The Eurozone debt crisis: Is this a banking problem?

by Jordi Gual

Vox
September 13, 2011

The IMF has recently suggested the recapitalisation of Europe’s banks as the most prudent way out of the continent’s economic crisis. This column argues that such thinking is based on a flawed analysis of the problem and is an unhelpful distraction at best. Europe is facing a crisis of government debt. The true problem of the Eurozone is not its banking system.

The recent calls by the IMF for a recapitalisation of European banks are, to say the least, disconcerting. A few weeks after the European Banking Authority (EBA) stress tests highlighted the resilience of European banks, it is discouraging that IMF officials (see Lagarde 2011) keep coming up with an argument that should have been settled months ago. This debate diverts attention from the real policy decisions that can deal with the dire predicament of the Eurozone economy.

This policy proposal is the result, I believe, of a flawed analysis of the current stage of the financial crisis. At present, we are fundamentally facing a government debt crisis and not a banking crisis. Of course, banks face challenges, since they are in the midst of a broad deleveraging process affecting both private and public debts. But banks will be sound if government debt is sound, since the process of gradual deleveraging of the private sector is well underway in most countries and, as shown by the EBA tests, the banking system is already sufficiently capitalised to absorb any potential losses from the completion of this process.

According to the Institute of International Finance (IIF 2011), European banks have raised $414 billion in capital since 2008, compared to the $314 billion raised by US banks. The perception of problems arises from the fact that, relative to their asset base, European banks hold much more public debt than US banks.

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