Trust and Clearing Corporation (DTCC), a financial infrastructure company that operates globally on a not-for-profit basis. A French citizen born in 1971, he has a quantitative background as a graduate from Ecole Polytechnique (1992) and Ecole Nationale Supérieure des Mines de Paris (1995). He is trilingual in English, French and Spanish, and has fluent understanding of German and Italian.

    In September 2012, Bloomberg Markets included Véron in its second annual 50 Most Influential list with reference to his early advocacy of European banking union.


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